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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------
(mark one)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Quarterly Period Ended July 31, 2004
or
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For transition period from ________________ to _________________
0-16438
(Commission File Number)
NATIONAL TECHNICAL SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
California 95-4134955
(State of Incorporation) (IRS Employer
Identification number)
24007 Ventura Boulevard, Suite 200, Calabasas, California
(Address of registrant's principal executive office)
(818) 591-0776 91302
(Registrant's telephone number) (Zip code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES |X| NO |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
YES |_| NO |X|
The number of shares of common stock, no par value, outstanding as of September
8, 2004 was 8,958,370.
NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES
Index
PART I. FINANCIAL INFORMATION Page No.
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets as of
July 31, 2004 (unaudited) and January 31, 2004 3
Unaudited Condensed Consolidated Statements of Income
For the Six Months Ended July 31, 2004 and 2003 4
Unaudited Condensed Consolidated Statements of Income
For the Three Months Ended July 31, 2004 and 2003 5
Unaudited Condensed Consolidated Statements of Cash Flows
For the Six Months Ended July 31, 2004 and 2003 6
Notes to the Unaudited Condensed Consolidated Financial
Statements 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11
Item 4. Controls and Procedures 18
PART II. OTHER INFORMATION & SIGNATURE
Item 4 Submission of Matters to a Vote of Security Holders 20
Item 6. Exhibits and Reports on Form 8-K 21
2
PART I - FINANCIAL
NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
July 31, January 31,
2004 2004
ASSETS (unaudited)
-------------------------------
CURRENT ASSETS:
Cash $ 3,231,000 $ 4,661,000
Accounts receivable, less allowance for doubtful accounts
of $1,030,000 at July 31, 2004 and $938,000 at January 31, 2004 19,461,000 18,822,000
Income taxes receivable 891,000 320,000
Inventories 1,663,000 1,995,000
Deferred tax assets 1,096,000 1,184,000
Prepaid expenses 1,108,000 827,000
-------------------------------
Total current assets 27,450,000 27,809,000
Property, plant and equipment, at cost 87,221,000 83,312,000
Less: accumulated depreciation (55,823,000) (53,357,000)
-------------------------------
Net property, plant and equipment 31,398,000 29,955,000
Goodwill 2,740,000 2,740,000
Other assets 3,305,000 3,128,000
-------------------------------
TOTAL ASSETS $ 64,893,000 $ 63,632,000
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 3,821,000 $ 4,485,000
Accrued expenses 3,567,000 3,514,000
Income taxes payable -- 23,000
Deferred income 682,000 185,000
Current installments of long-term debt 915,000 1,052,000
-------------------------------
Total current liabilities 8,985,000 9,259,000
Long-term debt, excluding current installments 19,966,000 19,754,000
Deferred income taxes 5,235,000 4,875,000
Deferred compensation 839,000 799,000
Minority interest 68,000 113,000
Commitments and contingencies
SHAREHOLDERS' EQUITY:
Preferred stock, no par value, 2,000,000 shares authorized; none issued -- --
Common stock, no par value. Authorized, 20,000,000 shares; issued and
outstanding, 8,953,000 as of July 31, 2004 and 8,863,000 as of January 31, 2004 13,953,000 13,760,000
Retained earnings 15,898,000 15,123,000
Accumulated other comprehensive income (51,000) (51,000)
-------------------------------
Total shareholders' equity 29,800,000 28,832,000
-------------------------------
-------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 64,893,000 $ 63,632,000
===============================
See accompanying notes.
ITEM 1. FINANCIAL STATEMENTS
3
NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES
Unaudited Condensed Consolidated Statements of Income
for the Six Months Ended July 31,
2004 2003
-------------------------------
Net revenues $ 54,422,000 $ 54,049,000
Cost of sales 42,574,000 42,125,000
-------------------------------
Gross profit 11,848,000 11,924,000
Selling, general and administrative expense 10,337,000 10,024,000
-------------------------------
Operating income 1,511,000 1,900,000
Other expense:
Interest expense, net (523,000) (605,000)
Other 163,000 7,000
-------------------------------
Total other expense (360,000) (598,000)
Income before income taxes and minority interest 1,151,000 1,302,000
Income taxes 421,000 602,000
-------------------------------
Income before minority interest 730,000 700,000
Minority interest 45,000 (32,000)
-------------------------------
Net income $ 775,000 $ 668,000
===============================
Net income per common share:
Basic $ 0.09 $ 0.08
===============================
Diluted $ 0.08 $ 0.07
===============================
Weighted average common shares outstanding 8,902,000 8,625,000
Dilutive effect of stock options 668,000 480,000
-------------------------------
Weighted average common shares outstanding,
assuming dilution 9,570,000 9,105,000
===============================
See accompanying notes.
