MTS Systems Corporation is a leading global supplier of advanced test systems, motion simulators and precision sensors. Our testing and simulation 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 to enable automation, enhance precision and safety, and lower our customers' production costs by improving performance and reducing downtime.

We have a 5-4-4 week, quarterly accounting cycle with our fiscal year ending on the Saturday closest to September 30. Fiscal years 2020, 2019 and 2018 ended October 3, 2020, September 28, 2019 and September 29, 2018, respectively. Fiscal year 2020 included 53 weeks and fiscal years 2019 and 2018 both included 52 weeks.

We adopted Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (Topic 606), followed by related amendments, on September 30, 2018 under the modified retrospective transition method. Our revenue recognition accounting policy and disclosures relative to this guidance are included in Note 3.

Research and development costs associated with new products are charged to operations as incurred. We have also allocated certain resources to capitalized software development activities. Total internal software development costs capitalized during fiscal years 2020 and 2019 were $8,403 and $5,883, respectively.

The financial position and results of operations of our foreign subsidiaries are measured using local currency as the functional currency. Assets and liabilities are translated using fiscal period-end exchange rates, and monthly statements of income are translated using average exchange rates applicable to each month, with the resulting adjustments recorded in foreign currency translation gain (loss) adjustments in the Consolidated Statements of Comprehensive Income. Net gains and losses from foreign currency transactions are recognized in the Consolidated Statements of Income. We recorded a net foreign currency transaction loss of $636 in fiscal year 2020, a net foreign currency transaction loss of $200 in fiscal year 2019 and a net foreign currency transaction gain of $104 in fiscal year 2018.

Cash and cash equivalents represent cash, demand deposits and highly liquid investments with original maturities of three months or less. Cash equivalents are recorded at cost, which approximates fair value. Cash equivalents, both within and outside the U.S., are invested in bank deposits or money market funds and are held in local currency.

We grant credit to customers and generally do not require collateral or other security from domestic customers. When deemed appropriate, receivables from customers located outside the U.S. are supported by letters of credit from financial institutions. The allowance for doubtful accounts is based on our assessment of the collectability of specific customer accounts and includes consideration of the credit worthiness and financial condition of those specific customers. We record an allowance to reduce receivables to the amount reasonably believed to be collectible and consider factors such as the financial condition of the customer and the aging of the receivables. If there is a deterioration of a customer's financial condition, if we become aware of additional information related to the credit worthiness of a customer or if future actual default rates on trade receivables differ from those currently anticipated, we may adjust the allowance for doubtful accounts, which would affect earnings in the period the adjustments were made.

We enter into long-term contracts for customized equipment sold to our customers. Under the terms of such contracts, revenue recognized over time may be invoiced upon completion of contractual milestones, shipment to the customer or installation and customer acceptance. Unbilled amounts relating to these contracts are included in unbilled accounts receivable, net in the Consolidated Balance Sheets. Amounts unbilled as of October 3, 2020 are expected to be invoiced during fiscal year 2021.

We capitalize certain software development costs related to software to be sold or otherwise marketed. Capitalized software development costs include purchased materials and services, salary and benefits of our development and technical support staff and other costs associated with the development of new products and services. Software development costs are expensed as incurred until technological feasibility has been established, at which time future costs incurred are capitalized until the product is available for general release to the public. Based on our product development process, technological feasibility is generally established once product and detailed program designs have been completed, uncertainties related to high-risk development issues have been resolved through coding and testing, and we have the capability to manufacture the end product. Once a software product is available for general release to the public, capitalized development costs associated with that product will begin to be amortized to cost of sales in the Consolidated Statements of Income over the product's estimated economic life, using the greater of straight-line or a method that results in cost recognition in future periods that is consistent with the anticipated timing of product revenue recognition.

Our capitalized software development costs are subject to an ongoing assessment of recoverability, which is impacted by estimates and assumptions of future revenues and expenses for these software products, as well as other factors such as changes in product technologies. Any portion of unamortized capitalized software development costs that is determined to be in excess of net realizable value is expensed in the period such a determination is made. We capitalized $13,882, $8,295 and $5,167 of software development costs during fiscal years 2020, 2019 and 2018, respectively. Amortization expense for software development costs was $264, $176 and $30 for fiscal years 2020, 2019 and 2018, respectively. See Note 6 for additional information on capitalized software development costs.

