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National Technical Systems 10-K 2008

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549


FORM 10-K

Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the fiscal year ended January 31, 2008
Commission file number 0-16438


NATIONAL TECHNICAL SYSTEMS, INC.
(Exact name of registrant as specified in its charter)

California
(State or other jurisdiction of
incorporation or organization)
  95-4134955
(I.R.S. Employer
Identification No.)

24007 Ventura Boulevard, Suite 200
Calabasas, CA

(Address of principal executive offices)

 

91302
(Zip Code)

(818) 591-0776
(Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:
 
Title of each class
  Name of each exchange on
which registered

Common stock-no par value   The NASDAQ Global Market

         Securities registered pursuant to Section 12(g) of the Act:
None


         Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o    No ý

         Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o    No ý

         Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý    No o

         Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ý

         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 definition of "accelerated filer," "large accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o   Accelerated filer o   Non-accelerated filer o
(Do not check if a smaller reporting company)
  Smaller reporting company ý

         Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of Act). Yes o    No ý

         State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant's most recently completed second fiscal quarter—$42,467,000 (as of July 31, 2007).

         The number of shares of registrant's Common Stock outstanding on April 24, 2008 was 8,958,138.

Documents Incorporated by Reference

         Portions of the Proxy Statement of the Company for the Annual Meeting of Shareholders to be held on July 15, 2008, are incorporated by reference into Part III of this report.




NATIONAL TECHNICAL SYSTEMS, INC.
FORM 10-K
FISCAL YEAR ENDED JANUARY 31, 2008

PART I   3
  ITEM 1.   BUSINESS   3
  ITEM 1A.   RISK FACTORS   9
  ITEM 2.   PROPERTIES   11
  ITEM 3.   LEGAL PROCEEDINGS   12
  ITEM 4.   SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS   12
PART II   12
  ITEM 5.   MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES   12
  ITEM 6.   SELECTED FINANCIAL DATA   13
  ITEM 7.   MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS   14
  ITEM 7A.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK   23
  ITEM 8.   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA   24
  ITEM 9.   CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES   50
  ITEM 9A.   CONTROLS AND PROCEDURES   50
  ITEM 9A(T).   CONTROLS AND PROCEDURES   50
  ITEM 9B.   OTHER INFORMATION   51
PART III   52
  ITEM 10.   DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE   52
  ITEM 11.   EXECUTIVE COMPENSATION   52
  ITEM 12.   SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS, MANAGEMENT AND RELATED STOCKHOLDER MATTERS   52
  ITEM 13.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE   53
  ITEM 14.   PRINCIPAL ACCOUNTANT FEES AND SERVICES   53
PART IV   53
  ITEM 15.   EXHIBITS AND FINANCIAL STATEMENT SCHEDULES   53
SIGNATURES   56

        This report contains certain statements that may be deemed "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements can be identified by the use of forward-looking words such as "may", "will", "expect", "anticipate", "intend", "estimate", "continue", "behave" and similar words. Financial information contained herein, to the extent it is predictive of financial condition and results of operations that would have occurred on the basis of certain stated assumptions may also be characterized as forward-looking statements. Although forward-looking statements are based on assumptions made, and information believed by management to be reasonable, no assurance can be given that such statements will prove to be correct. Such statements are subject to certain risks, uncertainties and assumptions. Actual outcomes are dependent upon National Technical Systems, Inc.'s ("NTS" or "the Company") successful performance of internal plans, ability to effectively integrate acquired companies, customer changes in short range and long range plans, competition in the Company's services areas and pricing, continued acceptance of new services, performance issues with key customers, and general economic risks and uncertainties.

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NATIONAL TECHNICAL SYSTEMS, INC.
Annual Report (Form 10-K)
For Year Ended January 31, 2008


PART I

ITEM 1.    BUSINESS.

        National Technical Systems, Inc. ("NTS" or the "Company") is a diversified services company that supplies technical services and solutions to a variety of industries including aerospace, defense, transportation, electronics, power, computers and telecommunications. NTS, utilizing its various testing facilities, staffing solutions and certification services, helps its customers sell their products in world markets. NTS is accredited by numerous national and international technical organizations which allow the Company to have its test data accepted in most countries.

        The Company was founded in 1961, incorporated in 1968 in California and subsequently was reincorporated in Delaware in 1987 to serve as a holding company for its subsidiaries. On January 31, 1997, the Company was merged into a newly formed California corporation named National Technical Systems, Inc.

        The Company's principal executive offices are located at 24007 Ventura Boulevard, Suite 200, Calabasas, California 91302 (telephone: 818-591-0776).

        NTS operates in two segments: "Engineering and Evaluation" and "Technical Solutions." The business of the Company is conducted by a number of operating units, each with its own organization. The management of each operating unit has responsibility for its operations and for achieving sales and profit goals. The executive staff from the Company's corporate headquarters sets the strategy and maintains overall supervision, coordination and financial control, and manages development of new services and acquisitions.

Overview

        The E&E segment of NTS is one of the largest independent conformity assessment and management system registration organizations in the U.S., with facilities throughout the country and at locations in Japan, Germany and Canada. E&E provides highly trained technical personnel for product certification, product safety testing and product evaluation to enable customers to sell their products in world markets. In addition, E&E performs management registration and certification services to ISO related standards. NTS is accredited by numerous national and international technical organizations which allows the Company to have its test data accepted in most countries.

E&E Markets

        E&E serves customers primarily in the defense, aerospace, transportation, telecommunications, electronics, power and computers markets. Defense and aerospace markets combined account for approximately 56% of E&E testing revenues for the year ended January 31, 2008.

        Defense.    E&E plays an active role in numerous U.S. defense related programs, performing almost every type of test discipline, including complete functionality and performance, reliability, safety, life

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prediction, structural, mechanical, fluids, material science, vibration, shock, climatic exposure, radiation, acoustic noise and electromagnetic interference and compatibility. Examples of items tested include components for small fixed wing aircraft, helicopters, submarines, aircraft carriers and other naval ships, tanks and other tracked vehicles, trucks and road vehicles, command control communication systems, electronics, weapon systems and complete ordnance and munitions testing. E&E has facilities that are specially constructed to handle munitions and hazardous materials where routine testing includes vibration and cook-off of explosive materials, ballistics tests and hydraulic burst tests. E&E performs a broad variety of ballistics related testing, up to 155 mm rounds. E&E's data acquisition systems are capable of collecting 1,000,000 data points and 22,000 photos per second. Additional instrumentation includes Doppler radar, 35 mm still cameras, digital recording, data loggers and real-time color and IR video. E&E's customers in this market include various major defense contractors, as well as the U.S. Department of Defense (DOD) and other government entities. As a result of our acquisition of United States Test Laboratory this past year, we now offer testing of products that stop bullets, particularly body armor.

        Aerospace.    E&E performs a wide variety of tests required on civil aircraft, space, military and missiles. E&E offers acceleration test facilities, G-tables and centrifuges with diameters ranging from one foot to 102 feet, with weight capacities from a few grams to 20,000 pounds. In climatic testing, E&E utilizes hundreds of test chambers to simulate nearly any environment: temperature, humidity, altitude, rain, salt spray, sand and dust, sunshine, explosive atmosphere or any combination. E&E designs and builds custom facilities and advanced instrumentation and data acquisition systems to support all types of flow testing for gases, liquids and cryogenics. E&E is capable of performing structural testing and analysis, and, in particular, structural loading of large objects such as entire airframes. It also performs fatigue testing of critical hardware items such as engine blades and high-pressure fluid components. The Company also enables its customers to minimize their personnel, testing time and costs by utilizing the Company's on-site climatic, dynamic, safety and electromagnetic compatibility test capabilities. E&E also has anechoic and reverberant chambers that are used for acoustic emission measurements or high level noise exposure.

        Transportation.    E&E performs fluids and gas tests that measure the flow of fuels, propellants, chemicals, water, steam and others. It also provides tests that measure temperature, thermal shock, leak detection and efficiencies in objects like filters and other components. Other more specialized tests include cryogenic protocols for elements such as liquid nitrogen, liquid hydrogen and liquid oxygen, as well as liquefied natural gas. E&E also performs dynamometer testing to measure the performance and power output of engines drive trains or any other rotating machinery. It also performs HALT/HASS (Highly Accelerated Stress Screen). These tests combine extremes of temperature, rapid temperature change, and multi-axis vibration to rapidly expose design weaknesses and process flaws. NTS is accredited to ISO 17025 through the American Accreditation of Laboratories Association (A2LA). This accreditation allows NTS automotive test reports to be accepted in the USA and internationally.

        Telecommunications.    E&E provides certification and evaluation of a broad array of telecommunications equipment and systems for manufacturers of central office equipment and the carriers. E&E's services are performed in accordance with the Network Equipment Building Systems specifications (NEBS) and fiber optics General Requirements (GRs) as required by the telecommunications industry. E&E is also an independent test laboratory certified and recognized by most carriers, which allows manufacturers to use E&E as a market channel for products tested at Original Equipment Manufacturers' ("OEM") facilities that are being developed for use in the regional bell operating companies' ("RBOCs") central offices. The Company has been approved as an Independent Test Laboratory (ITL) by the carriers to test and certify central office equipment developed by manufactures to the NEBS specifications. The Company is currently providing this service at laboratories in California, Massachusetts, Texas, Calgary, Canada and Germany. The Company has been approved as an ITL to offer Digital Subscriber Line (DSL) certification, Video Electronics Standard Association (VESA) certification and Multimedia over Coax (MoCA) certification. The Company is in the process of developing certifications programs for XM Radio and High Definition Audio-Video Networks (HANA).

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        Electronics.    As a Nationally Recognized Test Lab (NRTL), NTS provides electrical safety product certification, in the US and many other countries. NTS has been designated as a Conformity Assessment Body (CAB) for the EMC directive through the US-EU Mutual Recognition Agreement (MRA). NTS conducts EMC testing and provides customers with certification in the US and many other countries, particularly, Japan, Taiwan, Europe and Australia.

        Power.    E&E conducts a variety of tests relevant to the ongoing operations, safety and maintenance of nuclear facilities. These tests include mechanical aging, normal or accident radiation exposure, reliability simulation, evaluation, thermal aging, analysis, vacuum testing, leak detection, Nuclear Steam Accident, Loss Of Cooling Accident (LOCA), High Expansion Line Break (HELB) to 600F/300psig. E&E also performs seismic simulation tests up to 100,000 force-lbs, single axis, dependent and independent biaxial systems, vibration aging and fatigue studies, up to 45,000 force-lbs. E&E is active in industry task groups that influence the latest dedication guidelines. Through direct participation, E&E is involved in resolution of key Nuclear Regulatory Commission (NRC) questions such as selection and verification of critical characteristics, sampling, traceability, surveys, and like-for-like replacements. E&E engineers and technicians involved in the dedication process meet ANSI N45.2.6 Level II Inspectors guidelines. The Company's dedication programs utilize the best approach for each specified product. E&E also provides technical evaluations, critical characteristics and safety class determinations and focuses on solving plant needs in areas such as motor rewinds, governor rebuilds, modifications or design of replacement systems and instrumentation panel and component design.

        Computer.    E&E performs computer product testing, providing compatibility, stress/performance, functionality and compliance testing services for hardware, software, telecommunications and networking companies worldwide. E&E performs software game and game console testing including Microsoft Xbox compliance testing. E&E is the exclusive test center for Microsoft Xbox third party peripheral compatibility testing. E&E also provides testing for Data Over Cable Service Interface Specification (DOCSIS) cable modem, DSL modem, Set Top Box, Residential Gateway and Fiber Optics GR-253 testing, interoperability testing of broadband and network products such as cable modems, DSL modems, Cable Modem Termination System (CMTS), Digital Subscriber Line Access Multiplexer (DSLAM), Routers, Home PNA Gateways, Wireless Wi-Fi devices, Media Servers, Fiber Optics SONET switches, and systems network testing. E&E also performs Universal Serial Bus (USB) certification testing and was able to successfully transfer its USB technology to Japan.

Industry Overview

        Manufacturers often fulfill their evaluation testing needs on an outsourcing basis in order to reduce costs, avoid large capital expenditures, save time and remain competitive. Due to regulations requiring third party certification, manufacturers use third party certifiers to position their products for sale in world markets. NTS is currently geographically located to serve customers at locations close to their plants and NTS facilities are capable of providing the conformity assessment activity necessary to reduce product-handling costs and serve as a market gateway for manufacturers to sell products globally. E&E provides a "one stop" resource and single source responsibility for all conformity assessment requirements in the several markets it serves.

Geographic Locations

        In the United States, E&E's facilities are located in: Acton and Boxborough, Massachusetts; Tinton Falls, New Jersey; Rustburg, Virginia; Camden, Arkansas; Detroit, Michigan; Plano, Texas; Tempe, Arizona; Los Angeles, Fullerton, Culver City, Santa Clarita, Santa Rosa and Ventura, California; Albuquerque, New Mexico; Elkhart, Indiana; Wichita, Kansas; and internationally, in Yokohama, Japan; Calgary, Canada; and Munich, Germany.

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Business Strategy

        To meet its customers' needs, E&E continuously upgrades its facilities, equipment, accreditations, partnerships and personnel in line with market requirements. In addition, E&E's continuing expansion into new areas of technology will require it to invest in equipment needed to adequately service customers' needs. Through close consultation with its existing and prospective customers to ascertain their needs for the future, E&E is able to better determine its equipment needs. In fiscal 2008, the Company made additional investments to enhance both its capacity and capability. The Company acquired United States Test Laboratory (USTL) in Wichita, Kansas. This acquisition enabled the Company to add testing of any product that stops bullets up to 30 caliber. USTL has conducted testing on law enforcement and military body armor, helmets, shields, notebooks, briefcases, car door panels, glass windows, school book bags, aircraft cockpit doors and executive clothing with concealable armor. The Company also acquired a Quality Management Registration business, which expanded the Company's customer base and capability in Indiana.

Overview

        The Technical Solutions segment of NTS is a national provider of technical experts for engineering and information technology services. Over the recent years, the Company is aligning its service offerings to more closely match its services with its E&E group and thus capitalize on NTS's long history of testing and engineering services. As a valuable and respected resource, TS has developed long-term relationships with its customers for whom it provides engineering and IT personnel.

        TS's operational and technical knowledge allows it to effectively identify and screen highly skilled professionals. TS provides the technical resources its customers need to evaluate processes and products to meet the demands of compressing development cycles and critical time-to-market requirements. TS places its professionals on assignment at a customer site to perform specific tasks and projects for a predetermined period. Under negotiated terms, at the completion of an assignment, customers may directly hire an individual. TS also supports its customers in sourcing and identifying candidates for direct hire. Its comprehensive registry of engineering and information technology professionals allows it to provide fully screened and qualified individuals. TS can support its customers' needs, whether the need is to manage a project or an entire test facility; provide a team to take a product from design to production, or staff a project on a temporary basis.

Geographic Locations

        In the United States, Technical Solutions offices are located in: Culver City and San Mateo, California; Lowell, Massachusetts; Columbia, South Carolina; and Troy, Michigan. TS's headquarters are located in Culver City, California. In addition, TS has program managers on customer sites in Woodland Hills and San Diego, California, and Houston, Texas.