4
NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES
Unaudited Condensed Consolidated Statements of Income
for the Three Months Ended July 31,
2004 2003
-------------------------------
Net revenues $ 27,121,000 $ 27,237,000
Cost of sales 21,246,000 20,959,000
-------------------------------
Gross profit 5,875,000 6,278,000
Selling, general and administrative expense 5,279,000 5,265,000
-------------------------------
Operating income 596,000 1,013,000
Other income (expense):
Interest expense, net (271,000) (298,000)
Other 11,000 6,000
-------------------------------
Total other expense (260,000) (292,000)
Income before income taxes and minority interest 336,000 721,000
Income taxes 93,000 351,000
-------------------------------
Income before minority interest 243,000 370,000
Minority interest (1,000) (29,000)
-------------------------------
Net income $ 242,000 $ 341,000
============ ============
Net income per common share:
Basic $ 0.03 $ 0.04
============ ============
Diluted $ 0.03 $ 0.04
============ ============
Weighted average common shares outstanding 8,929,000 8,635,000
Dilutive effect of stock options 612,000 600,000
-------------------------------
Weighted average common shares outstanding,
assuming dilution 9,541,000 9,235,000
===============================
See accompanying notes.
5
NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES
Unaudited Consolidated Statements of Cash Flows
for the Six Months Ended July 31, 2004 and 2003
2004 2003
-----------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 775,000 $ 668,000
Adjustments to reconcile net income from continuing operations to cash provided
by (used for) operating activities:
Depreciation and amortization 2,525,000 2,353,000
Provisions for losses (recoveries) on receivables 91,000 97,000
Gain on sale of assets (158,000)
Undistributed earnings of affiliate (45,000) 32,000
Deferred income taxes 448,000 407,000
Tax benefit from stock options exercised -- 12,000
Changes in assets and liabilities (net of acquisition):
Accounts receivable (730,000) 1,121,000
Inventories 332,000 422,000
Prepaid expenses (281,000) (220,000)
Other assets and intangibles (109,000) (339,000)
Accounts payable (664,000) (807,000)
Accrued expenses 53,000 (214,000)
Income taxes payable (23,000) --
Deferred income 497,000 583,000
Deferred compensation 40,000 36,000
Income taxes receivable (571,000) (129,000)
-----------------------------
Cash provided by operating activities 2,180,000 4,022,000
-----------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property, plant and equipment (3,068,000) (1,620,000)
Sale of property, plant and equipment 311,000 --
Investment in life insurance (88,000) (67,000)
Acquisition of assets, net of cash (1,033,000) --
-----------------------------
Net cash used for investing activities (3,878,000) (1,687,000)
-----------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from current and long-term debt 906,000 55,000
Repayments of current and long-term debt (831,000) (1,287,000)
Proceeds from stock issuance 193,000 62,000
Common stock repurchase -- (37,000)
-----------------------------
Net cash provided by (used for) financing activities 268,000 (1,207,000)
-----------------------------
Net increase (decrease) in cash (1,430,000) 1,128,000
Beginning cash balance 4,661,000 3,559,000
-----------------------------
ENDING CASH BALANCE $ 3,231,000 $ 4,687,000
=============================
See accompanying notes.
6
NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES
Notes to the Unaudited Condensed Consolidated Financial Statements
1. Basis of Presentation
In accordance with instructions to Form 10-Q, the accompanying
consolidated financial statements and footnotes of National Technical
Systems, Inc. (NTS or the Company) have been condensed and, therefore, do
not contain all disclosures required by accounting principles generally
accepted in the United States. These statements should not be construed as
representing pro rata results of the Company's fiscal year and should be
read in conjunction with the financial statements and notes thereto
included in the Company's Form 10-K for the year ended January 31, 2004.
The statements presented as of and for the three and six months ended July
31, 2004 and 2003 are unaudited. In Management's opinion, all adjustments
have been made to present fairly the results of such unaudited interim
periods. All such adjustments are of a normal recurring nature.
The consolidated financial statements include the accounts of the Company
and its wholly owned and financially controlled subsidiaries. All
significant intercompany balances and transactions have been eliminated in
consolidation.
2. Income Taxes
Income taxes for the interim periods are computed using the effective tax
rates estimated to be applicable for the full fiscal year. The Company
recorded income tax expense of $93,000 and $421,000 for the three and six
months ended July 31, 2004, respectively, and $351,000 and $602,000 for
the three and six months ended July 31, 2003, respectively.
3. Inventories
Inventories consist of accumulated costs applicable to uncompleted
contracts and are stated at actual cost which is not in excess of
estimated net realizable value.
4. Interest and Taxes
Cash paid for interest and taxes for the six months ended July 31, 2004
was $536,000 and $574,000, respectively. Cash paid for interest and taxes
for the six months ended July 31, 2003 was $608,000 and $492,000,
respectively.
5. Minority Interest
Minority interest in the Company's NQA, Inc. subsidiary is a result of 50%
of the stock of NQA, Inc. being issued to National Quality Assurance, Ltd.
Effective with fiscal 2002, profits and losses are allocated 50.1% to NTS,
and 49.9% to National Quality Assurance, Ltd.
6. Stock Repurchase
On February 6, 2001, the Company's Board of Directors authorized the
repurchase of shares in the Company's common stock in open market
purchases. As of January 31, 2004, the Company had purchased 169,750
shares at an average price of $2.54 per share. The Company elected to
discontinue the repurchase of shares as of September 29, 2003; therefore
no shares were repurchased during the current quarter.
