- --------------------------------------------------------------------------------
United States
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------------------------
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15 (d) of the Securities
Exchange Act of 1934 for the Quarterly period ended December 28, 2002
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 Number 0-2382
MTS SYSTEMS CORPORATION
(Exact name of Registrant as specified in its charter)
MINNESOTA 41-0908057
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
14000 Technology Drive, Eden Prairie, MN 55344
(Address of principal executive offices) (Zip Code)
Registrant's telephone number: (952) 937-4000
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.
_X_ Yes ___ No
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act): N/A
The number of shares outstanding of the Registrant's common stock as of January
30, 2003 was 21,050,278 shares.
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MTS SYSTEMS CORPORATION
REPORT ON FORM 10-Q
FOR THE THREE MONTHS ENDED DECEMBER 28, 2002
INDEX
Page No.
--------
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)
Consolidated Balance Sheets
as of December 28, 2002 and September 28, 2002 2
Consolidated Statements of Income for the
Three Months Ended December 28, 2002 and
December 31, 2001 3
Consolidated Statements of Cash Flows for the
Three Months Ended December 28, 2002 and
December 31, 2001 4
Condensed Notes to Consolidated Financial Statements 5 - 9
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 10 - 14
Item 3. Quantitative and Qualitative Disclosures About
Market Risks 14
Item 4. Controls and Procedures 14
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 15
SIGNATURES 16
CERTIFICATIONS 16 - 18
1
PART 1 - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MTS SYSTEMS CORPORATION
Consolidated Balance Sheets
(unaudited - in thousands of dollars, except per share data)
December 28, September 28,
2002 2002
---------------- -----------------
ASSETS
Current Assets:
Cash and cash equivalents $ 53,293 $ 62,924
Short-term investments 42,394 35,094
Accounts receivable, net of allowances for
doubtful accounts 65,593 64,663
Unbilled contracts and retainage receivable 35,218 32,276
Inventories 39,771 41,357
Prepaid expense 6,664 5,502
Current deferred tax asset 9,068 8,739
---------------- -----------------
Total current assets 252,001 250,555
---------------- -----------------
Property and Equipment:
Land 3,247 3,247
Buildings and improvements 46,952 46,253
Machinery and equipment 88,467 86,702
Accumulated depreciation (79,598) (76,590)
---------------- -----------------
Total property and equipment, net 59,068 59,612
---------------- -----------------
Goodwill 4,304 4,268
Other assets 3,943 4,071
Non-current deferred tax asset 1,611 1,593
---------------- -----------------
Total Assets $ 320,927 $ 320,099
================ =================
LIABILITIES AND SHAREHOLDERS' INVESTMENT
Current Liabilities:
Notes payable to banks $ 618 $ 598
Current maturities of long-term debt 6,052 8,605
Accounts payable 11,738 14,621
Accrued payroll-related costs 29,621 27,409
Advance payments from customers 35,953 37,209
Accrued warranty costs 5,718 5,071
Accrued income taxes 8,744 9,585
Other accrued liabilities 9,835 9,769
---------------- -----------------
Total current liabilities 108,279 112,867
---------------- -----------------
Deferred income taxes 1,714 1,627
Long-term debt, less current maturities 43,572 43,340
---------------- -----------------
Total Liabilities 153,565 157,834
---------------- -----------------
Shareholders' Investment:
Common stock, $.25 par; 64,000,000 shares
authorized:
21,132,000 and 21,208,000 shares issued and
outstanding 5,283 5,302
Additional paid-in capital 9,073 9,770
Retained earnings 150,957 146,857
Accumulated other comprehensive income 2,049 336
---------------- -----------------
Total shareholders' investment 167,362 162,265
---------------- -----------------
Total Liabilities and Shareholders' Investment $ 320,927 $ 320,099
================ =================
The accompanying notes to consolidated financial statements are
an integral part of these statements.
2
MTS SYSTEMS CORPORATION
Consolidated Statements of Income
(unaudited - in thousands of dollars, except per share data)
Three Months Ended
-------------------------------------
December 28, December 31,
2002 2001
----------------- ----------------
Revenue $ 91,261 $ 87,164
Cost of sales 58,095 56,090
----------------- ----------------
Gross profit 33,166 31,074
----------------- ----------------
Operating expenses:
Selling 13,168 13,772
General and administrative 6,920 7,137
Research and development 4,286 5,102
----------------- ----------------
Total operating expenses 24,374 26,011
----------------- ----------------
Income from operations 8,792 5,063
----------------- ----------------
Interest expense 1,127 1,153
Interest income (491) (137)
Other expense (income), net 18 (1,299)
----------------- ----------------
Income before income taxes and cumulative effect of
accounting change 8,138 5,346
Provision for income taxes 2,767 1,633
----------------- ----------------
Income before cumulative effect of accounting change 5,371 3,713
Cumulative effect of accounting change, net of taxes - (13,721)
----------------- ----------------
Net income (loss) $ 5,371 $(10,008)
================= ================
Earnings (loss) per share:
Basic-
Before cumulative effect of accounting change $ 0.25 $ 0.17
Cumulative effect of accounting change, net of taxes - (0.65)
----------------- ----------------
Earnings (loss) per share $ 0.25 $ (0.48)
================= ================
Weighted average number of common shares outstanding
- basic 21,132 21,027
================= ================
Earnings (loss) per share:
Diluted-
Before cumulative effect of accounting change $ 0.25 $ 0.17
Cumulative effect of accounting change, net of taxes - (0.64)
----------------- ----------------
Earnings (loss) per share $ 0.25 $ (0.47)
================= ================
Weighted average number of common shares outstanding
- diluted 21,355 21,398
================= ================
The accompanying notes to consolidated financial statements are an integral part
of these statements.
