National Technical Systems 10-Q 2010
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the quarterly period ended April 30, 2010
For transition period from ________________ to _________________
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 T NO o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232,405 of this chapter) during the preceding 12 months (or such shorter period that the registrant was required to submit and post such files).
YES o NO o
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):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
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The number of shares of common stock, no par value, outstanding as of June 9, 2010 was 9,535,712.
PART I. FINANCIAL INFORMATION
PART I – FINANCIAL
ITEM 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets
See accompanying notes.
Unaudited Consolidated Statements of Income
for the Three Months Ended April 30, 2010 and 2009
See accompanying notes.
Unaudited Consolidated Statements of Cash Flows
for the Three Months Ended April 30, 2010 and 2009
See accompanying notes.
Notes to the Unaudited Consolidated Financial Statements
The consolidated financial statements include the accounts of National Technical Systems, Inc. (“NTS” or the “Company”) and its majority-owned or otherwise controlled subsidiaries. All significant intercompany accounts and transactions have been eliminated. Investments in entities in which the Company can exercise significant influence, but does not own a majority equity interest or otherwise control, are accounted for using the equity method and are included as investments in equity interests on the consolidated balance sheets. These statements should not be construed as representing pro rata results of the Company’s fiscal year ending January 31, 2011 and should be read in conjunction with the financial statements and notes thereto included in the Company's Form 10-K for the year ended January 31, 2010.
The statements presented as of April 30, 2010 and for the three months ended April 30, 2010 and 2009 are unaudited. In management's opinion, all adjustments have been made to present fairly the results of such unaudited interim periods. All such adjustments are of a normal recurring nature.
Income taxes for the interim periods are computed using the effective tax rates estimated to be applicable for the full fiscal year, as adjusted for any discrete taxable events that occur during the period.
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 or obligations will significantly change due to the settlement of examinations or the expiration of statutes of limitation during the next twelve months.
Accumulated other comprehensive income (loss) on the Company’s consolidated balance sheets consists of cumulative equity adjustments from foreign currency translation and unrealized gains or losses on marketable securities. During the three months ended April 30, 2010, total comprehensive income was $3,520,000 which includes foreign currency translation gain of $26,000. During the three months ended April 30, 2009, total comprehensive income was $525,000 which includes foreign currency translation loss of $15,000.
Inventories consist of accumulated costs applicable to uncompleted contracts and are stated at actual cost which is not in excess of estimated net realizable value.
Noncontrolling interest in the Company’s NQA, Inc. subsidiary is a result of 50% of the stock of NQA, Inc. being issued to NICEIC Group Limited (“NICEIC, Ltd.”) (formerly NQA, Ltd.). Profits and losses are allocated 50.1% to NTS, and 49.9% to NICEIC Ltd.
Basic earnings per share have been computed using the weighted average number of shares of common stock outstanding during the year. Basic earnings per share exclude any dilutive effects of options, warrants, non-vested restricted shares and convertible securities.
The following table summarizes the Company’s intangible assets:
As of April 30, 2010 and January 31, 2010, the Company had the following acquired intangible assets:
The Company has two employee incentive stock option plans: the “2002 stock option plan” and the “2006 equity incentive plan.” The 2006 equity incentive plan replaced the 2002 stock option plan, which was terminated early and no further options will be granted under it.
Additional information with respect to the option plans as of April 30, 2010 is as follows:
For the three months ended April 30, 2010 and 2009, potentially dilutive securities representing approximately 1,000 and 630,187 shares of common stock, respectively, were excluded from the computation of diluted earnings per share for these periods because their effect would have been anti-dilutive.
There was no compensation expense related to stock options in the current quarter compared to $9,000 for the three months ended April 30, 2009. As of April 30, 2010, there was no unamortized stock-based compensation expense related to unvested stock options.
The Company’s non-vested shares vest at 25% per year commencing with the first anniversary of the grant date. 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 $76,000 for the three months ended April 30, 2010. As of April 30, 2010, 181,000 non-vested shares were outstanding at a weighted average grant date value of $4.38. As of April 30, 2010, there was $715,000 of unamortized stock-based compensation cost related to unvested shares which is expected to be recognized over a remaining period of 39 months.
The Company recognized $165,000 in compensation expense related to the issuance of common stock for services rendered.
