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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 June 28, 2003
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):
__X__ Yes _____ No
The number of shares outstanding of the Registrant's common stock as of August
5, 2003 was 21,407,795 shares.
MTS SYSTEMS CORPORATION
REPORT ON FORM 10-Q
FOR THE THREE AND NINE MONTHS ENDED JUNE 28, 2003
INDEX
Page No.
--------
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)
Consolidated Balance Sheets
As of June 28, 2003 and September 28, 2002 2
Consolidated Statements of Income
For the Three and Nine Months Ended
June 28, 2003 and June 30, 2002 3
Consolidated Statements of Cash Flows
For the Nine Months Ended June 28, 2003 and June 30, 2002 4
Condensed Notes to Consolidated Financial Statements 5 - 10
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 10 - 17
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 17
Item 4. Controls and Procedures 17
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 18
SIGNATURES 19
1
PART 1 - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MTS SYSTEMS CORPORATION
Consolidated Balance Sheets
(unaudited - in thousands, except per share data)
June 28, September 28,
2003 2002
--------- ---------
ASSETS
Current Assets:
Cash and cash equivalents $ 99,034 $ 62,456
Short-term investments 46,696 35,094
Accounts receivable, net of allowances for doubtful accounts 50,613 59,943
Unbilled contracts and retainage receivable 27,215 32,276
Inventories 31,503 34,773
Prepaid expense 4,658 5,380
Current deferred tax asset 8,739 8,739
Other current assets 940 19
Assets of discontinued operations -- 15,311
--------- ---------
Total current assets 269,398 253,991
--------- ---------
Property and Equipment:
Land 3,247 3,247
Buildings and improvements 47,276 44,723
Machinery and equipment 84,219 79,679
Accumulated depreciation (77,773) (70,765)
--------- ---------
Total property and equipment, net 56,969 56,884
--------- ---------
Goodwill 4,388 4,268
Other assets 2,477 3,363
Non-current deferred tax asset 1,593 1,593
--------- ---------
Total Assets $ 334,825 $ 320,099
========= =========
LIABILITIES AND SHAREHOLDERS' INVESTMENT
Current Liabilities:
Notes payable $ 400 $ 598
Current maturities of long-term debt 6,831 8,605
Accounts payable 13,562 13,137
Accrued payroll-related costs 31,365 26,112
Advance payments from customers 43,962 37,209
Accrued warranty costs 5,036 4,482
Accrued income taxes 5,807 11,120
Other accrued liabilities 10,299 9,917
Liabilities of discontinued operations -- 1,795
--------- ---------
Total current liabilities 117,262 112,975
--------- ---------
Deferred income taxes 1,881 1,519
Long-term debt, less current maturities 36,044 42,790
Other long-term liabilities 926 550
--------- ---------
Total Liabilities 156,113 157,834
--------- ---------
Shareholders' Investment:
Common stock, $.25 par; 64,000 shares authorized:
21,172 and 21,208 shares issued and outstanding 5,293 5,302
Additional paid-in capital 8,589 9,770
Retained earnings 158,245 146,857
Accumulated other comprehensive income 6,585 336
--------- ---------
Total shareholders' investment 178,712 162,265
--------- ---------
Total Liabilities and Shareholders' Investment $ 334,825 $ 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, except per share data)
Three Months Ended Nine Months Ended
---------------------- ----------------------
June 28, June 30, June 28, June 30,
2003 2002 2003 2002
--------- --------- --------- ---------
Revenue $ 79,312 $ 79,695 $ 256,987 $ 243,958
Cost of sales 48,573 48,872 161,622 150,069
--------- --------- --------- ---------
Gross profit 30,739 30,823 95,365 93,889
--------- --------- --------- ---------
Operating expenses:
Selling 12,951 12,611 39,303 38,779
General and administrative 6,637 7,988 20,078 19,895
Research and development 3,986 3,540 11,609 12,113
--------- --------- --------- ---------
Total operating expenses 23,574 24,139 70,990 70,787
--------- --------- --------- ---------
Income from operations 7,165 6,684 24,375 23,102
--------- --------- --------- ---------
Interest expense 811 969 2,804 3,071
Interest income (660) (224) (1,764) (529)
Gain on sale of investments -- -- -- (2,630)
Other expense (income), net 917 898 (795) (800)
--------- --------- --------- ---------
Income before income taxes, discontinued operations,
and cumulative effect of accounting change 6,097 5,041 24,130 23,990
Provision for income tax 2,012 1,577 7,963 7,869
--------- --------- --------- ---------
Income before discontinued operations and
cumulative effect of accounting change 4,085 3,464 16,167 16,121
--------- --------- --------- ---------
Discontinued operations:
Income (loss) from discontinued operations, net of tax 419 (205) 199 (3,986)
Gain (loss) on sale of discontinued businesses, net of tax 1,225 -- (1,177) --
Cumulative effect of accounting change, net of tax -- -- -- (9,198)
--------- --------- --------- ---------
Income (loss) from discontinued operations, net of tax 1,644 (205) (978) (13,184)
--------- --------- --------- ---------
Income before cumulative effect of accounting change
on continuing operations 5,729 3,259 15,189 2,937
Cumulative effect of accounting change on continuing
operations, net of tax -- -- -- (4,523)
--------- --------- --------- ---------
Net income (loss) $ 5,729 $ 3,259 $ 15,189 $ (1,586)
========= ========= ========= =========
Earnings (loss) per share:
Basic-
Income before discontinued operations and cumulative
effect of accounting change $ 0.19 $ 0.16 $ 0.77 $ 0.76
Discontinued operations:
Income (loss) from discontinued operations, net of tax 0.02 (0.01) 0.01 (0.19)
Gain (loss) on sale of discontinued businesses, net of tax 0.06 0.00 (0.06) 0.00
Cumulative effect of accounting change, net of tax 0.00 0.00 0.00 (0.44)
--------- --------- --------- ---------
Income (loss) from discontinued operations, net of tax 0.08 (0.01) (0.05) (0.63)
--------- --------- --------- ---------
Income before cumulative effect of accounting change