Business Strategy

        With nearly 30 years of experience in technical project outsourcing services, TS continues to focus on supplying: (i) project teams managed by the Company, (ii) project teams managed by the customer, (iii) individual personnel and (iv) managed service programs. TS expects to continue to develop and expand its customer relationships.

        TS's strategy continues to be the alignment of its technical talent and client base with the NTS core compentencies. The strategy is expected to increase productivity by improving internal processes, diversifying the range of services the Company provides to its existing customers, attracting and retaining qualified technical consultants from a variety of sources, both national and international, and pursuing

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strategic relationships with non-competing organizations. TS's company-wide sales force is aligned with the Company's strategy and promotes cross-selling and lead generation between existing customers of one business unit to another. TS strives to provide its customers with technical personnel with the right skills, at the right time, for the right duration and at a cost that is lower than what its customers could otherwise achieve.

Engineering & Evaluation

        In the aerospace and defense markets, the main competition for independent laboratories is the customers' own laboratories, including government laboratories. E&E also competes with a small number of large conformity assessment organizations, within each of the markets it serves. It also competes with a large number of small niche oriented test laboratories. It has competitive advantages in several areas which include the following: (i) ability to service customers at facilities close to their locations; (ii) ability to provide complete conformity assessment activities at a single location, which reduces product-handling cost for the customers and enhances timeliness of service; (iii) diverse and technically competent employees; and (iv) accreditations that allow the E&E segment's test data to be accepted worldwide. Customers can use the Company's complete services, including quality registration, to position their products for the world markets.

Technical Solutions

        Potential customers for services offered by the Technical Solutions segment are from a broad base of high technology and product manufacturing companies. Competition in this segment comes from a large number of public and privately held companies and more recently, from off-shore companies. The Company competes in this segment primarily on its niche position, price and quality of service.

        The Company believes its engineering and testing services gives the Company an advantage over most staffing companies, which merely provide personnel as contractors, by understanding the technical challenges facing its customers and providing the expertise to meet those challenges.

        Many large companies are increasingly using primary suppliers to fulfill their staffing needs. Technical Solutions competes with and, in certain relationships, teams with other major staffing companies in actively pursuing primary supplier relationships with large customers in its existing markets. These relationships can have a significant impact on Technical Solutions' revenues and operating profits.

        The Company's backlog at January 31, 2008 and 2007 was as follows:

 
  2008
  2007
Engineering & Evaluation   $ 41,714,000   $ 32,000,000
Technical Solutions     8,591,000     8,390,000
   
 
Total Backlog   $ 50,305,000   $ 40,390,000
   
 

        The Company estimates that approximately 85% of the backlog at January 31, 2008 will be completed by January 31, 2009.

        a.    Service Marks    

        The Company has registered its service marks "NTS" and "XXCAL" with the U.S. Patent and Trademark Office.

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        b.    Environmental Effect    

        We are subject to various federal, state, local and foreign government requirements regulating the discharge of materials into the environment or otherwise relating to the protection of the environment. It is our policy to comply with these requirements, and we believe that, as a general matter, our policies, practices and procedures are properly designed to prevent unreasonable risk of environmental damage, and of resulting financial liability, in connection with our business. Some risk of environmental damage is, however, inherent in some of our operations, as it is with other companies engaged in similar businesses.

        The Company's Santa Clarita, California test facility is located immediately adjacent to property owned by a third party which has been the subject of extensive environmental remediation. The adjacent site has, in the past, been used for manufacture of solid rocket fuel propellants, munitions and flares that contained perchlorate, a hazardous substance. Soil samples taken from the western portion of the Santa Clarita property in 2003 were inconclusive as to the existence of perchlorate. Further testing is planned in cooperation with the government agency having oversight responsibility for the adjacent site. No cleanup activity has been conducted on the Santa Clarita property and it has yet to be determined whether remediation will be required at the site, or, if required, the extent and cost of any remediation. The Company believes that in the event it does incur remediation costs on the western portion of the property, that it will have valid claims for indemnification against the owner of the adjacent site and the municipality that built a road between the adjacent site and the Santa Clarita property that appears to have contributed to the runoff from the adjacent site. Recovery of such remediation costs may, however, be uncertain and may involve significant litigation expense.

        In January 2007, a sampling program was conducted on the eastern portion of the site in accordance with a voluntary clean up agreement the Company entered into with the Department of Toxic Substance Control (DTSC). The sampling did not detect any perchlorate in the soil, but one surface sample at a hazardous materials storage area did detect lead, cadmium, chromium, copper and nickel at concentrations in excess of typical background levels. As a result, additional testing was conducted at that location and it was determined that 1.5 cubic yards of soil needed to be removed from the site. The soil was removed and properly disposed of in a licensed disposal facility on October 10, 2007. On November 5, 2007, the DTSC issued a letter to the Company stating that no further action is required with respect to investigation and remediation of hazardous substances at the site.

        c.    Seasonal Effect    

        The Company experiences no material seasonal effects.

        d.    Employees    

        The Company employed 891 individuals at January 31, 2008 and 874 at January 31, 2007, as follows:

 
  2008
  2007
Engineering & Evaluation   540   484
Technical Solutions *   334   373
Corporate Administration   17   17
   
 
Total   891   874
   
 

*
The Technical Solutions total for 2008 includes 224 contract employees and 60 subcontractors, as compared to 237 contract employees and 97 subcontractors for 2007. None of the employees of the Company are represented by a union. The Company considers its relationship with its employees to be good.

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AVAILABLE INFORMATION

        Our website address is http://www.ntscorp.com. We make available, free of charge through our website, our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, Proxy Statements, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission (the "SEC").

        Our filings may also be read and copied at the SEC's Public Reference Room at 100 F Street NE, Room 1580 Washington, DC 20549. Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. The address of that website is www.sec.gov.

ITEM 1A.    RISK FACTORS.

        The factors discussed below are cautionary statements that identify important factors that could cause actual results to differ materially from those anticipated in the forward-looking statements in this Form 10-K. Any of the following risks may have a material negative impact on the Company's financial condition.

        The Company is subject to the effects of general economic and market conditions (including economic disruption caused by terrorist acts). If the economic conditions worsen, the Company may experience material adverse effects on its business, operating results, and financial condition.

        The Company experienced significant growth in recent years, partly due to domestic and worldwide political and economic developments that have positively affected the markets for defense and advanced technology systems. Homeland security and defeating terrorism have been among the Department of Defense's main initiatives. A slowing in defense spending due to political or budget shifts will put downward pressure on the Company's revenues and gross margins.

        Results may be adversely affected by:

    Increased competition from the Company's own customers' in-house testing laboratories or from government laboratories;

    Increased competition from large conformity assessment organizations and small niche oriented test laboratories;

    The loss of significant customers or significant decreases in their purchasing volume;

    Environmental issues arising from the use of hazardous substances;

    Pricing concessions that may be given on volume sales due to competition;

    The rescheduling or cancellation of customer orders;

    Fluctuations and availability of certain raw materials or components that are needed to test customers' products;

    The loss of key management or technical personnel;

    The financial condition of the Company's major customers;

    Fraudulent transactions committed against the Company;

    U.S. government defense programs are subject to special risk, including dependence on government appropriations, contract termination without cause, contract renegotiations, and intense competition for the available defense business;

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    Inability to find temporary workers with the skills required by customers in the Technical Solutions segment;

    The inability to procure sufficient insurance to cover operational and contractual risks;

    The inability to expand in international markets due to the Company's limited experience;

    The Company may be required to record a charge to earnings if goodwill becomes impaired;

    Program performance (including the ability to perform fixed-price contracts within estimated costs and the timing of test report deliveries);

    Future changes in zoning could adversely affect the Company's ability to fully utilize its facilities to service its customers;

    The Company's California facilities, including its principal executive offices, are located near major earthquake fault lines. A major earthquake or any other natural disaster in a region near any of the Company's facilities, could materially and adversely affect the Company's business; and

    To remain competitive, the Company must be able to respond effectively to technological changes and be able to hire, train and retain highly skilled sales, engineering and technical personnel.

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ITEM 2.    PROPERTIES.

        Operations    The Company owns/leases and operates the following properties:

State
  Owned Properties
City

  Business Segment
  Buildings (Sq.Ft.)
  Land (Acres)
California   Fullerton   E&E   36,000   3
    Santa Clarita (a), (b)   E&E   60,000   145
Massachusetts   Acton   E&E   30,000   5
    Boxborough   E&E   25,000   4
Texas   Plano   E&E   1,000   1
Virginia   Fredericksburg   E&E   66,000   87
           
 
Total owned properties   218,000   245
           
 
                    
State
  Leased Properties
City

  Business Segment
  Buildings (Sq.Ft.)
  Land (Acres)
Arizona   Tempe   E&E   17,000   n/a
Arkansas   Camden   E&E   30,000   258
California   Anaheim Hills   Corp   2,000   n/a
    Calabasas   Corp   7,000   n/a
    Culver City   TS and E&E   24,000   n/a
    Fullerton   E&E   20,000   n/a
    Los Angeles (LAX)   E&E   16,000   2
    San Mateo   TS   2,000   n/a
    Santa Rosa   E&E   18,000   n/a
    Ventura   E&E   870   n/a
Indiana   Elkhart   E&E   500   n/a
Kansas   Wichita   E&E   8,000   n/a
Massachusetts   Lowell   TS   1,000   n/a
    Boxborough   E&E   12,000   n/a
Michigan   Detroit   E&E   65,000   n/a
    Troy   TS   1,000   n/a
New Jersey   Tinton Falls   E&E   17,000   n/a
New Mexico   Albuquerque   E&E   6,500   n/a
South Carolina   Columbia   TS   3,000   n/a
Texas   Plano   E&E   24,000   n/a
Virginia   Rustburg   E&E   8,000   33
                    
International
   
   
   
   
Calgary   Canada   E&E   14,000   n/a
Germany   Munich   E&E   300   n/a
Japan   Yokohama   E&E   500   n/a
Vietnam   Ho Chi Minh   TS   1,000   n/a
           
 
Total leased properties   298,670   293
           
 

(a)
See "Environmental Matters" in Part 1, Item 1.

(b)
Approximately 120 acres on this site have been listed for sale by the Company. See "Investment Properies" below.

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        The Company believes that the space occupied by all of its operations is adequate for its current and near-term requirements. Should additional space be required, the Company does not anticipate problems in securing such additional space.

        There were no properties purchased or sold in fiscal year 2008. The Company has listed approximately 120 acres of its Santa Clarita, California land for sale, but because it does not meet all the criteria for accounting classification as an "asset held for sale" as defined in Statement of Financial Accounting Standards No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets", it was not classified as such in the accompanying consolidated financial statements.

ITEM 3.    LEGAL PROCEEDINGS.

        The Company is, from time to time, the subject of claims and suits arising out of matters occurring during the operation of the Company's business. In the opinion of management, no pending claims or suits would materially affect the financial position or the results of the operations of the Company.

ITEM 4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

        None.


PART II

ITEM 5.    MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

        The Company's common stock is traded on the Nasdaq Global Market under the symbol "NTSC". The range of high and low sales prices as reported by the Nasdaq Global Market for each of the quarters of the fiscal years ended January 31, 2008 and 2007 is presented below:

 
  2008
  2007
 
  High
  Low
  High
  Low
First Quarter   $ 6.35   $ 5.00   $ 7.38   $ 4.87
Second Quarter   $ 7.09   $ 5.50   $ 8.47   $ 5.73
Third Quarter   $ 7.48   $ 6.36   $ 7.47   $ 5.89
Fourth Quarter   $ 7.35   $ 5.71   $ 7.00   $ 5.93

        As of the close of business on April 24, 2008, there were 739 holders of record of the Company's common stock. The number of holders of record is based on the actual number of holders registered on the books of the Company's transfer agent and does not reflect holders of shares in "street name" or persons, partnerships, associations, corporations or other entities identified in security position listings maintained by depository trust companies.

    C.    Dividends

        The Company does not anticipate paying dividends in the foreseeable future.

12


ITEM 6.    SELECTED FINANCIAL DATA.

        The following selected consolidated financial data are derived from and should be read in conjunction with the Company's consolidated financial statements and related notes set forth in Item 8 below.

 
  Year Ended January 31,
 
  2008
  2007
  2006
  2005
  2004
 
  (in thousands except per share amounts)

INCOME STATEMENT DATA:                              
Net revenues   $ 122,376   $ 115,673   $ 111,254   $ 106,514   $ 104,550
Gross profit     29,875     26,643     27,230     23,687     22,612
Operating income     5,946     4,668     6,077     3,521     3,215
Interest expense, net     1,950     1,801     1,298     1,091     1,097
Income before income                              
  taxes and minority interest     4,410     2,978     4,855     2,592     2,310
Income taxes     1,711     1,309     1,966     910     1,056
   
 
 
 
 
Income from continuing operations before minority interest     2,699     1,669     2,989     1,682     1,254
Minority interest in earnings     (84 )   (88 )   (50 )       39
   
 
 
 
 
Net income   $ 2,615   $ 1,581   $ 2,939   $ 1,682   $ 1,293
   
 
 
 
 
Net income per common share:                              
  Basic   $ 0.30   $ 0.18   $ 0.32   $ 0.19   $ 0.15
   
 
 
 
 
  Diluted   $ 0.28   $ 0.17   $ 0.30   $ 0.18   $ 0.14
   
 
 
 
 
Weighted average common shares outstanding     8,795     8,705     9,125     8,946     8,640
Dilutive effect of stock options     662     800     537     620     566
   
 
 
 
 
Weighted average common shares outstanding, assuming dilution     9,457     9,505     9,662     9,566     9,206
   
 
 
 
 
BALANCE SHEET DATA:                              
Working capital   $ 19,145   $ 15,087   $ 16,276   $ 20,481   $ 18,550
Total assets     90,892     74,839     69,133     66,669     63,632
Long-term debt, excluding current installments     32,274     19,238     15,579     20,557     19,754
Shareholders' equity     37,355     33,779     34,378     30,951     28,832

*
Per share data may not always summate because each figure is independently calculated.

13


ITEM 7.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

        Except for the historical information contained herein, statements in the following section are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements can be identified by the use of forward-looking words such as "may", "will", "expect", "anticipate", "intend", "estimate", "continue", "behave" and similar words. Financial information contained herein, to the extent it is predictive of financial condition and results of operations that would have occurred on the basis of certain stated assumptions, may also be characterized as forward-looking statements. Although forward-looking statements are based on assumptions made, and information believed by management to be reasonable, no assurance can be given that such statements will prove to be correct. Such statements are subject to certain risks, uncertainties and assumptions. Actual outcomes are dependent upon National Technical Systems, Inc.'s ("NTS" or the "Company") successful performance of internal plans, ability to effectively integrate acquired companies, customer changes in short range and long range plans, competition in the Company's services areas and pricing, continued acceptance of new services, performance issues with key customers, and general economic risks and uncertainties.

OVERVIEW

        NTS is a diversified services company that supplies testing outsourcing services and conformity assessment and personnel to businesses in a variety of industries including aerospace, defense, transportation, power products, electronics, computers and telecommunications. Through its wide range of testing facilities, staffing solutions and certification services, NTS provides its customers with the ability to sell their products globally and enhance their overall competitiveness. NTS is accredited by numerous national and international technical organizations which allow the Company to have its test data accepted in most countries.

