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UNITED STATES SECURITIES AND EXCHANGE COMMISSION 
Washington, D.C. 20549 
 
FORM 10-K 
(Mark One)
  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended September 28, 2019
or
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____________ to ______________ 
Commission File No. 0-02382  
http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=13223124&doc=15
MTS SYSTEMS CORPORATION 
(Exact name of registrant as specified in its charter) 
Minnesota
 
41-0908057
(State or other jurisdiction
of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
 
14000 Technology Drive
 
 
Eden Prairie,
Minnesota
 
55344
(Address of principal executive offices)
 
(Zip Code)
 
Registrant's telephone number, including area code: (952) 937-4000 
Securities registered pursuant to Section 12(b) of the Act:  
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock, $0.25 par value
MTSC
The Nasdaq Stock Market LLC
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined by Rule 405 of the Securities Act. Yes ý No o
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No ý
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ý No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer ý     Accelerated filer o Non-accelerated filer o     
Smaller reporting company      Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes No ý
The aggregate market value of the voting and non-voting common stock held by non-affiliates of the registrant as of March 30, 2019 was approximately $1.0 billion based on the closing price of $54.46 as of March 29, 2019 as reported by The Nasdaq Stock Market LLC.
As of November 21, 2019, there were 19,140,444 shares of common stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of MTS Systems Corporation's Definitive Proxy Statement (to be filed pursuant to Regulation 14A within 120 days after the end of the fiscal year ended September 28, 2019) for its annual shareholders' meeting to be held on February 11, 2020, are incorporated by reference into Part III of this Annual Report on Form 10-K to the extent described in such Part.




MTS Systems Corporation
Annual Report on Form 10-K
For the Year Ended September 28, 2019
 
Table of Contents
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 



PART I 
ITEM 1. BUSINESS 
Business Overview  
MTS Systems Corporation is a leading global supplier of high-performance test, simulation and measurement systems and sensors that was incorporated under Minnesota law in 1966. Our operations are organized and managed in two reportable segments, Test & Simulation and Sensors, based on global similarities within their markets, products, operations and distribution. The Test & Simulation and Sensors segments represented 63% and 37% of our revenue, respectively, for the fiscal year ended September 28, 2019
Terms
The terms "MTS," "we," "us," the "Company" or "our" in this Annual Report on Form 10-K, unless the context otherwise requires, refer to MTS Systems Corporation and its wholly owned subsidiaries.  
Fiscal year 2019 refers to the fiscal year ended September 28, 2019, fiscal year 2018 refers to the fiscal year ended September 29, 2018, and fiscal year 2017 refers to the fiscal year ended September 30, 2017. Fiscal years 2019, 2018 and 2017 all include 52 weeks. All dollar amounts and shares are in thousands unless otherwise noted.
Products and Markets
Test & Simulation
Our Test & Simulation segment (Test & Simulation) provides testing and simulation solutions including hardware, software and services that are used by customers in product development to characterize a product's mechanical properties along with simulation systems for human response features. Our solutions simulate forces and motions that customers expect their products to encounter in use. Mechanical simulation testing in a lab setting is an accepted method to accelerate product development compared to reliance on full physical prototypes in real-world settings, proving ground testing, and virtual testing because it provides more controlled simulation and accurate measurement. The need for mechanical simulation increases in proportion to the cost of a product, the range and complexity of the physical environment in which the product will be used, expected warranty or recall risk and expense, governmental regulation and potential legal liability. A significant portion of Test & Simulation products are considered by our customers to be capital expenditures. We believe the timing of purchases of our products may be impacted by interest rates, general economic conditions, product development cycles and new product initiatives.
A typical Test & Simulation system includes a reaction frame to hold the prototype specimen; a hydraulic pump or electro-mechanical power source; actuators to create the force or motion; and a computer controller with specialized software to coordinate the actuator movement, and to measure, record, analyze and manipulate results. Lower force and less dynamic testing can usually be accomplished with electro-mechanical power sources, which are generally less expensive than hydraulic systems. In addition to these basic components, we sell a variety of accessories and spare parts.
We provide Test & Simulation customers across all sectors with a spectrum of services to maximize product performance. Our service offerings include installation, product life cycle management, professional training, calibration and metrology, technical consulting and onsite and factory repair and maintenance.
On November 21, 2018, we acquired all ownership interests of E2M Technologies B.V. (E2M), a manufacturer of high force, electrically driven actuation systems, serving primarily the human-rated entertainment and training simulation markets. The acquisition of E2M expands our technology and product offerings for human-rated simulation systems and brings key regulatory approvals and customers in the flight simulation and entertainment markets. E2M is included in our Test & Simulation structures sector.
Test & Simulation serves a diverse spectrum of customers by industry and geography. Regionally, the Americas, Europe and Asia represented 32%, 22% and 46% of revenue for fiscal year 2019, respectively, based on customer location.
Test & Simulation products, service and customers are grouped into the following three global sectors:
Ground Vehicles (approximately 50% of Test & Simulation revenue for fiscal year 2019)
This sector consists of automobile, truck, motorcycle, motorsports vehicles, construction equipment, agricultural equipment, rail and off-road vehicle manufacturers and their suppliers. Customers include original equipment manufacturers (OEMs), universities, government research and development institutes, motorsports teams and contract test facilities. Our products are used to measure and simulate solutions to assess durability, vehicle dynamics and aerodynamics of vehicles, sub-systems and components. Our products include:
Road simulators and component test systems for durability testing;

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Vehicle performance test systems that evaluate ride handling, ride comfort and noise;
Vehicle dynamics simulators to test conceptual vehicle designs in advance of physical prototypes;
High-performance electrical motors and energy recovery systems for high-end automotive and aerospace applications;
Tire performance and rolling resistance measurement systems; and
Moving ground-plane systems and balances for vehicle aerodynamic measurements in wind tunnels.
Materials (approximately 30% of Test & Simulation revenue for fiscal year 2019)
This sector covers a diverse range of applications, spanning many different industries, including power generation, aerospace, vehicles and biomedical. Our solutions deliver the reliable, innovative technologies required to satisfy every material evaluation needed from single-axle tension / compression testing to complex fracture mechanics and multi-axial fatigue testing. Our products and services support customers in the research and development of products through the physical characterization of material properties, such as metals, composites and ceramics to polymers, textiles, concrete, geomaterials and many others. Our biomedical applications include systems to test durability and performance of implants, prostheses and other medical and dental materials and devices.
Structures (approximately 20% of Test & Simulation revenue for fiscal year 2019)
This sector serves the structural testing and simulation needs and services of our customers in the fields of aerospace, structural engineering, oil and gas, wind energy, amusement parks, flight simulation and others. The aerospace structural testing market consists of manufacturers of commercial, military and private aircraft and their suppliers that use our products, systems and software to perform static and fatigue testing of aircraft. Systems for structural engineering include high force static and dynamic testing, as well as seismic simulation tables used around the world to test the design of structures, such as bridges and buildings, and to help governments establish building codes. Structural engineering customers include construction companies, government agencies, universities and building materials manufacturers. The wind energy market consists of wind turbine manufacturers and their component suppliers that use our products to reduce cost and improve reliability of blades, bearings and entire wind turbines. We provide high-quality, durable motion systems servicing human-rated entertainment and training simulation markets. Key product applications include high-technology motion simulators for the amusement park industry and flight simulators for certified pilot training. 
Sensors
Our Sensors segment (Sensors) is a global leader in sensing technologies and solutions used worldwide by design engineers and predictive maintenance professionals, serving customers with a focus on total customer satisfaction, and offering regional support to provide innovative and reliable sensing solutions. Our high-performance sensors provide measurements of vibration, pressure, position, force and sound in a variety of applications. Our products and solutions are used to enable automation, enhance precision and safety, and lower our customers' production costs by improving performance and reducing downtime. Revenue is fueled by our customers' spending on research and development activities and industrial capacity utilization. Sensors products and solutions serve the automotive, aerospace, industrial, defense, and research and development markets, as well as many other markets. Sensors manufactures products utilizing piezoelectric and magnetostriction technology, both of which provide highly accurate, reliable and durable sensors ideal for use in harsh operating environments.
On August 5, 2019, we acquired the Endevco sensors business from Meggitt PLC. Endevco is a historic leader in high performance test and measurement sensors used primarily in the testing of new products. This strategic product line purchase further enhances our long-term strategy of growth and market leadership in our core businesses. Endevco is included in our Sensors test sector.
Sensors serves a diverse spectrum of customers by industry and geography. Regionally, the Americas, Europe and Asia represented 50%, 31% and 19% of revenue for fiscal year 2019, respectively, based on customer location.
Sensors products and customers are grouped into the following four global sectors:  
Position Sensors (approximately 40% of Sensors revenue for fiscal year 2019)
This sector consists of a wide range of industrial machinery OEMs and their end use customers with applications in all areas of manufacturing including plastics, steel, construction, agriculture, wood and mining, as well as other factory automation applications. These sensors provide positional feedback for motion control systems, improve productivity by enabling high levels of automation, reduce maintenance costs and enhance safety of machine operations.
Test Sensors (approximately 35% of Sensors revenue for fiscal year 2019)
This sector covers diverse industries, including test and measurement, automotive, rail, aerospace and defense. These sensors are used in a variety of applications including research and development; structural monitoring; ground testing of aircraft and vehicles; testing for use in harsh environments; impact sensors for shock and vibration testing;

