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EX-32.2 - CERTIFICATION OF CFO PURSUANT TO SECTION 906 - MTS SYSTEMS CORPmts151608_ex32-2.htm
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EX-32.1 - CERTIFICATION OF CEO PURSUANT TO SECTION 906 - MTS SYSTEMS CORPmts151608_ex32-1.htm
EX-31.1 - CERTIFICATION OF CEO PURSUANT TO SECTION 302 - MTS SYSTEMS CORPmts151608_ex31-1.htm
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Table of Contents



United States
SECURITIES AND EXCHANGE COMMISSION
 
WASHINGTON, D.C. 20549
     
 
FORM 10-Q
 
(Mark One)
   
x
Quarterly Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934 for the quarterly period ended March 28, 2015
   
or
   
o
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
incorporation or organization)
(I.R.S. Employer
Identification No.)
 
14000 Technology Drive, Eden Prairie, MN  55344
(Address of principal executive offices) (Zip Code)
          
Registrant’s telephone number, including area code: (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
o No
 
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
       
 
x Yes
o No
 
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer x      Accelerated filer o      Non-accelerated filer o      (Do not check if a smaller reporting company) Smaller Reporting Company  o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):
       
 
o Yes
x No
 
 
The number of shares outstanding of the issuer’s common stock as of April 30, 2015 was 14,903,783 shares.



 
 
 

 

 
MTS SYSTEMS CORPORATION

REPORT ON FORM 10-Q
FOR THE THREE MONTHS ENDED MARCH 28, 2015

INDEX
         
       
Page No.
         
   
     
     
         
     
2
         
     
3
         
     
4
         
     
5
         
     
6 - 18
         
   
19 - 31
         
   
32
         
   
32
         
   
     
   
32
         
   
33
         
   
34
         
   
35
 
1
 

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MTS SYSTEMS CORPORATION
(unaudited - in thousands, except per share data)
             
             
   
March 28,
   
September 27,
 
   
2015
   
2014
 
ASSETS
           
             
Current Assets:
           
Cash and cash equivalents
  $ 61,259     $ 60,397  
Accounts receivable, net of allowances for doubtful accounts of $3,109 and $2,609, respectively
    111,474       104,399  
Unbilled accounts receivable
    68,423       75,762  
Inventories
    88,798       83,557  
Prepaid expenses and other current assets
    17,053       13,937  
Deferred income taxes
    12,688       12,930  
Total current assets
    359,695       350,982  
                 
Property and equipment, net
    79,924       81,575  
Goodwill
    27,458       26,123  
Other intangible assets, net
    20,229       21,178  
Other assets
    2,872       3,694  
Deferred income taxes
    3,161       3,856  
Total assets
  $ 493,339     $ 487,408  
                 
LIABILITIES AND SHAREHOLDERS EQUITY
               
                 
Current Liabilities:
               
Short-term borrowings
  $ 70,871     $ 60,000  
Accounts payable
    36,448       27,189  
Accrued payroll and related costs
    24,199       30,009  
Advance payments from customers
    54,159       52,335  
Accrued warranty costs
    5,325       4,286  
Accrued income taxes
    2,602       6,041  
Deferred income taxes
    1,410       1,641  
Accrued dividends
    4,407       4,476  
Other accrued liabilities
    22,247       17,004  
Total current liabilities
    221,668       202,981  
                 
Deferred income taxes
    10,555       6,045  
Non-current accrued income taxes
    4,329       5,990  
Defined benefit pension plan obligation
    4,772       7,654  
Other long-term liabilities
    4,548       6,611  
Total liabilities
    245,872       229,281  
                 
Shareholders’ Equity:
               
Common stock, $0.25 par; 64,000 shares authorized: 14,916 and 15,180 shares issued and outstanding as of March 28, 2015 and September 27, 2014, respectively
    3,729       3,795  
Additional paid-in capital
          6,112  
Retained earnings
    246,420       242,396  
Accumulated other comprehensive (loss) income
    (2,682 )     5,824  
Total shareholders’ equity
    247,467       258,127  
Total liabilities and shareholders’ equity
  $ 493,339     $ 487,408  

The accompanying condensed notes to consolidated financial statements are an integral part of these statements.
 
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MTS SYSTEMS CORPORATION
(unaudited - in thousands, except per share data)
                         
   
Three Months Ended
   
Six Months Ended
 
   
March 28,
   
March 29,
   
March 28,
   
March 29,
 
   
2015
   
2014
   
2015
   
2014
 
Revenue:
                       
Product
  $ 124,436     $ 116,681     $ 248,917     $ 237,840  
Service
    19,519       20,662       37,622       37,913  
Total revenue
    143,955       137,343       286,539       275,753  
Cost of sales:
                               
Product
    75,691       69,380       151,223       144,005  
Service
    11,722       12,429       21,943       21,675  
Total cost of sales
    87,413       81,809       173,166       165,680  
Gross profit
    56,542       55,534       113,373       110,073  
                                 
Operating expenses:
                               
Selling and marketing
    20,304       22,411       41,558       43,894  
General and administrative
    12,794       13,978       26,996       27,184  
Research and development
    5,689       6,791       11,253       12,494  
Total operating expenses
    38,787       43,180       79,807       83,572  
                                 