        NTS operates in two segments: "Engineering & Evaluation" and "Technical Solutions". The business of the Company is conducted by a number of operating units, each with its own organization. Each segment is under the direction of its own executive and management team. In making financial and operational decisions, NTS relies on an internal management reporting process that provides revenues and operating cost information for each of its operating units. Revenues and booking activities are also tracked by market type.

        In fiscal 2008, total revenues increased 5.8% to approximately $122 million.

        Summary of Revenues for fiscal years 2008 and 2007:

 
  FY 2008
  FY 2007
  Change
  % Change
 
 
  (Dollars in thousands)

   
 
Engineering & Evaluation Revenues   $ 90,548   $ 80,030   $ 10,518   13.1 %
Technical Solutions Revenues     31,828     35,643     (3,815 ) (10.7 )%
   
 
 
     
Total Revenues   $ 122,376   $ 115,673   $ 6,703   5.8 %
   
 
 
     

        Revenues in the Engineering & Evaluation segment increased 13.1% primarily due to organic growth combined with revenues from new acquisitions. Revenues in this segment are generated from physical testing services which include simulation of harsh environments such as high/low temperature, shock, vibration, seismic and electromagnetic interference, and functional testing which requires equipment such as switches, routers, servers and high bandwidth access to the Internet to subject telecommunication equipment to a full spectrum of performance type testing. Revenues in this segment also include registration services which perform quality management audits to ISO 9000, quality training and laboratory accreditation. The Engineering & Evaluation segment is one of the largest independent conformity

14



assessment organizations in the U.S., with facilities throughout the United States and in Japan, Canada and Germany, serving a large variety of industries.

        Revenues in the Technical Solutions segment decreased 10.7% primarily due to decreased contractor headcount and the competitive environment in the general IT service business. Revenues in this segment are generated from a variety of staffing and workforce management services and solutions, including contract services, temporary and full time placements to meet its customers' information technology ("IT") such as help-desk analysts and managers, relational database administrators and developers, application and systems programmers, configuration and project managers and engineering service needs.

        On May 31, 2007, NQA, USA, a 50% owned consolidated subsidiary of NTS, acquired the existing business of TRA Certification, Inc. ("TRA"), located in Elkhart, Indiana, for a total purchase price of $821,000. The Company paid $471,000 in cash and will pay an additional $350,000 which is payable in five annual payments of $70,000 each, starting upon the first anniversary of the purchase. All existing TRA customers and associated certifications and backlog were transferred to NQA, USA. The purchase price was allocated $350,000 to covenant not to compete, $207,000 to customer relationships and $264,000 to goodwill. The results of operations of the acquired business are included in the accompanying consolidated statement of operations from June 1, 2007 to January 31, 2008.

        On December 5, 2007, NTS Technical Systems, a wholly owned subsidiary of NTS, acquired the assets and the existing business of United States Test Laboratory, LLC ("USTL"), located in Wichita Kansas. The purchase price paid for USTL at closing was $12,500,000 cash. The selling members of USTL may earn up to an additional $1,800,000 in cash on the second anniversary of the date of closing of the acquisition if the company achieves a certain level of revenue. USTL is a leading provider of testing soft body armor, helmets, firearm safety devices, handgun testing, stab resistance and hard body armor testing. The results of operations of the acquired business are included in the accompanying consolidated statement of operations from December 5, 2007 to January 31, 2008.

        Summary of Cash Flows for fiscal years 2008 and 2007:

 
  FY 2008
  FY 2007
  Change
 
 
  (Dollars in thousands)

 
Net cash provided by operating activities   $ 6,022   $ 6,253   $ (231 )
Net cash used in investing activities     (18,387 )   (9,280 )   (9,107 )
Net cash provided by financing activities     11,991     2,117     9,874  
Effect of exchange rate changes on cash     16     (65 )   81  
   
 
 
 
Net decrease in cash   $ (358 ) $ (975 ) $ 617  
   
 
 
 

        The increase in net cash used in investing activities increased from FY 2007 to FY 2008, primarily due to cash spent for the acquisition of USTL in FY 2008 compared to a lower amount of cash spent on acquisitions in FY 2007. The increase in net cash provided by financing activities was due to borrowings to purchase USTL.

Critical Accounting Policies

        The consolidated financial statements of the Company are prepared in accordance with U.S. generally accepted accounting principles ("GAAP"), which require the Company to make certain estimates and assumptions (see Note 1 to the consolidated financial statements in Item 8). Estimates are based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources.

        Management believes the following critical accounting policies, among others, affect its more significant judgments and estimates used in the preparation of its consolidated financial statements.

15


Revenue Recognition

        Revenues are derived from development, qualification and production testing and engineering services for commercial products, space systems and military equipment of all types. The Company also provides technical staffing, qualification of safety related systems and components, and ISO 9000 certification services.

        Revenue from fixed price testing contracts is generally recorded upon completion of the contracts, which are generally short-term, or upon completion of identifiable contractual tasks. At the time the Company enters into a contract that includes multiple tasks, the Company estimates the amount of actual labor and other costs that will be required to complete each task based on historical experience. Revenues are recognized which provide for a profit margin relative to the testing performed. Revenue relative to each task and from contracts which are time and materials based is recorded as effort is expended. Billings in excess of amounts earned are deferred. Any anticipated losses on contracts are charged to income when identified and can be reasonably estimated. To the extent management does not accurately forecast the level of effort required to complete a contract, or individual tasks within a contract, and the Company is unable to negotiate additional billings with a customer for cost over-runs, the Company may incur losses on individual contracts. All selling, general and administrative costs are treated as period costs and expensed as incurred.

        Reimbursements made to the Company by customers under contract provisions, including those related to travel and other out-of-pocket expenses are recorded as revenues. An equivalent amount of reimbursable expenses is recorded as cost of sales.

Allowance for Uncollectible Receivables

        The Company maintains an allowance for doubtful accounts for estimated losses resulting from the inability of customers to make required payments. The Company uses a combination of write-off history, aging analysis and any specific known troubled accounts in determining the allowance. If the financial condition of customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances could be required.

Inventories

        Inventories consist of accumulated costs including direct labor, material and overhead applicable to uncompleted contracts and are stated at actual cost, which is not in excess of estimated net realizable value. Such inventories for each contract are reviewed on a monthly basis over the life of the contract and additional write-downs of inventories are made if there are insufficient revenues remaining on the contract.

Accounting for Income Taxes

        We account for income taxes under the liability method in accordance with SFAS No. 109 "Accounting for Income Taxes." Deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. We record a valuation allowance, if necessary, to reduce deferred tax assets to an amount management believes is more likely than not to be realized.

        To the extent that we have deferred tax assets, we must assess the likelihood that our deferred tax assets will be recovered from taxable temporary differences, tax strategies or future taxable income and to

16



the extent that we believe that recovery is not likely, we must establish a valuation allowance. As of January 31, 2008 and 2007, we have not established a valuation allowance against our deferred tax assets. In the future, we may adjust our estimates of the amount of valuation allowance needed and such adjustment would impact our provision for income taxes in the period of such change.

Recently Issued Accounting Standards

        In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements" ("SFAS 157"), which clarifies the definition of fair value, establishes guidelines for measuring fair value, and expands disclosures regarding fair value measurements. SFAS 157 does not require any new fair value measurements and eliminates inconsistencies in guidance found in various prior accounting pronouncements. SFAS 157 will be effective for the Company on February 1, 2008. However, on February 12, 2008, the FASB issued FSP FAS 157-2 which delays the effective date of SFAS 157 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). This FSP partially defers the effective date of SFAS 157 to fiscal years beginning after November 15, 2008, and interim periods within those fiscal years for items within the scope of this FSP. Effective for 2008, the Company will adopt SFAS 157 except as it applies to those nonfinancial assets and nonfinancial liabilities as noted in FSP FAS 157-2. The partial adoption of SFAS 157 is not expected to have a material impact on our consolidated financial position, cash flows, or results of operations.

        In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities"("SFAS 159") which permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. SFAS 159 will be effective for the Company on February 1, 2008.

        In December 2007, the FASB issued SFAS No. 141 (revised 2007), "Business Combinations" ("SFAS 141R") and SFAS No. 160, "Accounting and Reporting of Noncontrolling Interest in Consolidated Financial Statements, an amendment of ARB 51" ("SFAS 160"), which will change the accounting for and reporting of business combination transactions and noncontrolling interests in consolidated financial statements. SFAS 141R and SFAS 160 will be effective for the Company on February 1, 2009. We are currently evaluating the impact of adopting SFAS 141R and SFAS 160 on our consolidated financial position, cash flows, and results of operations.

Off-Balance Sheet Arrangements

        The Company does not have any special purpose entities or off-balance sheet financing arrangements.

Results of Operations

        The following discussion should be read in conjunction with the consolidated financial statements and notes thereto.

REVENUES

 
  Twelve months ended January 31,
 
  2008
  % Change
  2007
 
  (Dollars in thousands)

Engineering & Evaluation   $ 90,548   13.1 % $ 80,030
Technical Solutions     31,828   (10.7 )%   35,643
   
     
  Total revenues   $ 122,376   5.8 % $ 115,673
   
     

17


        For the year ended January 31, 2008, total revenues increased $6,703,000 or 5.8%, as compared to the prior year. The year over year growth was primarily attributable to strong organic growth in the Engineering and Evaluation segment combined with growth from acquisitions, offset by a decrease in revenues in the Technical Solutions segment.

Engineering & Evaluation:

        For the year ended January 31, 2008, revenues in the Engineering & Evaluation segment increased $10,518,000 or 13.1%, as compared to the prior year, primarily due to strong testing revenues in the aerospace, defense and power markets. Revenues also increased as a result of additional revenues of $807,000 from the acquisition of United States Test Laboratory on December 5, 2007. These increases were partially offset by a decrease in the automotive testing business at the Detroit, Michigan facility.

Technical Solutions:

        For the year ended January 31, 2008, revenues in the Technical Solutions segment decreased by $3,815,000 or 10.7%, as compared to fiscal 2007. This was primarily due to decreased contractor headcount and the competitive environment in the general IT service business. The Company has recently added additional high-level management to leverage the Engineering & Evaluation customers by providing them with resources and solutions.

GROSS PROFIT

 
  Twelve months ended January 31,
 
 
  2008
  % Change
  2007
 
 
  (Dollars in thousands)

 
Engineering & Evaluation   $ 24,275   17.4 % $ 20,678  
% to segment revenue     26.8 %       25.8 %
Technical Solutions     5,600   (6.1 )%   5,965  
% to segment revenue     17.6 %       16.7 %
   
     
 
Total   $ 29,875   12.1 % $ 26,643  
   
     
 
% to total revenue     24.4 %       23.0 %

        For the year ended January 31, 2008, total gross profit increased $3,232,000 or 12.1%, as compared to the prior year. The year over year increase was primarily attributable to the strong growth in revenues in the Engineering & Evaluation segment, partially offset by lower gross profit in the Technical Solutions segment related to the decrease in revenues in that segment.

Engineering & Evaluation:

        For the year ended January 31, 2008, gross profit in the Engineering & Evaluation segment increased by $3,597,000 or 17.4%, as compared to the prior year, primarily due to the increase in revenues in higher margin contracts and the effect of fixed costs not increasing proportionately with sales which contributed to the increase in gross profit as a percentage of revenues.

Technical Solutions:

        For the year ended January 31, 2008, gross profit in the Technical Solutions segment decreased by $365,000 or 6.1%, as compared to the prior year, primarily as a result of the decrease in revenues. Gross profit margin as a percentage of revenues increased to 17.6% in the current year from 16.7% in the prior year. The decrease in revenues was primarily from lower margin contracts which contributed to the increase in the overall gross profit margin.

18


SELLING, GENERAL & ADMINISTRATIVE

 
  Twelve months ended January 31,
 
 
  2008
  % Change
  2007
 
 
  (Dollars in thousands)

 
Engineering & Evaluation   $ 18,349   11.9 % $ 16,391  
% to segment revenue     20.3 %       20.5 %
Technical Solutions     5,722   (1.1 )%   5,785  
% to segment revenue     18.0 %       16.2 %
   
     
 
Total   $ 24,071   8.5 % $ 22,176  
   
     
 
% to total revenue     19.7 %       19.2 %

        For the year ended January 31, 2008, total selling, general and administrative expenses increased $1,895,000 or 8.5%, as compared to the prior year. The year over year growth was primarily attributable to increased selling, general and administrative costs in the Engineering & Evaluation segment, offset by a slight reduction in selling, general and administrative costs in the Technical Solutions segment.

Engineering & Evaluation:

        For the year ended January 31, 2008, selling, general and administrative expenses increased by $1,958,000 or 11.9%, as compared to the prior year, primarily due to the increase in selling costs and incentive compensation associated with the increased revenues and margins discussed above and additional accounting fees related to Sarbanes Oxley section 404 costs.

Technical Solutions:

        For the year ended January 31, 2008, selling, general and administrative expenses decreased by $63,000 or 1.1% as compared to the prior year, primarily due to decreased depreciation expense, partially offset by increased wages for the additional high-level management hired in the current year to leverage the Engineering & Evaluation customers.

Equity Income from Non-Consolidated Subsidiary:

Engineering & Evaluation:

        For the year ended January 31, 2008, equity income from XXCAL Japan was $142,000, compared to $201,000 in the prior year. The decrease of $59,000 was primarily due to slightly lower revenues and increased wages related to preparation for embedded host and wireless USB testing. XXCAL Japan is 50% owned by NTS and is accounted for under the equity method since NTS does not have management or board control.

OPERATING INCOME

 
  Twelve months ended January 31,
 
 
  2008
  % Change
  2007
 
 
  (Dollars in thousands)

 
Engineering & Evaluation   $ 6,068   35.2 % $ 4,488  
% to segment revenue     6.7 %       5.6 %
Technical Solutions     (122 ) (167.8 )%   180  
% to segment revenue     (0.4 )%       0.5 %
   
     
 
Total   $ 5,946   27.4 % $ 4,668  
   
     
 
% to total revenue     4.9 %       4.0 %

19


        For the year ended January 31, 2008, operating income increased $1,278,000 or 27.4%, as compared to the prior year. The year over year increase was attributable to the higher gross profit, partially offset by the increase in selling, general and administrative expenses.

Engineering & Evaluation:

        For the year ended January 31, 2008, operating income increased by $1,580,000 or 35.2%, as compared to the prior year, as a result of the increase in revenues and gross profit as discussed above, partially offset by the increase in selling, general and administrative expenses.

Technical Solutions:

        For the year ended January 31, 2008, operating income decreased by $302,000 or 167.8%, as compared to the prior year, as a result of the decrease in gross profit discussed above, partially offset by a decrease in selling, general and administrative expenses.

Interest Expense

        Interest expense increased $149,000 in fiscal 2008 when compared to fiscal 2007 primarily due to additional borrowings for the USTL acquisition on December 5, 2007, partially offset by lower interest rate levels in fiscal 2008, as compared to the prior year.

Other Income

        Other income of $414,000 in fiscal 2008 is primarily attributable to proceeds received from insurance recoveries related to equipment damaged at the Company's Santa Clarita facility.

