10-Q 1 mts032234_10q.txt MTS SYSTEMS CORPORATION FORM 10Q -------------------------------------------------------------------------------- United States SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ----------------- FORM 10-Q [X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the Quarterly period ended March 29, 2003 or [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from __________________ to __________________ Commission File Number 0-2382 MTS SYSTEMS CORPORATION (Exact name of Registrant as specified in its charter) MINNESOTA 41-0908057 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 14000 Technology Drive, Eden Prairie, MN 55344 (Address of principal executive offices) (Zip Code) Registrant's telephone number: (952) 937-4000 Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. _X_ Yes ___ No Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act): _X_ Yes ___ No The number of shares outstanding of the Registrant's common stock as of May 8, 2003 was 20,950,274 shares. MTS SYSTEMS CORPORATION REPORT ON FORM 10-Q FOR THE THREE AND SIX MONTHS ENDED MARCH 29, 2003 INDEX Page No. -------- PART I - FINANCIAL INFORMATION Item 1. Financial Statements (unaudited) Consolidated Balance Sheets As of March 29, 2003 and September 28, 2002 2 Consolidated Statements of Income For the Three and Six Months Ended March 29, 2003 and March 31, 2002 3 Consolidated Statements of Cash Flows For the Six Months Ended March 29, 2003 and March 31, 2002 4 Condensed Notes to Consolidated Financial Statements 5 - 11 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11 - 17 Item 3. Quantitative and Qualitative Disclosures About Market Risk 17 Item 4. Controls and Procedures 18 PART II - OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security Holders 19 Item 6. Exhibits and Reports on Form 8-K 19 SIGNATURES 20 CERTIFICATIONS 20 - 21 1 PART 1 - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS MTS SYSTEMS CORPORATION Consolidated Balance Sheets (unaudited - in thousands of dollars, except share data)
March 29, September 28, ASSETS 2003 2002 --------- --------- Current Assets: Cash and cash equivalents $ 59,228 $ 62,456 Short-term investments 53,997 35,094 Accounts receivable, net of allowance for doubtful accounts 55,844 59,943 Unbilled contracts and retainage receivable 29,813 32,276 Inventories 29,978 34,773 Prepaid expense 5,280 5,380 Current deferred tax asset 8,739 8,739 Other current assets 1,147 19 Assets of discontinued operations 13,458 15,311 --------- --------- Total current assets 257,484 253,991 --------- --------- Property and Equipment: Land 3,247 3,247 Buildings and improvements 46,009 44,723 Machinery and equipment 83,298 79,679 Accumulated depreciation (75,657) (70,765) --------- --------- Total property and equipment, net 56,897 56,884 --------- --------- Goodwill 4,329 4,268 Other assets 2,729 3,363 Non-current deferred tax asset 1,593 1,593 --------- --------- $ 323,032 $ 320,099 ========= ========= LIABILITIES AND SHAREHOLDERS' INVESTMENT Current Liabilities: Notes payable to banks $ 198 $ 598 Current maturities of long-term debt 6,828 8,605 Accounts payable 12,051 13,137 Accrued payroll-related costs 27,445 26,112 Advance payments from customers 43,376 37,209 Accrued warranty costs 5,035 4,482 Accrued income taxes 6,135 11,120 Other accrued liabilities 10,029 9,917 Liabilities of discontinued operations 3,789 1,795 --------- --------- Total current liabilities 114,886 112,975 --------- --------- Deferred income taxes 1,740 1,519 Long-term debt, less current maturities 36,325 42,790 Other long-term liabilities 584 550 --------- --------- Total liabilities 153,535 157,834 --------- --------- Shareholders' Investment: Common stock, $.25 par; 64,000,000 shares authorized: 21,072,000 and 21,208,000 shares issued and outstanding 5,268 5,302 Additional paid-in capital 8,101 9,770 Retained earnings 153,780 146,857 Accumulated other comprehensive income 2,348 336 --------- --------- Total shareholders' investment 169,497 162,265 --------- --------- $ 323,032 $ 320,099 ========= =========
The accompanying notes to consolidated financial statements are an integral part of these statements. 2
For The Three Months Ended For The Six Months Ended March 29, March 31, March 29, March 31, 2003 2002 2003 2002 --------- --------- --------- --------- Revenue $ 93,236 $ 84,665 $ 177,675 $ 164,263 Cost of sales 59,916 52,215 113,049 101,197 --------- --------- --------- --------- Gross profit 33,320 32,450 64,626 63,066 --------- --------- --------- --------- Operating expenses: Selling 13,817 12,694 26,352 25,873 General and administrative 7,290 5,874 13,441 12,202 Research and development 4,044 4,435 7,623 8,573 --------- --------- --------- --------- Total operating expenses 25,151 23,003 47,416 46,648 --------- --------- --------- --------- Income from continuing operations 8,169 9,447 17,210 16,418 Interest expense 949 995 1,993 2,102 Interest income (617) (168) (1,104) (305) Gain on sale of investments -- (2,630) -- (2,630) Other income, net (1,729) (435) (1,712) (1,698) --------- --------- --------- --------- Income before income taxes, discontinued operations, and cumulative effect of accounting change 9,566 11,685 18,033 18,949 Provision for income taxes 3,184 3,914 5,951 6,292 --------- --------- --------- --------- Income before discontinued operations and cumulative effect of accounting change 6,382 7,771 12,082 12,657 --------- --------- --------- --------- Discontinued operations: Loss from discontinued operations, net of tax (17) (2,608) (220) (3,781) Impairment on discontinued operations, net of tax (2,402) -- (2,402) -- Cumulative effect of accounting change, net of tax -- -- -- (9,198) --------- --------- --------- --------- Loss from discontinued operations, net of tax (2,419) (2,608) (2,622) (12,979) --------- --------- --------- --------- Income (loss) before cumulative effect of accounting change on continuing operations 3,963 5,163 9,460 (322) Cumulative effect of accounting change on continuing operations, net of tax -- -- -- (4,523) --------- --------- --------- --------- Net income (loss) $ 3,963 $ 5,163 $ 9,460 $ (4,845) ========= ========= ========= ========= Earnings per share: Basic - Income before discontinued operations and cumulative effect of accounting change $ 0.30 $ 0.37 $ 0.57 $ 0.60 Discontinued operations: Loss from discontinued operations, net of tax 0.00 (0.12) (0.01) (0.18) Impairment on discontinued operations, net of tax (0.11) -- (0.11) -- Cumulative effect of accounting change, net of tax -- -- -- (0.44) --------- --------- --------- --------- Loss from discontinued operations, net of tax (0.11) (0.12) (0.12) (0.62) --------- --------- --------- --------- Income (loss) before cumulative effect of accounting change on continuing operations 0.19 0.25 0.45 (0.02) Cumulative effect of accounting change, net of tax -- -- -- (0.21) --------- --------- --------- --------- Earnings (loss) per share $ 0.19 $ 0.25 $ 0.45 $ (0.23) ========= ========= ========= ========= Weighted average number of common shares outstanding - basic 21,112 21,057 21,122 21,042 ========= ========= ========= ========= Diluted - Income before discontinued operations and cumulative effect of accounting change $ 0.30 $ 0.36 $ 0.56 $ 0.59 Discontinued operations: Loss from discontinued operations, net of tax 0.00 (0.12) (0.01) (0.18) Impairment on discontinued operations, net of tax (0.11) -- (0.11) -- Cumulative effect of accounting change, net of tax -- -- -- (0.43) --------- --------- --------- --------- Loss from discontinued operations, net of tax (0.11) (0.12) (0.12) (0.61) --------- --------- --------- --------- Income (loss) before cumulative effect of accounting change on continuing operations 0.19 0.24 0.44 (0.02) Cumulative effect of accounting change, net of tax -- -- -- (0.21) --------- --------- --------- --------- Earnings (loss) per share $ 0.19 $ 0.24 $ 0.44 $ (0.23) ========= ========= ========= ========= Weighted average number of common shares outstanding - diluted 21,404 21,336 21,379 21,367 ========= ========= ========= =========
The accompanying notes to consolidated financial statements are an integral part of these statements. 3 MTS SYSTEMS CORPORATION Consolidated Statements of Cash Flows (unaudited - in thousands of dollars)
