-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, PZ75sE4hwRJB+5iEogd869f6FDZRzvipdxLSUGbPjYYVqkp/TjTOES53c+2bMCvo YjLDPGJaVtDWgYhJz6S8NA== 0000897101-97-001278.txt : 19971222 0000897101-97-001278.hdr.sgml : 19971222 ACCESSION NUMBER: 0000897101-97-001278 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19970930 FILED AS OF DATE: 19971219 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: MTS SYSTEMS CORP CENTRAL INDEX KEY: 0000068709 STANDARD INDUSTRIAL CLASSIFICATION: MEASURING & CONTROLLING DEVICES, NEC [3829] IRS NUMBER: 410908057 STATE OF INCORPORATION: MN FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-02382 FILM NUMBER: 97741110 BUSINESS ADDRESS: STREET 1: 14000 TECHNOLOGY DR CITY: EDEN PRAIRIE STATE: MN ZIP: 55344-2290 BUSINESS PHONE: 6129374000 MAIL ADDRESS: STREET 1: 14000 TECHNOLOGY DR CITY: EDEN PRAIRIE STATE: MN ZIP: 55344 FORMER COMPANY: FORMER CONFORMED NAME: RESEARCH INC DATE OF NAME CHANGE: 19670216 10-K 1 =============================================================================== UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON D.C. 20549 -------------------- FORM 10-K Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 (Fee Required) For The Fiscal Year Ended September 30, 1997 Commission File Number 0-2382 -------------------- MTS SYSTEMS CORPORATION (Exact name of registrant as specified in its charter) MINNESOTA 612-937-4000 41-0908057 (State or other jurisdiction (Telephone number of registrant (I.R.S. Employer of incorporation or including area code) Identification No.) organization) 14000 TECHNOLOGY DRIVE, EDEN PRAIRIE, MINNESOTA 55344-9763 (Address of principle executive offices) (Zip Code) Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK (PAR VALUE OF $.25 PER SHARE) Indicate by check mark whether 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. _X_ Yes ___ No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ( ) As of December 1, 1997, 9,147,204 shares of the Registrant's Common Stock were outstanding and the aggregate market value of such Common Stock (based upon the average of the high and low prices) held by non-affiliates was $308,717,790. -------------------- DOCUMENTS INCORPORATED BY REFERENCE Annual Report to Shareholders for Fiscal Year ended September 30, 1997 - Parts I, II and IV. Proxy Statement for Annual Meeting of Shareholders, statement dated prior to January 27, 1998 - Part III. MTS SYSTEMS CORPORATION ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 PART I ITEM 1. BUSINESS MTS Systems Corporation (hereafter called "MTS" or "the Company" or "the Registrant") is a technology-based company providing engineering services, equipment, and software for applications in research, product development, quality control and production. MTS bases its business on a set of building-block technologies and business processes. Technologies include sensors for measuring machine and process parameters, control technologies for test and process automation, hydraulic and electric servodrives for precise actuation, and application software to tailor the test or automation system to the customer's needs and to analyze results. Business processes include project and product styles of operations on a worldwide basis. In combination, they offer solutions to customers in a variety of markets. In the Mechanical Testing and Simulation sector, customers use the Company's products and services in research, product development and quality control to determine the mechanical properties and performance of materials, products and civil structures. Many of the Company's products and services support the customers' mechanical design automation processes. In the Factory Automation sector, customers use the Company's measurement and control instrumentation to automate production processes. CUSTOMERS AND PRODUCTS BY BUSINESS SECTOR The Company's operations are organized into two business sectors: 1) Mechanical Testing and Simulation (MT&S), and 2) Factory Automation (FA). The operational alignment of the sectors allows the Company to maintain a strategic focus on markets with different applications of the Company's technologies and with different competitors. Mechanical testing and simulation sector: Customers in this sector use MTS's systems and software for research, product development and quality control in the design and manufacture of materials, products and structures. Customer industries in this sector include: AIRCRAFT AND AEROSPACE VEHICLE MANUFACTURERS AND THEIR SUPPLIERS: These customers use the Company's systems and software for full scale structural tests on complete vehicles and principal subsystems such as landing gear. In the aircraft industry, the Company's customers include manufacturers of commercial, military and general aviation planes and their suppliers, such as engine manufacturers. The space vehicle industry utilizes the Company's systems and software for such applications as solid fuel development and heat shield studies. Both aircraft and space vehicle manufacturers and their suppliers use the Company's systems and software to perform research on new materials and to control quality in the manufacturing of materials. CIVIL ENGINEERING: This market is comprised of university and government laboratories, and construction and mineral/petroleum production companies. Systems sold in this market include seismic (earthquake) simulators, civil construction component (e.g., beam) testing systems, pavement material testing systems, and specialized systems for rock and soil studies in construction and mineral/petroleum production. CONSUMER AND BIOMECHANICAL PRODUCTS/MATERIAL PRODUCERS: These use the Company's electromechanical and servohydraulic material testing systems in research, product development and are used extensively for quality control during production. Typical consumer products are made of textiles, paper products and plastic films of many types. Biomechanical products include implants, prostheses and other medical and dental devices and materials. Material producers include metal, ceramic, composite, paper and plastic manufacturers. GROUND VEHICLE INDUSTRY: This market consists of automobile, truck and off-road vehicle manufacturers and their suppliers. This market is the largest within the MT&S sector. Applications of the Company's systems and software include the design and production testing of engines and drivetrains, suspension and steering components, body and chassis, tires and wheels, and fuel storage and exhaust components. Vehicle manufacturers strive to improve performance, durability and safety, accelerate design development work and decrease the cost to manufacture their products and components. ADVANCED SYSTEMS: The Company also offers highly customized systems for simulation and testing through its Advanced Engineering Solutions Division (AESD). These systems frequently embody technology which is new to the application. Customers of AESD come from all industries served by the MT&S sector - aerospace and advanced materials, civil engineering, and ground vehicles - as well as customers from other industries interested in the development of new manufacturing technologies and systems such as welding and material processing. MT&S sector accounted for 79% of revenue in 1997, 82% of revenue in 1996 and 81% of revenue in 1995. It represents the oldest and is the principal market for the Company's technology. This sector is responsible for the Company's traditional corporate image: " a leading supplier of test equipment to laboratories." Factory Automation Sector: FA customers use MTS products in discrete part manufacturing and chemical process industries. Products in this sector include: DISPLACEMENT POSITION AND LIQUID-LEVEL SENSORS BASED ON MAGNETOSTRICTIVE TECHNOLOGY. Displacement sensors accurately measure position up to 50 feet. They are used in discrete (piece part) manufacturing where accurate positioning is critical. Major applications include injection molding and die casting machines, printing and packaging machines and presses of all types. Liquid level sensors accurately measure levels of liquids in tanks or vessels. These sensors are sold in three markets: the underground storage tank (UST) market, the production support tank (PST) market, and the large, above-ground inventory storage tank (AST) market. The UST market consists primarily of retail gas stations. It is served by original equipment manufacturers who purchase MTS sensing probes and incorporate them with their proprietary electronic unit to monitor fuel inventory and detect leaks. The PST market includes a wide variety of applications in the chemical, pharmaceutical and food and beverage industries. This market generally requires sensors less than 25 feet in length. The AST market of above ground liquid storage tanks and tank farms in the petroleum refining industry is the newest application for these sensors. This market requires sensors up to 100 feet in length. MTS also sells controlling and indicating instruments to this market for use on installations of up to several hundred tanks. SERVO MOTORS AND CONTROLLERS: Customers use high-performance brushless servo motors and amplifiers for challenging factory automation applications in a wide range of industries, including machine tools, fabrication and packaging. Specialized plug-in amplifiers are used in light duty applications such as the semiconductor and textile industries. The Company's controllers are used for precise control of a wide variety of applications ranging from simple applications requiring only one axis of control to high-speed, complex operations requiring up to 28 axes of control. These combined product lines address the need for high performance systems and are used primarily by original equipment manufacturers and large end users. The FA sector accounted for 21% of revenue in 1997, 18% of revenue in 1996, and 19% of revenue in 1995. COMMON TECHNOLOGIES MTS' systems and products in both sectors are constructed using employees' application engineering know-how with common technology building block components generally composed of measuring and actuation devices, electronic controls and application software. Many of these components are proprietary and are developed and manufactured within the Company. MTS employees engineer or configure the components into products and systems to match the application called for in the customer's order. Frequently, special-purpose software is developed to meet a customer's unique requirements. Such software often represents a significant part of the value added by the Company. Services offered to system customers include on-site installation, training of customer personnel, technical manuals and continuing maintenance. Such services are often included in the contract amount charged for completed systems, but these services may be purchased separately, during and after the system warranty period. Certain proprietary products, such as sensors, process controls, motors, actuators and process software and firmware are sold as products to end users and to other companies for incorporation into their systems, machines or processes. All products and most systems are sold on fixed-price contracts. Complex systems and applied research in the MT&S sector are in some cases undertaken on "cost-plus-fixed-fee" contract basis. 1997 PRODUCT DEVELOPMENT HIGHLIGHTS The Company funds new application and product development within its market sectors. Highlights of product development undertaken or completed in 1997 include: Mechanical Testing and Simulation Sector - ---------------------------------------- * The Company introduced the SWIFT(TM) spinning wheel integrated force transducer. Automotive engineers can use the same SWIFT transducer to measure both the forces a test vehicle experiences on the roadway and on an MTS Model 329 Road Simulator, resulting in high data correlation and playback accuracy, and more efficient test preparation and monitoring. * The Company introduced the MTS Motorcycle Simulator, a multi-axial road simulator for fatigue and durability testing of motorcycles. * The Company introduced the MTS Engineering Office(TM) NVH software which runs on the Microsoft Windows NT(TM) platform. This software is designed for use in automotive testing and development. Using NVH software, tests run on various MTS systems can be analyzed to determine the causes of noise, vibration, and harshness on vehicles, components and prototypes. * The Company introduced the TestWatch remote monitoring software for material testing. This software provides a convenient way for customers to monitor the status of their tests remotely via modem using Internet browser technology. Factory Automation Sector - ------------------------- * The Company introduced software modularity to its Temposonics(R) III linear displacement sensors. The Company expects the software modularity will broaden the applications for its sensors since they will be compatible with a wider number of industrial control architectures. * The Company introduced a line of high performance, configurable amplifiers that offers machine tool users efficient X-Y-Z axis control. The modular drive features a common power supply reducing AC wiring to a single connection. CHARACTERISTICS OF SALES The Company's systems and products are sold and delivered throughout the world and its customer orders cover a broad spectrum of industries, government agencies, institutions, applications and geographic locations. As such, MTS is not dependent upon any single customer for its business. MT&S systems range in price from less than $20,000 to over $20 million. Large, individual, fixed-price orders, generally considered to be over $10 million, although important to the Company's image and technical advancement, can produce volatility in both backlog and quarterly operating results. The majority of the orders received in any one year are based on fixed-price quotations and some require extensive technical communication with potential customers prior to receipt of an order. The current typical delivery time for a system ranges from one to twelve months, depending upon the complexity of the system and the availability of components in the Company's or suppliers' inventories. Larger system contracts can run as long as three years and cost-plus-fixed-fee contracts have run longer. FA products are sold in quantity at unit prices ranging from $500 to $10,000. Delivery varies from several days to several months. Approximately 47% of revenue in fiscal 1997, 49% of revenue in fiscal 1996, and 54% of revenue in 1995 was from domestic customers. The balance of the revenue, some of which was sold in currencies other than the U.S. dollar, was to customers located outside the United States--mainly in Europe, Asia-Pacific, Latin America and Canada. The Company's foreign operations and foreign revenues may be affected by local political conditions, export licensing problems and/or currency restrictions. Sales Channels: MTS markets its products using a number of sales channels. The Company sells its MT&S equipment through an employee sales network, independent sales representatives and a direct mail (catalog) operation. Sales personnel are generally graduate engineers or highly skilled technicians and are specially trained to sell MTS products and services. Employee salespersons are compensated with salary and sales incentives, and independent representatives are paid a commission. A list of major domestic and international offices for the Company's MT&S sector follows: Domestic offices: Akron Dayton Philadelphia Austin Denver Raleigh Baltimore Detroit Pittsburgh Boston Huntsville San Diego Chicago Los Angeles San Jose Cincinnati Minneapolis Seattle Dallas Washington, D.C. International offices: Beijing and other cities, Paris, France Peoples Republic of China Berlin and other cities, Seoul, South Korea Germany Torino, Italy Gothenburg, Sweden Stroud, United Kingdom Hong Kong Nagoya and Tokyo, Japan Singapore In addition, MTS works with sales and service representative organizations in nearly all industrialized countries of the world and in the developing countries of Latin America, Asia, Africa and the Middle East. The Company offers a mail-order catalog of material testing components, accessories and products. The catalog includes products of complementary vendors and aims to reach a broad range of customers involved in mechanical testing and simulation. The FA sector sells its products through sales channels separate from the MT&S sector. A network of employees, direct sales, external domestic distributors, representatives and system houses market the products of these divisions. International revenue currently accounts for 40% of this sector's volume. Efforts continue to expand sales channels in international markets. International Operations and Export Sales: The sections entitled Geographic Analysis of New Orders and Geographic Segment Information on pages 18 and 29 of the Company's 1997 Annual Report to Shareholders, which sections are incorporated by reference herein, contain information regarding the Company's operations by geographic area. Export Licensing: The Company's foreign shipments in fiscal 1997, 1996, and 1995 included sales to Asia-Pacific, Europe and other regions that may require the Company to obtain export permission from the U.S. government. The Company does not undertake manufacturing on custom systems or projects until it is assured that permission will be granted. However, due to the extended time to process and receive a license, design work is performed on some systems during the licensing period. Changes in political relations between the U.S. and countries requiring import licenses, as well as other factors, can adversely affect the Company's ability to complete a sale should a previously issued license be withdrawn. While political reform occurring internationally may relax export controls, the U.S. government still maintains multilateral controls in agreement with allies and unilateral controls based on U.S. initiatives and foreign policy that may cause delays for certain shipments or the rejection of orders by the Company. BACKLOG The Company's backlog, which it defines as firm orders remaining unfilled, totaled $175.8 million at September 30, 1997, $120.5 million at September 30, 1996, and $98.8 million at September 30, 1995. The Company believes that approximately $150 million of the backlog at September 30, 1997 will become revenue during fiscal 1998. Delays may occur due to technical difficulties, export licensing approval or the customer's preparation of the installation site. Any such delay can affect the period when backlog is recognized as revenue. COMPETITION In the MT&S sector, customers may choose to buy equipment from the Company or from competitors, principally: Instron (U.S.-based), Instron Schenck Testing Systems (U.S.