The accounting standard for fair value establishes a framework for measuring fair value and requires disclosures about fair value measurements by establishing a hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are described below:
Basis of Fair Value Measurement at Reporting Date Using
The following inputs were used to determine the fair value of the Company’s investment securities and contingent consideration obligations at April 30, 2010:
The fair value of the contingent consideration related to the Unitek acquisition was estimated by applying the income approach. That measure is based on significant inputs not observable in the market, which are referred to as Level 3 inputs. Key assumptions include the discount rate and probability adjusted revenues.
The acquisition of Elliott Laboratories, Inc., on June 6, 2008, included an agreement to pay the sellers up to a maximum of $1,275,000 in earn-out consideration, plus $84,000 in additional consideration for tax benefits that resulted from the acquisition transaction, payable in Company stock and cash contingent upon the achievement by Elliott Laboratories of certain targets over the 24 months immediately following the closing of the transaction. This will be added to the purchase price and result in an increase to goodwill in the second quarter of fiscal 2011.
Payment of earn-out consideration for United States Test Laboratory, LLC (USTL) of $2,053,000 was made on March 5, 2010. The earn-out consideration was previously added to the purchase price and recorded as an increase to goodwill in fiscal 2010.
On April 22, 2010, the Company sold its property in Fredericksburg, Virginia for a sales price of $3,395,000. $1,000,000 will be paid to the Company in 120 monthly installments under a promissory note at an 8.5% interest rate. The remaining balance of $2,300,000 net of costs was held in a trust account until June 9, 2010. The gain of $3,017,000 from the sale of the property was included in other income in the current quarter.
Subsequent events have been evaluated up to and including the date these financial statements were issued.
Except for the historical information contained herein, the matters addressed in this Item 2 contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements can be identified by the use of forward-looking words such as "may", "will", "expect", "anticipate", "intend", "estimate", "continue", "behave" and similar words. Financial information contained herein, to the extent it is predictive of financial condition and results of operations that would have occurred on the basis of certain stated assumptions may also be characterized as forward-looking statements. Although forward-looking statements are based on assumptions made, and information believed by management to be reasonable, no assurance can be given that such statements will prove to be correct. Such statements are subject to certain risks, uncertainties and assumptions. Should one or more of these risks or uncertainties occur, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated.
These forward-looking statements are not guarantees of future performance. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. This discussion should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in the Company’s Annual Report on Form 10-K for the year ended January 31, 2010 and the consolidated financial statements included elsewhere in this report.
The Company is a diversified business to business services organization that supplies technical services to the defense, aerospace, telecommunications, automotive, energy and high technology markets. Through its wide range of testing facilities and certification services, the Company’s services allow its customers the ability to sell their products globally and enhance their overall competitiveness. NTS is accredited by numerous national and international technical organizations which allow the Company to have its test data accepted in most countries.
The Company operates facilities throughout the United States and in Japan, Vietnam, Canada and Germany, providing highly trained technical personnel for engineering services, product certification, product safety testing and product evaluation. In addition, it performs management registration and certification services to ISO related standards.
The following discussion should be read in conjunction with the consolidated quarterly financial statements and notes thereto. All information is based upon operating results of the Company for the three-month periods ended April 30, 2010 and 2009.
RESULTS OF OPERATIONS
For the three months ended April 30, 2010, consolidated revenues increased by $7,440,000 or 25.9% when compared to the same period in fiscal 2010, primarily due to the solid performance in the aerospace and defense markets in the current quarter compared to the same period in the prior year. $2,303,000 of the increase was from the acquisition of Unitek Technical Services on November 30, 2009. The strong organic growth of $5,137,000 or 17.9% was as a result of several factors: capital investments on unique capabilities, capacity expansion, recent large contract wins and improved efficiencies.
Total gross profit for the three months ended April 30, 2010 increased by $3,378,000 or 45.6% when compared to the same period in fiscal 2010. Gross profit margin, as a percentage of revenues increased by 4.0%, primarily due to the strong increase in revenues in the defense market, which normally carries higher margin contracts. In addition, this increase was also due to fixed costs not increasing proportionately with revenues.