on continuing operations 0.27 0.15 0.72 0.13
Cumulative effect of accounting change, net of tax 0.00 0.00 0.00 (0.21)
--------- --------- --------- ---------
Earnings (loss) per share $ 0.27 $ 0.15 $ 0.72 $ (0.08)
========= ========= ========= =========
Weighted average number of common shares outstanding - basic 21,049 21,123 21,098 21,069
========= ========= ========= =========
Diluted-
Income before discontinued operations and cumulative
effect of accounting change $ 0.19 $ 0.16 $ 0.76 $ 0.75
Discontinued operations:
Income (loss) from discontinued operations, net of tax 0.02 (0.01) 0.01 (0.18)
Gain (loss) on sale of discontinued businesses, net of tax 0.06 0.00 (0.06) 0.00
Cumulative effect of accounting change, net of taxes 0.00 0.00 0.00 (0.43)
--------- --------- --------- ---------
Income (loss) from discontinued operations, net of tax 0.08 (0.01) (0.05) (0.61)
--------- --------- --------- ---------
Income before cumulative effect of accounting change
on continuing operations 0.27 0.15 0.71 0.14
Cumulative effect of accounting change, net of tax 0.00 0.00 0.00 (0.21)
--------- --------- --------- ---------
Earnings (loss) per share $ 0.27 $ 0.15 $ 0.71 $ (0.07)
========= ========= ========= =========
Weighted average number of common shares outstanding - diluted 21,433 21,411 21,397 21,381
========= ========= ========= =========
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)
Nine Months Ended
--------------------
June 28, June 30,
2003 2002
-------- --------
Cash flows from operating activities:
Net income (loss) $ 15,189 $ (1,586)
Adjustments to reconcile net income (loss) to net cash provided by
continuing operating activities:
Non-cash cumulative effect of accounting change on continuing operations -- 4,523
Non-cash cumulative effect of accounting change on discontinued operations -- 9,198
(Income) loss from discontinued operations (199) 3,986
Loss on sale of discontinued businesses 1,177 --
Gain on sale of investment -- (2,630)
Depreciation and amortization 7,104 7,721
Deferred income taxes 69 (73)
Bad debt provision 225 430
Inventory provision 1,629 3,771
Changes in operating assets and liabilities, net of effects of businesses divested:
Accounts, unbilled contracts and retainage receivables 18,750 31,836
Inventories 4,964 11,821
Prepaid expenses 769 414
Other assets (947) (963)
Accounts payable 43 (391)
Accrued compensation and benefits 5,261 (4,461)
Advance billings to customers 4,448 7,196
Accrued warranty costs 350 271
Other liabilities (6,458) (2,095)
-------- --------
Net cash provided by continuing operating activities 52,374 68,968
-------- --------
Cash flows from investing activities:
Additions to property and equipment (4,931) (2,066)
Proceeds from maturity of short-term investments 42,594 --
Proceeds from sale of short-term investments -- 4,920
Purchases of short-term investments (54,196) --
Net proceeds from sale of businesses 12,356 --
-------- --------
Net cash (used in) provided by investing activities (4,177) 2,854
-------- --------
Cash flows from financing activities:
Net repayments under notes payable to banks (230) --
Payments of long-term debt (9,557) (1,326)
Cash dividends (3,806) (3,794)
Proceeds from exercise of stock options 4,698 1,445
Payments to purchase and retire common stock (5,888) (836)
-------- --------
Net cash used in financing activities (14,783) (4,511)
-------- --------
Net cash provided by discontinued operations 182 4,248
Effect of exchange rate on changes in cash 2,982 311
-------- --------
Net increase in cash and cash equivalents 36,578 71,870
Cash and cash equivalent, at beginning of period 62,456 17,336
-------- --------
Cash and cash equivalent, at end of period $ 99,034 $ 89,206
======== ========
Supplemental disclosure of cash flow information:
Cash paid during the period for -
Interest expense $ 1,959 $ 3,117
Income taxes $ 12,468 $ 4,230
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 and majority 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 that 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 Annual Report on Form 10-K filed with the SEC. Interim
results of operations for the nine-month period ended June 28, 2003 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,
including the impact of the Company's discontinued operations, 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 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. Inventories as of June 28, 2003 and September 28, 2002, respectively,
were as follows:
5
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
June 28, 2003 September 28, 2002
------------- ------------------
(in thousands of dollars)
Customer projects in various
stages of completion $ 7,512 $ 8,679
Components,
assemblies and parts 23,991 26,094
------------ ------------
Total $ 31,503 $ 34,773
============ ============
Short-Term Investments
- ----------------------
Short-term investments at June 28, 2003 consist of highly liquid United States
government and Agency obligations, bank certificates of deposit, and highly
rated corporate obligations maturing in four to twelve months from the date of
purchase, with balances of $21.7 million, $3.0 million, and $22.0 million,
respectively. The Company classifies its investment securities as
held-to-maturity. Held-to-maturity securities are carried at amortized cost,
which approximates market value. There were no substantive unrealized gains or
losses from the investment in held-to-maturity securities at June 28, 2003. All
investments in equity securities are classified as available-for-sale and are
carried at fair value. Unrealized gains and losses are reported as a component
of other comprehensive income. At June 28, 2003 the Company had no investments
in equity securities.
2. RECENTLY ISSUED ACCOUNTING STANDARDS
- ---------------------------------------
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 does
not expect the adoption to have a material impact on the Company's consolidated
financial statements.