-German joint venture) Interlachen (U.S.), SATEC (U.S.), AVL (Austria), Zwick (Germany), Saganomiya and Shimadzu (Japan). There are also smaller local competitors in most major countries. In lieu of buying equipment from the Company or its competitors, customers may contract with testing laboratories such as EG&G, Peabody, Wyle, or with universities. Government laboratories also market testing services to the public. Finally, customers may choose to construct their own testing equipment from commercially available components. Customers in the aerospace and automotive industries and universities sometimes choose this approach, purchasing equipment from companies such as Parker Hannifin, Moog and Mannesman (Germany). In the FA sector, the Company competes directly with small to medium-sized specialty suppliers and also with divisions of the large control system companies such as Rockwell, Emerson Electric, Mannesman (Germany) and Fanuc (Japan). MANUFACTURING AND ENGINEERING The Company conducted a significant portion of its fiscal 1997 MT&S manufacturing and engineering activities in Minneapolis. Certain engineering, project management, final system assembly and quality testing may be done in Berlin, Germany, and Tokyo, Japan. Electromechanical material testing systems are assembled in the Raleigh, NC, facility and in the Paris, France facility. The Company's MTS-PowerTek subsidiary engineers and assembles dynamometer control systems and provides related services from Detroit. Manufacturing and engineering activities for the FA sector occur in Raleigh, NC, in New Ulm, MN, in Ludenscheid, Freiburg, and Stralsund, Germany, and at the Company's majority-owned subsidiary in Nagoya, Japan. PATENTS AND TRADEMARKS The Company holds a number of patents, patent applications, licenses, trademarks and copyrights which it considers, in the aggregate, to constitute a valuable asset. The Company's system business is not dependent upon any single patent, license, trademark or copyright. RESEARCH AND DEVELOPMENT The Company does not do basic research, but does fund significant product, system and application developments. Costs of these development programs are expensed as incurred, and amounted to $17.5, $17.7, and $13.7 million for fiscal years 1997, 1996, and 1995 respectively. Additionally, the Company also undertakes "first of their kind" high-technology, customer-funded contracts which contain considerable technical pioneering. The combination of internally sponsored product development and system or application innovation on customer contracts approximates 10% of annual sales volume. EXECUTIVE OFFICERS OF THE COMPANY The Corporate Executive Officers of the Registrant on September 30, 1997 were: Name and Age Position Officer Since - ------------ -------- ------------- D. M. Sullivan (62) Chairman, President and 1976 Chief Executive Officer K. D. Zell (55) Executive Vice President 1979 W. G. Beduhn (56) Vice President 1983 M. L. Carpenter (60) Vice President 1973 and Chief Financial Officer M. G. Togneri (60) Vice President 1991 Officers serve at the discretion of and are elected annually by the board of directors, and serve until their successors are elected. EMPLOYEES MTS employed 1,981 persons as of September 30, 1997, including 397 employees in Europe, 49 in Japan, 13 in China, 5 in Canada, 11 in Korea, 4 in Hong Kong, and 2 in Singapore. None of the Company's U.S. employees are covered by a collective bargaining agreement, and MTS has experienced no work stoppages at any location. SOURCES AND AVAILABILITY OF RAW MATERIALS AND COMPONENTS A major portion of products and systems delivered to a customer may consist of equipment purchased from vendors. The relationship which the Company promotes with its vendors is one of close cooperation. The Company is dependent upon certain computing hardware and software devices and certain raw materials which have limited sources. However, the Company has not experienced significant problems in procurement or delivery of any essential materials, parts or components in the last several years. Due to the manner in which the Company sells the majority of its products, on a fixed-price contract agreed upon at the time the order is obtained, wide fluctuations up or down in cost of materials and components from order date to delivery date, if not accurately forecast by the Company at an early date, can change the expected profitability of any sale. The Company believes that such fluctuations have not had a material effect on reported earnings, except as affected by changes in foreign currency rates, which have been reported. ENVIRONMENTAL MATTERS Management believes the Company's operations are in compliance with federal, state and local provisions relating to the protection of the environment. BUSINESS SYSTEMS DEVELOPMENT The Company undertook the development and deployment of an enterprise-wide financial and business operations software system in 1997. The company expects to complete its first phase of implementation in late 1998, with subsequent phases to follow. This system is expected to improve business processing and to provide software processing capability beyond the end of the century. ITEM 2. PROPERTIES Domestic Facilities: The Company's corporate headquarters and main MT&S plant, occupying 410,000 square feet, is located on 56 acres of land in Eden Prairie, Minnesota, a suburb of Minneapolis. The original plant was completed in 1967. Six additions have expanded the plant to its present size. The most recent addition, in 1997, added 43,000 square feet of warehouse space and made available a similar amount of space for assembly and staging of larger projects. Approximately 50% of the Eden Prairie facility is used for manufacturing and assembly while the balance of the facility is used for office space. Electronic design and component assembly is conducted in a 57,000 square foot facility in Chaska, Minnesota, approximately 10 miles west of the headquarters in Eden Prairie. The building was completed in 1996. MTS has a five year operating lease with provisions to extend, purchase or terminate at the end of the lease period. The terms of the lease agreement do not require capitalization of the asset and the related obligation. Custom Servo Motors, Inc. occupies a 30,000 square foot plant in New Ulm, Minnesota (65 miles southwest of Minneapolis). The plant provides assembly operations and office space. The facility was constructed in 1993 by the New Ulm Economic Development Corporation and expanded in 1995. MTS has a five year operating lease for the facility with provisions to extend the lease, purchase the property, or terminate the lease. The terms of the lease agreement do not require capitalization of the asset and the related obligation. MTS Sensors Division is located near the Research Triangle Park in Cary, North Carolina, a suburb of Raleigh. A 40,000 square foot plant constructed in 1988 provides manufacturing and office space. In 1992, 25,000 square feet was added to the plant. MTD Raleigh is located adjacent to the MTS Sensors Division site in Cary, North Carolina. A 25,000 square foot plant, constructed in 1991, provides manufacturing and office space. MTS-PowerTek, Inc. occupies 20,000 square feet in Farmington Hills, Michigan, a suburb of Detroit. Plant and office space in two buildings is leased under conventional operating lease terms. The Company leases space in other U.S. cities for sales and service offices. Neither the space nor the rental obligations is significant. International Facilities: MTS Systems GmbH is located in a 80,000 square foot facility in Berlin, Germany. As of September 30, 1997 3,000 square feet has been leased to other companies. The building is situated on land leased by MTS from the city government. The lease expires in 2069. MTS Systems (France) operates in a leased facility in Paris, France, of approximately 38,000 square feet. Approximately 40% of this space is used for manufacturing with the remainder used as offices. The current lease expires at the end of fiscal 1998. MTS Sensors Technologie operates in a leased facility in Ludenscheid, Germany on approximately six acres of land. The manufacturing and office facilities occupy 18,000 square feet at this location. Custom Servo Motors Antriebstechnik Verwaltungs GmbH operates in three leased facilities in Germany, two in Freiburg, and one in Stralsund. The Freiburg facilities total about 7,500 square feet and the Stralsund location is about 7,000 square feet. Approximately 50% of the Freiburg facilities and 95% of the Stralsund facility are used for assembly with the remainder used as offices. The Company also leases office and general purpose space for its sales and service subsidiaries in Stroud, United Kingdom; Torino, Italy; Seoul, South Korea; Tokyo and Nagoya, Japan; Toronto, Canada; Sao Paulo, Brazil; Gothenburg, Sweden; Beijing and Shanghai, Peoples Republic of China; Singapore; and Hong Kong. No manufacturing is conducted at these locations. Expansion Opportunities: As noted above, the Company expanded its Eden Prairie facility by 43,000 square feet in 1997. Also in fiscal 1997 the company sold 50 acres of undeveloped property which was adjacent to its Eden Prairie facility. Room remains at its Eden Prairie location for limited facility expansions. Also, the sites in Cary could be expanded. Other suitable commercial real property is available for purchase or lease in metropolitan areas where the Company is presently located. The Company considers its current facilities adequate to support its operations in 1998. ITEM 3. LEGAL PROCEEDINGS No material legal proceedings were pending or threatened against the Company or its subsidiaries as of September 30, 1997. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted during the fourth quarter of the year ended September 30, 1997, for a vote by the shareholders. PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS The Company's stock is traded on The Nasdaq Stock Market's National Market (Nasdaq) under the symbol MTSC. The following table shows the Company's low and high closing sale transactions as reported by Nasdaq. Share prices for 1996 have been restated retroactively for the two-for-one stock split in the form of a 100% stock dividend effective April 1, 1996. Quarter Ended Low * High * ------------- ----- ------ December 31, 1995 $13.875 $17.75 March 31, 1996 $14.00 $19.375 June 30, 1996 $17.50 $22.50 September 30, 1996 $18.50 $21.50 December 31, 1996 $19.25 $21.50 March 31, 1997 $19.50 $22.625 June 30, 1997 $20.50 $30.50 September 30, 1997 $28.75 $39.25 * Source: The Nasdaq Stock Market, Inc. Summary of Activity Report At December 1, 1997 there were 1,575 holders of record of the Company's $.25 par value common stock. The Company estimates that there are an additional 2,000 shareholders whose stock is held by nominees or broker dealers. The Company has a history of paying quarterly dividends and expects to continue such payments in the future. During 1997, 1996 and 1995, the Company paid dividends totaling $.40, $.32 and $.28 per share, per year, respectively, to holders of its common stock. Under the terms of the Company's credit agreements, certain covenants require that tangible net worth, as defined, must exceed a defined minimum amount and limit repurchases of its common stock to a defined maximum amount. As of September 30, 1997, tangible net worth exceeded the minimum by $14.7 million and the Company had $15.1 million available for repurchases of its common stock. Thus, the Company has flexibility to declare and pay dividends in the future similar to recent dividends. ITEM 6. SELECTED FINANCIAL DATA A comprehensive summary of selected financial information is presented in the "Six Year Financial Summary" on page 17 of the Company's 1997 Annual Report to Shareholders. Data included in the summary is incorporated herein by reference. 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 on pages 18 through 22 of the Company's 1997 Annual Report to Shareholders is incorporated herein by reference. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The Consolidated Financial Statements, Report of Independent Public Accountants, Quarterly Financial Information (unaudited), and Six Year Financial Summary (unaudited) included in the Company's 1997 Annual Report to Shareholders are incorporated herein by reference. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT (a) Information concerning the Company's directors may be found in the Company's Proxy Statement, a definitive copy of which will be filed with the Securities and Exchange Commission prior to January 27, 1998, and is incorporated herein by reference. (b) See Item 1. Business, on page 8 for information on the Company's Executive Officers. (c) The Company has no other significant employees requiring disclosure in this Form 10-K. (d) There are no family relationships between and among directors or officers. (e) Business experience of Directors may be found in the Company's Proxy Statement, a definitive copy of which will be filed with the Securities and Exchange Commission prior to January 27, 1998, and is incorporated herein by reference. Business experience of the Executive Officers for at least the last 5 years (consisting of positions with the Company unless otherwise indicated) is as follows: Officer Business Experience ------- ------------------- D. M. Sullivan Chairman in 1994. Chief Executive Officer since 1987. President and Chief Operating Officer since 1982. Vice President from 1976 to 1982. Has extensive prior experience in the management of technology intensive businesses. K. D. Zell Executive Vice President of Mechanical Testing and Simulation sector in 1993. Vice President of Materials Testing Division from 1988 to 1993. Vice President, Sales and Service from 1984 to 1988. Vice President, Product Group from 1979 to 1984. Division manager, Hydro-Mechanical Products from 1978 to 1979. Officer Business Experience ------- ------------------- W. G. Beduhn Vice President of Advanced Engineering Solutions Division since 1991. Vice President of Technology Development from 1983 to 1991. Division manager of various marketing and operating divisions from 1977 to 1983. M. L. Carpenter Vice President and Chief Financial Officer since 1991. Vice President and Treasurer since 1973. M.G. Togneri Vice President of Factory Automation sector since 1991. Prior to his employment at MTS was V.P. at Square D Corporation and General Manager of Crisp Automation. Has extensive experience in the industrial instrumentation and control business in the U.S. and internationally. (f) Information regarding compliance with Section 16(a) of the Securities Exchange Act of 1934 is incorporated herein by reference from the Company's Proxy Statement, a definitive copy of which will be filed with the Securities and Exchange Commission prior to January 27, 1998, pursuant to Regulation 14A under the Securities Exchange Act of 1934. ITEM 11. EXECUTIVE COMPENSATION See Item 12. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by Items 11 and 12 is incorporated herein by reference from the Company's Proxy Statement, a definitive copy of which will be filed with the Securities and Exchange Commission prior to January 27, 1998, pursuant to Regulation 14A under the Securities Exchange Act of 1934. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS None. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K The following documents are filed as part of this report: (a) Financial Statements: See accompanying Index to Financial Statements on Page F-1. (b) Reports on Form 8-K: No reports on Form 8-K were filed during the fourth quarter of fiscal 1997. (c) Exhibits: 3.a Restated and amended Articles of Incorporation, adopted January 30, 1996, incorporated by reference from exhibit 3.a of Form 10-K for the fiscal year ended September 30, 1996. 3.b Restated Bylaws, reflecting amendments through May 15, 1995, incorporated by reference to exhibit 3.b of Form 10-K for the fiscal year ended September 30, 1995. 10.a Management Variable Compensation Plan, Fiscal 1997, dated November 22, 1996. 10.b 1985 Employee Stock Option Incentive Plan, incorporated by reference to exhibit 4(a) from Form S-8, File No. 2-99389. 10.c 1987 Stock Option Plan, as amended, incorporated by reference from exhibit 10.c of Form 10-K for the fiscal year ended September 30, 1996. 10.d 1990 Stock Option Plan, as amended, incorporated by reference from exhibit 10.d of Form 10-K for the fiscal year ended September 30, 1996. 10.e 1994 Stock Plan, as amended, incorporated by reference from exhibit 10.e of Form 10-K for the fiscal year ended September 30, 1996. 10.f Severance Agreement, dated May 1, 1990 between the Registrant and William G. Beduhn, incorporated by reference to exhibit 10.g of Form 10-K for the fiscal year ended September 30, 1996. 10.g Severance Agreement, dated May 1, 1990 between the Registrant and Marshall L. Carpenter, incorporated by reference to exhibit 10.i of Form 10-K for the fiscal year ended September 30, 1990. 10.h Severance Agreement, dated December 3, 1990 between the Registrant and Kenneth E. Floren, incorporated by reference to exhibit 10.k of Form 10-K for the fiscal year ended September 30, 1990. 10.i Severance Agreement, dated May 1, 1990 between the Registrant and Werner Ongyert, incorporated by reference to exhibit 10.m of Form 10-K for the fiscal year ended September 30, 1990. 10.j Severance Agreement, dated May 1, 1990 between the Registrant and J. Howell Owens, incorporated by reference to exhibit 10.n of Form 10-K for the fiscal year ended September 30, 1990. 10.k Severance Agreement, dated May 20, 1997 between the Registrant and Donald M. Sullivan, as amended. 10.l Severance Agreement, dated May 1, 1990 between the Registrant and Richard S. White, incorporated by reference to exhibit 10.q of Form 10-K for the fiscal year ended September 30, 1990. 10.m Severance Agreement, dated May 1, 1990 between the Registrant and Keith D. Zell, incorporated by reference to exhibit 10.r of Form 10-K for the fiscal year ended September 30, 1990. 10.n Severance Agreement, dated April 1, 1991 between the Registrant and Mauro G. Togneri, incorporated by reference to exhibit 10.s of Form 10-K for the fiscal year ended September 30, 1991. 10.o 1992 Employee Stock Purchase Plan, incorporated by reference to exhibit 4(a) from Form S-8, File No. 33-45386. 10.p 1997 Stock Option Plan, incorporated by reference to exhibit 10.p of Form 10-K for the fiscal year ended September 30, 1996 10.q Severance Agreement, dated September 30, 1996 between the Registrant and Steven M. Cohoon, incorporated by reference from exhibit 10.q of Form 10-K for the fiscal year ended September 30, 1996. 13. Annual Report to Shareholders for the fiscal year ended September 30, 1997. 21. Subsidiaries of the Company. 23. Consent of Independent Public Accountants. 27. Financial Data Schedule. (d) Financial Statement Schedules: See accompanying Index to Financial Statements on page F-1. SIGNATURES Pursuant to the requirement of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. MTS SYSTEMS CORPORATION By: /s/ Donald M. Sullivan ------------------------------------------ Donald M. Sullivan Chairman, Chief Executive Officer, President and Director By: /s/ Marshall L. Carpenter ------------------------------------------ Marshall L. Carpenter Vice President and Chief Financial Officer By: /s/ Marvin R. Eckerle ------------------------------------------ Marvin R. Eckerle Controller Date: December 19, 1997 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated: By: /s/ E. T. Binger ------------------------------------------ E. Thomas Binger, December 19, 1997 Director By: /s/ Charles A. Brickman ------------------------------------------ Charles A. Brickman, December 19, 1997 Director By: /s/ Bobby I. Griffin ------------------------------------------ Bobby I. Griffin, December 19, 1997 Director By: /s/ Russell A. Gullotti ------------------------------------------ Russell A. Gullotti, December 19, 1997 Director By: /s/ Thomas E. Holloran ------------------------------------------ Thomas E. Holloran, December 19, 1997 Director By: /s/ Thomas E. Stelson ------------------------------------------ Thomas E. Stelson, December 19, 1997 Director By: /s/ Linda Hall Whitman ------------------------------------------ Linda Hall Whitman, December 19, 1997 Director MTS SYSTEMS CORPORATION AND SUBSIDIARIES INDEX TO FINANCIAL STATEMENTS A. CONSOLIDATED FINANCIAL STATEMENTS Reference is made to the consolidated financial statements in the Company's 1997 Annual Report to Shareholders which are incorporated by reference in accordance with Rule 12b-23 under the Securities Exchange Act of 1934 and attached hereto. Annual Report 10-K Page Page ---- ---- Quarterly Financial Information (Unaudited) 22 --- Consolidated Balance Sheets - September 30, 1997 23 --- and 1996 Consolidated Statements of Income and Shareholders' Investment for the Years Ended September 30, 1997, 1996 and 1995 24 --- Consolidated Statements of Cash Flows for the Years Ended September 30, 1997, 1996 and 1995 25 --- Notes to Consolidated Financial Statements 26 --- Report of Independent Public Accountants 35 --- F-1 Annual Report 10-K Page Page ---- ---- B. REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULE --- F-3 C. CONSOLIDATED SCHEDULE Schedule Description - -------- ----------- II Summary of Consolidated Allowances for Doubtful Accounts --- F-4 All schedules except the one listed above have been omitted as not required, not applicable, or the information required therein is contained in the financial statements or the footnotes thereto. F-2 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULE To MTS Systems Corporation: We have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in MTS Systems Corporation's annual report to shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated November 21, 1997. Our audit was made for the purpose of forming an opinion on those statements taken as a whole. The schedule (page F-4) listed as a part of Item 14 in this Form 10-K is the responsibility of the Company's management and is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole. ARTHUR ANDERSEN LLP Minneapolis, Minnesota, November 21, 1997 F-3 MTS SYSTEMS CORPORATION AND SUBSIDIARIES SCHEDULE II - SUMMARY OF CONSOLIDATED ALLOWANCES FOR DOUBTFUL ACCOUNTS FOR THE YEARS ENDED SEPTEMBER 30, 1997, 1996 AND 1995 Balance Provision Amounts Balance Beginning Charged to Written End of of Year Operations Off Year ------- ---------- --- ---- (expressed in thousands) 1997 $1,742 $449 $(181) $2,010 1996 1,824 330 (412) 1,742 1995 1,439 620 (235) 1,824 F-4 EXHIBIT INDEX Exhibit No. Description --- ----------- 10.a Management Variable Compensation Plan-Fiscal 1997 10.k Severance Agreement, dated May 20, 1997, as amended 13. Annual Report to Shareholders for the fiscal year ended September 30, 1997 21. Subsidiaries of the Company 23. Consent of Independent Public Accountants 27. Financial Data Schedule EX-10.A 2 MANAGEMENT VARIABLE COMPENSATION (MVC) PLAN EXHIBIT 10.a (Approved by the Human Resources Committee November 22, 1996) MANAGEMENT VARIABLE COMPENSATION (MVC) PLAN FISCAL'97 1. PURPOSE OF PLAN To focus efforts on achievement of objectives which are critical to the success of the Company; to reward accomplishment at a level above competition when performance is above that of comparable companies; to more closely couple total compensation costs (salary plus variable) to the financial results of the enterprise. The Plan's payout is primarily related to achievement of Corporate/Sector/Division/Niche profit and growth objectives. Other measurable objectives may be included at the discretion of the cognizant officer with approval by the CEO. 2. RELATIONSHIP TO OTHER COMPENSATION PLANS 2.a SALARY PLAN The midpoint of a given salary range will be suppressed by 1/4th of the average competitive payout potential of participants in that range to conform to the Company's fixed vs. variable compensation strategy (i.e., if the participants in a range have an average competitive payout potential of 20%, the midpoint of that range will be suppressed 5%). 