Income from operations
    17,755       12,354       33,566       26,501  
                                 
Interest expense, net
    (273 )     (205 )     (440 )     (365 )
Other expense, net
    (607 )     (211 )     (1,366 )     (503 )
                                 
Income before income taxes
    16,875       11,938       31,760       25,633  
Provision for income taxes
    5,169       4,159       6,268       8,709  
Net income
  $ 11,706     $ 7,779     $ 25,492     $ 16,924  
                                 
Earnings per share:
                               
Basic-
                               
Earnings per share
  $ 0.78     $ 0.51     $ 1.69     $ 1.11  
Weighted average number of common shares outstanding - basic
    14,986       15,245       15,047       15,299  
                                 
Diluted-
                               
Earnings per share
  $ 0.77     $ 0.50     $ 1.68     $ 1.09  
Weighted average number of common shares outstanding - diluted
    15,155       15,434       15,212       15,487  
                                 
Dividends declared per share
  $ 0.30     $ 0.30     $ 0.60     $ 0.60  

The accompanying condensed notes to consolidated financial statements are an integral part of these statements.
 
3
 

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MTS SYSTEMS CORPORATION
(unaudited - in thousands)
                         
   
Three Months Ended
   
Six Months Ended
 
   
March 28,
   
March 29,
   
March 28,
   
March 29,
 
   
2015
   
2014
   
2015
   
2014
 
Net income
  $ 11,706     $ 7,779     $ 25,492     $ 16,924  
Other comprehensive loss, net of tax:
                               
Foreign currency translation adjustments
    (6,338 )     (1,029 )     (11,150 )     (69 )
Derivative instruments:
                               
Unrealized net gain (loss)
    553       (121 )     1,997       (94 )
Net gain reclassified to earnings
    (697 )     (737 )     (1,779 )     (418 )
Defined benefit pension plan:
                               
Unrealized net gain (loss)
    901       (12 )     1,287       421  
Net loss reclassified to earnings
    86       82       181       163  
Currency exchange rate change
    640       11       958       (75 )
Other comprehensive loss
    (4,855 )     (1,806 )     (8,506 )     (72 )
Comprehensive income
  $ 6,851     $ 5,973     $ 16,986     $ 16,852  
 
The accompanying condensed notes to consolidated financial statements are an integral part of these statements.
 
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MTS SYSTEMS CORPORATION
(unaudited - in thousands)
             
   
Six Months Ended
 
   
March 28,
   
March 29,
 
   
2015
   
2014
 
             
Cash flows from operating activities:
           
Net income
  $ 25,492     $ 16,924  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Stock-based compensation
    3,922       2,469  
Excess tax benefits for stock-based compensation
    (467 )     (917 )
Net periodic pension benefit cost
    511       620  
Depreciation and amortization
    10,354       9,037  
Deferred income taxes
    5,233       (527 )
Bad debt provision
    639       453  
                 
Changes in operating assets and liabilities:
               
Accounts and unbilled accounts receivable
    (9,407 )     (5,178 )
Inventories
    (6,761 )     (1,123 )
Prepaid expenses
    (3,297 )     (1,391 )
Accounts payable
    10,283       (1,312 )
Accrued payroll and related costs
    (5,852 )     (2,035 )
Advance payments from customers
    1,478       5,015  
Accrued warranty costs
    1,087       408  
Other assets and liabilities
    2,407       1,680  
Net cash provided by operating activities
    35,622       24,123  
                 
Cash flows from investing activities:
               
Purchases of property and equipment
    (9,132 )     (10,494 )
                 
Cash flows from financing activities:
               
Receipts under short-term borrowings
    10,871       10,000  
Payments under short-term borrowings
    (26 )      
Excess tax benefits from stock-based compensation
    467       917  
Cash dividends
    (9,079 )     (9,238 )
Proceeds from exercise of stock options and employee stock purchase plan
    3,370       3,477  
Payments to purchase and retire common stock
    (26,370 )     (23,322 )
Net cash used in financing activities
    (20,767 )     (18,166 )
Check
    -       -  
Effect of exchange rate on changes in cash
    (4,861 )     (76 )
                 
Net increase (decrease) in cash and cash equivalents
    862       (4,613 )
Check
    -       -  
Cash and cash equivalents, at beginning of period
    60,397       48,333  
Cash and cash equivalents, at end of period
  $ 61,259     $ 43,720  
Check
    -       -  
Supplemental disclosure of cash flow information:
               
Cash paid during the period for -
               
Interest
  $ 451     $ 202  
Income taxes
  $ 8,319     $ 9,854  
Non-cash financing activities:
               
Dividends declared not yet paid
  $ 4,407     $ 4,476  
                 
The accompanying condensed notes to consolidated financial statements are an integral part of these statements.
               

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(unaudited)

1. Basis of Presentation

The consolidated financial statements include the accounts of MTS Systems Corporation and its wholly owned subsidiaries (the “Company”). All significant intercompany balances and transactions have been eliminated.

The interim unaudited consolidated financial statements included herein have been prepared by the Company, pursuant to the rules and regulations of the United States (“U.S.”) Securities and Exchange Commission (“SEC”). The information furnished in these consolidated 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. The consolidated financial statements are prepared in accordance with generally accepted accounting principles accepted in the United States of America (“U.S. GAAP”), and U.S. GAAP requires the Company to make estimates and assumptions that affect amounts reported. Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to SEC rules and regulations. The accompanying consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended September 27, 2014 filed with the SEC. Interim results of operations for the second quarter ended March 28, 2015 are not necessarily indicative of the results to be expected for the full year.

