10-K 1 mtsfy1810k20180929.htm 10-K Document



  
UNITED STATES SECURITIES AND EXCHANGE COMMISSION 
Washington, D.C. 20549 
 
FORM 10-K 
(Mark One)
☒  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended September 29, 2018
or
☐  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. 0-02382  
mtslogoa47.jpg
MTS SYSTEMS CORPORATION 
(Exact name of registrant as specified in its charter) 
Minnesota
41-0908057
(State or other jurisdiction
of incorporation or organization)
(I.R.S. Employer Identification No.)
 
 
14000 Technology Drive
Eden Prairie, Minnesota 
55344
(Address of principal executive offices)
(Zip Code)
 
Registrant's telephone number, including area code: (952) 937-4000 
Securities registered pursuant to Section 12(b) of the Act:  
Title of each class
Name of each exchange on which registered
Common Stock, $0.25 par value
The Nasdaq Stock Market LLC 

Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined by Rule 405 of the Securities Act. Yes ý No o
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 ý
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 ý No o
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ý No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) 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. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer ý     Accelerated filer o Non-accelerated filer o     
Smaller reporting company o     Emerging growth company o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. 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 ý
The aggregate market value of the voting and non-voting common stock held by non-affiliates of the registrant as of March 31, 2018 was approximately $1.0 billion based on the closing price of $51.65 as of March 29, 2018 as reported by Nasdaq.
As of November 21, 2018, there were 17,870,004 shares of common stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of MTS Systems Corporation's Definitive Proxy Statement (to be filed pursuant to Regulation 14A within 120 days after the end of the fiscal year ended September 29, 2018) for its annual shareholders' meeting to be held on February 13, 2019, are incorporated by reference into Part III of this Annual Report on Form 10-K to the extent described in such Part.




MTS Systems Corporation
Annual Report on Form 10-K
For the Year Ended September 29, 2018
 
Table of Contents
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 



PART I 
ITEM 1. BUSINESS 
Business Overview  
MTS Systems Corporation is a leading global supplier of high-performance test systems and sensors that was incorporated under Minnesota law in 1966. Our operations are organized and managed in two reportable segments, Test and Sensors, based on global similarities within their markets, products, operations and distribution. The Test and Sensors segments represented 60% and 40% of our revenue, respectively, for the fiscal year ended September 29, 2018
Terms
The terms "MTS," "we," "us," the "Company" or "our" in this Annual Report on Form 10-K, unless the context otherwise requires, refer to MTS Systems Corporation and its wholly owned subsidiaries.  
Fiscal year 2018 refers to the fiscal year ended September 29, 2018, fiscal year 2017 refers to the fiscal year ended September 30, 2017, and fiscal year 2016 refers to the fiscal year ended October 1, 2016. Fiscal years 2018, 2017 and 2016 all include 52 weeks. All dollar amounts and shares are in thousands unless otherwise noted.
Products and Markets
Test
Our Test segment (Test) provides testing solutions including hardware, software and services that are used by customers in product development to characterize a product's mechanical properties. Our solutions simulate forces and motions that customers expect their products to encounter in use. Mechanical simulation testing in a lab setting is an accepted method to accelerate product development compared to reliance on full physical prototypes in real-world settings, proving ground testing, and virtual testing because it provides more controlled simulation and accurate measurement. The need for mechanical simulation increases in proportion to the cost of a product, the range and complexity of the physical environment in which the product will be used, expected warranty or recall risk and expense, governmental regulation and potential legal liability. A significant portion of Test products are considered by our customers to be capital expenditures. We believe the timing of purchases of our products may be impacted by interest rates, general economic conditions, product development cycles and new product initiatives.
A typical Test system includes a reaction frame to hold the prototype specimen; a hydraulic pump or electro-mechanical power source; piston actuators to create the force or motion; and a computer controller with specialized software to coordinate the actuator movement, record and manipulate results. Lower force and less dynamic testing can usually be accomplished with electro-mechanical power sources, which are generally less expensive than hydraulic systems. In addition to these basic components, we sell a variety of accessories and spare parts.
We provide Test customers across all sectors with a spectrum of services to maximize product performance. Our service offerings include installation, product life cycle management, professional training, calibration and metrology, technical consulting and onsite and factory repair and maintenance.  
Test serves a diverse spectrum of customers by industry and geography. Regionally, the Americas, Europe and Asia represented approximately 28%, 24% and 48% of revenue for fiscal year 2018, respectively, based on customer location.
Test products, service and customers are grouped into the following three global sectors:
Ground Vehicles (approximately 55% of Test revenue for fiscal year 2018)
This sector consists of automobile, truck, motorcycle, motorsports vehicles, construction equipment, agricultural equipment, rail and off-road vehicle manufacturers and their suppliers. Customers include original equipment manufacturers (OEMs), universities, government research and development institutes, motorsports teams and contract test facilities. Our products are used to measure and simulate solutions to assess durability, vehicle dynamics and aerodynamics of vehicles, sub-systems and components. Our products include:
Road simulators and component test systems for durability testing;
Vehicle performance test systems that evaluate ride handling, ride comfort and noise;
Vehicle dynamics simulators to test conceptual vehicle designs in advance of physical prototypes;
High-performance electrical motors and energy recovery systems for high-end automotive and aerospace applications;
Tire performance and rolling resistance measurement systems; and
Moving ground-plane systems and balances for vehicle aerodynamic measurements in wind tunnels.

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Materials (approximately 30% of Test revenue for fiscal year 2018)
This sector covers diverse industries, including power generation, aerospace, vehicles and biomedical. Our products and services support customers in the research and development of products through the physical characterization of material properties, such as ceramics, composites and steel. Biomedical applications include systems to test durability and performance of implants, prostheses and other medical and dental materials and devices. 
Structures (approximately 15% of Test revenue for fiscal year 2018)
This sector serves the structural testing needs and services in the fields of aerospace, structural engineering, oil and gas, and wind energy, among others. The aerospace structural testing market consists of manufacturers of commercial, military and private aircraft and their suppliers that use our products, systems and software to perform static and fatigue testing of aircraft and space vehicles. Systems for structural engineering include high force static and dynamic testing, as well as seismic simulation tables used around the world to test the design of structures, such as bridges and buildings, and to help governments establish building codes. Structural engineering customers include construction companies, government agencies, universities and building materials manufacturers. The wind energy market consists of wind turbine manufacturers and their component suppliers that use our products to reduce cost and improve reliability of blades, bearings and entire wind turbines.  
Sensors
Our Sensors segment (Sensors) is a global leader in sensing technologies and solutions used worldwide by design engineers and predictive maintenance professionals, serving customers with a focus on total customer satisfaction, and offering regional support to provide innovative and reliable sensing solutions. Our high-performance sensors provide measurements of vibration, pressure, position, force and sound in a variety of applications. Our products and solutions are used to enable automation, enhance precision and safety, and lower our customers' production costs by improving performance and reducing downtime. Revenue is partially fueled by our customers' spending on research and development activities and industrial capacity utilization. Sensors products and solutions serve the automotive, aerospace, industrial, defense, and research and development markets, as well as many other markets. Sensors manufactures products utilizing piezoelectric and magnetostriction technology, both of which provide an accurate and reliable sensor ideal for use in harsh operating environments.
During fiscal year 2016, we completed the acquisition of 100% of PCB Group, Inc. (PCB), a manufacturer of piezoelectric sensors and components used for vibration, pressure and force measurement. The acquisition of PCB expanded our market position in Sensors and our ability to deliver a wide variety of applications including acceleration, pressure, noise, force, load and torque to both enhance the performance of our customers' products and enable those products to enter the market more rapidly and reliably.
Sensors serves a diverse spectrum of customers by industry and geography. Regionally, the Americas, Europe and Asia represented approximately 46%, 35% and 19% of revenue for fiscal year 2018, respectively, based on customer location.
Sensors products and customers are grouped into the following four global sectors:  
Position Sensors (approximately 40% of Sensors revenue for fiscal year 2018)
This sector consists of a wide range of industrial machinery OEMs and their end use customers with applications in all areas of manufacturing including plastics, steel, construction, agriculture, wood and mining, as well as other factory automation applications. These sensors provide positional feedback for motion control systems, improve productivity by enabling high levels of automation, reduce maintenance costs and enhance safety of machine operations.
Test Sensors (approximately 35% of Sensors revenue for fiscal year 2018)
This sector covers diverse industries, including test and measurement, automotive, rail, aerospace and defense. These sensors are used in a variety of applications including research and development; structural monitoring; ground testing of aircraft and vehicles; harsh environmental testing; impact sensors for shock and vibration testing; component and system performance; ride and handling; durability testing; and noise, vibration, and harshness testing. These sensors provide engineers and scientists with precise and accurate measurements to accelerate technology advancement and reduce new product development cycle time.
Industrial Sensors (approximately 15% of Sensors revenue for fiscal year 2018)
This sector consists of sensors used in heavy industrial markets and energy and power generation. Sensors used in heavy industrial markets are primarily used to monitor the vibration and pressure in a wide spectrum of applications including motors, pumps, paper machines and steel rollers. These sensors provide valuable feedback on equipment performance, reducing downtime and maximizing safety and productivity. Sensors used in the energy and power generation markets are equipped to address hazardous and inaccessible locations and serve gas and wind turbines, oil and gas refineries, and nuclear power instrumentation, as well as other critical energy infrastructure providers. 