2.b "NON MANAGEMENT" VARIABLE COMPENSATION PLAN (NMVC) Certain units may have a variable compensation plan for employees who are not eligible for the MVC, sales commissions, or other variable compensation plans. Payout in these NMVC Plans is linked directly to payout on the unit's MVC profit objectives. These non-management plans are subject to the approval of the unit vice president, corporate Human Resources manager and CEO. The following is an outline summary to which these NMVC plans must adhere. They are included in this MVC Plan for reference only. 2.b(1) NMVC Competitive payout potential is 3% of the midpoint of the salary range in which the employee is placed at the beginning of the fiscal year. 2.b(2) NMVC payout will normally be based on the results of the employee's unit vice president's (in some cases the unit manager's) profit objective(s) for the year. If the unit's vice president (manager) has more than one such objective, the payout will be based on the weighted average of the officer's objectives. 2.b(3) The entire 3% NMVC payout potential is eligible for overranging for participating employees. The overranging will be at the same ratio as the unit officer (manager's) profit objective(s) overranging, if any. 2.b(4) Eligibility and participation rules for NMVC will be the same as those for MVC, where appropriate. 2.c RETIREMENT PLAN The calculations for the Management Variable Compensation Plan (and "NMVC") are made after deductions for retirement plans. Payout to a U.S. based participant in the Management Variable Compensation Plan (and "NMVC") is included in the calculation of the Company's contribution to that employee's retirement plan. 3. ELIGIBILITY AND PARTICIPATION * Corporate officers * Unit vice presidents * Market and functional unit managers * Managers, technical supervisors and key marketing or technical employees who meet certain minimum responsibilities for profitability, financial/human resource acquisition and allocation, balance sheet control, and/or market/technical direction - defined as beginning at SAM 15 and TE 5, or equivalent. An employee must be in such a position by the November Board of Directors meeting in order to be eligible for the fiscal year plan beginning the preceding 1 October, unless otherwise authorized by the CEO. Certain subsidiaries may have other management variable compensation plans approved by the cognizant corporate vice president, corporate HR manager and CEO. An officer may recommend that an employee, who is otherwise eligible, not participate but such a recommendation must be agreed to by the CEO. Participants are eligible for payout in proportion to the % of the fiscal year the participant is responsible for the qualifying position, unless otherwise authorized by the CEO. Employees who work less than full time during a year (e.g., due to a personal leave, but not due to illness) would earn a proportionately reduced payout. Unless authorized by the CEO, no payout will be made to employees who work less than 1,000 hours in the fiscal year. The participant must be on MTS' payroll at the end of the fiscal year to qualify for a payout. Employees resigning or terminated before the end, regardless of cause, are not eligible unless otherwise authorized by the CEO. (An example of an exception could be early retirement or voluntary separation under a workforce reduction plan.) No employment contract is implied by participation in this Plan. 4. ESTABLISHMENT OF OBJECTIVES a. The Board of Directors sets the CEO's Corporate profit objectives (Return on Beginning Equity [ROBE]/share and Return on Average Net Assets [ROANA]), the revenue growth objective, and the CEO's individual "other" objective, at their November meeting. b. Profit objectives for other participants (typically ROANA, but may be contribution or pretax for other than officers) and their revenue growth objective will also be finalized by the November Board of Directors' meeting. They are not renegotiable. All other objectives must be finalized by 15 December. The cognizant officers and CEO approve the profit and revenue growth objectives for other participants. The purpose of these approvals is to: * Integrate objectives into Company operating plan * Guard against conflicting objectives * Help to assure consistency in degree of difficulty The cognizant vice president and one other manager approve all "other" objectives c. Each participant whose competitive payout potential exceeds 10% will have a mix of objectives per paragraph 7. 5. CRITERIA FOR OBJECTIVES 5.a CORPORATE The Corporate Profit and Growth, Objectives are set by the Board based on the current 3 Year Business Plan. Currently they are: ROBE/Share: 15% return on beginning equity/share (span -1/3 to + 2/3) ROANA: 21% (span -1/3 to + 2/3), calculated with net assets including cash above short term borrowings. (Both ROBE and ROANA may be increased in '98 based on an analysis of comparable company performance and MTS's cost of capital.) Revenue Growth 12% /year; span +/-1/3 All objectives include all transactions, acquisitions, write-offs, sale of assets, etc. unless specifically excluded by the Board in writing. 5.b UNIT Sector/Division/Niche profit and growth objectives are set as appropriate for the 3 Year Business Plan for the unit. For example, (MT&S + MTS PowerTek + ASD) ROANA objectives are 19.25% cashless for '97; and 22.5% cashless for '98. Sector/Niches whose ROANA budget in a given year exceeds the equivalent of the Corporate ROANA goal without cash (22.5%) could have their budget number as their MVC goal, but it would not more than 120% of the equivalent Corporate goal (1.2x22.5=27%) Revenue growth objectives are set on a year-to-year basis using the current three year business plan as a reference. "Other" objectives must be stated in measurable terms and must not be activities (i.e. number of sales calls or technical society presentations). 6. COMPETITIVE PAYOUT POTENTIAL The competitive payout potential, when added to the mid-point of the salary range is intended to yield total cash compensation somewhat above that of comparable companies to compensate for the salary suppression (ref. 2a). The competitive payout potential, expressed as a % of the midpoint of the salary structure, or actual salary in the case of subsidiary management, is shown below:
POSITION COMPETITIVE PAYOUT POTENTIAL % CEO E5 70 Executive Vice President, MT&S E-4 50 Vice President E-3 25-50, depending on revenue level (profit potential) Vice President E-2 25-50, depending on revenue level (profit potential) Vice President (Unit) E-1 15-45, depending on revenue level (profit potential) Market Division P&L Mgrs. SAM 17-21 15-35, depending on revenue level (profit potential) All Other Management/ Leadership SAM 18-21 10-25, depending on profit impact SAM 15-17 6-20, depending on profit impact TE 5/5S -9/9S 6-15, depending on profit impact
7. OVERRANGING/MAXIMUM POTENTIAL PAYOUT The objectives are set at challenging but realistic levels which are used in the overall process of planning and resource allocation. This is not meant to be a limit to our aspirations, and performance above of those objectives should be rewarded as it is to the benefit of all stakeholders in the enterprise. Payout above the competitive payout potential is termed overranging. Two MVC mixes are possible for participants with a competitive payout potential of 15% or higher. Both versions yield the same maximum potential expressed at a percentage of competitive payout. A) Financial objective at 70% with 300% overranging (O.R.) Other objectives including revenue growth at 30% with no O.R. (70 x 3) + (30 x 1) = 240% B) Financial objectives at 60% with 300% O.R. Revenue growth objective at 20% with 200% O.R. Other objectives at 20% without O.R. (60 x 3) + (20 x 2) + (20 x 1) = 240% The unit VP and CEO determine which mix is appropriate for each participant 8. PAYOUT Payouts under this Plan (and the Non Management Variable Compensation Plan) are considered costs for the calculation of profit objectives (EPS/ROANA/Pretax/Contribution); so simultaneous equations are used for calculations. Payouts are audited by the manager of internal audit and approved by the CFO. Payout will be made within 90 days of the end of the fiscal year. 9. APPROVAL OF PLAN The Plan, and participation therein, are subject to annual review and approval by the Board of Directors. Attachments: FY "97MVC Plan Participation Short Form Schedule of CEO and direct report Objectives EX-10.K 3 SEVERANCE AGREEMENT EXHIBIT 10.k SEVERANCE AGREEMENT AGREEMENT made as of this 20th day of May, 1997 by and between MTS Systems Corporation, a Minnesota corporation ("MTS") and Donald M. Sullivan (the "Executive"). WHEREAS, MTS considers the establishment and maintenance of a sound and vital management to be essential to protecting and enhancing the best interests of MTS and its shareholders; and WHEREAS, Executive has made and is expected to make, due to Executive's intimate knowledge of the business and affairs of MTS, its policies, methods, personnel and problems, a significant contribution to the profitability, growth and financial strength of MTS; and WHEREAS, Executive is willing to remain in the employ of MTS upon the understanding that MTS will provide income security if the Executive's employment is terminated under certain terms and conditions; THEREFORE, in consideration of the foregoing and other respective covenants and agreements of the parties herein contained, the parties hereto agree as follows: 1. Term of Agreement. This Agreement shall commence on the date hereof and shall continue in effect until the earlier of (a) September 30, 2000, (b) the date the Executive and MTS agree in writing to terminate this Agreement, or (c) the Date of Termination indicated under paragraph 2, 3, or 4 hereunder. Notwithstanding the preceding sentence, if a change in control occurs, this Agreement, except for subparagraph 4(b), shall be superseded by the provisions of any other Agreement in effect between the Executive and MTS which contains provisions relating to benefits due Executive following a Change in Control if the Executive would receive greater benefits thereunder. If this Agreement has not terminated under (b) or (c) by September 30, 2000, it shall automatically renew for successive one-year terms effective October 1, 2000 (and each successive October 1 thereafter during which the Agreement remains in effect) unless Executive or MTS has provided a Notice of Termination to the other party prior to the October 1 renewal date. 2. Termination by Reason of Death or Disability. In the event of the Executive's death or disability while employed by MTS, Executive shall be entitled to such benefits provided under any policy, plan or program governing death or disability maintained by MTS and covering such Executive. The determination of disability and the amount and entitlement of benefits shall be governed by the terms of such policy, plan or program. The gross (pre-tax) benefits which Executive receives under subparagraph 4(a) shall be reduced by any gross (pre-tax) benefits which Executive receives under any MTS disability or life insurance policy, plan or program for which MTS paid the premiums, including if those premiums were reported as taxable income to Executive. 3. Termination for Cause. (a) If Executive's employment shall be terminated by MTS for Cause, MTS shall pay to Executive his full base salary through the Date of Termination at the rate in effect at the time of Notice of Termination is given and MTS shall have no further obligation to Executive under this Agreement. (b) Termination by MTS of Executive's employment for "Cause" shall mean termination as a result of: (i) the conviction of the Executive by a court of competent jurisdiction for felony criminal conduct; or (ii) willful misconduct by the Executive; or (iii) violation by the Executive of any employment agreement applicable to the Executive. 4. Termination Other Than for Cause. Except for Cause or Change in Control, Executive will be Chief Executive Officer at least until October 1, 1997 and Chairman of the Board until January 28, 1998, and neither party will terminate the employment relationship before January 28, 1998. If Executive's employment is terminated by MTS other than for Cause or if Executive voluntarily terminates his employment, including because a successor to the assets of MTS fails to assume MTS's obligations under this Agreement, Executive shall be entitled to the following benefits: (a) Executive shall be paid a monthly Severance Payment of an amount equal to the Executive's Monthly Gross Income, as defined in subparagraph (vi) below, for the time periods set forth in subparagraphs (i) through (v) below. (i) If Executive's Date of Termination is on or before April 30, 1998, Severance Payments shall be paid to Executive for 24 months. (ii) If Executive's Date of Termination is between May 1, 1998 and September 30, 1998, Severance Payments shall be paid to Executive for the number of months indicated below. Month in which Date Months of Severance of Termination Occurs Payments --------------------- -------- May, 1998 23 June, 1998 22 July, 1998 21 August, 1998 20 September, 1998 19 (iii) If Executive's Date of Termination is between October 1, 1998 and September 30, 1999, Severance Payments shall be paid for 18 months. (iv) If Executive's Date of Termination is between October 1, 1999 and February 28, 2000, Severance Payments shall be paid for the number of months indicated below. Month in which Date Months of Severance of Termination Occurs Payments --------------------- -------- October, 1999 17 November, 1999 16 December, 1999 15 January, 2000 14 February, 2000 13 (v) If Executive's Date of Termination is on or after March 1, 2000, Severance Payments shall be paid for 12 months. (vi) For purposes of this Agreement, Monthly Gross Income shall mean the sum of the following amounts, subject to applicable federal and state withholding. (A) 1/12 of the highest average base salary for any 12-consecutive month period during the 36 calendar month period ending immediately prior to the Date of Termination; plus (B) 1/36 of the total Management Variable Compensation earned during the 3 most recent fiscal years ending immediately prior to the Date of Termination; plus (C) the product of the average percentage of MTS profit sharing contributions to the MTS Systems Corporation Profit Sharing Retirement Plan and Trust (as a percent of Compensation as defined in the Plan) for the 3 most recent Plan Years ending immediately prior to the Date of Termination multiplied by the sum of (i) and (ii) above. (b) MTS shall continue to pay the employer share of Executive's MTS group life, disability, accident and health insurance benefits until Executive's Date of Termination. Thereafter, the following shall occur: (i) If Executive's Date of Termination occurs prior to September 30, 1998, MTS shall continue to pay the employer share of Executive's said group benefit premiums until that date. (ii) Effective October 1, 1998 and until September 30, 2000, MTS shall pay 50% of said group benefit premiums. All premium payments made on Executive's behalf following his Date of Termination and Executive's continued participation in the plans are contingent upon Executive making the appropriate timely written election to continue his group benefits following his Date of Termination, said group benefits continuing in effect for active MTS employees, and Executive continuing to be eligible under the terms of the plans and applicable laws. Executive shall be responsible for payment of his portion of the premiums for such benefits. MTS may deduct from its payments to the Executive those amounts. Benefits otherwise receivable by Executive pursuant to this subparagraph (b) shall be reduced or eliminated to the extent comparable benefits are actually received by Executive during such period from a source outside MTS, and any such benefits actually received by Executive shall be reported to MTS. (c) MTS shall pay to Executive all legal fees and expenses reasonably incurred by Executive in seeking to obtain or enforce any right or benefit to which he is entitled under this Agreement. (d) Executive shall be entitled to receive all benefits payable to the Executive under the MTS Systems Corporation Profit Sharing Retirement Plan and any other plan or agreement relating to retirement benefits. (e) Executive shall receive, on the date of this Agreement, an option to purchase 50,000 shares of MTS common stock. Such option shall be granted pursuant to one or more Option Agreements, substantially in the form of Exhibit A, and shall have the following terms: The option shall be immediately vested and exercisable and shall be transferrable to the extent provided under the MTS 1997 Stock Option Plan. The exercise period of the option shall expire on the fifth anniversary of the date of execution of this Agreement by the Executive. The exercise price shall equal the closing price of the Company's common stock on the NASDAQ national market on the date of this Agreement, subject to adjustment in certain events as provided in the Option Agreement. Executive's rights under any existing Option Agreements and under any other options which the Executive may be granted in the future, shall remain in full force and effect including, in particular, the expiration of the exercise period for such options as contained in the Option Agreements. Nothing under this Agreement or under the Option Agreement referred to above, shall extend the exercise period for any existing options or any future options granted to Executive. 5. No Mitigation. Executive shall not be required to mitigate the amount of any payment provided for in this Agreement by seeking other employment or otherwise; nor shall the amount of any payment or benefit provided for in this Agreement be reduced by any compensation earned by Executive as the result of employment by another employer or by retirement benefits after the Date of Termination or otherwise except as specifically provided herein. 6. Non-Competition and Confidentiality. (a) Executive agrees that, as a condition of receiving benefits under this Agreement, he will not render services directly or indirectly to any competing organization located in any market in which MTS is doing business as of Executive's Date of Termination for the period of time during which Executive is receiving benefits under this Agreement or any other Agreement containing Change in Control provisions, in connection with the design, implementation, development, manufacture, marketing, sale, merchandising, leasing, servicing or promotion of any "Conflicting Product" which as used herein means any product, process, system or service of any person, firm, corporation, organization other than MTS, in existence or under development, which is the same as or similar to or competes with, or has a usage allied to, a product, process, system, or service produced, developed, or used by MTS. MTS agrees that it will respond in writing to Executive within 15 days of its receipt of Executive's written inquiry to the Board as to whether an activity proposed by him would constitute competition under this subparagraph. If MTS fails to respond to Executive as set forth in the preceding sentence, Executive's proposed activity shall be deemed not to constitute competition under this subparagraph. MTS agrees that its approval of such proposed activity by Executive shall not be unreasonably withheld. Executive agrees that violation of this covenant not to compete with MTS shall result in immediate cessation of all benefits hereunder, other than insurance benefits, which Executive may continue where permitted under federal and state law at his own expense. (b) Executive further agrees and acknowledges his existing obligation that, at all times during and subsequent to his employment with MTS, he will not divulge or appropriate to his own use or the uses of others any secret or confidential information pertaining to the business of MTS, or any of its subsidiaries, obtained during his employment by MTS or any of its subsidiaries. 