Income Taxes

        The provisional income tax rate for fiscal year 2008 is 38.8%, compared to 44.0% in the prior year. The decrease in the income tax rate in fiscal 2008 was primarily due to lower share-based compensation expense, which is a non-taxable expense and lower taxes for the Company's Calgary, Canada division. See Note 4 to the consolidated financial statements for a reconciliation of the provision for income taxes from continuing operations at the statutory rate to the provision for income taxes from continuing operations.

        Management has determined that it is more likely than not that the Company's deferred tax asset will be realized on the basis of offsetting it against deferred tax liabilities and future income. The Company analyzes the value of the deferred income tax asset quarterly in conjunction with external reporting.

Net Income

        In fiscal 2008, net income increased $1,034,000 to $2,615,000 as compared to the prior year, primarily due to the increase in operating income and the decrease in the income tax rate, partially offset by the increase in interest expense.

Business Environment

        The defense and aerospace markets generate approximately 56% of the Company's overall Engineering and Evaluation revenues. In recent years, domestic and worldwide political and economic developments have impacted positively the market demands for defense and advanced technology systems. Government research and development funding specifically for defense has increased this year. In addition, it is anticipated that both the commercial and military aerospace markets will continue to grow for the next several years. Also, the increase in government outsourcing activity has created additional opportunities for NTS. An example of the outsourcing activity is the increase in munitions and ordnance

20



work NTS has received this year from government bases. This type of work was historically done by the government directly. The Company is well equipped to handle this increase in demand.

        The trend in the telecommunications market appears to be stable in the short term and is expected to grow in the future. Carriers are deploying voice, video and data using fiber networks. This may increase the demand for certification of suppliers' premises equipment, and certification of additional central office equipment. The Company expects an increase in business demand as carriers upgrade networks packet-based Voice Over Internet Protocol (VOIP) devices. The Company is currently evaluating the overall compliance requirements for the deployment of Broadband wireless products and how best to position NTS to service the anticipated growth of this technology. The Company anticipates a moderate increase in the telecom business.

        The computer and electronics markets have been stable. The Company anticipates growth in these markets as it captures additional market share due to the planned international expansion. Currently NTS is developing compliance and interoperabiltiy testing for emerging technologies; Multimedia over Coax Cable (MoCA), Video Electronics Standards (VESA), WiMedia, satellite radio and electronic product compliance for Zune applications. In addition, the Company believes demand will increase for certification of "ZigBee" platforms and "ZigBee" Alliance-recognized products. The Company believes these compliance activities will have applicability in both the Asian and US markets.

        The transportation market and power markets have been stable with the Company continuing to experience a decrease in the transportation business at its Detroit facility, while the Company has recently experienced a moderate increase in the power business.

        In the Technical Solutions segment (TS), the Company provides a variety of staffing and workforce management services and solutions with a focus on IT and engineering. Over the past few years, the IT general services business transferred to off-shore facilities and became a commodity service for some of the Company's largest competitors. TS is positioning itself to provide its clients with resources and solutions from product concept to market entry by leveraging the Engineering & Evaluation aerospace, defense and telecommunications customers and aligning its services with the Engineering & Evaluation sales team.

        Notwithstanding the foregoing, and because of factors affecting the Company's operating results, past financial performance should not be considered to be a reliable indicator of future performance.

Liquidity and Capital Resources

        Summary of cash flows:

 
  FY 2008
  FY 2007
 
 
  (Dollars in thousands)

 
Net cash provided by operating activities   $ 6,022   $ 6,253  
Net cash used in investing activities     (18,387 )   (9,280 )
Net cash provided by financing activities     11,991     2,117  
Effect of exchange rate changes on cash     16     (65 )
   
 
 
Net decrease in cash   $ (358 ) $ (975 )
   
 
 

        Net cash provided by operating activities of $6,022,000 in fiscal 2008 consisted of net income of $2,615,000, adjusted for non-cash items of $6,155,000 in depreciation and amortization, share-based compensation of $388,000, and $422,000 in other non-cash items, partially offset by $2,908,000 of changes in working capital, $291,000 in deferred income taxes and $359,000 in net gain on insurance claim. Net cash provided by operating activities of $6,253,000 in fiscal 2007 consisted of net income of $1,581,000, adjusted for non-cash items of $5,822,000 in depreciation and amortization, share-based compensation of $569,000, partially offset by $1,658,000 of changes in working capital and $61,000 in other non-cash items.

21


        Net cash used in investing activities in fiscal 2008 of $18,387,000 was primarily attributable to capital spending of $5,100,000, total cash used for acquisitions of $13,082,000, which consisted of cash used to acquire TRA Certification, Inc. ("TRA") of $471,000 and cash used to acquire United States Test Laboratory, LLC ("USTL") of $12,611,000, and cash used for investment in retirement funds of $363,000. Capital spending is generally comprised of purchases of machinery and equipment, building, leasehold improvements, computer hardware, software and furniture and fixtures. Cash used in investing activities increased from fiscal 2007 to fiscal 2008 by $9,107,000 primarily as a result of the increase in cash used for acquisitions, partially offset by a decrease of $928,000 in capital spending on property, plant and equipment, and net proceeds from insurance claim of $359,000. Net cash used for investing activities in fiscal 2007 of $9,280,000 was primarily attributable to capital spending of $6,028,000, cash used to acquire American International Registrars Corporation ("AIR") of $386,000, cash used to acquire B&B Technologies of $414,000 and cash used to acquire Dynamic Labs of $2,254,000.

        Net cash provided by financing activities in fiscal 2008 of $11,991,000, consisted primarily of proceeds from borrowings of $24,697,000 and proceeds from stock options exercised of $402,000, partially offset by repayment of debt of $13,058,000. Net cash provided by financing activities in fiscal 2007 of $2,117,000, consisted of proceeds from borrowings of $15,326,000, proceeds from stock options exercised of $633,000, partially offset by repayment of debt of $9,949,000, and common stock repurchase of $3,893,000 from a former executive officer and director of the Company.

        On December 5, 2007, the Company entered into an Amendment No. 9 to the Revolving Credit Agreement with Comerica Bank, as agent and lender, holding 60%, and First Bank, as lender, holding 40% (the "Amendment"). This agreement matures on December 1, 2012. The amendment included the following changes: (a) $16,500,000 revolving line of credit with interest rate at the agent's prime rate less 25 basis points, with an option for the Company to convert to loans at the Libor rate plus 200 basis points for periods ranging from 30 days to 365 days, with minimum advances of $1,000,000. There is an annual fee of 25 basis points and a quarterly unused credit fee of 25 basis points. The outstanding balance on the revolving line of credit at January 31, 2008 was $9,500,000. This balance is reflected in the accompanying consolidated balance sheets as long-term. The amount available on the line of credit was $7,000,000 as of January 31, 2008. (b) $9,000,000 in Term Loan A which was used to consolidate previous term loans. The interest rate is at the agent's prime rate less 25 basis points, with an option for the Company to convert to loans at the Libor rate plus 225 basis points for periods ranging from 30 days to 365 days, with minimum advances of $1,000,000. The principal amount is amortized over a 7 year period. (c) $12,650,000 in Term Loan B which was used to acquire USTL on December 5, 2007. The interest rate is at the agent's prime rate less 25 basis points, with an option for the Company to convert to loans at the Libor rate plus 225 basis points for periods ranging from 30 days to 365 days, with minimum advances of $1,000,000. The principal amount is amortized at the rate of 0% during the first year of the note, 5% in the second year, 10% in the third year and 15% in the fourth and fifth years.

        In addition to the Comerica agreement, the Company has two mortgage notes with other banks on land and buildings owned by the Company in Massachusetts and California with interest rates of 5.5% and 9.0% in the aggregate amount of $1,957,000 and an additional $775,000 in equipment line balances which were used to finance various test equipment with terms of 60 months for each equipment schedule at interest rates ranging from 5.56% to 7.47%. The Company was in compliance with all of the covenants with its banks at January 31, 2008.

        Management is not aware of any significant demands for capital funds that may materially affect short or long-term liquidity in the form of large fixed asset acquisitions, unusual working capital commitments or contingent liabilities. In addition, the Company has made no material commitments for capital expenditures. The Company's long-term debt may be accelerated if the Company fails to meet its covenants with its banks. The Company believes that the cash flow from operations and the revolving line of credit will be sufficient to fund its operations for the next twelve months.

22



ITEM 7A.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Interest Rate Risk

        The Company is exposed to changes in interest rates primarily from its long-term revolving line of credit arrangement. Under its current policies, the Company does not use interest rate derivative instruments to manage exposure to interest rate changes. A hypothetical one percentage point adverse move in interest rates along the entire interest rate yield curve would adversely affect interest expense by $312,000 at January 31, 2008 as compared to $88,000 at January 31, 2007.

Impact of Inflation

        The Company continues to incur increased costs in the areas of wages, insurance, workers compensation, and utilities which it cannot pass along to customers in the current economic environment. To date, these increases have been partially offset by reductions in other operating areas through improved efficiencies. The Company can give no assurances, however, that in the future it can offset such increased costs.

23


ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.


Index to Consolidated Financial Statements and Schedule

 
   
Report of Independent Registered Public Accounting Firm   25

Financial Statements:

 

 
 
Consolidated Balance Sheets—January 31, 2008 and 2007

 

26
 
Consolidated Statements of Income—Years ended January 31, 2008 and 2007

 

27
 
Consolidated Statements of Shareholders' Equity—Years ended January 31, 2008 and 2007

 

28
 
Consolidated Statements of Cash Flows—Years ended January 31, 2008 and 2007

 

29
 
Notes to Consolidated Financial Statements

 

30

    

 

 

 

 

Schedule


 

 

 

Schedule Supporting Financial Statements:

 

 
 
Valuation and Qualifying Accounts and Reserves

 

II

All other schedules are omitted as inapplicable or because the required information is contained in the financial statements or the notes thereto.

24



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Shareholders
National Technical Systems, Inc.

        We have audited the accompanying consolidated balance sheets of National Technical Systems, Inc. and Subsidiaries as of January 31, 2008 and 2007, and the related consolidated statements of income, shareholders' equity, and cash flows for the years then ended. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. The financial statements of NQA, Inc., a corporation in which the Company has an 50.1% interest and whose financial statements are consolidated with those of the Company, have been audited by other auditors whose report has been furnished to us, and our opinion on the consolidated financial statements, insofar as it relates to the amounts included for NQA, is based solely on the report of the other auditors. In the consolidated financial statements, NQA's total assets constitute $3,044,000 in 2008 and $2,597,000 in 2007 and total revenues constitute $8,419,000 in 2008 and $7,463,000 in 2007 of the related consolidated totals. Also, the financial statements of XXCAL Japan, a corporation in which the Company has a 50% interest and is accounted for under the equity method, have been audited by other auditors whose report has been furnished to us, and our opinion on the consolidated financial statements, insofar as it relates to the amounts included for XXCAL Japan, is based solely on the report of the other auditors. In the consolidated financial statements, the Company's investment in XXCAL Japan is stated at $1,362,000 and $1,220,000, respectively, at January 31, 2008 and 2007, and the Company's equity in the net income of XXCAL Japan is stated at $142,000 and $201,000 for the years ended January 31, 2008 and 2007, respectively.

        We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company's internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits and the report of other auditors provide a reasonable basis for our opinion.

        In our opinion, based on our audits and the report of other auditors, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of National Technical Systems, Inc. and Subsidiaries at January 31, 2008 and 2007, and the consolidated results of their operations and their cash flows for the years then ended in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.

                        /s/ Ernst & Young LLP

Los Angeles, California
April 25, 2008

25



NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

January 31,

 
  2008
  2007
 
ASSETS              
CURRENT ASSETS:              
  Cash   $ 2,863,000   $ 3,221,000  
  Investments     363,000      
  Accounts receivable, net of allowance for doubtful accounts of $907,000 at January 31, 2008 and $691,000 at January 31, 2007     23,925,000     21,900,000  
  Income taxes receivable     327,000      
  Inventories     2,915,000     2,892,000  
  Deferred income taxes     2,216,000     1,690,000  
  Prepaid expenses and other current assets     1,330,000     958,000  
   
 
 
    Total current assets     33,939,000     30,661,000  
Property, plant and equipment, at cost              
  Land     1,415,000     1,415,000  
  Buildings     10,241,000     10,238,000  
  Machinery and equipment     83,423,000     78,513,000  
  Leasehold improvements     11,886,000     11,323,000  
   
 
 
    Total property, plant and equipment     106,965,000     101,489,000  
Less: accumulated depreciation     (71,914,000 )   (66,055,000 )
   
 
 
  Net property, plant and equipment     35,051,000     35,434,000  
Goodwill     10,471,000     4,126,000  
Intangible assets     6,677,000     245,000  
Other assets     4,754,000     4,373,000  
   
 
 
    TOTAL ASSETS   $ 90,892,000   $ 74,839,000  
   
 
 
LIABILITIES AND SHAREHOLDERS' EQUITY              
CURRENT LIABILITIES:              
  Accounts payable   $ 6,090,000   $ 5,843,000  
  Accrued expenses     5,857,000     5,213,000  
  Income taxes payable         401,000  
  Deferred revenue     959,000     832,000  
  Current installments of long-term debt     1,888,000     3,285,000  
   
 
 
    Total current liabilities     14,794,000     15,574,000  
Long-term debt, excluding current installments     32,274,000     19,238,000  
Deferred income taxes     5,148,000     5,052,000  
Deferred compensation     986,000     946,000  
Minority interest liability     335,000     250,000  
Commitments and contingencies              
SHAREHOLDERS' EQUITY:              
  Preferred stock, no par value, 2,000,000 shares authorized; none issued          
  Common stock, no par value. Authorized, 20,000,000 shares; issued and outstanding, 8,846,000 as of January 31, 2008 and 8,717,000 as of January 31, 2007     13,769,000     12,863,000  
  Retained earnings     23,486,000     20,971,000  
  Accumulated other comprehensive income (loss)     100,000     (55,000 )
   
 
 
    Total shareholders' equity     37,355,000     33,779,000  
   
 
 
  TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY   $ 90,892,000   $ 74,839,000  
   
 
 

See accompanying notes.

26



NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES

Consolidated Statements of Income

Years Ended January 31,

 
  2008
  2007
 
Net revenues   $ 122,376,000   $ 115,673,000  
Cost of sales     92,501,000     89,030,000  
   
 
 
Gross profit     29,875,000     26,643,000  
Selling, general and administrative expense     24,071,000     22,176,000  
Equity income from non-consolidated subsidiary     (142,000 )   (201,000 )
   
 
 
Operating income     5,946,000     4,668,000  
Other income (expense):              
  Interest expense, net     (1,950,000 )   (1,801,000 )
  Other income, net     414,000     111,000  
   
 
 
Total other expense, net     (1,536,000 )   (1,690,000 )
Income before income taxes and minority interest     4,410,000     2,978,000  
Income taxes     1,711,000     1,309,000  
   
 
 
Income before minority interest     2,699,000     1,669,000  
Minority interest in earnings     (84,000 )   (88,000 )
   
 
 
Net income   $ 2,615,000   $ 1,581,000  
   
 
 
Net income per common share:              
  Basic   $ 0.30   $ 0.18  
   
 
 
  Diluted   $ 0.28   $ 0.17  
   
 
 
Weighted average common shares outstanding     8,795,000     8,705,000  
Dilutive effect of stock options     662,000     800,000  
   
 
 
Weighted average common shares outstanding, assuming dilution     9,457,000     9,505,000  
   
 
 

See accompanying notes.