Six Months Ended --------------------- March 29, March 31, 2003 2002 -------- -------- Cash flows from operating activities: Net income (loss) $ 9,460 $ (4,845) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Non-cash cumulative effect of accounting change on continuing operations -- 4,523 Non-cash cumulative effect of accounting change on discontinued operations -- 9,198 Loss on discontinued operations 220 3,781 Impairment on discontinued operations 2,402 -- Gain on sale of investment -- (2,630) Depreciation and amortization 4,736 5,318 Deferred income taxes 70 134 Bad debt provision 151 290 Inventory provision 783 1,318 Changes in operating assets and liabilities, net of effects of businesses divested: Accounts, unbilled contracts and retainage receivables 8,758 22,498 Inventories 5,706 7,899 Prepaid expenses (236) (2,316) Other assets (1,187) (983) Accounts payable (1,276) 963 Accrued compensation and benefits 3,025 (9,370) Advance billings to customers 4,996 (4,181) Accrued warranty costs 448 277 Other liabilities (8,515) 1,614 -------- -------- Net cash provided by continuing operating activities 29,541 33,488 -------- -------- Cash flows from investing activities: Additions to property and equipment (3,425) (1,475) Proceeds from maturity of short-term investments 20,594 -- Proceeds from sale of short-term investments -- 4,920 Proceeds from sale of businesses 550 -- Purchases of short-term investments (39,497) -- -------- -------- Net cash (used in) provided by investing activities (21,778) 3,445 -------- -------- Cash flows from financing activities: Net repayments under notes payable to banks (418) -- Payments of long-term debt (8,774) (217) Cash dividends (2,540) (2,530) Proceeds from exercise of stock options 822 639 Payment to purchase and retire common stock (2,523) (816) -------- -------- Net cash used in financing activities (13,433) (2,924) -------- -------- Net cash provided by discontinued operations 1,008 3,045 Effect of exchange rate on changes in cash 1,434 (463) -------- -------- Net (decrease) increase in cash and cash equivalents (3,228) 36,591 Cash and cash equivalent, at beginning of period 62,456 17,336 -------- -------- Cash and cash equivalent, at end of period $ 59,228 $ 53,927 ======== ======== Supplemental disclosure of cash flow information: Cash paid during the period for - Interest expense $ 1,914 $ 1,615 Income taxes $ 10,576 $ 2,897 ======== ========
The accompanying notes to consolidated financial statements are an integral part of these statements. 4 MTS SYSTEMS CORPORATION CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) 1. BASIS OF PRESENTATION ------------------------ Accounting Policies ------------------- The consolidated financial statements include the accounts of MTS SYSTEMS CORPORATION and its wholly and majority owned subsidiaries (the "Company"). All significant intercompany balances and transactions have been eliminated. The interim consolidated financial statements included herein have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). The information furnished in these financial statements includes normal recurring adjustments and reflects all adjustments that are, in the opinion of management, necessary for a fair presentation of such financial statements. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. The accompanying financial statements of the Company should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company's 2002 Annual Report on Form 10-K filed with the SEC. Interim results of operations for the six-month period ended March 29, 2003 may not necessarily be indicative of the results to be expected for the full year. Certain prior year amounts included in the accompanying financial statements, including the impact of the Company's discontinued operations, have been reclassified to conform to the current year's presentation. Such reclassifications had no effect on the Company's previously reported financial position, net income or cash flows. The Company believes that of its significant accounting policies, the following are particularly important to the portrayal of the Company's results of operations and financial position and may require the application of a higher level of judgment by the Company's management, and as a result are subject to an inherent degree of uncertainty. Revenue Recognition ------------------- For orders that are manufactured and delivered in less than twelve months with routine installations and no special acceptance protocol, revenue is recognized when systems are shipped and title has passed to the customer, less the portion of related revenues associated with installation, which are deferred until customer acceptance. The remaining revenue on these contracts is recognized upon installation and customer acceptance. In cases where special acceptance protocols exist, the Company recognizes revenue upon the completion of installation and fulfillment of obligations specific to the terms of the customer's contract. Revenue on contracts requiring longer delivery periods (long-term contracts) is recognized using the percentage-of-completion method based on the cost incurred to date relative to estimated total cost of the contract. In most cases, orders with complex installations and/or unusual acceptance protocols involve long-term contracts for custom systems that follow the percentage-of-completion method of revenue recognition through customer acceptance. The Company enters into long-term contracts for customized equipment sold to its customers. Under the terms of such contracts, revenue recognized using the percentage-of-completion method may not be invoiced until completion of contractual milestones, upon shipment of the equipment, or upon installation and acceptance by the customer. Unbilled amounts for these contracts appear in the Consolidated Balance Sheets as Unbilled Contracts and Retainage Receivable. Revenue for services is recognized as the service is performed and ratably over a defined contractual period for service maintenance contracts. Short-Term Investments ---------------------- Short-term investments at March 29, 2003 consisted of highly liquid United States government obligations, certificates of deposit, and highly rated corporate bonds maturing in four to twelve months from the date of purchase. The Company classifies its debt securities as held-to-maturity. Held-to-maturity securities are carried at amortized cost, which approximates market value. There were no substantive unrealized gains or losses from the investment in held-to-maturity securities as of the quarter ended March 29, 2003. All investments in equity securities are classified as available-for-sale 5 CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) and are carried at fair value. Unrealized gains and losses are reported as a component of other comprehensive income. At March 29, 2003 the Company had no investments in equity securities. Inventories ----------- Inventories consist of material, labor and overhead costs and are stated at the lower of cost or market, determined under the first-in, first-out accounting method. Inventories as of March 29, 2003 and September 28, 2002, respectively, were as follows: March 29, 2003 September 28, 2002 -------------- ------------------ (in thousands of dollars) Customer projects in various stages of completion $ 6,229 $ 8,679 Components, assemblies and parts 23,749 26,094 ------- ------- Total $29,978 $34,773 ======= ======= 2. RECENTLY ISSUED ACCOUNTING STANDARDS --------------------------------------- In November 2002, the Emerging Issues Task Force ("EITF") finalized its tentative consensus on EITF Issue 00-21, "Revenue Arrangements with Multiple Deliverables," which provides guidance on the timing of revenue recognition for sales undertakings to deliver more than one product or service. The Company is required to adopt EITF 00-21 on transactions occurring after June 2003 and is currently analyzing the impact of its adoption on the Company's financial statements. In April 2003, the FASB issued Statement of Financial Accounting Standard ("SFAS") No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging," which amends and clarifies financial accounting and reporting for derivative instruments. The Company is required to adopt this statement for transactions occurring after June 2003 and is currently analyzing the impact of its adoption on the Company's financial statements. 