7. Successors; Binding Agreement (a) MTS will require any successor (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of MTS to expressly assume and agree to perform this Agreement in the same manner and to the same extent that MTS would be required to perform it if no such succession had taken place. Failure of MTS to obtain such assumption and agreement prior to the effectiveness of any such succession shall be a breach of this Agreement and shall entitle Executive (i), if Executive is still employed by MTS, to terminate his employment by written Notice of Termination and to receive the compensation and benefits from MTS described in this Agreement as if his termination was by MTS other than for Cause, or (ii) if Executive is no longer employed by MTS but is receiving benefits hereunder, to accelerate all remaining benefits due him hereunder and receive them, to the extent possible, in a lump sum, upon his written notice to the Board. (b) This Agreement shall inure to the benefit of and be enforceable by Executive's personal or legal representatives, heirs, and designated beneficiaries. If Executive should die while any amount would still be payable to Executive hereunder if the Executive had continued to live, all such amounts, unless otherwise provided herein, shall be paid in accordance with the terms of this Agreement to the Executive's designated beneficiaries, or, if there is no such designated beneficiary, to the Executive's estate. 8. Notice of Termination. (a) Any purported termination of Executive's employment by either Executive or MTS under this Agreement shall be communicated by written notice to the other party. (b) For purposes of this Agreement, "Date of Termination" shall mean the date specified in the written Notice of Termination which shall not be less than 10 nor more than 30 days from the date such Notice of Termination is given. (c) Notice of Termination and all other communications provided for in the Agreement shall be deemed to have been duly given when delivered or mailed by United States registered or certified mail, return receipt requested, postage pre-paid, addressed to the last known residence address of the Executive or in the case of MTS, to its principal office to the attention of each of the then directors of MTS with a copy to its Secretary, or to such other address as either party may have furnished to the other in writing in accordance herewith, except that notice of change of address shall be effective only upon receipt. 9. Release of Claims. Executive's right to the benefits and payments described in paragraph 4 of this Agreement is contingent upon Executive's execution of a severance release agreement which shall be provided to Executive by MTS with or following his Notice of Termination. The severance release agreement shall require a full release of all claims which Executive may have against MTS or any MTS affiliate or individual associated with MTS. 10. Injunctive Relief. Executive consents that, in the case of any violation or threatened violation of paragraph 6 of this Agreement, MTS may apply for and secure injunctive relief, temporary or provisional, in court, without bond but upon due notice, pending final resolution on the merits pursuant to arbitration as set forth in paragraph 11 hereof. No waiver of any violation of this Agreement shall be implied from any failure by MTS to take action under this paragraph. 11. Arbitration. Any and all claims or disputes between Executive and MTS (including the validity, scope, and enforceability of this paragraph), except as otherwise provided under paragraph 10, shall be submitted for arbitration and resolution to an arbitrator. No demand for arbitration may be made after the date when the institution of legal or equitable proceedings based on such claim or dispute would be barred by the applicable statute of limitation. The arbitrator shall be selected by mutual agreement of the parties. Unless otherwise provided for in this Agreement, the Expedited Labor Arbitration Rules of the American Arbitration Association shall apply. If the parties are unable to agree upon an arbitrator, any such dispute shall be solely and finally settled by arbitration in accordance with the Expedited Labor Arbitration Rules of the American Arbitration Association ("AAA"). The parties agree that no punitive damages shall be awarded hereunder. The parties also agree that all awards, decisions and remedies in favor of a winning party hereunder with respect to any issue shall be proportional to the violation caused by the losing party with respect to that issue. All costs in conducting the arbitration, including but not limited to the arbitration filing fee, the arbitrator's fees and expenses, and the reasonable attorney's fees and expenses of the prevailing party (including the attorney's fees and costs incurred by the prevailing party in seeking or resisting temporary or provisional court relief as set out in paragraph 10 above), shall be the responsibility of the losing party. In the event there is more than one issue in dispute and there is no one prevailing party with respect to all issues in dispute, costs and attorney's fees shall be prorated by the arbitrator according to the relative dollar value of each issue. The arbitrator's Award shall be final and binding. In the event either party must resort to the judicial process to enforce the provisions of this Agreement, the award of an arbitrator or equitable relief granted by an arbitrator, the party seeking enforcement shall be entitled to recover from the other party all costs of litigation including, but not limited to, reasonable attorney's fees and court costs. The arbitration proceedings and Award shall be maintained by both parties as strictly confidential, except as otherwise required by court order and with respect to the parties' attorneys and tax advisors, and, with respect to MTS, members of its management, and, with respect to Executive, his family. 12. Miscellaneous. (a) No provision of this Agreement may be modified, waived or discharged unless such waiver, modification or discharge is agreed to in writing and signed by the parties. No waiver by either party hereto at any time of any breach by the other party to this Agreement of, or compliance with, any other party shall be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior or similar time. (b) No agreements or representations, oral or otherwise, express or implied, with respect to the subject matter hereof have been made by either party which are not expressly set forth in this Agreement. (c) The validity, interpretation, construction and performance of this Agreement shall be governed by the laws of the State of Minnesota. (d) Any provision of this Agreement which conflicts with applicable law shall be modified to the extent necessary to ensure its enforceability. The invalidity or unenforceability or any provision of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement, which shall remain in full force and effect. This Agreement supersedes the Employment Agreements between MTS and the Executive dated 25th of January, 1984 and May 1, 1990. IN WITNESS WHEREOF, MTS, through its authorized officer, and the Executive have executed this Agreement as of the day and date first above written. EXECUTIVE: MTS SYSTEMS CORPORATION By ------------------------------ ----------------------------- Donald M. Sullivan Its ----------------------------- FIRST AMENDMENT TO SEVERANCE AGREEMENT THIS AGREEMENT, made as of this 19th day of August, 1997, amends the Severance Agreement between MTS SYSTEMS CORPORATION, a Minnesota corporation (the "Company") and DONALD M. SULLIVAN, an employee of the Company (the "Employee") dated as of May 20, 1997. WHEREAS, the Company on May 20, 1997, granted to the Employee, pursuant to subparagraph 4(e) of the Severance Agreement and in accordance with the terms of the Nonqualified Stock Option Agreement also dated May 20, 1997, the right and option to purchase up to 50,000 shares of common stock of the Company on the terms and conditions set forth therein; and WHEREAS, the Employee and the Company desire that the number of Shares granted to Employee pursuant to the Severance Agreement and under the terms of the Nonqualified Stock Option Agreement be reduced to 40,000 Shares; THEREFORE, the parties hereto agree that Subparagraph 4(e) of the Severance Agreement be and hereby is amended to reduce the number of shares subject to the option grant from 50,000 Shares to 40,000 Shares, by substituting "40,000" for "50,000" on the second line of said Subparagraph. Except as and set forth above, the terms and conditions of the Severance Agreement dated as of May 20, 1997 be and hereby shall remain in full force and effect including, but not limited to, the exercise price per Share upon exercise and the date of expiration of the Option. IN WITNESS WHEREOF, the Company has duly executed this Agreement and the Employee has hereunto set his hand as of the day and year first above written. MTS SYSTEMS CORPORATION By: By: Assistant Secretary EMPLOYEE Donald M. Sullivan NONQUALIFIED STOCK OPTION AGREEMENT THIS AGREEMENT, made as of the 20th day of May, 1997, between MTS SYSTEMS CORPORATION, a Minnesota corporation (the "Company") and DONALD M. SULLIVAN, an employee of the Company or of a subsidiary corporation of the Company (the "Employee"). The Company desires, by affording the Employee an opportunity to purchase its Common Shares, par value $0.25 (hereinafter sometimes called "Shares"), to provide the Employee with an added incentive to extend his period of service to the Company, and through a proprietary interest, to increase his personal participation in the success of the Company. THEREFORE, the parties agree: 1. The Company hereby irrevocably grants to the Employee, as a matter of separate agreement and not in lieu of salary or any other compensation for services, the right and option (the "Option"), to purchase all or any part of an aggregate of 50,000 Shares on the terms and conditions herein set forth, at the price of $22.25 per Share. These Shares are issued to the Employee directly from the authorized but unissued stock of the Company and are not issued pursuant to any existing stock option plan of the Company. 2. Subject to the other provisions of this Agreement, this Option shall be exercisable immediately after the date of this Agreement and Shares may be purchased at any time thereafter until expiration of the Option. This Option shall expire, and neither the Employee nor his transferee as defined in Section 6 may exercise this Option after the 20th day of May, 2002. 3. This Agreement does not confer any right with respect to continuance of employment by the Company or by a subsidiary of the Company, nor will this Agreement interfere in any way with the Employee's right, or Employee's employer's right, to terminate Employee's employment at any time. 4. The Employee shall have none of the rights of a shareholder with respect to the Shares subject to this Option until the Shares shall have been issued to Employee upon exercise of the Option. 5. Except as provided in Section 6, this Option shall not be transferable by the Employee (or by his transferee as provided in Section 6) otherwise than by will or the laws of descent and distribution, and is exercisable, during Employee's lifetime, only by Employee. Any attempt to assign, transfer, pledge, hypothecate, or otherwise dispose of this Option contrary to the provisions of Sections 5 or 6, or any attachment or similar process upon this Option, shall be null and void and without effect. 6. The Employee may transfer this Option in whole or in increments of 1,000 Shares to (a) the Employee's spouse, children or grandchildren ("Immediate Family Members"), (b) a trust or trusts for the exclusive benefit of the Employee and/or such Immediate Family Members, or (c) a partnership or partnerships in which the Employee and/or such Immediate Family Members are the only partners, provided that (i) there is no consideration for any such transfer, and (ii) subsequent transfers of transferred Options shall be prohibited except to other Immediate Family Members of the Employee or by the laws of descent and distribution of the transferee. Following transfer, the Option or Options shall continue to be subject to the same terms and conditions as were applicable immediately prior to transfer, provided that the term Employee herein shall in such event be deemed to refer to the transferee. 7. In the event this Option is being exercised by any person or persons other than the Employee, the notice of exercise shall be accompanied by an appropriate proof of the right of such person or persons to exercise this Option. 8. The Employee understands that upon exercise of this Option, in whole or in part, that the Shares purchased may not be sold, transferred, pledged or otherwise disposed of unless the Shares are registered under the Securities Act of 1933, or unless the Company has received an opinion of counsel satisfactory to the Company that said registration is not required. 9. In the event that the Employee breaches the terms of the Non-Competition and Confidentiality provisions described in Section 6 of the Employee's Severance Agreement dated May 20, 1997, any Options which are unexercised shall immediately be forfeited and shall not thereafter be exercisable. In addition, the Company shall have the right to repurchase for cash any shares of the Company's common stock acquired by the Employee as a result of the exercise of any portion or all of this Option and held by either the Employee or by any Immediate Family Member or by any trust or partnership in which Employee or any Immediate Family Member has a beneficial interest. The Company shall give the Employee written notice of the exercise of its right to repurchase and shall close on the repurchase no later than three months after the date of that notice. The purchase price for the shares so purchased shall be the purchase price for Option Shares under this Option Agreement or the closing bid price for shares of the Company's common stock on the date of the Company's notice, whichever is lower. 10. In the event that the Employee breaches the terms of the Non-Competition and Confidentiality provision described in Section 6 of the Employee's Severance Agreement dated May 20, 1997, Employee shall pay to the Company in cash, upon demand, all gains or other economic value actually or constructively received by Employee, any Immediate Family Member or any trust or partnership in which Employee or any Immediate Family Member has a beneficial interest, upon the sale of any Option Shares in connection with the Employee's or transferee's exercise of any portion or all of the Option under this Option Agreement, equal to the difference between the purchase price for Option Shares under this Option Agreement and the value received upon the sale of any such shares. The foregoing payment will apply to all such sales which occur at any time after that date which is 12 months prior to the date of the termination of the employment of the Employee. 11. This Option Agreement shall be administered by the Compensation Committee of the Board of Directors consisting of at least two Directors, all of whom shall be Outside Directors and Non-Employee Directors, who shall serve at the pleasure of the Board. 12. The Committee shall have the authority to adopt, alter and repeal such administrative rules, guidelines and practices governing this Option as it shall, from time to time, deem advisable; to interpret the terms and provisions of the Option Agreement and to otherwise supervise the administration of the Option. 13. All decisions made by the Committee pursuant to the provisions of the Option shall be final and binding on all persons, including the Company, Employee and the Employee's Immediate Family Members. 14. In the event of any merger, reorganization, consolidation, recapitalization, stock dividend, other change in corporate structure affecting the Shares or spin-off or other distribution of assets to shareholders, such substitution or adjustment shall be made in the number and option price of Shares subject to this Option, as may be determined to be appropriate by the Committee, in its sole discretion, provided that the number of Shares subject to any award shall always be a whole number. 15. The grant of this Option shall not limit in any way the right or power of the Company to make adjustments, reclassifications, reorganizations or changes of its capital or business structure or to merge, exchange or consolidate or to dissolve, liquidate, sell or transfer all or any part of its business or assets. 16. This Option may be exercised in whole or in part at any time during the exercise period by giving written notice of exercise to the Company, specifying the number of Shares to be purchased. Such notice shall be accompanied by payment in full of the purchase price, either by certified or bank check, or by any other form of legal consideration deemed sufficient by the Committee and consistent with applicable law, including promissory notes or a properly executed exercise notice together with irrevocable instructions to a broker acceptable to the Company to promptly deliver to the Company the amount of sale or loan proceeds to pay the exercise price. Payment in full or in part may also be made in the form of unrestricted Shares already owned by the Employee (which in the case of Stock acquired upon exercise of the Option have been owned for more than six months on the date of surrender). All or part of the option exercise price made be paid by having the Company withhold from the Shares that would otherwise be issued upon exercise that number of Shares having a Fair Market Value equal to the aggregate option exercise price for the Shares with respect to which such election is made. No Shares shall be issued until full payment therefor has been made. The Employee shall generally have the rights to dividends and other rights of a shareholder with respect to shares subject to the option when the Employee has given written notice of exercise, has paid in full for such shares, and, if requested, has given the representation described in Section 8. 17. The Committee may not amend, alter, or terminate this Option without the written consent of the Employee. 18. The Employee shall, no later than the date as of which any part of the value of an award first becomes includible as compensation in the gross income of the Employee for Federal income tax purposes, pay to the Company, or make arrangements satisfactory to the Committee regarding payment of, any Federal, state, or local taxes of any kind required by law to be withheld with respect to the award. The obligations of the Company under this Option shall be conditional on such payment or arrangements and the Company shall, to the extent permitted by law, have the right to deduct any such taxes from any payment of any kind otherwise due to the Employee. The Employee may elect by written notice to the Company to satisfy part or all of the withholding tax requirements associated with the award by (i) authorizing the Company to retain from the number of Shares that would otherwise be deliverable to the Employee, or (ii) delivering to the Company from Shares already owned by the Employee, that number of shares having an aggregate Fair Market Value equal to part or all of the tax payable by the Employee under this Section 18. Any such election shall be in accordance with, and subject to, applicable tax and securities laws, regulations and rulings. 