In April 2003, the FASB issued Statement of Financial Accounting Standard
("SFAS") No. 149, "Amendment of Statement 133 on Derivative Instruments and
Hedging," which amends and clarifies financial accounting and reporting for
derivative instruments. SFAS No. 149 is effective for contracts entered into or
modified after June 30, 2003 and for hedging relationships designated after June
30, 2003. The Company has concluded there will be no material impact of its
adoption.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity," which
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. SFAS
No. 150 is effective for financial instruments entered into or modified after
May 31, 2003 and otherwise is effective at the beginning of the first interim
period beginning after June 15, 2003. The Company does not have any activities
that are subject to the requirements of SFAS No. 150.
3. DISCONTINUED OPERATIONS
- --------------------------
During the second quarter of fiscal year 2003, the Company's board of directors
approved the sale of the Automation division, which was based in New Ulm,
Minnesota and also maintained operations in Montgomeryville, Pennsylvania and
Freiburg and Straslund, Germany. On March 31, 2003, the Company sold
substantially all of the net assets associated with the Automation division's
gradient amplifier product line to Performance Controls, Inc., an affiliate of
Hitachi Medical Corporation, with certain of the intellectual property assets
being sold to Hitachi Medical Corporation. On April 11, 2003, the Company sold
all the remaining net assets of the North American Automation division, based in
New Ulm, Minnesota, to Parker Hannifin Corporation ("Parker-Hannifin"). On April
30, 2003, the Company also sold to Parker-Hannifin 100% of its stock in the
Automation division's German operations, which completed the sale of the
Company's entire Automation division and its exit from the motor and amplifier
business. In March 2003, the Company discontinued the custom military business
of its Automation division.
As a result of the Company's second quarter decision to sell the Automation
division, the characterization of the related assets changed from "held-for-use"
to "held-for-sale" at March 29, 2003. In accordance with the requirements of
SFAS
6
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
144, "Accounting for the Impairment or Disposal of Long-Lived Assets," the
Company was required to perform a valuation of the held-for-sale assets to
determine whether these assets were impaired at March 29, 2003. Per SFAS 144,
the anticipated selling prices of the various asset groups comprising the
Automation business were used as the basis for the valuation. As a result of
this valuation, the Company recorded an impairment charge on discontinued
operations in the second quarter of fiscal year 2003 of $2.4 million, net of
taxes. After the final sale transactions were completed, the Company recorded a
gain on the sale of the Automation division of $1.2 million, net of taxes, for
third quarter of fiscal 2003.
The Automation division was historically included in the Company's Industrial
segment (formerly named "Factory Automation") for financial reporting. Per SFAS
144, the Company reported the results of the operations of the Automation
division as discontinued operations effective March 29, 2003.
Following are the operating results of the discontinued operations included in
the Company's results for the respective periods:
Three Months Ended Nine Months Ended
June 28, 2003 June 30, 2002 June 28, 2003 June 30, 2002
--------------- --------------- ---------------- ---------------
(in thousands of dollars) (in thousands of dollars)
Revenue $ 1,581 $ 7,010 $ 15,756 $ 21,986
Income (loss) on discontinued operations before taxes,
gain (loss) on sale, and cumulative effect of
accounting change $ 697 $ (349) $ 353 $ (6,518)
4. EARNINGS (LOSS) PER COMMON SHARE
- -----------------------------------
Basic earnings (loss) per share is computed by dividing net income (loss) by the
weighted average number of common shares outstanding during the applicable
periods. Diluted 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:
Three Months Ended Nine Months Ended
June 28, June 30, June 28, June 30,
2003 2002 2003 2002
---------- ---------- ---------- ----------
(in thousands, except per share data)
Income before cumulative effect of accounting
change on continuing operations $ 5,729 $ 3,259 $ 15,189 $ 2,937
Cumulative effect of accounting change on continuing
operations, net of tax -- -- -- (4,523)
---------- ---------- ---------- ----------
Net income (loss) $ 5,729 $ 3,259 $ 15,189 $ (1,586)
========== ========== ========== ==========
Weighted average common shares outstanding 21,049 21,123 21,098 21,069
Diluted potential common shares 384 288 299 312
---------- ---------- ---------- ----------
Total diluted common shares 21,433 21,411 21,397 21,381
========== ========== ========== ==========
Basic earnings (loss) per share $ 0.27 $ 0.15 $ 0.72 $ (0.08)
========== ========== ========== ==========
Diluted earnings (loss) per share $ 0.27 $ 0.15 $ 0.71 $ (0.07)
========== ========== ========== ==========
7
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
5. COMPREHENSIVE INCOME
- -----------------------
Comprehensive income represents net earnings 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 Nine Months Ended
June 28, 2003 June 30, 2002 June 28, 2003 June 30, 2002
---------- ---------- ---------- ----------
(in thousands of dollars) (in thousands of dollars)
Net income (loss) $ 5,729 $ 3,259 $ 15,189 $ (1,586)
Change in cumulative translation adjustment 4,137 4,423 6,768 1,988
Unrealized gain (loss) on derivative instruments 100 (15) (519) (376)
Unrealized gain on investments -- -- -- 146
---------- ---------- ---------- ----------
Comprehensive income $ 9,966 $ 7,667 $ 21,438 $ 172
========== ========== ========== ==========
6. BUSINESS SEGMENT INFORMATION
- -------------------------------
The Company's Chief Executive Officer and its management regularly reviews the
available financial information for the Company's discrete business units. Based
on similarities in the economic characteristics, nature of products and
services, production processes, type or class of customer served, method of
distribution and regulatory environments, the operating units have been
aggregated for financial statement purposes into two reportable segments called
Test (formerly "MT&S") and Industrial (formerly "Factory Automation"). The Test
segment manufactures test equipment used in both mechanical and virtual
simulation and testing in ground vehicles, aerospace, and infrastructure
markets. The Industrial segment manufactures component parts for end products in
industrial markets.