Fiscal Year

The Company’s fiscal year ends on the Saturday closest to September 30. The Company’s fiscal years ended September 27, 2014 and September 28, 2013 consisted of 52 weeks. The Company’s fiscal year ending October 3, 2015 will consist of 53 weeks.

2. Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606)”. This update clarifies the principles for revenue recognition in transactions involving contracts with customers. The new revenue recognition guidance provides a five-step analysis to determine when and how revenue is recognized. The new guidance will require revenue recognition to depict the transfer of promised goods or services to a customer in an amount that reflects the consideration a company expects to receive in exchange for those goods or services. The guidance will be effective for the Company’s interim and annual reporting periods beginning after December 15, 2016, which is the Company’s fiscal year 2018. Early adoption is not permitted. The Company has not yet evaluated what impact, if any, the adoption of this guidance may have on the Company’s financial condition, results of operations, or disclosures.

3. Inventories

Inventories consist of material, labor and overhead costs and are stated at the lower of cost or market value, determined under the first-in, first-out accounting method. Inventories as of March 28, 2015 and September 27, 2014 were as follows:
             
 
 
March 28,
   
September 27,
 
   
2015
   
2014
 
   
(in thousands)
 
Customer projects in various stages of completion
  $ 24,303     $ 22,559  
Components, assemblies and parts
    64,495       60,998  
Total
  $ 88,798     $ 83,557  
 
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4. Warranty Obligations

Sales of the Company’s products and systems are subject to limited warranty obligations that are included in customer contracts. For sales that include installation services, warranty obligations typically extend for a period of twelve to twenty-four months from the date of either shipment or acceptance. Product obligations typically extend for a period of twelve to twenty-four months from the date of purchase. 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 general warranty provisions based on an estimated warranty expense percentage applied to current period revenue. The percentage applied reflects historical warranty claims experience over the preceding twelve-month period. Both the experience percentage and the warranty liability are evaluated on an ongoing basis for adequacy. In addition, warranty provisions are also recognized for certain nonrecurring product claims that are individually significant. Warranty provisions and claims for the three and six months ended March 28, 2015 and March 29, 2014 were as follows:
                         
    Three Months Ended     Six Months Ended  
   
March 28,
   
March 29,
   
March 28,
   
March 29,
 
   
2015
   
2014
   
2015
   
2014
 
 
(in thousands)
 
Beginning balance
  $ 5,188     $ 5,308     $ 4,286     $ 4,694  
Warranty provisions
    1,145       1,801       3,280       3,964  
Warranty claims
    (1,039 )     (1,826 )     (2,535 )     (3,393 )
Adjustments to preexisting warranties
    63       (162 )     342       (162 )
Currency translation
    (32 )     (1 )     (48 )     17  
Ending balance
  $ 5,325     $ 5,120     $ 5,325     $ 5,120  
 
5. Stock-Based Compensation

The Company compensates its officers, directors, and employees with stock-based compensation under the 2011 Stock Incentive Plan (“2011 Plan”) approved by the Company’s shareholders in 2011, and administered under the supervision of the Company’s Board of Directors. During fiscal year 2013, the Company’s shareholders approved a 1.3 million increase in the number of shares that may be issued under the 2011 Plan, bringing the aggregate total to 2.3 million. During the three months ended December 27, 2014 and December 28, 2013, the Company awarded stock options and restricted stock units under the 2011 Plan. At March 28, 2015, a total of 972,042 shares were available for future grant under the 2011 Plan. These shares will be available for issuance under the 2011 Plan until January 31, 2018.

In 2011, the Company’s shareholders approved a 2012 Employee Stock Purchase Plan (“ESPP”) that was effective on January 1, 2012. During the three months ended March 28, 2015 and the three months ended September 27, 2014, the Company issued shares of its common stock to participants under the ESPP. At March 28, 2015, a total of 695,669 shares were available for ESPP share issuances. Shares will be available for issuance under the ESPP until December 31, 2021.

During the three months ended December 27, 2014, the Company granted an award of approximately 162,000 stock options, 41,000 restricted stock units and 16,000 performance restricted stock units to officers and employees of the Company. During the three months ended December 28, 2013, the Company granted an award of approximately 331,000 stock options and 70,000 restricted stock units to officers and employees of the Company. The stock options vest proportionally on the first three anniversaries of the grant date and expire seven years from the grant date. The restricted stock units vest proportionally on the first three anniversaries of the grant date and performance restricted stock units vest based on the attainment of return on invested capital performance targets at the end of the one, two and three year performance periods.
 
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The stock options were granted at an exercise price equal to the closing market price of the Company’s stock on the date of grant. The fair value of stock options granted has been estimated as of the date of grant using the multiple option form of the Black-Scholes valuation model, based on the grant price and assumptions regarding the expected grant life, stock price volatility, dividends, and risk-free interest rates. Each vesting period of an option award is valued separately, with this value being recognized as expense evenly over the vesting period. The weighted average per share fair value of the stock options granted under the Company-wide award during the three months ended December 27, 2014 and December 28, 2013 was $12.12 and $13.97, respectively. The weighted average assumptions used to determine the fair value of these stock options were as follows:
     
Expected life (in years)
 3.5
 
Risk-free interest rate
 1.1
%
Expected volatility
 27.4
%
Dividend yield
 1.8
%

The expected life represents the period that the stock option awards are expected to be outstanding and was determined based on historical and anticipated future exercise and expiration patterns.