19. For purposes of this Option, the following terms shall have the following meaning: (a) "Fair Market Value" of Share on any given date shall be determined by the Committee as follows: (i) if the Share is listed for trading on one of more national securities exchanges, or is traded on the Nasdaq Stock Market, the last reported sales price on the principal such exchange or the Nasdaq Stock Market on the date in question, or if such Share shall not have been traded on such principal exchange on such date, the last reported sales price on such principal exchange or the Nasdaq Stock Market on the first day prior thereto on which such Share was so traded; or (ii) if the Share is not listed for trading on a national securities exchange or the Nasdaq Stock Market, but is traded in the over-the-counter market, including the Nasdaq Small Cap Market, the closing bid price for such Share on the date in question, or if there is no such bid price for such Share on such date, the closing bid price on the first day prior thereto on which such price existed; or (iii) if neither (i) or (ii) is applicable, by any means fair and reasonable by the Committee, which determination shall be final and binding on all parties. (b) "Non-Employee Director" means a "Non-Employee Director" within the meaning of Rule 16b-3(b)(3) under the Securities Exchange Act of 1934. (c) "Outside Director" means a Director who: (i) is not a current employee of the Company or any member of an affiliated group which includes the Company; (ii) is not a former employee of the Company who receives compensation for prior services (other than benefits under a tax-qualified retirement plan) during the taxable year; (iii) has not been an officer of the Company; (iv) does not receive remuneration from the Company, either directly or indirectly, in any capacity other than as a director, except as otherwise permitted under Code Section 162(m) and regulations thereunder. For this purpose, remuneration includes any payment in exchange for good or services. This definition shall be further governed by the provisions of Code Section 162(m) and regulations promulgated thereunder. IN WITNESS WHEREOF, the Company has duly executed this Agreement and the Employee has hereunto set his/her hand as of the day and year first above written. MTS SYSTEMS CORPORATION By: Its: By: Its Assistant Secretary EMPLOYEE Donald M. Sullivan FIRST AMENDMENT TO NONQUALIFIED STOCK OPTION AGREEMENT THIS AGREEMENT, made as of this 19th day of August, 1997, amends that certain Stock Option Agreement between MTS SYSTEMS CORPORATION, a Minnesota corporation (the "Company") and DONALD M. SULLIVAN, an employee of the Company (the *Employee*) dated as of May 20, 1997. WHEREAS, the Company on May 20, 1997, granted to the Employee, pursuant to the terms of the Nonqualified Stock Option Agreement, the right and option to purchase up to 50,000 shares of common stock of the Company on the terms and conditions set forth therein; and WHEREAS, the Employee and the Company desire that the number of Shares granted to Employee under the terms of the Nonqualified Stock Option Agreement be reduced to 40,000 Shares; THEREFORE, the parties hereto agree that Section 1 of the Nonqualified Stock Option Agreement be and hereby is amended to reduce the number of shares subject to the option grant from 50,000 Shares to 40,000 Shares and to accomplish this, said Section 1 hereby is amended to read as follows: *The Company hereby irrevocably grants to the Employee, as a matter of a separate Agreement and not in lieu of salary or another compensation for services, the right and option (the *Option*), to purchase all or any part of an aggregate of 40,000 Shares on the terms and conditions herein set forth, at a price of $22.25 per Share. These Shares are issued to the Employee directly from the authorized, but unissued stock of the Company and are not issued pursuant to any existing Stock Option Plan of the Company.* Except as and set forth above, the terms and conditions of the Nonqualified Stock Option Agreement dated as of May 20, 1997 be and hereby shall remain in full force and effect including, but not limited to, the exercise price per Share upon exercise and the date of expiration of the Option. IN WITNESS WHEREOF, the Company has duly executed this Agreement and the Employee has hereunto set his hand as of the day and year first above written. MTS SYSTEMS CORPORATION By: By: Assistant Secretary EMPLOYEE Donald M. Sullivan EX-13 4 1997 ANNUAL REPORT EXHIBIT 13 SIX YEAR FINANCIAL SUMMARY (September 30)
1997 1996 1995 1994 1993 1992 - --------------------------------------------------------------------------------------------------------------------------------- (EXPRESSED IN THOUSANDS, EXCEPT PER SHARE DATA AND NUMBERS OF SHAREHOLDERS AND EMPLOYEES) OPERATIONS - --------------------------------------------------------------------------------------------------------------------------------- Net revenue $ 303,480 $ 261,029 $234,131 $ 200,550 $189,499 $ 161,013 United States revenue 143,913 128,593 125,659 101,747 92,153 68,931 International revenue 159,567 132,436 108,472 98,803 97,346 92,082 Gross profit 121,503 106,104 91,638 79,840 78,882 61,919 Income before income taxes 28,380(1) 20,006 14,031 12,629 14,937 6,452 Net income 18,209(1) 14,109 10,461 8,659 10,382 4,915 Net income per share, fully diluted basis 1.92(1) 1.48 1.15 .92 1.14 .54 Research and development costs 17,511 17,696 13,733 12,645 13,697 9,999 Net interest expense 1,125 1,123 2,424 1,860 1,207 704 Depreciation and amortization 8,557 7,820 7,217 6,214 5,648 5,789 FINANCIAL POSITION - --------------------------------------------------------------------------------------------------------------------------------- Current assets $ 152,805 $ 130,382 $131,589 $ 123,206 $123,445 $ 100,929 Current liabilities 79,479 60,834 67,014 66,361 66,961 50,717 Current ratio 1.9:1 2.1:1 2.0:1 1.9:1 1.8:1 2.0:1 Net working capital 73,326 69,548 64,575 56,845 56,484 50,212 Property and equipment, net 50,419 48,090 48,490 47,368 37,254 38,079 Total assets 216,132 187,396 189,500 175,708 165,716 144,650 Interest bearing debt 12,865 11,836 22,965 23,851 33,299 19,335 Shareholders' investment 124,619 112,814 106,677 100,046 93,011 84,992 Shareholders' investment per share 13.04 12.30 11.60 10.95 10.24 9.52 OTHER STATISTICS AND RATIOS - --------------------------------------------------------------------------------------------------------------------------------- Fully diluted shares outstanding(2) 9,478 9,553 9,090 9,336 9,144 9,190 Number of shareholders 1,575(3) 1,523 1,395 1,394 1,400 1,413 Number of employees 1,981 1,725 1,612 1,557 1,447 1,404 New orders $ 356,123 $ 282,753 $245,919 $ 195,260 $178,786 $ 178,178 Backlog of orders $ 175,841 $ 120,481 $ 98,757 $ 84,591 $ 88,731 $ 99,221 Gross profit percent 40.0% 40.6% 39.1% 39.8% 41.6% 38.5% Research and development costs as a percent of net revenue 5.8% 6.8% 5.9% 6.3% 7.2% 6.2% Net income as a percent of net revenue 6.0%(1) 5.4% 4.5% 4.3% 5.5% 3.1% Effective tax rate 36% 29% 25% 31% 30% 24% Interest bearing debt to equity percent 10% 10% 22% 24% 36% 23% Return on average net assets(4) 22.9%(1) 17.2% 12.9% 11.6% 16.3% 7.6% Return on beginning shareholders' investment per share 15.6%(1) 12.8% 10.5% 9.0% 11.9% 5.9% Cash dividends paid per share $ .40 $ .32 $ .28 $ .28 $ .24 $ .24 - ---------------------------------------------------------------------------------------------------------------------------------
(1) EXCLUDES AN AFTER-TAX GAIN OF $2,654,000 FROM THE SALE OF LAND IN MAY 1997, WHICH IS EQUAL TO $.28 PER SHARE (2) PRESENTED ON A WEIGHTED AVERAGE BASIS OF COMMON SHARES ASSUMING CONVERSION OF COMMON STOCK EQUIVALENTS DURING EACH YEAR AFTER RETROACTIVE ADJUSTMENTS FOR ISSUED SHARES, FOR STOCK SPLITS AND FOR REDUCTION OF SHARES FROM TREASURY STOCK PURCHASES (IN THOUSANDS OF SHARES). (3) ON DECEMBER 1, 1997, THERE WERE 1,575 COMMON SHAREHOLDERS OF RECORD, WITH ANOTHER ESTIMATED 2,000 SHAREHOLDERS WHOSE STOCK IS HELD BY NOMINEES OR BROKER DEALERS. (4) (INCOME BEFORE INCOME TAXES PLUS NET INTEREST EXPENSE) DIVIDED BY (AVERAGE QUARTERLY ASSETS MINUS NON-INTEREST BEARING LIABILITIES). 17 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS BACKLOG/NEW ORDERS 1997 1996 1995 - -------------------------------------------------------------- (EXPRESSED IN THOUSANDS) New Orders: North America* $ 186,155 $ 139,725 $ 137,775 International 169,968 143,028 108,144 - -------------------------------------------------------------- Total $ 356,123 $ 282,753 $ 245,919 - -------------------------------------------------------------- Backlog $ 175,841 $ 120,481 $ 98,757 ============================================================== *INCLUDES U.S. AND CANADA Record 1997 new orders of $356.1 million were up 26% from 1996 and represented a 45% increase over 1995. 1997 orders included a $18.5 million contract for a large crash simulation system and 1996 orders included a $23.3 million earthquake simulator. There were no orders over $10 million in 1995. In 1997, the Mechanical Test and Simulation sector (MT&S) new orders of $292.9 million increased 25% from 1996 and represented a 46% increase over 1995. Orders from the ground vehicle industry and for civil engineering applications were particularly strong in 1997 and 1996. The Factory Automation sector (FA) new orders in 1997 of $63.2 million increased 31% over the prior year and represented a 38% increase over 1995. About 17% of the order growth in 1997 came from the acquisition of Bregenhorn-Butow & Co., (BB & Co.) located in Freiburg, Germany. The European and Japanese markets reflected solid growth in local currencies but were affected in translation due to the strengthening dollar. Orders for industrial automation applications (servo motors, amplifiers, and motion controllers), including the BB & Co. acquisition, experienced double-digit growth in all three years. Orders for industrial sensors grew at a slower rate during this three year period. North American orders increased 33%, in 1997, 1% in 1996, and 36% in 1995. International orders increased 19% in 1997, 32% in 1996, and 15% in 1995. See Geographic Analysis of New Orders (below) for the percentage breakdown by geographic area. See Foreign Currencies Effects (page 20) for the impact on orders due to changing foreign currency rates. The backlog of undelivered orders at September 30, 1997 amounted to $175.8 million, an increase of 46% from 1996, and resulted mainly from the record new orders received in 1997. Approximately 15% of the orders in backlog have delivery dates beyond fiscal 1998. REVENUES 1997 1996 1995 - -------------------------------------------------------------- (EXPRESSED IN THOUSANDS) United States $ 143,913 $128,593 $ 125,659 International 159,567 132,436 108,472 - -------------------------------------------------------------- Total $ 303,480 $261,029 $ 234,131 ============================================================== Record 1997 revenues of $303.5 million were up 16% from the prior year and represented a 30% increase over 1995. For 1997, MT&S revenues of $240.7 million increased 13% from 1996 and represented a 26% increase compared to 1995. FA revenues in 1997 of $62.8 million increased 30% over the prior year and represented a 44% increase compared to 1995 (the BB & Co. acquisition represented 17% and 19% of the growth, respectively). For industry sector and geographic information, see Note 2 of "Notes to Consolidated Financial Statements." See Foreign Currencies Effects (page 20) for impact on revenues due to changing foreign currency rates. Revenues in the United States increased over the prior years: 12% in 1997, 2% in 1996 and 24% in 1995, reflecting a strengthening domestic market for most of the Company's business segments during 1997 and 1995. The domestic market softened in 1996. International revenues increased 20% in 1997, 22% in 1996, 10% in 1995. The 1995 international growth rate was significantly affected by the recessionary economies of Europe and Japan during this period. International revenues grew at a faster rate in 1997 and 1996 reflecting improved economic conditions which began late in 1995. The MT&S sector revenue increases for 1997 and 1996 reflected a strong worldwide demand from our ground vehicle customers and for civil engineering applications, an improved market for aftermarket sales of accessories and services, and revenue recognition on the large earthquake simulator order received in 1996. The FA sector revenue increases for 1997 and 1996 reflected moderate growth in demand from European and Japanese original equipment manufacturers for our sensor products. The demand for our servo motor, amplifier, and motion control products was strong in both years. Selective price increases and decreases were implemented in all three years. However, the overall impact of pricing changes did not have a material effect on reported revenue volume.
GEOGRAPHIC ANALYSIS OF NEW ORDERS 1997 1996 1995 1994 1993 1992 - ----------------------------------------------------------------------------------------------------- North America 52% 49% 57% 52% 55% 49% - ----------------------------------------------------------------------------------------------------- Europe/Africa/Middle East 28 22 25 21 20 25 - ----------------------------------------------------------------------------------------------------- Asia Pacific/Japan 18 26 17 26 23 25 - ----------------------------------------------------------------------------------------------------- Latin America/Rest of the World 2 3 1 1 2 1 - -----------------------------------------------------------------------------------------------------
18 GROSS PROFIT 1997 1996 1995 - -------------------------------------------------------------- (EXPRESSED IN THOUSANDS) Gross Profit $ 121,503 $ 106,104 $ 91,638 - -------------------------------------------------------------- % of Revenues 40.0% 40.6% 39.1% - -------------------------------------------------------------- The gross profit percentage for 1997 decreased slightly to 40.0% from 40.6% in 1996. The decrease was principally due to higher continuing product engineering costs in the MT&S sector, associated with enhancing current product offerings, and a material cost problem at our FA plants in Germany. The lower gross profit percentage in 1995 was caused primarily by the effect of a weak dollar on foreign currency denominated revenues and the cost of sales, and low-margin projects in the MT&S sector. The majority of these low-margin projects was shipped during the first half of 1995 after which point the gross profit margin began to show improvement from revenues with higher margin, operating efficiencies, and a more favorable business mix. RESEARCH AND DEVELOPMENT 1997 1996 1995 - -------------------------------------------------------------- (EXPRESSED IN THOUSANDS) R&D Expense $ 17,511 $ 17,696 $ 13,733 - -------------------------------------------------------------- % of Revenues 5.8% 6.8% 5.9% - -------------------------------------------------------------- The Company provides funds for product, system and application developments (R&D) in both the MT&S and FA sectors. The majority of the R&D expenditures in all three years were for new systems and system components such as software, control and mechanical products; new measurement products; servo motors and amplifiers; and accessories. The R&D as a percentage of revenues reflected above are representative of the ratio range the Company normally commits to in its annual planning process. A shift of some MT&S engineering personnel from R&D to continuing product engineering caused the R&D expense and ratio reduction in 1997. Accelerated development programs in both the MT&S and FA sectors and a shift from customer funded development caused the higher 1996 percentage. The Company also undertakes "first of their kind" system level development efforts as part of its custom projects sold to customers. The cost of these efforts is reported as cost of sales. The combination of internally funded R&D and these customer funded system innovations typically approximates about 10% of revenues. SELLING, GENERAL, AND ADMINISTRATIVE EXPENSES 1997 1996 1995 - -------------------------------------------------------------- (EXPRESSED IN THOUSANDS) Selling $ 52,229 $ 48,260 $ 45,088 General & Administrative 20,898 17,260 16,053 - -------------------------------------------------------------- Total $ 73,127 $ 65,520 $ 61,141 ============================================================== % of Revenues 24.1% 25.1% 26.1% ============================================================== Selling and General & Administrative (SG&A) expenses for 1997 as a percentage of revenues was 1.0 percentage point lower than 1996 and 2.0 percentage points lower than 1995. Full year spending for 1997 totaled $73.1 million, which represented a $7.6 million (12%) increase over 1996 and a $12.0 million (20%) increase over 1995. All three years were similar in that cost control and alignment of existing resources with markets having the greatest potential were heavily emphasized during the planning process. New investments were also made based on evaluations as to how to serve our markets better or to support long-term business strategies. Specific expenses in the Selling category are variable, such as commissions, and increased significantly in 1997 due to record orders and revenues. SG&A expenses of newly acquired companies represented $1.9 million of the expense increase in 1997 and $2.2 million of the increase in 1995. INCOME 1997 1996 1995 - -------------------------------------------------------------- (EXPRESSED IN THOUSANDS EXCEPT PER SHARE DATA) Income Before Income Taxes $ 32,712 $ 20,006 $ 14,031 - -------------------------------------------------------------- % of Revenues 10.8% 7.7% 6.0% - -------------------------------------------------------------- Net Income $ 20,863 $ 14,109 $ 10,461 - -------------------------------------------------------------- % of Revenues 6.9% 5.4% 4.5% - -------------------------------------------------------------- Effective Tax Rate 36.2% 29.5% 25.4% - -------------------------------------------------------------- Return On Beginning Shareholder's Investment Per Share 17.9% 12.8% 10.5% - -------------------------------------------------------------- Net Income Per Share, fully diluted basis $ 2.20 $ 1.48 $ 1.15 - -------------------------------------------------------------- Income Before Income Taxes (pretax income) in 1997 included a $4.3 million gain from the sale of land. Without the land sale gain (included in other income), pretax income increased $8.4 million to $28.4 million (9.4% of revenues) from $20.0 million achieved in 1996. The improved income before income taxes as a percentage of revenues reflects the record revenues and reduced operating expense percentage achieved in 1997. The MT&S pretax income of $24.2 million, net of the $4.3 million gain from the sale of land, increased 58% from 1996. FA pretax income decreased 9% to $4.2 million from 1996 19 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS to 1997. This decrease was primarily caused by integration costs associated with the BB & Co. acquisition, higher development costs for new and expanded uses of our industrial sensors products, and the material cost problem at our plants in Germany. (See Note 2 of "Notes to Consolidated Financial Statements"). Pretax income in 1996 increased $6.0 million (43%) from 1995 and reflected an improved return on revenues which resulted from an 11% increase in revenues, a 1.5% improvement in the gross profit percentage, a 1.0% decrease in the SG&A percentage, and lower interest expense. For 1996, the MT&S pretax income of $15.3 million increased 59% from 1995. The FA pretax income in 1996 of $4.7 million increased 5% from the prior year. Net income and net income per share for 1997 reflected the gain from the sale of land which amounted to $2.7 million after taxes, or $.28 per share. In 1997 the effective tax rate rose to 36.2% reflecting the increase in higher taxed foreign sourced income and a reduction in tax credits as a percentage of provided taxes. Net income in 1996 and 1995 benefited from an effective tax rate that was lower than the federal statutory tax rate, primarily the result of the tax benefit of the Company's Foreign Sales Corporation and Research and Development tax credits. The 1996 effective tax rate increased over 1995 as a result of having the reinstated Research and Development tax credit available only for the fourth quarter of 1996. See Note 4 of "Notes to Consolidated Financial Statements" for the reconciliation between the federal statutory and effective income tax rates and other related tax information. FOREIGN CURRENCIES EFFECTS The Company is exposed to market risk from changes in foreign currency exchange rates which can affect its results from operations and financial condition. To minimize the risk, the Company manages exposure to changes in foreign currency rates through its regular operating and financing activities and, when deemed appropriate, through the use of derivative financial instruments, principally forward exchange contracts. Foreign exchange contracts are used to hedge the Company's overall exposure to exchange rate fluctuations, since the gains and losses on these contracts offset losses and gains on the assets, liabilities, and transactions being hedged. Approximately 50% of the Company's revenues occur outside of the United States and about 75% (approximately 40% of the Company's total revenues) of these revenues are denominated in currencies other than the U.S. dollar. As a result, a strengthening of the U.S. dollar decreases translated foreign currency denominated revenues and earnings. Conversely, weakening of the U.S. dollar has the reverse impact on revenues and earnings. During 1997 and 1996, the U.S. dollar was generally stronger against other major currencies, however during 1995, the U.S. dollar was generally weaker. Gains and losses attributed to translating the financial statements for all non-U.S. subsidiaries and the gains and losses on forward exchange contracts used to hedge these exposures, are included in other expense (income). The total effect of foreign exchange rate fluctuations on translation of orders, revenues, and net income plus transaction gains and losses reported in other expense (income) is set forth in the following table: 1997 1996 1995 - -------------------------------------------------------------- (EXPRESSED IN THOUSANDS) Increase (Decrease) from Translation: Orders $ (13,150) $(8,980) $4,641 Revenues (8,852) (4,921) 3,311 Net Income (237) (66) (19) - -------------------------------------------------------------- Transaction Gain in "Other Expense (Income)" $ 1,266 $ 104 $1,401 - -------------------------------------------------------------- LIQUIDITY AND CAPITAL RESOURCES At September 30, 1997, the Company's capital structure was comprised of $5.3 million of current debt, $7.6 million long-term debt and $124.6 million of shareholders' investment. The ratio of total debt to total capitalization was 9.4%, compared with 9.5% at September 30, 1996. Total debt increased $1 million during 1997 to $12.9 million. This resulted from a $4.3 million increase in notes payable to banks offset by a $2.1 million reduction in current maturities of long-term debt and a $1.1 million reduction in long-term debt. Shareholders' investment increased $11.8 million in 1997 to $124.6 million. Shareholders' investment per share in 1997 increased to $13.04 from $12.30 in 1996. The increase was primarily due to an increase in retained earnings of $20.8 million from current year net earnings and $4.6 million from the Company's employee stock option and purchase plans. These increases were offset by $3.6 million of dividends, $7.6 million of treasury stock repurchases, and a $2.4 million reduction in the cumulative translation adjustment. 