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 Nine Months Ended
June 28, June 30, June 28, June 30,
2003 2002 2003 2002
-------- -------- -------- --------
(in thousands of dollars)
REVENUE BY SEGMENT:
Test $ 66,675 $ 69,343 $221,431 $214,322
Industrial 12,637 10,352 35,556 29,636
-------- -------- -------- --------
Total revenue $ 79,312 $ 79,695 $256,987 $243,958
======== ======== ======== ========
INCOME FROM OPERATIONS BY SEGMENT:
Test $ 6,051 $ 6,070 $ 21,761 $ 21,560
Industrial 1,114 614 2,614 1,542
-------- -------- -------- --------
Total income from operations $ 7,165 $ 6,684 $ 24,375 $ 23,102
======== ======== ======== ========
7. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
- ------------------------------------------------
The Company utilizes forward exchange contracts to protect the U.S. dollar value
of estimated foreign currency denominated cash flows (primarily the Euro,
British Pound, Swedish Krona, and the Japanese Yen). These contracts are
recognized on the balance sheet at fair value, which reflects the estimated
amount at which they could be settled based on forward market exchange rates.
These contracts generally mature within one year.
8
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
The Company documents all relationships between hedging instruments and hedged
items, as well as its risk management objectives and strategy. The Company
formally assesses, both at the contract'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. 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 under the
Statement of Financial Accounting Standard ("SFAS") No. 133, "Accounting for
Derivatives Instruments and Hedging Activities," are recorded in other
comprehensive income until they are recognized in earnings at the time the
forecasted transaction occurs. When it is determined that a derivative is not
highly effective as a hedge or has ceased to be a highly effective hedge, the
Company discontinues hedge accounting prospectively. Hedge accounting is
discontinued 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 will be recognized immediately in earnings.
The Company also uses forward exchange contracts to hedge specific foreign
exchange 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 June 28, 2003 and June 30, 2002, the Company had outstanding foreign currency
forward contracts with U.S. dollar notional equivalent amounts of $24.5 million
and $25.0 million, respectively. At June 28, 2003 and June 30, 2002, the fair
value of the foreign currency forward contracts was ($0.5) million and $0.8
million, respectively. The amount recognized in earnings as a result of the
ineffectiveness of cash flow hedges was negligible for the three-month periods
ended June 28, 2003 and June 30, 2002. At June 28, 2003, approximately ($0.6)
million was projected to be reclassified from other comprehensive income into
earnings in the next 12 months. At June 30, 2002, approximately $0.3 million was
projected to be reclassified from other comprehensive income into earnings in
the next 12 months. The maximum maturity of any derivative was 0.9 years at June
28, 2003 and 1.6 years at June 30, 2002.
8. DEFERRED TAX ASSET
- ---------------------
At June 28, 2003, the Company had an aggregate deferred tax asset of $10.3
million in connection with accrued compensation and benefits, inventory
reserves, and allowances for doubtful accounts and other assets.
Management routinely performs an analysis of the realization of the deferred tax
asset 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.
9. WARRANTY GUARANTEES
- ----------------------
Sales of the Company's products and systems are subject to limited warranty
guarantees. For sales that include installation services, system guarantees
typically extend for a period of twelve months from the date of either shipment
or system acceptance. Product guarantees typically extend for a period of
twenty-four 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 periods ended June 28, 2003 and
June 30, 2002 were as follows:
9
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
Three Months Ended Nine Months Ended
June 28, June 30, June 28, June 30,
2003 2002 2003 2002
---------- ---------- ---------- ----------
(in thousands of dollars)
Beginning Balance $ 5,035 $ 4,559 $ 4,482 $ 4,324
Warranty Provisions 1,386 926 4,396 3,404
Warranty Claims (1,572) (948) (4,167) (3,182)
Translation 187 107 325 98
---------- ---------- ---------- ----------
Ending Balance $ 5,036 $ 4,644 $ 5,036 $ 4,644
========== ========== ========== ==========
10. STOCK OPTIONS
- -----------------
As permitted by SFAS No. 123, "Accounting for Stock-Based Compensation," the
Company has elected to continue to follow the guidance of Accounting Principles
Board ("APB") Opinion No. 25 for measurement and recognition of stock-based
transactions with employees. No compensation expense has therefore been
recognized in the financial statements for stock options granted to employees
under the Company's stock option plans as the exercise price of all options
granted is at least equal to the fair value of the underlying common stock at
the dates of grant. Alternatively, if compensation expense for employee options
granted under the plans had been determined based on the fair value at the grant
dates for the awards under these plans, consistent with the methods provided in
SFAS No. 123, the Company's net income (loss) and earnings (loss) per share
would have been as follows:
Three Months Ended Nine Months Ended
June 28, June 30, June 28, June 30,
2003 2002 2003 2002
---------- ---------- ---------- ----------
(in thousands of dollars)
Net income (loss) as reported $ 5,729 $ 3,259 $ 15,189 $ (1,586)
Less employee stock-based
compensation (690) (502) (1,877) (1,734)
---------- ---------- ---------- ----------
Pro forma net income (loss) $ 5,039 $ 2,757 $ 13,312 $ (3,320)
========== ========== ========== ==========
Earnings (loss) per share - Basic:
As reported $ 0.27 $ 0.15 $ 0.72 $ (0.08)
Less employee stock-based
compensation (0.03) (0.02) (0.09) (0.08)
---------- ---------- ---------- ----------
Pro forma earnings (loss) per share $ 0.24 $ 0.13 $ 0.63 $ (0.16)
---------- ---------- ---------- ----------
Earnings (loss) per share - Diluted:
As reported $ 0.27 $ 0.15 $ 0.71 $ (0.07)
Less employee stock-based
compensation (0.03) (0.02) (0.09) (0.09)
---------- ---------- ---------- ----------
Pro forma earnings (loss) per share $ 0.24 $ 0.13 $ 0.62 $ (0.16)
========== ========== ========== ==========
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.