27



NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES

Consolidated Statements of Shareholders' Equity

 
  Number of Shares
  Common Stock Amount
  Retained Earnings
  Accumulated Other Comprehensive Income (Loss)
  Total Shareholders' Equity
 
Balance at January 31, 2006   9,176,000   $ 14,624,000   $ 19,744,000   $ 10,000   $ 34,378,000  
   
 
 
 
 
 
Correction of deferred tax error from prior years           (354,000 )       (354,000 )
Net income           1,581,000         1,581,000  
Foreign currency translation               (65,000 )   (65,000 )
                         
 
  Comprehensive income                           1,516,000  
Stock options exercised   281,000     839,000             839,000  
Stock retired for option exercise   (31,000 )   (206,000 )           (206,000 )
Issuance of restricted stock       32,000             32,000  
Share-based compensation       537,000             537,000  
Tax benefit from stock options exercise       282,000             282,000  
Stock repurchase   (792,000 )   (3,893,000 )           (3,893,000 )
Stock issued for acquisition of B&B Technologies   83,000     648,000             648,000  
   
 
 
 
 
 
Balance at January 31, 2007   8,717,000   $ 12,863,000   $ 20,971,000   $ (55,000 ) $ 33,779,000  
   
 
 
 
 
 
Net income           2,615,000         2,615,000  
Foreign currency translation               16,000     16,000  
Unrealized gain on securities available for sale, net of tax effect of $78,000               139,000     139,000  
                         
 
  Comprehensive income                           2,770,000  
Stock options exercised   123,000     430,000             430,000  
Stock retired for option exercise   (5,000 )   (28,000 )           (28,000 )
Vesting of restricted stock   11,000                  
Issuance of restricted stock       123,000             123,000  
Share-based compensation       236,000             236,000  
Tax benefit from stock options exercise       116,000             116,000  
Tax benefit from distribution of restricted stock       29,000             29,000  
Cash dividends paid by NQA,
Inc. 
          (100,000 )       (100,000 )
   
 
 
 
 
 
Balance at January 31, 2008   8,846,000   $ 13,769,000   $ 23,486,000   $ 100,000   $ 37,355,000  
   
 
 
 
 
 

See accompanying notes.

28



NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES

Unaudited Consolidated Statements of Cash Flows

for the Twelve Months Ended January 31, 2008 and 2007

 
  2008
  2007
 
CASH FLOWS FROM OPERATING ACTIVITIES:              
Net income   $ 2,615,000   $ 1,581,000  
Adjustments to reconcile net income to net cash provided by operating activities:              
  Depreciation and amortization     6,155,000     5,822,000  
  Write-off (recoveries) of receivables     217,000     (125,000 )
  Loss on retirement of assets     5,000     23,000  
  Undistributed earnings of affiliate     84,000     88,000  
  Deferred income taxes     (291,000 )   (329,000 )
  Tax benefit from stock option exercises     116,000     282,000  
  Share based compensation     388,000     569,000  
  Net gain on insurance claim     (359,000 )    
  Changes in operating assets and liabilities (net of acquisitions):              
    Accounts receivable     (2,242,000 )   (1,102,000 )
    Inventories     (23,000 )   (673,000 )
    Prepaid expenses     (369,000 )   (157,000 )
    Other assets and intangibles     (230,000 )   (244,000 )
    Accounts payable     (106,000 )   896,000  
    Accrued expenses     623,000     (229,000 )
    Income taxes payable     (401,000 )   (193,000 )
    Deferred income     127,000     (38,000 )
    Deferred compensation     40,000     72,000  
    Income taxes receivable     (327,000 )   10,000  
   
 
 
Net cash provided by operating activities     6,022,000     6,253,000  
CASH FLOWS FROM INVESTING ACTIVITIES:              
  Purchase of property, plant and equipment     (5,100,000 )   (6,028,000 )
  Investment in life insurance     (201,000 )   (197,000 )
  Acquisitions of businesses, net of cash acquired     (13,082,000 )   (3,055,000 )
  Net proceeds from insurance claim     359,000      
  Investment in retirement funds     (363,000 )    
   
 
 
Net cash used in investing activities     (18,387,000 )   (9,280,000 )
CASH FLOWS FROM FINANCING ACTIVITIES:              
  Proceeds from current and long-term debt     24,697,000     15,326,000  
  Repayments of current and long-term debt     (13,058,000 )   (9,949,000 )
  Net cash dividends paid by NQA, Inc.      (50,000 )    
  Proceeds from stock options exercised     402,000     633,000  
  Common stock repurchase         (3,893,000 )
   
 
 
Net cash provided by financing activities     11,991,000     2,117,000  
   
 
 
Effect of exchange rate changes on cash     16,000     (65,000 )
   
 
 
Net decrease in cash     (358,000 )   (975,000 )
Beginning cash balance     3,221,000     4,196,000  
   
 
 
ENDING CASH BALANCE   $ 2,863,000   $ 3,221,000  
   
 
 
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION              
Cash payments during the year for:              
  Interest   $ 1,637,000   $ 1,837,000  
  Income taxes   $ 2,211,000   $ 1,487,000  

See accompanying notes.

29



NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

January 31, 2008

(1)    Summary of Significant Accounting Policies

Principles of Consolidation

        The consolidated financial statements include the accounts of National Technical Systems, Inc. ("NTS" or the "Company") and its subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

        The Company has consolidated NQA, Inc., a 50% owned subsidiary for which the distribution of profits and losses is 50.1% to the Company, and 49.9% to the other shareholder. NTS controls the management decisions and elects the president of NQA, Inc. and therefore has operating control of the subsidiary.

        XXCAL Japan is a 50% owned subsidiary which started in fiscal 1999 and is accounted for under the equity method since NTS does not have operating control. XXCAL Japan's financial statements are prepared in accordance with generally accepted accounting principles in Japan. There are no material adjustments that need to be made to XXCAL Japan's financial statements for them to be in conformity with U.S. generally accepted accounting principles. The equity investment recorded in the accompanying balance sheets is $1,362,000 and $1,220,000 at January 31, 2008 and 2007, respectively. The Company's equity earnings recorded in the accompanying income statements totaled $142,000 and $201,000 for the years ended January 31, 2008 and 2007, respectively.

Risks and Uncertainties

        The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Estimates made by the Company relate primarily to the recognition of revenue under long-term contracts, the valuation of goodwill and other intangible assets useful lives for depreciation and amortization, share-based compensation and accounting for income taxes. Actual results could differ from those estimates.

        The Company performs ongoing credit evaluations of its customers' financial condition and generally requires no collateral.

Revenue Recognition

        Revenues are derived from development, qualification and production testing and engineering services for commercial products, space systems and military equipment of all types. The Company also provides technical staffing, qualification of safety related systems and components, and ISO 9000 certification services.

        Revenue from fixed price testing contracts is generally recorded upon completion of the contracts, which are generally short-term, or upon completion of identifiable contractual tasks. At the time the Company enters into a contract that includes multiple tasks, the Company estimates the amount of actual labor and other costs that will be required to complete each task based on historical experience. Revenues are recognized which provide for a profit margin relative to the testing performed. Revenue relative to each task and from contracts which are time and materials based is recorded as effort is expended. Billings in excess of amounts earned are deferred. Any anticipated losses on contracts are charged to income when identified and can be reasonably estimated. To the extent management does not accurately forecast the

30


NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

January 31, 2008

(1)    Summary of Significant Accounting Policies (Continued)


level of effort required to complete a contract, or individual tasks within a contract, and the Company is unable to negotiate additional billings with a customer for cost over-runs, the Company may incur losses on individual contracts. All selling, general and administrative costs are treated as period costs and expensed as incurred.

        Reimbursements made to the Company by customers under contract provisions, including those related to travel and other out-of-pocket expenses are recorded as revenues. An equivalent amount of reimbursable expenses is recorded as cost of sales.

Inventories

        Inventories consist of accumulated costs including direct labor, material and overhead applicable to uncompleted contracts and are stated at actual cost, which is not in excess of estimated net realizable value. Such inventories for each contract are reviewed on a monthly basis over the life of the contract and additional write-downs of inventories are made if there are insufficient revenues remaining on the contract.

Property Held for Sale

        The Company has listed approximately 120 acres of its Santa Clarita, California land for sale, but because it does not meet all the criteria for accounting classification as an "asset held for sale" as defined in Statement of Financial Accounting Standards ("SFAS") No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets," it was not classified as such in the accompanying consolidated financial statements.

Property, Plant and Equipment

        Property, plant, and equipment is stated at actual cost and is depreciated or amortized using the straight-line method over the following estimated useful lives:

Buildings   30 to 35 years
Machinery and equipment   3 to 20 years
Leasehold improvements   Terms of lease, or estimated useful life
(whichever is less)

Intangible Assets

        The Company accounts for goodwill and other intangible assets in accordance with SFAS No. 141 "Business Combinations" and SFAS No. 142 "Goodwill and Other Intangible Assets."

        Under SFAS No. 142, goodwill and intangible assets that have indefinite useful lives are not amortized but are tested at least annually for impairment. The goodwill test for impairment consists of a two-step process that begins with an estimation of the fair value of the reporting unit. The first step of the test is a screen for potential impairment and the second step measures the amount of impairment, if any. The first step of the goodwill impairment test includes a comparison of the fair value of each reporting unit that has associated goodwill with the carrying value of the reporting unit. The Company has identified five reporting units in the Engineering and Evaluation segment and one reporting unit in the Technical

31


NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

January 31, 2008

(1)    Summary of Significant Accounting Policies (Continued)


Solutions segment, which constitute components of its business that include goodwill. The Company completed its annual goodwill impairment test and has determined that the fair value of each of the reporting units exceeded the reporting unit's carrying amount, and no impairment was indicated.

Long-Lived Assets

        In accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", the Company periodically evaluates the recoverability of the carrying amount of long-lived assets (including property, plant and equipment, and intangible assets with determinable lives) whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable. The Company evaluates events or changes in circumstances based on a number of factors including operating results, business plans and forecasts, general and industry trends and economic projections and anticipated cash flows. An impairment loss is recorded when the undiscounted expected future cash flows derived from an asset are less than its carrying amount. Impairment losses are measured as the amount by which the carrying value of an asset exceeds its fair value and are recognized in earnings.

Share-Based Compensation

        Effective February 1, 2006, the Company adopted the provisions of SFAS No. 123(R) "Share-Based Payment". SFAS No. 123(R) requires employee stock options and rights to purchase shares under stock participation plans to be accounted for under the fair value method and requires the use of an option pricing model for estimating fair value. Accordingly, share-based compensation is measured at grant date, based on the fair value of the award. The Company previously accounted for awards granted under its equity incentive plans under the intrinsic value method prescribed by Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations, and provided the required pro forma disclosures prescribed by SFAS No. 123, "Accounting for Stock-Based Compensation," as amended. The exercise price of options is equal to the market price of National Technical Systems, Inc. common stock (defined as the closing price reported by the NASDAQ global market) on the date of grant. Accordingly, no share-based compensation, other than acquisition-related compensation, was recognized in the financial statements prior to February 1, 2006.

        The Company used the modified prospective method of adoption for SFAS No. 123(R), under which the compensation cost recognized by the Company beginning in fiscal 2007 includes (a) compensation cost for all equity incentive awards granted prior to, but not yet vested as of February 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123, and (b) compensation cost for all equity incentive awards granted subsequent to February 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS No. 123(R). The Company uses the straight-line attribution method to recognize share-based compensation costs over the service period of the award. Upon exercise, cancellation, or expiration of non qualified stock options, deferred tax assets for options with multiple vesting dates are eliminated for each vesting period on a first-in, first-out basis as if each vesting period was a separate award. To calculate the excess tax benefits available for use in offsetting future tax shortfalls as of the date of implementation, the Company followed the alternative transition method discussed in FASB Staff Position No. 123(R)-3.

        No options have been granted by the Company during fiscal years 2008 or 2007. Options to be granted to existing and newly hired employees or directors will generally vest over a four-year period from the date

32


NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

January 31, 2008

(1)    Summary of Significant Accounting Policies (Continued)


of grant. The Company may also assume the equity incentive plans and the outstanding equity awards of certain acquired companies. Once assumed, the Company does not grant additional stock under these plans. The Company may use other types of equity incentive awards, such as restricted stock. The Company's equity incentive plan also allows for performance-based vesting for equity incentive awards.

        Share-based compensation is based on the Black-Scholes-Merton option pricing model for estimating fair value of options granted under the Company's equity incentive plans and rights to acquire stock granted under the Company's stock participation plan.

        Compensation expense related to non-vested shares represents the fair value of the shares at the date of the grant, net of assumptions regarding estimated future forfeitures, and is charged to earnings over the vesting period.

        In accordance with SFAS No. 123(R), the Company adjusts share-based compensation on a quarterly basis for changes to the estimate of expected equity award forfeitures based on actual forfeiture experience. The effect of adjusting the forfeiture rate is recognized in the period the forfeiture estimate is changed. The effect of forfeiture adjustments for fiscal years 2008 and 2007 was immaterial.

Accounting for Income Taxes

        Income taxes are accounted for under the liability method in accordance with SFAS No. 109 "Accounting for Income Taxes". Deferred income taxes are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is recorded, if necessary, to reduce deferred tax assets to an amount management believes is more likely than not to be realized.

        In July 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109" ("FIN 48"). This Interpretation was effective for the fiscal year beginning February 1, 2007. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 requires the recognition of penalties and interest on any unrecognized tax benefits. The Company's policy is to reflect penalties and interest as part of income tax expense when and if they become applicable.

        The Company has reviewed its positions in recording income and expenses and has no reason to record a liability under the provisions of FIN 48. The Company files income tax returns in the United States ("U.S.") on a federal basis and in many U.S. state and foreign jurisdictions. Certain tax years remain open to examination by the major taxing jurisdictions to which the Company is subject. The Company does not anticipate that its total unrecognized tax benefits will significantly change due to the settlement of examinations or the expiration of statutes of limitations during the next twelve months.

33


NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

January 31, 2008

(1)    Summary of Significant Accounting Policies (Continued)

Comprehensive Income

        In accordance with SFAS No. 130, "Reporting Comprehensive Income", the Company is required to report and display the components of comprehensive income, including unrealized gains or losses on marketable securities and foreign currency translation adjustments. Accumulated other comprehensive income was $100,000 as of January 31, 2008 and accumulated other comprehensive loss was $55,000 as of January 31, 2007.

Earnings Per Share

        Basic and diluted net income per common share is presented in conformity with SFAS No. 128, "Earnings Per Share" for all periods presented. In accordance with SFAS No. 128, basic earnings per share has been computed using the weighted average number of shares of common stock outstanding during the year. Basic earnings per share excludes any dilutive effects of options, warrants and convertible securities and non-vested restricted shares. Diluted earnings per share excludes any non-vested restricted shares with an anti-dilutive effect.