3
MTS SYSTEMS CORPORATION
Consolidated Statements of Cash Flows
(unaudited - in thousands of dollars)
Three Months Ended
-----------------------------------
December 28, December 31,
2002 2001
---------------- ---------------
Cash flows from operating activities:
Net income (loss) $ 5,371 $(10,008)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Non-cash cumulative effect of accounting change - 13,721
Depreciation and amortization 2,570 2,906
Deferred income taxes (348) 67
Bad debt provision 140 260
Inventory provision 1,501 1,808
Changes in operating assets and liabilities:
Accounts, unbilled contracts and retainage receivable (2,550) 5,051
Inventories 1,080 5,835
Prepaid expense (969) 8
Other assets (159) (1,766)
Accounts payable (2,998) (986)
Accrued compensation and benefits 895 (5,259)
Advance payments from customers (1,938) 5,349
Accrued warranty costs 587 419
Other liabilities (409) 1,432
---------------- ---------------
Net cash provided by operating activities 2,773 18,837
---------------- ---------------
Cash flows from investing activities:
Additions to plant, property and equipment (1,316) (1,107)
Additions to short-term investments (7,300) -
---------------- ---------------
Net cash used in investing activities (8,616) (1,107)
---------------- ---------------
Cash flows from financing activities:
Net repayments under notes payable to banks 7 -
Payments of long-term debt (2,656) (71)
Proceeds from issuance of long-term debt 13 -
Cash dividends (1,273) (1,263)
Proceeds from exercise of stock options 43 108
Payment to purchase or retire common stock (758) (20)
---------------- ---------------
Net cash used in financing activities (4,624) (1,246)
---------------- ---------------
Effect of exchange rate on changes in cash 836 (388)
---------------- ---------------
Net (decrease) increase in cash and cash equivalents (9,631) 16,096
Cash and cash equivalent, at beginning of period 62,924 17,515
---------------- ---------------
Cash and cash equivalent, at end of period $ 53,293 $ 33,611
================ ===============
Supplemental disclosure of cash flow information:
Cash paid during the period for -
Interest expense $ 892 $ 782
Income taxes $ 4,198 $ 2,399
================ ===============
The accompanying notes to consolidated financial statements are an integral part
of these statements.
4
MTS SYSTEMS CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. BASIS OF PRESENTATION
- ------------------------
Accounting Policies
- -------------------
The consolidated financial statements include the accounts of MTS SYSTEMS
CORPORATION and its wholly owned subsidiaries (the "Company"). All significant
intercompany balances and transactions have been eliminated.
The interim consolidated financial statements included herein have been prepared
by the Company, without audit, pursuant to the rules and regulations of the
Securities and Exchange Commission ("SEC"). The information furnished in these
financial statements includes normal recurring adjustments and reflects all
adjustments which are, in the opinion of management, necessary for a fair
presentation of such financial statements. Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with accounting principles generally accepted in the United States of America
have been condensed or omitted pursuant to such rules and regulations. The
accompanying financial statements of the Company should be read in conjunction
with the audited consolidated financial statements and notes thereto included in
the Company's 2002 Form 10-K filed with the SEC, which includes audited
financial statements for the fiscal year ended September 28, 2002 and restated
audited financial statements for the fiscal years ended September 30, 2001 and
2000. Interim results of operations for the three-month period ended December
28, 2002 may not necessarily be indicative of the results to be expected for the
full year.
Certain prior year amounts included in the accompanying financial statements
have been reclassified to conform to the current year's presentation. Such
reclassifications had no effect on the Company's previously reported financial
position, net income or cash flows.
The Company believes that of its significant accounting policies, the following
are particularly important to the portrayal of the Company's results of
operations and financial position and may require the application of a higher
level of judgment by the Company's management and, as a result, are subject to
an inherent degree of uncertainty.
Revenue Recognition
- -------------------
For orders that are manufactured and delivered in less than twelve months with
routine installations and no special acceptance protocol, revenue is recognized
when systems are shipped and title has passed to the customer, less the portion
of related revenues associated with installation, which are deferred until
customer acceptance. The remaining revenue on these contracts is recognized upon
installation and customer acceptance. In cases where special acceptance
protocols exist, the Company recognizes revenue upon the completion of
installation and fulfillment of obligations specific to the terms of the
customer's contract.