7
7. Earnings per share
Basic and diluted net income per common share is presented in conformity
with Statement of Financial Accounting Standards ("SFAS") No. 128,
"Earnings Per Share" for all periods presented. In accordance with SFAS
No. 128, basic earnings per share have been computed using the weighted
average number of shares of common stock outstanding during the year.
Basic earnings per share excludes any dilutive effects of options,
warrants and convertible securities.
8. Intangible Assets
The Company adopted the new rules on accounting for goodwill and other
intangible assets beginning in the first quarter of fiscal year 2003 in
accordance with SFAS No. 142, "Goodwill and Other Intangible Assets."
There have been no indications of any impairments through July 31, 2004.
As of July 31, 2004 and January 31, 2004, the Company had the following acquired
intangible assets:
July 31, 2004
---------------------------------------------------------------
Gross Net Estimated
Carrying Accum. Carrying Useful
Amount Amort. Amount Life
Intangible assets subject to
amortization:
Covenant not to compete $ 148,000 $ 59,000 $ 89,000 3-5 years
=============================================
Intangible assets not
subject to amortization:
Goodwill $ 3,537,000 $ 797,000 $ 2,740,000
=============================================
January 31, 2004
---------------------------------------------------------------
Gross Net Estimated
Carrying Accum. Carrying Useful
Amount Amort. Amount Life
Intangible assets subject to
amortization:
Covenant not to compete $ 148,000 $ 39,000 $ 109,000 3-5 years
=========== =========== ===========
Intangible assets not
subject to amortization:
Goodwill $ 3,537,000 $ 797,000 $ 2,740,000
=========== =========== ===========
Amortization expense for intangible assets subject to amortization was $20,000
and $14,000 for the six months ended July 31, 2004 and 2003, respectively.
9. Long-Lived Assets: Adoption of Statement 144
In August 2001, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets," which is effective for fiscal years beginning after December 15,
2001. SFAS No. 144 supersedes FASB Statement No. 121, "Accounting for the
Impairment or Disposal of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of," and the accounting and reporting provisions relating to
the disposal of a segment of a business of Accounting Principles Board
Opinion No. 30. The Company has adopted SFAS No. 144 beginning in the
first quarter of fiscal year 2003. The adoption had no impact on the
Company's consolidated financial position or results of operations.
8
10. Stock-Based Compensation
As of July 31, 2004, the Company had two stock-based employee compensation
plans, the Amended and Restated 1994 stock option plan and the 2002 stock
option plan. The Company accounts for these plans under the intrinsic
value method recognition and measurement principles of Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to
Employees" and related Interpretations. No stock-based employee
compensation cost is reflected in net income, as all options granted under
these plans had an exercise price equal to the market value of the
underlying common stock on the date of grant. The following table
illustrates the effect on net income and net income per share as if the
Company had applied the fair value recognition provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation," to stock-based employee
compensation using the Black-Scholes option pricing model:
Six Months Ended Three Months
July 31, July 31,
-------------------------- -------------------------
2004 2003 2004 2003
---- ---- ---- ----
Net Income
As reported $ 775,000 $ 668,000 $ 242,000 $ 341,000
Stock compensation expense, net of tax (271,000) (162,000) (144,000) (88,000)
---------------------------------------------------------
Pro forma $ 504,000 $ 506,000 $ 98,000 $ 253,000
Basic earnings per common share
As reported $0.09 $0.08 $0.03 $0.04
Pro forma $0.06 $0.06 $0.01 $0.03
Diluted earnings per common share
As reported $0.08 $0.07 $0.03 $0.04
Pro forma $0.05 $0.06 $0.01 $0.03
11. Recently Issued Accounting Standards
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" (FIN 46) Until this interpretation, a company
generally included another entity in its consolidated financial statements
only if it controlled the entity through voting interests. FIN 46 requires
a variable interest entity, as defined, to be consolidated by a company if
that company is subject to a majority of the risk of loss from the
variable interest entity's activities or entitled to receive a majority of
the entity's residual returns. The adoption of FIN 46 did not have a
material impact on the Company's financial position, cash flows or results
of operations.
12. Acquisition of Assets
On July 30, 2004, AETL Testing Inc. (a Canadian Corporation), a
wholly-owned subsidiary of the Company ("AETL"), acquired substantially
all of the fixed assets of a Canadian Test Laboratory involved in the
testing of telecommunication equipment, located in Calgary, Alberta,
Canada, for a total purchase price of $1,033,000. By making this
acquisition, the Company intends to expand its presence to Canada and
increase its opportunities in the testing of telecommunication equipment.
9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Except for the historical information contained herein, the matters
addressed in this Item 2 contain forward-looking statements within the meaning
of the Private Securities Litigation Reform Act of 1995. Such statements can be
identified by the use of forward-looking words such as "may", "will", "expect",
"anticipate", "intend", "estimate", "continue", "behave" and similar words.
