The assets and liabilities of discontinued operations at September 27, 2008 and September 29, 2007 were as follows:
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Cash flow from operatingactivities provided cash of $30.2 million during fiscal year 2008, compared to cash provided of $44.9 million and $38.2 million in fiscal years 2007 and 2006, respectively. Fiscal year 2008 cash flow from operating activities was primarily due to strong earnings, partially offset by $13.2 million contributions to a defined benefit pension plan, $11.1 million increased working capital requirements due to strong fourth quarter revenue, and $4.6 million net cash usage for the discontinued Nano Instruments product line. The defined benefit pension plan was funded during fiscal year 2008 in order to better utilize excess cash reserves and increase the Company’s return on investment. Fiscal year 2007 cash flow from operating activities was primarily due to strong earnings and a $7.6 million increase in income taxes payable due to timing of tax payments, partially offset by $9.2 million increased working capital requirements and a $4.6 net increase in deferred tax assets. Operating cash flow in fiscal year 2006 primarily resulted from strong earnings and a net decrease in deferred tax assets of $2.2 million, partially offset by $11.1 million increased working capital requirements.
Cash flow from investing activities provided cash of $3.6 million during fiscal year 2008, compared to $5.2 million used during fiscal year 2007, and $47.5 million provided during fiscal year 2006. During fiscal year 2008, the Company received net proceeds of $17.1 million and $10.3 million for the maturity of short term investments and the sale of the Nano Instruments product line, respectively, and invested $13.7 million and $9.8 million in SANS and property and equipment, respectively. During fiscal year 2007, the Company invested $12.0 million in property and equipment, and received net proceeds of $6.5 million and $1.0 million from the maturity of short-term investments and the sale of assets associated with the Company’s linear friction welding technology, respectively. During fiscal year 2006, the Company received net proceeds of $53.1 million from the maturity of short-term investments and $1.9 million related to the fiscal year 2005 sale of discontinued businesses and invested $7.2 million in property and equipment.
Cash flow from financing activities required a use of cash of $26.5 million during fiscal year 2008, compared to $41.5 million and $73.6 million used in fiscal years 2007 and 2006, respectively. During fiscal year 2008, the Company’s cash usage primarily resulted from purchases of the Company’s common stock of $42.0 million, including purchases of stock related to stock option exercises of $3.2 million, payment of cash dividends of $10.5 million, and net repayment of interest-bearing debt of $6.7 million, partially offset by $23.9 million net proceeds received from short-term borrowings, and $7.9 million received from stock option exercises and stock purchases under the Company’s employee stock purchase plan. During fiscal year 2007, the Company’s cash usage primarily resulted from purchases of the Company’s common stock of $38.2 million, including purchases of stock related to stock option exercises of $0.3 million, payment of cash dividends of $8.0 million, and net repayment of interest-bearing debt of $6.7 million, partially offset by $9.3 million received from stock option exercises and stock purchases under the Company’s employee stock purchase plan. The cash usage in fiscal year 2006 primarily resulted from purchases of the Company’s common stock of $64.5 million, including purchases of stock related to stock option exercises of $0.3 million, net repayment of interest-bearing debt of $8.0 million, and payment of cash dividends of $7.6 million, partially offset by $5.2 million received from stock option exercises and stock purchases under the Company’s employee stock purchase plan.
During fiscal year 2008, 2007, and 2006 the Company purchased approximately 1.0 million, 1.0 million, and 1.8 million shares of its common stock, respectively, for $38.8 million, $37.9 million, and $64.2 million, respectively.
Liquidity and Capital Resources
The Company had cash and cash equivalents of $114.1 million at September 27, 2008. Of this amount, approximately $13.0 million was located in North America, $75.1 million in Europe, and $26.0 million in Asia. The North American balance was primarily invested in U.S. municipal securities directly or through money market funds, as well as in taxable money market funds and in bank deposits. In Europe, the balances were primarily invested in a Euro money market fund and bank deposits. In Asia, the balances were primarily invested in bank deposits.
At September 27, 2008, the Company’s capital structure was comprised of $24.3 million in short-term debt, $2.3 million in long-term debt, and $204.9 million in Shareholders’ Investment. Total interest-
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bearing debt at September 27, 2008 was $26.3 million, an increase of $17.3 million from $9.0 million at September 29, 2007, due to $24.0 million of borrowings on the credit facility, partially offset by scheduled long term debt payments. Shareholders’ Investment increased by $15.2 million during fiscal year 2008, primarily due to strong operating results, $7.9 million received from stock option exercises and stock purchases under the Company’s employee stock purchase plan, $4.2 million in stock-based compensation, $3.9 million of foreign currency translation gains, and $1.3 million excess tax benefits from stock-based compensation, partially offset by $42.0 million in purchases of the Company’s common stock, and $10.3 million in dividends declared.
The Company believes its liquidity, represented by funds available from cash, cash equivalents, credit facility, anticipated cash from operations, and capital structure are adequate to fund ongoing operations, capital expenditures and Company share purchases, as well as to fund internal growth opportunities and strategic acquisitions.
At September 27, 2008, the Company’s contractual obligations were as follows:
| | | | | | | | | | | | | | | | |
| | | | | Payments Due by Period
(expressed in thousands) | |
| | | | | | |
Contractual Obligations | | Total | | Less than 1
year | | 1 - 3 years | | 3 - 5 years | | More than 5
years | |
| | | | | | | | | | | | |
Short-Term Borrowings | | $ | 24,338 | | $ | 24,338 | | $ | — | | $ | — | | $ | — | |
Long-Term Debt Obligations | | | 2,308 | | | 2,308 | | | — | | | — | | | — | |
Capital Lease Obligations | | | 41 | | | 19 | | | 22 | | | — | | | — | |
Operating Lease Obligations | | | 16,264 | | | 4,790 | | | 6,535 | | | 2,272 | | | 2,667 | |
Interest Payable | | | 149 | | | 149 | | | — | | | — | | | — | |
Pension and Other Long-Term Obligations | | | 3,086 | | | 457 | | | 183 | | | — | | | 2,446 | |
| | | | | | | | | | | | | | | | | |
Total | | $ | 46,186 | | $ | 32,061 | | $ | 6,740 | | $ | 2,272 | | $ | 5,113 | |
| | | | | | | | | | | | | | | | | |
Notes payable outstanding on September 27, 2008 consisted of $24.0 million in interest-bearing short-term notes payable placed with the Company’s credit facility, as well as $0.3 million of non-interest bearing notes payable to vendors by the Company’s Japanese Sensors subsidiary. Notes payable outstanding on September 29, 2007 consisted of non-interest bearing notes payable to vendors by the Company’s Japanese Sensors subsidiary. Under the terms of both the credit facility and its long-term debt agreements, the Company has agreed to certain financial covenants, including, among other covenants, minimum net worth, the ratio of consolidated total indebtedness to consolidated earnings before interest, taxes, depreciation, and amortization (“EBITDA”), as well as the ratio of consolidated EBITDA to consolidated interest expense. These covenants restrict the Company’s ability to pay dividends and purchase outstanding shares of common stock. At September 27, 2008, the Company was in compliance with these financial covenants.
At September 27, 2008, the Company had letters of credit and guarantees outstanding totaling $41.4 million and $3.0 million, respectively, primarily to bond advance payments and performance related to customer contracts in the Test segment. The Company’s operating leases are primarily for office space and automobiles.
Off-Balance Sheet Arrangements
At the end of fiscal year 2008, the Company did not have any off-balance sheet arrangements, as such term is defined in rules promulgated by the SEC, that have or are reasonably likely to have a current or future effect on the Company’s financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors.
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Critical Accounting Policies
The Consolidated Financial Statements are prepared in accordance with U.S. generally accepted accounting principles (“GAAP”), which require the Company to make estimates and assumptions in certain circumstances that affect amounts reported. In preparing these financial statements, management has made its best estimates and judgments of certain amounts, giving due consideration to materiality. The Company believes that of its significant accounting policies, the following are particularly important to the portrayal of the Company’s results of operations and financial position, may require the application of a higher level of judgment by the Company’s management, and as a result, are subject to an inherent degree of uncertainty. Further information see “Summary of Significant Accounting Policies” and “Stock-Based Compensation” under Notes 1 and 2, respectively, to the Consolidated Financial Statements, included in Item 8 of this Annual Report on Form 10-K.
Revenue Recognition: Due to the diversity of its products, the Company is required to comply with a variety of technical accounting requirements in order to achieve consistent and accurate revenue recognition. This requires a certain amount of judgment in the evaluation of completed contract versus percentage-of-completion accounting, the determination of estimated costs to complete contracts, and evaluation of customer acceptance terms.
Inventories: The Company maintains a material amount of inventory to support its engineering and manufacturing operations, and a certain amount of judgment is required in determining the appropriate level of inventory valuation reserves. While the Company expects its sales to grow, a reduction in its sales could reduce the demand for the Company’s products, and additional inventory valuation adjustments may be required.
Software Development Costs: The Company incurs costs associated with the development of software to be sold, leased, or otherwise marketed. Software development costs are expensed as incurred until technological feasibility has been established, at which time future costs incurred are capitalized until the product is available for general release to the public. A certain amount of judgment and estimation is required to assess when technological feasibility is established, as well as the ongoing assessment of the recoverability of capitalized costs. In evaluating the recoverability of capitalized software costs, the Company compares expected product performance, utilizing forecasted revenue amounts, to the total costs incurred to date and estimates of additional costs to be incurred. If revised forecasted product revenue is less than, and/or revised forecasted costs are greater than, the previously forecasted amounts, the net realizable value may be lower than previously estimated, which could result in the recognition of an impairment charge in the period in which such a determination is made.
Warranty Obligations: The Company is subject to warranty guarantees on sales of its products. A certain amount of judgment is required in determining appropriate reserve levels for anticipated warranty claims. While these reserve levels are based on historical warranty experience, they may not reflect the actual claims that will occur over the upcoming warranty period, and additional warranty reserves may be required.
Stock-Based Compensation: For purposes of determining estimated fair value of stock-based payment awards on the date of grant in accordance with Statement of Financial Accounting Standard (“SFAS”) No. 123R, “Share-Based Payment,” the Company utilizes a Black-Scholes option pricing model for estimating the fair value of stock option grants, which requires the input of certain assumptions requiring management judgment. Because the Company’s employee stock option awards have characteristics significantly different from those of traded options, and because changes in the input assumptions can materially affect fair value estimates, existing models may not provide a reliable single measure of the fair value of employee stock options. Management will continue to assess the assumptions and methodologies used to calculate estimated fair value of stock-based compensation. Circumstances may change and additional data may become available over time that could result in changes to these assumptions and methodologies and thereby materially impact the fair value determination. If factors change and the Company employs different assumptions in the application of SFAS No. 123R in future periods, the compensation expense recorded under SFAS No. 123R may differ significantly from the stock-based compensation expense recorded in the current period.