Revenue on contracts requiring longer delivery periods (long-term contracts) is
recognized using the percentage-of-completion method based on the cost incurred
to date relative to the estimated total cost of the contract. In most cases,
orders with complex installations and/or unusual acceptance protocols involve
long-term contracts for custom systems that follow the percentage-of-completion
method of revenue recognition through customer acceptance. The Company enters
into long-term contracts for customized equipment sold to its customers. Under
the terms of such contracts, revenue recognized using the
percentage-of-completion method may not be invoiced until completion of
contractual milestones, upon shipment of the equipment, or upon installation and
acceptance by the customer. Unbilled amounts for these contracts appear in the
Consolidated Balance Sheets as Unbilled Contracts and Retainage Receivable.
Revenue for services is recognized as the service is performed and ratably over
a defined contractual period for service maintenance contracts.
5
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
Inventories
- -----------
Inventories consist of material, labor and overhead costs and are stated at the
lower of cost or market, determined under the first-in, first-out accounting
method. Inventories as of December 28, 2002 and September 28, 2002,
respectively, were as follows:
December 28, 2002 September 28, 2002
--------------------- ----------------------
(in thousands of dollars)
Customer projects in various
stages of completion $ 8,425 $ 8,679
Components,
assemblies and parts 31,346 32,678
-------------------- ---------------------
Total $ 39,771 $ 41,357
-------------------- ---------------------
2. RECENTLY ISSUED ACCOUNTING STANDARDS
- ---------------------------------------
In October 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Standards ("SFAS") No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," which addresses financial
accounting and reporting for the impairment or disposal of long-lived assets.
The Company adopted this statement in this first quarter of fiscal year 2003.
The Company has concluded that there will be no material impact of the adoption
of SFAS No. 144.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities," which addresses financial accounting and
reporting for costs associated with exit or disposal activities. The Company
will adopt this statement for exit or disposal activities initiated after
December 31, 2002, as required.
In November 2002, the Emerging Issues Task Force ("EITF") finalized its
tentative consensus on EITF Issue 00-21, "Revenue Arrangements with Multiple
Deliverables," which provides guidance on the timing of revenue recognition for
sales undertakings to deliver more than one product or service. The Company is
required to adopt EITF 00-21 on transactions occurring after June 2003 and is
currently analyzing the impact of its adoption on the Company's financial
statements.
In November 2002, the FASB issued FASB Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others," which addresses certain disclosure
requirements to be made by a guarantor about its obligations under guarantees.
See Note 8 to the Condensed Notes to Consolidated Financial Statements for the
required disclosures.
In January 2003, the FASB issued FASB Interpretation No. 46, "Consolidation of
Variable Interest Entities," which addresses accounting for special-purpose and
variable interest entities. The Company is required to adopt this guidance for
financial statements issued after December 31, 2002, as required and is
currently analyzing the impact of its adoption on the Company's financial
statements.
3. EARNINGS (LOSS) PER COMMON SHARE
- -----------------------------------
Basic net earnings (loss) per share is computed by dividing net earnings (loss)
by the weighted average number of common shares outstanding during the
applicable periods. Diluted net earnings (loss) per share is computed under the
treasury stock method and is calculated to reflect the potentially dilutive
effect of common shares issued in connection with outstanding stock options. A
reconciliation of these amounts is as follows:
6
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
Three Months Ended
-------------------------------------------------
December 28, 2002 December 31, 2001
----------------------- ----------------------
(in thousands, except per share data)
Income before cumulative effect of
accounting change $ 5,371 $ 3,713
Cumulative effect of accounting change - (13,721)
----------------------- ----------------------
Net income (loss) $ 5,371 $ (10,008)
======================= ======================
Weighted average common shares outstanding 21,132 21,027
Diluted potential common shares 223 371
----------------------- ----------------------
Total diluted common shares 21,355 21,398
Basic earnings (loss) per share $ 0.25 $ (0.48)
Diluted earnings (loss) per share $ 0.25 $ (0.47)
======================= ======================
4. COMPREHENSIVE INCOME (LOSS)
- ------------------------------
Comprehensive income (loss) represents net earnings (loss) adjusted for foreign
currency translation adjustments, the unrealized gain or loss on
available-for-sale investments, and the net effect of accumulated hedging
activity.
Three Months Ended
--------------------------------------------------
December 28, 2002 December 31, 2001
----------------------- -----------------------
(in thousands of dollars)
Net income (loss) $ 5,371 $ (10,008)
Change in cumulative translation adjustment 1,687 (2,132)
Derivative instruments 26 829
Unrealized gain on investments - 401
----------------------- -----------------------
Comprehensive income (loss) $ 7,084 $ (10,910)
======================= =======================
5. BUSINESS SEGMENT INFORMATION
- -------------------------------
The Company's Chief Executive Officer regularly reviews the available financial
information for five discrete business units: Vehicle Testing Systems, Material
Testing Systems, Advanced Systems, Automation and Sensors. The Vehicle Testing
Systems unit manufactures and markets systems for vehicle and component
manufacturers to aid in the acceleration of design development work and to
decrease the cost of product manufacturing. The Material Testing Systems unit
manufactures and markets systems to aid customers in product development and
quality control toward an effort of design improvement. The Advanced Systems
unit offers highly customized systems primarily for simulation and
manufacturing. The Automation unit manufactures and markets products for high
performance industrial machine applications in a wide range of industries. The
Sensors unit manufactures and markets displacement and liquid level sensors used
in various applications to monitor and automate industrial processes. The
economic characteristics, nature of products and services, production processes,
type or class of customer served, method of distribution and regulatory
environments are similar for the Vehicle Testing Systems, Material Testing
Systems and Advanced Systems business units. As a result of these similarities,
these units have been aggregated for financial statement purposes into one
reportable segment called Mechanical Testing and Simulation ("MT&S"). In
addition, the economic characteristics, nature of products and services,
production processes, type or class of customer served, method of distribution
and regulatory environments are similar for the Automation and Sensors business
units. As a result, these units have been aggregated into one reportable segment
called Factory Automation ("FA").