Financial information contained herein, to the extent it is predictive of
financial condition and results of operations that would have occurred on the
basis of certain stated assumptions, may also be characterized as
forward-looking statements. Although forward-looking statements are based on
assumptions made, and information believed by management to be reasonable, no
assurance can be given that such statements will prove to be correct. Such
statements are subject to certain risks, uncertainties and assumptions. Should
one or more of these risks or uncertainties occur, or should underlying
assumptions prove incorrect, actual results may vary materially from those
anticipated.
OVERVIEW
The Company is a diversified business to business services organization
that supplies technical services and solutions to a variety of industries
including aerospace, defense, automotive, power products, electronics, computers
and telecommunications. Through its wide range of testing facilities, solutions
and certification services, the Company provides its customers the ability to
sell their products globally and enhance their overall competitiveness. NTS is
accredited by numerous national and international technical organizations which
allow the Company to have its test data accepted in most countries.
The Company operates in two segments: "Engineering & Evaluation" and
"Technical Solutions". The business of the Company is conducted by a number of
operating units, each with its own management and profit center. Each segment is
under the direction of its own executive and operational management team. In
making financial and operational decisions, NTS relies on an internal management
reporting process that provides revenue and operating cost information for each
of its operating units. Revenues and booking activities are also tracked by
industry.
The Engineering & Evaluation segment is one of the largest independent
conformity assessment and management system registration organizations in the
U.S., with facilities throughout the United States, Japan and Germany serving a
large variety of high technology industries, including aerospace, defense,
automotive, power products, electronics, computers and telecommunications. This
segment provides highly trained technical personnel for product certification,
product safety testing and product evaluation to allow customers to sell their
products in world markets. In addition, it performs management registration and
certification services to ISO related standards.
The Technical Solutions segment is a national provider of professional and
specialty staffing services including contract services, temporary and full time
placements, providing specialty solutions services to its customers specifically
in the area of information technology, information systems, software engineering
and construction needs. Technical Solutions supplies professionals in support of
customers who need help-desk analysts and managers, relational database
administrators and developers, application and systems programmers,
configuration and project managers, engineering personnel and multiple levels of
system operations personnel.
The following discussion should be read in conjunction with the
consolidated quarterly financial statements and notes thereto. All information
is based upon operating results of the Company for the six months ended July 31.
10
RESULTS OF OPERATIONS
REVENUES
Six months ended July 31, 2004 % Change 2003
---------------------------------
(Dollars in thousands)
Engineering & Evaluation $31,317 4.8% $29,877
Technical Solutions 23,105 (4.4)% 24,172
------- -------
Total revenues $54,422 0.7% $54,049
======= =======
For the six months ended July 31, 2004, consolidated revenues increased by
$373,000 or 0.7% when compared to the same period in fiscal 2004.
Engineering & Evaluation:
For the six months ended July 31, 2004, Engineering and Evaluation revenues
increased by $1,440,000 or 4.8% when compared to the same period in fiscal 2004,
primarily due to revenues of $1,741,000 from the acquisition of DTI Holdings,
LLC, located in Rustburg, Virginia, which was effective on January 1, 2004, and
the increases in the Company's space and automotive testing businesses. The
Company also experienced an improvement in its computer testing business in
Japan. These increases were partially offset by the decrease in the passive
fiber optic testing business and the decrease in defense related business at the
Camden, Arkansas facility, which included revenues from a major contract related
to the war on terrorism. The contract was completed during the second quarter of
the prior year.
Technical Solutions:
For the six months ended July 31, 2004, revenues in Technical Solutions
decreased by $1,067,000 or 4.4% when compared to the same period in fiscal 2004,
due to the continued weakness in the IT market staffing business.
GROSS PROFIT
Six months ended July 31, 2004 % Change 2003
---------------------------------
(Dollars in thousands)
Engineering & Evaluation $ 8,212 1.2% $ 8,115
% to segment revenue 26.2% 27.2%
Technical Solutions 3,636 (4.5)% 3,809
% to segment revenue 15.7% 15.8%
------- -------
Total $11,848 (0.6)% $11,924
======= =======
% to total revenue 21.8% 22.1%
Total gross profit for the six months ended July 31, 2004 decreased by $76,000
or 0.6% when compared to the same period in fiscal 2003.
Engineering & Evaluation:
For the six months ended July 31, 2004, gross profit for the Engineering &
Evaluation Group increased by $97,000 or 1.2% when compared to the same period
in fiscal 2004, primarily as a result of the revenue increase discussed above.
However, the gross profit margin as a percentage of revenues decreased in the
current year primarily due to the decreases in gross profit from the passive
fiber optic testing business and completion of the Camden, Arkansas project, as
noted above.
11
Technical Solutions:
For the six months ended July 31, 2004, gross profit decreased by $173,000 or
4.5% in the Technical Solutions Group when compared to the same period in fiscal
2004, primarily as a result of the revenue decrease discussed above. Gross
profit margin as a percentage of revenues remained approximately the same when
compared to the same period in the prior year.