1997 1996 1995 - -------------------------------------------------------------- (EXPRESSED IN THOUSANDS EXCEPT PER SHARE DATA) Total Interest Bearing Debt $ 12,865 $ 11,836 $ 22,965 % of Total Capitalization 9.4% 9.5% 17.7% - -------------------------------------------------------------- Shareholders' Investment $ 124,619 $112,814 $ 106,677 - -------------------------------------------------------------- Per Share $ 13.04 $ 12.30 $ 11.60 - -------------------------------------------------------------- 20 CASH FLOWS During 1997, $9.6 million of cash was generated from operating activities, compared with $36.1 million in 1996, and $23.1 million in 1995. The decrease in 1997 was largely due to increased accounts receivable from strong shipments in the fourth quarter, which more than offset the results of higher earnings. Major uses of cash included $12.4 million for additions to property and equipment, $7.6 million for stock repurchases, $5.9 million for an acquisition of a business, $3.6 million for cash dividends, and $2.7 million for repayments of long-term debt. Significant non-operating sources of cash were $5.7 million from sale of land and $4.6 million from employee stock option exercises. Cash and cash equivalents decreased $8.9 million during 1997. Capital expenditures for property and equipment additions totaled $12.4 million in 1997, $7.4 million in 1996, and $6.3 million in 1995. Significant additions in 1997 were associated with a Minneapolis facility expansion and with investments in an enterprise-wide financial and operations software system. Capital spending in 1998 is planned to be about $17 million. The Company anticipates that 1998 capital expenditures will be financed primarily with cash balances, funds from operations, and short term lines of credit. DIVIDENDS The Company's dividend policy is to maintain a payout ratio which allows dividends to increase with the long-term growth of earnings per share, while sustaining dividends in down years. The Company's dividend payout ratio target is about 25% of earnings per share. In December 1997, the Company's Board of Directors increased the quarterly dividend to $.12 per share from $.10 per share. SHARE REPURCHASE PLAN In 1997, the Company repurchased 349,065 shares of common stock on the open market for $7.6 million, at an average cost of $21.81 per share. The Company repurchased 415,307 shares in 1996 for $7.9 million. The Company's practice for share repurchases is to offset the dilutive effect of shares of common stock issued from the Company's stock option and stock purchase plans, and for other corporate stock-based programs. During the past two years, the Company issued 705,648 shares of its common stock from these stock option and stock purchase plans. During 1997, the Company completed the Board of Director's January 1995 stock repurchase authorization. In November 1996, the Company's Board of Directors authorized the repurchase of an additional 500,000 shares of common stock in the open market within the Securities and Exchange Commission guidelines. At September 30,1997, 304,890 shares remained available to be repurchased under this authorization. The above share amounts have been adjusted for the Company's two-for-one stock split in the form of a 100% stock dividend, effective April 1, 1996. FINANCIAL RESOURCES The Company believes that its 1998 anticipated cash flows from operations, a forecasted decrease in unbilled contract and retainage receivables, and its lines of credit will adequately finance ongoing operations, allow for reinvestment in the business and strategic acquisitions. QUARTERLY STOCK ACTIVITY(1) The Company's common shares trade on The Nasdaq Stock Market's National Market under the symbol MTSC. The following table sets forth the high, low and volume of shares traded (expressed in thousands) for the periods indicated: 1997 1996 - ---------------------------------------------------------------------- Shares Shares High Low Traded High Low Traded - ---------------------------------------------------------------------- 1st Quarter 21 1/2 19 1/4 787 17 3/4 13 7/8 2796 2nd Quarter 22 5/8 19 1/2 769 19 3/8 14 2635 3rd Quarter 30 1/2 20 1/2 2194 22 1/2 17 1/2 1471 4th Quarter 39 1/4 28 3/4 1098 21 1/2 18 1/2 1937 - ---------------------------------------------------------------------- (1) SOURCE: THE NASDAQ STOCK MARKET THE ABOVE PRICES AND SHARE VOLUMES HAVE BEEN ADJUSTED FOR THE COMPANY'S TWO-FOR-ONE STOCK SPLIT IN THE FORM OF A 100% STOCK DIVIDEND, EFFECTIVE APRIL 1, 1996. QUARTERLY FINANCIAL INFORMATION (UNAUDITED) Quarter-to-quarter revenue and earnings comparisons do not necessarily reflect changes in the demand for the Company's products or its operating efficiency. Revenues and earnings in any quarter can be significantly affected by delivery delays or acceleration of one or more high-value systems, not accounted for using the percentage-of-completion accounting method. The use of the percentage-of-completion revenue recognition method for large long-term projects helps alleviate those fluctuations. (See Note 1 of "Notes to Consolidated Financial Statements"). High-value, state-of-the-art custom orders can also contain leading-edge applications of the Company's technology, which in some cases have resulted in lower gross profit margins, albeit not necessarily low marginal profit contribution. Product development in these state-of-the-art custom orders is as essential to the Company's long term growth as is Company funded research and development. Quarterly earnings will also vary based on the use of estimated, effective income tax rates for providing federal, state, and foreign income taxes. See Note 4 of "Notes to Consolidated Financial Statements" for more information on the Company's income taxes. 21 Selected quarterly financial information, for the three fiscal years ended September 30, 1997, is presented below.
First Second Third Fourth Total Quarter Quarter Quarter Quarter Year - ------------------------------------------------------------------------------------------------------------ (EXPRESSED IN THOUSANDS EXCEPT PER SHARE DATA) 1997 Revenues $66,841 $73,880 $74,153 $88,606 $303,480 Gross margin 27,091 30,359 29,481 34,572 121,503 Pretax income 4,683 7,060 10,947(1) 10,022 32,712(1) - ------------------------------------------------------------------------------------------------------------ Net income $ 3,221 $ 4,642 $ 6,741(1) $ 6,259 $ 20,863(1) - ------------------------------------------------------------------------------------------------------------ Fully diluted earnings per share $ .34 $ .50 $ .71(1) $ .65 $ 2.20(1) - ------------------------------------------------------------------------------------------------------------ Pro forma earnings per share(2) Basic $ .35 $ .51 $ .74(1) $ .69 $ 2.29(1) Diluted $ .34 $ .50 $ .71(1) $ .65 $ 2.20(1) - ------------------------------------------------------------------------------------------------------------ 1996 Revenues $56,135 $67,082 $60,630 $77,182 $261,029 Gross margin 23,867 28,066 24,374 29,797 106,104 Pretax income 3,570 5,363 4,286 6,787 20,006 - ------------------------------------------------------------------------------------------------------------ Net income $ 2,430 $ 3,632 $ 2,914 $ 5,133 $ 14,109 - ------------------------------------------------------------------------------------------------------------ Fully diluted earnings per share $ .26 $ .38 $ .30 $ .54 $ 1.48 - ------------------------------------------------------------------------------------------------------------ Pro forma earnings per share(2) Basic $ .26 $ .39 $ .31 $ .55 $ 1.51 Diluted $ .26 $ .38 $ .30 $ .54 $ 1.48 - ------------------------------------------------------------------------------------------------------------ 1995 Revenues $49,468 $58,949 $55,709 $70,005 $234,131 Gross margin 18,195 21,061 21,327 31,055 91,638 Pretax income 1,652 2,022 1,961 8,396 14,031 - ------------------------------------------------------------------------------------------------------------ Net income $ 1,239 $ 1,511 $ 1,488 $ 6,223 $ 10,461 - ------------------------------------------------------------------------------------------------------------ Fully diluted earnings per share $ .14 $ .17 $ .17 $ .67 $ 1.15 - ------------------------------------------------------------------------------------------------------------ Pro forma earnings per share(2) Basic $ .14 $ .17 $ .17 $ .68 $ 1.16 Diluted $ .14 $ .17 $ .17 $ .67 $ 1.15 - ------------------------------------------------------------------------------------------------------------
(1) INCLUDES $4.3 MILLION PRETAX GAIN ON LAND SALE EQUAL TO $.28 PER SHARE AFTER TAXES. (2) IN FEBRUARY 1997, THE FINANCIAL ACCOUNTING STANDARDS BOARD (FASB) ISSUED STATEMENT OF FINANCIAL ACCOUNTING STANDARDS (SFAS) NO. 128, "EARNINGS PER SHARE," EFFECTIVE FOR FISCAL AND INTERIM FINANCIAL REPORTING PERIODS ENDING AFTER DECEMBER 15, 1997. SFAS NO. 128 REPLACES PRIMARY EARNINGS PER SHARE (EPS) WITH BASIC EPS. BASIC EPS IS COMPUTED BY DIVIDING NET INCOME BY THE WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING DURING THE PERIOD. DILUTED EPS, FORMERLY FULLY DILUTED EPS, WHICH INCLUDES ALL POTENTIALLY DILUTIVE SECURITIES MUST BE PRESENTED WITH BASIC EPS. PRO FORMA FISCAL AND QUARTERLY EARNINGS PER SHARE FOR THE THREE FISCAL YEARS ENDED SEPTEMBER 30, 1997, HAVE BEEN CALCULATED IN ACCORDANCE WITH THE NEW REQUIREMENTS AND ARE NOT MATERIALLY DIFFERENT FROM THE FULLY DILUTED EPS PRESENTED IN THE CONSOLIDATED STATEMENTS OF INCOME. 22 CONSOLIDATED BALANCE SHEETS (September 30)
ASSETS 1997 1996 - ------------------------------------------------------------------------------------------------------------------------------ (EXPRESSED IN THOUSANDS EXCEPT PER SHARE DATA) CURRENT ASSETS: Cash and cash equivalents $ 10,285 $ 19,231 Accounts receivable, net of allowance for doubtful accounts of $2,010 and $1,724 62,023 53,717 Unbilled contracts and retainage receivable 32,653 16,418 Inventories 43,591 36,276 Prepaid expenses 4,253 4,740 - ------------------------------------------------------------------------------------------------------------------------------ Total current assets 152,805 130,382 - ------------------------------------------------------------------------------------------------------------------------------ PROPERTY AND EQUIPMENT: Land 2,453 3,459 Buildings and improvements 37,779 38,644 Machinery and equipment 68,071 59,060 Accumulated depreciation (57,884) (53,073) - ------------------------------------------------------------------------------------------------------------------------------ Total property and equipment, net 50,419 48,090 - ------------------------------------------------------------------------------------------------------------------------------ OTHER ASSETS 12,908 8,924 - ------------------------------------------------------------------------------------------------------------------------------ $216,132 $187,396 ============================================================================================================================== LIABILITIES AND SHAREHOLDERS' INVESTMENT ============================================================================================================================== CURRENT LIABILITIES: Notes payable to banks $ 4,356 $ 56 Current maturities of long-term debt 920 3,030 Accounts payable 17,771 11,604 Accrued compensation and benefits 25,487 23,664 Advance billings to customers 21,065 13,807 Other accrued liabilities 9,880 8,673 - ------------------------------------------------------------------------------------------------------------------------------ Total current liabilities 79,479 60,834 - ------------------------------------------------------------------------------------------------------------------------------ Deferred income taxes 4,445 4,998 Long-term debt 7,589 8,750 - ------------------------------------------------------------------------------------------------------------------------------ SHAREHOLDERS' INVESTMENT: Common stock, 25(cent) par; 32,000,000 shares authorized: 9,153,766 and 9,173,518 shares issued and outstanding 2,284 2,293 Additional paid-in capital 1,438 -- Retained earnings 119,167 106,485 Cumulative translation adjustment 1,730 4,036 - ------------------------------------------------------------------------------------------------------------------------------ Total shareholders' investment 124,619 112,814 - ------------------------------------------------------------------------------------------------------------------------------ $216,132 $187,396 ==============================================================================================================================
THE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ARE AN INTEGRAL PART OF THESE BALANCE SHEETS. 23 CONSOLIDATED STATEMENTS OF INCOME AND SHAREHOLDERS' INVESTMENT (for the Years Ended September 30)
INCOME 1997 1996 1995 - ----------------------------------------------------------------------------------------------------------------------------- (EXPRESSED IN THOUSANDS EXCEPT PER SHARE DATA) NET REVENUE $303,480 $261,029 $234,131 COST OF REVENUE 181,977 154,925 142,493 - ----------------------------------------------------------------------------------------------------------------------------- GROSS PROFIT 121,503 106,104 91,638 - ----------------------------------------------------------------------------------------------------------------------------- OPERATING EXPENSES: Selling 52,229 48,260 45,088 General and administrative 20,898 17,260 16,053 Research and development 17,511 17,696 13,733 - ----------------------------------------------------------------------------------------------------------------------------- INCOME FROM OPERATIONS 30,865 22,888 16,764 - ----------------------------------------------------------------------------------------------------------------------------- Interest expense 1,531 1,524 2,670 Interest income (406) (401) (246) Other expense (income), net (2,972) 1,759 309 - ----------------------------------------------------------------------------------------------------------------------------- INCOME BEFORE INCOME TAXES 32,712 20,006 14,031 PROVISION FOR INCOME TAXES 11,849 5,897 3,570 - ----------------------------------------------------------------------------------------------------------------------------- NET INCOME $ 20,863 $ 14,109 $ 10,461 ============================================================================================================================= NET INCOME PER SHARE $ 2.20 $ 1.48 $ 1.15 ============================================================================================================================= WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 9,478 9,553 9,090 =============================================================================================================================
SHAREHOLDERS' INVESTMENT
Common Stock -------------------------- Additional Cumulative Shares Paid-In Retained Translation Issued Amount Capital Earnings Adjustment - -------------------------------------------------------------------------------------------------------------------------------- (EXPRESSED IN THOUSANDS EXCEPT PER SHARE DATA) BALANCE, SEPTEMBER 30, 1994 4,568,374 $1,142 $ 2,928 $ 91,762 $ 4,214 ================================================================================================================================ Exercise of stock options 44,277 11 899 -- -- Translation adjustment -- -- -- -- 615 Common stock purchased and retired (158,840) (39) (3,572) -- -- Acquisitions through pooling of interests 144,500 36 -- 743 -- Net income -- -- -- 10,461 -- Cash dividends, 28(cent)per share -- -- -- (2,523) -- - -------------------------------------------------------------------------------------------------------------------------------- BALANCE, SEPTEMBER 30, 1995 4,598,311 1,150 255 100,443 4,829 ================================================================================================================================ Exercise of stock options 264,604 66 3,642 -- -- Translation adjustment -- -- -- -- (793) Common stock purchased and retired (381,055) (95) (3,897) (3,904) -- Stock split, 2 for 1 4,691,658 1,172 -- (1,172) -- Net income -- -- -- 14,109 -- Cash dividends, 32(cent)per share -- -- -- (2,991) -- - -------------------------------------------------------------------------------------------------------------------------------- BALANCE, SEPTEMBER 30, 1996 9,173,518 2,293 -- 106,485 4,036 ================================================================================================================================ Exercise of stock options 311,313 78 4,511 -- -- Translation adjustment -- -- -- (83) (2,306) Common stock purchased and retired (349,065) (87) (3,073) (4,453) -- Net income -- -- -- 20,863 -- Cash dividends, 40(cent)per share -- -- -- (3,645) -- - -------------------------------------------------------------------------------------------------------------------------------- BALANCE, SEPTEMBER 30, 1997 9,135,766 $2,284 $ 1,438 $119,167 $ 1,730 ================================================================================================================================
THE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ARE AN INTEGRAL PART OF THESE STATEMENTS. 24 CONSOLIDATED STATEMENTS OF CASH FLOWS (For the Years Ended September 30)