7
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
The accounting policies of the reportable segments are the same as those
described in Note 1 to the Consolidated Financial Statements found in the
Company's 2002 Form 10-K. In evaluating each segment's performance, management
focuses on income from operations. This measurement excludes interest income and
expense, income taxes and other non-operating items. Corporate expenses,
including costs associated with various support functions such as human
resources, information technology, finance and accounting, and general and
administrative costs, are allocated to the reportable segments primarily on the
basis of revenue.
Financial information by reportable segment is as follows:
Three Months Ended
December 28, 2002 December 31, 2001
--------------------- ---------------------
(in thousands of dollars)
REVENUE BY SEGMENT:
Mechanical Testing and Simulation $ 73,952 $ 70,283
Factory Automation 17,309 16,881
--------------------- ---------------------
Total revenue $ 91,261 $ 87,164
===================== =====================
INCOME (LOSS) FROM OPERATIONS BY SEGMENT:
Mechanical Testing and Simulation $ 8,399 $ 6,569
Factory Automation 393 (1,506)
--------------------- ---------------------
Total income from operations $ 8,792 $ 5,063
===================== =====================
6. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
- ------------------------------------------------
The Company periodically enters into forward exchange contracts principally to
hedge the estimated cash flow of foreign currency denominated transactions
(primarily the EURO, British Pound, Swedish Krona, and the Japanese Yen). These
contracts are recognized on the balance sheet at fair value, which is the
estimated amount at which they could be settled based on forward market exchange
rates. The contracts generally mature within one year and are designed to limit
exposure to exchange rate fluctuations. On the date the forward exchange
contract is entered into, it is designated as a foreign currency cash flow
hedge. Subsequent changes in the fair value of contracts that are highly
effective and qualify as foreign currency cash flow hedges are recorded in other
comprehensive income until they are recognized in earnings at the time the
forecasted transaction occurs. The Company formally documents all relationships
between hedging instruments and hedged items, as well as its risk management
objective and strategy for undertaking various hedge transactions. This process
includes linking all derivatives that are designated as foreign currency hedges
to specific forecasted transactions. The Company formally assesses, both at a
hedge's inception and on an ongoing basis, whether the derivatives that are used
in hedging transactions are highly effective in offsetting changes in cash flows
of hedged items. When it is determined that a derivative is not highly effective
as a hedge or that it has ceased to be a highly effective hedge, the Company
discontinues hedge accounting prospectively, as discussed below.
The Company discontinues hedge accounting prospectively when the derivative is
(1) determined to be no longer effective in offsetting the fair value of the
cash flows of a hedged item; (2) sold, terminated, or exercised; or (3)
de-designated as a hedge instrument because it is unlikely that a forecasted
transaction will occur. When hedge accounting is discontinued, the derivative
will be carried at its fair value on the balance sheet, with changes in its fair
value recognized in current period earnings. Any related gains or losses that
were accumulated in other comprehensive income (loss) will be recognized
immediately in earnings.
The Company uses forward exchange contracts to hedge specific foreign currency
denominated assets or liabilities on the balance sheet. These are recorded at
their fair value with the related gains and losses included in "Other (income)
expense, net" on the income statement. Results of these contracts offset in full
or in part the gains and losses stemming from the normal mark-to market of the
underlying balance sheet exposures. The Company does not use derivative
financial instruments for speculative or trading purposes.
At December 28, 2002 and December 31, 2001, the Company had outstanding foreign
currency forward contracts with U.S. dollar notional equivalent amounts of $36.2
million and $39.2 million, respectively. At December 28, 2002 and December 31,
2001, the fair value of the foreign currency forward contracts was zero and $2.6
million, respectively. The
8
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
amounts recognized in earnings as a result of the ineffectiveness of cash flow
hedges were not material for the periods ended December 28, 2002 and December
31, 2001. At December 28, 2002, there was no amount projected to be reclassified
from other comprehensive income into earnings in the next 12 months. At December
31, 2001, approximately $0.1 million was projected to be reclassified from other
comprehensive income into earnings in the next 12 months. The maximum maturity
of any derivative was 1.1 years at December 28, 2002, and 1.1 years at December
31, 2001.
7. DEFERRED TAX ASSET
- ---------------------
At December 28, 2002, the Company had an aggregate deferred tax asset of $10.7
million in connection with accrued compensation and benefits, inventory
reserves, and allowances for doubtful accounts and other assets.