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component and system performance; ride and handling; durability testing; and noise, vibration, and harshness testing. These sensors provide engineers and scientists with precise and accurate measurements to accelerate technology advancement and reduce new product development cycle time.
Industrial Sensors (approximately 15% of Sensors revenue for fiscal year 2019)
This sector consists of sensors used in heavy industrial markets and energy and power generation. Sensors used in heavy industrial markets are primarily used to monitor the vibration and pressure in a wide spectrum of applications including motors, pumps, paper machines and steel rollers. These sensors provide valuable feedback on equipment performance, reducing downtime and maximizing safety and productivity. Sensors used in the energy and power generation markets are equipped to address hazardous and inaccessible locations and serve gas and wind turbines, oil and gas refineries, and nuclear power instrumentation, as well as other critical energy infrastructure providers. 
Systems Sensors (approximately 10% of Sensors revenue for fiscal year 2019)
This sector consists of dynamic test, measurement and sensing systems primarily used to test, model and monitor the behavior of structures and processes, as well as to ensure safety and compliance from exposure to noise and vibration. This sector also includes the calibration systems used with a variety of sensors, our comprehensive rental offering of both transactional sensor products, and consultative systems that serve a broad range of testing and industrial customers. 
Financial and geographical information about our segments is included in Item 7 and Item 8 of Part II of this Annual Report on Form 10-K.  
Sales and Service 
Test & Simulation
Test & Simulation products are sold worldwide through a direct field sales and service organization, independent representatives and distributors and, to a much lesser extent, through other means (e.g., catalogs, internet, etc.) for standard products and accessories. Direct field sales and service personnel are compensated through salary and order incentive programs. Independent representatives and distributors are either compensated through commissions based upon orders or discounts off list prices. 
In addition to direct field sales and service personnel throughout the U.S., we have sales and service subsidiaries in Toronto, Canada; Berlin, Germany; Paris, France; Amsterdam, Netherlands; Guildford, United Kingdom; Turin, Italy; Gothenburg and Gislaved, Sweden; Chinchon, Spain; Tokyo and Nagoya, Japan; Seoul, South Korea; Moscow, Russia; Bangalore, India; and Beijing, Shanghai and Shenzhen, China.
The timing and volume of large orders (valued at $5,000 or greater on a U.S. dollar-equivalent basis) may produce volatility in backlog and quarterly operating results. Most customer orders are based on fixed-price quotations and typically have an average sales cycle of three to nine months due to the technical nature of the test systems and customer capital expenditure approval processes. The sales cycle for larger, more complex test systems may be several years. 
Sensors 
Sensors products are sold worldwide through a direct sales and service organization as well as through independent distributors. The direct sales and service organization is compensated through salary and commissions based upon revenue. The independent distributors purchase our products at wholesale pricing and resell the products to their customers.
In addition to direct field sales and service personnel throughout the U.S., we have sales subsidiaries in Treviolo, Italy; Stevenage, United Kingdom; Aubervilliers, France; Huckelhoven and Dresden, Germany; Beijing and Shanghai, China; Vandreuil, Canada; and Zaventem, Belgium.
The average sales cycle for Sensors products ranges from approximately one week to one month for existing customers purchasing standard products. The average sales cycle for a new account can range from approximately two weeks to two years depending on customer testing and specification requirements.   
Manufacturing and Engineering 
Test & Simulation
Test & Simulation systems are largely built to order and primarily engineered and assembled at our headquarters in Eden Prairie, Minnesota. We also operate manufacturing facilities in Guilford, United Kingdom for certain ground vehicles test systems and in Amsterdam, Netherlands for electrical motion platforms. We perform certain smaller system assembly at our locations in Berlin, Germany and Seoul, South Korea. Certain materials testing products are produced by a contract manufacturer in Shanghai and Hangzhou, China.

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Installation of systems, training and services are primarily delivered at customer sites. The engineering and assembly cycle for a typical test system ranges from one to 12 months, depending on the complexity of the system and the availability of components. The engineering and assembly cycle for larger, more complex systems may be several years.
Sensors
Sensors are engineered and assembled regionally at facilities located in Depew, New York; Halifax and Cary, North Carolina; Sunnyvale, California; Farmington Hills, Michigan; Provo, Utah; Cincinnati, Ohio; and Lüdenscheid, Germany. Assembly cycles generally vary from several days to several weeks, depending on the degree of product customization, the size of the order and manufacturing capacity. 
Sources and Availability of Raw Materials and Components 
Test & Simulation
A significant portion of our test systems consist of materials and component parts purchased from independent vendors. We are dependent, in certain situations, on a limited number of vendors to provide raw materials and components. As Test & Simulation generally sells products and services based on fixed-price contracts, fluctuations in the cost of materials and components between the date of the order and the delivery date may impact the expected profitability. Material and component cost variability is considered in the estimation and customer negotiation process.
Sensors
A significant portion of Sensors products consists of materials and component parts purchased from independent vendors. We are dependent, in certain situations, on a limited number of vendors to provide raw materials and components, such as mechanical and electronic components. As Sensors generally sells products and services based on fixed-price contracts and the products are manufactured and delivered within days to months from the time of order, fluctuations in the cost of materials and components between the date of the order and the delivery date are not likely to materially impact the expected profitability.
Patents and Trademarks 
We rely on a combination of patents, copyrights, trademarks and proprietary trade secrets to protect our proprietary technology, some of which are material to our segments. We have obtained numerous patents and trademarks worldwide and actively file and renew patents and trademarks on a global basis to establish and protect our proprietary technology. We are also party to exclusive and non-exclusive license and confidentiality agreements relating to our own and third-party technologies. We aggressively protect certain of our processes, products and strategies as proprietary trade secrets. Our efforts to protect intellectual property and avoid disputes over proprietary rights include ongoing review of third-party patents and patent applications.  
Seasonality 
There is no significant seasonality in Test & Simulation or Sensors.  
Working Capital 
Test & Simulation
Test & Simulation does not have significant finished product inventory, but maintains inventories of materials and components to facilitate on-time product delivery. Test & Simulation may have varying levels of work-in-process projects that are classified as inventories, net or unbilled accounts receivable, net in our Consolidated Balance Sheets, depending upon the manufacturing cycle, timing of orders, project revenue recognition and shipments to customers.  
Payments are often received from Test & Simulation customers upon order or at milestones during the fulfillment of the order depending on the size and customization of the system. These payments are recorded as advance payments from customers in our Consolidated Balance Sheets and reduced as revenue is recognized. Conversely, if revenue is recognized on a project prior to customer billing, this revenue is recorded as unbilled accounts receivable, net in our Consolidated Balance Sheets until the customer has been billed. Upon billing, it is recorded as accounts receivable, net in our Consolidated Balance Sheets. Changes in the average size, payment terms and revenue recognition for orders in Test & Simulation may have a significant impact on accounts receivable, net; unbilled accounts receivable, net; advance payments from customers; and inventories, net. It has not been our practice to provide rights of return for our products. Payment terms vary and are subject to negotiation.

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Sensors
Sensors has finished product inventory, as well as inventories of materials and components to facilitate rapid delivery of product to exceed customer expectations on delivery time. The type and amount of finished goods on hand are targeted based on historical and anticipated customer demands for high-volume products. Payment terms vary and are subject to negotiation. Revenue is primarily recognized when products are shipped. 
Customers 
We do not have a significant concentration of sales with any individual customer within Test & Simulation, Sensors or total MTS. Therefore, the loss of any one customer would not have a material impact on our results.  
Backlog 
Most of our products are built to order. Our backlog of orders, defined as firm orders from customers that remain unfulfilled, totaled approximately $420,115, $415,155 and $360,016 at September 28, 2019, September 29, 2018 and September 30, 2017, respectively. Test & Simulation backlog was $342,652, $346,006 and $311,551 at September 28, 2019, September 29, 2018 and September 30, 2017, respectively. Sensors backlog was $77,463, $69,149 and $48,465 at September 28, 2019, September 29, 2018 and September 30, 2017, respectively. Based on anticipated manufacturing schedules, we expect approximately 82% of the backlog as of September 28, 2019 will be converted to revenue in fiscal year 2020. Delays may occur in the conversion of backlog into revenue as a result of export licensing compliance, technical difficulties, specification changes, manufacturing capacity, supplier issues or access to the customer site for installation. While certain contracts within backlog are subject to order cancellation, we have not historically experienced a significant number of order cancellations. Refer to Item 7 of Part II of this Annual Report on Form 10-K for further discussion of order cancellations.
Government Contracts 
Revenue from U.S. government contracts varies by year. A portion of our government business is subject to renegotiation of profits or termination of contracts or subcontracts at the election of the U.S. government. In addition to contract terms, we must comply with procurement laws and regulations relating to the formation, administration and performance of U.S. government contracts. Failure to comply with these laws and regulations could lead to the termination of contracts at the election of the U.S. government or the suspension or debarment from U.S. government contracting or subcontracting. U.S. government revenue as a percentage of our total revenue was 6%, 4% and 4% for fiscal years 2019, 2018 and 2017, respectively. 
Competition 
Test & Simulation
For relatively simple and inexpensive mechanical testing applications, customers may satisfy their needs internally by building their own test systems or using competitors who compete on price, performance, quality and service. For larger and more complex mechanical test systems, we compete directly with several companies worldwide based upon customer value including application knowledge, engineering capabilities, technical features, price, quality and service. 
Sensors
We primarily compete on factors that include technical performance, price and customer service in new applications or in situations in which other sensing technologies have been used. Sensors competitors are typically larger companies that carry multiple sensors product lines; larger diverse companies with only a small portion of business in the sensors market; or smaller, privately held companies throughout the world. 
Environmental Compliance 
We believe our operations are in compliance with all applicable material environmental regulations within the jurisdictions in which we operate. Capital expenditures for environmental compliance were not material in fiscal year 2019, 2018 and 2017, and we do not expect such expenditures will be material in fiscal year 2020.
Employees 
We had approximately 3,500 employees as of September 28, 2019, including approximately 1,220 employees located outside the U.S. 