Foreign Currency

        The accounts of the foreign divisions are translated into United States dollars in accordance with SFAS No. 52, "Foreign Currency Translation". All balance sheet accounts, except for certain fixed assets accounts, have been translated using the current rate of exchange at the balance sheet date. Results of operations have been translated using the average rates prevailing throughout the year. Translation gains or losses resulting from the changes in the exchange rates from year-to-year are accumulated in a separate component of shareholders' equity. The translation of the balance sheet accounts resulted in $16,000 in unrealized gain and $65,000 in unrealized loss in fiscal years 2008 and 2007, respectively. In addition, a transaction gain of $132,000 and a transaction loss of $2,000 for the fiscal years 2008 and 2007, respectively, are included in operating income for each period.

Related Party Transactions

        NTS provides management and consulting services to NQA, Inc. for an agreed-upon management fee. Such services include, but are not limited to, advice and assistance concerning any and all aspects of the operations of the Company. Management fees earned by the Company for fiscal 2008 and 2007 were $407,000 and $475,000, respectively.

        NQA, Ltd., the minority shareholder of NQA, Inc., provides certification oversight and advice and processes and issues ISO registration certificates. NQA, Ltd. charges NQA, Inc. an agreed-upon fee for each certificate in place at the beginning of the year and issued during the year together with the appropriate United Kingdom Accreditation Service ("UKAS") and Raad voor Accreditatie ("RVA") levy. Certification fees for fiscal 2008 and 2007 were $407,000 and $475,000, respectively.

        NQA, Inc. leases space from NTS and was assessed $71,000 for rent and utilities in fiscal years 2008 and 2007.

34


NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

January 31, 2008

(1)    Summary of Significant Accounting Policies (Continued)

Reclassifications

        Certain amounts in the prior year financial statements have been reclassified to conform to the current year financial statement presentation.

Recently Issued Accounting Standards

        In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements" ("SFAS 157"), which clarifies the definition of fair value, establishes guidelines for measuring fair value, and expands disclosures regarding fair value measurements. SFAS 157 does not require any new fair value measurements and eliminates inconsistencies in guidance found in various prior accounting pronouncements. SFAS 157 will be effective for the Company on February 1, 2008. However, on February 12, 2008, the FASB issued FSP FAS 157-2 which delays the effective date of SFAS 157 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). This FSP partially defers the effective date of SFAS 157 to fiscal years beginning after November 15, 2008, and interim periods within those fiscal years for items within the scope of this FSP. Effective for 2008, the Company will adopt SFAS 157 except as it applies to those nonfinancial assets and nonfinancial liabilities as noted in FSP FAS 157-2. The partial adoption of SFAS 157 is not expected to have a material impact on our consolidated financial position, cash flows, or results of operations.

        In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities"("SFAS 159") which permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. SFAS 159 will be effective for the Company on February 1, 2008. The Company is currently evaluating the impact of adopting SFAS 159 on its financial position, cash flows and results of operations.

        In December 2007, the FASB issued SFAS No. 141 (revised 2007), "Business Combinations" ("SFAS 141R") and SFAS No. 160, "Accounting and Reporting of Noncontrolling Interest in Consolidated Financial Statements, an amendment of ARB 51" ("SFAS 160"), which will change the accounting for and reporting of business combination transactions and noncontrolling interests in consolidated financial statements. SFAS 141R and SFAS 160 will be effective for the Company on February 1, 2009. We are currently evaluating the impact of adopting SFAS 141R and SFAS 160 on our consolidated financial position, cash flows, and results of operations.

(2)    Business Acquisitions

Acquisition of TRA Certification, Inc.

        On May 31, 2007, NQA USA, Inc., a 50% owned consolidated subsidiary of NTS, acquired the assets of TRA Certification, Inc. ("TRA"), located in Elkhart, Indiana, for a total purchase price of $821,000. The Company paid $471,000 in cash and will pay an additional $350,000 which is payable in five annual payments of $70,000 each, starting upon the first anniversary of the purchase. All existing TRA customers and associated certifications and backlog were transferred to NQA, USA. The preliminary purchase price was allocated $350,000 to covenant not to compete, $207,000 to customer relationships and $264,000 to goodwill. The results of operations for TRA are included in the Company's consolidated statement of

35


NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

January 31, 2008

(2)    Business Acquisitions (Continued)


income from June 1, 2007 to January 31, 2008. The purchase price allocation has not been finalized, pending further information that may impact the valuation of certain assets or liabilities.

Acquisition of United States Test Laboratory, LLC

        On December 5, 2007, the Company acquired all of the outstanding membership interests of United States Test Laboratory, L.L.C. ("USTL"), located in Wichita, Kansas, pursuant to an Interests Purchase Agreement between NTS and USTL. Under the terms of the Interests Purchase Agreement, the Company paid to the sellers at the closing an aggregate of $12,500,000, of which $750,000 was deposited into a third-party escrow as security for indemnification claims the Company may have against the sellers under the agreement. The amount remaining in the escrow will be released to the sellers on June 5, 2009, except for amounts subject to pending indemnification claims, if any. In addition, the Company agreed to pay to the sellers up to $1,800,000 in earnout consideration contingent upon the achievement by USTL of certain revenue targets over the 24 months immediately following the closing of the agreement. This will be added to the purchase price and result in an increase to goodwill if and when the requirements are met and the contingency is removed. The President of USTL will continue to be employed at USTL as General Manager.

        The aggregate purchase price is comprised of the following:

Cash paid to sellers   $ 11,750,000  
Cash deposited in escrow     750,000  
Acquisition costs     282,000  
Cash received from sellers     (171,000 )
   
 
    $ 12,611,000  
   
 

        The purchase price allocation has not been finalized pending further information that may impact the valuation of certain assets or liabilities. We allocated the aggregated purchase price of approximately $12,611,000 to the estimated fair value at the date of acquisition of the acquired tangible and intangible assets and assumed liabilities of USTL as follows:

Prepaid expense   $ 3,000  
Property, plant and equipment     431,000  
Goodwill     6,081,000  
Other intangibles     6,120,000  
Accounts payable     (3,000 )
Other accrued liabilities     (21,000 )
   
 
    $ 12,611,000  
   
 

        The excess of the purchase price over the estimated fair value of the assets acquired and liabilities assumed amounted to $6,081,000, which was allocated to goodwill and is deductible for tax purposes. The results of operations for USTL are included in the Company's consolidated statement of income from December 5, 2007 to January 31, 2008.

36


NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

January 31, 2008

(2)    Business Acquisitions (Continued)

        The following unaudited pro forma information presents the results of operations of the Company as if the acquisition of USTL had taken place at the beginning of the applicable periods:

 
  January 31, 2008
  January 31, 2007
Net revenues     126,888,000     119,144,000
Net income     3,960,000     2,215,000
Earnings per diluted share   $ 0.42   $ 0.23

        A breakdown of the intangible assets acquired is as follows:

 
  Fair Value
  Estimated Useful Life
Covenants not to compete   $ 200,000   10 years
Customer relationships     5,700,000   15 years
Trademarks and tradenames     200,000   Indefinite
Accreditations and certifications     20,000   5 years
   
   
    $ 6,120,000    

(3)    Debt

        Long-term debt consists of the following:

 
  2008
  2007
Revolving lines of credit (a)   $ 9,500,000   $ 8,843,000
Term loan A (b)     9,000,000    
Term loan B (c)     12,650,000    
Notes payable secured by land and buildings     1,957,000     2,415,000
Secured and other notes payable     1,055,000     11,265,000
   
 
Subtotal     34,162,000     22,523,000
Less current installments     1,888,000     3,285,000
   
 
Total   $ 32,274,000   $ 19,238,000
   
 

On December 5, 2007, the Company entered into an Amendment No. 9 to the Revolving Credit Agreement with Comerica Bank, as agent and lender, holding 60%, and First Bank, as lender, holding 40% (the "Amendment"). This agreement matures on December 1, 2012. Under the Amendment, the credit facility was restructured as follows:

    (a)
    $16,500,000 revolving line of credit with interest rate at the agent's prime rate (6.0% at January 31, 2008) less 25 basis points, with an option for the Company to convert to loans at the Libor rate (ranging from 2.98% to 3.26% at January 31, 2008) plus 200 basis points for periods ranging from 30 days to 365 days, with minimum advances of $1,000,000. There is an annual fee of 25 basis points and a quarterly unused credit fee of 25 basis points. The outstanding balance on the revolving line of credit at January 31, 2008 was $9,500,000. This balance is reflected in the

37


NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

January 31, 2008

(3)    Debt (Continued)

      accompanying consolidated balance sheets as long-term. The amount available on the line of credit was $7,000,000 as of January 31, 2008.

    (b)
    $9,000,000 in Term Loan A which was used to consolidate previous term loans. The interest rate is at the agent's prime rate (6.0% at January 31, 2008) less 25 basis points, with an option for the Company to convert to loans at the Libor rate (ranging from 2.98% to 3.26% at January 31, 2008) plus 225 basis points for periods ranging from 30 days to 365 days, with minimum advances of $1,000,000. Interest and principal payments of $321,000 are made quarterly with the remaining principal due at the maturity date.

    (c)
    $12,650,000 in Term Loan B which was used to acquire United States Test Laboratory on December 5, 2007. The interest rate is at the agent's prime rate (6.0% at January 31, 2008) less 25 basis points, with an option for the Company to convert to loans at the Libor rate (ranging from 2.98% to 3.26% at January 31, 2008) plus 225 basis points for periods ranging from 30 days to 365 days, with minimum advances of $1,000,000. Interest is paid quarterly and the principal amount is amortized at the rate of 0% during the first year of the note, 5% in the second year, 10% in the third year and 15% in the fourth and fifth years. The remaining principal is due at the maturity date.

        In addition to the Comerica agreement, the Company has two mortgage notes with other banks on land and buildings owned by the Company in Massachusetts and California with interest rates of 5.5% and 9.0% in the aggregate amount of $1,957,000, an additional $775,000 in equipment line balances which were used to finance various test equipment with terms of 60 months for each equipment schedule at interest rates ranging from 5.56% to 7.47% and a $280,000 note payable for a covenant not to compete related to the TRA acquisition. The Company was in compliance with all of the covenants with its banks at January 31, 2008.

        Maturities of long-term debt for five years subsequent to January 31, 2008 are as follows:

2009   $ 1,888,000
2010     2,634,000
2011     2,696,000
2012     3,340,000
2013     22,375,000
Thereafter     1,229,000
   
    $ 34,162,000
   

        In accordance with the requirements of SFAS No. 107, "Disclosure about Fair Value of Financial Instruments", a reasonable estimate of fair value for the Company's fixed rate debt was based on a discounted cash flow analysis. The carrying amount of variable rate debt, including borrowings under the Company's revolving lines of credit, approximate their fair values.

38


NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

January 31, 2008

(3)    Debt (Continued)

        The carrying amounts and estimated fair values of the Company's financial instruments are:

 
  2008
Carrying
amount

  2008
Estimated
fair value

  2007
Carrying
amount

  2007
Estimated
fair value

Notes payable   $ 1,957,000   $ 1,987,000   $ 2,415,000   $ 2,451,000
Secured and other notes payable     22,705,000     18,876,000     11,265,000     8,359,000
Revolving lines of credit     9,500,000     9,500,000     8,843,000     8,843,000

(4)    Income Taxes

        The provision (benefit) for income taxes from continuing operations consists of:

 
  2008
  2007
 
Current:              
  Federal   $ 1,732,000   $ 1,244,000  
  State     386,000     264,000  
  Foreign     79,000     120,000  
   
 
 
      2,197,000     1,628,000  
Deferred:              
  Federal     (434,000 )   (292,000 )
  State     (52,000 )   (27,000 )
   
 
 
      (486,000 )   (319,000 )
   
 
 
Income tax expense   $ 1,711,000   $ 1,309,000  
   
 
 

        Pre-tax profit generated from foreign operations was $597,000 and $658,000 in fiscal 2008 and 2007, respectively. The earnings associated with the Company's foreign subsidiary in Japan are reported net of tax and are included in operating income. Accumulated foreign earnings were $1,362,000 as of January 31, 2008 and $1,220,000 as of January 31, 2007.

        The following is a reconciliation of the difference between the actual provision for income taxes and the provision computed by applying the federal statutory tax rate on income from continuing operations before income taxes:

 
  2008
  2007
 
Income before income taxes and minority interest   $ 4,410,000   $ 2,978,000  
   
 
 
Federal income tax computed at statutory rate   $ 1,500,000   $ 1,010,000  
State income taxes, net of federal benefits     220,000     153,000  
Foreign income not subject to US Tax     (203,000 )   (224,000 )
Foreign tax     79,000     120,000  
Other, principally non-deductible expenses     115,000     250,000  
   
 
 
Income tax expense   $ 1,711,000   $ 1,309,000  
   
 
 

39


NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

January 31, 2008

(4)    Income Taxes (Continued)

        Deferred income taxes on the consolidated balance sheets reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Net operating loss of $539,000 and $262,000 for federal and state, respectively, relate to the purchase of Phase Seven Laboratories, Inc. in March 2005. Of this amount $262,000 relating to the state net operating losses will expire in 2015 and $539,000 will expire in 2025. The primary components of the Company's deferred tax assets and liabilities at January 31 were as follows:

 
  2008
  2007
 
 
  Current
  Non-current
  Current
  Non-current
 
Deferred tax assets:                          
Bad debts reserves   $ 372,000   $   $ 240,000   $  
Vacation accrual     666,000         567,000      
State taxes     357,000         264,000      
Deferred compensation     391,000         407,000      
Net operating loss     204,000         199,000      
Other     226,000         13,000      
   
 
 
 
 
Total deferred tax assets     2,216,000         1,690,000      

Deferred tax liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 
Goodwill         (425,000 )       (280,000 )
Gain on involuntary conversion         (10,000 )       (13,000 )
Tax over book depreciation         (4,391,000 )       (4,759,000 )
Other         (322,000 )        
   
 
 
 
 
Total deferred tax liabilities   $   $ (5,148,000 ) $   $ (5,052,000 )
   
 
 
 
 
Net deferred tax asset (liability)   $ 2,216,000   $ (5,148,000 ) $ 1,690,000   $ (5,052,000 )
   
 
 
 
 

        In July 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109" ("FIN 48"). This Interpretation was effective for the fiscal year beginning February 1, 2007. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 requires the recognition of penalties and interest on any unrecognized tax benefits. The Company's policy is to reflect penalties and interest as part of income tax expense when and if they become applicable.

        The Company has reviewed its positions in recording income and expenses and has no reason to record a liability under the provisions of FIN 48. The Company files income tax returns in the United States ("U.S.") on a federal basis and in many U.S. state and foreign jurisdictions. Certain tax years remain open to examination by the major taxing jurisdictions to which the Company is subject. The Company does not anticipate that its total unrecognized tax benefits will significantly change due to the settlement of examinations or the expiration of statutes of limitations during the next twelve months.

40


NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

January 31, 2008

(5)    Stock Options, Equity Incentive and Pension Plans

        The Company has two employee incentive stock option plans; the "2002 stock option plan" and the "1994 stock option plan."

        Under both stock option plans, officers, key employees, non-employee directors and consultants may be granted options to purchase shares of the Company's authorized but unissued common stock. The number of shares approved for issuance under the 2002 stock option plan was 1,000,000 shares. During fiscal 2008 there were no shares granted under the 2002 stock option plan. The 1994 stock option plan is terminated and no additional options will be granted under this plan.