Management performs an analysis of the realization of the deferred tax asset at
each fiscal year-end. This analysis largely relies on continued long-term
profitability. Unanticipated negative changes in future operations of the
Company would adversely affect the realization of the Company's deferred tax
asset. Such negative changes would result in the establishment of a valuation
reserve for the deferred tax asset.
8. WARRANTY GUARANTEES
- ----------------------
Sales of the Company's products and systems are subject to limited warranty
guarantees. System guarantees typically extend for a period of twelve months
from the date of either shipment or system acceptance, for sales that include
installation services. Product guarantees typically extend for a period of 24
months from the date of purchase. Standard warranty terms are included in
customer contracts. Under the terms of these warranties, the Company is
obligated to repair or replace any components or assemblies it deems defective
due to workmanship or materials. The Company reserves the right to reject
warranty claims where it determines that failure is due to normal wear, customer
modifications, improper maintenance, or misuse. The Company records warranty
provisions monthly based on an estimated warranty expense percentage applied to
current period revenue. The percentage applied reflects historical warranty
incidence over the preceding twelve-month period. Both the experience percentage
and the warranty liability are evaluated on an ongoing basis for adequacy.
Warranty provisions and claims for the period ended December 28, 2002 were as
follows:
Three Months Beginning Warranty Warranty Ending
Ended Balance Provisions Claims Translation Balance
- ------------------------ -------------- --------------- -------------- --------------- --------------
(in thousands of dollars)
December 28, 2002 $ 5,071 $ 1,627 $ (1,040) $ 60 $ 5,718
9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
CRITICAL ACCOUNTING POLICIES
- ----------------------------
The consolidated financial statements are prepared in accordance with accounting
principles generally accepted in the United States of America, which require the
Company to make estimates and assumptions in certain circumstances that affect
amounts reported. In preparing these financial statements, management has made
its best estimates and judgments of certain amounts, giving due consideration to
materiality. The Company believes that of its significant accounting policies,
the following are particularly important to the portrayal of the Company's
results of operations and financial position and may require the application of
a higher level of judgment by the Company's management, and as a result are
subject to an inherent degree of uncertainty.
Revenue Recognition. For orders that are manufactured and delivered in less than
twelve months with routine installations and no special acceptance protocol,
revenue is recognized when systems are shipped and title has passed to the
customer, less the portion of related revenues associated with installation,
which are deferred until customer acceptance. The remaining revenue on these
contracts is recognized upon installation and customer acceptance. In cases
where special acceptance protocols exist, the Company recognizes revenue upon
the completion of installation and fulfillment of obligations specific to the
terms of the customer's contract.
Revenue on contracts requiring longer delivery periods (long-term contracts) is
recognized using the percentage-of-completion method based on the cost incurred
to date relative to the estimated total cost of the contract. In most cases,
orders with complex installations and/or unusual acceptance protocols involve
long-term contracts for custom systems that follow the percentage-of-completion
method of revenue recognition through customer acceptance. The Company enters
into long-term contracts for customized equipment sold to its customers. Under
the terms of such contracts, revenue recognized using the
percentage-of-completion method may not be invoiced until completion of
contractual milestones, upon shipment of the equipment, or upon installation and
acceptance by the customer. Unbilled amounts for these contracts appear in the
Consolidated Balance Sheets as Unbilled Contracts and Retainage Receivable.
Revenue for services is recognized as the service is performed and ratably over
a defined contractual period for service maintenance contracts.
Inventories. Inventories consist of material, labor and overhead costs and are
stated at the lower of cost or market, determined under the first-in, first-out
accounting method. Reserves for slow-moving and obsolete inventories are
provided based upon current and expected future product sales and the expected
impact of product transitions or modifications. While the Company expects its
sales to grow, a reduction in its sales could reduce the demand for the
Company's products, and additional inventory reserves may be required.
NEW ACCOUNTING PRINCIPLES
- -------------------------
In October 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Standards ("SFAS") No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," which addresses financial
accounting and reporting for the impairment or disposal of long-lived assets.
The Company adopted this statement in this first quarter of fiscal year 2003.
The Company has concluded that there will be no material impact of the adoption
of SFAS No. 144.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities," which addresses financial accounting and
reporting for costs associated with exit or disposal activities. The Company
will adopt this statement for exit or disposal activities initiated after
December 31, 2002, as required.
In November 2002, the Emerging Issues Task Force ("EITF") finalized its
tentative consensus on EITF Issue 00-21, "Revenue Arrangements with Multiple
Deliverables," which provides guidance on the timing of revenue recognition for
sales undertakings to deliver more than one product or service. The Company is
required to adopt EITF 00-21 on transactions occurring after June 2003 and is
currently analyzing the impact of its adoption on the Company's financial
statements.
In November 2002, the FASB issued FASB Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others," which addresses certain disclosure
requirements to be made by a guarantor about its obligations under guarantees.
See Note 8 to the Condensed Notes to Consolidated Financial Statements for the
required disclosures.
10
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(continued)
In January 2003, the FASB issued FASB Interpretation No. 46, "Consolidation of
Variable Interest Entities," which addresses accounting for special-purpose and
variable interest entities. The Company is required to adopt this guidance for
financial statements issued after December 31, 2002, as required and is
currently analyzing the impact of its adoption on the Company's financial
statements.