10
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(continued)
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.
Short-term investments. Short-term investments at June 28, 2003 consist of
highly liquid United States government and Agency obligations, bank certificates
of deposit, and highly rated corporate obligations maturing in four to twelve
months from the date of purchase, with balances of $21.7 million, $3.0 million,
and $22.0 million, respectively. The Company classifies its investment
securities as held-to-maturity. Held-to-maturity securities are carried at
amortized cost, which approximates market value. There were no substantive
unrealized gains or losses from the investment in held-to-maturity securities at
June 28, 2003. All investments in equity securities are classified as
available-for-sale and are carried at fair value. Unrealized gains and losses
are reported as a component of other comprehensive income. At June 28, 2003 the
Company had no investments in equity securities.
RECENTLY ISSUED ACCOUNTING STANDARDS
- ------------------------------------
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 does
not expect the adoption to have a material impact on the Company's consolidated
financial statements.
In April 2003, the FASB issued Statement of Financial Accounting Standard
("SFAS") No. 149, "Amendment of Statement 133 on Derivative Instruments and
Hedging," which amends and clarifies financial accounting and reporting for
derivative instruments. SFAS No. 149 is effective for contracts entered into or
modified after June 30, 2003 and for hedging relationships designated after June
30, 2003. The Company has concluded there will be no material impact of its
adoption.
In May 2003, the FASB issued No. 150, "Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity," which
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. SFAS
No. 150 is effective for financial instruments entered into or modified after
May 31, 2003 and otherwise is effective at the beginning of the first interim
period beginning after June 15, 2003. The Company does not have any activities
that are subject to the requirements of SFAS No. 150.
11
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(continued)
RESULTS OF OPERATIONS
NEW CUSTOMER ORDERS AND BACKLOG
- -------------------------------
THREE MONTHS ENDED JUNE 28, 2003 ("THIRD QUARTER OF FISCAL 2003") COMPARED TO
THREE MONTHS ENDED JUNE 30, 2002 ("THIRD QUARTER OF FISCAL 2002")
New orders from customers during Third Quarter of Fiscal 2003 aggregated $97.8
million, an increase of 4.9% compared to customer orders of $93.2 million booked
during Third Quarter of Fiscal 2002.
Orders for the Test segment (formerly named "Mechanical Testing and Simulation")
rose 3.5% to $85.7 million, compared to customer orders of $82.8 million for
Third Quarter of Fiscal 2002, primarily due to strength in the international
motorsports and aerospace markets. The automotive and infrastructure markets
continue to experience weak demand. The Test segment accounted for 87.6% of
total Company orders for Third Quarter of Fiscal 2003, compared to 88.8% for the
Third Quarter of Fiscal 2002.
Orders for the Industrial segment (formerly named "Factory Automation")
increased 16.3% to $12.1 million for Third Quarter of Fiscal 2003, from $10.4
million for Third Quarter of Fiscal 2002. Orders for the Sensors business
increased in both North America and Europe due to customer inventory
replenishment and sales into new markets. The Industrial segment accounted for
12.4% of total Company orders during Third Quarter of Fiscal 2003, compared to
11.2% in Third Quarter of Fiscal 2002.
NINE MONTHS ENDED JUNE 28, 2003 ("FIRST NINE MONTHS OF FISCAL 2003") COMPARED TO
NINE MONTHS ENDED JUNE 30, 2002 ("FIRST NINE MONTHS OF FISCAL 2002")
New orders for the First Nine Months of Fiscal 2003 aggregated $252.1 million, a
decrease of 5.5% compared to orders of $266.7 million for the First Nine Months
of Fiscal 2002.
Orders for the Test segment of $216.7 million in the First Nine Months of Fiscal
2003 decreased 8.5% compared to $236.9 million in the First Nine Months of
Fiscal 2002. The decrease was primarily due to the impact of a $13 million
aerospace order booked in the First Nine Months of Fiscal 2002. This segment
accounted for 86.0% of total new orders in the First Nine Months of Fiscal 2003,
compared to 88.8% for the First Nine Months of Fiscal 2002.
Orders for the Industrial segment of $35.4 million in the First Nine Months of
Fiscal 2003 increased 18.8% from orders of $29.8 million booked in the First
Nine Months of Fiscal 2002. This increase was largely due to a $1.5 million U.S.
government contract awarded to the AeroMet business and strong demand in Europe
and Japan related to the Sensors business. The Industrial segment accounted for
14.0% of total orders during the First Nine Months of 2003 compared to 11.2%
during the First Nine Months of Fiscal 2002.
Backlog of undelivered orders at June 28, 2003 was $169.1 million, relatively
flat from backlog of $170.0 million at September 28, 2002 and an increase of
1.7% from backlog of $166.3 million at June 30, 2002. The Company's backlog is
subject to order cancellations.
RESULTS OF OPERATIONS
- ---------------------
THIRD QUARTER OF FISCAL 2003 COMPARED TO THIRD QUARTER OF FISCAL 2002
REVENUE for Third Quarter of Fiscal 2003 was $79.3 million, relatively flat
compared to revenue of $79.7 million for the Third Quarter of Fiscal 2002.
Revenue from international customers for Third Quarter of Fiscal 2003
represented 56.2% of total revenues, compared to 43.6% for Third Quarter of
Fiscal 2002. Growth in the European market of 43.4% was offset by a decline in
North America of 22.4%. Revenue in the current period was favorably impacted by
the effect of exchange rate changes.