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Information about our Executive Officers
The names, ages and positions of our executive officers are presented below.
Name
Age
Position
Jeffrey A. Graves
58
Director, President and Chief Executive Officer
Steven B. Harrison
53
Executive Vice President and President, Test & Simulation
David T. Hore
54
Executive Vice President and President, Sensors
Brian T. Ross
43
Executive Vice President and Chief Financial Officer
Todd J. Klemmensen
46
Senior Vice President, General Counsel and Corporate Secretary
Dr. Jeffrey A. Graves, Ph.D. - President, Chief Executive Officer, and a Director of MTS since May 2012. Prior to joining MTS, Dr. Graves was President, Chief Executive Officer, and a Director of C&D Technologies, Inc., a leading global manufacturer of energy storage systems, from July 2005 to April 2012. From July 2001 to January 2005, Dr. Graves was employed at Kemet Electronics Corporation, a manufacturer of high performance capacitor solutions, where he last held the position of Chief Executive Officer. From 1994 to 2001, Dr. Graves held a number of key leadership positions with General Electric Company’s Power Systems Division and Corporate Research & Development Center. Prior to working for GE, Dr. Graves held various positions of increasing responsibility at Rockwell International Corporation and Howmet Corporation. Dr. Graves also serves as a Director of Hexcel Corporation (NYSE: HXL) and FARO Technologies (NASDAQ: FARO). Dr. Graves holds a Bachelors Degree in Metallurgical Engineering from Purdue University, and Masters Degree and Ph.D. in Metallurgical Engineering from the University of Wisconsin-Madison.
Steven B. Harrison - Executive Vice President and President, Test & Simulation. Prior to joining MTS in 2017, Mr. Harrison served as President, AAR Airlift Group, Inc., as well as President and CEO, National Air Cargo, Inc. During a distinguished 22 year career in the United States Air Force, Mr. Harrison commanded at the wing, group, and squadron level, including three deployed commands. He also held senior staff positions at Headquarters US Air Force, the Joint Staff and US Transportation Command. Mr. Harrison is a command pilot with more than 3,400 flight hours in the C-32A, C-5B, C-17A, KC-10A, T-38A, and T-37B. A Rhodes Scholar, he holds Masters Degrees in Engineering Science as well as Politics, Philosophy, and Economics, from Oxford University, England. He also earned a Bachelor of Science in Aeronautical Engineering from the United States Air Force Academy and a Masters of National Security Strategy from the United States Air War College.
David T. Hore - Executive Vice President and President, Sensors since July 2016. Mr. Hore joined MTS through the acquisition of PCB Group, Inc. (PCB). Mr. Hore initially led PCB as its Co-President and later its President, from 2003-2016. Prior to joining PCB, Mr. Hore was Founder and Managing Partner of the CPA firm Tronconi Segarra & Hore LLP, where he served as strategic consultant and outsourced CFO for PCB from 1995-2003. Prior to that, Mr. Hore was a CPA at Price Waterhouse from 1987-1994. Mr. Hore holds a bachelor’s degree in business administration with a concentration in accounting from the State University of New York at Buffalo.
Brian T. Ross - Executive Vice President and Chief Financial Officer since May 2017. Prior to joining MTS as Corporate Controller in 2014, Mr. Ross was the Director of Financial Planning and Analysis at Digi International Inc. (NASDAQ: DGII), where he gained valuable global experience ranging from strategic planning and acquisitions to operational execution and internal control. Earlier in his career, Mr. Ross served as Controller at Restore Medical, following a seven year tenure at PricewaterhouseCoopers LLP. Mr. Ross holds a BA in Accounting from the University of Northern Iowa, and is a licensed CPA (inactive) in Minnesota.

Todd J. Klemmensen - Senior Vice President, General Counsel and Secretary since July 2018. Mr. Klemmensen directs MTS’s global legal affairs, including corporate governance, commercial and strategic agreements, U.S. Government contracting, litigation, and intellectual property. Previously, Mr. Klemmensen served within MTS as Acting General Counsel (April 2017 - July 2018), Associate General Counsel (November 2015 - March 2017) and Director of Contracts & Senior Counsel (January 2012 - October 2015). Mr. Klemmensen served in various roles at Alliant Techsystems, Inc. (ATK), including Sr. Manager - Contracts and providing legal counsel within its Armament Systems Group. Prior to transitioning into industry, Mr. Klemmensen practiced business and corporate law in Minneapolis, MN. He holds a Bachelor of Arts degree from Gustavus Adolphus College and a Juris Doctor degree from Hamline University School of Law. Mr. Klemmensen is a former board member of the National Contract Management Association (NCMA) Twin Cities Chapter and a graduate of the NCMA - Leadership Development Program.
Available Information 
The U.S. Securities and Exchange Commission (SEC) maintains a website that contains reports, proxy and information statements and other information regarding issuers, including us, that file with the SEC. The public can obtain any documents

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that we file with the SEC at http://www.sec.gov. We file annual reports, quarterly reports, current reports, proxy statements and other documents with the SEC under the Securities Exchange Act of 1934, as amended (the Exchange Act).
We also make available free of charge on or through the "Investor Relations" pages of our corporate website (www.mts.com) our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and, if applicable, amendments to those reports filed or furnished pursuant to the Exchange Act as soon as reasonably practicable after we file such material with, or furnish it to, the SEC. Our Code of Conduct (the Code); any waivers from or amendments to the Code; our Corporate Governance Guidelines, Articles of Incorporation and Bylaws; and the Charters for the Audit, Compensation and Leadership Development, and Governance and Nominating Committees of our Board of Directors are also available free of charge on the "Investor Relations" pages of our corporate website (www.mts.com). We are not including the information on our corporate website as a part of or incorporating it by reference into this Annual Report on Form 10-K. 
ITEM 1A. RISK FACTORS 
Our business involves risks. The following summarizes what we believe to be the most important risks facing us that could adversely impact our business, financial condition or operating results. The information about these risks should be considered carefully together with the other information contained in this Annual Report on Form 10-K. Additional risks not currently known to us or that we currently deem to be immaterial may also adversely affect our business, financial condition or results of operations in future periods.  
Market Risks 
Our business is significantly international in scope.
We have manufacturing facilities in North America, Europe and Asia. Over the past 15 years, approximately 70% of our revenue has been derived from customers outside of the U.S. Although our financial results are reported in U.S. dollars, a large portion of our sales and operating costs are transacted in Euros, Chinese yuan, Japanese yen and other foreign currencies.
Accordingly, our business is subject to the political, economic and other risks that are inherent in operating in foreign countries. These risks include, but are not limited to:
exposure to the risk of foreign currency fluctuations, where payment for products is denominated in a currency other than U.S. dollars;
variability in the U.S. dollar value of foreign currency-denominated assets, earnings and cash flows;
difficulty enforcing agreements, including patents and trademarks, and collecting receivables through foreign legal systems;
trade protection measures and import or export licensing requirements;
tax rates in certain foreign countries that exceed those in the U.S., the imposition of withholding requirements on foreign earnings and restrictions on repatriation of foreign earnings;
elevated risk of terrorist activity, war or civil unrest;
imposition of tariffs, exchange controls or other restrictions, including tariffs recently imposed by the U.S. and responsive tariffs imposed by China and the European Union;
difficulty in staffing and managing global operations;
required compliance with a variety of existing and emerging foreign laws and regulations and U.S. laws and regulations, such as the Foreign Corrupt Practices Act, applicable to our international operations, and significant compliance costs and penalties for failure to comply with any of these laws and regulations; and
changes in general economic and political conditions in countries where we operate including emerging markets, continued volatility in currency exchange rates and uncertainties caused by the United Kingdom's pending exit from the European Union.
These risks could have an adverse effect on our financial position, results of operations or cash flows. In addition, foreign currency fluctuations could also make our products more expensive than competitors' products not subject to these fluctuations, which could adversely affect our revenues and profitability in international markets. As further described in Item 7 of Part II of this Annual Report on Form 10-K, revenue for fiscal year 2019 was unfavorably impacted by currency translation.
Our business is subject to competition.
Our products are sold in competitive markets throughout the world. Competition is based on application knowledge, product features and design, brand recognition, reliability, technology, breadth of product offerings, price, delivery, customer relationships and after-market support. If we are not perceived as competitive in overall value as measured by these criteria, our customers would likely choose solutions offered by our competitors or developed internally. 

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Our business is subject to customer demand cycles.
For many of our products, orders are subject to customers' procurement cycles and their willingness and ability to invest in capital, especially in the cyclical automotive, aircraft and machine tool industries. Any event that adversely impacts those customers' new product development activities may reduce their demand for our products. 
We may experience difficulty obtaining materials or components for our products, or the cost of materials or components may increase.
We purchase materials and components from third-party suppliers, some of whom may be competitors. Other materials and components may be provided by a limited number of suppliers or by sole sources and could only be replaced with difficulty or at significant added cost. Additionally, some materials or components may become scarce or difficult to obtain in the market or they may increase in price. This could adversely affect the lead time within which we receive the materials or components, and in turn affect our commitments to our customers, or could adversely affect the cost or quality of materials. Our intention is to partner with suppliers who engage in supply chain transparency and responsible sourcing and who support human rights.
Our level and terms of indebtedness could adversely affect our business and results of operations and may require the use of our available cash resources to meet repayment obligations, which could reduce the cash available for other purposes.
We have a senior secured credit facility that provides for a revolving credit facility and a tranche B term loan facility, both of which require that we pay a variable interest rate on outstanding borrowings, as well as a $350,000 aggregate principal amount of 5.750% senior unsecured notes due 2027. The debt under the tranche B term loan facility amortizes in equal quarterly installments in an aggregate annual amount equal to 1% of the original principal amount and matures on July 5, 2023.
As of September 28, 2019, we had $173,695 outstanding under our senior secured credit facilities, consisting of $173,695 on our tranche B term loan facility and no amounts drawn under our revolving credit facility, and we had $350,000 in aggregate principal amount of senior unsecured notes outstanding. We may, at times, use debt under the revolving credit facility to continue to finance the growth of the business through acquisitions, finance working capital needs or purchase shares of our common stock.
Our substantial debt could have important consequences to us, including:
increasing our vulnerability to general economic and industry conditions;
requiring a substantial portion of our cash flow used in operations to be dedicated to the payment of principal and interest on our indebtedness, which would reduce our liquidity and our ability to use our cash flow to fund our operations, capital expenditures and future business opportunities;
exposing us to the risk of increased interest rates, and corresponding increased interest expense, because future borrowings under our senior secured credit facilities would be at variable rates of interest;
reducing funds available for working capital, capital expenditures, acquisitions and other general corporate purposes due to the costs and expenses associated with such debt;
limiting our ability to obtain additional financing for working capital, capital expenditures, debt service requirements, acquisitions, and general corporate or other purposes;
limiting our ability to adjust to changing marketplace conditions and placing us at a competitive disadvantage compared to our competitors who may have less debt; and
potentially causing us to fail to comply with the financial and other restrictive covenants in our debt instruments, which, among other things, require us to maintain specified financial ratios, which failure could, if not cured or waived, have a material adverse effect on our ability to fulfill our obligations under our senior secured credit facilities and the senior unsecured notes and on our business and prospects generally.
In addition, the credit agreement that governs our senior secured credit facilities and the indenture that governs the senior unsecured notes impose significant operating and financial restrictions on us, including limitations on our ability to, among other things, incur additional indebtedness (including guarantee obligations); incur liens; engage in mergers, consolidations and certain other fundamental changes; dispose of assets; make advances, investments and loans; engage in sale and leaseback transactions; engage in certain transactions with affiliates; pay dividends, distributions and other payments in respect of capital stock; repurchase or retire capital stock, warrants or options; and engage in other actions that we may believe are advisable or necessary for our business. As a result of these restrictions, we will be limited as to how we conduct our business and we may be unable to raise additional debt or equity financing to compete effectively or to capitalize on available business opportunities. Further, our tranche B term loan facility is also subject to mandatory prepayments in certain circumstances and requires a prepayment of a certain percentage of our excess cash flow. Any future mandatory prepayments will reduce our cash available for other purposes and could impact our ability to reinvest in other areas of our business. Due to prepayments made during fiscal year 2019, we do not anticipate an excess cash flow payment will be required in the first quarter of fiscal year 2020.