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Systems Sensors (approximately 10% of Sensors revenue for fiscal year 2018)
This sector consists of dynamic test, measurement and sensing systems primarily used to test, model and monitor the behavior of structures and processes, as well as to ensure safety and compliance from exposure to noise and vibration. This sector also includes the calibration systems used with a variety of sensors, our comprehensive rental offering of both transactional sensor products, and consultative systems that serve a broad range of testing and industrial customers. 
Financial and geographical information about our segments is included in Item 7 and Item 8 of Part II of this Annual Report on Form 10-K.  
Sales and Service 
Test
Test products are sold worldwide through a direct field sales and service organization, independent representatives and distributors and, to a much lesser extent, through other means (e.g., catalogs, internet, etc.) for standard products and accessories. Direct field sales and service personnel are compensated through salary and order incentive programs. Independent representatives and distributors are either compensated through commissions based upon orders or discounts off list prices. 
In addition to direct field sales and service personnel throughout the U.S., we have sales and service subsidiaries in Toronto, Canada; Berlin, Germany; Paris, France; Guildford, United Kingdom; Turin, Italy; Gothenburg and Gislaved, Sweden; Chinchon, Spain; Tokyo and Nagoya, Japan; Seoul, South Korea; Moscow, Russia; Chennai and Bangalore, India; and Beijing, Shanghai and Shenzhen, China.
The timing and volume of large orders (valued at $5,000 or greater on a U.S. dollar-equivalent basis) may produce volatility in backlog and quarterly operating results. Most 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 test systems and customer capital expenditure approval processes. The sales cycle for larger, more complex test systems may be two years or longer. 
Sensors 
Sensors products are sold worldwide through a direct sales and service organization as well as through independent distributors. The direct sales and service organization is compensated through salary and commissions based upon revenue. The independent distributors purchase our products at wholesale pricing and resell the products to their customers.
In addition to direct field sales and service personnel throughout the U.S., we have sales subsidiaries in Treviolo, Italy; Hitchin, United Kingdom; Aubervilliers, France; Huckelhoven and Dresden, Germany; Beijing and Shanghai, China; Vandreuil, Canada; and Zaventem, Belgium.
The average sales cycle for Sensors products ranges from approximately one week to one month for existing customers purchasing standard products. The average sales cycle for a new account can range from approximately two weeks to two years depending on customer testing and specification requirements.   
Manufacturing and Engineering 
Test
Test systems are largely built to order and primarily engineered and assembled at our headquarters in Eden Prairie, Minnesota. We also operate manufacturing facilities in Shenzhen and Shanghai, China, which manufacture materials test systems, and in Guilford, United Kingdom which manufactures certain ground vehicles test systems. We perform certain smaller system assembly at our locations in Berlin, Germany and Seoul, South Korea. During the fourth quarter of fiscal year 2017, we initiated a series of Test workforce reductions and facility closures intended to increase organizational effectiveness, gain manufacturing efficiencies and provide cost savings that can be reinvested in our growth initiatives. These actions included the transfer of certain production operations for materials test systems in China to a contract manufacturing partner throughout fiscal years 2018 and 2019.
Installation of systems, training and services are primarily delivered at customer sites. The engineering and assembly cycle for a typical test system ranges from one to 12 months, depending on the complexity of the system and the availability of components. The engineering and assembly cycle for larger, more complex systems may be up to three years.

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Sensors
Sensors are engineered and assembled regionally at facilities located in Depew, New York; Halifax and Cary, North Carolina; Farmington Hills, Michigan; Provo, Utah; Cincinnati, Ohio; and Lüdenscheid, Germany. Assembly cycles generally vary from several days to several weeks, depending on the degree of product customization, the size of the order and manufacturing capacity. 
Sources and Availability of Raw Materials and Components 
Test
A significant portion of test systems consist of materials and component parts purchased from independent vendors. We are dependent, in certain situations, on a limited number of vendors to provide raw materials and components, such as mechanical and electronic components. As Test generally sells products and services based on fixed-price contracts, fluctuations in the cost of materials and components between the date of the order and the delivery date may impact the expected profitability. The material and component cost variability is considered in the estimation and customer negotiation process.
Sensors
A significant portion of Sensors products consists of materials and component parts purchased from independent vendors. We are dependent, in certain situations, on a limited number of vendors to provide raw materials and components, such as mechanical and electronic components. As Sensors generally sells products and services based on fixed-price contracts and the products are manufactured and delivered within days to months from the time of order, fluctuations in the cost of materials and components between the date of the order and the delivery date are not likely to materially impact the expected profitability.
Patents and Trademarks 
We rely on a combination of patents, copyrights, trademarks and proprietary trade secrets to protect our proprietary technology, some of which are material to our segments. We have obtained numerous patents and trademarks worldwide and actively file and renew patents and trademarks on a global basis to establish and protect our proprietary technology. We are also party to exclusive and non-exclusive license and confidentiality agreements relating to our own and third-party technologies. We aggressively protect certain of our processes, products and strategies as proprietary trade secrets. Our efforts to protect intellectual property and avoid disputes over proprietary rights include ongoing review of third-party patents and patent applications.  
Seasonality 
There is no significant seasonality in Test or Sensors.  
Working Capital 
Test
Test does not have significant finished product inventory, but maintains inventories of materials and components to facilitate on-time product delivery. Test may have varying levels of work-in-process projects that are classified as inventories, net or unbilled accounts receivable, net in our Consolidated Balance Sheets, depending upon the manufacturing cycle, timing of orders, project revenue recognition and shipments to customers.  
Payments are often received from Test customers upon order or at milestones during the fulfillment of the order depending on the size and customization of the system. These payments are recorded as advance payments from customers in our Consolidated Balance Sheets and reduced as revenue is recognized. Conversely, if revenue is recognized on a project prior to customer billing, this revenue is recorded as unbilled accounts receivable, net in our Consolidated Balance Sheets until the customer has been billed. Upon billing, it is recorded as accounts receivable, net in our Consolidated Balance Sheets. Changes in the average size, payment terms and revenue recognition for orders in Test may have a significant impact on accounts receivable, net; unbilled accounts receivable, net; advance payments from customers; and inventories, net. It has not been our practice to provide rights of return for our products. Payment terms vary and are subject to negotiation.
Sensors
Sensors has finished product inventory, as well as inventories of materials and components to facilitate rapid delivery of product to exceed customer expectations on delivery time. The type and amount of finished goods on hand are targeted based on historical and anticipated customer demands for high-volume products. Payment terms vary and are subject to negotiation. Revenue is primarily recognized when products are shipped. 
Customers 
We do not have a significant concentration of sales with any individual customer within Test, Sensors or total MTS. Therefore, the loss of any one customer would not have a material impact on our results.  

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Backlog 
Most of our products are built to order. Our backlog of orders, defined as firm orders from customers that remain unfulfilled, totaled approximately $415,155, $360,016 and $370,523 at September 29, 2018, September 30, 2017 and October 1, 2016, respectively. Test backlog was $346,006, $311,551 and $331,044 at September 29, 2018, September 30, 2017 and October 1, 2016, respectively. Sensors backlog was $69,149, $48,465 and $39,479 at September 29, 2018, September 30, 2017 and October 1, 2016, respectively. Based on anticipated manufacturing schedules, we expect approximately 87% of the backlog as of September 29, 2018 will be converted to revenue in fiscal year 2019. Delays may occur in the conversion of backlog into revenue as a result of export licensing compliance, technical difficulties, specification changes, manufacturing capacity, supplier issues or access to the customer site for installation. While certain contracts within backlog are subject to order cancellation, we have not historically experienced a significant number of order cancellations. Refer to Item 7 of Part II of this Annual Report on Form 10-K for further discussion of order cancellations.
Government Contracts 
Revenue from U.S. government contracts varies by year. A portion of our government business is subject to renegotiation of profits or termination of contracts or subcontracts at the election of the U.S. government. In addition to contract terms, we must comply with procurement laws and regulations relating to the formation, administration and performance of U.S. government contracts. Failure to comply with these laws and regulations could lead to the termination of contracts at the election of the U.S. government or the suspension or debarment from U.S. government contracting or subcontracting. U.S. government revenue as a percentage of our total revenue was 4%, 4% and 3% for fiscal years 2018, 2017 and 2016, respectively, though it is anticipated to increase in fiscal year 2019. 
Competition 
Test
For relatively simple and inexpensive mechanical testing applications, customers may satisfy their needs internally by building their own test systems or using competitors who compete on price, performance, quality and service. For larger and more complex mechanical test systems, we compete directly with several companies worldwide based upon customer value including application knowledge, engineering capabilities, technical features, price, quality and service. 
Sensors
We primarily compete on factors that include technical performance, price and customer service in new applications or in situations in which other sensing technologies have been used. Sensors competitors are typically larger companies that carry multiple sensors product lines; larger diverse companies with only a small portion of business in the sensors market; or smaller, privately held companies throughout the world. 
Environmental Compliance 
We believe our operations are in compliance with all applicable material environmental regulations within the jurisdictions in which we operate. Capital expenditures for environmental compliance were not material in fiscal year 2018, 2017 and 2016, and we do not expect such expenditures will be material in fiscal year 2019.
Employees 
We had approximately 3,400 employees as of September 29, 2018, including approximately 1,250 employees located outside the U.S. 
Available Information 
The U.S. Securities and Exchange Commission (SEC) maintains a website that contains reports, proxy and information statements and other information regarding issuers, including us, that file electronically with the SEC. The public can obtain any documents that we file with the SEC at http://www.sec.gov. We file annual reports, quarterly reports, current reports, proxy statements and other documents with the SEC under the Securities Exchange Act of 1934, as amended (the Exchange Act).
We also make available free of charge on or through the "Investor Relations" pages of our corporate website (www.mts.com) our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and, if applicable, amendments to those reports filed or furnished pursuant to the Exchange Act as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. Our Code of Conduct (the Code); any waivers from or amendments to the Code; our Corporate Governance Guidelines, Articles of Incorporation and Bylaws; and the Charters for the Audit, Compensation and Leadership Development, and Governance and Nominating Committees of our Board of Directors are also available free of charge on the "Investor Relations" pages of our corporate website (www.mts.com). We are not including the information on our corporate website as a part of or incorporating it by reference into this Annual Report on Form 10-K. 

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ITEM 1A. RISK FACTORS 
Our business involves risks. The following summarizes what we believe to be the most important risks facing us that could adversely impact our business, financial condition or operating results. The information about these risks should be considered carefully together with the other information contained in this Annual Report on Form 10-K. Additional risks not currently known to us or that we currently deem to be immaterial may also adversely affect our business, financial condition or results of operations in future periods.  
Market Risks 
Our business is significantly international in scope.
We have manufacturing facilities in North America, Europe and Asia. Approximately 70% of our revenue has historically been derived from customers outside of the U.S. Although our financial results are reported in U.S. dollars, a large portion of our sales and operating costs are realized in Euros, Chinese yuan, Japanese yen and other foreign currencies.
Accordingly, our business is subject to the political, economic and other risks that are inherent in operating in foreign countries. These risks include, but are not limited to:
exposure to the risk of currency value fluctuations, where payment for products is denominated in a currency other than U.S. dollars;
variability in the U.S. dollar value of foreign currency-denominated assets, earnings and cash flows;
difficulty enforcing agreements, including patent and trademarks, and collecting receivables through foreign legal systems;
trade protection measures and import or export licensing requirements;
tax rates in certain foreign countries that exceed those in the U.S., the imposition of withholding requirements on foreign earnings and restrictions on repatriation of foreign earnings;
higher danger of terrorist activity, war or civil unrest compared to domestic operations;
imposition of tariffs, exchange controls or other restrictions, including tariffs recently imposed by the U. S. and responsive tariffs imposed by China and the European Union;
difficulty in staffing and managing global operations;
required compliance with a variety of foreign laws and regulations and U.S. laws and regulations, such as the Foreign Corrupt Practices Act applicable to our international operations, and significant compliance costs and penalties for failure to comply with any of these laws and regulations; and
changes in general economic and political conditions in countries where we operate, particularly in emerging markets, and including the continued volatility in currency exchange rates and uncertainties caused by the United Kingdom's pending exit from the European Union.
These risks could have an adverse effect on our financial position, results of operations or cash flows. In addition, exchange rate fluctuations could also make our products more expensive than competitors' products not subject to these fluctuations, which could adversely affect our revenues and profitability in international markets. As further described in Item 7 of Part II of this Annual Report on Form 10-K, revenue for fiscal year 2018 was favorably impacted by currency translation.
Our business is subject to strong competition.
Our products are sold in competitive markets throughout the world. Competition is based on application knowledge, product features and design, brand recognition, reliability, technology, breadth of product offerings, price, delivery, customer relationships and after-market support. If we are not perceived as competitive in overall value as measured by these criteria, our customers would likely choose solutions offered by our competitors or developed internally. 
Our business is subject to customer demand cycles.
For many of our products, orders are subject to customers' procurement cycles and their willingness and ability to invest in capital, especially in the cyclical automotive, aircraft and machine tool industries. Any event that adversely impacts those customers' new product development activities may reduce their demand for our products. 
We may experience difficulty obtaining materials or components for our products, or the cost of materials or components may increase.
We purchase materials and components from third-party suppliers, some of whom may be competitors. Other materials and components may be provided by a limited number of suppliers or by sole sources and could only be replaced with difficulty or at significant added cost. Additionally, some materials or components may become scarce or difficult to obtain in the market or they may increase in price. This could adversely affect the lead time within which we receive the materials or components, and in turn affect our commitments to our customers, or could adversely affect the cost or quality of materials.