GROSS PROFIT for Third Quarter of Fiscal 2003 was $30.7 million, flat compared
to gross profit of $30.8 million for Third Quarter of Fiscal 2002. Gross profit
as a percentage of revenue was 38.7% for Third Quarter of Fiscal 2003,
relatively flat from 38.6% reported for Third Quarter of Fiscal 2002. Gross
profit as a percentage of revenue for the Test segment was 36.6% for Third
Quarter of Fiscal 2003, down 0.5 percentage points compared to Third Quarter of
Fiscal 2002, due
12
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(continued)
RESULTS OF OPERATIONS (CONTINUED)
- ---------------------
to product mix. Gross profit as a percentage of revenue for the Industrial
segment was 50.1% for Third Quarter of Fiscal 2003, unchanged from the Third
Quarter of Fiscal 2002.
SELLING EXPENSES were $13.0 million for Third Quarter of Fiscal 2003, an
increase of 3.2% from $12.6 million for Third Quarter of Fiscal 2002, primarily
due to the launch of a new product line. Selling expense as a percentage of
revenue increased slightly from 15.8% for the Third Quarter of Fiscal 2002 to
16.4% for Third Quarter of Fiscal 2003.
GENERAL AND ADMINISTRATIVE EXPENSES totaled $6.6 million for Third Quarter of
Fiscal 2003, a decrease of 17.5% compared to $8.0 million for Third Quarter of
Fiscal 2002. General and administrative expenses as a percentage of revenue
decreased by 1.7 percentage points from 10.0% for Third Quarter of Fiscal 2002
to 8.3% for Third Quarter of Fiscal 2003. The decrease is largely due to
non-recurring consulting and legal expenses of $0.4 million and $0.4 million,
respectively, recorded in the Third Quarter of Fiscal 2002.
RESEARCH AND DEVELOPMENT EXPENSES totaled $4.0 million for the Third Quarter of
2003, an increase of 14.3% compared to $3.5 million for the Third Quarter of
Fiscal 2002. Research and development expenses as a percentage of revenue were
5.0% for Third Quarter of Fiscal 2003 compared to 4.4% for Third Quarter of
Fiscal 2002. The increase was primarily due to expense associated with a new
product line and expenditures for a new testing system.
INCOME FROM OPERATIONS increased 7.5%, from $6.7 million in Third Quarter of
Fiscal 2002 to $7.2 million in Third Quarter of Fiscal 2003. Income from
operations in the Test segment remained flat at approximately $6.1 million.
Industrial segment income from operations increased 83.3% from $0.6 million to
$1.1 million, driven by improved volume in the Industrial segment.
INTEREST EXPENSE decreased to $0.8 million for Third Quarter of Fiscal 2003
compared to $1.0 million for Third Quarter of Fiscal 2002. This decrease was the
result of a reduction in long-term debt. Interest expense as a percentage of
revenue decreased to 1.0% for Third Quarter of Fiscal 2003, compared to 1.3% for
Third Quarter of Fiscal 2002.
INTEREST INCOME increased to $0.7 million for Third Quarter of Fiscal 2003
compared to $0.2 million for Third Quarter of Fiscal 2002, primarily due to an
increase in the Company's holdings of short-term investments.
OTHER INCOME AND EXPENSE for Third Quarter of Fiscal 2003 was $0.9 million, flat
compared to Third Quarter of Fiscal 2002.
INCOME BEFORE DISCONTINUED OPERATIONS AND CUMULATIVE EFFECT OF ACCOUNTING CHANGE
increased to $4.1 million for Third Quarter of Fiscal 2003 compared to $3.5
million for Third Quarter of Fiscal 2002, primarily driven by reduced general
and administrative expenses and increased interest income. Income before
discontinued operations as a percentage of revenue increased to 5.2% for Third
Quarter of Fiscal 2003, compared to 4.4% for Third Quarter of Fiscal 2002. The
effective tax rate for Third Quarter of Fiscal 2003 was 33.0% compared with a
tax rate of 31.3% for Third Quarter of Fiscal 2002. The increase in the overall
effective tax rate was primarily the result of an increase in the proportion of
foreign income to domestic income, resulting in the offset of lower federal and
state rates in the U.S. with higher foreign tax rates.
FIRST NINE MONTHS OF FISCAL 2003 COMPARED TO FIRST NINE MONTHS OF FISCAL 2002
REVENUE for the First Nine Months of Fiscal 2003 was $257.0 million, an increase
of $13.0 million, or 5.3%, compared to $244.0 million in the First Nine Months
of Fiscal 2002. The increase was primarily due to a higher backlog position at
the beginning of fiscal year 2003 than at the beginning of fiscal year 2002 as
well as current year replenishment of customer inventory levels. Revenue for the
First Nine Months of Fiscal 2003 was favorably impacted by the effect of
exchange rate changes. Revenue generated by the Test segment was $221.4 million
during the First Nine Months of Fiscal 2003, an increase of $7.1 million
compared to the First Nine Months of Fiscal 2002. Industrial segment revenue
increased to $35.6 million for the First Nine Months of Fiscal 2003, compared to
$29.6 million for the First Nine Months of Fiscal 2002.
GROSS PROFIT for the First Nine Months of Fiscal 2003 increased to $95.4
million, up 1.6% compared to gross profit of $93.9 million for the First Nine
Months of Fiscal 2002. The increase in gross profit was primarily due to higher
revenue
13
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(continued)
RESULTS OF OPERATIONS (CONTINUED)
- ---------------------
volume. Gross profit as a percentage of revenue was 37.1% for the First Nine
Months of Fiscal 2003 compared to 38.5% for the First Nine Months of Fiscal
2002. The decrease is primarily the result of favorable product mix in the prior
year.
SELLING EXPENSES increased 1.3% to $39.3 million for the First Nine Months of
Fiscal 2003 compared to $38.8 million for the First Nine Months of Fiscal 2002,
principally related to higher revenue volume. Selling expense as a percentage of
revenue decreased to 15.3% for the First Nine Months of Fiscal 2003 compared to
15.9% for the First Nine Months of Fiscal 2002, primarily due to cost reduction
initiatives that were implemented throughout fiscal year 2002.