Long-lived assets or asset groups, including definite-lived intangible assets ("intangible assets") subject to amortization and property and equipment, are reviewed for impairment whenever events or changes in circumstances such as asset utilization, physical change, legal factors or other matters indicate that the carrying value of those assets may not be recoverable. When this review indicates the carrying value of an asset or asset group exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset or asset group, an asset impairment charge in recognized in earnings in the period such a determination is made. The amount of the impairment loss recorded is the amount by which the carrying value of the impaired asset or asset group exceeds its fair value based on discounted cash flows.

An impairment charge of $36,471 in amortizing intangible assets was recognized in the fourth quarter of fiscal year 2020 in Test & Simulation. These charges relate to technology and patents, trademarks and trade names, and customer lists that experienced a significant decline in asset value due to an overall decline in market conditions as a result of COVID-19, including significant declines in the flight simulation and entertainment markets. These charges are included in the impairment of assets line of the Consolidated Statements of Income. See Note 6 for additional information on impairment charges recorded.

In performing this assessment, we have made reasonable accounting estimates based on the facts and circumstances that were available as of the measurement date considering the developing situation driven by COVID-19. However, if actual results are not consistent with the estimates and assumptions used in the calculations, we may be exposed to future impairment losses that could be material.

Goodwill represents the excess of cost over the fair value of the identifiable net assets of businesses acquired and allocated to our reporting units at the time of acquisition. Goodwill for each reporting unit is tested for impairment at least annually, during our fourth quarter, and whenever events occur or circumstances change that indicate the carrying value of the reporting unit may not be recoverable.

Evaluating goodwill for impairment involves the determination of the fair value of each reporting unit in which goodwill is recorded using a qualitative or quantitative analysis. A reporting unit is an operating segment or a component of an operating segment for which discrete financial information is available and reviewed by management on a regular basis. For fiscal year 2020, we identified five reporting units: Legacy Test, E2M, R&D, PCB and Temposonics.

Prior to completing the quantitative analysis, we have the option to perform a qualitative assessment of goodwill for impairment to determine whether it is more likely than not (a likelihood of more than 50%) that the fair value of a reporting unit is less than its carrying value, including goodwill and other intangible assets. If we conclude the fair value is more likely than not less than the carrying amount, a quantitative analysis is performed. Otherwise, no further testing is needed.

If the quantitative analysis is required or elected, the impairment test is used to compare the calculated fair value of each reporting unit to its carrying value, including goodwill and other intangible assets. We estimate the fair value of a reporting unit using both the income approach and the market approach. The income approach uses a discounted cash flow model that requires input of certain estimates and assumptions requiring significant judgment, including projected revenue growth rates, gross profit margins, operating expenses, capital expenditures, working capital requirements, terminal growth rates and discount rates. Revenue growth rates, gross profit margins, operating expenses, capital expenditures and working capital requirements are projected based on each reporting unit's current business, expected developments and operational strategies typically over a five-year period. The discount rates reflect the risk factors associated with the cash flow streams of the reporting unit. The market approach uses a multiple of earnings and revenue based on guidelines for publicly traded companies. If the fair value exceeds the carrying value, no further work is required and no impairment loss is recognized. If the carrying value exceeds the fair value, an impairment loss is recognized in an amount equal to the excess, limited to the total amount of goodwill allocated to that reporting unit.

For our fiscal year 2020 annual goodwill impairment analysis, performed during the fourth quarter, we elected to bypass the qualitative analysis and performed a quantitative analysis for each of our reporting units given the economic impact from COVID-19 and the sustained decline in our stock price. Based on the analysis, our Legacy Test, E2M and PCB reporting units were determined to have a carrying value in excess of their fair value, resulting in goodwill impairment charges of $22,509, $30,835 and $188,174, respectively. These charges are included in the impairment of assets line of the Consolidated Statements of Income. These impairment charges recorded in fiscal year 2020 were primarily the result of a decline in market conditions as a result of COVID-19, including a sustained decrease in our stock price and significant declines in the flight simulation and entertainment markets. As of October 3, 2020, our Legacy Test, E2M, R&D, PCB and Temposonics reporting units had goodwill balances of $4,011, $7,056, $37,773, $178,328 and $1,472, respectively. The fair value exceeded carrying value by a significant margin for our Temposonics and R&D reporting units.

In performing this assessment, we have made reasonable accounting estimates and assumptions in determining the fair value of our reporting units based on the facts and circumstances available as of the measurement date considering the developing situation driven by COVID-19. However, if actual results are not consistent with the estimates and assumptions used in the calculations, we may be exposed to future impairment losses that could be material. Events and conditions that could negatively impact the estimated fair value include a sustained further decline in our stock price, inability to realize the anticipated sales growth opportunities, lack of development of new products and a decrease in projected profitability.