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Income Taxes: The Company records a tax provision for the anticipated tax consequences of the reported results of operations. Deferred tax assets and liabilities are measured using the currently enacted tax rates that apply to taxable income in effect for the years in which those deferred tax assets and liabilities are expected to be realized or settled. The Company records a valuation allowance to reduce deferred tax assets to the amount that is believed more likely than not to be realized. The Company believes it is more likely than not that forecasted income, including income that may be generated as a result of certain tax planning strategies, together with the tax effects of the deferred tax liabilities, will be sufficient to fully recover the remaining net realizable value of its deferred tax assets. In the event that all or part of the net deferred tax assets are determined not to be realizable in the future, an adjustment to the valuation allowance would be charged to earnings in the period such determination is made. In addition, the calculation of tax liabilities involves significant judgment in estimating the impact of uncertainties in the application of complex tax laws. Resolution of these uncertainties in a manner inconsistent with management’s expectations could have a material impact on the Company’s financial condition and operating results.
Recent Accounting Pronouncements
In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 157, “Fair Value Measurements.” SFAS No. 157 clarifies the principle that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. Under this statement, fair value measurements are required to be separately disclosed, by level, within the fair value hierarchy. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. The Company does not expect the adoption of SFAS No. 157 to have a material impact on its consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities Including an Amendment of SFAS No. 115, ‘Accounting for Certain Investments in Debt and Equity Securities.’” SFAS No. 159 allows entities to choose, at specified election dates, to measure eligible financial assets and liabilities at fair value in situations in which they are not otherwise required to be measured at fair value. If a company elects the fair value option for an eligible item, changes in that item’s fair value in subsequent reporting periods must be recognized in current period earnings. SFAS No. 159 also establishes presentation and disclosure requirements designed to draw comparison between entities that elect different measurement attributes for similar assets and liabilities. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. The Company does not expect the adoption of SFAS No. 159 to have a material impact on its consolidated financial statements.
In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations.” SFAS No. 141R expands the definition of a business combination and requires the fair value of the purchase price of an acquisition, including the issuance of equity securities, to be determined on the acquisition date. SFAS No. 141R also requires that all assets, liabilities, contingent considerations, and contingencies of an acquired business be recorded at fair value at the acquisition date. In addition, SFAS No. 141R requires that acquisition costs generally be expensed as incurred, restructuring costs generally be expensed in periods subsequent to the acquisition date and changes in accounting for deferred tax asset valuation allowances and acquired income tax uncertainties after the measurement period impact income tax expense. SFAS No. 141R is effective for the Company’s fiscal years beginning on or after December 15, 2008, with early adoption prohibited. The Company is evaluating the effect the adoption of SFAS No. 141R will have on its consolidated financial statements.
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements, an Amendment of ARB No. 51.” SFAS No. 160 requires minority interests to be recharacterized as noncontrolling interests and reported as a component of equity. In addition, SFAS No. 160 requires that purchases or sales of equity interests that do not result in a change in control be accounted for as equity transactions and, upon a loss of control, requires the interests sold, as well as any interests retained, to be recorded at fair value with any gain or loss recognized in earnings. SFAS No. 160 is effective for fiscal years beginning on or after December 15, 2008, with early adoption prohibited. The Company does not expect the adoption of SFAS No. 160 to have a material impact on its consolidated financial statements.
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In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities, an Amendment to SFAS No. 133.” SFAS No. 161 requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative agreements. SFAS No. 161 is effective for fiscal years beginning after November 15, 2008. The Company does not expect the adoption of SFAS No. 161 to have a material impact on its consolidated financial statements.
In April 2008, the FASB issued Staff Position (“FSP”) FAS 142-3 “Determination of the Useful Life of Intangible Assets.” FSP FAS 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of intangible assets under SFAS No. 142 “Goodwill and Other Intangible Assets.” FSP FAS 142-3 is intended to improve the consistency between the useful life of a recognized intangible asset under SFAS No. 142 and the period of the expected cash flows used to measure the fair value of the asset under SFAS No. 141R and other GAAP. FSP No. FAS 142-3 is effective for fiscal years beginning after December 15, 2008, with early adoption prohibited. The Company does not expect the adoption of FSP No. FAS 142-3 to have a material impact on its consolidated financial statements.
In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles.” SFAS No. 162 is intended to improve financial reporting by identifying a consistent framework, or hierarchy, for selecting accounting principles to be used in preparing financial statements that are presented in accordance with GAAP. SFAS No. 162 will be effective 60 days after the SEC approves the Public Company Accounting Oversight Board’s amendments to AU Section 411, “The Meaning of Present Fairly in Accordance With Generally Accepted Accounting Principles.” The Company does not expect the adoption of SFAS No. 162 to have a material impact on its consolidated financial statements.
In June 2008, the FASB issued FSP Emerging Issues Task Force (“EITF”) No. 03-6-1 “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities” FSP EITF No. 03-6-1 clarifies that all outstanding unvested share-based payment awards that contain rights to non-forfeitable dividends participate in undistributed earnings with common shareholders. Awards of this nature are considered participating securities and the two-class method of computing basic and diluted earnings per share must be applied. FSP EITF No. 03-6-1 is effective for fiscal years beginning after December 15, 2008. The Company does not expect the adoption of FSP EITF No. 03-6-1 to have a material impact on its consolidated financial statements.
In June 2008, the FASB issued EITF No. 07-5, “Determining Whether an Instrument (or an Embedded Feature) Is Indexed to an Entity’s Own Stock.” EITF No. 07-5 provides that an entity should use a two step approach to evaluate whether an equity-linked financial instrument (or embedded feature) is indexed to its own stock, including evaluating the instrument’s contingent exercise and settlement provisions. It also clarifies the impact of foreign currency denominated strike prices and market-based employee stock option valuation instruments on the evaluation. EITF No. 07-5 is effective for fiscal years beginning after December 15, 2008. The Company does not expect the adoption of EITF No. 07-5 to have a material impact on its consolidated financial statements.
Quarterly Financial Information
Revenue and operating results reported on a quarterly basis do not necessarily reflect trends in demand for the Company’s products or its operating efficiency. Revenue and operating results in any quarter may be significantly affected by customer shipments, installation timing, or the timing of the completion of one or more contracts where revenue is recognized upon shipment or customer acceptance rather than on the percentage-of-completion method of revenue recognition. The Company’s use of the percentage-of-completion revenue recognition method for large, long-term projects generally has the effect of smoothing significant fluctuations from quarter to quarter. See Note 1 to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for additional information on the Company’s revenue recognition policy. Quarterly earnings also vary as a result of the use of estimates including, but not limited to, the rates used in recording federal, state, and foreign income tax
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expense. See Notes 1 and 6 to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for additional information on the Company’s use of estimates and income tax related matters, respectively.
Selected quarterly financial information for the fiscal years ended September 27, 2008 and September 29, 2007 was as follows:
| | | | | | | | | | | | | | | | |
| | First
Quarter | | Second
Quarter | | Third
Quarter | | Fourth
Quarter | | Total
Year | |
| | | | | | | | | | | | |
| | (expressed in thousands, except per share data) | |
| | | | | | | | | | | | | | | | |
2008 | | | | | | | | | | | | | | | | |
Revenue | | $ | 107,392 | | $ | 112,168 | | $ | 116,886 | | $ | 124,069 | | $ | 460,515 | |
Gross profit | | | 43,222 | | | 46,074 | | | 47,246 | | | 53,711 | | | 190,253 | |
Income before income taxes and discontinued operations | | | 12,604 | | | 15,381 | | | 15,327 | | | 22,148 | | | 65,460 | |
Income before discontinued operations | | | 8,181 | | | 13,445 | | | 10,985 | | | 14,499 | | | 47,110 | |
Discontinued operations, net of tax | | | 175 | | | 94 | | | 1,765 | | | 47 | | | 2,081 | |
| | | | | | | | | | | | | | | | | |
Net income | | $ | 8,356 | | $ | 13,539 | | $ | 12,750 | | $ | 14,546 | | $ | 49,191 | |
| | | | | | | | | | | | | | | | | |
Earnings per share: | | | | | | | | | | | | | | | | |
Basic | | | | | | | | | | | | | | | | |
Income before discontinued operations | | $ | 0.46 | | $ | 0.76 | | $ | 0.64 | | $ | 0.86 | | $ | 2.72 | |
Discontinued operations, net of tax | | | 0.01 | | | 0.01 | | | 0.10 | | | — | | | 0.12 | |
| | | | | | | | | | | | | | | | | |
Earnings per share | | $ | 0.47 | | $ | 0.77 | | $ | 0.74 | | $ | 0.86 | | $ | 2.84 | |
| | | | | | | | | | | | | | | | | |
Diluted | | | | | | | | | | | | | | | | |
Income before discontinued operations | | $ | 0.45 | | $ | 0.75 | | $ | 0.63 | | $ | 0.85 | | $ | 2.68 | |
Discontinued operations, net of tax | | | 0.01 | | | 0.01 | | | 0.10 | | | — | | | 0.12 | |
| | | | | | | | | | | | | | | | | |
Earnings per share | | $ | 0.46 | | $ | 0.76 | | $ | 0.73 | | $ | 0.85 | | $ | 2.80 | |
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
2007 | | | | | | | | | | | | | | | | |
Revenue | | $ | 96,734 | | $ | 99,476 | | $ | 105,180 | | $ | 108,701 | | $ | 410,091 | |
Gross profit | | | 40,877 | | | 45,028 | | | 41,119 | | | 46,614 | | | 173,638 | |
Income before income taxes and discontinued operations | | | 12,791 | | | 16,340 | | | 11,747 | | | 15,712 | | | 56,590 | |
Income before discontinued operations | | | 9,803 | | | 10,280 | | | 9,396 | | | 11,562 | | | 41,041 | |
Discontinued operations, net of tax | | | 314 | | | 51 | | | 609 | | | (19 | ) | | 955 | |
| | | | | | | | | | | | | | | | | |
Net income | | $ | 10,117 | | $ | 10,331 | | $ | 10,005 | | $ | 11,543 | | $ | 41,996 | |
| | | | | | | | | | | | | | | | | |
Earnings per share: | | | | | | | | | | | | | | | | |
Basic | | | | | | | | | | | | | | | | |
Income before discontinued operations | | $ | 0.54 | | $ | 0.57 | | $ | 0.53 | | $ | 0.65 | | $ | 2.29 | |
Discontinued operations, net of tax | | | 0.02 | | | — | | | 0.03 | | | — | | | 0.05 | |
| | | | | | | | | | | | | | | | | |
Earnings per share | | $ | 0.56 | | $ | 0.57 | | $ | 0.56 | | $ | 0.65 | | $ | 2.34 | |
| | | | | | | | | | | | | | | | | |
Diluted | | | | | | | | | | | | | | | | |
Income before discontinued operations | | $ | 0.52 | | $ | 0.56 | | $ | 0.52 | | $ | 0.64 | | $ | 2.24 | |
Discontinued operations, net of tax | | | 0.02 | | | — | | | 0.03 | | | — | | | 0.05 | |
| | | | | | | | | | | | | | | | | |
Earnings per share | | $ | 0.54 | | $ | 0.56 | | $ | 0.55 | | $ | 0.64 | | $ | 2.29 | |
| | | | | | | | | | | | | | | | | |
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| |
Item 7A. | Quantitative and Qualitative Disclosures About Market Risk |
Foreign Currency Exchange Risk
Approximately 65-70% of the Company’s revenue is derived from shipments to customers outside of the United States and about 65% of this revenue (approximately 44% of the Company’s total revenue) is denominated in currencies other than the U.S. dollar. The Company’s international subsidiaries have functional currencies other than the Company’s U.S. dollar reporting currency and, occasionally, transact business in currencies other than their functional currencies. These non-functional currency transactions expose the Company to market risk on assets, liabilities and cash flows recognized on these transactions.