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There are no assurances that we will maintain a level of liquidity sufficient to permit us to pay the principal, premium and interest on our indebtedness. If our cash flows and capital resources are insufficient to fund our debt service obligations, we may be forced to reduce or delay capital expenditures, sell assets, seek additional capital, or restructure or refinance our indebtedness. These alternative measures may not be successful and may not permit us to meet our scheduled debt service obligations, which could cause us to default on our debt obligations and impair our liquidity. In the event of a default under any of our indebtedness, the holders of the defaulted debt could elect to declare all the funds borrowed to be due and payable, together with accrued and unpaid interest, which in turn could result in cross-defaults under our other indebtedness. The lenders under our senior secured credit facilities could also elect to terminate their commitments thereunder and cease making further loans, and such lenders could institute foreclosure proceedings against their collateral, and we could be forced into bankruptcy or liquidation.
For further information on our financing arrangements, see Note 8 to the Consolidated Financial Statements included in Item 8 of Part II of this Annual Report on Form 10-K.
Our variable rate indebtedness subjects us to interest rate risk, which could cause our debt service obligations to increase significantly.
Our senior secured credit facilities bear, and other indebtedness we may incur in the future may bear, interest at a variable rate. As a result, at any given time interest rates on the senior secured credit facilities and any other variable rate debt could be higher or lower than current levels. If interest rates increase, our debt service obligations on our variable rate indebtedness will increase even though the amount borrowed remains the same, and therefore net income and associated cash flows, including cash available for servicing our indebtedness, will correspondingly decrease.
Increases in interest rates may directly impact the amount of interest we are required to pay and reduce earnings accordingly. In addition, recent developments in tax policy as a part of the Tax Act, such as the disallowance of tax deductions for a portion of the interest paid on outstanding indebtedness, could have a material adverse effect on our results of operations and liquidity.
Despite our current level of indebtedness, the terms of our existing indebtedness allow us, under certain circumstances, to incur substantially more debt, incur substantial ordinary course operating obligations, and enter into other transactions, which would increase our leverage and further exacerbate the risks to our financial condition described above.
We may be able to incur additional indebtedness in the future. Although the credit agreement that governs our senior secured credit facilities and the indenture that governs the senior unsecured notes contain restrictions on incurring additional indebtedness and entering into certain types of other transactions, these restrictions are subject to a number of qualifications and exceptions. Additional indebtedness incurred in compliance with these restrictions could be substantial. In addition, these restrictions do not prevent us from incurring obligations, such as certain trade payables, that do not constitute indebtedness as defined under our debt instruments. To the extent we incur additional indebtedness or other obligations, the risks described herein may increase.
Operational Risks
Transfer of certain Test & Simulation production operations in China to our new contract manufacturing partner may be subject to delays, increased costs or other unanticipated consequences.
On March 13, 2018, we announced workforce reductions and manufacturing facility closures in our Test & Simulation segment corresponding to the transfer of certain production operations in China to a contract manufacturing partner. These changes are designed to increase organizational effectiveness, gain efficiencies and provide cost savings that can be reinvested in growth initiatives. We can make no assurances that our current estimates of costs and timing of this restructuring action will be accurate or that additional costs will not be incurred as we continue the restructuring action. Any differences from our current estimates could be material and could adversely impact our business, financial condition and results of operations through delays in our timeline or increased costs.
While we believe our China contract manufacturing partner to be qualified to manufacture our Test & Simulation segment products, we may need to address short-term quality and delivery issues. We have not previously used contract manufacturing partners on a large scale. Significant quality or delivery schedule concerns and unforeseen costs may adversely affect our relationships with customers and our overall business, financial condition or results of operations.
Our business operations may be affected by government contracting risks.
Government business is important to us and is expected to increase in the future. Revenue from U.S. government contracts varies by year. Such revenue as a percent of our total revenue was 6%, 4% and 4% for fiscal years 2019, 2018 and 2017, respectively. 

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We must comply with procurement laws and regulations relating to the formation, administration and performance of U.S. government contracts. Failure to comply with these laws and regulations could lead to suspension or debarment from U.S. government contracting or subcontracting and result in administrative, civil or criminal penalties. Failure to comply could also have a material adverse effect on our reputation, our ability to secure future U.S. government contracts and export control licenses, and our results of operations or financial condition. These laws and regulations also create compliance risks and affect how we do business with federal agency clients. U.S. government contracts, as well as contracts with certain foreign governments with which we do business, are also subject to modification or termination by the government, either for the convenience of the government or for default as a result of our failure to perform under the applicable contract. Further, any investigation relating to, or suspension or debarment from, U.S. government contracting could have a material impact on our results of operations as, during the duration of any suspension or debarment, we would be prohibited or otherwise limited in our ability to enter into prime contracts or subcontracts with U.S. government agencies, certain entities that receive U.S. government funds or that are otherwise subject to the Federal Acquisition Regulations, and certain state government or commercial customers who decline to contract with suspended or debarred entities. A federal suspension could also impact our ability to obtain export control licenses which are materially important to our business. 
We are subject to risks because we design and manufacture first-of-a-kind products.
We design and build systems that are unique and innovative and, in some cases, the first created to address complex and unresolved issues. The design, manufacture and support of these systems may involve higher than planned costs. If we are unable to meet our customers' expectations, our reputation and ability to further utilize our expertise will likely be damaged.
Backlog, sales, delivery and acceptance cycle for many of our products is irregular and may not develop as anticipated.
Many of our products have long sales, delivery and acceptance cycles. In addition, certain contracts within our backlog are subject to order cancellations. If an order is canceled, we typically would only be entitled to receive reimbursement from the customer for actual costs incurred under the arrangement plus a reasonable margin. Events may cause recognition of orders, backlog and results of operations to be irregular over shorter periods of time. These factors include the timing of individual large orders which may be impacted by interest rates, customer capital spending and product development cycles, design and manufacturing problems, capacity constraints, delays in product readiness, damage or delays in transit, problems in achieving technical performance requirements, and various customer-initiated delays. Any such delay or any cancellations may cause fluctuations in our reported periodic financial results and may cause our stated backlog conversion to revenue to be inaccurate. 
The business could be adversely affected by product liability and commercial litigation.
Our products or services may be claimed to cause or contribute to personal injury or property damage to our customers' facilities, which could damage our reputation or necessitate a product recall. Additionally, we are, at times, involved in commercial disputes with third parties, such as customers, vendors and others. The ensuing claims may arise singularly, in groups of related claims or in class actions involving multiple claimants. Such claims, litigation and product recalls may be expensive and time consuming to resolve and may result in substantial liability to us, and any liability and related costs and expenses may not be recoverable through insurance or other forms of reimbursement. 
We may experience difficulties obtaining and retaining the services of skilled employees.
We rely on knowledgeable, experienced and skilled technical personnel, particularly engineers, sales management and service personnel, to design, assemble, sell and service our products. We may be unable to attract, retain and motivate a sufficient number of such people which could adversely affect our business. The inability to transfer knowledge and transition between roles within these teams could also adversely affect our business. 
We may fail to protect our intellectual property effectively or may infringe upon the intellectual property of others.
We have developed significant proprietary technology and other rights that are used in our businesses. We rely on trade secret, copyright, trademark and patent laws and contractual provisions to protect our intellectual property. While we take enforcement of these rights seriously, other companies such as competitors or others in markets in which we do not participate may attempt to copy or use our intellectual property for their own benefit. 
The intellectual property of others also has an impact on our ability to offer some of our products and services for specific uses or at competitive prices. Competitors' patents or other intellectual property may limit our ability to offer products and services to our customers. Any infringement on the intellectual property rights of others could result in litigation and adversely affect our ability to continue to provide, or could increase the cost of providing, our products and services. 
Intellectual property litigation can be very costly and could result in substantial expense and diversion of our resources, both of which could adversely affect our businesses, financial condition and results of operations. In addition, there may be no effective legal recourse against infringement of our intellectual property by third parties, whether due to limitations on enforcement of rights in foreign jurisdictions or as a result of other factors. 