SELLING, GENERAL & ADMINISTRATIVE
Six months ended July 31, 2004 % Change 2003
---------------------------------
(Dollars in thousands)
Engineering & Evaluation $ 7,023 10.1% $ 6,378
% to segment revenue 22.4% 21.3%
Technical Solutions 3,314 (9.1)% 3,646
% to segment revenue 14.3% 15.1%
------- -------
Total $10,337 3.1% $10,024
======= =======
% to total revenue 19.0% 18.5%
Total selling, general and administrative expenses increased $313,000 or 3.1%
for the six months ended July 31, 2004 when compared to the same period in
fiscal 2004.
Engineering & Evaluation:
For the six months ended July 31, 2004, selling, general and administrative
expenses increased by $645,000 or 10.1% when compared to the same period in
fiscal 2004, primarily due to one-time start-up costs associated with the
development of new test specifications for the emerging wireless technologies
and the development of capabilities to perform testing on new DSL services, and
one-time costs incurred by the Company to prepare for Section 404 of the
Sarbanes-Oxley Act, that makes reporting on internal controls mandatory for all
SEC registrants. Selling, general and administrative expenses also increased due
to sales costs related to efforts to expand the Company nationally and
internationally, the addition of new sales and customer service representatives
and costs related to the improvement of the Company's internal IT infrastructure
and website.
Technical Solutions:
For the six months ended July 31, 2004, selling, general and administrative
expenses decreased by $332,000 or 9.1% when compared to the same period in
fiscal 2004, primarily due to the reduction in selling costs associated with the
lower revenues and other administrative cost reductions.
OPERATING INCOME
Six months ended July 31, 2004 % Change 2003
---------------------------------
(Dollars in thousands)
Engineering & Evaluation $ 1,189 (31.5)% $ 1,737
% to segment revenue 3.8% 5.8%
Technical Solutions 322 97.5% 163
% to segment revenue 1.4% 0.7%
------- -------
Total $ 1,511 (20.5)% $ 1,900
======= =======
% to total revenue 2.8% 3.5%
Operating income for the six months ended July 31, 2004 decreased by $389,000 or
20.5% when compared to fiscal 2004.
12
Engineering & Evaluation:
For the six months ended July 31, 2004, operating income in the Engineering &
Evaluation Group decreased by $548,000 or 31.5% when compared to the same period
in fiscal 2004, as a result of the increase in selling, general and
administrative expenses discussed above, partially offset by a slight increase
in gross profit discussed above.
Technical Solutions:
For the six months ended July 31, 2004, operating income in the Technical
Solutions Group increased by $159,000 or 97.5% when compared to the same period
in fiscal 2004, as a result of the decrease in selling and general and
administrative expenses discussed above, partially offset by the decrease in
gross profit discussed above.
INTEREST EXPENSE
Net interest expense decreased by $82,000 in the six months ended July 31, 2004
when compared to the same period in fiscal 2004. This decrease was principally
due to lower interest rate levels for the six months ended July 31, 2004,
partially offset by slightly higher average debt balances during the six months
ended July 31, 2004, when compared to the same period last year.
INCOME TAXES
The income tax provisional rate of 36.6% for the six months ended July 31, 2004
reflects a rate in excess of the U.S. federal statutory rate primarily due to
the inclusion of state income taxes and certain non-deductible expenses. This
rate is based on the estimated provision for fiscal year ending January 31, 2005
and is lower than normal due to the earnings associated with the Company's
foreign subsidiary which significantly increased in the second quarter and are
considered to be permanently invested and no provision for U.S. federal or state
income taxes is provided for this subsidiary. Management has determined that it
is more likely than not that the deferred tax asset will be realized on the
basis of offsetting it against deferred tax liabilities. It is the Company's
intention to assess the need for a valuation account by evaluating the
realizability of the deferred tax asset quarterly based upon projected future
taxable income of the Company.
NET INCOME
The increase in net income for the six months ended July 31, 2004, compared to
the same period in fiscal 2004, was primarily due to the increase in other
income and minority interest, decrease in interest expense and income taxes,
partially offset by a lower operating income.
The following information is based upon results for National Technical Systems,
Inc. for the three months ended July 31.
RESULTS OF OPERATIONS
REVENUES
Three months ended July 31, 2004 % Change 2003
--------------------------------
(Dollars in thousands)
Engineering & Evaluation $15,629 (0.2)% $15,658
Technical Solutions 11,492 (0.8)% 11,579
------- -------
Total revenues $27,121 (0.4)% $27,237
======= =======
For the three months ended July 31, 2004, consolidated revenues decreased by
$116,000 or 0.4% when compared to the same period in fiscal 2004.
13
Engineering & Evaluation:
For the three months ended July 31, 2004, Engineering and Evaluation revenues
decreased by $29,000 or 0.2% when compared to the same period in fiscal 2004,
primarily due to the decrease in the passive fiber optic testing business and
the decrease in defense related business at the Camden, Arkansas facility which
included revenues from a major contract related to the war on terrorism that was
completed in the prior year. These decreases were partially offset by revenues
of $922,000 from the acquisition of DTI Holdings, LLC, located in Rustburg,
Virginia, which was effective on January 1, 2004 and the increases in the
Company's space and automotive testing businesses. The Company also experienced
an improvement in its computer testing business in Japan.