The strengthening of the U.S. dollar relative to foreign currencies decreases the value of foreign currency-denominated revenue and earnings when translated into U.S. dollars. Conversely, a weakening of the U.S. dollar increases the value of foreign currency-denominated revenue and earnings. The following table illustrates financial results utilizing currency exchange rates from the prior year to estimate the impact of currency on the following financial items:
Foreign Currency Exchange Rates
| | | | | | | | | | |
| | 2008 | | 2007 | | 2006 | |
| | | | | | | | |
| | (expressed in thousands) | |
Increase (decrease) from currency translation on: | | | | | | | | | | |
Orders | | $ | 21,090 | | $ | 9,107 | | $ | (6,901 | ) |
Revenue | | | 22,128 | | | 11,593 | | | (9,590 | ) |
Net Income | | $ | 2,243 | | $ | 868 | | $ | (895 | ) |
| | | | | | | | | | | |
The net effect of currency translation on orders, revenue, and net income was favorable in fiscal year 2008, as the value of the U.S. dollar, on average, decreased by approximately 5% against the Euro and by approximately 6% against the Japanese Yen.
A hypothetical 10% appreciation or depreciation in foreign currencies against the U.S. dollar, assuming all other variables are held constant, would result in an increase or decrease in fiscal year 2008 revenue of approximately $20.9 million.
The Company has operational procedures to mitigate these non-functional currency exposures. The Company also utilizes committed and optional foreign currency exchange contracts to exchange currencies at set exchange rates on future dates to offset expected gains or losses on specifically identified exposures. See Note 1 to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.
Gains and losses on foreign currency transactions are included in both Revenue and Other Income (Expense), net in the accompanying Consolidated Statements of Income, was a net gain of $0.6 million in fiscal year 2008, a net loss of $0.6 million in fiscal year 2007, and a net gain of $0.8 million in fiscal year 2006. Mark-to-market gains and losses on derivatives designated as cash flow hedges in the Company’s currency hedging program, as well as on the translation of non-current assets and liabilities, are recorded within Accumulated Other Comprehensive Income in the Consolidated Balance Sheet. The Company recognizes gains and losses on fair value and cash flow hedges at the time a gain or loss is recognized on the hedged exposure in the Consolidated Statement of Income, or at the time the cash flow hedge is determined to be ineffective. The associated mark-to-market gains and losses are reclassified from Accumulated Other Comprehensive Income to the same line item in the Consolidated Statements of Income that the underlying hedged transaction is reported.
Interest Rates
The Company is also directly exposed to changes in market interest rates on cash, cash equivalents, short-term investments, and debt and is indirectly exposed to the impact of market interest rates on overall business activity.
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On floating-rate investments, increases and decreases in market interest rates will increase or decrease future interest income, respectively. On floating-rate debt, increases or decreases in market interest rates will increase or decrease future interest expense, respectively. On fixed-rate investments, increases or decreases in market interest rates do not impact future interest income but may decrease or increase the fair market value of the investments, respectively. For fixed-rate debt or other interest-bearing obligations, increases or decreases in market interest rates do not impact future interest expense but may decrease or increase the fair market value of the debt, respectively.
At September 27, 2008, the Company had cash and cash equivalents of $114.1 million. Most of this balance was invested in interest-bearing bank deposits or money market funds, with interest rates reset every 1-89 days. A hypothetical increase or decrease of 1% in market interest rates, assuming all other variables were held constant, would increase or decrease interest income by approximately $1.2 million on an annualized basis.
The Company’s short-term borrowings outstanding at the end of fiscal year 2008 consisted of $24.0 million utilization of the revolving credit facility and $0.3 million in non-interest bearing notes payable to vendors. This utilization of the credit facility involves interest payments calculated at a floating rate. In order to mitigate the Company’s exposure to interest rate increases, the Company entered into a four-year floating to fixed interest rate swap agreement on July 25, 2008. The notes payable to vendors are non-interest bearing and, therefore, are not impacted by the effect of increases or decreases in market interest rates. The Company’s long-term debt has a fixed rate of interest and, therefore, is not impacted by changes in market interest rates.
A discount rate of 6.4% and an expected rate increase in future compensation levels of 3.2% was used in the calculation of the pension liability related to the non-contributory, defined benefit pension plan of one of the Company’s international subsidiaries. In addition, a 5.9% expected rate of return was used in the calculation of the plan assets associated with this defined benefit pension plan.
| |
Item 8. | Financial Statements and Supplementary Data |
The Company’s audited financial statements and notes thereto described in Item 15(1) of this Annual Report on Form 10-K, and appearing on pages F-1 through F-31 of this report, are incorporated by reference herein. See also “Quarterly Financial Data” in Management’s Discussion and Analysis under Item 7 of this Annual Report on Form 10-K, which is incorporated herein by reference.
| |
Item 9. | Changes in and Disagreements With Accountants on Accounting and Financial Disclosure |
None.
| |
Item 9A. | Controls and Procedures |
The Company’s management, including the Chief Executive Officer and Chief Financial Officer, have conducted an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Rule 13a-15 under the Securities Exchange Act of 1934 (the “1934 Act”) as of September 27, 2008. Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective in ensuring that information required to be disclosed by the Company in the reports it files or submits under the 1934 Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms.
There have been no changes in internal control over financial reporting during the fiscal quarter ended September 27, 2008 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Exchange Act. The
31
Table of Contents
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. Under the supervision and with the participation of management, including its Chief Executive Officer and Chief Financial Officer, the Company conducted an evaluation of the effectiveness of internal controls over financial reporting as of September 27, 2008. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission inInternal Control – Integrated Framework. Based on management’s assessment using this framework, management concluded that the Company’s internal control over financial reporting is effective as of September 27, 2008.
| |
Item 9B. | Other Information |
None.
PART III
| |
Item 10. | Directors and Executive Officers of Registrant |
The required information with respect to the directors of the Company, the Company’s Code of Business Conduct and compliance with Section 16(a) of the Securities Exchange Act of 1934, is incorporated herein by reference to the information set forth under the headings “Election of Directors” and “Other Information” in the Company’s Proxy Statement for the Annual Meeting of Shareholders scheduled to be held on February 4, 2009. Information regarding the Company’s executive officers is contained under Item 1 of this Annual Report on Form 10-K.
| |
Item 11. | Executive Compensation |
The information required by this Item is incorporated herein by reference to the information set forth under heading “Executive Compensation” (except as expressly set forth therein) in the Company’s Proxy Statement for the Annual Meeting of Shareholders scheduled to be held on February 4, 2009.
| |
Item 12. | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters |
Equity Compensation Plan Information:
The following table sets forth the aggregate information regarding grants under all equity compensation plans as of September 27, 2008:
32
Table of Contents
| | | | | | | | | | |
Plan Category | | Number of Securities to
be Issued Upon Exercise of
Outstanding Options, Warrants
and Rights
(in thousands)
(a) | | Weighted-
Average
Exercise
Price of
Outstanding
Warrants and
Rights
(b) | | Number of Securities
Remaining Available for
Future Issuance Under
Equity Compensation Plans
(Excluding Securities Reflected
in Column (a))(1)
(in thousands)
(c) | |
| | | | | | | | |
Equity compensation plans approved by security holders | | 1,592 | | | $ | 37.12 | | 1,767 | | |
| | | | | | | | | | |
Equity compensation plans not approved by security holders | | — | | | $ | — | | — | | |
| | | | | | | | | | | |
| | | | | | | | | | |
Total | | 1,592 | | | $ | 37.12 | | 1,767 | | |
| | | | | | | | | | | |
(1) Includes 514 shares available for issuance under the 2002 Employee Stock Purchase Plan as of September 27, 2008.
Certain other information required by this Item is incorporated herein by reference to the information set forth under the heading “Other Information - Security Ownership of Principal Shareholders and Management” in the Company’s Proxy Statement for the Annual Meeting of Shareholders scheduled to be held on February 4, 2009.
| |
Item 13. | Certain Relationships and Related Transactions, and Directors Independence |
The information required by this Item is incorporated herein by reference to the information set forth under headings “Election of Directors” and “Other Information – Related Party Transactions” in the Company’s Proxy Statement for the Annual Meeting of Shareholders scheduled to be held on February 4, 2009.
| |
Item 14. | Principal Accountant Fees and Services |
The information required by this Item is incorporated by reference to the information set forth under the heading “Ratification of Appointment of Independent Registered Public Accounting Firm” in the Company’s Proxy Statement for the Annual Meeting of Shareholders scheduled to be held on February 4, 2009.