NEW CUSTOMER ORDERS AND BACKLOG
- -------------------------------
THREE MONTHS ENDED DECEMBER 28, 2002 ("FIRST QUARTER OF FISCAL 2003") COMPARED
TO THREE MONTHS ENDED DECEMBER 31, 2001 ("FIRST QUARTER OF FISCAL 2002")
New orders from customers during First Quarter of Fiscal 2003 aggregated $81.8
million, a decrease of 15.4% compared to customer orders of $96.7 million booked
during First Quarter of Fiscal 2002.
Orders for the Mechanical Testing and Simulation ("MT&S") segment totaled $65.3
million, a decrease of 20.1% compared to customer orders of $81.7 million for
First Quarter of Fiscal 2002. This decrease was primarily due to the impact of a
$13 million aerospace order booked in the First Quarter of Fiscal 2002. The MT&S
segment accounted for 79.8% of total Company orders, compared to 84.5% for the
First Quarter of Fiscal 2002.
Orders for the Factory Automation ("FA") segment increased 10% to $16.5 million
for First Quarter of Fiscal 2003 from $15.0 million for First Quarter of Fiscal
2002. The increase in orders was the result of general strengthening in the
automotive, semiconductor and industrial markets in Europe and Asia which
increased demand for the FA segment's products in those markets. The FA segment
accounted for 20.2% of total Company orders during First Quarter of Fiscal 2003,
compared to 15.5% in First Quarter of Fiscal 2002.
Backlog of undelivered orders at December 28, 2002 was $168.5 million, a
decrease of 5.0% from backlog of $177.3 million at September 28, 2002, due to
reduced order volume in First Quarter of Fiscal 2003. The Company's backlog is
subject to order cancellations.
RESULTS OF OPERATIONS
- ---------------------
REVENUE for First Quarter of Fiscal 2003 was $91.3 million, an increase of $4.1
million, or 4.7%, compared to First Quarter of Fiscal 2002. The increase in
revenue was principally driven by favorable performance in the MT&S segment
resulting from strong performance in the European automotive and motorsports
markets and the worldwide civil engineering market as well as the favorable
impact of currency translation. Revenue from foreign customers for First Quarter
of Fiscal 2003 represented 48.6% of total revenues, compared to 58.0% for First
Quarter of Fiscal 2002. Growth in the North America and Europe markets of 20.9%
and 13.0%, respectively, was partially offset by a decline in Asia of 38.6%.
GROSS PROFIT for First Quarter of Fiscal 2003 increased 6.8%, to $33.2 million,
compared to gross profit of $31.1 million for First Quarter of Fiscal 2002.
Gross profit as a percentage of net revenue was 36.4% for First Quarter of
Fiscal 2003, up from 35.7% for First Quarter of Fiscal 2002. Gross profit for
the MT&S segment was 35.4% for First Quarter of Fiscal 2003, compared to 37.0%
for First Quarter of Fiscal 2002, primarily due to product mix and the favorable
impact of currency translation. Gross profit for the FA segment increased to
40.4% for First Quarter of Fiscal 2003, compared to 30.2% for First Quarter of
Fiscal 2002, largely due to reduced charges for obsolete and surplus inventory
recorded in First Quarter of Fiscal 2002 compared to the First Quarter of Fiscal
2003.
SELLING EXPENSES for First Quarter of Fiscal 2003 decreased to $13.2 million, or
4.3%, from $13.8 million for First Quarter of Fiscal 2002. Selling expenses as a
percentage of revenue decreased to 14.5% for First Quarter of Fiscal 2003,
compared to 15.8% for First Quarter of Fiscal 2002, due to reduced staffing and
sales commission expenses.
GENERAL AND ADMINISTRATIVE EXPENSES totaled $6.9 million for First Quarter of
Fiscal 2003, a decrease of 2.8% compared to $7.1 million for First Quarter of
Fiscal 2002. The decrease in overall expenses was primarily due to cost
reduction initiatives undertaken by the Company throughout 2002. General and
administrative expenses as a percentage of revenue decreased by 0.5%, to 7.6%
for First Quarter of Fiscal 2003, compared to 8.1% for First Quarter of Fiscal
2002.
11
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(continued)
RESULTS OF OPERATIONS (CONTINUED)
- ---------------------
RESEARCH AND DEVELOPMENT expenses totaled $4.3 million for First Quarter of
Fiscal 2003, a decrease of 15.7% compared to $5.1 million for First Quarter of
Fiscal 2002. Research and development expenses as a percentage of revenue
decreased to 4.7% for First Quarter of Fiscal 2003, compared to 5.8% for First
Quarter of Fiscal 2002, primarily due to reallocation of engineering staff to
revenue-generating projects.
INCOME FROM OPERATIONS increased 72.5% to $8.8 million for First Quarter of
2003, compared to $5.1 million for First Quarter of 2002. Operating earnings in
the MT&S segment increased to $8.4 million from $6.6 million in First Quarter of
Fiscal 2002 due to the higher revenue volume as well as reduced operating
expenses. Operating earnings in the FA segment increased by $1.9 million to $0.4
million compared to a $1.5 million operating loss in First Quarter of Fiscal
2002, largely due to reduced charges for obsolete and surplus inventory recorded
in First Quarter of Fiscal 2002 compared to the First Quarter of Fiscal 2003.