The risk-free interest rate used is based on the yield of constant maturity U.S. Treasury bonds on the grant date with a remaining term equal to the expected life of the grant. The Company estimates stock price volatility based on a historical weekly price observation. The dividend yield assumption is based on the annualized current dividend divided by the share price on the grant date.

The fair value of the restricted stock units granted under the Company-wide award during the three months ended December 27, 2014 and December 28, 2013 was $64.65 and $64.90, respectively, representing the market value of the Company’s shares at the date of grant minus the present value of estimated foregone dividends over the vesting period. The proportionate value of restricted stock units and performance restricted stock units associated with each vesting period is allocated to expense evenly over the vesting period.

6. Capital Assets

Property and Equipment
Property and equipment as of March 28, 2015 and September 27, 2014 consisted of the following:
             
   
March 28,
   
September 27,
 
 
 
2015
   
2014
 
 
(in thousands)
 
Land and improvements
  $ 1,704     $ 1,710  
Buildings and improvements
    52,572       54,271  
Machinery and equipment
    155,095       150,917  
Total
    209,371       206,898  
Less accumulated depreciation
    (129,447 )     (125,323 )
Property and equipment, net
  $ 79,924     $ 81,575  

Goodwill
Goodwill as of March 28, 2015 and September 27, 2014 was $27.5 million and $26.1 million, respectively. During the three months ended December 27, 2014, the Company recognized an adjustment of $1.7 million related to a deferred tax liability as part of the provisional allocation of the Roehrig Engineering, Inc. (“REI”) purchase price assigned to the assets acquired and liabilities assumed. Refer to Note 16 for details regarding this acquisition.
 
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Other Intangible Assets
Other intangible assets as of March 28, 2015 and September 27, 2014 consisted of the following:
                         
    March 28, 2015  
                     
Weighted
 
                     
Average
 
   
Gross Carrying
   
Accumulated
   
Net Carrying
   
Useful Life
 
   
Amount
   
Amortization
   
Value
   
(in Years)
 
 
(dollar amounts in thousands)
 
Software development costs
  $ 17,858     $ (12,845 )   $ 5,013       6.4  
Patents
    12,123       (4,859 )     7,264       14.5  
Trademarks and trade names
    6,292       (1,568 )     4,724       29.4  
Customer List
    2,562       (426 )     2,136       8.1  
Land-use rights
    1,256       (164 )     1,092       47.8  
Total
  $ 40,091     $ (19,862 )   $ 20,229       13.8  
 
                         
    September 27, 2014  
                     
Weighted
 
                     
Average
 
   
Gross Carrying
   
Accumulated
   
Net Carrying
   
Useful Life
 
   
Amount
   
Amortization
   
Value
   
(in Years)
 
 
(dollar amounts in thousands)
 
Software development costs
  $ 16,713     $ (11,644 )   $ 5,069       5.7  
Patents
    12,204       (4,453 )     7,751       14.4  
Trademarks and trade names
    6,349       (1,458 )     4,891       29.3  
Customer List
    2,485       (134 )     2,351       8.1  
Land-use rights
    1,269       (153 )     1,116       47.8  
Total
  $ 39,020     $ (17,842 )   $ 21,178       13.4  

Amortization expense recognized during the three months ended March 28, 2015 and March 29, 2014 was $1.1 million and $0.9 million, respectively. Amortization expense recognized during the six months ended March 28, 2015 and March 29, 2014 was $2.1 million and $1.9 million, respectively.

7. Earnings Per Common Share

Basic earnings per share are computed by dividing net earnings by the daily weighted average number of common shares outstanding during the applicable periods. Diluted earnings per share include the potentially dilutive effect of common shares issued in connection with outstanding stock-based compensation awards using the treasury stock method. Under the treasury stock method, shares associated with certain stock options have been excluded from the diluted weighted average shares outstanding calculation because the exercise of those options would lead to a net reduction in common shares outstanding. As a result, stock options to acquire 0.2 million and 0.3 million weighted common shares have been excluded from diluted weighted shares outstanding for each of the three months ended March 28, 2015 and March 29, 2014, respectively. Stock options to acquire 0.1 million and 0.2 million weighted common shares have been excluded from diluted weighted shares outstanding for each of the six months ended March 28, 2015 and March 29, 2014, respectively. The potentially dilutive effect of common shares issued in connection with outstanding stock options is determined based on net income. A reconciliation of these amounts is as follows:
                         
    Three Months Ended     Six Months Ended  
   
March 28,
   
March 29,
   
March 28,
   
March 29,
 
   
2015
   
2014
   
2015
   
2014
 
 
(in thousands, except per share data)
 
                         
Net income
  $ 11,706     $ 7,779     $ 25,492     $ 16,924  
                                 
Weighted average common shares outstanding
    14,986       15,245       15,047       15,299  
Dilutive potential common shares
    169       189       165       188  
Total diluted weighted average shares outstanding
    15,155       15,434       15,212       15,487  
                                 
Earnings per share:
                               
 Basic
  $ 0.78     $ 0.51     $ 1.69     $ 1.11  
 Diluted
  $ 0.77     $ 0.50     $ 1.68     $ 1.09  

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8. Business Segment Information

The Company’s Chief Executive Officer and management regularly review financial information for the Company’s two operating segments, “Test” and “Sensors.” Test provides testing equipment, systems, and services to the ground vehicles, materials and structures markets. Sensors provides high-performance position sensors for a variety of industrial, mobile hydraulic and liquid level applications.