3. DISCONTINUED OPERATIONS -------------------------- During the second quarter of fiscal year 2003, the Company decided to sell its Automation division, which was based in New Ulm, Minnesota and also maintained operations in Montgomeryville, Pennsylvania and Freiburg and Straslund, Germany. On March 31, 2003, the Company sold substantially all of the net assets associated with the Automation division's gradient amplifier product line to Performance Controls, Inc., an affiliate of Hitachi Medical Corporation, with certain of the intellectual property assets being sold to Hitachi Medical Corporation. On April 11, 2003, the Company sold all the remaining net assets of the North American Automation division, based in New Ulm, Minnesota, to Parker Hannifin Corporation ("Parker-Hannifin"). On April 30, 2003, the Company sold 100% of its stock in the Automation division's German operations also to Parker Hannifin, which completed the sale of the Company's entire Automation division and marked the Company's exit from the motor and amplifier business. As a result of the Company's decision to sell the Automation division, the characterization of the related assets changed from "held-for-use" to "held-for-sale" at March 29, 2003. In accordance with the requirements of SFAS 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," the Company was required to perform a valuation of the held-for-sale assets to determine whether these assets were impaired at March 29, 2003. Per SFAS 144, the anticipated selling price of the business was used as the basis for this valuation. As a result of the valuation, the Company recorded an impairment charge on discontinued operations of $2.4 million, net of taxes of $0.8 million, for the quarter ended March 29, 2003. This included a charge of $1.5 million related to impairment of the New Ulm and German assets and $0.9 million of closing-related expenses, net of taxes. The Automation division has historically been included in the Company's Factory Automation segment for financial reporting. Per SFAS 144, the Company has reported the results of the operations of the Automation division as discontinued operations at March 29, 2003. 6 CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) The following are the operating results of the discontinued operations:
Three Months Ended Six Months Ended March 29, 2003 March 31, 2002 March 29, 2003 March 31, 2002 -------------- -------------- -------------- -------------- (in thousands of dollars) (in thousands of dollars) Revenue $ 7,353 $ 7,410 $ 14,175 $ 14,976 Loss on discontinued operations before taxes, impairment charge, and cumulative effect of accounting change $ (15) $ (4,251) $ (344) $ (6,169)
The assets and liabilities of the Automation division at March 29, 2003 were as follows: Cash and cash equivalents $ 1,116 Accounts receivable, net of allowances for doubtful accounts 4,520 Inventories 4,848 Other current assets 126 -------- Current assets of discontinued operations 10,610 Buildings and improvements 1,569 Machinery and equipment 7,115 Accumulated depreciation (6,014) Other assets 2,580 Impairment charge (2,402) -------- Long-lived assets of discontinued operations 2,848 -------- Total assets of discontinued operations $ 13,458 ======== Accounts payable $ 1,363 Accrued payroll-related costs 608 Accrued warranty costs 675 Other accrued liabilities 1,025 -------- Current liabilities of discontinued operations 3,671 Other liabilities 118 -------- Total liabilities of discontinued operations $ 3,789 ======== 4. EARNINGS (LOSS) PER COMMON SHARE ----------------------------------- Basic net income (loss) per share is computed by dividing net income (loss) by the weighted average number of common shares outstanding during the applicable periods. Diluted net income (loss) per share is computed under the treasury stock method and is calculated to reflect the potentially dilutive effect of common shares issued in connection with outstanding stock options. A reconciliation of these amounts is as follows: 7 CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Three Months Ended Six Months Ended March 29, March 31, March 29, March 31, 2003 2002 2003 2002 -------- -------- -------- -------- (in thousands, except per share data) Income (loss) before cumulative effect of accounting change on continuing operations $ 3,963 $ 5,163 $ 9,460 $ (322) Cumulative effect of accounting change on continuing operations, net of tax -- -- -- (4,523) -------- -------- -------- -------- Net income (loss) $ 3,963 $ 5,163 $ 9,460 $ (4,845) ======== ======== ======== ======== Weighted average common shares outstanding 21,112 21,057 21,122 21,042 Diluted potential common shares 292 279 257 325 -------- -------- -------- -------- Total diluted common shares 21,404 21,336 21,379 21,367 Basic earnings (loss) per share $ 0.19 $ 0.25 $ 0.45 $ (0.23) Diluted earnings (loss) per share $ 0.19 $ 0.24 $ 0.44 $ (0.23) ======== ======== ======== ========
5. COMPREHENSIVE INCOME (LOSS) ------------------------------ Comprehensive income (loss) represents net earnings (loss) adjusted for foreign currency translation adjustments, the unrealized gain or loss on available-for-sale investments, and the net effect of accumulated hedging activity.
Three Months Ended Six Months Ended March 29, March 31, March 29, March 31, 2003 2002 2003 2002 -------- -------- -------- -------- (in thousands of dollars) (in thousands of dollars) Net income (loss) $ 3,963 $ 5,163 $ 9,460 $ (4,845) Change in cumulative translation adjustment 944 (303) 2,631 (2,435) Unrealized loss on derivative instruments (645) (1,190) (619) (361) Unrealized (loss)/gain on investments -- (255) -- 146 -------- -------- -------- -------- Comprehensive income (loss) $ 4,262 $ 3,415 $ 11,472 $ (7,495) ======== ======== ======== ========
6. BUSINESS SEGMENT INFORMATION ------------------------------- The Company's Chief Executive Officer regularly reviews the available financial information for five discrete business units: Vehicle Testing Systems, Material Testing Systems, Advanced Systems, Automation, and Sensors. The Vehicle Testing Systems unit manufactures and markets systems for vehicle and component manufacturers to aid in the acceleration of design development work and to decrease the cost of product manufacturing. The Material Testing Systems unit manufactures and markets systems to aid customers in product development and quality control toward an effort of design improvement. The Advanced Systems unit offers highly customized systems primarily for simulation and manufacturing. The Automation unit manufactures and markets products for high performance industrial machine applications in a wide range of industries. The Automation unit also includes the Company's AeroMet subsidiary, which develops a laser-additive manufacturing process for aerospace applications. The Sensors unit manufactures and markets displacement and liquid level sensors used in various applications to monitor and automate industrial processes. The economic characteristics, nature of products and services, production processes, type or class of customer served, method of distribution and regulatory environments are similar for the Vehicle Testing Systems, Material Testing Systems and Advanced Systems business units. As a result of these similarities, these units have been aggregated for financial statement purposes into one reportable segment called Mechanical Testing and Simulation ("MT&S"). In addition, the economic characteristics, nature of products and services, production processes, type or class of customer served, method of distribution and regulatory environments are similar for the Automation and Sensors business units. As a result, these units have been aggregated into one reportable segment called Factory Automation ("FA"). 8 CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) The accounting policies of the reportable segments are the same as those described in Note 1 to the Consolidated Financial Statements found in the Company's 2002 Form 10-K. In evaluating each segment's performance, management focuses on income from operations. This measurement excludes interest income and expense, income taxes and other non-operating items. Corporate expenses, including costs associated with various support functions such as human resources, information technology, finance and accounting, and general and administrative costs, are allocated to the reportable segments primarily on the basis of revenue. In accordance with the classification of the Automation division as a discontinued operation at March 29, 2003, financial information for the Factory Automation segment has been restated for fiscal years 2003 and 2002 to conform to the remaining businesses that represent the continuing operations of that segment. As a result, the Factory Automation segment data below includes the results of the Company's Sensors business unit and its AeroMet subsidiary. Financial information by reportable segment is as follows:
Three Months Ended Six Months Ended March 29, March 31, March 29, March 31, 2003 2002 2003 2002 -------- -------- -------- -------- (in thousands of dollars) REVENUE BY SEGMENT: Mechanical Testing and Simulation $ 80,804 $ 74,696 $154,757 $144,979 Factory Automation 12,432 9,969 22,918 19,284 -------- -------- -------- -------- Total revenue $ 93,236 $ 84,665 $177,675 $164,263 ======== ======== ======== ======== INCOME FROM CONTINUING OPERATIONS BY SEGMENT: Mechanical Testing and Simulation $ 7,310 $ 8,919 $ 15,710 $ 15,491 Factory Automation 859 528 1,500 927 -------- -------- -------- -------- Total income from continuing operations $ 8,169 $ 9,447 $ 17,210 $ 16,418 ======== ======== ======== ========
7. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES ------------------------------------------------ The Company periodically enters into forward exchange contracts principally to hedge the estimated cash flow of foreign currency denominated transactions (primarily the EURO, British Pound, Swedish Krona, and the Japanese Yen). These contracts are recognized on the balance sheet at fair value, which is the estimated amount at which they could be settled based on forward market exchange rates. The contracts generally mature within one year and are designed to limit exposure to exchange rate fluctuations. On the date the forward exchange contract is entered into, it is designated as a foreign currency cash flow hedge. Subsequent changes in the fair value of a contract that is highly effective and qualifies as a foreign currency cash flow hedge are recorded in other comprehensive income until they are recognized in earnings at the time the forecasted transaction occurs. The Company formally documents all relationships between hedging instruments and hedged items, as well as its risk management objective and strategy for undertaking various hedge transactions. This process includes linking all derivatives that are designated as foreign currency hedges to specific forecasted transactions. The Company formally assesses, both at the hedge's inception and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in cash flows of hedged items. When it is determined that a derivative is not highly effective as a hedge or that it has ceased to be a highly effective hedge, the Company discontinues hedge accounting prospectively, as discussed below. The Company discontinues hedge accounting prospectively when the derivative is (1) determined to be no longer effective in offsetting the fair value of the cash flows of a hedged item; (2) sold, terminated, or exercised; or (3) de-designated as a hedge instrument because it is unlikely that a forecasted transaction will occur. When hedge accounting is discontinued, the derivative will be carried at its fair value on the balance sheet with changes in its fair value recognized in current period earnings. Any related gains or losses that were accumulated in other comprehensive income will be recognized immediately in earnings. The Company uses forward exchange contracts to hedge specific foreign exchange currency denominated assets or liabilities on the balance sheet. These are recorded at their fair value with the related gains and losses included in "Other (income) expense, net" on the income statement. Results of these contracts offset in full or in part the gains and losses stemming from the normal mark-to-market of the underlying balance sheet exposures. The Company does not use derivative financial instruments for speculative or trading purposes. 9 CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) At March 29, 2003 and March 31, 2002, the Company had outstanding foreign currency forward contracts with U.S. dollar notional equivalent amounts of $32.8 million and $39.4 million respectively. At March 29, 2003 and March 31, 2002, the fair value of the foreign currency forward contracts was ($0.9) million and $2.2 million, respectively. The amount recognized in earnings as a result of the ineffectiveness of cash flow hedges was $0.1 million for the period ended March 29, 2003 and was negligible for the period ended March 31, 2002. At March 29, 2003, approximately ($0.7) million was projected to be reclassified from other comprehensive income into earnings in the next 12 months. At March 31, 2002, approximately $0.2 million was projected to be reclassified from other comprehensive income into earnings in the next 12 months. The maximum maturity of any derivative was 0.8 years at March 29, 2003 and 1.1 years at March 31, 2002. 8. DEFERRED TAX ASSET --------------------- At March 29, 2003, the Company had an aggregate deferred tax asset of $10.3 million in connection with accrued compensation and benefits, inventory reserves, and allowances for doubtful accounts and other assets. Management routinely performs an analysis of the realization of the deferred tax asset each fiscal year end. This analysis largely relies on continued long-term profitability. Unanticipated negative changes in future operations of the Company would adversely affect the realization of the Company's deferred tax asset. Such negative changes would result in the establishment of a valuation reserve for the deferred tax asset. 9. WARRANTY GUARANTEES ---------------------- Sales of the Company's products and systems are subject to limited warranty guarantees. For sales that include installation services, system guarantees typically extend for a period of twelve months from the date of either shipment or system acceptance. Product guarantees typically extend for a period of twenty-four months from the date of purchase. Standard warranty terms are included in customer contracts. Under the terms of these warranties, the Company is obligated to repair or replace any components or assemblies it deems defective due to workmanship or materials. The Company reserves the right to reject warranty claims where it determines that failure is due to normal wear, customer modifications, improper maintenance, or misuse. The Company records warranty provisions monthly based on an estimated warranty expense percentage applied to current period revenue. The percentage applied reflects historical warranty incidence over the preceding twelve-month period. Both the experience percentage and the warranty liability are evaluated on an ongoing basis for adequacy. Warranty provisions and claims for the periods ended March 29, 2003 and March 31, 2002 were as follows:
Three Months Ended Six Months Ended March 29, March 31, March 29, March 31, 2003 2002 2003 2002 ------- ------- ------- ------- (in thousands of dollars) Beginning Balance $ 5,071 $ 4,668 $ 4,482 $ 4,324 Warranty Provisions 1,527 1,162 3,011 2,478 Warranty Claims (1,642) (1,274) (2,595) (2,013) Translation 79 3 137 (230) ------- ------- ------- ------- Ending Balance $ 5,035 $ 4,559 $ 5,035 $ 4,559 ======= ======= ======= =======
10. STOCK OPTIONS As permitted by SFAS No. 123, "Accounting for Stock-Based Compensation," the Company has elected to continue to adopt the guidance of Accounting Principles Board ("APB") Opinion No. 25 for measurement and recognition of stock-based transactions with employees. No compensation expense has therefore been recognized in the financial statements for stock options granted to employees under the Company's stock option plans as the exercise price of all options granted is at least equal to the fair value of the underlying common stock at the dates of grant. Alternatively, if compensation expense for employee options granted under the plans had been determined based on the fair value at the grant dates, consistent with the methods provided in SFAS No. 123, the Company's net earnings and earnings per share would have been as follows: 10 CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Three Months Ended Six Months Ended March 29, March 31, March 29, March 31, 2003 2002 2003 2002 --------- --------- --------- --------- (in thousands of dollars) Net income (loss) as reported $ 3,963 $ 5,163 $ 9,460 $ (4,845) Less employee stock-based compensation (637) (667) (1,298) (1,343) --------- --------- --------- --------- Pro forma net income (loss) $ 3,326 $ 4,496 $ 8,162 $ (6,188) ========= ========= ========= ========= Earnings (loss) per share - Basic: As reported $ 0.19 $ 0.25 $ 0.45 $ (0.23) Less employee stock-based compensation (0.03) (0.03) (0.06) (0.06) --------- --------- --------- --------- Pro forma earnings (loss) per share $ 0.16 $ 0.22 $ 0.39 $ (0.29) --------- --------- --------- --------- Earnings (loss) per share - Diluted: As reported $ 0.19 $ 0.24 $ 0.44 $ (0.23) Less employee stock-based compensation (0.03) (0.03) (0.06) (0.06) --------- --------- --------- --------- Pro forma earnings (loss) per share $ 0.16 $ 0.21 $ 0.38 $ (0.29) ========= ========= ========= =========