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Our level of indebtedness and interest rate fluctuations on that indebtedness could adversely affect our business and results of operations and may require the use of our available cash resources to meet repayment obligations, which could reduce the cash available for other purposes.
We have a senior secured credit facility that provides for a revolving credit facility and a tranche B term loan facility, both of which require that we pay a variable interest rate on outstanding borrowings. The debt under the tranche B term loan facility amortizes in equal quarterly installments in an aggregate annual amount equal to 1% of the original principal amount and matures on July 5, 2023. As of September 29, 2018, we did not have any borrowings under the revolving credit facility; however, we may, at times, use debt under the revolving credit facility to purchase shares of our common stock, finance working capital needs or continue to finance the growth of the business through acquisitions.
Our level of indebtedness may place us at a competitive disadvantage to our competitors that are not as highly leveraged. Fluctuations in interest rates can increase borrowing costs. We hedge against a portion of the risk on the tranche B term loan facility by swapping the variable rate for a fixed rate. Increases in interest rates may directly impact the amount of interest we are required to pay and reduce earnings accordingly. In addition, developments in tax policy, such as the disallowance of tax deductions for interest paid on outstanding indebtedness, could have a material adverse effect on our results of operations and liquidity. Further, our senior secured credit facility and the indenture governing our tangible equity units contain customary affirmative and negative covenants and certain restrictions on operations that could impose operating and financial limitations and restrictions on us, including restrictions on our ability to enter into particular transactions and to engage in other actions that we may believe are advisable or necessary for our business. The tranche B term loan facility is also subject to mandatory prepayments in certain circumstances and requires a prepayment of a certain percentage of our excess cash flow. Any future mandatory prepayments will reduce our cash available for other purposes and could impact our ability to reinvest in other areas of our business. Due to planned prepayments made during fiscal year 2018, we do not anticipate an excess cash flow payment will be required in the first quarter of fiscal year 2019 based on fiscal year 2018 results. For further information on our financing arrangements, see Note 5 to the Consolidated Financial Statements included in Item 8 of Part II of this Annual Report on Form 10-K.
Our outstanding 8.75% tangible equity units (TEUs) may adversely affect the market price of our common stock.
The market price of our common stock may be influenced by the outstanding TEUs sold in our June 2016 public offering. For example, additional shares of our common stock are currently and will continue to be issuable upon settlement of the purchase contract component of the TEUs through expiration on July 1, 2019. The settlement rates for such purchase contracts are subject to certain anti-dilution and make-whole adjustments that could increase, potentially significantly, the number of shares of our common stock issuable upon such settlement. As a result, the market price of our common stock could become more volatile and could be depressed by the following factors:
investors' anticipation of the sale into the market of a substantial number of additional shares of common stock received upon settlement of the purchase contract component of the TEUs;
possible sales of our common stock by investors who view the TEUs as a more attractive means of equity participation in the Company than owning shares of our common stock; and
hedging or arbitrage trading activities that may develop involving the TEUs, the purchase contracts and our common stock.
In addition, our debt obligations under the senior amortizing note component of the TEUs may further influence the market price of our common stock, including but not limited to our ability to make timely payments to holders of the notes. For further information on our TEUs, see Note 9 to the Consolidated Financial Statements included in Item 8 of Part II of this Annual Report on Form 10-K.
Operational Risks
Transfer of certain Test production operations in China to our new contract manufacturing partner may be subject to delays, increased costs or other unanticipated consequences.
On March 13, 2018, we announced workforce reductions and manufacturing facility closures in our Test segment corresponding to the transfer of certain production operations in China to a contract manufacturing partner. These changes are designed to increase organizational effectiveness, gain manufacturing efficiencies and provide cost savings that can be reinvested in growth initiatives. We can make no assurances that our current estimates of costs and timing of this restructuring action will be accurate or that additional costs will not be incurred as we continue the restructuring action. Any differences from our current estimates could be material and could adversely impact our business, financial condition and results of operations through delays in our timeline or increased costs. For further information on restructuring initiatives, see Note 12 to the Consolidated Financial Statements included in Item 8 of Part II of this Annual Report on Form 10-K.

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While we believe our China contract manufacturing partner to be qualified to manufacture our Test segment products, we may need to address short-term quality and delivery issues. We have not previously used contract manufacturing partners on a large scale. Significant quality or delivery schedule concerns and unforeseen costs may adversely affect our relationships with customers and our overall business, financial condition or results of operations.
Final impacts of the Tax Cuts and Jobs Act could be materially different from our current estimates.
The Tax Cuts and Jobs Act (the Tax Act) was signed into law on December 22, 2017. The new law made numerous changes to U.S. federal corporate tax law and reduced our effective tax rate for fiscal year 2018 and future periods. Effective January 1, 2018, the Tax Act lowers the U.S. corporate tax rate from 35% to 21% and prompts various other changes to U.S. federal corporate tax law, including the establishment of a territorial-style system for taxing foreign-source income of domestic multinational corporations. The tax benefit recorded in fiscal year 2018 involved significant judgment and assumptions as to the impact of the Tax Act. Our estimated impact of the new law is based on management's current knowledge and assumptions. The provisional amounts are based on information available at this time and may change due to a variety of factors, including, among others, anticipated guidance from the U.S. Department of Treasury about implementing the Tax Act and management's further assessment of the Tax Act and related regulatory guidance. Recognized impacts could be materially different from current estimates based on anticipated guidance from the U.S. Department of Treasury, Internal Revenue Service and other standard setting and regulatory bodies about implementing the Tax Act. We expect to record any adjustments within one year of the enactment of the Tax Act, or during our first quarter of fiscal year 2019, in accordance with the guidance provided in Accounting Standards Update No. 2018-05, Income Taxes (Topic 740): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118 (SAB 118), and these adjustments could be material. The full impact of the Tax Act on our business, operations and financial statements cannot be predicted at this time, and we make no assurances in this regard.
Our business operations may be affected by government contracting risks.
Government business is important to us and is expected to increase in the future. Revenue from U.S. government contracts varies by year. Such revenue as a percent of our total revenue was 4%, 4% and 3% for fiscal years 2018, 2017 and 2016, respectively. 
We must comply with procurement laws and regulations relating to the formation, administration and performance of U.S. government contracts. Failure to comply with these laws and regulations could lead to suspension or debarment from U.S. government contracting or subcontracting and result in administrative, civil or criminal penalties. Failure to comply could also have a material adverse effect on our reputation, our ability to secure future U.S. government contracts and export control licenses, and our results of operations or financial condition. These laws and regulations also create compliance risks and affect how we do business with federal agency clients. U.S. government contracts, as well as contracts with certain foreign governments with which we do business, are also subject to modification or termination by the government, either for the convenience of the government or for default as a result of our failure to perform under the applicable contract. Further, any investigation relating to, or suspension or debarment from, U.S. government contracting could have a material impact on our results of operations as, during the duration of any suspension or debarment, we would be prohibited or otherwise limited in our ability to enter into prime contracts or subcontracts with U.S. government agencies, certain entities that receive U.S. government funds or that are otherwise subject to the Federal Acquisition Regulations, and certain state government or commercial customers who decline to contract with suspended or debarred entities. A federal suspension could also impact our ability to obtain export control licenses which are materially important to our business. 
We are subject to risks because we design and manufacture first-of-a-kind products.
We design and build systems that are unique and innovative and, in some cases, the first created to address complex and unresolved issues. The design, manufacture and support of these systems may involve higher than planned costs. If we are unable to meet our customers' expectations, our reputation and ability to further utilize our expertise will likely be damaged.
Backlog, sales, delivery and acceptance cycle for many of our products is irregular and may not develop as anticipated.
Many of our products have long sales, delivery and acceptance cycles. In addition, certain contracts within our backlog are subject to order cancellations. If an order is canceled, we typically would only be entitled to receive reimbursement from the customer for actual costs incurred under the arrangement plus a reasonable margin. Events may cause recognition of orders, backlog and results of operations to be irregular over shorter periods of time. These factors include the timing of individual large orders which may be impacted by interest rates, customer capital spending and product development cycles, design and manufacturing problems, capacity constraints, delays in product readiness, damage or delays in transit, problems in achieving technical performance requirements, and various customer-initiated delays. Any such delay or any cancellations may cause fluctuations in our reported periodic financial results and may cause our stated backlog conversion to revenue to be inaccurate. 