1997 1996 1995 - -------------------------------------------------------------------------------------------------------------------- (EXPRESSED IN THOUSANDS) OPERATING ACTIVITIES: Net income $ 20,863 $ 14,109 $ 10,461 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization 8,557 7,820 7,217 Deferred income taxes (227) 740 278 Gain from sale of real estate (4,332) -- (418) Changes in operating assets and liabilities: Accounts receivable, unbilled contracts, and retainage receivable (26,056) 13,362 (2,625) Inventories (6,954) (1,071) 1,065 Prepaid expenses 363 (2,380) 718 Advance billings to customers 8,157 (455) 4,629 Other liabilities, net 9,197 3,969 1,749 - -------------------------------------------------------------------------------------------------------------------- NET CASH PROVIDED BY OPERATING ACTIVITIES 9,568 36,094 23,074 - -------------------------------------------------------------------------------------------------------------------- INVESTING ACTIVITIES: Property and equipment additions (12,374) (7,437) (6,310) Proceeds from sale of real estate 5,700 -- 671 Acquisition of businesses (5,947) -- (4,687) Other assets (223) (649) (405) - -------------------------------------------------------------------------------------------------------------------- NET CASH USED IN INVESTING ACTIVITIES (12,844) (8,086) (10,731) - -------------------------------------------------------------------------------------------------------------------- FINANCING ACTIVITIES: Net borrowings under notes payable to banks 3,743 (10,386) (8,134) Proceeds from issuance of long-term debt 1,008 2,202 8,257 Repayments of long-term debt (2,745) (2,169) (3,185) Cash dividends (3,645) (2,991) (2,523) Proceeds from employee stock option and stock purchase plans 4,589 3,708 910 Payments to purchase and retire common stock (7,613) (7,896) (3,611) - -------------------------------------------------------------------------------------------------------------------- NET CASH USED IN FINANCING ACTIVITIES (4,663) (17,532) (8,286) - -------------------------------------------------------------------------------------------------------------------- EFFECT OF EXCHANGE RATE CHANGES ON CASH (1,007) 19 (240) - -------------------------------------------------------------------------------------------------------------------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (8,946) 10,495 3,817 CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 19,231 8,736 4,919 - -------------------------------------------------------------------------------------------------------------------- CASH AND CASH EQUIVALENTS AT END OF YEAR $ 10,285 $ 19,231 $ 8,736 ==================================================================================================================== SUPPLEMENTAL DISCLOSURES OF CASH FLOWS INFORMATION: Cash paid during the year for: Interest $1,531 $ 1,458 $ 2,615 Income taxes 13,295 6,677 3,317 ====================================================================================================================
THE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ARE AN INTEGRAL PART OF THESE STATEMENTS. 25 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: CONSOLIDATION AND TRANSLATION The consolidated financial statements include the accounts of MTS Systems Corporation (the Company) and its wholly and majority owned subsidiaries. All significant intercompany balances and transactions have been eliminated. All balance sheet accounts of foreign subsidiaries are translated to U.S. dollars at the current exchange rates as of the end of the fiscal year. Income statement items are translated at average exchange rates during the year. The resulting translation adjustment is recorded as a separate component of shareholders' investment. Gains and losses from translation of foreign currency denominated transactions and from foreign exchange hedge contracts are included in "Other expense (income) net" in the Consolidated Statements of Income and amounted to $1,265,800 in 1997, $104,000 in 1996, and $1,401,000 in 1995. REVENUE RECOGNITION Revenue is recognized upon shipment of equipment when the customer's order can be manufactured, delivered, and installed in less than twelve months. Revenue on contracts requiring longer delivery periods (long-term contracts) and other customized orders that permit progress billings is recognized using the percentage-of-completion method based on the cost incurred to date relative to estimated total cost of the contract (cost-to-cost method). The cumulative effects of revisions of estimated total contract costs and impact on revenues are recorded in the period in which the facts become known. When a loss is antici pated on a contract, the amount is provided currently. LONG-TERM CONTRACTS The Company enters into long-term contracts for customized equipment sold to its customers. Under terms of such contracts, revenue recognized using the percentage of completion method may not be invoiced until completion of contractual milestones, upon shipment of the equipment, or upon installation and acceptance by the customer. Unbilled amounts for these contracts appear in the Consolidated Balance Sheets as Unbilled contracts and retainage receivable. Amounts unbilled or retained at September 30, 1997 are expected to be invoiced during fiscal 1998. Long-term contracts consider the duration of the manufacturing and collection cycles at the time the contract is bid. Accordingly, Accounts receivable in the accompanying Consolidated Balance Sheets approximate fair value. WARRANTY OBLIGATIONS The Company warrants its products against defects in materials and workmanship under normal use and service, generally for one year. The Company maintains reserves for warranty costs based upon its past experience with warranty claims. RESEARCH AND DEVELOPMENT Research and product development costs associated with new products are charged to operations as incurred. CASH EQUIVALENTS Cash equivalents represent short-term liquid investments which have original maturities of three months or less and approximate fair value. ACCOUNTS RECEIVABLE The Company grants credit to customers, but generally does not require collateral or other security from domestic customers. International receivables, where deemed necessary, are supported by letters of credit from banking institutions. INVENTORIES Inventories consist of material, labor and overhead and are stated at the lower of cost or market, determined by the first-in, first-out method. Inventory components as of September 30, were as follows: 1997 1996 - -------------------------------------------------------------- (EXPRESSED IN THOUSANDS) Customer projects in various stages of completion $ 5,559 $ 7,535 Components, assemblies and parts 38,032 28,741 - -------------------------------------------------------------- Total $ 43,591 $ 36,276 ============================================================== PROPERTY AND EQUIPMENT Property and equipment is stated at cost. Additions, replacements and improvements are capitalized at cost, while main tenance and repairs are charged to operations as incurred. Depreciation is provided over the following estimated useful lives of the property: Buildings and improvements: 10 to 40 years. Machinery and equipment: 3 to 10 years. Most major building and equipment purchases are depreciated on a straight-line basis for financial reporting purposes and on an accelerated basis for income tax purposes. DERIVATIVE FINANCIAL INSTRUMENTS The Company periodically enters into forward exchange contracts principally to hedge the eventual dollar cash flow of foreign currency denominated transactions (primarily British Pound, German Deutschemark, French Franc, Swedish Krona, Italian Lira, and Japanese Yen). Gains and losses on forward exchange contracts entered into to hedge foreign currency denominated undelivered orders and net exposed assets are included in "Other expense (income) net" in the Consolidated Statements of Income. 26 The Company's accounting policy for these contracts is based on the Company's designation as hedging transactions. The Company does not use derivative financial instruments for speculative or trading purposes. The criteria the Company uses for designating a contract as a hedge include the contract's effectiveness in risk reduction and matching of contracts to underlying transactions. On September 30, 1997, there were no open hedge contracts. On September 30, 1996, there were open hedge contracts totaling $28,362,000 with an unrealized gain of $1,707,000. OTHER ASSETS Other assets consist principally of patents and excess cost over net assets acquired (goodwill), net of accumulated amortization. The carrying value of goodwill less accumulated amortization was $10,861,300 and $6,872,000 in 1997 and 1996, respectively. These assets are being amortized over various periods ranging from 8 to 40 years. The Company periodically evaluates whether events and circumstances have occurred that may affect the estimated useful life of its goodwill and other long-lived assests. If such events or circumstances were to indicate that the carrying amount of these assets would not be recoverable, an impairment loss would be recognized. No such impairment has been recognized for the year ended September 30, 1997. NET INCOME PER SHARE Net income per share is computed by dividing net in come by the weighted average number of shares of common stock and common stock equivalents outstanding during each period. Fully diluted and primary net income per share amounts are approximately equivalent for the years presented. Weighted average common shares and per share computations have been restated retroactively for the two-for-one stock split effective April 1, 1996. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make assumptions and estimates that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Ultimate results could differ from reported amounts based upon those assumptions and estimates. The Company undertakes significant technological innovation on some of its Long-term Contracts. These contracts involve performance risk which may result in delayed delivery of product and/or in revenue and gross profit variation from difficulties in estimating the ultimate cost of such contracts. FUTURE ACCOUNTING PRONOUNCEMENTS In February 1997, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings per Share". SFASNo. 128 requires all companies whose capital structure includes convertible securities and options to provide dual presentation of basic and diluted earnings per share. The new standard becomes effective beginning with the Company's first quarter ending on December 31, 1997. In June 1997, the FASB issued SFASNo. 130, "Reporting Comprehensive Income." SFAS No. 130 establishes requirements for disclosure of comprehensive income and becomes effective for the Company's fiscal year ending September 1999. Reclassification of earlier financial statements for comparative purposes is required. In June 1997, the FASB issued SFASNo. 131, "Disclosures about Segments of an Enterprise and Related Information." SFAS No. 131 which requires reported segments to be those used by management to disaggregate a company. The new standard becomes effective for the Company's fiscal year ending September 1999, and requires that comparative information from earlier years be restated. The Company anticipates that the effect of adopting SFAS Nos. 128, 130, and 131 will not have a significant impact on the Company's financial statements. 27 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 2. INDUSTRY SECTOR AND GEOGRAPHIC INFORMATION: Customers use the Company's hardware and software products and services to improve product quality, stimulate innovation, and increase machine and worker productivity. MTS sells these products and services in two markets--Mechanical Testing and Simulation (MT&S) and Factory Automation (FA). MT&S customers use the Company's products and services to determine how their products (materials, vehicles, components, or structures) will perform under actual service conditions. FA customers use the Company's instrumentation products to monitor and automate industrial processes and equipment. Financial information by sector follows:
1997 1996 1995 - ------------------------------------------------------------------------------------------------------ (EXPRESSED IN THOUSANDS) NET REVENUE Mechanical Testing & Simulation $ 240,706 $ 212,763 $ 190,464 Factory Automation 62,774 48,266 43,946 Transfers within and between sectors -- -- (279) - ------------------------------------------------------------------------------------------------------ Total $ 303,480 $ 261,029 $ 234,131 - ------------------------------------------------------------------------------------------------------ INCOME BEFORE INCOME TAXES Mechanical Testing & Simulation $ 28,485 $ 15,299 $ 9,550 Factory Automation 4,227 4,707 4,481 Total $ 32,712 $ 20,006 $ 14,031 ====================================================================================================== IDENTIFIABLE ASSETS Mechanical Testing & Simulation $ 189,727 $ 165,110 $ 161,678 Factory Automation 46,194 38,670 36,048 Eliminations between sectors (19,789) (16,384) (8,226) - ------------------------------------------------------------------------------------------------------ Total $ 216,132 $ 187,396 $ 189,500 ====================================================================================================== OTHER SECTOR DATA Mechanical Testing & Simulation: Capital expenditures $ 10,614 $ 6,198 $ 6,319 Depreciation 5,979 5,706 5,456 Amortization 379 380 417 - ------------------------------------------------------------------------------------------------------ Factory Automation: Capital expenditures $ 1,787 $ 1,803 $ 1,243 Depreciation 1,532 1,216 1,086 Amortization 667 518 258 ======================================================================================================
28 A geographic summary of the Company's operations and related year-end asset information for the three years ended September 30, 1997 follows:
International --------------------------------------------------- United Elimi- Consoli- States Far East Europe Other nations dated - ------------------------------------------------------------------------------------------------------------------------------ (EXPRESSED IN THOUSANDS) OPERATIONS FOR THE YEAR ENDED SEPTEMBER 30, 1997 Net revenue $143,913 $ 74,710 $66,905 $17,952 $ -- $303,480 Transfers between geographic areas(1) 825 26,988 27,927 -- (55,740) -- - ------------------------------------------------------------------------------------------------------------------------------ Total $144,738 $101,698 $94,832 $17,952 $(55,740) $303,480 ============================================================================================================================== Income (loss) before income taxes $ 17,327 $ 13,600 $(1,481) $ 3,266 $ -- $ 32,712 ============================================================================================================================== OPERATIONS FOR THE YEAR ENDED SEPTEMBER 30, 1996 Net revenue $128,593 $ 54,392 $63,023 $15,021 $ -- $261,029 Transfers between geographic areas(1) 2,513 18,411 21,499 3 (42,426) -- - ------------------------------------------------------------------------------------------------------------------------------ Total $131,106 $ 72,803 $84,522 $15,024 $(42,426) $261,029 ============================================================================================================================== Income before income taxes $ 10,690 $ 2,208 $ 3,876 $ 3,232 $ -- $ 20,006 ============================================================================================================================== OPERATIONS FOR THE YEAR ENDED SEPTEMBER 30, 1995 Net revenue $125,659 $ 42,032 $54,634 $11,806 $ -- $234,131 Transfers between geographic areas(1) 1,256 16,620 9,998 585 (28,459) -- - ------------------------------------------------------------------------------------------------------------------------------ Total $126,915 $ 58,652 $64,632 $12,391 $(28,459) $234,131 ============================================================================================================================== Income (loss) before income taxes $ 15,046 $ (192) $(1,955) $ 1,132 $ -- $ 14,031 ============================================================================================================================== IDENTIFIABLE ASSETS AT SEPTEMBER 30 1997 $198,055 $ 11,335 $50,670 $ 266 $(44,194) $ 216,132 1996 174,507 12,060 42,098 175 (41,444) 187,396 1995 164,341 12,895 51,708 311 (39,755) 189,500 ==============================================================================================================================
(1) TRANSFERS BETWEEN GEOGRAPHIC AREAS ARE MADE AT PRICES WHICH ALLOW APPROPRIATE MARKUP TO THE MANUFACTURING OR SELLING UNIT. No individual country, other than the United States, exceeded 10% of consolidated revenues on a recurrent annual basis. 29 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 3. FINANCING: Long-term debt as of September 30 follows:
1997 1996 - -------------------------------------------------------------------------------------------------------- (EXPRESSED IN THOUSANDS) 4.7% Note, unsecured, due in April 2001 $ 882 $ -- 7.8% Mortgage, due in October 2015, collateralized by building 6,287 7,413 6.7% Note, unsecured, due in April 1997 -- 2,296 5.5% Note, unsecured, due in September 2000 1,315 2,064 Other 25 7 - -------------------------------------------------------------------------------------------------------- TOTAL $ 8,509 $ 11,780 LESS CURRENT MATURITIES (920) (3,030) - -------------------------------------------------------------------------------------------------------- TOTAL LONG-TERM DEBT $ 7,589 $ 8,750 ========================================================================================================
Aggregate annual maturities of long-term debt for the next five fiscal years are as follows: 1998--$920,000; 1999--$874,000; 2000--$808,000; 2001--$363,000; 2002--$225,000 and $5,319,000 thereafter. The carrying value of the Company's long-term debt at September 30, 1997, approximates the fair value at current interest rates offered to the Company for debt with the same remaining maturities. The Company has credit agreements with two domestic banks totaling $20,000,000. One credit agreement, for $5,000,000, permits the Company to issue domestic and Euro-currency notes. The other credit agreement, for $15,000,000, permits the Company to issue domestic notes, Euro-currency notes, and banker's acceptances. As part of the same credit agreement, the bank has agreed to issue term loans up to a maximum of $15,000,000 until September 30, 1998. This agreement provides for repayment of these term loans through September 2000. The Company compensates both banks with loan commitment fees for the unused portion of the credit lines. The Company also has four uncommitted lines of credit with banks that total $40,000,000. In addition, the Company has standby letter-of-credit lines totaling $50,000,000. At September 30, 1997, standby letters of credit outstanding totaled $18,938,000. Under the terms of its credit agreements, the Company has agreed, among other matters, that (a) its defined cash flow or fixed charge coverage will exceed a defined minimum level; (b) its interest bearing debt will not exceed a defined percentage of total capital; (c) its tangible net worth will exceed a defined minimum amount; and (d) repurchases of its common stock will not exceed a maximum amount. At September 30, 1997, tangible net worth exceeded the defined minimum amount by $14,741,000 and the Company had $15,140,000 available for repurchases of its common stock. The Company was in compliance with the terms and covenants of its credit agreements and its lines of credit at September 30, 1997. Information on short-term borrowings for the years ended September 30 follows:
1997 1996 1995 - --------------------------------------------------------------------------------------------------------------- (EXPRESSED IN THOUSANDS) Balance outstanding at September 30 $ 4,356 $ 56 $ 10,475 Average balance outstanding 11,903 3,282 22,286 Maximum balance outstanding 23,458 11,223 26,642 Year-end interest rate 6.0% 7.0% 7.0% Weighted-average interest rate 6.0% 6.9% 6.5% - ---------------------------------------------------------------------------------------------------------------
30 4. INCOME TAXES: The provision for income taxes for the years ended September 30 consisted of:
1997 1996 1995 - ------------------------------------------------------------------------------------------------------------------------- (EXPRESSED IN THOUSANDS) Current payable (receivable): Federal $ 7,389 $ 3,717 $3,211 State 835 499 662 Foreign 3,568 1,830 (295) Deferred 57 (149) (8) - ------------------------------------------------------------------------------------------------------------------------- Total provision $11,849 $ 5,897 $3,570 - ------------------------------------------------------------------------------------------------------------------------- A reconciliation from the Federal statutory income tax rate to the Company's effective rate for the years ended September 30 follows: 1997 1996 1995 ========================================================================================================================= Statutory rate 35% 35% 35% Tax benefit of Foreign Sales Corporation (2) (5) (7) Foreign provision in excess of U.S. tax rate 3 2 -- State income taxes, net of Federal benefit 2 2 3 Research and development tax credits (2) (3) (7) Other, net -- (2) 1 - ------------------------------------------------------------------------------------------------------------------------- Effective rate 36% 29% 25% - ------------------------------------------------------------------------------------------------------------------------- DEFERRED TAX ASSET: 1997 1996 ========================================================================================================================= (EXPRESSED IN THOUSANDS) Accrued compensation and benefits $ 1,703 $1,446 Inventory reserves 2,088 1,586 Allowance for doubtful accounts 301 248 Other assets (15) (20) - ------------------------------------------------------------------------------------------------------------------------- TOTAL DEFERRED TAX ASSET $ 4,077 $3,260 ========================================================================================================================= DEFERRED TAX LIABILITY: 1997 1996 ========================================================================================================================= Property and equipment $ 4,445 $4,998 - ------------------------------------------------------------------------------------------------------------------------- NET DEFERRED TAX LIABILITY $ 368 $1,738 =========================================================================================================================