GENERAL AND ADMINISTRATIVE EXPENSES totaled $20.1 million for the First Nine
Months of Fiscal 2003, an increase of 1.0% compared to $19.9 million for the
First Nine Months of Fiscal 2002. General and administrative expenses as a
percentage of revenue declined to 7.8% for the First Nine Months of Fiscal 2003
from 8.2% for the First Nine Months of Fiscal 2002. The decrease is largely due
to non-recurring consulting and legal expenses of $0.7 million and $0.4 million,
respectively, recorded in the First Nine Months of Fiscal 2002.
RESEARCH AND DEVELOPMENT EXPENSES decreased 4.1% to $11.6 million for the First
Nine Months of Fiscal 2003 compared to $12.1 million for the First Nine Months
of Fiscal 2002. Research and development expense as a percentage of revenue
declined to 4.5% for the First Nine Months of Fiscal 2003 compared to 5.0% for
the First Nine Months of Fiscal 2002, primarily due to product rationalization
efforts implemented by the Company during the First Nine Months of Fiscal 2003,
partially offset by expense associated with a new product line.
INCOME FROM OPERATIONS increased by 5.6%, from $23.1 million for the First Nine
Months of Fiscal 2002 to $24.4 million for the First Nine Months of Fiscal 2003.
Income from operations increased slightly in the Test segment, from $21.6
million for the First Nine Months of Fiscal 2002 to $21.8 million for the First
Nine Months of Fiscal 2003. Income from operations in the Industrial segment
increased $1.1 million, from $1.5 million for the First Nine Months of Fiscal
2002 to $2.6 million for the First Nine Months of Fiscal 2003.
INTEREST EXPENSE declined to $2.8 million for the First Nine Months of Fiscal
2003 compared to $3.1 million for the First Nine Months of Fiscal 2002. Interest
expense as a percentage of revenue decreased by 0.2 percentage points, from 1.3%
for the First Nine Months of Fiscal 2002 to 1.1% for the First Nine Months of
Fiscal 2003. This decrease is primarily the result of a reduction in long-term
debt.
INTEREST INCOME increased $1.3 million, from $0.5 million for the First Nine
Months of Fiscal 2002 to $1.8 million for the First Nine Months of Fiscal 2003,
primarily due to an increase in short-term investments. Interest income as a
percentage of revenue increased from 0.2% to 0.7%.
GAIN ON SALE OF INVESTMENTS during the First Nine Months of Fiscal 2002 resulted
from the Company's sale of an equity investment in Mechanical Dynamics Inc. The
Company sold securities and recorded proceeds from the sale of $4.9 million,
which produced a gain on sale of $2.6 million. The investment sold represented
the entire amount of the Company's equity investment holdings.
OTHER INCOME AND EXPENSE was $0.8 million for the First Nine Months of Fiscal
2003, flat with other income of $0.8 million for the First Nine Months of Fiscal
2002. Other income for the First Nine Months of Fiscal 2003 primarily reflects a
one-time gain of $1.3 million from proceeds from penalties associated with a
cancelled customer contract, partially offset by $0.8 million of losses on
foreign currency transactions. Other income for the First Nine Months of Fiscal
2002 consisted primarily of a gain on foreign currency transactions of $0.9
million.
INCOME BEFORE DISCONTINUED OPERATIONS AND CUMULATIVE EFFECT OF ACCOUNTING CHANGE
was $16.2 million for the First Nine Months of Fiscal 2003 flat compared to
$16.1 million for the First Nine Months of Fiscal 2002. The effective tax rate
for the First Nine Months of Fiscal 2003 was 33.0%, compared to 32.8% for the
First Nine Months of Fiscal 2002.
CUMULATIVE EFFECT OF ACCOUNTING CHANGE, NET OF TAXES for the First Nine Months
of Fiscal 2002 reflects a non-cash transition charge to income related to the
adoption of SFAS 142, "Goodwill and Other Intangible Assets."
14
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(continued)
RESULTS OF DISCONTINUED OPERATIONS
During the second quarter of fiscal year 2003, the Company decided to sell its
Automation division, which was based in New Ulm, Minnesota and also maintained
operations in Montgomeryville, Pennsylvania and Freiburg and Straslund, Germany.
On March 31, 2003, the Company sold substantially all of the net assets
associated with the Automation division's gradient amplifier product line to
Performance Controls, Inc., an affiliate of Hitachi Medical Corporation, with
certain of the intellectual property assets being sold to Hitachi Medical
Corporation. On April 11, 2003, the Company sold all the remaining net assets of
the North American Automation division, based in New Ulm, Minnesota, to Parker
Hannifin Corporation ("Parker-Hannifin"). On April 30, 2003, the Company also
sold to Parker-Hannifin 100% of its stock in the Automation division's German
operations, which completed the sale of the Company's entire Automation division
and marked the Company's exit from the motor and amplifier business. In March
2003, the Company discontinued the custom military business of its Automation
division.
As a result of the Company's second quarter decision to sell the Automation
division, the characterization of the related assets changed from "held-for-use"
to "held-for-sale" at March 29, 2003. In accordance with the requirements of
SFAS 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," the
Company was required to perform a valuation of the held-for-sale assets to
determine whether these assets were impaired at March 29, 2003. Per SFAS 144,
the anticipated selling prices of the various asset groups comprising the
Automation business were used as the basis for the valuation. As a result of
this valuation, the Company recorded an impairment charge on discontinued
operations in the second quarter of fiscal year 2003 of $2.4 million, net of
taxes. After the final sale transactions were completed, the Company recorded a
gain on the sale of the Automation division of $1.2 million, net of taxes, for
third quarter of fiscal 2003.
The Automation division was historically included in the Company's Industrial
segment (formerly named "Factory Automation") for financial reporting. Per SFAS
144, the Company reported the results of the operations of the Automation
division as discontinued operations effective March 29, 2003.