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 Annual Report on Form 10-K for the fiscal year ended September 27, 2014. In evaluating each segment’s performance, management focuses on income from operations. This measure 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 for the three and six months ended March 28, 2015 and March 29, 2014 was as follows:
                         
    Three Months Ended     Six Months Ended  
   
March 28,
   
March 29,
   
March 28,
   
March 29,
 
   
2015
   
2014
   
2015
   
2014
 
 
(in thousands)
 
Revenue by Segment:
                       
 Test
  $ 118,737     $ 110,885     $ 236,822     $ 224,408  
 Sensors
    25,218       26,458       49,717       51,345  
 Total revenue
  $ 143,955     $ 137,343     $ 286,539     $ 275,753  
                                 
Income from Operations by Segment:
                               
 Test
  $ 13,141     $ 7,741     $ 25,117     $ 17,582  
 Sensors
    4,614       4,613       8,449       8,919  
 Total income from operations
  $ 17,755     $ 12,354     $ 33,566     $ 26,501  
 
9. Derivative Instruments and Hedging Activities

The Company uses foreign currency derivatives to hedge against foreign currency exchange risk. Some derivatives are designated as cash flow hedges and qualify as hedging instruments pursuant to Accounting Standards Codification (“ASC”) 815, “Derivatives and Hedging”; others are accounted for and reported under the guidance of ASC 830, “Foreign Currency Matters.” Regardless of the designation for accounting purposes, the Company believes that all of its derivative instruments are hedges of transactional risk exposures. The fair value of the Company’s outstanding designated and undesignated derivative assets and liabilities are reported in the March 28, 2015 and September 27, 2014 Consolidated Balance Sheets as follows:
             
   
March 28, 2015
 
   
Prepaid Expenses
       
   
and Other
   
Other Accrued
 
   
Current Assets
   
Liabilities
 
Designated hedge derivatives:
 
(in thousands)
 
Cash flow hedges
  $ 1,736     $ 505  
Total designated hedge derivatives
    1,736       505  
                 
Derivatives not designated as hedges:
               
Balance sheet derivatives
          394  
Total hedge and other derivatives
  $ 1,736     $ 899  
 
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September 27, 2014
 
   
Prepaid Expenses
       
   
and Other
   
Other Accrued
 
   
Current Assets
   
Liabilities
 
Designated hedge derivatives:
 
(in thousands)
 
Cash flow hedges
  $ 1,750     $ 178  
Total designated hedge derivatives
    1,750       178  
                 
Derivatives not designated as hedges:
               
Balance sheet derivatives
    641        
Total hedge and other derivatives
  $ 2,391     $ 178  

A reconciliation of the net fair value of foreign exchange cash flow hedge assets and liabilities subject to master netting arrangements that are recorded in the March 28, 2015 and September 27, 2014 Consolidated Balance Sheets to the net fair value that could have been reported in the respective Consolidated Balance Sheets is as follows:
                                                                     
March 28, 2015
Assets
 
Liabilities
Gross Amounts not Offset     Gross Amounts not Offset
in the Consolidated     in the Consolidated
Balance Sheet     Balance Sheet
           
Net
                               
Net
                 
           
Amount of
                               
Amount of
                 
     
Gross
 
Assets
                         
Gross
 
Liabilities
                 
Gross
 
Liabilities
 
Presented
                         
Assets
 
Presented
                 
Amount
 
Offset in the
 
in the
                   
Gross
 
Offset in the
 
in the
                 
of
 
Consolidated
 
Consolidated
 
Derivatives
 
Cash
 
Net
 
Amount of
 
Consolidated
 
Consolidated
 
Derivatives
 
Cash
 
Net
Recognized
 
Balance
 
Balance
 
Subject to
 
Collateral
 
Amount
 
Recognized
 
Balance
 
Balance
 
Subject to
 
Collateral
 
Amount
Assets
 
Sheet
 
Sheet
 
Offset
 
Received
 
(1)
 
Liabilities
 
Sheet
 
Sheet
 
Offset
 
Pledged
 
(2)
(in thousands)
$
 1,736
 
$
 —
 
$
 1,736
 
$
 —
 
$
 —
 
$
 1,736
 
$
 505
 
$
 —
 
$
 505
 
$
 —
 
$
 —
 
$
 505
                                                                     
September 27, 2014
Assets
 
Liabilities
Gross Amounts not Offset   Gross Amounts not Offset
in the Consolidated   in the Consolidated
Balance Sheet   Balance Sheet
           