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CRITICAL ACCOUNTING POLICIES ---------------------------- The consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America, which require the Company to make estimates and assumptions in certain circumstances that affect amounts reported. In preparing these financial statements, management has made its best estimates and judgments of certain amounts, giving due consideration to materiality. The Company believes that of its significant accounting policies, the following are particularly important to the portrayal of the Company's results of operations and financial position and may require the application of a higher level of judgment by the Company's management, and as a result are subject to an inherent degree of uncertainty. Revenue Recognition. For orders that are manufactured and delivered in less than twelve months with routine installations and no special acceptance protocol, revenue is recognized when systems are shipped and title has passed to the customer, less the portion of related revenues associated with installation, which are deferred until customer acceptance. The remaining revenue on these contracts is recognized upon installation and customer acceptance. In cases where special acceptance protocols exist, the Company recognizes revenue upon the completion of installation and fulfillment of obligations specific to the terms of the customer's contract. Revenue on contracts requiring longer delivery periods (long-term contracts) is recognized using the percentage-of-completion method based on the cost incurred to date relative to the estimated total cost of the contract. In most cases, orders with complex installations and/or unusual acceptance protocols involve long-term contracts for custom systems that follow the percentage-of-completion method of revenue recognition through customer acceptance. The Company enters into long-term contracts for customized equipment sold to its customers. Under the terms of such contracts, revenue recognized using the percentage-of-completion method may not be invoiced until completion of contractual milestones, upon shipment of the equipment, or upon installation and acceptance by the customer. Unbilled amounts for these contracts appear in the Consolidated Balance Sheets as Unbilled Contracts and Retainage Receivable. Revenue for services is recognized as the service is performed and ratably over a defined contractual period for service maintenance contracts. Inventories. Inventories consist of material, labor and overhead costs and are stated at the lower of cost or market, determined under the first-in, first-out accounting method. Reserves for slow-moving and obsolete inventories are provided based upon current and expected future product sales and the expected impact of product transitions or 11 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) modifications. While the Company expects its sales to grow, a reduction in its sales could reduce the demand for the Company's products, and additional inventory reserves may be required. Short-term investments at March 29, 2003 consisted of highly liquid United States government obligations, certificates of deposit, and highly rated corporate bonds maturing in four to twelve months from the date of purchase. The Company classifies its debt securities as held-to-maturity. Held-to-maturity securities are carried at amortized cost, which approximates market value. There were no substantive unrealized gains or losses from the investment in held-to-maturity securities as of the quarter ended March 29, 2003. All investments in equity securities are classified as available-for-sale and are carried at fair value. Unrealized gains and losses are reported as a component of other comprehensive income. At March 29, 2003 the Company had no investments in equity securities. RECENTLY ISSUED ACCOUNTING STANDARDS ------------------------------------ In November 2002, the Emerging Issues Task Force finalized its tentative consensus on EITF Issue 00-21, "Revenue Arrangements with Multiple Deliverables," which provides guidance on the timing of revenue recognition for sales undertakings to deliver more than one product or service. The Company is required to adopt EITF 00-21 on transactions occurring after June 2003 and is currently analyzing the impact of its adoption on the Company's financial statements. In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging," which amends and clarifies financial accounting and reporting for derivative instruments. The Company is required to adopt this statement for transactions occurring after June 2003 and is currently analyzing the impact of its adoption on the Company's financial statements. RESULTS OF DISCONTINUED OPERATIONS During the second quarter of fiscal year 2003, the Company decided to sell its Automation division, which was based in New Ulm, Minnesota and also maintained operations in Montgomeryville, Pennsylvania and Freiburg and Straslund, Germany. On March 31, 2003, the Company sold substantially all of the net assets associated with the Automation division's gradient amplifier product line to Performance Controls, Inc., an affiliate of Hitachi Medical Corporation, with certain of the intellectual property assets being sold to Hitachi Medical Corporation. On April 11, 2003, the Company sold all the remaining net assets of the North American Automation division, based in New Ulm, Minnesota, to Parker Hannifin Corporation ("Parker-Hannifin"). On April 30, 2003, the Company sold 100% of its stock in the Automation division's German operations also to Parker Hannifin, which completed the sale of the Company's entire Automation division and marked the Company's exit from the motor and amplifier business. As a result of the Company's decision to sell the Automation division, the characterization of the related assets changed from "held-for-use" to "held-for-sale" at March 29, 2003. In accordance with the requirements of SFAS 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," the Company was required to perform a valuation of the held-for-sale assets to determine whether these assets were impaired at March 29, 2003. Per SFAS 144, the anticipated selling price of the business was used as the basis for this valuation. As a result of the valuation, the Company recorded an impairment charge on discontinued operations of $2.4 million, net of taxes of $0.8 million, for the quarter ended March 29, 2003. This included a charge of $1.5 million related to impairment of the New Ulm and German assets and $0.9 million of closing-related expenses, net of taxes. The Automation division has historically been included in the Company's Factory Automation segment for financial reporting. Per SFAS 144, the Company has reported the results of the operations of the Automation division as discontinued operations at March 29, 2003. The discontinued operations of the Automation division reported essentially break-even results, before impairment charge, for the quarter ended March 29, 2003, compared to a loss of $2.6 million for the same period in the prior year. This improvement is primarily the result of charges for obsolete and surplus inventory of approximately $1.9 million, net of taxes, recorded during the three months ended March 31, 2002. Net loss before impairment charges and the cumulative effect of accounting change for the discontinued operation for the six months ended March 29, 2003 was $0.2 million, compared to a net loss of $3.8 million for the same period in the prior year. The decrease in net loss was primarily the result of obsolete and surplus inventory charges of approximately $2.7 million, net of taxes, recorded during the prior year period. Also during the prior year period the Company recorded a non-cash transition charge to income of $9.2 million, net of taxes, related to the adoption of SFAS 142, "Goodwill and Other Intangible Assets." 