8



The business could be adversely affected by product liability and commercial litigation.
Our products or services may be claimed to cause or contribute to personal injury or property damage to our customers' facilities. Additionally, we are, at times, involved in commercial disputes with third parties, such as customers, vendors and others. The ensuing claims may arise singularly, in groups of related claims or in class actions involving multiple claimants. Such claims and litigation are frequently expensive and time consuming to resolve and may result in substantial liability to us, and any liability and related costs and expenses may not be recoverable through insurance or other forms of reimbursement. 
We may experience difficulties obtaining and retaining the services of skilled employees.
We rely on knowledgeable, experienced and skilled technical personnel, particularly engineers, sales management and service personnel, to design, assemble, sell and service our products. We may be unable to attract, retain and motivate a sufficient number of such people which could adversely affect our business. The inability to transfer knowledge and transition between roles within these teams could also adversely affect our business. 
We may fail to protect our intellectual property effectively or may infringe upon the intellectual property of others.
We have developed significant proprietary technology and other rights that are used in our businesses. We rely on trade secret, copyright, trademark and patent laws and contractual provisions to protect our intellectual property. While we take enforcement of these rights seriously, other companies such as competitors or others in markets in which we do not participate may attempt to copy or use our intellectual property for their own benefit. 
In addition, the intellectual property of others also has an impact on our ability to offer some of our products and services for specific uses or at competitive prices. Competitors' patents or other intellectual property may limit our ability to offer products and services to our customers. Any infringement on the intellectual property rights of others could result in litigation and adversely affect our ability to continue to provide, or could increase the cost of providing, our products and services. 
Intellectual property litigation can be very costly and could result in substantial expense and diversion of our resources, both of which could adversely affect our businesses, financial condition and results. In addition, there may be no effective legal recourse against infringement of our intellectual property by third parties, whether due to limitations on enforcement of rights in foreign jurisdictions or as a result of other factors. 
If we are unable to protect our information systems against misappropriation of data or breaches of security, our business operations and financial results could be adversely impacted. Evolving regulations and legal obligations related to data privacy, data protection and information security and our actual or perceived failure to comply with such obligations could have an adverse effect on our business.
Information security risks have generally increased in recent years because of the proliferation of new technologies and the increased sophistication and activities of cyber-attacks. Although we strive to have appropriate security controls in place, prevention of security breaches cannot be assured, particularly as cyber threats continue to evolve. We may be required to expend additional resources to continue to enhance our security measures or to investigate and remediate any security vulnerabilities. The consequences of these risks could adversely impact our business operations and financial results. 
In addition, our handling of certain data is subject to a variety of laws and regulations, which have been adopted by various federal, state and foreign governments to regulate the collection, distribution, use and storage of personal information of individuals. Several foreign countries in which we conduct business, including the European Economic Area (EEA), currently have in place, or have recently proposed, laws or regulations concerning privacy, data protection and information security, which are more restrictive than those imposed in the U.S. Some of these laws are in their early stages and we cannot yet determine the impact these revised laws and regulations, if implemented, may have on our business. However, any failure or perceived failure by us to comply with these privacy laws, regulations, policies or obligations or any security incident that results in the unauthorized release or transfer of personally identifiable information or other customer data in our possession, could result in government enforcement actions, litigation, fines and penalties and/or adverse publicity, all of which could have an adverse effect on our reputation and business. For example, the EEA-wide General Data Protection Regulation became effective on May 25, 2018 and replaced the data protection laws of each EEA member state. If our privacy or data security measures fail to comply with applicable current or future laws and regulations, we may be subject to litigation, regulatory investigations and enforcement notices requiring us to change the way we use personal data.

9



Government regulation and policy imposes costs and other constraints.
Our manufacturing operations and past and present ownership and operations of real property are subject to extensive and changing federal, state, local and foreign laws and regulations, including laws and regulations pertaining to health and safety matters, as well as the handling or discharge of hazardous materials into the environment. We expect to continue to incur costs to comply with these laws and may incur penalties for any failure to do so. We may also be identified as a responsible party and be subject to liability relating to any investigation and cleanup of properties used for industrial purposes or the generation or disposal of hazardous substances. In addition, some of our products contain hazardous substances and are subject to requirements that regulate their content, such as the European Union's Restriction of Hazardous Substances Directive and analogous regulations elsewhere. Capital expenditures for environmental compliance were immaterial in fiscal year 2018, and we do not expect such expenditures will be material in fiscal year 2019; however, the factors described above may cause our estimates to differ from our expectations.
Some of our export sales require approval from the U.S. government. Changes in political relations between the U.S. and foreign countries and/or specific potential customers for which export licenses may be required, may cause a license application to be delayed or denied, or a previously issued license withdrawn, rendering us unable to complete a sale or vulnerable to competitors who do not operate under such restrictions. In addition, the U.S. government has recently imposed tariffs on certain products imported from China as well as steel and aluminum imported from the European Union, Mexico and Canada. China and the European Union have imposed tariffs on U.S. products in retaliation. These tariffs could force our customers or us to consider various strategic options including, but not limited to, looking for different suppliers, shifting production to facilities in different geographic regions, absorbing the additional costs or passing the cost on to customers. Moreover, any retaliatory actions by other countries where we operate could also negatively impact our financial performance.
We are required to conduct a good faith reasonable country of origin analysis on our use of conflict minerals, which has imposed and may impose additional costs on us and could raise reputational and other risks.
The SEC has promulgated final rules in connection with the Dodd-Frank Wall Street Reform and Consumer Protection Act regarding disclosure of the use of certain minerals, known as conflict minerals, mined from the Democratic Republic of the Congo and adjoining countries. While there is pending litigation challenging these rules, we have incurred and will continue to incur costs associated with complying with these disclosure requirements, including costs to determine the source of any conflict minerals used in our products. We have adopted a policy relating to conflict minerals, incorporating the standards set forth in the Organisation for Economic Co-operation and Development Due Diligence Guidance, which affects the sourcing, supply, and pricing of materials used in our products. As we continue our due diligence, we may face reputational challenges if we are unable to verify the origins for all metals used in our products through the procedures we have and may continue to implement. We may also encounter challenges in our efforts to satisfy customers that may require all of the components of products purchased to be certified as conflict-free. If we are not able to meet customer requirements, customers may choose to disqualify us as a supplier.
We may not achieve our growth plans for the expansion of the business.
In addition to market penetration, our long-term success depends on our ability to expand our business through (a) new product development and service offerings; (b) mergers and acquisitions; and/or (c) geographic expansion. 
New product development and service offerings require that we maintain our ability to improve existing products, continue to bring innovative products and services to market in a timely fashion and adapt products and services to the needs and standards of current and potential customers. Our products and services may become less competitive or eclipsed by technologies to which we do not have access or which render our solutions obsolete. 
Mergers and acquisitions will be accompanied by risks that may include:
suitable candidates may not exist or may not be available at acceptable costs;
failure to achieve, or delays in achieving, the financial and strategic goals, including growth opportunities and cost synergies, for the acquired and combined businesses;
difficulty integrating the operations and personnel of the acquired businesses, including the inability to eliminate duplicative costs or the substantial expenses that may be incurred in connection with integration;
disruption of ongoing business and acquired business and distraction of management from the operation of both businesses;
dilution of existing shareholders and earnings per share;
unanticipated, undisclosed or inaccurately assessed liabilities, legal risks and costs;
legal and regulatory requirements of the acquired business was not formerly a public company; and
difficulties retaining the key vendors, customers or employees of the acquired business.

10



Acquisitions of businesses having a significant presence outside the U.S. will increase our exposure to the risks of international operations discussed in the operational risk factors. 
Geographic expansion may be outside of the U.S., and hence will be disproportionately subject to the risks of international operations discussed in the operational risk factors. 
For further information on our business acquisitions, see Note 13 to the Consolidated Financial Statements included in Item 8 of Part II of this Annual Report on Form 10-K.
We may be required to recognize impairment charges for goodwill and long-lived assets.
As of September 29, 2018, the net carrying value of goodwill and long-lived assets (property and equipment, net and intangible assets, net) totaled $705,682. We periodically assess the value of these assets for impairment in accordance with U.S. generally accepted accounting principles (GAAP). Significant negative industry or economic trends, disruptions to our businesses, significant unexpected or planned changes in use of the assets, divestitures and market capitalization declines may result in impairments to goodwill and other long-lived assets. Future impairment charges could significantly affect reported financial results.
If we fail to maintain effective processes and controls relative to adherence to our Code of Conduct, our business, financial condition or results of operations may be adversely affected.
Our Code of Conduct and other internal policies prohibit us and our employees from engaging in unethical business practices. However, there can be no assurance that all of our employees or agents will refrain from acting in violation of such policies and procedures or that our processes and controls will be sufficient to detect any such violations. The investigation into potential violations of these policies, or even allegations of such violations, and evaluation of our internal controls, could disrupt our operations, involve significant management distraction, and lead to significant costs and expenses, including legal and accounting fees, and such expenses may have a material adverse effect on our financial results. Further, if our employees or agents violate such policies and procedures, such actions could result in management override of internal controls over financial reporting. If we, or our employees or agents acting on our behalf, are found to have engaged in practices that violate these policies and/or applicable law, we could suffer severe fines and penalties, repayment of ill-gotten gains, injunctions on future conduct, securities litigation, material weaknesses in our financial reporting and other consequences that may have a material adverse effect on our business, financial condition or results of operations. In addition, our reputation, sales activities or stock price could be adversely affected if we become the subject of any negative publicity related to actual or potential violations of applicable laws and regulations.
ITEM 1B. UNRESOLVED STAFF COMMENTS 
None.

11



ITEM 2. PROPERTIES
Shown below is a breakdown of the approximate square footage of our primary owned and leased facilities as of September 29, 2018. We consider our current facilities adequate to support our operations during fiscal year 2019
Owned Property
Location
Use of Facility
Approximate
Square Footage

Eden Prairie, Minnesota (U.S.)
Corporate headquarters and primary Test manufacturing and research
420,000

Depew, New York (U.S.)
Sensors manufacturing, sales and service administration
144,000

Cary, North Carolina (U.S.)
Sensors manufacturing, research and sales and service administration
65,000

Provo, Utah (U.S.)
Sensors manufacturing, sales and service administration
25,000

Farmington Hills, Michigan (U.S.)
Sensors manufacturing, sales and service administration
16,000

Lancaster, New York (U.S.)
Sensors sales and service administration
1,000

Berlin, Germany
Test manufacturing, sales and service administration
72,000

Shanghai, China
Test manufacturing, sales and service administration
129,000

Total
 
872,000



12



Leased Property
Location
 
Use of Facility
 
Lease
Expires
 
Approximate
Square Footage
Swartz Creek, Michigan (U.S.)
 
Test manufacturing and research
 
2022
 
8,000

Latham, New York (U.S.)
 
Sensors manufacturing, sales and service administration
 
2020
 
5,000

Cary, North Carolina (U.S.)
 
Sensors manufacturing
 
2020
 
8,000

Halifax, North Carolina (U.S.)
 
Sensors manufacturing, sales and service administration
 
2018
 
51,000

Cincinnati, Ohio (U.S.)
 
Sensors manufacturing, warehouse, sales and service administration
 
2019
 
16,000

 
 
Sensors warehouse, sales and service administration
 
2019
 
9,000

San Clemente, California (U.S.)
 