        Outstanding options under all plans are exercisable at 100% or more of fair market value (as determined by the compensation committee of the Board of Directors) at the date of grant. The options are contingent upon continued employment and are exercisable, unless otherwise specified, on a cumulative basis of one-fourth of the total shares each year, commencing one year from the date of grant. Options currently expire five to ten years from the date of grant. Proceeds received by the Company from the exercises are credited to common stock. No stock options were granted in fiscal years 2008 and 2007. A summary of option activity under the plan as of January 31, 2008, and changes during the two years then ended is presented below:

 
  Shares
  Weighted Avg.
Exercise Price

  Weighted Avg.
Remaining Contract
Life in years

  Aggregate
Intrinsic Value

Outstanding at January 31, 2006   2,167,445   $ 3.78          
Granted                
Exercised   (280,028 )   3.00          
Canceled or expired   (25,575 )   3.68          
   
 
         
Outstanding at January 31, 2007   1,861,842   $ 3.90   4.74   $ 3,960,000
   
 
         
Granted                
Exercised   (123,283 )   3.48          
Canceled or expired   (12,100 )   5.68          
   
 
         
Outstanding at January 31, 2008   1,726,459   $ 3.92   3.84   $ 3,793,000
   
 
 
 
Exercisable at January 31, 2008   1,585,959   $ 3.85   3.54   $ 3,595,000
   
 
 
 

        The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (the aggregate difference between the closing stock price of the Company's common stock at the end of each fiscal year and the exercise price for in-the-money options) that would have been received by the option holders if all in-the-money options had been exercised at the end of each fiscal year.

        The total intrinsic value of options exercised during the years ended January 31, 2008 and 2007 was $366,000 and $1,051,000, respectively.

        The range of exercise prices for options outstanding at January 31, 2008 was $1.35 to $6.75. The range of exercise prices for options is wide due primarily to the fluctuating price of the Company's stock over the period of the grants.

41


NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

January 31, 2008

(5)    Stock Options, Equity Incentive and Pension Plans (Continued)

        The following tables summarize information about options outstanding at January 31, 2008:

Range of
exercise prices

  Outstanding at
January 31,
2008

  Weighted Avg.
Remaining
contract life
in yrs.

  Weighted Avg.
Exercise
Price

  Number
Exercisable

  Weighted Avg.
Exercisable
Price

$1.00 to $2.00   119,500   3.8   $ 1.62   119,500   $ 1.62
$2.01 to $3.00   448,280   3.4   $ 2.59   448,280   $ 2.59
$3.01 to $4.00   179,706   2.0   $ 3.30   179,706   $ 3.29
$4.01 to $5.00   640,575   5.8   $ 4.61   515,825   $ 4.60
$5.01 to $6.00   307,981   1.8   $ 5.43   292,231   $ 5.45
$6.01 to $7.00   30,417   0.8   $ 6.27   30,417   $ 6.27
   
           
     
    1,726,459             1,585,959      
   
           
     

        These options will expire if not exercised at specific dates ranging from September 2008 to December 2016. During the year ended January 31, 2008, 123,283 options were exercised at prices from $1.35 to $5.50 per share.

        The Company presented an equity incentive plan for shareholder vote at its June 29, 2006 annual shareholders' meeting and it was approved by the shareholders. Additionally, 143,050 shares that were reserved for future grants, were cancelled. A total of 300,000 new shares of common stock were reserved for issuance under the 2006 Equity Incentive Plan ("EIP"). As of January 31, 2008, 87,037 shares of the Company's common stock had been issued under the 2006 EIP and 212,963 shares were reserved for future issuance under the plan. Shares are issued under the EIP as compensation to certain employee and non-employee directors of the Company.

        The Company's non-vested shares have a vesting period of four years. Compensation expense, representing the fair market value of the shares at the date of grant, net of assumptions regarding estimated future forfeitures, is charged to earnings over the vesting period. Compensation expense included in general and administrative expenses in the Company's consolidated statement of income, relating to these grants was $123,000 for fiscal year 2008 and $32,000 for fiscal year 2007.

42


NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

January 31, 2008

(5)    Stock Options, Equity Incentive and Pension Plans (Continued)

        The following table summarizes the non-vested shares transactions for fiscal year 2008:

 
  Number of Shares
  Weighted-Average Grant Date Fair Value
Non-vested shares:          
Outstanding at January 31, 2006      
Granted   43,270   $ 7.08
Vested      
Forfeited      
   
 
Outstanding at January 31, 2007   43,270   $ 7.08
   
 
Granted   43,766   $ 7.00
Vested   (10,821 ) $ 7.08
Forfeited      
   
 
Outstanding at January 31, 2008   76,215   $ 7.03
   
 

        Under the provisions of SFAS No. 123(R), $359,000 has been recorded as a credit to common stock during fiscal year 2008. In addition, the tax benefit realized for the tax deduction from option exercises and restricted stock totaled $145,000 and was credited to common stock. As of January 31, 2008, there was $120,000 of total unrecognized compensation costs related to stock options granted under the Company's equity incentive plans. The unrecognized compensation cost is expected to be recognized over a weighted average period of two years.

        As of January 31, 2008, there was $457,000 of total unrecognized compensation cost related to the non-vested share-based compensation arrangements granted under the plan. That cost is expected to be recognized over a weighted-average period of 41 months.

        The Company offers three 401(k) profit sharing plans: National Technical Systems 401(k) Profit Sharing Plan, XXCAL 401(k) Profit Sharing Plan and NQA 401(k) Pension Plan. The purpose of these plans is to provide retirement benefits to all employees of the Company. The Company's employees can contribute a portion of their salary into the 401(k) plan and the Company's Board of Directors, at its discretion, will determine each year the amount of matching contribution the Company will make. Employer contributions are allocated based on participants' own contribution percentage amount to the total amount contributed by all employees in each plan. In fiscal 2008, the Company contributed $281,000 to the 401(k) profit sharing plan as compared to $261,000 in 2007.

        In fiscal year 2007, the Company started a new Senior Executive Retirement Plan ("SERP"). During fiscal year 2008, the Company contributed $375,000 to the Plan and paid $14,000 in premium charges for life insurance policies with the Company designated as the beneficiary. There were no contributions or premium charges in fiscal year 2007.

        The former president of XXCAL has elected to receive the cash surrender value of life insurance owned by the Company on his life, in lieu of lifetime periodic deferred compensation payments. The cash surrender value is included in other assets and the deferred compensation liability is included in deferred compensation. The deferred compensation benefits are accrued and recognized over each employee's

43


NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

January 31, 2008

(5)    Stock Options, Equity Incentive and Pension Plans (Continued)


expected term of employment. The Company's total deferred compensation expenses were $78,000 and $81,000 for the years ended January 31, 2008 and 2007, respectively. Included in other assets is $2,626,000 and $2,425,000 for the cash surrender values as of January 31, 2008 and 2007, respectively.

(6)    Capital Stock

        As of January 31, 2008 and 2007, the Company had 20,000,000 authorized common shares with no par value. At January 31, 2008 and January 31, 2007, 8,846,000 shares and 8,717,000 were issued and outstanding, respectively.

        During fiscal year 2008, there were 123,000 options exercised, 5,000 shares retired and 11,000 shares of restricted stock became vested under the 2006 equity incentive plan.

        Holders of common stock vote on matters submitted to shareholders, including the election of directors. Except as required by law, the powers, preferences and rights of all common stock and the qualifications, limitations or restrictions thereof, shall in all respects be identical. The common stock shareholders will be entitled to receive, to the extent permitted by law, and to share equally and ratably, share for share, any such dividends as may be declared from time to time by the board of directors.

(7)    Commitments

        The Company leases certain of its operating facilities and equipment under operating leases which principally expire at various dates through fiscal year 2012. The leases are generally on a net-rent basis, whereby the Company pays taxes, maintenance, insurance and other operating expenses. Management expects that, in the normal course of business, leases that expire will be renewed or replaced by other leases. Total rental expense was $3,608,000 and $3,383,000 for the years ended January 31, 2008 and 2007, respectively.

        At January 31, 2008, minimum rental payment obligations under operating leases were as follows:

2008   $ 3,056,000
2009   $ 2,466,000
2010   $ 1,443,000
2011   $ 705,000
2012   $ 638,000
Thereafter   $ 1,806,000
   
    $ 10,114,000
   

44


NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

January 31, 2008

(8)    Intangible Assets

        As of January 31, 2008 and January 31, 2007, the Company had the following acquired intangible assets:

 
  January 31, 2008
  January 31, 2007
 
  Gross
Carrying
Amount

  Accum.
Amort.

  Net
Carrying
Amount

  Estimated
Useful
Life

  Gross
Carrying
Amount

  Accum.
Amort.

  Net
Carrying
Amount

  Estimated
Useful
Life

Intangible assets subject to amortization:                                            
Covenants not to compete   $ 849,000   $ 225,000   $ 624,000   3-10 years   $ 299,000   $ 144,000   $ 155,000   3-5 years
Customer relationships     6,012,000     178,000     5,834,000   3-15 years     105,000     15,000     90,000   3 years
Acreditations and Certifications     20,000     1,000     19,000   5 years                
   
 
 
     
 
 
   
  Total   $ 6,881,000   $ 404,000   $ 6,477,000       $ 404,000   $ 159,000   $ 245,000    
   
 
 
     
 
 
   
Intangible assets not subject to amortization:                                            
Goodwill               $ 10,471,000                   $ 4,126,000    
Trademarks and Tradenames                 200,000                        
               
                 
   
  Total               $ 10,671,000                   $ 4,126,000    
               
                 
   

        Amortization expense for intangible assets subject to amortization was $245,000 and $40,000 for the twelve months ended January 31, 2008 and 2007, respectively. The aggregate amortization for the next five years is estimated to be $617,000, $579,000, $527,000, $489,000 and $427,000 for fiscal years 2009 through 2013, respectively.

(9)    Accrued Expenses

        A summary of accrued expenses at January 31 is as follows:

 
  2008
  2007
Compensation and employee benefits   $ 4,329,000   $ 3,845,000
Other     1,528,000     1,368,000
   
 
Total accrued expenses   $ 5,857,000   $ 5,213,000
   
 

(10)    Investments

        The Company has investments in available for sale securities in the aggregate fair value of $217,000. A gain of $139,000, net of taxes of $78,000 was recorded as unrealized gain in accumulated other comprehensive income for fiscal 2008.

45


NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

January 31, 2008

(11)    Contingencies

        The Company is, from time to time, the subject of claims and suits arising out of matters occurring during the operation of the Company's business. In the opinion of management, no claims or suits would materially affect the financial position or the results of the operations or cash flows of the Company.

(12)    Segment of Business Information

        The Company maintains two core operating segments: Engineering & Evaluation and Technical Solutions.

        The Engineering & Evaluation segment operates test laboratories in various states in the U.S., Canada and Germany and provides technical support and technical support personnel to assist customers in a broad range of industries (aerospace, defense, telecommunications, power products, transportation and computer, among others) in the solving of technical problems via analysis and testing of materials, components, subsystems and systems, electro-magnetic interference testing and product safety testing under its NRTL status by the United States Department of Labor, Occupational Safety and Health Administration. This segment also provides registration, certification and conformance evaluation services to its customers, particularly with regard to EU standards. In addition, it performs compatibility testing of hardware and software components. This segment also performs quality registration services by evaluating a supplier's systems for conformity to ISO 9000, the international quality standard. The evaluations include an examination of the companies' quality policy, quality system documentation and quality records.

        The Technical Solutions segment locates, recruits, and hires a wide variety of technical personnel, engineers, drafters, designers, computer programmer technicians and others and assigns them to customers either on a temporary or permanent basis.

        The Company's reportable segments each represent strategic business units that offer different, yet related services. They are managed differently because each requires differing technical skills and sales strategies. Each segment is led by a chief operating decision maker, who, in coordination with the Company's Chief Executive Officer uses the information reported below in evaluating results and allocating resources pertaining to segment operations.

        The Company did not have any revenues from a single customer in the Engineering & Evaluation Group, which represented in excess of 10% of total segment revenues. Three major customers represented $7,187,000, $6,541,000 and $3,479,000 of fiscal 2008 Technical Solutions net revenues as compared to three major customers representing $8,765,000, $7,311,000 and $4,951,000 of fiscal 2007 Technical Solutions net revenues. Total revenues from customers in foreign countries were $6,236,000 in fiscal 2008 and $6,564,000 in fiscal 2007.

        The following table illustrates each segment's operating income for 2008 and 2007. Assets by segment are those assets that are used in the Company's operations in each segment. Corporate assets consist of cash, accounts receivable, income taxes receivable, investments in securities, real estate and fixed assets not allocated to segments. Corporate general and administrative expenses were allocated on the basis of

46


NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

January 31, 2008

(12)    Segment of Business Information (Continued)

revenues, gross profit, net property, plant and equipment and payroll expenses of the respective segments. Interest expense is allocated to the segments based on average borrowing rates and segment advances.