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If we are unable to protect our information systems against misappropriation of data or breaches of security, our business operations and financial results could be adversely impacted. Evolving regulations and legal obligations related to data privacy, data protection and information security and our actual or perceived failure to comply with such obligations could have an adverse effect on our business.
Information security risks have generally increased in recent years because of the proliferation of new technologies and the increased sophistication and activities of cyber-attacks. Although we strive to have appropriate security controls in place, prevention of security breaches cannot be assured, particularly as cyber threats continue to evolve. We may be required to expend additional resources to continue to enhance our security measures or to investigate and remediate any security vulnerabilities. The consequences of these risks could adversely impact our business operations and financial results. 
In addition, our handling of certain data is subject to a variety of existing and emerging laws and regulations, designed by various federal, state and foreign governments to regulate the collection, distribution, use and storage of personal information. Several foreign countries in which we conduct business, including the European Economic Area (EEA), currently have in place, or have recently proposed, laws or regulations concerning privacy, data protection and information security, which are more restrictive than those imposed in the U.S. Some of these laws are in the early stages and we cannot yet determine the impact these laws and regulations, if implemented, may have on our business. However, any failure or perceived failure by us to comply with these privacy laws, regulations, policies or obligations or any security incident that results in the unauthorized release or transfer of personally identifiable information or other customer data in our possession, could result in government enforcement actions, litigation, fines and penalties and/or adverse publicity, all of which could have an adverse effect on our reputation and business. For example, the EEA-wide General Data Protection Regulation (GDPR) became effective on May 25, 2018 and replaced the data protection laws of each EEA member state. If our privacy or data security measures fail to comply with applicable current or future laws and regulations, we may be subject to litigation, regulatory investigations and enforcement notices requiring us to change the way we use personal and customer data.
Government regulation and policy imposes costs and other constraints.
Our manufacturing operations and past and present ownership and operations of real property are subject to extensive and changing federal, state, local and foreign laws and regulations, including laws and regulations pertaining to regulatory compliance, such as environmental, health and safety, employee benefits, import and export compliance, intellectual property, product liability, tax matters and securities regulation. We expect to continue to incur costs to comply with these laws and may incur penalties for any failure to do so.
In particular, some of our export sales require approval from the U.S. government. Changes in political relations between the U.S. and foreign countries and/or specific potential customers for which export licenses may be required, may cause a license application to be delayed or denied, or a previously issued license withdrawn, rendering us unable to complete a sale or vulnerable to competitors who do not operate under such restrictions. In addition, the U.S. government has recently imposed tariffs on certain products imported from China as well as steel and aluminum imported from the European Union, Mexico and Canada. China and the European Union have imposed tariffs on U.S. products in response. These tariffs could force our customers or us to consider various strategic options including, but not limited to, looking for different suppliers, shifting production to facilities in different geographic regions, absorbing the additional costs or passing the cost on to customers. Moreover, any retaliatory actions by other countries where we operate could also negatively impact our financial performance.
We are required to conduct a good faith reasonable country of origin analysis on our use of conflict minerals, which has imposed and may impose additional costs on us and could raise reputational and other risks.
The SEC has promulgated final rules in connection with the Dodd-Frank Wall Street Reform and Consumer Protection Act regarding disclosure of the use of certain minerals, known as conflict minerals, mined from the Democratic Republic of the Congo and adjoining countries. While there is pending litigation challenging these rules, we have incurred and will continue to incur costs associated with complying with these disclosure requirements, including costs to determine the source of any conflict minerals used in our products. We have adopted a policy relating to conflict minerals, incorporating the standards set forth in the Organisation for Economic Co-operation and Development Due Diligence Guidance, which affects the sourcing, supply, and pricing of materials used in our products. As we continue our due diligence, we may face reputational challenges if we are unable to verify the origins for all metals used in our products through the procedures we have and may continue to implement. We may also encounter challenges in our efforts to satisfy customers that may require all of the components of products purchased to be certified as conflict-free. If we are not able to meet customer requirements, customers may choose to disqualify us as a supplier.
We may not achieve our growth plans for the expansion of the business.
In addition to market penetration, our long-term success depends on our ability to expand our business through (a) new product development and service offerings; (b) mergers and acquisitions; and/or (c) geographic expansion. 

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New product development and service offerings require that we maintain our ability to improve existing products, continue to bring innovative products and services to market in a timely fashion and adapt products and services to the needs and standards of current and potential customers. Our products and services may become less competitive or eclipsed by technologies to which we do not have access or which render our solutions obsolete. 
Mergers and acquisitions will be accompanied by risks that may include:
failure to achieve, or delays in achieving, the financial and strategic goals, including growth opportunities and cost synergies, for the acquired and combined businesses;
difficulty integrating the operations and personnel of the acquired businesses, including the inability to eliminate duplicative costs or the substantial expenses that may be incurred in connection with integration;
disruption of ongoing business and acquired business and distraction of management from the operation of both businesses;
dilution of existing shareholders and earnings per share;
unanticipated, undisclosed or inaccurately assessed liabilities, legal risks and costs;
reputation risk associated with any pre-existing legal matters resulting from the acquired business;
legal and regulatory requirements if the acquired business was not formerly a public company; and
difficulties retaining the key vendors, customers or employees of the acquired business.
Acquisitions of businesses having a significant presence outside the U.S. will increase our exposure to the risks of international operations discussed in the operational risk factors. 
Geographic expansion may be outside of the U.S., and hence will be disproportionately subject to the risks of international operations discussed in the operational risk factors. 
For further information on our business acquisitions, see Note 16 to the Consolidated Financial Statements included in Item 8 of Part II of this Annual Report on Form 10-K.
We may be required to recognize impairment charges for goodwill and long-lived assets.
As of September 28, 2019, the net carrying value of goodwill and long-lived assets (property and equipment, net and intangible assets, net) totaled $836,707. We periodically assess the value of these assets for impairment in accordance with U.S. generally accepted accounting principles (GAAP). Significant negative industry or economic trends, disruptions to our businesses, significant unexpected or planned changes in use of the assets, divestitures and market capitalization declines may result in impairments to goodwill and other long-lived assets. Future impairment charges could have an adverse effect on our results of operations.
If we fail to maintain effective processes and controls relative to adherence to our Code of Conduct and related company policies, our business, financial condition or results of operations may be adversely affected.
Our Code of Conduct and related company policies promote both a culture of ethical business practices and compliance with legal and regulatory requirements, covering topics such as human and labor rights, anti-bribery, product quality and safety, privacy, security and environmental compliance. However, there can be no assurance that all of our employees or agents will refrain from acting in violation of such policies and procedures or that our processes and controls will be sufficient to detect any such violations. The investigation into potential violations of these policies, or even allegations of such violations, and evaluation of our internal controls, could disrupt our operations, involve significant management distraction, and lead to significant costs and expenses, including legal and accounting fees, and such expenses may have a material adverse effect on our financial results. Further, if our employees or agents violate such policies and procedures, such actions could result in management override of internal controls over financial reporting. If we, or our employees or agents acting on our behalf, are found to have engaged in practices that violate these policies and/or applicable law, we could suffer severe fines and penalties, repayment of ill-gotten gains, injunctions on future conduct, securities litigation, material weaknesses in our internal control over financial reporting, delayed regulatory filings and other consequences that may have a material adverse effect on our business, financial condition or results of operations. In addition, our reputation, sales activities or stock price could be adversely affected if we become the subject of any negative publicity related to actual or potential violations of applicable laws and regulations.
ITEM 1B. UNRESOLVED STAFF COMMENTS 
None.

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ITEM 2. PROPERTIES
Our properties consist of owned and leased facilities for manufacturing, sales, service administration, research and warehouse space. We own our corporate headquarters, located in Eden Prairie, Minnesota, which is also the primary location for Test & Simulation manufacturing and research. We own facilities in Depew, New York and Cary, North Carolina, which are the primary manufacturing and research locations for Sensors. In addition, we own manufacturing, sales and service administration facilities in the U.S., Germany and China. We lease space in the U.S., Europe and Asia for manufacturing, sales, service administration, research and warehouse space. We consider our current facilities suitable for their purpose and adequate to support our business.
Additional information relative to lease obligations is included in Item 7 of Part II of this Annual Report on Form 10-K.
ITEM 3. LEGAL PROCEEDINGS  
Discussion of legal matters is incorporated by reference from Note 17 to the Consolidated Financial Statements included in Item 8 of Part II of this Annual Report on Form 10-K and should be considered an integral part of Item 3 of Part I of this Annual Report on Form 10-K.  
ITEM 4. MINE SAFETY DISCLOSURES  
Not applicable.  
PART II  
ITEM  5.
MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Shares of our common stock are traded on the Nasdaq Global Select Market under the trading symbol MTSC. The number of record holders of our common stock, par value $0.25 per share, as of November 21, 2019 was 625. This number does not reflect shareholders who hold their shares in the name of broker-dealers or other nominees.  
Issuer Purchases of Equity Securities
 
 
Total Number
of Shares
Purchased
 
Average
Price Paid
per Share
 
Total Number
of Shares
Purchased
As Part of Publicly Announced Plans or Programs
 
Maximum Number
of Shares that May
Yet be Purchased
As Part of Publicly Announced Plans or Programs
June 30, 2019 – August 3, 2019
 

 
$

 

 
438

August 4, 2019 – August 31, 2019
 

 
$

 

 
438

September 1, 2019 – September 28, 2019
 

 
$

 

 
438

We purchase common stock from time to time to mitigate dilution related to new shares issued as equity for employee compensation such as stock options, restricted stock units, performance restricted stock units and employee stock purchase plan activity, as well as to return to shareholders capital not immediately required to fund ongoing operations. 
Share Purchase Plan
Our Board of Directors approved, and on February 11, 2011 announced, a purchase authorization of 2,000 shares. Authority over pricing and timing under this authorization has been delegated to management. The share purchase authorization has no expiration date. We made no purchases during the fourth quarter of fiscal year 2019. As of September 28, 2019, there were 438 shares available for purchase under the existing authorization.
Capped Calls
In connection with the pricing of the tangible equity units (TEUs) sold in our public offering in fiscal year 2016, we purchased capped calls from third party banking institutions (Capped Calls) for $7,935. On June 13, 2018, we amended the agreements with third party banking institutions for the outstanding Capped Calls (Capped Call Agreements) to modify the timing of settlement to be only upon expiration for all outstanding Capped Calls. Per the Capped Call Agreements, the outstanding Capped Calls automatically settled upon expiration on July 1, 2019 with shares of our common stock based on the average market value of our common stock as defined in the Capped Call Agreements, resulting in us receiving and retiring 223 shares of our common stock. See Note 12 to the Consolidated Financial Statements included in Item 8 of Part II of this Annual Report on Form 10-K for additional information on our equity instruments.