Sensors warehouse, sales and service administration
 
2018
 
7,000

Beijing, China
 
Test sales and service administration
 
2019
 
6,000

 
 
Sensors sales and service administration
 
2020
 
5,000

Shanghai, China
 
Test sales, service administration and assembly
 
2019
 
13,000

 
 
Test sales and service administration
 
2019
 
7,000

 
 
Test land under Shanghai facility
 
2056
 
161,000

Shenzhen, China
 
Test manufacturing and warehouse
 
2019
 
13,000

 
 
Test manufacturing and warehouse
 
2019
 
16,000

 
 
Test sales, service administration and warehouse
 
2021
 
14,000

 
 
Test manufacturing, research, sales and service administration
 
2018
 
75,000

Creteil, France
 
Test sales and service administration
 
2027
 
16,000

Huckelhoven, Germany
 
Sensors sales and service administration
 
2021
 
12,000

Ludenscheid, Germany
 
Sensors manufacturing, research and sales and service administration
 
2019
 
48,000

 
 
Sensors research, sales and service administration
 
2019
 
10,000

 
 
Sensors manufacturing
 
2019
 
11,000

Tokyo, Japan
 
Test sales and service administration
 
2018
 
7,000

Sungnam, South Korea
 
Test sales, service administration and assembly
 
2019
 
17,000

Guildford, U.K.
 
Test sales, service and manufacturing
 
2025
 
8,000

Berlin, Germany
 
Test land under Berlin facility
 
2052
 
97,000

Torino, Italy
 
Test sales, service administration and warehouse
 
2024
 
8,000

Other Locations1
 
Test and Sensors other sales and service administration
 
 
 
89,000

Total
 
 
 
 
 
737,000


1 
We also lease space in the U.S., Europe and Asia for Test and Sensors sales and service administration, including locations in China, France, Germany, India, Italy, Japan, Russia, Spain, Sweden, Canada and the United Kingdom. Neither the amount of leased space nor the rental obligations in these locations is significant individually or in aggregate.
Additional information relative to lease obligations is included in Management's Discussion and Analysis of Financial Condition and Results of Operations included in Item 7 of Part II of this Annual Report on Form 10-K.

13



ITEM 3. LEGAL PROCEEDINGS  
Discussion of legal matters is incorporated by reference from Note 14 to the Consolidated Financial Statements included in Item 8 of Part II of this Annual Report on Form 10-K and should be considered an integral part of Item 3 of Part I of this Annual Report on Form 10-K.  
ITEM 4. MINE SAFETY DISCLOSURES  
Not applicable.  
PART II  
ITEM  5.
MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Shares of our common stock are traded on the Nasdaq Global Select MarketSM under the trading symbol MTSC. The number of record holders of our common stock, par value $0.25 per share, as of November 21, 2018 was 644. This number does not reflect shareholders who hold their shares in the name of broker-dealers or other nominees.  
Issuer Purchases of Equity Securities
 
 
Total Number
of Shares
Purchased
 
Average
Price Paid
per Share
 
Total Number
of Shares
Purchased
As Part of Publicly Announced Plans or Programs
 
Maximum Number
of Shares that May
Yet be Purchased
As Part of Publicly Announced Plans or Programs
July 1, 2018 – August 4, 2018
 

 
$

 

 
438

August 5, 2018 – September 1, 2018
 

 
$

 

 
438

September 2, 2018 – September 29, 2018
 

 
$

 

 
438

We purchase common stock from time to time to mitigate dilution related to new shares issued as equity for employee compensation such as stock options, restricted stock units, performance restricted stock units and employee stock purchase plan activity, as well as to return capital to shareholders not immediately required to fund ongoing operations. 
Share Purchase Plan
Our Board of Directors approved, and on February 11, 2011 announced, a purchase authorization of 2,000 shares. Authority over pricing and timing under this authorization has been delegated to management. The share purchase authorization has no expiration date. We made no purchases during the fourth quarter of fiscal year 2018. As of September 29, 2018, there were 438 shares available for purchase under the existing authorization.
Capped Calls
In connection with the pricing of the tangible equity units (TEUs) sold in our public offering in fiscal year 2016, we purchased capped calls from third party banking institutions (Capped Calls) for $7,935. On June 13, 2018, we amended the agreements with third party banking institutions for the outstanding Capped Calls (Capped Call Agreements) to modify the timing of settlement to be only upon expiration for all outstanding Capped Calls. Per the Capped Call Agreements, the outstanding Capped Calls will automatically settle upon expiration on July 1, 2019. As of September 29, 2018 the range of shares of our common stock to be received for the outstanding Capped Calls was a minimum of 0 shares to a maximum of 268 shares, subject to market conditions. See Note 9 to the Consolidated Financial Statements included in Item 8 of Part II of this Annual Report on Form 10-K for additional information on our equity instruments.
Dividends  
Our dividend policy is to maintain a payout ratio that allows dividends to increase in conjunction with the long-term growth of earnings per share, while sustaining dividends through economic cycles. Our dividend practice is to target, over time, a payout ratio of approximately 25% of net earnings per share. We have historically paid dividends to holders of our common stock on a quarterly basis. The declaration and payment of future dividends will depend on many factors, including, but not limited to, our earnings, financial condition, debt repayment obligations, business development needs and regulatory considerations and are at the discretion of our Board of Directors. During fiscal years 2018 and 2017, we declared quarterly cash dividends of $0.30 per share to holders of our common stock, resulting in a payout ratio of 38% and 92% of net earnings per share, respectively. The decrease in the payout ratio in fiscal year 2018 resulted from increased earnings per share, primarily driven by a reduction in

14



the effective tax rate as a result of U.S. tax reform in the current year, as well as non-recurring expenses incurred in the prior year.
Shareholder Performance Graph
The following graph compares the cumulative total shareholder return of our common stock over the last five fiscal years with the cumulative total shareholder return of the Russell 2000 Index and a peer group of companies in the Laboratory Apparatus and Analytical, Optical, Measuring and Controlling Instruments Standard Industrial Code (SIC Code 3820 Peer Group) that are traded on the Nasdaq, NYSE and NYSE American exchanges. The graph assumes that $100 (in actual dollars) was invested at market close on September 28, 2013 in our common stock, the Russell 2000 Index and the SIC Code 3820 Peer Group and that all dividends were reinvested. The graph is not necessarily indicative of future investment performance.
COMPARISION OF 5 YEAR CUMULATIVE TOTAL RETURN*
Among MTS Systems Corporation, the Russell 2000 Index, and SIC Code 3820 Peer Group


chart-417de4b53b37508b959.jpg
* $100 invested on 9/28/2013 in stock or index, including reinvestment of dividends.
Copyright© 2018 Russell Investment Group. All rights reserved.
 
 
Fiscal Year
(in actual dollars)
 
20132
 
20142
 
20152
 
2016
 
2017
 
2018
MTS Systems Corporation
 
$
100.00

 
$
109.91

 
$
93.98

 
$
76.70

 
$
91.08

 
$
95.38

Russell 2000 Index
 
100.00

 
105.55

 
106.49

 
121.46

 
146.65

 
169.00

SIC Code 3820 Peer Group1
 
100.00

 
114.54

 
110.03

 
138.58

 
176.08

 
216.28

1    Modified to remove non-exchange traded companies.
2 
Fiscal year 2015 refers to the fiscal year ended October 3, 2015, fiscal year 2014 refers to the fiscal year ended September 27, 2014 and fiscal year 2013 refers to the fiscal year ended September 28, 2013.

15



ITEM 6.
SELECTED FINANCIAL DATA
The following selected financial data should be read in conjunction with Item 7 and Item 8 of Part II of this Annual Report on Form 10-K. 
 
 
Fiscal Year1
 
 
2018
 
2017
 
2016
 
2015
 
2014
Operating Results
 
 
 
 
 
 
 
 
 
 
Revenue
 
$
778,032

 
$
787,955

 
$
650,147

 
$
563,934

 
$
564,328

Gross profit
 
305,529

 
302,278

 
231,404

 
219,613

 
223,643

Gross margin %
 
39.3
 %
 
38.4
 %
 
35.6
%
 
38.9
%
 
39.6
%
Research and development expense
 
$
34,784

 
$
34,999

 
$
25,336

 
$
23,705

 
$
23,844

Research and development expense as a % of revenue
 
4.5
 %
 
4.4
 %
 
3.9
%
 
4.2
%
 
4.2
%
Effective income tax rate
 
(38.7
)%
 
(9.0
)%
 
18.0
%
 
23.2
%
 
28.1
%
Net income
 
$
61,328

 
$
25,084

 
$
27,494

 
$
45,462

 
$
42,009

Net income as a % of revenue
 
7.9
 %
 
3.2
 %
 
4.2
%
 
8.1
%
 
7.4
%
Earnings per share
 
 
 
 
 
 
 
 
 
 
Basic
 
$
3.20

 
$
1.32

 
$
1.72

 
$
3.03

 
$
2.76

Diluted
 
$
3.18

 
$
1.31

 
$
1.70

 
$
3.00

 
$
2.73

Weighted average shares outstanding2
 
 
 
 
 
 
 
 
 
 
Basic
 
19,163

 
19,040

 
16,027

 
14,984

 
15,218

Diluted
 
19,293

 
19,137

 
16,179

 
15,142

 
15,397

Depreciation and amortization
 
$
34,492

 
$
35,523

 
$
24,077

 
$
21,106

 
$
19,279

Financial Position
 
 
 
 
 
 
 
 
 
 
Total assets
 
$
1,139,396

 
$
1,189,692

 
$
1,188,020

 
$
460,831

 
$
487,408

Interest-bearing debt3
 
400,706

 
474,309

 
484,985

 
21,183

 
60,000

Total shareholders' equity
 
477,932

 
428,777

 
405,260

 
258,142

 
258,127

Interest-bearing debt as a % of shareholders' equity
 
83.8
 %
 
110.6
 %
 
119.7
%
 
8.2
%
 
23.2
%
Return on equity4
 
14.3
 %
 
6.2
 %
 
10.7
%
 
17.6
%
 
16.4
%
Return on invested capital5
 
9.3
 %
 
7.3
 %
 
8.6
%
 
15.5
%
 
15.4
%
Other Statistics
 
 
 
 
 
 
 
 
 
 
Backlog of orders at year end
 
$
415,155

 
$
360,016

 
$
370,523

 
$
353,013

 
$
326,473

Dividends declared per share
 
1.20

 
1.20

 
1.20

 
1.20

 
1.20

Capital Expenditures
 
12,321

 
17,798

 
20,806

 
18,445

 
20,038

1 
Fiscal years 2018, 2017, 2016, 2015 and 2014 include 52, 52, 52, 53 and 52 weeks, respectively.
2 
Assumes the conversion of potential common shares using the treasury stock method.
3 
Interest-bearing debt consists of long-term debt for fiscal years 2018, 2017 and 2016 and short-term borrowings for fiscal years 2015 and 2014.
4 
Calculated by dividing net income by beginning shareholders' equity. 
5 
The measure Return on Invested Capital (ROIC) is not a measure of performance presented in accordance with GAAP. ROIC is calculated by dividing adjusted net income by average invested capital. Adjusted net income is calculated by excluding after-tax interest expense from reported net income. In addition, adjusted net income also excludes acquisition-related expenses, net of tax; acquisition integration expense, net of tax; acquisition inventory fair value adjustment, net of tax; restructuring expense, net of tax; and China investigation expense, net of tax. Average invested capital is defined as the aggregate of average interest-bearing debt and average shareholders' equity and is calculated as the sum of current and prior year ending amounts divided by two. Because the ratio is not prescribed or authorized by GAAP, the ROIC percentage is a non-GAAP financial measure. We believe ROIC is useful to investors as a measure of operating performance and the effectiveness of the use of capital in our operations. We use ROIC as a measure to monitor and evaluate operating performance relative to our invested capital. This measure should not be construed as an alternative to, or substitute for, return on equity or any other measure determined in accordance with GAAP.