Net
                               
Net
                 
           
Amount of
                               
Amount of
                 
     
Gross
 
Assets
                         
Gross
 
Liabilities
                 
Gross
 
Liabilities
 
Presented
                         
Assets
 
Presented
                 
Amount
 
Offset in the
 
in the
                   
Gross
 
Offset in the
 
in the
                 
of
 
Consolidated
 
Consolidated
 
Derivatives
 
Cash
 
Net
 
Amount of
 
Consolidated
 
Consolidated
 
Derivatives
 
Cash
 
Net
Recognized
 
Balance
 
Balance
 
Subject to
 
Collateral
 
Amount
 
Recognized
 
Balance
 
Balance
 
Subject to
 
Collateral
 
Amount
Assets
 
Sheet
 
Sheet
 
Offset
 
Received
 
(1)
 
Liabilities
 
Sheet
 
Sheet
 
Offset
 
Pledged
 
(2)
(in thousands)
$
 1,750
 
$
 —
 
$
 1,750
 
$
 —
 
$
 —
 
$
 1,750
 
$
 178
 
$
 —
 
$
 178
 
$
 —
 
$
 —
 
$
 178
 
 
(1)
Net fair value of foreign exchange cash flow hedge assets that could have been reported in the Consolidated Balance Sheets.
 
(2)
Net fair value of foreign exchange cash flow liabilities that could have been reported in the Consolidated Balance Sheets.
 
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Cash Flow Hedging – Currency Risks
Currency exchange contracts utilized to maintain the functional currency value of expected financial transactions denominated in foreign currencies are designated as cash flow hedges. Qualifying gains and losses related to changes in the market value of these contracts are reported as a component of Accumulated Other Comprehensive Income (“AOCI”) within Shareholders’ Equity on the Consolidated Balance Sheets and reclassified into earnings in the same period during which the underlying hedged transaction affects earnings. The effective portion of the cash flow hedges represents the change in fair value of the hedge that offsets the change in the functional currency value of the hedged item. Each month, the Company assesses whether its currency exchange contracts are effective and, when a contract is determined to be no longer effective as a hedge, the Company discontinues hedge accounting prospectively. Subsequent changes in the market value of ineffective currency exchange contracts are recognized as an increase or decrease in Revenue on the Consolidated Statements of Income, because that is the same line item upon which the underlying hedged transaction is reported.

As of March 28, 2015 and March 29, 2014, the Company had outstanding cash flow hedge currency exchange contracts with gross notional U.S. dollar equivalent amounts of $61.0 million and $36.5 million, respectively. Upon netting offsetting contracts to sell foreign currencies against contracts to purchase foreign currencies, irrespective of contract maturity dates, the net notional U.S. dollar equivalent amount of contracts outstanding was $49.9 million and $32.2 million as of March 28, 2015 and March 29, 2014, respectively.

As of March 28, 2015, the net market value of the foreign currency exchange contracts was a net asset of $1.2 million, consisting of $1.7 million in assets and $0.5 million in liabilities. As of March 29, 2014, the net market value of the foreign currency exchange contracts was a net liability of $0.3 million, consisting of $0.4 million in liabilities and $0.1 million in assets.

The pretax amounts recognized in AOCI on currency exchange contracts for the three and six months ended March 28, 2015 and March 29, 2014, including gains (losses) reclassified into earnings in the Consolidated Statements of Income and gains (losses) recognized in other comprehensive income (“OCI”), are as follows:
                         
    Three Months Ended     Six Months Ended  
   
March 28,
   
March 29,
   
March 28,
   
March 29,
 
   
2015
   
2014
   
2015
   
2014
 
 
(in thousands)
 
Beginning unrealized net gain in AOCI
  $ 1,978     $ 1,298     $ 1,414     $ 754  
Net gain reclassified into Revenue (effective portion)
    (1,095 )     (1,163 )     (2,793 )     (660 )
Net gain (loss) recognized in OCI (effective portion)
    869       (190 )     3,131       (149 )
Ending unrealized net gain (loss) in AOCI
  $ 1,752     $ (55 )   $ 1,752     $ (55 )

The amount recognized in earnings as a result of the ineffectiveness of cash flow hedges was less than $0.1 million in each of the three and six months ended March 28, 2015 and March 29, 2014. As of March 28, 2015 and March 29, 2014, the amount projected to be reclassified from AOCI into earnings in the next 12 months was a net gain of $1.8 million and a net loss of $0.1 million, respectively. The maximum remaining maturity of any forward or optional contract as of March 28, 2015 and March 29, 2014 was 2.2 years and 1.5 years, respectively.
 
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Foreign Currency Balance Sheet Derivatives
The Company also uses foreign currency derivative contracts to maintain the functional currency value of monetary assets and liabilities denominated in non-functional foreign currencies. The gains and losses related to the changes in the market value of these derivative contracts are included in Other expense, net in the Consolidated Statements of Income.

As of March 28, 2015 and March 29, 2014, the Company had outstanding foreign currency balance sheet derivative contracts with gross notional U.S. dollar equivalent amounts of $99.5 million and $71.2 million, respectively. Upon netting offsetting contracts by counterparty banks to sell foreign currencies against contracts to purchase foreign currencies, irrespective of contract maturity dates, the net notional U.S. dollar equivalent amount of contracts outstanding as of March 28, 2015 and March 29, 2014 was $30.3 million and $23.9 million, respectively. As of March 28, 2015, the net market value of the foreign exchange balance sheet derivative contracts was a net liability of $0.4 million. As of March 29, 2014, the net market value of the foreign exchange balance sheet derivative contracts was a net asset of $0.1 million.