Technical Solutions:
For the three months ended July 31, 2004, Technical Solutions revenues decreased
by $87,000 or 0.8% when compared to the same period in fiscal 2004, due to the
continued weakness in the IT market staffing business and the sluggish economy.
GROSS PROFIT
Three months ended July 31, 2004 % Change 2003
--------------------------------
(Dollars in thousands)
Engineering & Evaluation $ 4,017 (9.2)% $ 4,423
% to segment revenue 25.7% 28.2%
Technical Solutions 1,858 0.2% 1,855
% to segment revenue 16.2% 16.0%
------- -------
Total $ 5,875 (6.4)% $ 6,278
======= =======
% to total revenue 21.7% 23.0%
Total gross profit for the three months ended July 31, 2004 decreased by
$403,000 or 6.4% when compared to the same period in fiscal 2004.
Engineering & Evaluation:
For the three months ended July 31, 2004, gross profit for the Engineering &
Evaluation Group decreased by $406,000 or 9.2% when compared to the same period
in fiscal 2004, primarily as a result of the revenue decreases discussed above.
Gross profit as a percentage of revenue decreased to 25.7% from 28.2% when
compared to the same period in the prior year, primarily due to the effect of
fixed costs and competitive pricing pressures.
Technical Solutions:
For the three months ended July 31, 2004, gross profit increased by $3,000 or
0.2% in the Technical Solutions Group when compared to the same period in fiscal
2004. This increase is primarily due to a slight improvement in contract
margins. Gross profit as a percentage of revenue increased slightly to 16.2 %
from 16.0% when compared to the same period in the prior year.
SELLING, GENERAL & ADMINISTRATIVE
Three months ended July 31, 2004 % Change 2003
--------------------------------
(Dollars in thousands)
Engineering & Evaluation $ 3,624 5.6% $ 3,431
% to segment revenue 23.2% 21.9%
Technical Solutions 1,655 (9.8)% 1,834
% to segment revenue 14.4% 15.8%
------- -------
Total $ 5,279 0.3% $ 5,265
======= =======
% to total revenue 19.5% 19.3%
Total selling, general and administrative expenses increased $14,000 or 0.3% for
the three months ended July 31, 2004 when compared to the same period in fiscal
2004.
14
Engineering & Evaluation:
For the three months ended July 31, 2004, selling, general and administrative
expenses increased by $193,000 or 5.6% when compared to the same period in
fiscal 2004, primarily due to one-time start-up costs associated with the
development of new test specifications for the emerging wireless technologies
and the development of capabilities to perform testing on new DSL services, and
one-time costs incurred by the Company to prepare for Section 404 of the
Sarbanes-Oxley Act. Selling, general and administrative expenses also increased
due to sales costs related to efforts to expand the Company nationally and
internationally, the addition of new sales and customer service representatives
and costs related to the improvement of the Company's internal IT infrastructure
and website.
Technical Solutions:
For the three months ended July 31, 2004, selling, general and administrative
expenses decreased by $179,000 or 9.8% when compared to the same period in
fiscal 2004, primarily due to the reduction in selling costs associated with the
lower revenues and other administrative cost reductions.
OPERATING INCOME
Three months ended July 31, 2004 % Change 2003
--------------------------------
(Dollars in thousands)
Engineering & Evaluation $ 393 (60.4)% $ 992
% to segment revenue 2.5% 6.3%
Technical Solutions 203 866.7% 21
% to segment revenue 1.8% 0.2%
------- -------
Total $ 596 (41.2)% $ 1,013
======= =======
% to total revenue 2.2% 3.7%
Operating income for the three months ended July 31, 2004 decreased by $417,000
or 41.2% when compared to fiscal 2004.
Engineering & Evaluation:
For the three months ended July 31, 2004, operating income in the Engineering &
Evaluation Group decreased by $599,000 or 60.4% when compared to the same period
in fiscal 2004, as a result of the decrease in gross profit and the increase in
selling and general and administrative expenses discussed above.
Technical Solutions:
For the three months ended July 31, 2004, operating income in the Technical
Solutions Group increased by $182,000 or 866.7% when compared to the same period
in fiscal 2004, primarily as a result of the decrease in selling and general and
administrative expenses.
INTEREST EXPENSE
Net interest expense decreased by $27,000 in the three months ended July 31,
2004 when compared to the same period in fiscal 2004. This decrease was
principally due to lower interest rate levels for the three months ended July
31, 2004, offset by slightly higher average debt balances for the three months
ended July 31, 2004 when compared to the same period last year.
15
INCOME TAXES
The income tax provisional rate of 27.7% for the three months ended July 31,
2004 reflects a rate that is lower than the U.S. federal statutory rate due to
the earnings associated with the Company's foreign subsidiary which
significantly increased in the second quarter and are considered to be
permanently invested and no provision for U.S. federal or state income taxes is
provided for this subsidiary. Management has determined that it is more likely
than not that the deferred tax asset will be realized on the basis of offsetting
it against deferred tax liabilities. It is the Company's intention to assess the
need for a valuation account by evaluating the realizability of the deferred tax
asset quarterly based upon projected future taxable income of the Company.