16



Presented below is the reconciliation of ROIC to average invested capital, the nearest GAAP measure, and a reconciliation of each non-GAAP financial measure used to its nearest GAAP measure:
 
 
Fiscal Year
 
 
2018
 
2017
 
2016
 
2015
 
2014
Net income
 
$
61,328

 
$
25,084

 
$
27,494

 
$
45,462

 
$
42,009

Acquisition-related expenses, net of tax
 

 
(814
)
 
7,322

 

 

Acquisition integration expense, net of tax
 

 
2,659

 
2,049

 

 

Acquisition inventory fair value adjustment, net of tax
 

 
5,909

 
5,692

 

 

Restructuring expense, net of tax
 
2,033

 
2,980

 
1,465

 

 
4,376

China investigation expense, net of tax
 

 
6,749

 

 

 

Interest expense, net of tax
 
19,636

 
23,133

 
6,065

 
767

 
637

Adjusted net income*
 
$
82,997

 
$
65,700

 
$
50,087

 
$
46,229

 
$
47,022

 
 
 
 
 
 
 
 
 
 
 
Total beginning shareholders' equity
 
$
428,777

 
$
405,260

 
$
258,142

 
$
258,127

 
$
256,537

Total ending shareholders' equity
 
477,932

 
428,777

 
405,260

 
258,142

 
258,127

Total beginning interest-bearing debt
 
474,309

 
484,985

 
21,183

 
60,000

 
35,000

Total ending interest-bearing debt
 
400,706

 
474,309

 
484,985

 
21,183

 
60,000

Sum of invested capital
 
$
1,781,724

 
$
1,793,331

 
$
1,169,570

 
$
597,452

 
$
609,664

Average invested capital*
 
$
890,862

 
$
896,666

 
$
584,785

 
$
298,726

 
$
304,832

Return on invested capital*
 
9.3
%
 
7.3
%
 
8.6
%
 
15.5
%
 
15.4
%
*
Denotes non-GAAP financial measures.
Presented below is a reconciliation of adjusted net income to net income, which reconciles the tax impact of the non-GAAP financial measure of adjusted net income presented in the table above:
 
Fiscal Year
 
 
2018
 
 
 
2017
 
 
 
2016
 
 
Pre-tax
Tax
Net
 
Pre-tax
Tax
Net
 
Pre-tax
Tax
Net
Net income
$
44,223

$
(17,105
)
$
61,328

 
$
23,011

$
(2,073
)
$
25,084

 
$
33,512

$
6,018

$
27,494

Acquisition-related expensesª



 

814

(814
)
 
10,170

2,848

7,322

Acquisition integration expenseª



 
3,577

918

2,659

 
2,846

797

2,049

Acquisition inventory fair value adjustmentª



 
7,975

2,066

5,909

 
7,916

2,224

5,692

Restructuring expense«
2,730

697

2,033

 
4,079

1,099

2,980

 
2,165

700

1,465

China investigation expenseª



 
9,209

2,460

6,749

 



Interest expense
26,464

6,828

19,636

 
31,218

8,085

23,133

 
8,424

2,359

6,065

Adjusted net income*
$
73,417

$
(9,580
)
$
82,997

 
$
79,069

$
13,369

$
65,700

 
$
65,033

$
14,946

$
50,087


17



 
 
Fiscal Year
 
 
 
2015
 
 
 
2014
 
 
 
Pre-tax
Tax
Net
 
Pre-tax
Tax
Net
Net income
 
$
59,172

$
13,710

$
45,462

 
$
58,443

$
16,434

$
42,009

Restructuring expense«
 



 
6,336

1,960

4,376

Interest expense
 
1,204

437

767

 
1,003

366

637

Adjusted net income*
 
$
60,376

$
14,147

$
46,229

 
$
65,782

$
18,760

$
47,022

ª 
In determining the tax impact of acquisition-related expenses, acquisition integration expense, acquisition inventory fair value adjustment and China investigation expense, we applied a U.S. effective income tax rate before discrete items.
« 
In determining the tax impact of restructuring expenses, we applied the statutory rate in effect for each jurisdiction where restructuring expenses were incurred.
Ö    In determining the tax impact of interest expense, we applied a U.S. marginal income tax rate.
*
Denotes non-GAAP financial measures.

18



ITEM 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 
Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is designed to provide a reader of our financial statements with a narrative from the perspective of management on our financial condition, results of operations, liquidity and certain other factors that may affect our future results. Our MD&A is presented in nine sections: 
Overview
Financial Results
Cash Flow Comparison
Liquidity and Capital Resources
Off-balance Sheet Arrangements
Critical Accounting Policies
Recently Issued Accounting Pronouncements
Quarterly Financial Information
Forward-looking Statements
Our MD&A should be read in conjunction with the Consolidated Financial Statements and related Notes included in Item 8 of Part II of this Annual Report on Form 10-K. All dollar amounts are in thousands unless otherwise noted. 
Overview 
MTS Systems Corporation's testing hardware, software and service 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. Our high-performance sensors provide measurements of vibration, pressure, position, force and sound in a variety of applications.
Further globalization and expansion of many industries along with growth in emerging markets, such as China and India, provide a strong and vibrant market base from which we can grow revenue. We have aligned our organizational structure to be more flexible to the demands of globalized and volatile markets by adjusting our structure to be more cost effective and nimble in responding to our customers' needs. We are looking ahead to delivering distinctive business performance through our commitment to sustain the differentiated competitive advantage that comes from offering an innovative portfolio of Test and Sensor solutions that create value for customers and are delivered with total customer satisfaction. 
Fiscal Year
We have a 5-4-4 week, quarterly accounting cycle with the fiscal year ending on the Saturday closest to September 30. Fiscal years 2018, 2017 and 2016 ended September 29, 2018, September 30, 2017 and October 1, 2016, respectively. Fiscal years 2018, 2017 and 2016 all include 52 weeks.
Tax Cuts and Jobs Act
The Tax Cuts and Jobs Act (the Tax Act) was signed into law on December 22, 2017. The Tax Act made numerous changes to U.S. federal corporate tax law and reduced our effective tax rate for fiscal year 2018 and future periods. Effective January 1, 2018, the Tax Act lowers the U.S. corporate tax rate from 35% to 21% and prompts various other changes to U.S. federal corporate tax law, including the establishment of a territorial-style system for taxing foreign-source income of domestic multinational corporations. We have completed our initial analysis to quantify the tax impacts of the Tax Act and have recorded the estimated impact in our fiscal year 2018 results. See Note 8 to the Consolidated Financial Statements included in Item 8 of Part II of this Annual Report on Form 10-K for further discussion of the impact of the Tax Act.
Restructuring Initiatives
In fiscal year 2018, we initiated a Test workforce reduction intended to increase organizational effectiveness and provide cost savings. As a result, during the fourth quarter of fiscal year 2018, we recorded $880 of pre-tax severance and related expense.
During the fourth quarter of fiscal year 2017, we initiated a series of Test workforce reductions and facility closures intended to increase organizational effectiveness, gain manufacturing efficiencies and provide cost savings that can be reinvested in our growth initiatives. These actions include the transfer of certain production operations in China to a contract manufacturing partner throughout fiscal years 2018 and 2019. As a result, in fiscal year 2018, we recorded $1,550 of pre-tax severance and related expense, and $269 of pre-tax facility closure costs. In fiscal year 2017, we recorded $2,899 of pre-tax severance and related expense and $23 of pre-tax facility closure costs.
See Note 12 to the Consolidated Financial Statements included in Item 8 of Part II of this Annual Report on Form 10-K for further discussion of restructuring initiatives.

19



Foreign Currency
Approximately 70% of our revenue has historically been derived from customers outside of the U.S. Our financial results are principally exposed to changes in exchange rates between the U.S. dollar and the Euro, the Japanese yen and the Chinese yuan. A change in foreign exchange rates could positively or negatively affect our reported financial results. The discussion below quantifies the impact of foreign currency translation on our financial results for the periods discussed.
Financial Results 
Fiscal Year 2018 Compared to Fiscal Year 2017
Total Company 
Results of Operations
The following table compares results of operations in fiscal years 2018 and 2017, separately identifying the estimated impact of currency translation and restructuring expenses incurred in fiscal year 2018.
 
 
 
 
Estimated
 
 
 
 
2018
 
Business
Change
 
Restructuring
 
Currency
Translation
 
2017
Revenue
 
$
778,032

 
$
(26,993
)
 
$

 
$
17,070

 
$
787,955

Cost of sales
 
472,503

 
(26,536
)
 
1,622

 
11,740

 
485,677

Gross profit
 
305,529

 
(457
)
 
(1,622
)
 
5,330

 
302,278

Gross margin
 
39.3
%
 
 
 
 
 
 
 
38.4
%
 
 
 
 
 
 
 
 
 
 
 
Operating expenses
 
 
 
 
 
 
 
 
 
 
Selling and marketing
 
126,333

 
(1,304
)
 
267

 
2,458

 
124,912

General and administrative
 
79,240

 
(9,553
)
 
317

 
937

 
87,539

Research and development
 
34,784

 
(988
)
 
524

 
249

 
34,999

Total operating expenses
 
240,357

 
(11,845
)
 
1,108

 
3,644

 
247,450

Income from operations
 
$
65,172

 
$
11,388

 
$
(2,730
)
 
$
1,686

 
$
54,828

See Note 12 to the Consolidated Financial Statements included in Item 8 of Part II of this Annual Report on Form 10-K for additional information on restructuring and related costs. In the fourth quarter of fiscal year 2016, we completed the acquisition of PCB Group, Inc. (PCB). As a result of the PCB acquisition, we incurred certain non-recurring costs during fiscal year 2017 including acquisition integration costs and a fair value adjustment on acquired PCB inventory (PCB acquisition inventory adjustment).
Revenue
 
 
 
 
 
Increased / (Decreased)
 
 
2018
 
2017
 
$
 
%
Revenue
 
$
778,032

 
$
787,955

 
$
(9,923
)
 
(1.3
)%
The decrease in revenue of 1.3% was primarily driven by lower Test revenue, partially offset by growth in our Sensors business and the favorable impact of currency translation. Test revenue decreased $39,163 or 7.8% primarily driven by a decline in equipment volume resulting from weakness in the ground vehicles sector that continues to operate in a rapidly changing environment. Current year Test revenue was also impacted by custom project backlog which takes longer to convert to revenue and lower order volume in the first half of fiscal year 2018. This was partially offset by the favorable impact of currency translation, growth in Test service revenue and continued growth in the Test materials sector. Sensors revenue increased $30,401 or 10.7% primarily driven by continued growth in the Sensors position sector and broad demand across the remaining Sensors sectors, along with continued momentum from new revenue opportunities in the Sensors test sector and the favorable impact of currency translation. Excluding the impact of currency translation, revenue decreased 3.4%.