The net gains (losses) recognized in the Consolidated Statements of Income on foreign exchange balance sheet derivative contracts for the three and six months ended March 28, 2015 and March 29, 2014 were as follows:
                         
    Three Months Ended     Six Months Ended  
   
March 28,
   
March 29,
   
March 28,
   
March 29,
 
   
2015
   
2014
   
2015
   
2014
 
 
(in thousands)
 
Net gain (loss) recognized in Other expense, net
  $ 535     $ (143 )   $ 873     $ (283 )
 
10. Fair Value Measurements

In determining the fair value of financial assets and liabilities, the Company currently utilizes market data or other assumptions that it believes market participants would use in pricing the asset or liability in the principal or most advantageous market, and adjusts for non-performance and/or other risk associated with the Company as well as counterparties, as appropriate. When considering market participant assumptions in fair value measurements, the following fair value hierarchy distinguishes between observable and unobservable inputs, which are categorized in one of the following levels:

 
Level 1 Inputs: Unadjusted quoted prices that are available in active markets for identical assets or liabilities accessible to the Company at the measurement date.
 
 
Level 2 Inputs: Inputs other than quoted prices included in Level 1 inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the asset or liability.
 
 
Level 3 Inputs: Unobservable inputs for the asset or liability used to measure fair value to the extent that observable inputs are not available, thereby allowing for situations in which there is little, if any, market activity for the asset or liability at the measurement date.
 
The hierarchy gives the highest priority to Level 1, because this level provides the most reliable measure of fair value, while giving the lowest priority to Level 3.

Financial Instruments Measured at Fair Value on a Recurring Basis
As of March 28, 2015 and September 27, 2014, financial assets and liabilities subject to fair value measurements on a recurring basis were as follows:
                         
    March 28, 2015  
   
Level 1
   
Level 2
   
Level 3
   
Total
 
Assets:
(in thousands)
 
Currency contracts(1)
  $     $ 1,736     $     $ 1,736  
Total assets
  $     $ 1,736     $     $ 1,736  
                                 
Liabilities:
                               
Currency contracts(1)
  $     $ 899     $     $ 899  
Total liabilities
  $     $ 899     $     $ 899  
 
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    September 27, 2014  
   
Level 1
   
Level 2
   
Level 3
   
Total
 
Assets:
(in thousands)
 
Currency contracts(1)
  $     $ 2,391     $     $ 2,391  
Total assets
  $     $ 2,391     $     $ 2,391  
                                 
Liabilities:
                               
Currency contracts(1)
  $     $ 178     $     $ 178  
Total liabilities
  $     $ 178     $     $ 178  

 
(1)
Based on observable market transactions of spot currency rates and forward currency rates on equivalently termed instruments.

Nonfinancial Assets Measured at Fair Value on a Nonrecurring Basis
The Company’s goodwill, intangible assets and other long-lived assets are nonfinancial assets that were acquired either as part of a business combination, individually or with a group of other assets. These nonfinancial assets were initially, and are currently, measured and recognized at amounts equal to the fair value determined as of the date of acquisition. Periodically, these nonfinancial assets are tested for impairment, by comparing their respective carrying values to the estimated fair value of the reporting unit or asset group in which they reside. In the event any of these nonfinancial assets were to become impaired, the Company would recognize an impairment loss equal to the amount by which the carrying value of the reporting unit, impaired asset or asset group exceeds its estimated fair value.

Fair value measurements of reporting units are estimated using an income approach involving discounted or undiscounted cash flow models that contain certain Level 3 inputs requiring management judgment, including projections of economic conditions and customer demand, revenue and margins, changes in competition, operating costs, working capital requirements, and new product introductions. Fair value measurements of the reporting units associated with the Company’s goodwill balances are estimated at least annually in the fourth quarter of each fiscal year for purposes of impairment testing. Fair value measurements associated with the Company’s intangible assets and other long-lived assets are estimated when events or changes in circumstances such as market value, asset utilization, physical change, legal factors, or other matters indicate that the carrying value may not be recoverable.

Financial Instruments not Measured at Fair Value
Certain of the Company’s financial instruments are not measured at fair value but nevertheless are recorded at carrying amounts approximating fair value, based on their short-term nature or variable interest rate. These financial instruments include cash and cash equivalents, accounts receivable, accounts payable and short-term borrowings.

11. Other Comprehensive Income

Other Comprehensive Income, a component of Shareholders’ Equity, consists of foreign currency translation adjustments, gains or losses on derivative instruments, and defined benefit pension plan adjustments.
 
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Income tax expense or benefit allocated to each component of Other Comprehensive Income for the three and six months ended March 28, 2015 and March 29, 2014 was as follows:
                                     
    March 28, 2015  
   
Three Months Ended
   
Six Months Ended
 
         
Tax
   
Net of
             
Net of
 
   
Pretax
   
(Expense)
   
Tax
   
Pretax
   
Tax
   
Tax
 
   
Amount
   
or Benefit
   
Amount
   
Amount
   
Expense
   
Amount
 
 
(in thousands)
 
Foreign currency translation adjustments
  $ (6,338 )   $ -     $ (6,338 )   $ (11,150 )   $ -     $ (11,150 )
Derivative instruments:
                                               
Unrealized net gain
    869       (316 )     553       3,131       (1,134 )     1,997  
Net gain reclassified to earnings
    (1,095 )     398       (697 )     (2,793 )     1,014       (1,779 )
Defined benefit pension plan:
                                               