PART IV
| |
Item 15. | Exhibits and Financial Statement Schedules |
| | | |
| The following documents are filed as part of this report: |
| |
| | (1) Consolidated Financial Statements: |
| |
| | | Report of Independent Registered Public Accounting Firm |
| | | |
| | | Report of Independent Registered Public Accounting Firm |
| | | |
| | | Consolidated Balance Sheets – September 27, 2008 and September 29, 2007 |
| | | |
| | | Consolidated Statements of Income for the Years Ended September 27, 2008, September 29, 2007 and September 30, 2006 |
| | | |
| | | Consolidated Statements of Shareholders’ Investment for the Years Ended September 27, 2008, September 29, 2007 and September 30, 2006 |
| | | |
| | | Consolidated Statements of Cash Flows for the Years Ended September 27, 2008, September 29, 2007 and September 30, 2006 |
33
Table of Contents
| | | |
| | | Notes to Consolidated Financial Statements |
| | |
| | (2) Financial Statement Schedules: |
| | |
| | | See accompanying Index to Financial Statements on page F-1. |
| | |
| | (3) Exhibits: |
| | | |
| | | |
| Exhibit
Number | | Description |
| | | |
| 3.a | | Restated and Amended Articles of Incorporation, incorporated herein by reference from Exhibit 3.a of the Company’s Form 10-K for the fiscal year ended September 30, 1996. |
| | | |
| 3.b | | Amended and Restated Bylaws, incorporated herein by reference to Exhibit 3.b of the Company’s Form 10-K filed for the fiscal year ended September 29, 2007. |
| | | |
| 10.a | | Executive Variable Compensation Plan, incorporated herein by reference to Exhibit 99.1 of the Company’s Form 8-K Current Report filed on November 30, 2004. |
| | | |
| 10.b | | 1994 Stock Option Plan, as amended, incorporated herein by reference to Exhibit 10.e of the Company’s Form 10-K filed for the fiscal year ended September 30, 1996. |
| | | |
| 10.c | | 1997 Stock Option Plan, as amended, incorporated herein by reference to Exhibit 10.p of the Company’s Form 10-K filed for the fiscal year ended September 30, 1996 and Exhibit 10.p of the Company’s Form 10-K filed for the fiscal year ended September 30, 1999. |
| | | |
| 10.d | | 2002 Employee Stock Purchase Plan, as amended, incorporated herein by reference to Exhibit 10.d of the Company’s Form 10-K filed for the fiscal year ended October 1, 2005. |
| | | |
| 10.e | | 2006 Stock Incentive Plan, incorporated herein by reference to Exhibit 99.1 of the Company’s Form 8-K Current Report filed on February 7, 2006. |
| | | |
| 10.f | | Form of Notice of Grant of Restricted Stock under 2006 Stock Incentive Plan, incorporated herein by reference to Exhibit 99.2 of the Company’s Form 8-K Current Report filed on February 7, 2006. |
| | | |
| 10.g | | Uniform Terms and Conditions to Restricted Stock Awards under 2006 Stock Incentive Plan, incorporated herein by reference to Exhibit 99.3 of Company’s Form 8-K Current Report filed on February 7, 2006. |
| | | |
| 10.k | | Description of the terms of employment of Susan E. Knight, pursuant to an offer letter, incorporated by reference to Exhibit 10.r of the Company’s Form 10-Q/A for the fiscal quarter ended December 31, 2001. |
| | | |
| 10.l | | Letter dated February 6, 1987 from MTS Sensor Technologie GmbH and Co. KG (formerly, Hellwig GmbH) regarding its pension commitment to Joachim Hellwig, incorporated by reference to Exhibit 10.p of the Company’s Form 10-K filed for fiscal year ended October 2, 2004. |
34
Table of Contents
| | | |
| 10.m | | Employment Contract dated January 1, 1991 between MTS Sensor Technologie GmbH and Co. KG and Joachim Hellwig, incorporated by reference to Exhibit 10.q of the Company’s Form 10-K filed for fiscal year ended October 2, 2004. |
| | | |
| 10.n | | Change in Control Agreement, dated December 20, 2005, between the Company and Laura B. Hamilton, incorporated herein by reference to Exhibit 99.1 of the Company’s Form 8-K Current Report filed on December 23, 2005. |
| | | |
| 10.o | | Form of Indemnification Agreement between the Company and each of its directors and executive officers, incorporated herein by reference to Exhibit 10.1 of the Company’s Form 8-K Current Report filed on September 1, 2006. |
| | | |
| 10.p | | First Amendment to the Company’s 2006 Stock Incentive Plan, First Amendment to the Company’s Executive Variable Compensation Plan, amendments to the Company’s Executive Deferred Compensation Plan (2005), and amendments to the Company’s form of change in control agreements, incorporated herein by reference to Exhibits 10.1, 10.2, 10.3 and 10.4 of the Company’s Form 8-K Current Report filed on October 27, 2008. |
| | | |
| 10.q | | Master Asset Purchase Agreement dated April 28, 2008, between the Company and the SANS Group, incorporated herein by reference to Exhibit 2.1 of the Company’s Form 8-K Current Report filed October 2, 2008. |
| | | |
| 10.r | | Letter Agreement Regarding Accelerated Share Purchase Program by and between the Company and J.P. Morgan Securities Inc., as agent for JPMorgan Chase Bank, National Association, London Branch dated May 5, 2008, incorporated herein by reference to Exhibit 10.1 of the Company’s Form 8-K Current Report filed May 8, 2008. |
| | | |
| 10.s | | Credit Agreement dated December 18, 2007, among the Company, Wells Fargo Bank, National Association, Fifth Third Bank, The Bank of Tokyo Mitsubishi UFJ, Ltd., U.S. Bank National Association, JPMorgan Chase Bank, N.A. and J.P. Morgan Securities Inc., incorporated herein by reference to Exhibit 10.1 of the Company’s Form 8-K Current Report filed December 21, 2007. |
| | | |
| 21. | | Subsidiaries of the Company (Filed herewith). |
| | | |
| 23. | | Consent of Independent Registered Public Accounting Firm (Filed herewith). |
| | | |
| 31.1 | | Certification of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (Filed herewith). |
| | | |
| 31.2 | | Certification of the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (Filed herewith). |
| | | |
| 32.1 | | Certification of the Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Filed herewith). |
| | | |
| 32.2 | | Certification of the Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Filed herewith). |
35
Table of Contents
SIGNATURES
Pursuant to the requirement of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| | | |
| MTS SYSTEMS CORPORATION |
| | |
| By: | /s/ LAURA B. HAMILTON | |
| | | |
| | Laura B. Hamilton |
| | Chair, President and Chief Executive Officer |
| | |
Date: November 25, 2008 | | |
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 date indicated:
| | | | |
Signatures | | Title | | Date |
| | | | |
| | | | |
/s/ LAURA B. HAMILTON | | Chair, President and | | November 25 2008 |
| | | | | |
Laura B. Hamilton | | Chief Executive Officer | | |
| | | | |
/s/ SUSAN E. KNIGHT | | Chief Financial Officer | | November 25, 2008 |
| | | | | |
Susan E. Knight | | and Vice President | | |
| | | | |
/s/ JEAN-LOU CHAMEAU | | Director | | November 25, 2008 |
| | | | | |
Jean-Lou Chameau | | | | |
| | | | |
/s/ MERLIN E. DEWING | | Director | | November 25, 2008 |
| | | | | |
Merlin E. Dewing | | | | |
| | | | |
/s/ BRENDAN C. HEGARTY | | Director | | November 25, 2008 |
| | | | | |
Brendan C. Hegarty | | | | |
| | | | |
/s/ LOIS M. MARTIN | | Director | | November 25, 2008 |
| | | | | |
Lois M. Martin | | | | |
| | | | |
/s/ JOSEPH M. O’DONNEL | | Director | | November 25, 2008 |
| | | | | |
Joseph M. O’Donnell | | | | |
| | | | |
/s/ BARB J. SAMARDZICH | | Director | | November 25, 2008 |
| | | | | |
Barb J. Samardzich | | | | |
36
Table of Contents
MTS Systems Corporation and Subsidiaries
Index to Financial Statements
| | | |
CONSOLIDATED FINANCIAL STATEMENTS | Page |
| |
| | | |
Report of Independent Registered Public Accounting Firm | F-2 |
| | | |
Report of Independent Registered Public Accounting Firm | F-3 |
| | | |
Consolidated Balance Sheets – September 27, 2008 and September 29, 2007 | F-4 |
| | | |
Consolidated Statements of Income for the Years Ended
September 27, 2008, September 29, 2007 and September 30, 2006 | F-5 |
| | | |
Consolidated Statements of Shareholders’ Investment
and Comprehensive Income (Loss) for the Years Ended
September 27, 2008, September 29, 2007 and September 30, 2006 | F-6 |
| | | |
Consolidated Statements of Cash Flows for the Years Ended
September 27, 2008, September 29, 2007 and September 30, 2006 | F-7 |
| | | |
Notes to Consolidated Financial Statements | F-8 through F-31 |
| | | |
Financial Statement Schedule | |
| |
Schedule | Description | | |
| | | |
| | | |
II | Summary of Consolidated Allowances
For Doubtful Accounts and Restructuring
Reserves | | F-32 |
F-1
Table of Contents
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
MTS Systems Corporation:
We have audited the accompanying consolidated balance sheets of MTS Systems Corporation and subsidiaries as of September 27, 2008 and September 29, 2007, and the related consolidated statements of income, shareholders’ investment and comprehensive income (loss), and cash flows for each of the years in the three-year period ended September 27, 2008. In connection with our audits of the consolidated financial statements, we also have audited financial statement schedule II. These consolidated financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (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. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of MTS Systems Corporation and subsidiaries as of September 27, 2008 and September 29, 2007, and the results of their operations and their cash flows for each of the years in the three-year period ended September 27, 2008, 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 consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), MTS Systems Corporation and subsidiaries’ internal control over financial reporting as of September 27, 2008, based on criteria established inInternal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated November 25, 2008 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
In fiscal 2008, as disclosed in Note 6 to the consolidated financial statements, the Company adopted FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an Interpretation of FASB Statement No. 109” on September 30, 2007.