The discontinued operations of the Automation division reported income from
operations of $0.4 million, net of taxes, for the quarter ended June 28, 2003,
compared to a loss of $0.2 million, net of taxes, for the same period in the
prior year. This improvement is primarily the result of increased demand in the
European market. Income, after tax, from the operation of discontinued
operations for the nine months ended June 28, 2003 was $0.2 million, compared to
a net loss of $4.0 million for the same period in the prior year. The decrease
in net loss was primarily the result of obsolete and surplus inventory charges
of approximately $2.7 million, net of taxes, recorded during the prior year
period. Also during the prior year period the Company recorded a non-cash
transition charge to income of $9.2 million, net of taxes, related to the
adoption of SFAS 142, "Goodwill and Other Intangible Assets."
CAPITAL RESOURCES AND LIQUIDITY
- -------------------------------
CASH FLOWS FROM CONTINUING OPERATING ACTIVITIES provided cash of $52.4 million
during the First Nine Months of Fiscal 2003, compared to cash provided of $69.0
million during the First Nine Months of Fiscal 2002. The decrease in cash
provided by continuing operating activities during the First Nine Months of
Fiscal 2003 is primarily due to significant improvements in accounts receivable
and inventory made in the First Nine Months of Fiscal 2002.
CASH FLOWS FROM INVESTING ACTIVITIES required the use of cash totaling $4.2
million during the First Nine Months of Fiscal 2003, compared with cash provided
of $2.9 million for the First Nine Months of Fiscal 2002. Cash was used in the
First Nine Months of Fiscal 2003 for the purchase of short-term investments of
$54.2 million and additions to property, plant and equipment of $4.9 million,
partially offset by proceeds from the sale of short-term investments of $42.6
million and net proceeds from the sale of discontinued operations of $12.4
million. For the First Nine Months of Fiscal 2002, cash was primarily provided
by the $4.9 million gross proceeds from the sale of an equity investment.
CASH FLOWS FROM FINANCING ACTIVITIES required the use of cash totaling $14.8
million during the First Nine Months of Fiscal 2003, compared to usage of $4.5
million for the First Nine Months of Fiscal 2002. The increase in cash used for
financing activities was principally due to a $9.6 million reduction of
long-term debt and $5.9 million of payments to purchase or retire common stock
in the First Nine Months of Fiscal 2003. The Company's Board of Directors has
authorized The Company to repurchase 2.0 million shares of its common stock, of
which The Company had repurchased 0.4 million shares as of June 28, 2003.
CASH FLOWS FROM DISCONTINUED OPERATIONS provided cash of $0.2 million during the
First Nine Months of Fiscal 2003, compared to cash provided of $4.2 million for
the First Nine Months of Fiscal 2002. The decrease in cash provided by
15
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(continued)
CAPITAL RESOURCES AND LIQUIDITY (CONTINUED)
- -------------------------------
discontinued operations was primarily due to significant improvements in working
capital made in the First Nine Months of Fiscal 2002.
Under the terms of its credit agreements, the Company has certain financial
covenants. At June 28, 2003, the Company was in compliance with the terms and
covenants of its credit agreements. The Company believes that 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 make selected strategic
acquisitions.
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 that 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 Test 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.
16
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(continued)
(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.
(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 June 28, 2003, the Company had an investment portfolio that included some
investments maturing in less than 90 days, accounted for as cash equivalents,
and some investments maturing within 91 to 365 days, accounted for as short-term
investments. The short-term investments of $46.7 million at June 28, 2003
consisted of fixed income securities subject to interest rate risk, which would
decline in market value if market interest rates increase. However, because the
Company has the ability and intent to hold these securities to maturity, the
Company does not expect any change in market rates to have an adverse impact on
income or cash flows.
The Company operates internationally and thus is subject to 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 7 in the Condensed Notes to Consolidated Financial Statements.
As of June 28, 2003, the Company's long-term debt consisted primarily of fixed
interest rates ranging from 6.0% 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.
Notwithstanding the foregoing, there can be no assurance that the Company's
disclosure controls and procedures will detect or uncover all failures of
persons within the Company and its consolidated subsidiaries to disclose
material information otherwise required to be set forth in the Company's
periodic reports.
17
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
November 26, 2002 (filed herewith).
31.1 Certification of Chief Executive Officer Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002 (18U.S.C.
1350) (filed herewith).
31.2 Certification of Chief Financial Officer Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002 (18
U.S.C. 1350) (filed herewith).
32.1 Certification of Chief Executive Officer Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 (18
U.S.C. 1350) (filed herewith).
32.2 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 April 28, 2003, the Company filed a Current Report on Form
8-K under Item 5 to announce the sale of the U.S. and German
operations of its Automation Division to Parker Hannifin
Corporation and the sale of all of the assets of the gradient
amplifier business of the Automation Division to Performance
Controls, Inc., an affiliate of Hitachi Medical Corporation.
On May 9, 2003, the Company filed a Current Report on Form 8-K
under Item 2 to provide the pro forma financial statements of
the disposed businesses.
On April 25, 2003, the Company filed a Current Report on Form
8-K to furnish to the SEC the Company's Second Quarter Fiscal
2003 earnings release under Regulation FD.
18
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: August 11, 2003 /s/ Sidney W. Emery, Jr.
-----------------------------------------------
Sidney W. Emery, Jr.
Chairman, President and Chief Executive Officer
Dated: August 11, 2003 /s/ Susan E. Knight
-----------------------------------------------
Susan E. Knight
Vice President and Chief Financial Officer
19
EXHIBIT INDEX TO FORM 10-Q
3.b Restated Bylaws, reflecting amendments through November 26, 2002.
31.1 Certification of Chief Executive Officer Pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350).
31.2 Certification of Chief Financial Officer Pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350).
32.1 Certification of Chief Executive Officer Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350).
32.2 Certification of Chief Financial Officer Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350).