20



Revenue by geography is as follows:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Increased / (Decreased)
 
 
2018
 
2017
 
$
 
%
Americas
 
$
275,422

 
$
278,776

 
$
(3,354
)
 
(1.2
)%
Europe
 
223,236

 
192,491

 
30,745

 
16.0
 %
Asia
 
279,374

 
316,688

 
(37,314
)
 
(11.8
)%
Total Revenue
 
$
778,032

 
$
787,955

 
$
(9,923
)
 
(1.3
)%
Sales momentum in Europe was more than offset by decline in Asia primarily driven by weakness in the Test ground vehicles sector.
Gross Profit
 
 
 
 
 
Increased / (Decreased)
 
 
2018
 
2017
 
$
 
%
Gross profit
 
$
305,529

 
$
302,278

 
$
3,251

 
1.1
%
Gross margin
 
39.3
%
 
38.4
%
 
0.9

 
ppts
Gross profit increased 1.1% primarily driven by increased Sensors revenue volume and the prior year PCB acquisition inventory adjustment of $7,975, as well as the favorable impact of currency translation, partially offset by reduced Test revenue volume. Gross margin rate increased 0.9 percentage points primarily due to the prior year PCB acquisition inventory adjustment and leverage on increased Sensors revenue volume, partially offset by the lower contribution from product mix and unfavorable leverage on lower Test revenue volume. Excluding the impact of currency translation, the prior year PCB acquisition inventory adjustment, prior year PCB acquisition integration expenses and restructuring costs incurred in both fiscal years, gross profit declined 3.8% and the gross margin rate was flat. 
Selling and Marketing Expense
 
 
 
 
 
Increased / (Decreased)
 
 
2018
 
2017
 
$
 
%
Selling and marketing
 
$
126,333

 
$
124,912

 
$
1,421

 
1.1
%
% of Revenue
 
16.2
%
 
15.9
%
 
 
 
 
Selling and marketing expenses increased 1.1% primarily driven by the unfavorable impact of currency translation and increased compensation and commission expense in Sensors, partially offset by lower commission expense and cost containment measures in Test. Excluding the impact of currency translation, prior year PCB acquisition integration expenses, prior year China investigation expenses, and restructuring costs incurred in both fiscal years, selling and marketing expense was flat. 
General and Administrative Expense
 
 
 
 
 
Increased / (Decreased)
 
 
2018
 
2017
 
$
 
%
General and administrative
 
$
79,240

 
$
87,539

 
$
(8,299
)
 
(9.5
)%
% of Revenue
 
10.2
%
 
11.1
%
 
 
 
 
General and administrative expense decreased 9.5% primarily due to prior year China investigation expenses of $8,451, prior year PCB acquisition integration expenses of $3,039 and decreased compensation expense in Sensors, partially offset by an increase in professional fees and the unfavorable impact of currency translation. Excluding the impact of currency translation, prior year PCB acquisition integration expenses, prior year China investigation expenses and restructuring costs incurred in both fiscal years, general and administrative expense increased 3.4%.
Research and Development Expense
 
 
 
 
 
Increased / (Decreased)
 
 
2018
 
2017
 
$
 
%
Research and development
 
$
34,784

 
$
34,999

 
$
(215
)
 
(0.6
)%
% of Revenue
 
4.5
%
 
4.4
%
 
 
 
 
Research and development (R&D) expense decreased 0.6% primarily due to lower compensation expense in Test and prior year focused R&D spending to meet certain Test market needs, partially offset by continued investment in product development in Sensors. Excluding the impact of currency translation, prior year China investigation expenses and current year restructuring costs, R&D expense decreased 2.2%

21



Income from Operations
 
 
 
 
 
Increased / (Decreased)
 
 
2018
 
2017
 
$
 
%
Income from operations
 
$
65,172

 
$
54,828

 
$
10,344

 
18.9
%
% of Revenue
 
8.4
%
 
7.0
%
 
 
 
 
Income from operations increased 18.9% primarily driven by leverage on volume growth in Sensors, prior year China investigation expenses of $9,209, the prior year PCB acquisition inventory adjustment of $7,975 and prior year non-recurring PCB acquisition integration expenses of $3,577. The increase was partially offset by the lower gross margin contribution from unfavorable leverage on lower Test revenue volume and overall product mix. Excluding the impact of currency translation, the prior year PCB acquisition inventory adjustment, prior year non-recurring PCB acquisition integration expenses, prior year China investigation expenses and restructuring costs incurred in both fiscal years, income from operations decreased 16.9%.  
Interest Expense, Net
 
 
 
 
 
Increased / (Decreased)
 
 
2018
 
2017
 
$
 
%
Interest expense, net
 
$
25,882

 
$
30,821

 
$
(4,939
)
 
(16.0
)%
Interest expense decreased primarily due to reduced interest rates on the tranche B term loan facility as a result of the debt repricing completed in the fourth quarter of fiscal year 2017, lower current year average debt outstanding and current year gains on interest rate swaps.
Other Income (Expense), Net
 
 
 
 
 
Increased / (Decreased)
 
 
2018
 
2017
 
$
 
%
Other income (expense), net
 
$
4,933

 
$
(996
)
 
$
5,929

 
595.3
%
The increase in other income (expense), net was primarily driven by the gain on the sale of one of our China manufacturing facilities and a relative decrease in losses on foreign currency transactions.
Income Tax Provision (Benefit)
 
 

 
 

 
Increased / (Decreased)
 
 
2018
 
2017
 
$
 
%
Income tax provision (benefit)
 
$
(17,105
)
 
$
(2,073
)
 
$
(15,032
)
 
(725.1
)%
Effective rate
 
(38.7
)%
 
(9.0
)%
 
(29.7
)
 
ppts
 
The effective tax rate decreased primarily due to certain discrete benefits of $25,008 from the estimated impact of the Tax Act, including $31,647 of estimated benefit from the remeasurement of our estimated net deferred tax liabilities, partially offset by $6,639 of estimated expense associated with the mandatory deemed repatriation tax. Fiscal year 2017 included certain discrete benefits of $2,801 which consisted of additional U.S. tax benefits for prior fiscal years associated with domestic manufacturing, deductible PCB acquisition-related expenses and U.S. R&D tax credit. Excluding the impact of these discrete benefits, the effective tax rate for fiscal years 2018 and 2017 would have been 17.9% and 3.2%, respectively. The increase in the effective tax rate was primarily due to higher earnings before taxes, partially offset by the lower U.S. corporate tax rate under the Tax Act.
Net Income
 
 

 
 

 
Increased / (Decreased)
 
 
2018
 
2017
 
$
 
%
Net income
 
$
61,328

 
$
25,084

 
$
36,244

 
144.5
%
Diluted earnings per share
 
$
3.18

 
$
1.31

 
$
1.87

 
142.7
%
 
Net income increased due to a reduction in the effective tax rate driven by discrete benefits stemming from the Tax Act, as well as lower operating expenses and increased gross profit. 
Backlog
Backlog of undelivered orders as of September 29, 2018 was $415,155, an increase of $55,139 or 15.3%, compared to backlog of $360,016 as of September 30, 2017. Based on anticipated manufacturing schedules, we expect approximately 87% of the backlog as of September 29, 2018 will be converted into revenue during fiscal year 2019. The expected conversion rate is relatively flat compared to the prior year rate of 85%
We believe backlog is not an absolute indicator of future revenue because a portion of the orders in backlog could be canceled at the customer's discretion. While certain contracts within backlog are subject to order cancellation, we have not historically

22



experienced a significant number of order cancellations. During fiscal year 2018, order cancellations did not have a material effect on backlog.
Test Segment
Results of Operations
The following table compares results of operations in fiscal years 2018 and 2017 for Test, separately identifying the estimated impact of currency translation and restructuring expenses incurred in fiscal year 2018. See Note 11 to the Consolidated Financial Statements included in Item 8 of Part II of this Annual Report on Form 10-K for additional information on our operating segments.
 
 
 

 
Estimated
 
 
 
 
2018
 
Business
Change
 
Restructuring
 
Currency
Translation
 
2017
Revenue
 
$
464,924

 
$
(48,566
)
 
$

 
$
9,403

 
$
504,087

Cost of sales
 
314,735

 
(29,239
)
 
1,622

 
7,497

 
334,855

Gross profit
 
150,189

 
(19,327
)
 
(1,622
)
 
1,906

 
169,232

Gross margin
 
32.3
%
 
 

 
 
 
 

 
33.6
%
 
 
 
 
 
 
 
 
 
 
 
Operating expenses
 
 

 
 

 
 
 
 

 
 

Selling and marketing
 
68,899

 
(2,379
)
 
236

 
1,259

 
69,783

General and administrative
 
44,659

 
(7,623
)
 
317

 
600

 
51,365

Research and development
 
17,406

 
(2,594
)
 
524

 
14

 
19,462

Total operating expenses
 
130,964

 
(12,596
)
 
1,077

 
1,873

 
140,610

Income from operations
 
$
19,225

 
$
(6,731
)
 
$
(2,699
)
 
$
33

 
$
28,622

Revenue
 
 
 
 
 
Increased / (Decreased)
 
 
2018
 
2017
 
$
 
%
Revenue
 
$
464,924

 
$
504,087

 
$
(39,163
)
 
(7.8
)%
 
Revenue decreased 7.8% primarily driven by a decline in equipment volume resulting from weakness in the ground vehicles sector that continues to operate in a rapidly changing environment. Current year Test revenue was also impacted by custom project backlog which takes longer to convert to revenue and lower order volume in the first half of fiscal year 2018. This was partially offset by the favorable impact of currency translation, growth in service revenue and continued growth in the materials sector. Excluding the impact of currency translation, revenue decreased 9.6%.
Revenue by geography is as follows:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Increased / (Decreased)
 
 
2018
 
2017
 
$
 
%
Americas
 
$
132,201

 
$
146,338

 
$
(14,137
)
 
(9.7
)%
Europe
 
112,092

 
93,296

 
18,796

 
20.1
 %
Asia
 
220,631

 
264,453

 
(43,822
)
 
(16.6
)%
Total Revenue
 
$
464,924

 
$
504,087

 
$
(39,163
)
 
(7.8
)%
 
Sales momentum in Europe was more than offset by declines in Asia and the Americas primarily driven by weakness in the ground vehicles sector.