NET INCOME
The decrease in net income for the three months ended July 31, 2004, compared to
the same period in fiscal 2004, was primarily due to the lower operating income,
partially offset by lower interest expense and lower income taxes.
BUSINESS ENVIRONMENT
Engineering & Evaluation:
The Company provides product certification, product safety testing and product
evaluation to ensure its high tech clients' products meet established
specifications or standards. In recent years, domestic and worldwide political
and economic developments have significantly affected the markets for defense
and advanced technology systems. As a result, the Company has diversified, added
and continues to add, capability to provide high tech product compliance
services for the telecommunications industry, both domestically and
internationally. The Company currently offers a complete suite of product
certification (NEBS testing) in its laboratories in California, Massachusetts,
Texas and Germany to support legacy communication networks. Regional Bell
operating companies are now upgrading their networks for fiber transmission and
DSL services. NTS has recently achieved approvals, and recently developed in
California test suites, to certify passive fiber components and DSL modems for
the Regional Bell operating companies. NTS believes fiber certification and DSL
certification are emerging markets and NTS, with its recent approvals and
recently developed test suites is well positioned to service the demand. In
addition, NTS believes that certification of wireless products is an emerging
market and NTS has recently invested personnel and capital to develop test
specifications and test suites to service this future business need. In
addition, NTS has experienced an increased need for environmental testing for
satellite and automotive components. The Company believes this need will
continue for the foreseeable future.
The Company anticipates budget increases for operational readiness spending as
well as research and development spending for homeland security and defeating
terrorism. As products are developed for these activities, the Company is well
positioned to meet the test and evaluation requirements. The Company's Camden
facility performed a major weapons testing program last year which resulted in a
one time significant growth of revenue and margin. The Company does not foresee
in the immediate future a similar program to replace this activity. However, the
Company believes the demand for overall defense related testing will continue to
increase for the foreseeable future. The Company's Santa Clarita facility, its
largest aerospace facility, continues to experience a decline in sales during
this period, following construction of a public highway immediately adjacent to
the Santa Clarita facility. A portion of the highway was built on real property
taken from the Company by eminent domain. The Company is seeking, through the
appeal process, appropriate compensation for the taking of the Company's
property. In an effort to maintain the economic viability of the facility,
several new capabilities have been added which include fuel cell testing,
upgraded acoustical testing, clean environment satellite testing and
installation of a high pressure air system. New business is currently being
booked for these services. The Fullerton facility performed extensive passive
fiber optics component testing in accordance with the Fiber Distributing Frames
Certification. These tests resulted in significant revenue and margin growth for
this facility. This level of activity has reduced significantly as market
demands subsided. The Company does not believe the demand level for this
specific activity will be repeated in the foreseeable future. However, the
Company does believe the demand for general Passive Fiber Component
Certification will continue, as Regional Bell operating companies continue to
upgrade their networks.
Technical Staffing:
The Company provides a variety of staffing and workforce management services and
solutions, including contract,
16
contract-to-hire and full time placements to meet its customers' needs. One of
the strategies for growth is to extend the offering of the Company's technical
staffing services to the Engineering & Evaluations segment's customers to
provide them with technical and engineering personnel as part of a complete
suite of certification, registration and test services. The goal is to offer a
complete solution to the customers' product development needs, which include
consultants and technical experts provided by Technical Staffing.
Notwithstanding the foregoing, and because of factors affecting the Company's
operating results, past financial performance should not be considered to be a
reliable indicator of future performance.
17
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities of $2,180,000 in the six months ended
July 31, 2004 primarily consisted of net income of $775,000 adjusted for
non-cash items of $2,525,000 in depreciation and amortization offset by a
decrease of $962,000 of changes in working capital and the effect of the gain on
sale of assets of $158,000. The decrease in working capital changes was
primarily due to the decreases in accounts receivable, prepaid expenses,
accounts payable and income taxes receivable, partially offset by an increase in
deferred income and inventories. The decrease of $1,842,000 in cash provided by
operating activities from the six months ended July 31, 2003 to the six months
ended July 31, 2004 was primarily the result of the changes in accounts
receivable and income taxes receivable.
Net cash used for investing activities in the six months ended July 31, 2004 of
$3,878,000 was attributable to capital spending of $3,068,000, the acquisition
of the Canadian test laboratory for $1,033,000 and cash used in life insurance
of $88,000, offset by cash provided from the sale of property of $311,000.
Capital spending is generally comprised of purchases of machinery and equipment,
building, leasehold improvements, computer hardware, software and furniture and
fixtures. Cash used in investing activities increased from the six months ended
July 31, 2003 to the six months ended July 31, 2004, by $2,191,000 primarily as
a result of the increase in capital spending in the current year and the
acquisition of the Canadian test laboratory.