INTEREST EXPENSE decreased $0.1 million to $1.1 million for First Quarter of
Fiscal 2003, compared to $1.2 million for First Quarter of Fiscal 2002. This
decrease was the result of a reduction in debt during First Quarter of Fiscal
2003.
INTEREST INCOME increased $0.4 million to $0.5 million for First Quarter of
Fiscal 2003, compared to $0.1 million in First Quarter of 2002, due to an
increase in the amount of cash, cash equivalents and short-term investments
outstanding during First Quarter of Fiscal 2003.
OTHER (INCOME) EXPENSE for First Quarter of Fiscal 2003 was negligible, compared
to other income of $1.3 million for First Quarter of Fiscal 2002, which
consisted primarily of a gain on foreign currency transactions of $1.1 million.
CUMULATIVE EFFECT OF ACCOUNTING CHANGE, NET OF TAXES for First Quarter of Fiscal
2002 reflects a non-cash transition charge to earnings of $13.7 million related
to the Company's adoption of SFAS 142, "Accounting for Goodwill and Other
Intangible Assets."
NET INCOME was $5.4 million for First Quarter of Fiscal 2003, compared to a net
loss (after cumulative effect of accounting change) of $10.0 million for First
Quarter of Fiscal 2002. The effective tax rate for First Quarter of Fiscal 2003
was 34.0%, compared to 30.5% for First Quarter of Fiscal 2002. The increase in
the overall effective tax rate was primarily the result of an increase in
pre-tax income in First Quarter of Fiscal 2003 as compared to First Quarter of
Fiscal 2002 and uncertainties regarding the continuation of U.S. export tax
benefits.
CAPITAL RESOURCES AND LIQUIDITY
- -------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES provided cash of $2.8 million in the First
Quarter of Fiscal 2003, compared to cash provided of $18.8 million in the First
Quarter of Fiscal 2002. The decrease in cash provided by operating activities
during the First Quarter of Fiscal 2003 is primarily due to significant
improvements in accounts receivable, inventory and advanced payments from
customers made in First Quarter of Fiscal 2002.
CASH FLOWS FROM INVESTING ACTIVITIES required a use of cash totaling $8.6
million during First Quarter of Fiscal 2003, compared to usage of $1.1 million
in First Quarter of Fiscal 2002. The increase in cash usage was primarily the
result of $7.3 million in purchases of short-term investments in First Quarter
of Fiscal 2003.
CASH FLOWS FROM FINANCING ACTIVITIES required a use of cash totaling $4.6
million during First Quarter of Fiscal 2003, compared to $1.2 million for First
Quarter of Fiscal 2002. The increase in cash usage was primarily the result of
payments of long-term debt and purchases of treasury stock.
Under the terms of its credit agreements, the Company has agreed to certain
financial covenants. At December 28, 2002, the Company was in compliance with
the terms and covenants of its credit agreements. The Company believes the
combination of present capital resources, internally generated funds, and unused
financing sources will be adequate to finance ongoing operations, allow for
investment in opportunities to internally grow its business and to make selected
strategic acquisitions.
12
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(continued)
OTHER MATTERS
- -------------
The Company is exposed to market risk from changes in foreign currency exchange
rates that can affect its results from operations and financial condition. To
minimize that risk, the Company manages exposure to changes in foreign currency
rates through its regular operating and financing activities and, when deemed
appropriate, through the use of derivative financial instruments, principally
forward exchange contracts. Foreign exchange contracts are used to hedge the
Company's overall exposure to exchange rate fluctuations, since the gains and
losses on these contracts offset gains and losses on the assets, liabilities,
and transactions being hedged.
The Company's dividend policy is to maintain a payout ratio, which allows
dividends to increase with the long-term growth of earnings per share, while
sustaining dividends in down years. The Company's dividend payout ratio target
is approximately 25% of earnings per share over the long term.
FORWARD-LOOKING STATEMENTS
- --------------------------
Statements included or incorporated by reference in this Management's Discussion
and Analysis of Financial Condition and Results of Operations and elsewhere in
this Form 10-Q which are not historical or current facts are "forward-looking"
statements, as defined in the Private Securities Litigation Reform Act of 1995
and are subject to certain risks and uncertainties that could cause actual
results to differ materially from historical results and those presently
anticipated or projected. The following important facts, among others, could
affect the Company's actual results in the future and could cause the Company's
actual financial performance to differ materially from that expressed in any
forward-looking statements:
(i) With regard to the Company's new product developments, there
may be uncertainties currently unknown to the Company
concerning the expected results. In addition, the Company may
not be aware of the introduction of new products or product
enhancements by its competitors.
(ii) Possible significant volatility in both backlog and quarterly
operating results may result from individual large, fixed
price orders in connection with sales of MT&S systems.
(iii) Order volumes and other operating considerations may be
directly or indirectly impacted by economic conditions
generally and/or in various geographic areas in which the
Company operates.