31 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 5. STOCK OPTIONS: The Company has made certain stock-based awards to its officers, non-employee directors, and key employees under various stock plans. Awards under these plans can include incentive stock options (qualified), non-qualified stock options, stock appreciation rights, restricted stock, deferred stock, and other stock-based and non stock-based awards. At September 30, 1997, the Company had awarded only incentive stock options and non-qualified stock options. These were granted at exercise prices that are 100% of the fair-market value at the day of grant. Beginning one year after grant, the options generally can be exercised proportionately each year for periods of three, four, or six years, as defined in the respective plans. Options currently expire no later than seven years from the grant date, as defined. Option holders may exercise options by delivering Company stock already owned, cash, or a combination of stock and cash. The shares tendered in the exchange are cancelled and, therefore, reduce shares issued. During 1997 and 1996, option holders exchanged 38,633 and 52,189 shares, respectively, of the Company's stock in payment of options exercised. (All share and share price data herein have been restated retroactively for the two-for-one stock split, effective April 1, 1996.) A summary of the status of the Company's stock option plans as of September 30, 1995, 1996, and 1997, and changes during the years ending on those dates follows:
1995 1996 1997 - ----------------------------------------------------------------------------------------------------------------------- SHARES WAEP* SHARES WAEP* SHARES WAEP* - ----------------------------------------------------------------------------------------------------------------------- Outstanding at beginning of year 969 $12.20 1,078 $12.21 982 $14.23 - ----------------------------------------------------------------------------------------------------------------------- Granted 260 $11.65 321 $16.28 304 $21.44 - ----------------------------------------------------------------------------------------------------------------------- Exercised (88) $10.62 (394) $10.46 (308) $13.56 - ----------------------------------------------------------------------------------------------------------------------- Forfeited (63) $12.06 (23) $12.73 (18) $15.73 - ----------------------------------------------------------------------------------------------------------------------- Outstanding at end of year 1,078 $12.21 982 $14.23 960 $16.70 - ----------------------------------------------------------------------------------------------------------------------- Options exercisable at year-end 657 $11.68 463 $13.53 447 $15.18 - -----------------------------------------------------------------------------------------------------------------------
SHARES IN THOUSANDS *WEIGHTED-AVERAGE EXERCISE PRICE The following table summarizes information concerning outstanding and exercisable options as of September 30, 1997:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE - ------------------------------------------------------------------------------------------------------------------------------- WEIGHTED AVERAGE WEIGHTED WEIGHTED RANGE OF NUMBER REMAINING AVERAGE NUMBER AVERAGE EXERCISE PRICES OUTSTANDING CONTRACTUAL LIFE* EXERCISE PRICE EXERCISABLE EXERCISE PRICE - ------------------------------------------------------------------------------------------------------------------------------- $11.56-14.38 245 3.3 $ 11.81 164 $ 11.80 - ------------------------------------------------------------------------------------------------------------------------------- $14.50-15.88 145 3.1 $ 15.85 143 $ 15.86 - ------------------------------------------------------------------------------------------------------------------------------- $16.25 265 3.3 $ 16.25 85 $ 16.25 - ------------------------------------------------------------------------------------------------------------------------------- $19.38-30.75 305 4.3 $ 21.40 55 $ 21.88 - ------------------------------------------------------------------------------------------------------------------------------- TOTAL 960 3.6 $ 16.70 447 $ 15.18 ===============================================================================================================================
SHARES IN THOUSANDS *IN YEARS These options will expire if not exercised at specific dates ranging from January 1998 to August 2002. Prices for options exercised during the three-year period ended September 30, 1997 ranged from $10.46 to $13.56. In January 1992 the Company's shareholders authorized an Employee Stock Purchase Plan (the Purchase Plan), whereby 500,000 shares of the Company's common stock were reserved for sale to employees until April 2002. Participants in the 1997 and 1996 phases, all at dates specified in the Purchase Plan, were issued 41,684 shares in 1997, and 49,539 shares in 1996. During 1997, participants subscribed to purchase 51,537 shares at 85% of market price for issuance in 1998. 32 PRO FORMA INFORMATION: The Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," in accounting for its employee stock options. Under this pronouncement, no compensation expense is recognized in the Company's financial statements because the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant. However, Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation," requires the use of option valuation models to estimate compensation expense from the granting of employee stock options and to present the pro forma effect of such expense on reported net income and earnings per share. SFAS No. 123 requires this information be determined as if the Company had accounted for employee stock options granted in fiscal years beginning subsequent to December 31, 1994 under the fair value method of that statement. The fair value of options granted in 1997 and 1996 reported below has been estimated at the date of grant using the Black-Scholes option valuation model with the following weighted average assumptions: 1997 1996 - ------------------------------------------------------------- Expected life (in years) 2.1 2.1 Risk-free interest rate 5.8% 5.8% Volatility .49 .50 Dividend yield 1.2% 1.9% - ------------------------------------------------------------- The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models required the input of highly subjective assumptions, including the expected stock price volatility. Because the Company's options have characteristics significantly different from those of traded options, and because change in the subjective input assumptions can affect materially the fair value estimate, in the opinion of management, the existing models do not necessarily provide a reliable measure of the fair value of its options. The weighted average estimated fair value of employee stock options granted during 1997 and 1996 was $21.08 and $16.28 per share, respectively. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The Company's pro forma information follows (in thousands except for earnings per share data): 1997 1996 - -------------------------------------------------------------- Pro forma net income $ 20,020 $13,556 Pro forma earnings per share $ 2.11 $ 1.42 - -------------------------------------------------------------- The effects on pro forma disclosures of applying SFAS No. 123 are not likely to be representative of the effects on pro forma disclosures of future years. Because SFAS No. 123 is applicable only to options granted in fiscal years subsequent to December 31, 1994, the pro forma effect will not be fully reflected until 2002. 6. EMPLOYEE BENEFIT PLANS: The Company's profit sharing plan functions as a retirement program for most U.S. and certain international employees. Employees who have completed 1,000 hours of service during the plan year are eligible to participate. The formula for calculating the Company's contribution is approved annually by the Board of Directors and is based primarily on operating results for the year, before management variable compensation. The plan provides for a minimum contribution of 4% of participant compensation, as defined, up to the social security taxable wage base, and 8% of participant compensation in excess of the taxable wage base up to the maximum profit sharing contribution allowed by federal law, so long as the entire contribution calculation does not exceed pretax income. The contributions were 4.4% of participant compensation in 1997 and 4.3% in 1996 and 1995, respectively. The provisions for profit sharing were $3,163,000 in 1997, $2,338,000 in 1996, and $2,132,000 in 1995, and are distributed among the various operating expenses shown in the accompanying Consolidated Statements of Income. Two of the Company's international subsidiaries have noncontributory, unfunded retirement plans for eligible employees. These plans provide benefits based on the employee's years of service and compensation during the years immediately preceding retirement, early retirement, termination, disability, or death, as defined in the respective plans. 33 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The expenses for these plans consist of the following components:
1997 1996 1995 - ----------------------------------------------------------------------------------------------------------------------------- (EXPRESSED IN THOUSANDS) Service cost-benefit earned during the period $ 327 $ 360 $ 395 Interest cost on projected benefit obligation 269 261 278 Net amortization and deferral 29 5 40 - ----------------------------------------------------------------------------------------------------------------------------- NET PERIODIC PENSION COST $ 625 $ 626 $ 713 ============================================================================================================================= The status of the Company's benefit plans and the amounts recognized in the consolidated financial statements are: 1997 1996 ============================================================================================================================= (EXPRESSED IN THOUSANDS) ACTUARIAL PRESENT VALUE: Accumulated benefit obligation: Vested $ 3,332 $3,135 Nonvested 575 552 - ----------------------------------------------------------------------------------------------------------------------------- TOTAL $ 3,907 $3,687 ============================================================================================================================= Projected benefit obligation 4,723 4,532 Unrecognized net gain 464 822 Unrecognized net liability being amortized (528) (631) Adjustment required to recognize minimum liability 29 86 - ----------------------------------------------------------------------------------------------------------------------------- ACCRUED PENSION LIABILITY $ 4,688 $4,809 ============================================================================================================================= Major assumptions at year-end are: - ----------------------------------------------------------------------------------------------------------------------------- Discount rate 3.5 to 6.5% 3.5 to 7.0% Rate of increase in future compensation levels 3.0% 3.0% =============================================================================================================================
7. ACQUISITIONS: In fiscal 1995 the Company acquired three entities. The Company acquired the stock of PowerTek, Inc. for an initial cash payment and a contingent future payment. The transaction was accounted for by the purchase method of accounting. PowerTek became a wholly-owned subsidiary and conducts business as MTS-PowerTek, Inc. The Company also completed transactions to exchange shares of its common stock for all the outstanding shares of Gull Engineering, Inc. and Incon Corporation. Both transactions were accounted for as poolings of interests. These companies were absorbed into existing operating units of the Company. In fiscal 1997 the Company acquired the stock of Bregenhorn-Butow & Co., Freiburg, Germany (name subsequently changed to Custom Servo Motors Antriebstechnik GmbH & Co. KG), a privately held supplier of low power, electronic servo motors and drives, for cash and debt. The transaction was accounted for by the purchase method of accounting. Financial data for prior periods were not restated for the acquisitions by pooling of interests as neither assets nor operations were material, individually or in total, to the Company's Consolidated Financial Statements. 34 REPORTS ON CONSOLIDATED FINANCIAL STATEMENTS REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS TO MTS SYSTEMS CORPORATION: We have audited the accompanying consolidated balance sheets of MTS Systems Corporation (a Minnesota corporation) and Subsidiaries as of September 30, 1997 and 1996, and the related consolidated statements of income, shareholders' investment and cash flows for each of the three years in the period ended September 30, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of MTS Systems Corporation and Subsidiaries as of September 30, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 1997 in conformity with generally accepted accounting principles. ARTHUR ANDERSEN LLP Minneapolis, Minnesota, November 21, 1997 REPORT OF MANAGEMENT The management of MTS Systems Corporation is responsible for the integrity and objectivity of the financial information presented in this report. The financial statements have been prepared in accordance with generally accepted accounting principles and include certain amounts based on management's best estimates and judgment. Management is also responsible for establishing and maintaining the Company's accounting systems and related internal controls, which are designed to provide reasonable assurance that assets are safeguarded, transactions are properly recorded, and the policies and procedures are implemented by qualified personnel. The Audit Committee of the Board of Directors, which is comprised solely of outside directors, meets regularly with management and its independent auditors to review audit activities, internal controls, and other accounting, reporting, and financial matters. This Committee also recommends independent auditors for appointment by the full Board, subject to shareholder ratification. The financial statements included in this annual report have been audited by Arthur Andersen LLP, independent public accountants. We have been advised that their audits were conducted in accordance with generally accepted auditing standards and included such reviews of internal controls and tests of transactions as they considered necessary in setting the scope of their audits. Donald M. Sullivan Chairman, Chief Executive Officer, and President /s/ Donald M. Sullivan Marshall L. Carpenter Vice President and Chief Financial Officer /s/ Marshall L. Carpenter 35 CORPORATE INFORMATION BOARD OF DIRECTORS E. Thomas Binger GENERAL PARTNER, PITTSBURGH PACIFIC CO. Charles A. Brickman PRESIDENT, PINNACLE CAPITAL CORPORATION Bobby I. Griffin PRESIDENT, MEDTRONIC PACING BUSINESS; EXECUTIVE VICE PRESIDENT, MEDTRONIC, INC. Russell A. Gullotti CHAIRMAN, PRESIDENT, CHIEF EXECUTIVE OFFICER, NATIONAL COMPUTER SYSTEMS Thomas E. Holloran PROFESSOR, UNIVERSITY OF ST. THOMAS Thomas E. Stelson, Ph.D INDEPENDENT ENGINEERING CONSULTANT Donald M. Sullivan CHAIRMAN, CHIEF EXECUTIVE OFFICER, PRESIDENT MTS SYSTEMS CORPORATION Linda Hall Whitman, Ph.D PRESIDENT, CERIDIAN PERFORMANCE PARTNERS CHAIRMAN EMERITUS George N. Butzow FOUNDER EXECUTIVE OFFICERS Donald M. Sullivan CHAIRMAN, CHIEF EXECUTIVE OFFICER, PRESIDENT William G. Beduhn VICE PRESIDENT Marshall L. Carpenter VICE PRESIDENT AND CHIEF FINANCIAL OFFICER Mauro Togneri VICE PRESIDENT Keith D. Zell EXECUTIVE VICE PRESIDENT CORPORATE OFFICERS Barbara J. Carpenter ASSISTANT CORPORATE SECRETARY Patrick Delaney SECRETARY, PARTNER, LINDQUIST & VENNUM Thomas J. Minneman TREASURER Werner Ongyert VICE PRESIDENT/EUROPE J. Howell Owens VICE PRESIDENT Richard S. White VICE PRESIDENT/ASIA PACIFIC DIVISIONAL OFFICERS William G. Anderson PRESIDENT, CUSTOM SERVO MOTORS INC. Frank G. Arcella PRESIDENT, AEROMET CORPORATION Steven M. Cohoon VICE PRESIDENT James M. Egerdal VICE PRESIDENT Kenneth E. Floren VICE PRESIDENT Joachim Hellwig VICE PRESIDENT Daniel T. Sparks VICE PRESIDENT REFERENCES Bank Reference FIRST BANK NATIONAL ASSOCIATION MINNEAPOLIS, MN Transfer Agent NORWEST BANK MINNESOTA, N.A. SOUTH ST. PAUL, MN SHAREHOLDER ASSISTANCE: 800-468-9716 General Counsel LINDQUIST & VENNUM PLLP MINNEAPOLIS, MN Patent Counsel WESTMAN, CHAMPLIN & KELLY MINNEAPOLIS, MN Auditors ARTHUR ANDERSEN LLP MINNEAPOLIS, MN NOTICE OF ANNUAL MEETING The annual meeting of stockholders will be held at 4:00 p.m. (Central Standard Time) on Tuesday, January 27, 1998 at the Company's Headquarters in Eden Prairie, Minnesota. STOCKHOLDERS WHO CANNOT ATTEND THE MEETING ARE URGED TO EXERCISE THEIR RIGHT TO VOTE BY PROXY. A PROXY CARD, A PROXY STATEMENT, AND A RETURN ENVELOPE ARE ENCLOSED FOR THIS PURPOSE. 10-K REPORT Copies of the Annual Report on Form 10-K, filed with the Securities and Exchange Commission, are available on request without charge from Marketing Communications MTS Systems Corporation 14000 Technology Drive Eden Prairie, Minnesota 55344-2290. Telephone 612-974-6073 COMMON STOCK MTS Systems Corporation's common stock publicly trades on The Nasdaq Stock Market's National Market under the symbol "MTSC". FOR NEWS RELEASES AND OTHER INFORMATION Our latest news releases are available on the World Wide Web at http://www.mts.com. To obtain financial documents including annual reports, 10-K's, and quarterly reports, send a written request to: Marketing Communications MTS Systems Corporation 14000 Technology Drive Eden Prairie, Minnesota 55344-2290. Telephone 612-974-6073 INVESTOR RELATIONS Securities analysts, portfolio managers, and representatives of financial institutions seeking information about the Company should direct their inquiries to: Thomas J. Minneman Treasurer and Manager of Investor Relations MTS Systems Corporation 14000 Technology Drive Eden Prairie, Minnesota 55344-2290. Telephone 612-937-4647 TRADEMARKS MTS, Flat-Trac, TestWare, and TestWorks are registered trademarks, and FlexTest, MaxPlus, Model-in-the-Loop, MotionPlus, MTS Engineering Office, PowerTek, ReNew, and VX-In are trademarks of MTS Systems Corporation. AeroMet is a servicemark of MTS Systems Corporation. Microsoft and Windows are trademarks of Microsoft Corporation. 36 EX-21 5 SUBSIDIARIES OF THE COMPANY EXHIBIT 21 MTS SYSTEMS CORPORATION AND SUBSIDIARIES OF THE COMPANY Incorporation Name Jurisdiction ---- ------------ MTS Systems (Hong Kong) Inc. Minnesota, U.S.A. MTS Testing Systems (Canada) Ltd. Canada MTS Systems GmbH (Berlin) Germany MTS Sensors Technologie GmbH and Co. KG Germany MTS Systems France MTS Holdings France, SARL France MTS (Japan) Ltd. Japan MTS Sensors Technology K.K. Japan MTS Systems Limited (London) United Kingdom MTS Systems SRL (Italy) Italy MTS International, Ltd. West Indies MTS Systems Norden AB Sweden MTS Systems do Brasil, Ltda. Brazil MTS Systems (China) Inc. Peoples Republic of China Custom Servo Motors, Inc. Minnesota, U.S.A. MTS Korea, Inc. Republic of Korea MTS-PowerTek, Inc. Michigan, U.S.A. MTS Systems (Singapore) Pte Ltd Singapore MTS Services Ltd Japan MTS Automotive Sensors GmbH Germany MTS Sensor Technology Verwaltungs GmbH and Co. KG Germany MTS Systems Holding for Europe GmbH Germany Customer Servo Motors Antriebstechnik Verwaltungs GmbH Germany Custom Servo Motors Antriebstechnik GmbH & Co. KG Germany AeroMet Corporation Minnesota, U.S.A EX-23 6 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS EXHIBIT 23 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation of our report dated November 21, 1997, included and incorporated by reference in this Form 10-K and into the Company's previously filed Registration Statements on Form S-8 and Form S-3. ARTHUR ANDERSEN LLP Minneapolis, Minnesota, December 19, 1997 EX-27 7 FINANCIAL DATA SCHEDULE
5 1,000 12-MOS SEP-30-1997 OCT-01-1996 SEP-30-1997 10,285 0 96,686 2,010 43,591 152,805 108,303 57,884 216,132 79,479 8,509 0 0 2,284 122,335 216,132 303,480 303,480 181,977 270,768 0 2,010 1,531 32,712 11,849 32,712 0 0 0 20,863 2.20 2.20
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