Net cash provided by financing activities in the six months ended July 31, 2004
of $268,000 consisted of proceeds from borrowings of debt of $906,000, proceeds
from stock options exercised of $193,000, offset by cash used for repayment of
debt of $831,000. Net cash provided by financing activities increased from the
six months ended July 31, 2003 to the six months ended July 31, 2004, by
$1,475,000 primarily as a result of the increase in borrowings of debt and the
decrease in repayments of debt.
On November 25, 2002, the Company increased the revolving line of credit with
Comerica Bank California and First Bank to $20,000,000. Comerica Bank
California, as the agent Bank, retained 60% of the line with First Bank, as the
participant Bank, holding 40% of the line. The revolving line of credit was
reduced by $1,750,000 on August 1, 2003 and was reduced again on August 1, 2004
by $1,750,000 and will be reduced by $1,750,000 each year thereafter. If during
any fiscal year, the Company's net income equals or exceeds $2,000,000, there
will be no required reduction in the revolving line of credit. The interest rate
is at the agent bank's prime rate, with an option for the Company to convert to
loans at the Libor rate plus 250 basis points for 30, 60, 90, 180 or 365 days,
with minimum advances of $1,000,000. The Company paid a 0.5% commitment fee of
the total line amount and is paying an additional 0.25% of the commitment amount
annually and a 0.25% fee for any unused line of credit. The outstanding balance
on the revolving line of credit at July 31, 2004 was $15,502,000. This balance
is reflected in the accompanying condensed consolidated balance sheets as
long-term. This agreement is subject to certain covenants, which require the
maintenance of certain working capital, debt-to-equity, earnings-to-expense and
cash flow ratios. The amount available on the line of credit was $998,000 as of
July 31, 2004. The Company is currently in negotiations with its banks to
increase its line of credit. The Company was in full compliance with all of the
covenants with its banks as of July 31, 2004.
The Company has additional equipment line of credit agreements (at
interest rates of 7.60 % to 10.21%) to finance various test equipment with terms
of 60 months for each equipment schedule. The outstanding balance at July 31,
2004 was $1,769,000. The balance of other notes payable collateralized by land
and building was $3,054,000, and the balance of unsecured notes was $556,000 at
July 31, 2004.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation Of Disclosure Controls And Procedures
The Company's Chief Executive Officer and Chief Financial Officer carried
out an evaluation with the participation of the Company's management, of the
effectiveness of the design and operation of the Company's disclosure controls
and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the
18
Securities Exchange Act of 1934, as amended (the "Exchange Act")). Based upon
that evaluation, the Chief Executive Officer and Chief Financial Officer
concluded that, as of the end of the period covered by this report, the
Company's disclosure controls and procedures are effective in timely alerting
them to material information relating to the Company (including its consolidated
subsidiaries) required to be included in the Company's Exchange Act filings.
Disclosure controls and procedures, no matter how well designed and
implemented, can provide only reasonable assurance of achieving an entity's
disclosure objectives. The likelihood of achieving such objectives is affected
by limitations inherent in disclosure controls and procedures. These include the
fact that human judgment in decision-making can be faulty and that breakdowns in
internal control can occur because of human failures such as simple errors or
mistakes or intentional circumvention of the established process.
Changes in Internal Controls
There was no change in the Company's internal control over financial
reporting, known to the Chief Executive Officer or Chief Financial Officer that
occurred during the period covered by this report that has materially affected,
or is reasonably likely to materially affect, the Company's internal control
over financial reporting.
19
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders
At the Company's Annual Meeting of shareholders held on June 28, 2004,
four nominees of the Board of Directors were elected directors for three
year terms as Class II Directors expiring on the date of the annual
meeting in 2007. The votes were as follows:
--------------------------------------------------------------------
For Withheld
--------------------------------------------------------------------
Ralph Clements 7,606,397 827,233
--------------------------------------------------------------------
Aaron Cohen 7,723,875 709,755
--------------------------------------------------------------------
Donald Tringali 7,606,471 827,159
--------------------------------------------------------------------
Dan Yates 7,724,402 709,228
--------------------------------------------------------------------
The shareholders of the Company voted to ratify Ernst & Young LLP as auditors
for the year ending January 31, 2005. The results of the vote of the
shareholders were as follows:
--------------------------------------------------------------------------
For Against Abstain
--------------------------------------------------------------------------
Ratify Ernst & Young LLP as auditors for
the year ending January 31, 2005 8,426,874 6,201 555
--------------------------------------------------------------------------
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
31.1 - Certification of the Principal Executive Officer pursuant to
rule 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934,
as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
31.2 - Certification of the Principal Financial Officer pursuant to
rule 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934,
as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
32.1 - Certification of the Principal Executive Officer pursuant to
18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 - Certification of the Principal Financial Officer pursuant to
18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
NONE
20
SIGNATURE
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.
NATIONAL TECHNICAL SYSTEMS, INC.
Date: September 10, 2004 By: /s/ Lloyd Blonder
-----------------------------
Lloyd Blonder
Senior Vice President
Chief Financial Officer
(Signing on behalf of the
registrant and as principal
financial officer)
21