Minneapolis, Minnesota
November 25, 2008
F-2
Table of Contents
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
MTS Systems Corporation:
We have audited MTS Systems Corporation and subsidiaries’ internal control over financial reporting as of September 27, 2008, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). MTS Systems Corporation and subsidiaries’ management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting appearing under Item 9A of this Form 10-K. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process 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. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, MTS Systems Corporation and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of September 27, 2008, based on criteria established inInternal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of MTS Systems Corporation and subsidiaries as of September 27, 2008 and September 29, 2007, and the related consolidated statements of income, shareholders’ investment and comprehensive income (loss), and cash flows for each of the years in the three-year period ended September 27, 2008, and our report dated November 25, 2008 expressed an unqualified opinion on those consolidated financial statements
Minneapolis, Minnesota
November 25, 2008
F-3
Table of Contents
Consolidated Balance Sheets
(September 27 and September 29, respectively)
| | | | | | | |
Assets | | 2008 | | 2007 | |
| | | | | | |
| | (expressed in thousands) | |
Current Assets: | | | | | | | |
Cash and cash equivalents | | $ | 114,099 | | $ | 104,345 | |
Short-term investments | | | — | | | 17,050 | |
Accounts receivable, net of allowance for doubtful accounts of $1,008 and $1,518 respectively | | | 101,331 | | | 73,474 | |
Unbilled accounts receivable | | | 43,022 | | | 41,026 | |
Inventories | | | 46,135 | | | 42,384 | |
Prepaid expenses and other current assets | | | 6,205 | | | 3,801 | |
Current deferred tax assets | | | 11,825 | | | 6,451 | |
Assets of discontinued operations | | | 380 | | | 8,077 | |
| | | | | | | | |
Total current assets | | | 322,997 | | | 296,608 | |
| | | | | | | | |
| | | | | | | |
Property and Equipment: | | | | | | | |
Land | | | 1,668 | | | 1,668 | |
Buildings and improvements | | | 45,700 | | | 45,525 | |
Machinery and equipment | | | 91,851 | | | 88,108 | |
Accumulated depreciation | | | (88,685 | ) | | (85,554 | ) |
| | | | | | | | |
Total property and equipment, net | | | 50,534 | | | 49,747 | |
| | | | | | | | |
Goodwill | | | 1,668 | | | 1,642 | |
Software development costs | | | 4,155 | | | — | |
Other assets | | | 17,491 | | | 3,664 | |
Non-current deferred tax assets | | | 2,312 | | | 1,320 | |
| | | | | | | | |
Total assets | | $ | 399,157 | | $ | 352,981 | |
| | | | | | | | |
| | | | | | | |
Liabilities and Shareholders’ Investment | | | | | | | |
| | | | | | | | |
| | | | | | | |
Current Liabilities: | | | | | | | |
Short-term borrowings | | $ | 24,338 | | $ | 265 | |
Current maturities of long-term debt | | | 2,308 | | | 6,683 | |
Accounts payable | | | 28,567 | | | 22,341 | |
Accrued payroll and related costs | | | 33,819 | | | 29,236 | |
Advance payments from customers | | | 64,979 | | | 51,536 | |
Accrued warranty costs | | | 6,107 | | | 6,205 | |
Accrued income taxes | | | 4,510 | | | 7,572 | |
Current deferred income taxes | | | 3,723 | | | 3,564 | |
Other accrued liabilities | | | 17,042 | | | 15,437 | |
Liabilities of discontinued operations | | | 177 | | | 1,944 | |
| | | | | | | | |
Total current liabilities | | | 185,570 | | | 144,783 | |
| | | | | | | | |
Deferred income taxes | | | 1,354 | | | 846 | |
Non-current accrued income taxes | | | 4,009 | | | — | |
Long-term debt, less current maturities | | | — | | | 2,308 | |
Pension benefit plan | | | 245 | | | 12,777 | |
Other long-term liabilities | | | 3,037 | | | 2,566 | |
| | | | | | | | |
Total liabilities | | | 194,215 | | | 163,280 | |
| | | | | | | | |
| | | | | | | |
Shareholders’ Investment: | | | | | | | |
Common stock, 25¢ par value; 64,000 shares authorized:
16,976 and 17,704 shares issued and outstanding | | | 4,244 | | | 4,426 | |
Retained earnings | | | 175,216 | | | 164,862 | |
Accumulated other comprehensive income | | | 25,482 | | | 20,413 | |
| | | | | | | | |
Total shareholders’ investment | | | 204,942 | | | 189,701 | |
| | | | | | | | |
Total liabilities and shareholders’ investment | | $ | 399,157 | | $ | 352,981 | |
| | | | | | | | |
The accompanying Notes to Consolidated Financial Statements are an integral part of these consolidated financial statements.
F-4
Table of Contents
Consolidated Statements of Income
(For the Fiscal Years Ended September 27, September 29 and September 30, respectively)
| | | | | | | | | | |
| | 2008 | | 2007 | | 2006 | |
| | | | | | | | |
| | | | | | | | | | |
Revenue: | | | | | | | | | | |
Product | | $ | 395,173 | | $ | 350,156 | | $ | 335,006 | |
Service | | | 65,342 | | | 59,935 | | | 52,918 | |
| | | | | | | | | | | |
Total Revenue | | | 460,515 | | | 410,091 | | | 387,924 | |
| | | | | | | | | | | |
Cost of Sales: | | | | | | | | | | |
Product | | | 235,861 | | | 206,067 | | | 193,243 | |
Service | | | 34,401 | | | 30,386 | | | 26,446 | |
| | | | | | | | | | | |
Total Cost of Sales | | | 270,262 | | | 236,453 | | | 219,689 | |
| | | | | | | | | | | |
Gross Profit | | | 190,253 | | | 173,638 | | | 168,235 | |
| | | | | | | | | | | |
Operating Expenses: | | | | | | | | | | |
Selling and marketing | | | 76,867 | | | 68,907 | | | 63,901 | |
General and administrative | | | 35,393 | | | 32,216 | | | 32,851 | |
Research and development | | | 16,232 | | | 19,285 | | | 17,969 | |
| | | | | | | | | | | |
Total Operating Expenses | | | 128,492 | | | 120,408 | | | 114,721 | |
| | | | | | | | | | | |
Gain on sale of assets | | | — | | | 742 | | | 872 | |
| | | | | | | | | | | |
Income From Operations | | | 61,761 | | | 53,972 | | | 54,386 | |
| | | | | | | | | | | |
Interest expense | | | (1,083 | ) | | (1,309 | ) | | (1,716 | ) |
Interest income | | | 4,033 | | | 3,899 | | | 3,595 | |
Other income, net | | | 749 | | | 28 | | | 1,041 | |
| | | | | | | | | | | |
Income Before Income Taxes and Discontinued Operations | | | 65,460 | | | 56,590 | | | 57,306 | |
Provision for Income Taxes | | | 18,350 | | | 15,549 | | | 19,337 | |
| | | | | | | | | | | |
Income Before Discontinued Operations | | | 47,110 | | | 41,041 | | | 37,969 | |
| | | | | | | | | | | |
Discontinued Operations: | | | | | | | | | | |
(Loss) income from discontinued operations, net of tax | | | (368 | ) | | 955 | | | 1,354 | |
Net gain on disposal of discontinued businesses, net of tax | | | 2,449 | | | — | | | — | |
| | | | | | | | | | | |
Income from Discontinued Operations, net of tax | | | 2,081 | | | 955 | | | 1,354 | |
| | | | | | | | | | | |
Net Income | | | 49,191 | | | 41,996 | | | 39,323 | |
| | | | | | | | | | | |
Earnings Per Share | | | | | | | | | | |
Basic: | | | | | | | | | | |
Income Before Discontinued Operations | | $ | 2.72 | | $ | 2.29 | | $ | 2.03 | |
Discontinued Operations: | | | | | | | | | | |
(Loss) income from discontinued operations, net of tax | | | (0.02 | ) | | 0.05 | | | 0.07 | |
Net gain on disposal of discontinued businesses, net of tax | | | 0.14 | | | — | | | — | |
| | | | | | | | | | | |
Income from Discontinued Operations, net of tax | | | 0.12 | | | 0.05 | | | 0.07 | |
| | | | | | | | | | | |
Earnings Per Share - Basic | | $ | 2.84 | | $ | 2.34 | | $ | 2.10 | |
| | | | | | | | | | | |
Diluted: | | | | | | | | | | |
Income Before Discontinued Operations | | $ | 2.68 | | $ | 2.24 | | $ | 1.97 | |
Discontinued Operations: | | | | | | | | | | |
(Loss) income from discontinued operations, net of tax | | | (0.02 | ) | | 0.05 | | | 0.07 | |
Net gain on disposal of discontinued businesses, net of tax | | | 0.14 | | | — | | | — | |
| | | | | | | | | | | |
Income from Discontinued Operations, net of tax | | | 0.12 | | | 0.05 | | | 0.07 | |
| | | | | | | | | | | |
Earnings Per Share - Diluted | | $ | 2.80 | | $ | 2.29 | | $ | 2.04 | |
| | | | | | | | | | | |
The accompanying Notes to Consolidated Financial Statements are an integral part of these consolidated financial statements.