23



Gross Profit
 
 

 
 

 
Increased / (Decreased)
 
 
2018
 
2017
 
$
 
%
Gross profit
 
$
150,189

 
$
169,232

 
$
(19,043
)
 
(11.3
)%
Gross margin
 
32.3
%
 
33.6
%
 
(1.3
)
 
ppts
 
Gross profit decreased 11.3% primarily due to lower equipment volume. The gross margin rate decreased by 1.3 percentage points primarily driven by unfavorable leverage on lower revenue volume and the lower contribution from product mix, partially offset by the impact of lower compensation expense and restructuring costs. Excluding the impact of currency translation and restructuring costs incurred in both fiscal years, gross profit declined 12.7% and gross margin rate declined 1.2 percentage points. 
Selling and Marketing Expense
 
 
 
 
 
Increased / (Decreased)
 
 
2018
 
2017
 
$
 
%
Selling and marketing
 
$
68,899

 
$
69,783

 
$
(884
)
 
(1.3
)%
% of Revenue
 
14.8
%
 
13.8
%
 
 

 
 

 
Selling and marketing expense decreased 1.3% primarily due to a decrease in commission expense and cost containment measures, partially offset by the unfavorable impact of currency translation. Excluding the impact of currency translation, prior year China investigation expenses and restructuring costs incurred in both fiscal years, selling and marketing expense decreased 2.5%  
General and Administrative Expense
 
 
 
 
 
Increased / (Decreased)
 
 
2018
 
2017
 
$
 
%
General and administrative
 
$
44,659

 
$
51,365

 
$
(6,706
)
 
(13.1
)%
% of Revenue
 
9.6
%
 
10.2
%
 
 

 
 

 
General and administrative expense decreased 13.1% primarily due to prior year China investigation expenses of $8,451, partially offset by the unfavorable impact of currency translation. Excluding the impact of currency translation, prior year China investigation expenses and restructuring costs incurred in both fiscal years, general and administrative expense increased 2.8%.  
Research and Development Expense
 
 

 
 

 
Increased / (Decreased)
 
 
2018
 
2017
 
$
 
%
Research and development
 
$
17,406

 
$
19,462

 
$
(2,056
)
 
(10.6
)%
% of Revenue
 
3.7
%
 
3.9
%
 
 

 
 

 
R&D expense decreased 10.6% primarily due to prior year focused R&D spending to meet certain Test market needs and lower compensation expense. Excluding the impact of currency translation, prior year China investigation expenses and current year restructuring costs, R&D expense decreased 12.4%
Income from Operations
 
 

 
 

 
Increased / (Decreased)
 
 
2018
 
2017
 
$
 
%
Income from operations
 
$
19,225

 
$
28,622

 
$
(9,397
)
 
(32.8
)%
% of Revenue
 
4.1
%
 
5.7
%
 
 

 
 

 
Income from operations decreased 32.8% primarily due to the decrease in gross profit driven by the decline in equipment volume resulting from weakness in the ground vehicles sector and the lower contribution from product mix. The decrease was partially offset by prior year China investigation expenses of $9,209, lower compensation expense and prior year focused R&D spending to meet certain Test market needs. Excluding the impact of currency translation, prior year China investigation expenses and restructuring costs incurred in both fiscal years, income from operations decreased 46.3%.
Backlog
Backlog of undelivered orders at September 29, 2018 was $346,006, an increase of 11.1% from backlog of $311,551 at September 30, 2017. Based on anticipated manufacturing schedules, we expect approximately 85% of the backlog as of September 29, 2018 will be converted into revenue during fiscal year 2019. The expected conversion rate is relatively flat compared to the prior year rate of 83%. Order cancellations in fiscal year 2018 did not have a material effect on backlog.

24



Sensors Segment 
Results of Operations
The following table compares results of operations in fiscal years 2018 and 2017 for Sensors, separately identifying the estimated impact of currency translation and restructuring expenses incurred in fiscal year 2018. See Note 11 to the Consolidated Financial Statements included in Item 8 of Part II of this Annual Report on Form 10-K for additional information on our operating segments.
 
 
 
 
Estimated
 
 
 
 
2018
 
Business
Change
 
Restructuring
 
Currency
Translation
 
2017
Revenue
 
$
314,269

 
$
22,734

 
$

 
$
7,667

 
$
283,868

Cost of sales
 
158,896

 
3,831

 

 
4,243

 
150,822

Gross profit
 
155,373

 
18,903

 

 
3,424

 
133,046

Gross margin
 
49.4
%
 
 

 
 

 
 

 
46.9
%
 
 
 
 
 
 
 
 
 
 
 
Operating expenses
 
 

 
 

 
 

 
 

 
 

Selling and marketing
 
57,434

 
1,075

 
31

 
1,199

 
55,129

General and administrative
 
34,581

 
(1,930
)
 

 
337

 
36,174

Research and development
 
17,378

 
1,606

 

 
235

 
15,537

Total operating expenses
 
109,393

 
751

 
31

 
1,771

 
106,840

Income from operations
 
$
45,980

 
$
18,152

 
$
(31
)
 
$
1,653

 
$
26,206

Revenue
 
 

 
 

 
Increased / (Decreased)
 
 
2018
 
2017
 
$
 
%
Revenue
 
$
314,269

 
$
283,868

 
$
30,401

 
10.7
%
 
Revenue increased 10.7% primarily driven by continued growth in the Sensors position sector and broad demand across the remaining Sensors sectors, along with continued momentum from new revenue opportunities in the Sensors test sector and the favorable impact of currency translation. Strong demand in the Sensors position sector, particularly in the heavy industrial markets, and new revenue opportunities in the Sensors test sector from advanced technology sensors to be used in systems for the U.S. Department of Defense drove revenue growth. Excluding the impact of currency translation, revenue growth was 8.0%.
Revenue by geography is as follows:
 
 
 
 
 
 
 
 
 
 
 

 
 

 
Increased / (Decreased)
 
 
2018
 
2017
 
$
 
%
Americas
 
$
144,382

 
$
132,438

 
$
11,944

 
9.0
%
Europe
 
111,144

 
99,195

 
11,949

 
12.0
%
Asia
 
58,743

 
52,235

 
6,508

 
12.5
%
Total Revenue
 
$
314,269

 
$
283,868

 
$
30,401

 
10.7
%
 
Gross Profit
 
 

 
 

 
Increased / (Decreased)
 
 
2018
 
2017
 
$
 
%
Gross profit
 
$
155,373

 
$
133,046

 
$
22,327

 
16.8
%
Gross margin
 
49.4
%
 
46.9
%
 
2.5

 
ppts 
 
Gross profit increased 16.8% primarily due to increased revenue volume, the prior year PCB acquisition inventory adjustment of $7,975 and the favorable impact of currency translation, partially offset by an increase in compensation expense. The gross margin rate increased 2.5 percentage points primarily driven by the prior year PCB acquisition inventory adjustment and favorable leverage on increased revenue volume, partially offset by the lower gross margin contribution from product mix. Excluding the impact of currency translation, the prior year PCB acquisition inventory adjustment, prior year non-recurring PCB acquisition integration expenses and prior year restructuring costs, gross profit increased 7.0% and the gross margin rate declined 0.4 percentage points. 

25



Selling and Marketing Expense
 
 

 
 

 
Increased / (Decreased)
 
 
2018
 
2017
 
$
 
%
Selling and marketing
 
$
57,434

 
$
55,129

 
$
2,305

 
4.2
%
% of Revenue
 
18.3
%
 
19.4
%
 
 

 
 

 
Selling and marketing expense increased 4.2% primarily driven by the unfavorable impact of currency translation, increased compensation expense and increased commission expense on higher revenue volume. Excluding the impact of currency translation, prior year PCB acquisition integration expenses and restructuring costs incurred in both fiscal years, selling and marketing expense increased 2.8%
General and Administrative Expense
 
 

 
 

 
Increased / (Decreased)
 
 
2018
 
2017
 
$
 
%
General and administrative
 
$
34,581

 
$
36,174

 
$
(1,593
)
 
(4.4
)%
% of Revenue
 
11.0
%
 
12.7
%
 
 

 
 

 
General and administrative expense declined 4.4% primarily driven by prior year PCB acquisition integration expenses of $3,039 and decreased compensation expense, partially offset by an increase in professional fees. Excluding the impact of currency translation, prior year PCB acquisition integration expenses and prior year restructuring costs, general and administrative expense increased 4.1%.
Research and Development Expense
 
 

 
 

 
Increased / (Decreased)
 
 
2018
 
2017
 
$
 
%
Research and development
 
$
17,378

 
$
15,537

 
$
1,841

 
11.8
%
% of Revenue
 
5.5
%
 
5.5
%
 
 

 
 

 
R&D expense increased 11.8% primarily driven by continued investment in product development. Excluding the impact of currency translation, R&D expense increased 10.3%.
Income from Operations
 
 

 
 

 
Increased / (Decreased)
 
 
2018
 
2017
 
$
 
%
Income from operations
 
$
45,980

 
$
26,206

 
$
19,774

 
75.5
%
% of Revenue
 
14.6
%
 
9.2
%
 
 

 
 

 
Income from operations increased 75.5% primarily driven by leverage on increased revenue volume, the prior year PCB acquisition inventory adjustment of $7,975, prior year PCB acquisition integration expenses of $3,577 and the favorable impact of currency translation. The increase was partially offset by an increase in professional fees, higher compensation and commission expense and investments in product development. Excluding the impact of currency translation, the prior year PCB acquisition inventory adjustment, prior year PCB acquisition integration expenses and restructuring costs incurred in both fiscal years, income from operations increased 14.0%
Backlog
Backlog of undelivered orders at September 29, 2018 was $69,149, an increase of 42.7% compared to backlog of $48,465 at September 30, 2017. We generally expect Sensors backlog to convert to revenue in less than one year.

26



Fiscal Year 2017 Compared to Fiscal Year 2016
Total Company 
Results of Operations
The following table compares results of operations in fiscal years 2017 and 2016, separately identifying the estimated impact of currency translation, the acquisition of PCB for the first three quarters of fiscal year 2017 for comparability, and restructuring expenses incurred in fiscal year 2017.
 
 
 
 
Estimated
 
 
 
 
2017
 
Business
Change
 
Acquisition /
Restructuring
1
 
Currency
Translation
 
2016
Revenue
 
$
787,955

 
$
11,926

 
$
129,197

 
$
(3,315
)
 
$
650,147

Cost of sales
 
485,677

 
(6,722
)
 
76,786

 
(3,130
)
 
418,743

Gross profit
 
302,278

 
18,648