13



Dividends  
Our dividend policy is to maintain a payout ratio that allows dividends to increase in conjunction with the long-term growth of earnings per share, while sustaining dividends through economic cycles. Our dividend practice is to target, over time, a payout ratio of approximately 25% of net earnings per share. We have historically paid dividends to holders of our common stock on a quarterly basis. The declaration and payment of future dividends will depend on many factors, including, but not limited to, our earnings, financial condition, debt repayment obligations, business development needs and regulatory considerations and are at the discretion of our Board of Directors. During fiscal years 2019 and 2018, we declared quarterly cash dividends of $0.30 per share to holders of our common stock, resulting in a payout ratio of 54% and 38% of net earnings per share, respectively. The increase in the payout ratio in fiscal year 2019 resulted from decreased earnings per share, primarily driven by a reduction in the effective tax rate as a result of discrete tax benefits related to the U.S. tax reform in the prior year, as well as non-recurring expenses incurred in the current year.
Shareholder Performance Graph
The following graph compares the cumulative total shareholder return of our common stock over the last five fiscal years with the cumulative total shareholder return of the Russell 2000 Index and a peer group of companies in the Laboratory Apparatus and Analytical, Optical, Measuring and Controlling Instruments Standard Industrial Code (SIC Code 3820 Peer Group) that are traded on the Nasdaq, NYSE and NYSE American exchanges. The graph assumes that $100 (in actual dollars) was invested at market close on September 27, 2014 in our common stock, the Russell 2000 Index and the SIC Code 3820 Peer Group and that all dividends were reinvested. The graph is not necessarily indicative of future investment performance.
COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*
Among MTS Systems Corporation, the Russell 2000 Index, and SIC Code 3820 Peer Grouphttp://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=13223124&doc=14
* $100 invested on 9/27/2014 in stock or index, including reinvestment of dividends.
Copyright© 2019 Russell Investment Group. All rights reserved.
 
 
Fiscal Year
(in actual dollars)
 
20142
 
20152
 
20162
 
2017
 
2018
 
2019
MTS Systems Corporation
 
$
100.00

 
$
85.50

 
$
69.78

 
$
82.86

 
$
86.78

 
$
89.63

Russell 2000 Index
 
100.00

 
100.89

 
115.07

 
138.94

 
160.12

 
145.60

SIC Code 3820 Peer Group1
 
100.00

 
96.60

 
121.86

 
154.88

 
190.51

 
207.45

1    Modified to remove non-exchange traded companies.
2 
Fiscal year 2016 refers to the fiscal year ended October 1, 2016, fiscal year 2015 refers to the fiscal year ended October 3, 2015 and fiscal year 2014 refers to the fiscal year ended September 27, 2014.

14



ITEM 6.
SELECTED FINANCIAL DATA
The following selected financial data should be read in conjunction with Item 7 and Item 8 of Part II of this Annual Report on Form 10-K. 
 
 
Fiscal Year1
 
 
2019
 
2018
 
2017
 
2016
 
2015
Operating Results
 
 
 
 
 
 
 
 
 
 
Revenue
 
$
892,518

 
$
778,032

 
$
787,955

 
$
650,147

 
$
563,934

Gross profit
 
328,930

 
305,529

 
302,278

 
231,404

 
219,613

Gross margin %
 
36.9
%
 
39.3
 %
 
38.4
 %
 
35.6
%
 
38.9
%
Research and development expense
 
$
30,928

 
$
34,784

 
$
34,999

 
$
25,336

 
$
23,705

Research and development expense as a % of revenue
 
3.5
%
 
4.5
 %
 
4.4
 %
 
3.9
%
 
4.2
%
Effective income tax rate
 
11.4
%
 
(38.7
)%
 
(9.0
)%
 
18.0
%
 
23.2
%
Net income
 
$
43,067

 
$
61,328

 
$
25,084

 
$
27,494

 
$
45,462

Net income as a % of revenue
 
4.8
%
 
7.9
 %
 
3.2
 %
 
4.2
%
 
8.1
%
Earnings per share
 
 
 
 
 
 
 
 
 
 
Basic
 
$
2.24

 
$
3.20

 
$
1.32

 
$
1.72

 
$
3.03

Diluted
 
$
2.21

 
$
3.18

 
$
1.31

 
$
1.70

 
$
3.00

Weighted average shares outstanding2
 
 
 
 
 
 
 
 
 
 
Basic
 
19,258

 
19,163

 
19,040

 
16,027

 
14,984

Diluted
 
19,447

 
19,293

 
19,137

 
16,179

 
15,142

Depreciation and amortization
 
$
37,975

 
$
34,492

 
$
35,523

 
$
24,077

 
$
21,106

Financial Position
 
 
 
 
 
 
 
 
 
 
Total assets
 
$
1,297,977

 
$
1,139,396

 
$
1,189,692

 
$
1,188,020

 
$
460,831

Interest-bearing debt3
 
525,131

 
400,706

 
474,309

 
484,985

 
21,183

Total shareholders' equity
 
484,059

 
477,932

 
428,777

 
405,260

 
258,142

Interest-bearing debt as a % of shareholders' equity
 
108.5
%
 
83.8
 %
 
110.6
 %
 
119.7
%
 
8.2
%
Return on equity4
 
9.0
%
 
14.3
 %
 
6.2
 %
 
10.7
%
 
17.6
%
Return on invested capital5
 
7.6
%
 
9.3
 %
 
7.3
 %
 
8.6
%
 
15.5
%
Other Statistics
 
 
 
 
 
 
 
 
 
 
Backlog of orders at year end
 
$
420,115

 
$
415,155

 
$
360,016

 
$
370,523

 
$
353,013

Dividends declared per share
 
1.20

 
1.20

 
1.20

 
1.20

 
1.20

Capital Expenditures
 
30,525

 
12,321

 
17,798

 
20,806

 
18,445

1 
Fiscal years 2019, 2018, 2017, 2016 and 2015 include 52, 52, 52, 52 and 53 weeks, respectively.
2 
Assumes the conversion of potential common shares using the treasury stock method.
3 
Interest-bearing debt consists of long-term debt for fiscal years 2019, 2018, 2017 and 2016 and short-term borrowings for fiscal year 2015.
4 
Calculated by dividing net income by beginning shareholders' equity. 
5 
The measure Return on Invested Capital (ROIC) is not a measure of performance presented in accordance with GAAP. ROIC is calculated by dividing adjusted net income by average invested capital. Adjusted net income is calculated by excluding after-tax interest expense from reported net income. In addition, adjusted net income also excludes acquisition-related expense, net of tax; acquisition integration expense, net of tax; acquisition inventory fair value adjustment, net of tax; restructuring expense, net of tax; and China investigation expense, net of tax. Average invested capital is defined as the aggregate of average interest-bearing debt and average shareholders' equity and is calculated as the sum of current and prior year ending amounts divided by two. Because the ratio is not prescribed or authorized by GAAP, the ROIC percentage is a non-GAAP financial measure. We believe ROIC is useful to investors as a measure of operating performance and the effectiveness of the use of capital in our operations. We use ROIC as a measure to monitor and evaluate operating

15



performance relative to our invested capital. This measure should not be construed as an alternative to, or substitute for, return on equity or any other measure determined in accordance with GAAP.
Presented below is the reconciliation of ROIC to average invested capital, the nearest GAAP measure, and a reconciliation of each non-GAAP financial measure used to its nearest GAAP measure:
 
 
Fiscal Year
 
 
2019
 
2018
 
2017
 
2016
 
2015
Net income
 
$
43,067

 
$
61,328

 
$
25,084

 
$
27,494

 
$
45,462

Interest expense, net of tax
 
24,848

 
19,636

 
23,133

 
6,065

 
767

Acquisition-related expense, net of tax
 
2,321

 

 
(814
)
 
7,322

 

Acquisition integration expense, net of tax
 

 

 
2,659

 
2,049

 

Acquisition inventory fair value adjustment, net of tax
 
1,332

 

 
5,909

 
5,692

 

Restructuring expense, net of tax
 
635

 
2,033

 
2,980

 
1,465

 

China investigation expense, net of tax
 

 

 
6,749

 

 

Adjusted net income*
 
$
72,203

 
$
82,997

 
$
65,700

 
$
50,087

 
$
46,229

 
 
 
 
 
 
 
 
 
 
 
Total beginning shareholders' equity
 
$
477,932

 
$
428,777

 
$
405,260

 
$
258,142

 
$
258,127

Total ending shareholders' equity
 
484,059

 
477,932

 
428,777

 
405,260

 
258,142

Average shareholders' equity
 
480,996

 
453,355

 
417,019

 
331,701

 
258,135

 
 
 
 
 
 
 
 
 
 
 
Total beginning interest-bearing debt
 
400,706

 
474,309

 
484,985

 
21,183

 
60,000

Total ending interest-bearing debt
 
525,131

 
400,706

 
474,309

 
484,985

 
21,183

Average interest-bearing debt
 
$
462,919

 
$
437,508

 
$
479,647

 
$
253,084

 
$
40,592

 
 
 
 
 
 
 
 
 
 