F-5
Table of Contents
Consolidated Statements of Shareholders’ Investment and Comprehensive Income (Loss)
(For the Fiscal Years Ended September 27, September 29 and September 30, respectively, expressed in thousands)
| | | | | | | | | | | | | | | | | | | |
| | Common Stock | | Additional
Paid-In
Capital | | Retained
Earnings | | Accumulated
Other
Comprehensive
Income (Loss) | | Total
Shareholders’
Investment | |
| | | | | | | |
| | Shares
Issued | | Amount | | | | | |
| | | | | | | | | | | | | | |
Balance, October 1, 2005 | | | 19,664 | | | 4,916 | | | — | | | 173,487 | | | 10,029 | | | 188,432 | |
| | | | | | | | | | | | | | | | | | | | |
Net income | | | — | | | — | | | — | | | 39,323 | | | — | | | 39,323 | |
Foreign currency translation | | | — | | | — | | | — | | | — | | | 2,927 | | | 2,927 | |
Minimum pension liability adjustment | | | — | | | — | | | — | | | — | | | 115 | | | 115 | |
Derivative instruments | | | — | | | — | | | — | | | — | | | (961 | ) | | (961 | ) |
| | | | | | | | | | | | | | | | | | | | |
Total comprehensive income | | | — | | | — | | | — | | | 39,323 | | | 2,081 | | | 41,404 | |
Exercise of stock options | | | 288 | | | 72 | | | 4,600 | | | — | | | — | | | 4,672 | |
Stock-based compensation | | | 13 | | | 3 | | | 4,677 | | | — | | | — | | | 4,680 | |
Tax benefit from equity compensation | | | — | | | — | | | 1,686 | | | — | | | — | | | 1,686 | |
Issuance for employee stock purchase plan | | | 20 | | | 5 | | | 572 | | | — | | | — | | | 577 | |
Common stock purchased and retired | | | (1,769 | ) | | (442 | ) | | (11,535 | ) | | (52,564 | ) | | — | | | (64,541 | ) |
Dividends, $0.41 per share | | | — | | | — | | | — | | | (7,589 | ) | | — | | | (7,589 | ) |
| | | | | | | | | | | | | | | | | | | | |
Balance, September 30, 2006 | | | 18,216 | | | 4,554 | | | — | | | 152,657 | | | 12,110 | | | 169,321 | |
| | | | | | | | | | | | | | | | | | | | |
Net income | | | — | | | — | | | — | | | 41,996 | | | — | | | 41,996 | |
Foreign currency translation | | | — | | | — | | | — | | | — | | | 9,298 | | | 9,298 | |
Minimum pension liability adjustment | | | — | | | — | | | — | | | — | | | 738 | | | 738 | |
Derivative instruments | | | — | | | — | | | — | | | — | | | (735 | ) | | (735 | ) |
| | | | | | | | | | | | | | | | | | | | |
Total comprehensive income | | | — | | | — | | | — | | | 41,996 | | | 9,301 | | | 51,297 | |
Adjustment to initially apply FASB Statement No. 158 | | | — | | | — | | | — | | | — | | | (998 | ) | | (998 | ) |
Exercise of stock options | | | 426 | | | 107 | | | 8,448 | | | — | | | — | | | 8,555 | |
Stock-based compensation | | | 12 | | | 3 | | | 5,052 | | | — | | | — | | | 5,055 | |
Tax benefit from equity compensation | | | — | | | — | | | 2,675 | | | — | | | — | | | 2,675 | |
Issuance for employee stock purchase plan | | | 21 | | | 5 | | | 696 | | | — | | | — | | | 701 | |
Common stock purchased and retired | | | (971 | ) | | (243 | ) | | (16,871 | ) | | (21,122 | ) | | — | | | (38,236 | ) |
Dividends, $0.48 per share | | | — | | | — | | | — | | | (8,669 | ) | | — | | | (8,669 | ) |
| | | | | | | | | | | | | | | | | | | | |
Balance, September 29, 2007 | | | 17,704 | | $ | 4,426 | | $ | — | | $ | 164,862 | | $ | 20,413 | | $ | 189,701 | |
| | | | | | | | | | | | | | | | | | | | |
Net income | | | — | | | — | | | — | | | 49,191 | | | — | | | 49,191 | |
Foreign currency translation | | | — | | | — | | | — | | | — | | | 3,859 | | | 3,859 | |
Pension benefit plan adjustments | | | — | | | — | | | — | | | — | | | 890 | | | 890 | |
Derivative instruments | | | — | | | — | | | — | | | — | | | 320 | | | 320 | |
| | | | | | | | | | | | | | | | | | | | |
Total comprehensive income | | | — | | | — | | | — | | | 49,191 | | | 5,069 | | | 54,260 | |
Exercise of stock options | | | 332 | | | 83 | | | 7,096 | | | — | | | — | | | 7,179 | |
Stock-based compensation | | | 11 | | | 3 | | | 4,190 | | | — | | | — | | | 4,193 | |
Tax benefit from equity compensation | | | — | | | — | | | 1,302 | | | — | | | — | | | 1,302 | |
Issuance for employee stock purchase plan | | | 21 | | | 5 | | | 682 | | | — | | | — | | | 687 | |
Common stock purchased and retired | | | (1,092 | ) | | (273 | ) | | (13,270 | ) | | (28,499 | ) | | — | | | (42,042 | ) |
Dividends, $0.60 per share | | | — | | | — | | | — | | | (10,338 | ) | | — | | | (10,338 | ) |
| | | | | | | | | | | | | | | | | | | | |
Balance, September 27, 2008 | | | 16,976 | | $ | 4,244 | | $ | — | | $ | 175,216 | | $ | 25,482 | | $ | 204,942 | |
| | | | | | | | | | | | | | | | | | | | |
The accompanying Notes to Consolidated Financial Statements are an integral part of these consolidated financial statements.
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|
Consolidated Statements of Cash Flows |
(For the Fiscal Years Ended September 27, September 29 and September 30, respectively) |
| | | | | | | | | | |
| | 2008 | | 2007 | | 2006 | |
| | | | | | | | |
| | (expressed in thousands) | |
Cash Flows from Operating Activities: | | | | | | | | | | |
Net income | | $ | 49,191 | | $ | 41,996 | | $ | 39,323 | |
Adjustments to reconcile net income to net cash provided by operating activities: | | | | | | | | | | |
Loss (income) from discontinued operations | | | 368 | | | (955 | ) | | (1,354 | ) |
Net gain on disposal of discontinued operations | | | (2,449 | ) | | — | | | — | |
Gain on sale of assets | | | — | | | (742 | ) | | (872 | ) |
Stock-based compensation | | | 4,199 | | | 5,023 | | | 4,377 | |
Excess tax benefits from stock-based compensation | | | (925 | ) | | (2,123 | ) | | (1,249 | ) |
Net periodic pension benefit cost | | | 1,282 | | | 1,208 | | | 1,079 | |
Depreciation and amortization | | | 9,207 | | | 7,985 | | | 7,302 | |
Deferred income taxes | | | (5,726 | ) | | (4,599 | ) | | 2,222 | |
Bad debt provision | | | (111 | ) | | 320 | | | 354 | |
Changes in operating assets and liabilities: | | | | | | | | | | |
Accounts and unbilled contracts receivable | | | (27,462 | ) | | (11,414 | ) | | (11,829 | ) |
Inventories | | | (3,191 | ) | | (1,733 | ) | | (1,346 | ) |
Prepaid expenses | | | 119 | | | 387 | | | (466 | ) |
Other assets | | | (6,030 | ) | | (3,876 | ) | | 1,033 | |
Accounts payable | | | 6,138 | | | 4,994 | | | 1,028 | |
Accrued payroll and related costs | | | 4,441 | | | (654 | ) | | (1,989 | ) |
Advance payments from customers | | | 13,398 | | | (1,054 | ) | | 1,082 | |
Accrued warranty costs | | | (138 | ) | | 138 | | | 669 | |
Other liabilities | | | 5,613 | | | 8,581 | | | (3,187 | ) |
Contributions to pension benefit plan | | | (13,198 | ) | | (257 | ) | | (212 | ) |
Operating activities of discontinued operations | | | (4,552 | ) | | 1,690 | | | 2,264 | |
| | | | | | | | | | | |
Net Cash Provided by Operating Activities | | | 30,174 | | | 44,915 | | | 38,229 | |
| | | | | | | | | | | |
Cash Flows from Investing Activities: | | | | | | | | | | |
Additions to property and equipment | | | (9,752 | ) | | (12,040 | ) | | (7,187 | ) |
Proceeds from maturity of short-term investments | | | 19,050 | | | 71,260 | | | 130,857 | |
Purchases of short-term investments | | | (2,000 | ) | | (64,735 | ) | | (77,782 | ) |
Investment in business | | | (13,737 | ) | | — | | | — | |
Net proceeds from sale of businesses | | | 10,293 | | | 1,000 | | | 1,882 | |
Investing activities of discontinued operations | | | (287 | ) | | (695 | ) | | (318 | ) |
| | | | | | | | | | | |
Net Cash Provided by (Used in) Investing Activities | | | 3,567 | | | (5,210 | ) | | 47,452 | |
| | | | | | | | | | | |
Cash Flows from Financing Activities: | | | | | | | | | | |
Net receipts under short-term borrowings | | | 23,866 | | | 36 | | | 161 | |
Payments of notes payable | | | — | | | — | | | (1,477 | ) |
Repayments of long-term debt | | | (6,683 | ) | | (6,683 | ) | | (6,708 | ) |
Excess tax benefits from stock-based compensation | | | 925 | | | 2,123 | | | 1,249 | |
Cash dividends | | | (10,478 | ) | | (7,988 | ) | | (7,576 | ) |
Proceeds from exercise of stock options and employee stock | | | | | | | | | | |
purchase plan | | | 7,866 | | | 9,256 | | | 5,249 | |
Payments to purchase and retire common stock | | | (42,042 | ) | | (38,236 | ) | | (64,541 | ) |
| | | | | | | | | | | |
Net Cash Used in Financing Activities | | | (26,546 | ) | | (41,492 | ) | | (73,643 | ) |
| | | | | | | | | | | |
Effect of Exchange Rate Changes on Cash and Cash Equivalents | | | 2,559 | | | 8,170 | | | 2,781 | |
| | | | | | | | | | | |
Cash and Cash Equivalents: | | | | | | | | | | |
Increase during the year | | | 9,754 | | | 6,383 | | | 14,819 | |
Balance, beginning of year | | | 104,345 | | | 97,962 | | | 83,143 | |
| | | | | | | | | | | |
Balance, end of year | | $ | 114,099 | | $ | 104,345 | | $ | 97,962 | |
| |
Supplemental Disclosures of Cash Flows: | | | | | | | | | | |
Cash paid during the year for: | | | | | | | | | | |
Interest | | $ | 726 | | $ | 1,052 | | $ | 1,591 | |
Income taxes | | | 22,157 | | | 11,172 | | | 17,315 | |
| |
The accompanying Notes to Consolidated Financial Statements are an integral part of these consolidated financial statements.
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Notes to Consolidated Financial Statements
1. Summary of Significant Accounting Policies:
Nature of Operations
MTS Systems Corporation is a leading global supplier of mechanical test systems and high-performance industrial position sensors. The Company’s testing solutions help customers accelerate and improve their design, development, and manufacturing processes and are used for determining the mechanical behavior of materials, products, and structures. MTS high-performance position sensors provide controls for a variety of industrial and vehicular applications.
Fiscal Year
The Company’s fiscal year ends on the Saturday closest to September 30. The Company’s fiscal years ended September 27, 2008, September 29, 2007 and September 30, 2006 each consisted of 52 weeks.
Consolidation
The Consolidated Financial Statements include the accounts of MTS Systems Corporation and its wholly owned subsidiaries (the “Company”). Significant intercompany balances and transactions have been eliminated.