SELLING, GENERAL & ADMINISTRATIVE
Total selling, general and administrative expenses increased by $1,349,000 or 22.1% for the three months ended April 30, 2010 when compared to the same period in fiscal 2010. Selling, general and administrative expenses at Unitek, acquired on November 30, 2009, were $335,000. The remaining increase of $1,014,000 or 16.6% in selling, general and administrative expenses was primarily due to (1) costs and incentive compensation related to the increase in revenues, (2) compensation and other sales costs associated with the investment in the engineering services group, innovation and marketing activities, (3) additional expenses related to the development of a new Enterprise Resource Planning (ERP) system and (4) additional accounting costs related to Sarbanes-Oxley Section 404 compliance preparation fees.
Operating income for the three months ended April 30, 2010 increased by $2,043,000 or 159.4% when compared to the same period in fiscal 2010, primarily as a result of the increase in gross profit, partially offset by the increase in selling, general and administrative expenses. Operating income as a percentage of revenues increased by 4.7% to 9.2% in the current quarter compared to the same period in the prior year.
Net interest expense decreased by $100,000 to $296,000 in the three months ended April 30, 2010 when compared to the same period in the prior year, primarily due to lower interest rates and lower average debt balances in the current quarter compared to the same period in the prior year.
Other income was $2,991,000 for the three months ended April 30, 2010, compared to other expense of $69,000 for the same period in the prior year. The income in the current year was primarily due to the gain on the sale of the Company’s Virginia property of $3,017,000 and the net gain recognized from insurance recovery of $269,000 related to the fire at the Company’s Fullerton facility in the prior year, partially offset by other non-recurring expenses.
The income tax provision rate for the three months ended April 30, 2010 was 39.9% compared to the 40.1% income tax rate for the same period in the prior year. Management has determined that it is more likely than not that the deferred tax assets will be realized on the basis of offsetting them against the reversal of deferred tax liabilities. The Company analyzes the value of the deferred income tax asset quarterly in conjunction with external reporting.
Net income for the three months ended April 30, 2010 was $3,546,000 compared to $540,000 for the same period in fiscal 2010, an increase of $3,006,000 or 556.7%. This increase was primarily due to the $3,060,000 increase in other income and the $2,043,000 increase in operating income, partially offset by higher income taxes.
OFF BALANCE SHEET ARRANGEMENTS
The aerospace and defense markets generate approximately 69% of the Company’s overall revenue. Commercial airplane deliveries have slowed due to the global economic conditions of the past two years, exacerbated by Airbus’ and Boeing’s inability to field the A380 and B787, respectively. Market conditions, however, are expected to rebound with the B787 (Dreamliner), now in flight test and aging fleets needing replacement by more fuel efficient aircraft. Forecasts call for some 29,000 new aircraft valued at over $3.2 trillion through 2020. Original Equipment Manufacturers continue to move toward large scale integration, consolidation around core competencies, outsourcing, and globalization. We expect these trends to continue to present significant opportunity for NTS to fill capability gaps that emerge in the product development cycles of its customers. The careful positioning of NTS’ Life Cycle Product Services—engineering, testing, and supply chain services—allows the Company to profit in both down and up markets. In the down market, NTS fills the capability gaps that its customers cannot afford to maintain on a full-time basis. When the market is up, NTS fills capacity gaps during surge periods.
The defense market is subject to the funding vagaries of the current administration and a greater propensity for in-sourcing in certain areas. Recently, NTS has seen increased activity from government laboratories in competition with its body armor testing. To date, there has been no decline in business, but NTS could be impacted negatively on future, related body armor contracts. Other high-profile programs have been eliminated, but Defense Research, Development, Testing, and Evaluation (RDT&E) spending is expected to be up 4% at around $80 billion in the current year. Severe political pressure has increased cost consciousness in the Department of Defense. Today, there is heavy scrutiny on maintaining test and production schedules leading toward increased outsourcing from Government-run test facilities to independent private sector test labs. NTS’ competitive cost structure and significant breadth of capability have resulted in increased market share. As is the case in the aerospace market, the Company’s unique Life Cycle Product Services value proposition acts counter to defense market economic cycles, providing opportunity to fill gaps in growing and declining conditions.
The telecommunications market remains relatively flat with some signs of improvement, particularly in the Silicon Valley market. However the wireless market, a subset of the telecommunications market, is showing a strong rebound. Carriers are delivering voice, video and data using fiber networks. New means of delivery may increase the demand for certification of suppliers’ premises equipment, and certification of new central office equipment. The Company, with multiple EMI and EMC facilities, including its recent acquisition of Elliott Laboratories in the Silicon Valley, is well equipped to grow in this market.