 
Average invested capital*
 
$
943,914

 
$
890,862

 
$
896,666

 
$
584,785

 
$
298,726

Return on invested capital*
 
7.6
%
 
9.3
%
 
7.3
%
 
8.6
%
 
15.5
%
*
Denotes non-GAAP financial measures.
Presented below is a reconciliation of adjusted net income to net income, which reconciles the tax impact of the non-GAAP financial measure of adjusted net income presented in the table above:
 
Fiscal Year
 
 
2019
 
 
 
2018
 
 
 
2017
 
 
Pre-tax
Tax
Net
 
Pre-tax
Tax
Net
 
Pre-tax
Tax
Net
Net income
$
48,613

$
5,546

$
43,067

 
$
44,223

$
(17,105
)
$
61,328

 
$
23,011

$
(2,073
)
$
25,084

Interest expense
32,062

7,214

24,848

 
26,464

6,828

19,636

 
31,218

8,085

23,133

Acquisition-related expenseª
2,938

617

2,321

 



 

814

(814
)
Acquisition integration expenseª



 



 
3,577

918

2,659

Acquisition inventory fair value adjustmentª
1,601

269

1,332

 



 
7,975

2,066

5,909

Restructuring expense«
830

195

635

 
2,730

697

2,033

 
4,079

1,099

2,980

China investigation expenseª



 



 
9,209

2,460

6,749

Adjusted net income*
$
86,044

$
13,841

$
72,203

 
$
73,417

$
(9,580
)
$
82,997

 
$
79,069

$
13,369

$
65,700


16



 
 
Fiscal Year
 
 
 
2016
 
 
 
2015
 
 
 
Pre-tax
Tax
Net
 
Pre-tax
Tax
Net
Net income
 
$
33,512

$
6,018

$
27,494

 
$
59,172

$
13,710

$
45,462

Interest expense
 
8,424

2,359

6,065

 
1,204

437

767

Acquisition-related expenseª
 
10,170

2,848

7,322

 



Acquisition integration expenseª
 
2,846

797

2,049

 



Acquisition inventory fair value adjustmentª
 
7,916

2,224

5,692

 



Restructuring expense«
 
2,165

700

1,465

 



Adjusted net income*
 
$
65,033

$
14,946

$
50,087

 
$
60,376

$
14,147

$
46,229

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

17



ITEM 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 
Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is designed to provide a reader of our financial statements with a narrative from the perspective of management on our financial condition, results of operations, liquidity and certain other factors that may affect our future results. Our MD&A is presented in nine sections: 
Overview
Financial Results
Cash Flow Comparison
Liquidity and Capital Resources
Off-balance Sheet Arrangements
Critical Accounting Policies and Estimates
Recently Issued Accounting Pronouncements
Quarterly Financial Information
Forward-looking Statements
Our MD&A should be read in conjunction with the Consolidated Financial Statements and related Notes included in Item 8 of Part II of this Annual Report on Form 10-K. All dollar amounts are in thousands unless otherwise noted. 
The following discussion includes a comparison of our Financial Results, Cash Flow Comparisons and Liquidity and Capital Resources for fiscal year 2019 and fiscal year 2018. A discussion of changes in our financial results and cash flow comparisons from fiscal year 2017 to fiscal year 2018 has been omitted from this Form 10-K, but may be found in Item 7 of Part II of our Annual Report on Form 10-K for the fiscal year ended September 29, 2018, filed with the SEC on November 26, 2018.
Overview 
MTS Systems Corporation's testing and simulation hardware, software and service solutions simulate real world environments in other than real world settings thereby enabling customers to improve design, development and manufacturing processes, determine the mechanical behavior of materials, products and structures, or create a desired human experience such as amusement rides, vehicle simulators or flight training simulators. Our high-performance sensors provide measurements of vibration, pressure, position, force and sound in a variety of applications.
Further globalization and expansion of many industries along with growth in emerging markets, such as China and India, provide a strong and vibrant market base from which we can grow revenue. We have aligned our organizational structure to be more flexible to the demands of globalized and volatile markets by adjusting our structure to be more cost effective and nimble in responding to our customers' needs. We continue to deliver distinctive business performance through our commitment to sustain the differentiated competitive advantage that comes from offering an innovative portfolio of Test & Simulation and Sensor solutions that create value for customers and are delivered with total customer satisfaction. 
Fiscal Year
We have a 5-4-4 week, quarterly accounting cycle with the fiscal year ending on the Saturday closest to September 30. Fiscal years 2019 and 2018 ended September 28, 2019 and September 29, 2018, respectively, and both included 52 weeks.
Issuance of Senior Unsecured Notes
On July 16, 2019, we issued $350,000 in aggregate principal amount of 5.750% senior unsecured notes due 2027 (the Notes). The Notes will mature on August 15, 2027. We used the net proceeds to repay all outstanding debt under the revolving credit facility, to repay a portion of the tranche B term loan facility and for general corporate purposes. See Note 8 to the Consolidated Financial Statements included in Item 8 of Part II of this Annual Report on Form 10-K for further discussion of our financing activities.
Acquisitions
On November 21, 2018, we acquired E2M Technologies B.V. (E2M) for a cash purchase price of $80,287. The acquisition of E2M expands our technology and product offerings for human-rated simulation systems and brings key regulatory approvals and customers in the flight simulation and entertainment markets. We funded the E2M acquisition through borrowings on our revolving credit facility.
On August 5, 2019, we acquired the Endevco sensors business from Meggitt PLC for a cash purchase price of $68,330. This strategic product line purchase brings together two iconic brands in the test and measurement sensors market, in PCB and Endevco, and further enhances our long-term strategy of growth and market leadership in our core businesses. We funded the Endevco acquisition through cash on hand.

18



See Note 16 to the Consolidated Financial Statements included in Item 8 of Part II of this Annual Report on Form 10-K for further discussion of the acquisitions of E2M and Endevco.
Foreign Currency
Over the past 15 years, approximately 70% of our revenue has been derived from customers outside of the U.S. Our financial results are principally exposed to changes in exchange rates between the U.S. dollar and the Euro, the Japanese yen and the Chinese yuan. A change in foreign exchange rates could positively or negatively affect our reported financial results. The discussion below quantifies the impact of foreign currency translation on our financial results for the periods discussed.
Adoption of New Revenue Recognition Standard
In fiscal year 2019, we adopted Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (Topic 606), followed by related amendments (collectively, "the new revenue standard" or "ASC 606"). See Notes 2 and 3 to the Consolidated Financial Statements included in Item 8 of Part II of this Annual Report on Form 10-K for the impact of this adoption on Consolidated Income Statements and Consolidated Balance Sheets.

Financial Results 
Total Company 
Results of Operations
The following table compares results of operations, separately identifying the estimated impact of currency translation and the acquisitions of E2M and Endevco in the first and fourth quarter of fiscal year 2019, respectively, and restructuring expenses incurred in fiscal year 2019.
 
 
 
 
Estimated
 
 
 
 
2019 1
 
Business
Change
 
Acquisition /Restructuring 2
 
Currency
Translation
 
2018
Revenue
 
$
892,518

 
$
96,699

 
$
33,963

 
$
(16,176
)
 
$
778,032

Cost of sales
 
563,588

 
77,051

 
25,825

 
(11,791
)
 
472,503

Gross profit
 
328,930

 
19,648

 
8,138

 
(4,385
)
 
305,529

Gross margin
 
36.9
%
 
 
 
 
 
 
 
39.3
%
 
 
 
 
 
 
 
 
 
 
 
Operating expenses
 
 
 
 
 
 
 
 
 
 
Selling and marketing
 
131,639

 
6,004

 
1,128

 
(1,826
)
 
126,333

General and administrative
 
86,658

 
(533
)
 
8,790

 
(839
)
 
79,240

Research and development
 
30,928

 
(4,979
)
 
1,303

 
(180
)
 
34,784

Total operating expenses
 
249,225

 
492

 
11,221

 
(2,845
)
 
240,357

Income from operations
 
$
79,705

 
$
19,156

 
$
(3,083
)
 
$
(1,540
)
 
$
65,172

1 
Financial results for fiscal year 2019 are presented in accordance with the new revenue standard adopted in the first quarter of fiscal year 2019. Prior period results have not been restated to reflect this change. Fiscal year 2019 includes a favorable impact on income from operations of $12,584 related to the ASC 606 adoption. See Note 3 to the Consolidated Financial Statements included in Item 8 of Part II of this Annual Report on Form 10-K for additional information on the new revenue standard.
2 
The Acquisition / Restructuring column includes operating results and costs incurred as part of the acquisitions of E2M and Endevco and restructuring expenses. See Note 16 to the Consolidated Financial Statements included in Item 8 of Part II of this Annual Report on Form 10-K for additional information on the E2M and Endevco acquisitions.