Revenue Recognition
Orders that are manufactured and delivered in less than six months with routine installations and no special acceptance protocol may involve separable elements for revenue recognition purposes. Sufficient evidence of fair value of these elements exists to allow revenue recognition for these systems upon shipment, less the greater of the fair value associated with installation and training (if applicable) or the amount of revenue for which payment is deemed contingent upon delivery of these elements, which amount is deferred until customer acceptance. Fair value is determined based upon the sale price of similar products sold individually. In cases where special acceptance protocols exist, installation and training are not considered to be separable from the other elements of the arrangement. Accordingly, revenue for these systems is recognized upon the completion of installation and fulfillment of obligations specific to the terms of the arrangement.
Certain contractual arrangements require longer production periods, generally longer than six months (long-term contracts), and may contain non-routine installations and special acceptance protocols. These arrangements often include hardware, software, installation services, training and support. In certain arrangements software may be essential to the functionality of the system deliverable. For these arrangements the Company considers Emerging Issues Task Force (“EITF”) No. 03-05, “Applicability of AICPA Statement of Position 97-2 to Non-Software Deliverables in an Arrangement Containing More-Than-Incidental Software,” to identify components of the arrangement which are considered software-related. For software and software-related components, the Company applies the requirements of Statement of Position (“SOP”) No. 97-2, “Software Revenue Recognition,” when recognizing revenue. Contractual arrangements in which software is essential to system functionality typically include significant production, modification, and customization. For arrangements with essential software and all other long-term arrangements with complex installations and/or unusual acceptance protocols, revenue is recognized using the percentage-of-completion method prescribed by SOP No. 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type Contracts,” based on the cost incurred to-date relative to estimated total cost of the contract. Elements of an arrangement that do not separately fall within the scope of SOP No. 81-1 (e.g. software maintenance and training) are accounted for as the service is provided based on fair value as determined by stand-alone sales.
The Company enters into long-term contracts for customized equipment sold to its customers. Under the terms of such contracts, revenue recognized using the percentage-of-completion method may not, in certain circumstances, be invoiced until completion of contractual milestones, upon shipment of the equipment, or upon installation and acceptance by the customer. Unbilled amounts for these contracts appear in the Consolidated Balance Sheets as Unbilled Accounts Receivable.
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Revenue for services is recognized as the service is performed or ratably over a defined contractual period for service maintenance contracts.
Revenue is recorded net of taxes collected from customers that are remitted to governmental authorities, with the collected taxes recorded as current liabilities until remitted to the relevant government authority.
Shipping and Handling
Freight revenue billed to customers is reported within Revenue on the Consolidated Statements of Income, and expenses incurred for shipping products to customers are reported within Cost of Sales on the Consolidated Statements of Income.
Research and Development
Research and development costs associated with new products are charged to operations as incurred.
Foreign Currency
The financial position and results of operations of the Company’s foreign subsidiaries are measured using local currency as the functional currency. Assets and liabilities are translated using fiscal period-end exchange rates, and statements of income are translated using average exchange rates for the fiscal year, with the resulting translation adjustments recorded as a separate component of Shareholders’ Investment. The Company recorded gains on foreign currency translation in Comprehensive Income of $3.9 million, $9.3 million, and $2.9 million for fiscal years 2008, 2007, and 2006 respectively. Gains and losses from foreign currency transactions are recognized in the Consolidated Statements of Income. The Company recorded net foreign currency transaction gains/(losses) of $0.6 million, ($0.6) million, and $0.8 million in fiscal years 2008, 2007, and 2006, respectively.
Cash and Cash Equivalents
Cash and cash equivalents represent cash, demand deposits, and highly liquid investments with original maturities of three months or less. Cash equivalents are recorded at cost, which approximates fair value. Cash equivalents, both inside and outside the United States, are invested in money market funds and bank deposits in local currency denominations.
Short-Term Investments
The Company held no short-term investments as of September 27, 2008. As of September 29, 2007, the Company’s short-term investments consisted of U.S. municipal bonds. The Company classified these investments as available-for-sale, and liquidated them in fiscal year 2008 to fund current operations, as well as to return capital to shareholders. All investments in available-for-sale securities at September 29, 2007 were carried at fair value, and unrealized gains and losses were reported as a component of Accumulated Other Comprehensive Income within Shareholders’ Investment on the Consolidated Balance Sheets. At September 29, 2007, there were no material unrealized gains or losses associated with any of the Company’s short-term investments, as the fair value of each investment approximated amortized cost.
Accounts Receivable and Long-Term Contracts
The Company grants credit to customers, but it generally does not require collateral or other security from domestic customers. When deemed appropriate, receivables from customers located outside the United States are supported by letters of credit from financial institutions. The allowance for doubtful accounts is based on management’s assessment of the collectibility of specific customer accounts and includes consideration of the credit worthiness and financial condition of those specific customers. The Company records an allowance to reduce receivables to the amount that is reasonably believed to be collectible and considers factors such as the financial condition of the customer and the aging of the receivables. If there is a deterioration of a customer’s financial condition, if the Company becomes aware of additional information related to the credit worthiness of a customer, or if future actual default rates on trade receivables in general differ from those currently anticipated, the Company may have to adjust its allowance for doubtful accounts, which would affect earnings in the period the adjustments were made.
The Company enters into long-term contracts for customized equipment sold to its customers. Under the terms of such contracts, revenue recognized using the percentage-of-completion method may be invoiced upon completion of contractual milestones, shipment to the customer, or installation and customer acceptance. Unbilled amounts relating to these contracts are reflected as Unbilled Accounts Receivable in
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the accompanying Consolidated Balance Sheets. Amounts unbilled at September 27, 2008 are expected to be invoiced during fiscal year 2009.
Inventories
Inventories consist of material, labor, and overhead costs and are stated at the lower of cost or market value, determined under the first-in, first-out accounting method. Inventories at September 27, 2008 and September 29, 2007 were as follows:
| | | | | | | |
| | 2008 | | 2007 | |
| | | | | | |
| | (expressed in thousands) | |
Customer projects in various stages of completion | | $ | 14,257 | | $ | 14,534 | |
Components, assemblies and parts | | | 31,878 | | | 27,850 | |
| | | | | | | | |
Total | | $ | 46,135 | | $ | 42,384 | |
| |
Software Development Costs.
The Company capitalizes certain software development costs related to software to be sold, leased, or otherwise marketed in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 86, “Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed.” Capitalized software development costs include purchased materials and services, salary and benefits of the Company’s development and technical support staff, and other costs associated with the development of new products and services. Software development costs are expensed as incurred until technological feasibility has been established, at which time future costs incurred are capitalized until the product is available for general release to the public. Based on the Company’s product development process, technological feasibility is generally established once product and detailed program designs have been completed, uncertainties related to high-risk development issues have been resolved through coding and testing, and the Company has established that the necessary skills, hardware, and software technology are available for production of the product. Once a software product is available for general release to the public, capitalized development costs associated with that product will begin to be amortized to cost of sales over the product’s estimated economic life, using a method that results in cost recognition in future periods that is consistent with the anticipated timing of product revenue recognition.
The Company’s capitalized software development costs are subject to an ongoing assessment of recoverability, which is impacted by estimates and assumptions of future revenues and expenses for these software products, as well as other factors such as changes in product technologies. The portion of unamortized capitalized software development costs that are determined to be in excess of net realizable value will be expensed in the period such a determination is made. The Company reached technological feasibility for certain software products and began capitalizing software development costs during the fiscal year ended September 27, 2008. At September 27, 2008, capitalized software development costs, including capitalized interest, were approximately $4.2 million. No amortization expense was recognized during the year ended September 27, 2008.
The anticipated amortization expense related to capitalized software development costs for the next five fiscal years is as follows:
| | | | | | | | | | | | | | | | |
| | 2009 | | 2010 | | 2011 | | 2012 | | 2013 | |
| | | | | | | | | | | |
| | (expressed in thousands) | |
Amortization of Software Development Costs | | $ | 693 | | $ | 831 | | $ | 831 | | $ | 831 | | $ | 831 | |
Capitalized Interest
The Company capitalizes interest on outstanding borrowings during the active construction period of certain assets that require a period of time to develop before being available for general release to customers. Capitalized interest is added to the cost of the underlying assets and is amortized over the useful life of the
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assets. During the fiscal year ended September 27, 2008, interest costs of $0.1 million were capitalized and included in capitalized software development costs. No interest costs were capitalized during the fiscal years ended September 29, 2007 and September 30, 2006.
Impairment of Long-lived Assets
In accordance with SFAS No. 144, “Accounting for Impairment or Disposal of Long-Lived Assets,” the Company reviews the carrying value of long-lived assets or asset groups, such as property and equipment and intangibles subject to amortization, when events or changes in circumstances such as market value, asset utilization, physical change, legal factors, or other matters indicate that the carrying value may not be recoverable. When this review indicates the carrying value of an asset or asset group exceeds the sum of the undiscounted cash flows expected to result from the use and eventual sale of the asset or asset group, the Company recognizes an asset impairment charge against operations. The amount of the impairment loss recorded is the amount by which the carrying value of the impaired asset or asset group exceeds its fair value.
Property and Equipment
Property and equipment is stated at cost. Additions, replacements, and improvements are capitalized at cost, while maintenance and repairs are charged to operations as incurred. Depreciation is recorded over the following estimated useful lives of the property:
Buildings and improvements: 10 to 40 years.
Machinery and equipment: 3 to 10 years.
Building and equipment additions are generally depreciated on a straight-line basis for financial reporting purposes and on an accelerated basis for income tax purposes.
Goodwill
Goodwill represents the excess of acquisition costs over the fair value of the net assets of businesses acquired. SFAS No. 142, “Goodwill and Other Intangible Assets,” requires that goodwill and certain other intangible assets having indefinite lives not be amortized to income, but instead be periodically tested for impairment. The Company determined there was no impairment of its goodwill at September 27, 2008 or September 29, 2007. At both September 27, 2008 and September 29, 2007, goodwill was associated with the Sensors segment. There was no change in these Goodwill balances over the three-year period ending September 27, 2008, other than changes associated with the effect of currency translation.
Other Assets
Other assets at September 27, 2008 and September 29, 2007 include security deposits paid on leased property, cash redemption values on group insurance policies, and intangible assets such as patents and other intellectual property. Other assets at September 27, 2008 also include a $13.7 million investment in the SANS Group (“SANS”). See Note 10 to the Consolidated Financial Statements for additional information regarding the acquisition of the SANS business. Intangible assets are amortized on a straight-line basis over the expected period to be benefited by future cash flows, up to 25 years. The Company evaluates the estimated useful lives of all intangible assets and periodically revises such estimates based on current events.