(iv) Export controls based on U.S. initiatives and foreign policy,
as well as import controls imposed by foreign governments, may
cause delays in certain shipments or the rejection of orders
by the Company. Such delays could create material fluctuations
in quarterly operating results and could have a material
adverse effect on results of operations. Local political
conditions and/or currency restrictions may also affect
foreign revenue.
(v) Delays in realization of backlog orders may occur due to
technical difficulties, export licensing approval or the
customer's preparation of the installation site, any of which
can affect the quarterly or annual period when backlog is
recognized as revenue and could materially affect the results
of any such period.
(vi) The Company experiences competition on a worldwide basis.
Customers may choose to purchase equipment from the Company or
from its competitors. For certain of the Company's products,
customers may also contract with testing laboratories or
construct their own testing equipment, purchasing commercially
available components. Factors that may influence a customer's
decision include price, service, or required level of
technology.
(vii) The Company is exposed to market risk from changes in foreign
currency exchange rates, which can affect its results from
operations and financial condition.
13
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(continued)
(viii) The Company's short-term borrowings carry interest rate risk
that is generally related to either LIBOR or the prime rate.
The Company has minimal earnings and cash flow exposure due to
market risks on its long-term debt obligations as a result of
the primarily fixed-rate nature of its debt.
The foregoing list is not exhaustive, and the Company disclaims any obligation
to revise any forward-looking statements to reflect events or circumstances
after the date of such statements or to reflect the occurrence of anticipated or
unanticipated events.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
At December 28, 2002, the Company had an investment portfolio of fixed income
securities, excluding those classified as cash and cash equivalents, of $42.4
million. These securities, like all fixed income instruments, are subject to
interest rate risk and will decline in value if market interest rates increase.
However, the Company has the ability and intent to hold its fixed income
investments until maturity, and therefore the Company does not expect any such
increase in interest rates to have an adverse impact on income or cash flows.
The fair market value of these securities was $42.7 million at December 28,
2002.
The Company operates internationally and thus is subject to movements in foreign
currency rate changes. The Company enters into foreign exchange forward
contracts to reduce its exposure to foreign currency rate changes on
intercompany foreign currency denominated balance sheet positions. Additional
information is included in Note 6 in the Condensed Notes to Consolidated
Financial Statements.
As of December 28, 2002, the Company's long-term debt consisted of notes payable
with fixed interest rates ranging from 5.4% to 7.5%. As such, interest rate
fluctuations would not have an impact on interest expense or cash flows.
ITEM 4. CONTROLS AND PROCEDURES
The Company's management, including the Chief Executive Officer and Chief
Financial Officer, have conducted an evaluation of the effectiveness of the
design and operation of the Company's disclosure controls and procedures
pursuant to Rule 13a-15 under the Securities Exchange Act of 1934 (the "1934
Act") within 90 days prior to the filing date of this quarterly report. Based on
that evaluation, the Company's Chief Executive Officer and Chief Financial
Officer concluded that the Company's disclosure controls and procedures are
effective in ensuring that information required to be disclosed by the Company
in the reports it files or submits under the 1934 Act is recorded, processed,
summarized and reported within the time periods specified in the SEC's rules and
forms.
There have been no significant changes in internal controls, or in other factors
that could significantly affect internal controls, subsequent to the date the
Chief Executive Officer and Chief Financial Officer completed their evaluation.
14
PART II ------ OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
3.a Restated and Amended Articles of Incorporation,
adopted January 30, 1996, incorporated by reference
from Exhibit 3.a. of Form 10-K for the year ended
September 30, 1996.
3.b Restated Bylaws, reflecting amendments through May
26, 1998, incorporated by reference from Exhibit 3.b.
of Form 10-K for the year ended September 30, 1998.
99.1 Certification of Chief Executive Officer Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
(18U.S.C. 1350) (filed herewith).
99.2 Certification of Chief Financial Officer Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 (18
U.S.C. 1350) (filed herewith).
(b) Reports on Form 8-K:
On December 2, 2002, the Company filed a Current Report on
Form 8-K to report under Item 8 a change in the Company's
fiscal quarter- and year-end dates.
15
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MTS SYSTEMS CORPORATION
Dated: February 6, 2003 /s/ Sidney W. Emery, Jr.
-----------------------------------------------
Sidney W. Emery, Jr.
Chairman, President and Chief Executive Officer
Dated: February 6, 2003 /s/ Susan E. Knight
-----------------------------------------------
Susan E. Knight
Vice President and Chief Financial Officer
CERTIFICATIONS
I, Sidney W. Emery, Jr., certify that:
1. I have reviewed this quarterly report on Form 10-Q of MTS Systems
Corporation;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
16
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: February 6, 2003
/s/ Sidney W. Emery
-----------------------------------------------
Sidney W. Emery, Jr.
Chairman, President and Chief Executive Officer
I, Susan E. Knight, certify that:
1. I have reviewed this quarterly report on Form 10-Q of MTS Systems
Corporation;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
17
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: February 6, 2003
/s/ Susan E. Knight
------------------------------------------
Susan E. Knight
Vice President and Chief Financial Officer
18
EXHIBIT INDEX TO FORM 10-Q
99.1 Certification of Chief Executive Officer Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350).
99.2 Certification of Chief Financial Officer Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350).