 
  Year Ended January 31, 2008
 
 
  Engineering &
Evaluation

  Technical
Solutions

  Corporate
  Total
 
Net revenues   $ 90,548,000   $ 31,828,000   $   $ 122,376,000  
   
 
 
 
 
Gross profit     24,275,000     5,600,000         29,875,000  
Selling, general and administrative expense     18,349,000     5,722,000         24,071,000  
Equity income from non-consolidated subsidiary     142,000             142,000  
   
 
 
 
 
Operating income (loss)     6,068,000     (122,000 )       5,946,000  
Other income (expense):                          
  Interest expense, net     (1,836,000 )   (114,000 )       (1,950,000 )
  Other income, net     359,000     55,000         414,000  
   
 
 
 
 
Income (loss) before income taxes and minority interest   $ 4,591,000   $ (181,000 ) $   $ 4,410,000  
   
 
 
 
 
Assets   $ 76,051,000   $ 7,876,000   $ 6,965,000   $ 90,892,000  
   
 
 
 
 
Equity investments     1,362,000             1,362,000  
   
 
 
 
 
Expenditures for long-lived assets     4,727,000     38,000     335,000     5,100,000  
   
 
 
 
 
Depreciation and amortization     5,618,000     299,000     238,000     6,155,000  
   
 
 
 
 
Goodwill     10,275,000     196,000         10,471,000  
   
 
 
 
 

47


NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

January 31, 2008

(12)    Segment of Business Information (Continued)

 
 
  Year Ended January 31, 2007
 
 
  Engineering &
Evaluation

  Technical
Solutions

  Corporate
  Total
 
Net revenues   $ 80,030,000   $ 35,643,000   $   $ 115,673,000  
   
 
 
 
 
Gross profit     20,678,000     5,965,000         26,643,000  
Selling, general and administrative expense     16,391,000     5,785,000         22,176,000  
Equity income from non-consolidated subsidiary     201,000             201,000  
   
 
 
 
 
Operating income     4,488,000     180,000         4,668,000  
Other income (expense):                          
  Interest expense, net     (1,677,000 )   (125,000 )       (1,802,000 )
  Other income, net     18,000     94,000         112,000  
   
 
 
 
 
Income before income taxes and minority interest   $ 2,829,000   $ 149,000   $   $ 2,978,000  
   
 
 
 
 
Assets   $ 61,398,000   $ 8,279,000   $ 5,162,000   $ 74,839,000  
   
 
 
 
 
Equity investments     1,220,000             1,220,000  
   
 
 
 
 
Expenditures for long-lived assets     5,960,000     57,000     11,000     6,028,000  
   
 
 
 
 
Depreciation and amortization     5,072,000     548,000     202,000     5,822,000  
   
 
 
 
 
Goodwill     3,930,000     196,000         4,126,000  
   
 
 
 
 

(13)    Quarterly Financial Data (Unaudited)

 
  Three months ended,
2008

  Apr 30
  Jul 31
  Oct 31
  Jan 31
Net revenues   $ 29,804,000   $ 31,025,000   $ 31,003,000   $ 30,544,000
Gross profit     7,015,000     8,129,000     7,705,000     7,026,000
Net income     591,000     770,000     631,000     623,000
Earnings per common share                        
  Basic     0.07     0.09     0.07     0.07
  Diluted     0.06     0.08     0.07     0.07
Weighted average common shares outstanding     8,744,000     8,779,000     8,822,000     8,834,000
Dilutive effect of stock options     578,000     664,000     711,000     695,000
Weighted average common shares outstanding,                        
  assuming dilution     9,322,000     9,443,000     9,533,000     9,529,000

48


NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

January 31, 2008

(13)    Quarterly Financial Data (Unaudited) (Continued)

 
 
  Three months ended,
2007

  Apr 30
  Jul 31
  Oct 31
  Jan 31
Net revenues   $ 28,151,000   $ 28,438,000   $ 29,809,000   $ 29,275,000
Gross profit     6,238,000     6,579,000     6,855,000     6,971,000
Net income     352,000     247,000     409,000     573,000
Earnings per common share                        
  Basic*     0.04     0.03     0.05     0.07
  Diluted     0.04     0.03     0.04     0.06
Weighted average common shares outstanding     8,892,000     8,544,000     8,676,000     8,707,000
Dilutive effect of stock options     683,000     899,000     819,000     759,000
Weighted average common shares outstanding,                        
  assuming dilution     9,575,000     9,443,000     9,495,000     9,466,000

*
Per share data may not always add to the total for the year because each figure is independently calculated.

49


ITEM 9.    CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES.

        None.

ITEM 9A.    CONTROLS AND PROCEDURES.

        Not applicable.

ITEM 9A(T).    CONTROLS AND PROCEDURES.

Evaluation of Disclosure Controls and Procedures

        The Company's Chief Executive Officer and Chief Financial Officer carried out an evaluation with the participation of the Company's management, of the effectiveness of the design and operation of the Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, the Company's disclosure controls and procedures were effective.

Changes in Internal Controls Over Financial Reporting

        As required by Rule 13a-15(d) under the Exchange Act, the Company's Chief Executive Officer and Chief Financial Officer, with the participation of the Company's management, also conducted an evaluation of the Company's internal controls over financial reporting to determine whether any changes occurred during the Company's fourth fiscal quarter that have materially affected, or are reasonably likely to affect, the Company's internal controls over financial reporting. Based on that evaluation, there has been no such change during the Company's fourth fiscal quarter.

Limitations of the Effectiveness

        A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the internal control system are met. Because of the inherent limitations of any internal control system, no evaluation of controls can provide absolute assurance that all control issues, if any, within a company have been detected. Notwithstanding these limitations, the Company's disclosure controls and procedures are designed to provide reasonable assurance of achieving their objectives. The Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures were, in fact, effective at the "reasonable assurance" level as of the end of the period covered by this report.

Management's Report on Internal Control over Financial Reporting

        Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. The Company's internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States. However, all internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and reporting.

        Management assessed the effectiveness of the Company's internal control over financial reporting as of January 31, 2008. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO") in Internal Control-Integrated

50



Framework. Based on this assessment, management believes that the Company's internal control over financial reporting was effective as of January 31, 2008.

        The annual report on internal control over financial reporting does not include an attestation report of the Company's registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Company to provide only management's report in its annual report.

ITEM 9B.    OTHER INFORMATION.

        None.

51



PART III

ITEM 10.    DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.

        The sections entitled "Nomination and Election of Directors" and "Remuneration of Directors and Officers" in the Company's definitive Proxy Statement to be furnished to shareholders in connection with the Annual Meeting of Shareholders to be held on July 15, 2008 are incorporated herein by reference.

Name

  Age
  Position
Lloyd Blonder   68   Senior Vice President Finance, Treasurer. He has been associated with the Company since 1983.

Douglas Briskie

 

44

 

Vice President, Corporate Development. He has been associated with the Company since 1987.

Aaron Cohen

 

71

 

Senior Vice President. He has been associated with the Company since 1961.

Jack Lin

 

75

 

Chairman of the board of the Company. He has been associated with the Company since 1961.

Raffy Lorentzian

 

52

 

Senior Vice President, Chief Financial Officer, Chief Accounting Officer. He has been associated with the Company since 1997.

Cynthia Maher

 

49

 

Corporate Secretary, Corporate Counsel, Human Resources Director. She has been associated with the Company since 2005.

William McGinnis

 

49

 

President and Chief Executive Officer of the Company. He has been associated with the Company since 1980.

Dwight Moore

 

45

 

Vice President, Chief Operating Officer. He has been associated with the Company since 1997.

        The Company's Board of Directors has adopted a code of ethics that applies to our principal executive officers, principal financial officer, and corporate controller, as well as other employees. A copy of this code of ethics has been posted on the Company's website. Any amendments to, or waivers from, a provision of our code of ethics that applies to our principal executive officer, principal financial officer, controller, or persons performing similar functions and that relates to any element of the code of ethics enumerated in paragraph (b) of Item 406 of Regulations S-K shall be disclosed by posting such information on our website.

ITEM 11.    EXECUTIVE COMPENSATION.

        The section entitled "Remuneration of Directors and Officers" in the Company's definitive Proxy Statement to be furnished to shareholders in connection with the Annual Meeting of Shareholders to be held on July 15, 2008 is incorporated herein by reference.

ITEM 12.    SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS, MANAGEMENT AND RELATED STOCKHOLDER MATTERS.

        The sections entitled "Voting Securities and Principal Holders Thereof" and "Nomination and Election of Directors" in the Company's definitive Proxy Statement to be furnished to shareholders in

52



connection with the Annual Meeting of Shareholders to be held on July 15, 2008 are incorporated herein by reference.

ITEM 13.    CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.

        The section entitled "Certain Relationships and Related Party Transactions" and "Nomination and Election of Directors" in the Company's definitive Proxy Statement to be furnished to shareholders in connection with the Annual Meeting of Shareholders to be held on July 15, 2008 is incorporated herein by reference.

ITEM 14.    PRINCIPAL ACCOUNTANT FEES AND SERVICES.

        The information under the heading "Audit Fees and All Other Fees" in the Company's definitive Proxy Statement to be furnished to shareholders in connection with the Annual Meeting of Shareholders to be held on July 15, 2008 is incorporated herein by reference.


PART IV

ITEM 15.    EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.

 
   
   
A.   Consolidated Financial Statements and Schedules.    

 

 

Financial statements required by Item 15 are included in Item 8 above.

 

 

 

 

Financial Statements:

 

 

 

 

    Consolidated Balance Sheets—January 31, 2008 and 2007

 

 

 

 

    Consolidated Statements of Income—Years ended January 31, 2008 and 2007

 

 

 

 

    Consolidated Statements of Shareholders' Equity—Years ended January 31, 2008 and 2007

 

 

 

 

    Consolidated Statements of Cash Flows—Years ended January 31, 2008 and 2007

 

 

 

 

Notes to Consolidated Financial Statements

 

 

    

 

 

 

 
 
   
  Schedule

 

 

Schedule Supporting Financial Statements:

 

 

 

 

    Valuation and Qualifying Accounts and Reserves

 

II

B.

 

Exhibits.

 

 
 
   
2.1   Asset Purchase Agreement, dated as of January 23, 2004, by and among National Technical Systems, Inc., NTS Technical Systems, Robert Wakefield, Randolph Fairfield, Calvin Milam, E&C Holdings, Inc., Peterson Builders, Inc., and DTI Holdings LLC. (filed January 30, 2004 and is incorporated herein by reference thereto).
2.2   Pro forma financial information related to the acquisition of DTI Holdings LLC. (filed with the Company's 8-K/A on March 22, 2004 and is incorporated herein by reference thereto).
2.3   Interests Purchase Agreement dated December 5, 2007 among NTS Technical Systems, the 2007 Richard W. Mouser Revocable Trust, the Richard W. Mouser Revocable Trust, the Debra S. Mouser Revocable Trust, Richard W. Mouser and Debra S. Mouser (filed with the Company's 8-K on December 11, 2007 and is incorporated herein by reference thereto).

53


2.4   Pro forma financial information related to the acquisition of United States Test Laboratory, LLC (USTL) (filed with the Company's 8-K/A on February 20, 2008 and is incorporated herein by reference thereto).
3.1   Articles of Incorporation of National Technical Systems, Inc., a California corporation, as amended to date. (filed with the Company's Annual Report on Form 10-K on April 28, 2004 and is incorporated herein by reference thereto).
3.2   Bylaws of National Technical Systems, Inc., a California corporation, as adopted on May 29, 1996 and as amended by amendment number one thereto, adopted on June 25, 1999. (filed with the Company's Annual Report on Form 10-K on April 28, 2004 and is incorporated herein by reference thereto).
3.3   Bylaws of National Technical Systems, Inc., a California corporation, as adopted on December 14, 2004. (filed on September 13,2006 and is incorporated herein by reference thereto).
10.1   Form of the Company's 1994 Stock Option Plan (filed as Appendix B to the Company's Proxy Statement for Annual Meeting of June 30, 1994, and is incorporated herein by reference thereto).
10.2   Amendment to the Company's 1994 Stock Option Plan (filed as Proposal No. 3 to the Company's Proxy Statement for Annual Meeting of June 26, 1998, and is incorporated herein by reference thereto).
10.3   Form of the Company's 2002 Stock Option Plan (filed as Proposal 2 to the Company's Proxy Statement for Annual Meeting of June 28, 2002, and is incorporated herein by reference thereto).
10.4   Amendment number one to revolving credit agreement between NTS and Comerica Bank effective July 17, 2002 (filed on September 12, 2002 and is incorporated herein by reference thereto).
10.5   Amendment number two to revolving credit agreement between the Company and Comerica Bank effective November 25, 2002 (filed on December 13, 2002 and is incorporated herein by reference thereto).
10.6   Amendment number three to revolving credit agreement between the Company and Comerica Bank effective July 21, 2003 (filed on September 11, 2003 and is incorporated herein by reference thereto).
10.7   Amendment number four to revolving credit agreement between the Company and Comerica Bank effective July 30, 2004 (filed on December 15, 2004 and is incorporated herein by reference thereto).
10.8   Employment agreement between the Company and Dr. Jack Lin dated April 28, 2005 (filed on May 3, 2005 and is incorporated herein by reference thereto).
10.9   Amendment number five to revolving credit agreement between the Company and Comerica Bank effective July 1, 2005 (filed on September 14, 2005 and is incorporated herein by reference thereto).
10.10   Amendment number six to revolving credit agreement between the Company and Comerica Bank effective March 29, 2006 (filed on March 30, 2006 and is incorporated herein by reference thereto).
10.11   Amendment number seven to revolving credit agreement between the Company and Comerica Bank effective September 21, 2006 (filed on December 14, 2006 and is incorporated herein by reference thereto).
10.12   National Technical Systems, Inc. 2006 Long-Term Incentive Plan (filed on December 14, 2006 and is incorporated herein by reference thereto).
10.13   National Technical Systems, Inc. 2006 Supplemental Executive Retirement Plan (filed on December 14, 2006 and is incorporated herein by reference thereto).

54


10.14   Amendment number eight to revolving credit agreement between the Company and Comerica Bank effective September 26, 2007 (filed on December 13, 2007 and is incorporated herein by reference thereto).
10.15   Amendment No. 9 to Revolving Credit Agreement dated December 5, 2007 among the registrant, certain subsidiaries of the registrant, Comerica Bank and First Bank (filed on December 11, 2007 and is incorporated herein by reference thereto).
21.1   Subsidiaries of the Company.
23.1   Consent of Independent Registered Public Accounting Firm.
23.2   Consent of XXCAL Japan, Inc. Independent Auditors and Independent Auditor's Report.
23.3   Consent of NQA, Inc. Independent Auditors and Report of Independent Registered Public Accounting Firm.
31.1   Certification of the Principal Executive Officer pursuant to rule 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2   Certification of the Principal Financial Officer pursuant to rule 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1   Certification of the Principal Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes- Oxley Act of 2002.
32.2   Certification of the Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes- Oxley Act of 2002.

55



SIGNATURES

        Pursuant to the requirements of Section 13 or 15(d) of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

    NATIONAL TECHNICAL SYSTEMS, INC.

April 29, 2008

 

By

/s/  
WILLIAM MCGINNIS      
William McGinnis,
Chief Executive Officer
and Director
(Principal Executive Officer)

        Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

/s/  JACK LIN      
Jack Lin,
Chairman of the Board
  /s/  AARON COHEN      
Aaron Cohen,
Senior Vice President and
Vice Chairman of the Board

/s/  
WILLIAM MCGINNIS      
William McGinnis,
Chief Executive Officer
(Principal Executive Officer)

 

/s/  
RAFFY LORENTZIAN      
Raffy Lorentzian,
Senior Vice President and
Chief Financial Officer
(Principal Financial and Accounting
Officer)

/s/  
LLOYD BLONDER      
Lloyd Blonder,
Senior Vice President
and Treasurer

 

/s/  
JOHN GIBBONS      
John Gibbons,
Director

/s/  
DAN YATES      
Dan Yates,
Director

 

/s/  
RALPH F. CLEMENTS      
Ralph F. Clements,
Director

/s/  
NORMAN S. WOLFE      
Norman S. Wolfe,
Director

 

/s/  
DONALD J. TRINGALI      
Donald J. Tringali,
Director

/s/  
ROBERT I. LIN      
Robert I. Lin,
Director

 

 

56



Schedule II

NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES

Valuation and Qualifying Accounts and Reserves

Years ended January 31, 2008 and 2007

COLUMN A
  COLUMN B
  COLUMN C
  COLUMN D
  COLUMN E
Description
  Balance at
beginning of
period

  Additions—
charged to costs
and expenses

  Deductions
  Balance
at end
of period

Allowance for doubtful accounts receivable:                        
  Year ended January 31, 2008                        
    2008   $ 691,000   $ 336,000   $ (120,000 ) $ 907,000
    2007   $ 816,000   $ 314,000   $ (439,000 ) $ 691,000

57




QuickLinks

PART I
PART II
Index to Consolidated Financial Statements and Schedule
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES Consolidated Balance Sheets January 31,
NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES Consolidated Statements of Income Years Ended January 31,
NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES Consolidated Statements of Shareholders' Equity
NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES Unaudited Consolidated Statements of Cash Flows for the Twelve Months Ended January 31, 2008 and 2007
NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements January 31, 2008
PART III
PART IV
SIGNATURES
Schedule II
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