In fiscal year 2019, we performed a qualitative analysis of goodwill for each of our reporting units as described above. Based on the analysis, we determined that it was more likely than not that the fair value exceeded the carrying value for all of our reporting units. Therefore, a quantitative analysis was not necessary for any of our reporting units.

Intangible assets with indefinite lives are not amortized. These assets are tested for impairment at least annually, during our fourth quarter, and whenever events occur or circumstances change that indicate the carrying value of the asset may not be recoverable. If a quantitative analysis is deemed necessary, fair value of indefinite-lived intangible assets is determined using a relief from royalty method requiring input of certain estimates and assumptions requiring significant judgment, including the royalty rate, discount rate and projected revenue growth rates.

For our fiscal year 2020 annual indefinite-lived intangible asset impairment analysis, performed during the fourth quarter of fiscal year 2020, we elected to bypass the qualitative analysis and performed a quantitative analysis. Driven by a decline in market conditions as a result of COVID-19, including a sustained decrease in our stock price, we recorded an impairment charge of $13,400 to our only indefinite-lived intangible asset included within Sensors. This charge is included in the impairment of assets line of the Consolidated Statements of Income. See Note 6 for additional information on intangible assets.

Our results of operations could be materially impacted by changes in foreign currency exchange rates, as well as interest rates on our floating-rate indebtedness. In an effort to manage exposure to these risks, we periodically enter into forward and option currency exchange contracts, interest rate swaps and forward interest rate swaps. Since the market value of these hedging contracts is derived from current market rates, they are classified as derivative financial instruments. We do not use derivatives for speculative or trading purposes. The derivative contracts contain credit risk to the extent that our bank counterparties may be unable to meet the terms of the agreements. The amount of such credit risk is generally limited to the unrealized gains, if any, in such contracts. Such risk is minimized by limiting those counterparties to major financial institutions of high credit quality. For derivative instruments executed under master netting arrangements, we have the contractual right to offset fair value amounts recognized for the right to reclaim cash collateral against obligations to return cash collateral. We do not offset fair value amounts recognized on these derivative instruments. As of both October 3, 2020 and September 28, 2019, we did not have any foreign exchange contracts with credit risk related contingent features. See Note 8 for additional information on derivatives and hedging activities.

We record a tax provision for the anticipated tax consequences of the reported results of operations. Deferred tax assets and liabilities are measured using the currently enacted tax rates that apply to taxable income in effect for the years in which those deferred tax assets and liabilities are expected to be realized or settled. We record a valuation allowance to reduce deferred tax assets to the amount that is believed more likely than not to be realized. We believe it is more likely than not that forecasted income, including income that may be generated as a result of certain tax planning strategies, together with the tax effects of the deferred tax liabilities, will be sufficient to fully recover the remaining net realizable value of our deferred tax assets. In the event that all or part of the net deferred tax assets are determined not to be realizable in the future, an adjustment to the valuation allowance would be charged to earnings in the period such determination is made. In addition, the calculation of tax liabilities involves significant judgment in estimating the impact of uncertainties in the application of complex tax laws. Resolution of these uncertainties in a manner inconsistent with our expectations could have a material impact on our financial condition and operating results. See Note 12 for additional information on income taxes.

We measure the cost of employee services received in exchange for the award of equity instruments based on the fair value of the award at the date of grant. We recognize the cost over the period during which an employee is required to provide services in exchange for the award. Forfeitures of stock-based awards are recognized as they occur.

For purposes of determining estimated fair value of stock-based payment awards, we utilize the Black-Scholes option pricing model, which requires the input of certain assumptions requiring management judgment. Because our employee stock option awards have characteristics significantly different from those of traded options and because changes in the input assumptions can materially affect fair value estimates, existing models may not provide a reliable single measure of the fair value of employee stock options. We continue to assess the assumptions and methodologies used to calculate estimated fair value of stock-based compensation. Circumstances may change and additional data may become available over time that could result in

changes to these assumptions and methodologies and thereby materially impact the fair value determination of future grants of stock-based payment awards. If factors change and we employ different assumptions in future periods, the compensation expense recorded may differ significantly from the stock-based compensation expense recorded in the current period. See Note 10 for additional information on stock-based compensation.

We establish an accrual for loss contingencies when it is both probable that an asset has been impaired or a liability has been incurred and the amount of the loss can be reasonably estimated. When both of these criteria are not met, we do not establish an accrual. However, when there is at least a reasonable possibility that a loss has been incurred, but it is not probable or reasonably estimable, we disclose the nature of the loss contingency and an estimate of the possible loss or range of loss, as applicable. Any adjustment made to a loss contingency accrual during an accounting period affects the earnings of the period.