19



Revenue
 
 
 
 
 
Increased / (Decreased)
 
 
2019
 
2018
 
$
 
%
Revenue
 
$
892,518

 
$
778,032

 
$
114,486

 
14.7
%
The increase in revenue of 14.7% was primarily driven by growth in both the Test & Simulation and Sensors businesses, partially offset by the unfavorable impact of currency translation. Test & Simulation revenue increased $93,984 or 20.2%, primarily driven by volume growth from the conversion of robust beginning-of-year backlog across all sectors and geographies and contributions from the acquisition of E2M, partially offset by the unfavorable impact of currency translation. Sensors revenue increased $20,707, or 6.6%, primarily driven by growth in the Sensors test sector from a multi-year contract with the U.S. Department of Defense, growth in the Sensors position sector in the first half of fiscal year 2019, contributions from the acquisition of Endevco and growth in the Sensors industrial sector from a continued rebound in the energy market, partially offset by the unfavorable impact of currency translation. Excluding the impact of currency translation and the E2M and Endevco acquisitions, revenue increased 12.4%.
Revenue by geography is as follows:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Increased / (Decreased)
 
 
2019
 
2018
 
$
 
%
Americas
 
$
346,538

 
$
275,422

 
$
71,116

 
25.8
%
Europe
 
224,982

 
223,236

 
1,746

 
0.8
%
Asia
 
320,998

 
279,374

 
41,624

 
14.9
%
Total Revenue
 
$
892,518

 
$
778,032

 
$
114,486

 
14.7
%
Gross Profit
 
 
 
 
 
Increased / (Decreased)
 
 
2019
 
2018
 
$
 
%
Gross profit
 
$
328,930

 
$
305,529

 
$
23,401

 
7.7
%
Gross margin
 
36.9
%
 
39.3
%
 
(2.4
)
 
ppts
Gross profit increased 7.7% primarily driven by higher revenue volume in both segments and contributions from the E2M acquisition, partially offset by higher compensation expense in both segments, the unfavorable impact of currency translation and the E2M and Endevco inventory acquisition adjustments of $1,601. Gross margin decreased 2.4 percentage points primarily due to higher compensation expense, the impact from the acquisition of E2M and Endevco and the E2M and Endevco inventory acquisition adjustments, partially offset by leverage on currency translation. Excluding the impact of currency translation, the E2M and Endevco acquisitions and restructuring costs incurred in both fiscal years, gross profit increased 5.9% and the gross margin declined 2.3 percentage points. 
Selling and Marketing Expense
 
 
 
 
 
Increased / (Decreased)
 
 
2019
 
2018
 
$
 
%
Selling and marketing
 
$
131,639

 
$
126,333

 
$
5,306

 
4.2
%
% of Revenue
 
14.7
%
 
16.2
%
 
 
 
 
Selling and marketing expenses increased 4.2% primarily due to higher compensation and commissions expense to support sales growth and the addition of E2M and Endevco expenses, partially offset by the favorable impact of currency translation. Excluding the impact of currency translation, the E2M and Endevco expenses and restructuring costs incurred in both fiscal years, selling and marketing expense increased 4.9%
General and Administrative Expense
 
 
 
 
 
Increased / (Decreased)
 
 
2019
 
2018
 
$
 
%
General and administrative
 
$
86,658

 
$
79,240

 
$
7,418

 
9.4
%
% of Revenue
 
9.7
%
 
10.2
%
 
 
 
 
General and administrative expense increased 9.4% primarily due to the addition of E2M expenses, acquisition-related expenses of $2,697 and higher professional fees. Excluding the impact of currency translation, E2M and Endevco expenses and restructuring costs incurred in both fiscal years, general and administrative expense decreased 0.3%.

20



Research and Development Expense
 
 
 
 
 
Increased / (Decreased)
 
 
2019
 
2018
 
$
 
%
Research and development
 
$
30,928

 
$
34,784

 
$
(3,856
)
 
(11.1
)%
% of Revenue
 
3.5
%
 
4.5
%
 
 
 
 
Research and development (R&D) expense decreased 11.1% primarily due to the shift of internal resources to larger, capitalizable, Test & Simulation projects as we continue to invest in our technology to support current and future customer needs and overall lower Test & Simulation compensation expense. This decline was partially offset by the addition of E2M expenses and continued investment in new product development in Sensors. Excluding the impact of currency translation, E2M and Endevco expenses and restructuring costs incurred in the prior fiscal year, R&D expense decreased 13.0%
Income from Operations
 
 
 
 
 
Increased / (Decreased)
 
 
2019
 
2018
 
$
 
%
Income from operations
 
$
79,705

 
$
65,172

 
$
14,533

 
22.3
%
% of Revenue
 
8.9
%
 
8.4
%
 
 
 
 
Income from operations increased 22.3% primarily due to increased gross profit from higher revenue volume and contributions from the E2M acquisition, partially offset by higher compensation expense in both segments, acquisition-related expenses of $2,938 and the unfavorable impact of foreign currency translation. Excluding the impact of currency translation, E2M and Endevco expenses and restructuring costs incurred in both fiscal years, income from operations increased 24.2%.  
Interest Expense, Net
 
 
 
 
 
Increased / (Decreased)
 
 
2019
 
2018
 
$
 
%
Interest expense, net
 
$
31,558

 
$
25,882

 
$
5,676

 
21.9
%
Interest expense increased primarily due to additional interest expense recognized on the revolving credit facility drawn on in the first quarter of fiscal year 2019 to fund the acquisition of E2M, which was paid down in the fourth quarter of fiscal year 2019, the acceleration of non-cash debt issuance costs related to the pre-payment on the tranche B term loan facility and incurring interest expense on an increased debt position related to the issuance of the Notes in the fourth quarter of fiscal year 2019.
Other Income (Expense), Net
 
 
 
 
 
Increased / (Decreased)
 
 
2019
 
2018
 
$
 
%
Other income (expense), net
 
$
466

 
$
4,933

 
$
(4,467
)
 
(90.6
)%
The decrease in other income (expense), net was primarily driven by the gain on the sale of one of our China manufacturing facilities recognized in the prior year.
Income Tax Provision (Benefit)
 
 

 
 

 
Increased / (Decreased)
 
 
2019
 
2018
 
$
 
%
Income tax provision (benefit)
 
$
5,546

 
$
(17,105
)
 
$
22,651

 
132.4
%
Effective rate
 
11.4
%
 
(38.7
)%
 
50.1

 
ppts
 
The effective tax rate increased primarily due to certain discrete benefits of $25,008 in the prior year for the estimated impact of the Tax Act. The current year also included $3,547 for the favorable true-up of our previously recorded transition tax estimate, successful closure of prior year audit activity and a reduction in the Netherlands income tax rate resulting in remeasurement of the deferred tax liability associated with certain intangible assets acquired in the E2M acquisition. Excluding the impact of these discrete benefits, the effective tax rate for fiscal years 2019 and 2018 would have been 18.7% and 17.9%, respectively. Factors that increased the effective tax rate for fiscal year 2019 included impacts of the Tax Act, such as elimination of the domestic manufacturing deduction and the implementation of the global intangible low-taxed income (GILTI) provision. These increases were partially offset by favorable aspects of the Tax Act, such as the decrease in the U.S. income tax rate and provisions for incentivizing foreign-derived intangible income (FDII).

21



Net Income
 
 

 
 

 
Increased / (Decreased)
 
 
2019
 
2018
 
$
 
%
Net income
 
$
43,067

 
$
61,328

 
$
(18,261
)
 
(29.8
)%
Diluted earnings per share
 
$
2.21

 
$
3.18

 
$
(0.97
)
 
(30.5
)%
 
Net income declined primarily due to an increase in the effective tax rate and lower income from operations in Sensors, partially offset by higher income from operations in Test & Simulation.
Backlog
Backlog of undelivered orders as of September 28, 2019 was $420,115, an increase of $4,960, or 1.2%, compared to backlog of $415,155 as of September 29, 2018. Based on anticipated manufacturing schedules, we expect to convert approximately 82% of the backlog as of September 28, 2019 into revenue during fiscal year 2020. The expected conversion rate is slightly lower than the prior year rate of 87% primarily due to timing of long-term contracts in Test & Simulation. 
We believe backlog is not an absolute indicator of future revenue because a portion of the orders in backlog could be canceled at the customer's discretion. While certain contracts within backlog are subject to order cancellation, we have not historically experienced a significant number of order cancellations. During fiscal year 2019, order cancellations did not have a material effect on backlog.
Test & Simulation Segment
Results of Operations
The following table compares results of operations for Test & Simulation, separately identifying the estimated impact of currency translation and the acquisition of E2M in the first quarter of fiscal year 2019 and restructuring expenses incurred in fiscal year 2019. See Note 15 to the Consolidated Financial Statements included in Item 8 of Part II of this Annual Report on Form 10-K for additional information on our reportable segments.
 
 
 
 

 
Estimated
 
 
 
 
2019 1
 
Business
Change
 
Acquisition / Restructuring 2
 
Currency
Translation
 
2018
Revenue
 
$
558,908

 
$
74,380

 
$
29,554

 
$
(9,950
)
 
$
464,924

Cost of sales
 
391,493

 
63,342

 
21,668

 
(8,252
)
 
314,735

Gross profit
 
167,415

 
11,038

 
7,886

 
(1,698
)
 
150,189

Gross margin
 
30.0
%
 
 

 
 
 
 

 
32.3
%
 
 
 
 
 
 
 
 
 
 
 
Operating expenses
 
 

 
 

 
 
 
 

 
 

Selling and marketing
 
72,804

 
3,830

 
913

 
(838
)
 
68,899

General and administrative
 
47,721

 
(3,254
)
 
7,002

 
(686
)
 
44,659

Research and development
 
12,810

 
(5,810
)
 
1,224

 
(10
)
 
17,406

Total operating expenses
 
133,335

 
(5,234
)
 
9,139

 
(1,534
)
 
130,964

Income from operations
 
$
34,080

 
$
16,272

 
$
(1,253
)
 
$
(164
)
 
$
19,225

1 
Financial results for fiscal year 2019 are presented in accordance with the new revenue standard adopted in the first quarter of fiscal year 2019. Prior period results have not been restated to reflect this change. Fiscal year 2019 includes a favorable impact on income from operations of $12,584 related to the ASC 606 adoption. See Note 3 to the Consolidated Financial Statements included in Item 8 of Part II of this Annual Report on Form 10-K for additional information on the new revenue standard.
2 
The Acquisition / Restructuring column includes operating results and costs incurred as part of the acquisition of E2M and restructuring costs. See Note 16 to the Consolidated Financial Statements included in Item 8 of Part II of this Annual Report on Form 10-K for additional information on the E2M acquisition.

22



Revenue
 
 
 
 
 
Increased / (Decreased)
 
 
2019
 
2018
 
$
 
%
Revenue
 
$
558,908

 
$
464,924

 
$
93,984

 
20.2
%
 
Revenue increased 20.2% primarily driven by volume growth across all sectors and geographies from the conversion of robust beginning-of-year backlog and contributions from the acquisition of E2M, partially offset by the unfavorable impact of currency translation. Excluding the impact of currency translation and the E2M acquisition, revenue increased 16.0%.
Revenue by geography is as follows:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Increased / (Decreased)