NTS made substantial investments in the last two years in engineering services and the Company is now well positioned to support the anticipated increased demand for integrated engineering services in the aerospace and defense markets as a result of continued outsourcing activity. The Company has developed capability and capacity to support large and regional commercial transport aircraft and business aircraft. The focus within the defense market is on developing capability and capacity around weapons systems. The Company anticipates a growing demand for engineering services for military aircraft, general aviation, space craft and unmanned vehicles.
The energy market, is improving in both nuclear and solar energy, including power generation and distribution. The Company also provides dedication and certification work for the international community. The Company believes there is a positive outlook for this market as the government and industry search for alternative energy solutions.
In the automotive industry, alternative fuel vehicle testing is showing signs of growth; however the industry in general remains weak. The Company has experienced a decrease in both revenues and earnings in recent years as a result of troubles in the automotive industry.
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
Net cash provided by operating activities of $4,443,000 in the three months ended April 30, 2010 primarily consisted of net income of $3,546,000, adjusted for changes in working capital of $1,820,000, non-cash items of $1,787,000 in depreciation and amortization, share-based compensation of $241,000 and other adjustments of $66,000, partially offset by gain on sale of assets of $3,017,000. Net cash provided by operating activities of $1,732,000 in the three months ended April 30, 2009 primarily consisted of net income of $540,000 adjusted for non-cash items of $1,781,000 in depreciation and amortization and write off of receivables of $169,000, partially offset by changes in working capital of $608,000, deferred income taxes $131,000 and other adjustments of $19,000.
Net cash used in investing activities in the three months ended April 30, 2010 of $57,000 was primarily attributable to capital spending of $2,123,000 and cash used to acquire businesses of $2,053,000, partially offset by proceeds from sale of property of $2,293,000 and proceeds from sale of life insurance of $1,826,000. Net cash used in investing activities in the three months ended April 30, 2009 of $1,640,000 was primarily attributable to capital spending of $1,414,000, investment in retirement funds of $176,000 and investment in life insurance of $50,000.
Net cash used in financing activities in the three months ended April 30, 2010 of $612,000 consisted of repayment of debt of $1,183,000, partially offset by proceeds from borrowing of $508,000 and proceeds from stock options exercised of $63,000. Net cash used in financing activities in the three months ended April 30, 2009 of $1,070,000 consisted of repayment of debt of $1,070,000.
The Company has a Revolving Credit Agreement with Comerica Bank, as agent and lender, holding 60%, and Bank of the West, as lender, holding 40%. This agreement matures on December 1, 2012. The credit facility is structured as follows:
In addition to the Comerica agreement, the Company has an additional $2,059,000 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 compliant with all bank covenants as of April 30, 2010.
The Company’s 50% owned subsidiary, NQA, Inc., has total borrowings of $1,212,000 at April 30, 2010, for the acquisitions of Unitek Technical Services, Inc., TRA Certification, Inc. and International Management Systems, Inc. (IMS).
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. The Company has from time to time made acquisitions of other businesses. The Company believes that it has adequate borrowing capability to absorb such acquisitions.
There have been no material changes in the Company’s quantitative and qualitative market risk since the disclosure in the Company’s Annual Report on Form 10-K for the year ended January 31, 2010, filed with the Securities and Exchange Commission on April 30, 2010.
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 first 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 current 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.
PART II. OTHER INFORMATION
From time to time the Company may be involved in judicial or administrative proceedings concerning matters arising in the ordinary course of business. Management does not expect that any of these matters, individually or in the aggregate, will have a material adverse effect on the Company’s business, financial condition, cash flows or results of operations.
There have been no material changes in the Company’s risk factors since the disclosure in the Company’s Annual Report on Form 10-K for the year ended January 31, 2010 filed with the Securities and Exchange Commission on April 30, 2010.
The Company granted 25,000 and 5,000 shares of common stock to Donald Tringali and John Gibbons, respectively for services performed outside of their normal responsibilities.
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.
Pursuant to the requirements of the Securities Exchange Act of 1934 the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
NATIONAL TECHNICAL SYSTEMS, INC.