12 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) RESULTS OF CONTINUING OPERATIONS NEW CUSTOMER ORDERS AND BACKLOG ------------------------------- THREE MONTHS ENDED MARCH 29, 2003 ("SECOND QUARTER OF FISCAL 2003") COMPARED TO THREE MONTHS ENDED MARCH 31, 2002 ("SECOND QUARTER OF FISCAL 2002") New orders from customers during Second Quarter of Fiscal 2003 aggregated $78.8 million, a decrease of 3.8% compared to customer orders of $81.9 million booked during Second Quarter of Fiscal 2002. Orders for the Mechanical Testing and Simulation ("MT&S") segment decreased 9.4% to $65.7 million, compared to customer orders of $72.5 million for Second Quarter of Fiscal 2002, primarily due to continued weakness in global automotive and industrial markets. The MT&S segment accounted for 83.4% of total Company orders for Second Quarter of Fiscal 2003, compared to 88.5% for the Second Quarter of Fiscal 2002. Orders for the Factory Automation ("FA") segment increased 39.4% to $13.1 million for Second Quarter of Fiscal 2003, from $9.4 million for Second Quarter of Fiscal 2002. The Company's AeroMet business was awarded a $1.5 million development contract from the U.S. government, and orders in the Sensors business improved due to increased demand in Europe and Japan. The FA segment accounted for 16.6% of total Company orders during Second Quarter of Fiscal 2003, compared to 11.5% in Second Quarter of Fiscal 2002. SIX MONTHS ENDED MARCH 29, 2003 ("FIRST HALF OF FISCAL 2003") COMPARED TO SIX MONTHS ENDED MARCH 31, 2002 ("FIRST HALF OF FISCAL 2002") New orders for the First Half of Fiscal 2003 aggregated $154.3 million, a decrease of 11.1% compared to orders of $173.5 million for the First Half of Fiscal 2002. Orders for the MT&S segment of $131.0 million in First Half of Fiscal 2003 decreased approximately 15.0% compared to $154.2 million in the First Half of Fiscal 2002. The decrease was primarily due to the impact of a $13 million aerospace order booked in the First Half of Fiscal 2002 and continuing weakness in the global automotive and industrial markets. This segment accounted for 84.9% of total new orders in First Half of Fiscal 2003, compared to 88.9% for First Half of Fiscal 2002. Orders for the FA segment of $23.3 million in First Half of Fiscal 2003 increased 20.7% from orders of $19.3 million booked in First Half of Fiscal 2002. This increase was largely due to a $1.5 million U.S. government contract awarded to the AeroMet business and strong demand in Europe and Japan related to the Sensors business. The FA segment accounted for 15.1% of total orders during First Half of 2003 compared to 11.1% in First Half of Fiscal 2002. Backlog of undelivered orders at March 29, 2003 was $148.2 million, a decrease of 12.8% from backlog of $170.0 million at September 28, 2002 and a decrease of 3.4% from backlog of $153.4 million at March 31, 2002. The Company's backlog is subject to order cancellations. RESULTS OF CONTINUING OPERATIONS -------------------------------- SECOND QUARTER OF FISCAL 2003 COMPARED TO SECOND QUARTER OF FISCAL 2002 REVENUE for Second Quarter of Fiscal 2003 was $93.2 million, an increase of $8.5 million, or 10.0%, compared to revenue of $84.7 million for the Second Quarter of Fiscal 2002. The increase was primarily due to a higher backlog position at the end of fiscal year 2002 and an increase in booking and shipment of short-cycle orders. Revenue from European and Asian markets for Second Quarter of Fiscal 2003 represented 56.4% of total revenues, compared to 54.2% for Second Quarter of Fiscal 2002. GROSS PROFIT for Second Quarter of Fiscal 2003 increased to $33.3 million, up 2.5% compared to gross profit of $32.5 million for Second Quarter of Fiscal 2002. Gross profit as a percentage of revenue was 35.7% for Second Quarter of Fiscal 2003, down from 38.4% reported for Second Quarter of Fiscal 2002. The gross margin rate for the MT&S segment was 34.4% for Second Quarter of Fiscal 2003, down 2.6 percentage points compared to Second Quarter of 13 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) RESULTS OF CONTINUING OPERATIONS (CONTINUED) -------------------------------------------- Fiscal 2002, primarily due to unfavorable product mix in the quarter. Gross profit as a percentage of revenue for the FA segment was 44.3% for Second Quarter of Fiscal 2003, compared to 47.7% for the Second Quarter of Fiscal 2002. The decrease was primarily the result of favorable product mix in the prior year period and one-time costs associated with a canceled contract in Second Quarter of Fiscal 2003. SELLING EXPENSES were $13.8 million for Second Quarter of Fiscal 2003, an increase of 8.7% from $12.7 million for Second Quarter of Fiscal 2002, primarily due to an increase in sales volume for the quarter. Selling expense as a percentage of revenue was relatively flat at 14.8% for Second Quarter of Fiscal 2003 compared to selling expense of 15.0% for Second Quarter of Fiscal 2002. GENERAL AND ADMINISTRATIVE EXPENSES totaled $7.3 million for Second Quarter of Fiscal 2003, an increase of 23.7% compared to $5.9 million for Second Quarter of Fiscal 2002. General and administrative expenses as a percentage of net revenue increased by 0.8 percentage points from 7.0% for Second Quarter of Fiscal 2002 to 7.8% for Second Quarter of Fiscal 2003. The increase is largely due to higher projected incentive compensation payments in fiscal year 2003 compared to fiscal year 2002. RESEARCH AND DEVELOPMENT EXPENSES totaled $4.0 million for the Second Quarter of 2003, a decrease of 9.1% compared to $4.4 million for the Second Quarter of Fiscal 2002. Research and development expenses as a percentage of net revenue were 4.3% for Second Quarter of Fiscal 2003 compared to 5.2% for the Second Quarter of Fiscal 2002. The decrease was primarily due to product rationalization efforts implemented by the Company during fiscal year 2003. INCOME FROM CONTINUING OPERATIONS decreased 12.8%, from $9.4 million in Second Quarter of Fiscal 2002 to $8.2 million in the Second Quarter of Fiscal 2003. Operating earnings in the MT&S segment decreased from $8.9 million to $7.2 million. This decrease was offset by a $0.3 million improvement in the operating earnings of the FA segment. INTEREST EXPENSE decreased to $0.9 million for Second Quarter of Fiscal 2003 compared to $1.0 million for the Second Quarter of Fiscal 2002. This decrease was the result of a reduction in long-term debt. Interest expense as a percentage of net revenue decreased to 1.0% for Second Quarter of Fiscal 2003, compared to 1.2% for Second Quarter of Fiscal 2002. INTEREST INCOME increased to $0.6 million for Second Quarter of Fiscal 2003 compared to $0.2 million for Second Quarter of Fiscal 2002, primarily due to an increase in the Company's holdings of short-term investments. GAIN ON SALE OF INVESTMENTS during the second quarter of Fiscal 2002 resulted from the Company's sale of an equity investment in Mechanical Dynamics Inc. The Company sold securities and recorded proceeds from the sale of $4.9 million, which produced a gain on sale of $2.6 million. The investment sold represented the entire amount of the Company's holdings. OTHER INCOME AND EXPENSE for Second Quarter of Fiscal 2003 primarily reflects a non-recurring gain of $1.3 million due to proceeds from penalties associated with a canceled customer contract. NET INCOME decreased to $6.4 million for Second Quarter of Fiscal 2003 compared to net income of $7.8 million for Second Quarter of Fiscal 2002. Net income as a percentage of revenue decreased to 6.8% for Second Quarter of Fiscal 2003, compared to 9.2% for Second Quarter of Fiscal 2002. The effective tax rate for Second Quarter of Fiscal 2003 was 33.3%; approximately flat with a tax rate of 33.5% for Second Quarter of Fiscal 2002. FIRST HALF OF FISCAL 2003 COMPARED TO FIRST HALF OF FISCAL 2002 --------------------------------------------------------------- REVENUE for First Half of Fiscal 2003 was $177.7 million, an increase of $13.4 million, or 8.2%, compared to $164.3 million in the First Half of Fiscal 2002. The increase was primarily due to a higher backlog position at the end of Fiscal 2002 than fiscal 2001 and an increase in booking and shipment of short-cycle orders. Revenue from European and Asian markets for First Half of Fiscal 2003 represented 51.9% of revenues, compared to 54.5% of revenues for First Half of Fiscal 2002. Revenue generated by the MT&S segment was $154.8 million during the First Half of 2003, an increase of $9.8 million compared to First Half of Fiscal 2002. The FA segment revenue increased to $22.9 million for the First Half of Fiscal 2003, compared to $19.3 million for First Half of Fiscal 2002. 