Unrealized net gain
    1,290       (389 )     901       1,843       (556 )     1,287  
Net loss reclassified to earnings
    123       (37 )     86       259       (78 )     181  
Currency exchange rate change
    640       -       640       958       -       958  
Other comprehensive loss
  $ (4,511 )   $ (344 )   $ (4,855 )   $ (7,752 )   $ (754 )   $ (8,506 )
 
                                     
    March 29, 2014  
   
Three Months Ended
   
Six Months Ended
 
         
Tax
   
Net of
         
Tax
   
Net of
 
   
Pretax
   
(Expense)
   
Tax
   
Pretax
   
(Expense)
   
Tax
 
   
Amount
   
or Benefit
   
Amount
   
Amount
   
or Benefit
   
Amount
 
 
(in thousands)
 
Foreign currency translation adjustments
  $ (1,029 )   $ -     $ (1,029 )   $ (69 )   $ -     $ (69 )
Derivative instruments:
                                               
Unrealized net loss
    (190 )     69       (121 )     (149 )     55       (94 )
Net gain reclassified to earnings
    (1,163 )     426       (737 )     (660 )     242       (418 )
Defined benefit pension plan:
                                               
Unrealized net (loss) gain
    (17 )     5       (12 )     603       (182 )     421  
Net loss reclassified to earnings
    117       (35 )     82       233       (70 )     163  
Currency exchange rate change
    11       -       11       (75 )     -       (75 )
Other comprehensive loss
  $ (2,271 )   $ 465     $ (1,806 )   $ (117 )   $ 45     $ (72 )
 
The changes in the net-of-tax balances of each component of AOCI during the three and six months ended March 28, 2015 and March 29, 2014 were as follows:
                                                 
   
March 28, 2015
 
   
Three Months Ended
   
Six Months Ended
 
   
Foreign
   
Unrealized
   
Defined
         
Foreign
   
Unrealized
   
Defined
       
   
Currency
   
Gain (Loss)
   
Benefit
         
Currency
   
Gain (Loss)
   
Benefit
       
   
Translation
   
on Derivative
   
Pension Plan
         
Translation
   
on Derivative
   
Pension Plan
       
   
Adjustments
   
Instruments
   
Adjustments
   
Total
   
Adjustments
   
Instruments
   
Adjustments
   
Total
 
 
(in thousands)
 
Beginning balance
  $ 7,408     $ 1,260     $ (6,495 )   $ 2,173     $ 12,220     $ 898     $ (7,294 )   $ 5,824  
Other comprehensive income (loss) before reclassifications
    (6,338 )     553       1,541       (4,244 )     (11,150 )     1,997       2,245       (6,908 )
Amounts reclassified to earnings
    -       (697 )     86       (611 )     -       (1,779 )     181       (1,598 )
Other comprehensive income (loss)
    (6,338 )     (144 )     1,627       (4,855 )     (11,150 )     218       2,426       (8,506 )
Ending balance
  $ 1,070     $ 1,116     $ (4,868 )   $ (2,682 )   $ 1,070     $ 1,116     $ (4,868 )   $ (2,682 )
 
                                                 
   
March 29, 2014
 
   
Three Months Ended
   
Six Months Ended
 
   
Foreign
   
Unrealized
   
Defined
       
Foreign
   
Unrealized
   
Defined
     
   
Currency
   
Gain (Loss)
   
Benefit
       
Currency
   
Gain (Loss)
   
Benefit
     
   
Translation
   
Derivative
   
Pension Plan
       
Translation
   
on Derivative
   
Pension Plan
     
   
Adjustments
   
Instruments
   
Adjustments
   
Total
   
Adjustments
   
Instruments
   
Adjustments
   
Total
 
 
(in thousands)
 
Beginning balance
  $ 18,279     $ 823     $ (5,031 )   $ 14,071     $ 17,319     $ 477     $ (5,459 )   $ 12,337  
Other comprehensive income (loss) before reclassifications
    (1,029 )     (121 )     (1 )     (1,151 )     (69 )     (94 )     346       183  
Amounts reclassified to earnings
    -       (737 )     82       (655 )     -       (418 )     163       (255 )
Other comprehensive income (loss)
    (1,029 )     (858 )     81       (1,806 )     (69 )     (512 )     509       (72 )
Ending balance
  $ 17,250     $ (35 )   $ (4,950 )   $ 12,265     $ 17,250     $ (35 )   $ (4,950 )   $ 12,265  
 
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The effect on certain line items in the Consolidated Statements of Income of amounts reclassified out of AOCI for the three and six months ended March 28, 2015 and March 29, 2014 was as follows:

                             
     
Three Months Ended
   
Six Months Ended
 
Affected Line Item in the
   
March 28,
 
March 29,
 
March 28,
 
March 29,
 
Consolidated Statements
   
2015
 
2014
 
2015
 
2014
 
of Income
Derivative instruments:
(in thousands)
   
Currency exchange contracts
 
$
 1,095
 
$
 1,163
 
$
 2,793
 
$
 660
 
Revenue
Total net gains included in income before income taxes
   
 1,095
   
 1,163
   
 2,793
   
 660
   
Income tax expense
   
 (398)
   
 (426)
   
 (1,014)
   
 (242)
   
Total net gains included in net income
   
 697