14 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) RESULTS OF CONTINUING OPERATIONS (CONTINUED) -------------------------------- GROSS PROFIT for First Half of Fiscal 2003 increased to $64.6 million, up 2.4% compared to gross profit of $63.1 million for First Half of Fiscal 2002. The fluctuation in margin was primarily due to higher revenue volume. Gross profit as a percentage of net revenue was 36.4% for First Half of Fiscal 2003 compared to 38.4% reported for First Half of Fiscal 2002. The decrease is primarily the result of favorable product mix in the prior year. SELLING EXPENSES increased to $26.4 million in First Half of Fiscal 2003 compared to $25.9 million for First Half of Fiscal 2002, due to higher revenue volume. Selling expense as a percentage of net revenue decreased to 14.9% in First Half of Fiscal 2003 compared to 15.8% for First Half of Fiscal 2002, primarily due to cost reduction initiatives that were implemented throughout fiscal year 2002. GENERAL AND ADMINISTRATIVE EXPENSES totaled $13.4 million for First Half of Fiscal 2003, an increase of 9.8% compared to $12.2 million for First Half of Fiscal 2002. General and administrative expenses as a percentage of revenue increased only slightly from 7.4% in First Half of Fiscal 2002 to 7.5% in First Half of Fiscal 2003. RESEARCH AND DEVELOPMENT EXPENSES decreased to $7.6 million in First Half of Fiscal 2003 compared to $8.6 million in First Half of Fiscal 2002. Research and development expense as a percentage of revenue declined to 4.3% in First Half of Fiscal 2003 compared to 5.2% in First Half of Fiscal 2002, primarily due to product rationalization efforts implemented by the Company during the First Half of Fiscal 2003. INCOME FROM CONTINUING OPERATIONS increased by 4.9%, from $16.4 million in First Half of Fiscal 2002 to $17.2 million in First Half of Fiscal 2003. Operating earnings increased slightly in the MT&S segment, from $15.5 million to $15.7 million, and operating earnings of the FA segment increased $0.6 million from First Half of Fiscal 2003. INTEREST EXPENSE remained roughly flat at $2.0 million in First Half of Fiscal 2003 compared to $2.1 million in First Half of Fiscal 2002. Interest expense as a percentage of revenue decreased by 0.2 percentage points, to 1.1% for First Half of Fiscal 2003. INTEREST INCOME increased $0.8 million to $1.1 million for First Half of Fiscal 2003, primarily due to an increase in short-term investments. Interest income as a percentage of revenue increased from 0.4% to 0.6%. GAIN ON SALE OF INVESTMENTS during the First Half of Fiscal 2002 resulted from the Company's sale of an equity investment in Mechanical Dynamics Inc. The Company sold securities and recorded proceeds from the sale of $4.9 million, which produced a gain on sale of $2.6 million. The investment sold represented the entire amount of the Company's holdings. OTHER INCOME AND EXPENSE was $1.7 million in First Half of Fiscal 2003, flat with other income of $1.7 million in First Half of Fiscal 2002. Other income in First Half of Fiscal 2003 primarily reflects a one-time gain of $1.3 million from proceeds from penalties associated with a cancelled customer contract. Other income in First Half of Fiscal 2002 consisted primarily of a gain on foreign currency transactions of $1.6 million. CUMULATIVE EFFECT OF ACCOUNTING CHANGE, NET OF TAXES for First Half of Fiscal 2002 reflects a non-cash transition charge to income related to the adoption of SFAS 142, "Goodwill and Other Intangible Assets." NET INCOME BEFORE DISCONTINUED OPERATIONS INCLUDING CUMULATIVE EFFECT OF ACCOUNTING CHANGE was $12.1 million for First Half of Fiscal 2003 compared to net income of $8.1 million for First Half of Fiscal 2002. This increase is primarily the result of adoption of SFAS 142 in fiscal year 2002 and the related cumulative effect, which resulted in a $4.5 million charge, net of taxes. Before the cumulative effect of accounting change, net income decreased $0.6 million. The effective tax rate for First Half of Fiscal 2003 was 33.0%, compared to 33.2% for First Half of Fiscal 2002. CAPITAL RESOURCES AND LIQUIDITY ------------------------------- CASH FLOWS FROM CONTINUING OPERATING ACTIVITIES provided cash of $29.5 million during the First Half of Fiscal 2003, compared to cash provided of $33.5 million during the First Half of Fiscal 2002. The decrease in cash provided by continuing operating activities during the First Half of Fiscal 2003 is primarily due to significant improvements in accounts receivable and inventory made in the First Half of Fiscal 2002. 15 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) RESULTS OF CONTINUING OPERATIONS (CONTINUED) -------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES required the use of cash totaling $21.8 million during the First Half of Fiscal 2003, compared with cash provided of $3.4 million in the First Half of Fiscal 2002. Cash was used in the First Half of Fiscal 2003 principally for the purchase of short-term investments of $39.5 million, partially offset by proceeds from the sale of short-term investments of $20.6 million. In the First Half of Fiscal 2002, cash was primarily provided through $4.9 million gross proceeds from the sale of an investment. CASH FLOWS FROM FINANCING ACTIVITIES required the use of cash totaling $13.4 million during the First Half of Fiscal 2003, compared to usage of $2.9 million for the First Half of Fiscal 2002. The increase in cash used for financing activities was principally due to a $9.2 million reduction of debt and $2.5 million of payments to purchase or retire common stock. CASH FLOWS FROM DISCONTINUED OPERATIONS provided cash of $1.0 million during the First Half of Fiscal 2003, compared to cash provided of $3.0 million for the First Half of Fiscal 2002. The decrease in cash provided by discontinued operations was primarily due to significant improvements in working capital made in the First Half of Fiscal 2002. Under the terms of its credit agreements, the Company has agreed to certain financial covenants. At March 29, 2003, the Company was in compliance with the terms and covenants of its credit agreements. The Company believes that the combination of present capital resources, internally generated funds, and unused financing sources will be adequate to finance ongoing operations, allow for investment in opportunities to internally grow its business and make selected strategic acquisitions. OTHER MATTERS ------------- The Company is exposed to market risk from changes in foreign currency exchange rates that can affect its results from operations and financial condition. To minimize that risk, the Company manages exposure to changes in foreign currency rates through its regular operating and financing activities and, when deemed appropriate, through the use of derivative financial instruments, principally forward exchange contracts. Foreign exchange contracts are used to hedge the Company's overall exposure to exchange rate fluctuations, since the gains and losses on these contracts offset gains and losses on the assets, liabilities, and transactions being hedged. The Company's dividend policy is to maintain a payout ratio, which allows dividends to increase with the long-term growth of earnings per share, while sustaining dividends in down years. The Company's dividend payout ratio target is approximately 25% of earnings per share over the long term. FORWARD-LOOKING STATEMENTS -------------------------- Statements included or incorporated by reference in this Management's Discussion and Analysis of Financial Condition and Results of Operations and elsewhere in this Form 10-Q which are not historical or current facts are "forward-looking" statements, as defined in the Private Securities Litigation Reform Act of 1995 and are subject to certain risks and uncertainties that could cause actual results to differ materially from historical results and those presently anticipated or projected. The following important facts, among others, could affect the Company's actual results in the future and could cause the Company's actual financial performance to differ materially from that expressed in any forward-looking statements: 16 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) (i) With regard to the Company's new product developments, there may be uncertainties currently unknown to the Company concerning the expected results. In addition, the Company may not be aware of the introduction of new products or product enhancements by its competitors. (ii) Possible significant volatility in both backlog and quarterly operating results may result from individual large, fixed price orders in connection with sales of MT&S systems. (iii) Order volumes and other operating considerations may be directly or indirectly impacted by economic conditions generally and/or in various geographic areas in which the Company operates. (iv) Export controls based on U.S. initiatives and foreign policy, as well as import controls imposed by foreign governments, may cause delays in certain shipments or the rejection of orders by the Company. Such delays could create material fluctuations in quarterly operating results and could have a material adverse effect on results of operations. Local political conditions and/or currency restrictions may also affect foreign revenue. (v) Delays in realization of backlog orders may occur due to technical difficulties, export licensing approval or the customer's preparation of the installation site, any of which can affect the quarterly or annual period when backlog is recognized as revenue and could materially affect the results of any such period. (vi) The Company experiences competition on a worldwide basis. Customers may choose to purchase equipment from the Company or from its competitors. For certain of the Company's products, customers may also contract with testing laboratories or construct their own testing equipment, purchasing commercially available components. Factors that may influence a customer's decision include price, service, or required level of technology. (vii) The Company is exposed to market risk from changes in foreign currency exchange rates, which can affect its results from operations and financial condition. (viii) The Company's short-term borrowings carry interest rate risk that is generally related to either LIBOR or the prime rate. The Company has minimal earnings and cash flow exposure due to market risks on its long-term debt obligations as a result of the primarily fixed-rate nature of its debt. The foregoing list is not exhaustive, and the Company disclaims any obligation to revise any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK At March 29, 2003, the Company had an investment portfolio of fixed income securities, excluding those classified as cash and cash equivalents, of $54.0 million. These securities, like all fixed income instruments, are subject to interest rate risk and will decline in value if market interest rates increase. However, the Company has the ability and intent to hold its fixed income investments until maturity, and therefore the Company does not expect any such increase in interest rates to have an adverse impact on income or cash flows. The fair market value of these securities was $53.9 million at March 29, 2003. The Company operates internationally and thus is subject to movements in foreign currency rate changes. The Company enters into foreign exchange forward contracts to reduce its exposure to foreign currency rate changes on intercompany foreign currency denominated balance sheet positions. Additional information is included in Note 7 in the Condensed Notes to Consolidated Financial Statements. As of March 29, 2003, the Company's long-term debt consisted of notes payable with fixed interest rates ranging from 6.0% to 7.5%. As such, interest rate fluctuations would not have an impact on interest expense or cash flows. 17 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) ITEM 4. CONTROLS AND PROCEDURES The Company's management, including the Chief Executive Officer and Chief Financial Officer, have conducted an evaluation of the effectiveness of the design and operation of the Company's disclosure controls and procedures pursuant to Rule 13a-15 under the Securities Exchange Act of 1934 (the "1934 Act") within 90 days prior to the filing date of this quarterly report. Based on that evaluation, the Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective in ensuring that information required to be disclosed by the Company in the reports it files or submits under the 1934 Act is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. There have been no significant changes in internal controls, or in other factors that could significantly affect internal controls, subsequent to the date the Chief Executive Officer and Chief Financial Officer completed their evaluation. 18 PART II --- OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS None ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS None ITEM 3. DEFAULTS UPON SENIOR SECURITIES None ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS (a) The Company's Annual Meeting of Shareholders was held on February 12, 2003. (b) The following persons were nominated and elected to continue as directors of the Company until the next Annual Meeting of Shareholders. Voted For Voted Against --------- ------------- Jean-Lou Chameau 19,051,782 238,215 Merlin E. Dewing 19,075,410 214,587 Sidney W. Emery 19,067,918 222,079 Brendan C. Hegarty 18,280,864 1,009,133 Bruce D. Hertzke 18,831,603 458,394 Barb J. Samardzich 18,809,809 480,188 Linda Hall Whitman 19,083,133 206,864 There were no abstentions or broker non-votes for any of the directors. (c) KPMG LLP was ratified to serve as the Company's independent auditors for fiscal year 2003 with 18,999,547 votes in favor, 279,777 votes against, and 15,059 votes abstained. ITEM 5. OTHER INFORMATION None ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits: 3.a Restated and Amended Articles of Incorporation, adopted January 30, 1996, incorporated by reference from Exhibit 3.a. of Form 10-K for the year ended September 30, 1996. 3.b Restated Bylaws, reflecting amendments through May 26, 1998, incorporated by reference from Exhibit 3.b. of Form 10-K for the year ended September 30, 1998. 99.1 Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18U.S.C. 1350) (filed herewith). 99.2 Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350) (filed herewith) (b) Reports on Form 8-K: On January 14, 2003, the Company filed a Current Report on Form 8-K to furnish to the SEC its 2002 Annual Report to shareholders under Regulation FD. 19 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. MTS SYSTEMS CORPORATION Dated: May 13, 2003 /s/ Sidney W. Emery, Jr. ----------------------------------------------- Sidney W. Emery, Jr. Chairman, President and Chief Executive Officer Dated: May 13, 2003 /s/ Susan E. Knight ----------------------------------------------- Susan E. Knight Vice President and Chief Financial Officer CERTIFICATIONS I, Sidney W. Emery, Jr., certify that: 1. I have reviewed this quarterly report on Form 10-Q of MTS Systems Corporation; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) Presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 20 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: May 13, 2003 /s/ Sidney W. Emery ----------------------------------------------- Sidney W. Emery, Jr. Chairman, President and Chief Executive Officer I, Susan E. Knight, certify that: 1. I have reviewed this quarterly report on Form 10-Q of MTS Systems Corporation; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) Presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: May 13, 2003 /s/ Susan E. Knight ------------------------------------------ Susan E. Knight Vice President and Chief Financial Officer 21 EXHIBIT INDEX TO FORM 10-Q 99.1 Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350). 99.2 Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350).