At September 27, 2008 and September 29, 2007, the carrying value of intangible assets, net of accumulated amortization, was $0.2 million and $0.3 million respectively. Annual amortization of other intangible assets was less than $0.1 million in both fiscal years 2008 and 2007, and $0.3 million in fiscal year 2006.
The anticipated amortization expense related to other intangible assets for the next five fiscal years is as follows:
| | | | | | | | | | | | | | | | |
| | 2009 | | 2010 | | 2011 | | 2012 | | 2013 | |
| | | | | | | | | | | |
| | (expressed in thousands) | |
Amortization of intangible assets | | $ | 18 | | $ | 15 | | $ | 14 | | $ | 14 | | $ | 13 | |
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Warranty Obligations
Sales of the Company’s products and systems are subject to limited warranty guarantees that are included in customer contracts. For sales that include installation services, warranty guarantees typically extend for a period of twelve months from the date of either shipment or acceptance. Product guarantees typically extend for a period of twelve to twenty-four months from the date of purchase. Under the terms of these warranties, the Company is obligated to repair or replace any components or assemblies it deems defective due to workmanship or materials. The Company reserves the right to reject warranty claims where it determines that failure is due to normal wear, customer modifications, improper maintenance, or misuse. The Company records warranty provisions monthly based on an estimated warranty expense percentage applied to current period revenue. The percentage applied reflects historical warranty claims experience over the preceding twelve-month period. Both the experience percentage and the warranty liability are evaluated on an ongoing basis for adequacy. Warranty provisions and claims for the years ended September 27, 2008 and September 29, 2007, were as follows:
| | | | | | | |
| | 2008 | | 2007 | |
| | | | | | |
| | (expressed in thousands) | |
Beginning balance | | $ | 6,205 | | $ | 5,848 | |
Warranty provisions | | | 7,585 | | | 7,146 | |
Warranty claims | | | (7,643 | ) | | (7,141 | ) |
Translation adjustment | | | (40 | ) | | 352 | |
| | | | | | | | |
Ending balance | | $ | 6,107 | | $ | 6,205 | |
| | | | | | | | |
Derivative Financial Instruments
The Company uses interest rate swaps, currency swaps, forward and option currency exchange contracts to manage risks associated with foreign exchange and interest rate fluctuations. Because the market value of these contracts is derived from current market rates, they are classified as derivative financial instruments. The Company does not use derivatives for speculative or trading purposes. Derivative contracts contain credit risk to the extent that the Company’s bank counterparties may be unable to meet the terms of the agreements. Such risk is minimized by limiting those counterparties to major financial institutions of high credit quality.
Foreign Currency Cash Flow Hedging
Currency exchange contracts utilized to maintain the functional currency value of expected financial transactions denominated in foreign currencies are designated as cash flow hedges. Qualifying gains and losses related to changes in the market value of the contracts are recorded in Accumulated Other Comprehensive Income within Shareholders’ Investment on the Consolidated Balance Sheets until they are recognized in revenue at the time a gain or loss is recognized on the underlying expected transaction. The Company periodically assesses whether the contracts are effective in offsetting the changes in the functional currency value of the expected transactions. When a contract is no longer effective as a hedge, the Company discontinues hedge accounting prospectively. Subsequent changes in the market value of the contract are recognized in revenue on the Consolidated Statement of Income for the current period.
At September 27, 2008 and September 29, 2007, the Company had outstanding cash flow hedge currency exchange contracts with gross notional U.S. dollar equivalent amounts of $59.1 million and $64.2 million, respectively. Upon netting offsetting contracts to sell foreign currencies against contracts to purchase foreign currencies, irrespective of contract maturity dates, the net notional U.S. dollar equivalent amount of contracts outstanding were $39.8 million and $37.3 million at September 27, 2008 and September 29, 2007, respectively. At September 27, 2008 the net market value of the foreign currency exchange contracts was an asset of $0.6 million consisting of $1.1 million in assets and $0.5 million in liabilities. At September 29, 2007, the net market value of foreign currency exchange contracts was a net liability of $0.7 million consisting of $0.5 million in assets and $1.2 million in liabilities. The amount recognized in earnings as a result of the ineffectiveness of cash flow hedges was less than $0.1 million in each of the fiscal years ended September 27, 2008 and September 29, 2007. At September 27, 2008 and September 29, 2007, the amount projected to be reclassified from Accumulated Other Comprehensive Income into earnings in the next 12 months was a net gain of $0.4 million and a net loss of $0.4 million, respectively. The maximum
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remaining maturity of any forward or optional contract at September 27, 2008 and September 29, 2007 was 1.3 years and 1.6 years, respectively.
Foreign Currency Balance Sheet Hedging
The Company also uses currency exchange contracts to hedge the functional currency value of monetary assets and liabilities denominated in non-functional foreign currencies. The gains and losses related to the changes in the market value of these contracts are included in Other income, net on the Consolidated Statement of Income in the current period.
At September 27, 2008 and September 29, 2007, the Company had outstanding balance sheet hedge currency exchange contracts with gross notional U.S. dollar equivalent amounts of $17.3 million and $56.9 million, respectively. Upon netting offsetting contracts by counterparty bank to sell foreign currencies against contracts to purchase foreign currencies, irrespective of contract maturity dates, the net notional U.S. dollar equivalent amount of contracts outstanding was $0.5 million at September 27, 2008 and $3.8 million at September 29, 2007. At September 27, 2008, the net market value of the balance sheet foreign currency exchange contracts was less than $0.1 million. On September 29, 2007, the net market value of the balance sheet forward exchange contracts was a liability of $2.3 million, consisting of $2.3 million in liabilities with a less than $0.1 million in offsetting assets.
Interest Rate Swap
On July 25, 2008, the Company entered into a four-year floating to fixed interest rate swap agreement to mitigate its exposure to an increase in interest rates related to a portion of its floating rate indebtedness. The total notional amount of the interest rate swap is $13.0 million. As a result of this agreement, every month, the Company pays fixed interest at 4.24% in exchange for interest received at 1 month U.S. LIBOR. The market value of the interest rate swap at September 27, 2008 was a liability of $0.2 million. As of the effective date, the Company designated the interest rate swap as a cash flow hedge. As a result, changes in the fair value of the interest rate swap are recorded in Accumulated Other Comprehensive Income within Shareholders’ Investment on the Consolidated Balance Sheets.
Income Taxes
The Company records a tax provision for the anticipated tax consequences of the reported results of operations. Deferred tax assets and liabilities are measured using the currently enacted tax rates that apply to taxable income in effect for the years in which those deferred tax assets and liabilities are expected to be realized or settled. The Company records a valuation allowance to reduce deferred tax assets to the amount that is believed more likely than not to be realized. The Company believes it is more likely than not that forecasted income, including income that may be generated as a result of certain tax planning strategies, together with the tax effects of the deferred tax liabilities, will be sufficient to fully recover the remaining net realizable value of its deferred tax assets. In the event that all or part of the net deferred tax assets are determined not to be realizable in the future, an adjustment to the valuation allowance would be charged to earnings in the period such determination is made. In addition, the calculation of tax liabilities involves significant judgment in estimating the impact of uncertainties in the application of complex tax laws. Resolution of these uncertainties in a manner inconsistent with management’s expectations could have a material impact on the Company’s financial condition and operating results. See Note 6 to the Consolidated Financial Statements for additional information on income taxes.
Earnings Per Common Share
Basic earnings per share are computed by dividing net earnings by the daily weighted average number of common shares outstanding during the applicable periods. Diluted earnings per share include the potentially dilutive effect of common shares issued in connection with outstanding stock-based compensation options and grants, using the treasury stock method. Under the treasury stock method, shares associated with certain stock options have been excluded from the diluted weighted average shares outstanding calculation because the exercise of those options would lead to a net reduction in common shares outstanding. As a result, stock options to acquire 0.9 million, 0.5 million, and 0.6 million weighted common shares have been excluded from the diluted weighted shares outstanding calculation for the fiscal year ended September 27, 2008, September 29, 2007, and September 30, 2006, respectively. The potentially dilutive effect of common shares issued in connection with outstanding stock options is determined based on income before discontinued operations. A reconciliation of these amounts is as follows:
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Table of Contents
| | | | | | | | | | |
| | 2008 | | 2007 | | 2006 | |
| | | | | | | | |
| | (expressed in thousands, except per share data) | |
| | | |
Income before discontinued operations | | $ | 47,110 | | $ | 41,041 | | $ | 37,969 | |
Income from discontinued operations, net of tax | | | 2,081 | | | 955 | | | 1,354 | |
| | | | | | | | | | | |
Net income | | $ | 49,191 | | $ | 41,996 | | $ | 39,323 | |
| | | | | | | | | | | |
Weighted average common shares outstanding | | | 17,351 | | | 17,980 | | | 18,749 | |
Dilutive potential common shares | | | 193 | | | 350 | | | 480 | |
| | | | | | | | | | | |
Total dilutive common shares | | | 17,544 | | | 18,330 | | | 19,229 | |
| | | | | | | | | | | |
| | | | | | | | | | |
Earnings per share: | | | | | | | | | | |
Basic: | | | | | | | | | | |
Income before discontinued operations | | $ | 2.72 | | $ | 2.29 | | $ | 2.03 | |
Income from discontinued operations, net of tax | | | 0.12 | | | 0.05 | | | 0.07 | |
| | | | | | | | | | | |
Earnings per share | | $ | 2.84 | | $ | 2.34 | | $ | 2.10 | |
| | | | | | | | | | | |
Diluted: | | | | | | | | | | |
Income before discontinued operations | | $ | 2.68 | | $ | 2.24 | | $ | 1.97 | |
Income from discontinued operations, net of tax | | | 0.12 | | | 0.05 | | | 0.07 | |
| | | | | | | | | | | |
Earnings per share | | $ | 2.80 | | $ | 2.29 | | $ | 2.04 | |
| | | | | | | | | | | |
Stock-Based Compensation
Effective October 2, 2005, the Company adopted the provisions of the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123R, “Share-Based Payment,” using the modified prospective method. SFAS 123R requires a public entity to measure the cost of employee services received in exchange for the award of equity instruments based on the fair value of the award at the date of grant. The cost is to be recognized over the period during which an employee is required to provide services in exchange for the award.
For purposes of determining estimated fair value of stock-based payment awards, the Company utilizes a Black-Scholes option pricing model, which requires the input of certain assumptions requiring management judgment. Because the Company’s employee stock option awards have characteristics significantly different from those of traded options, and because changes in the input assumptions can materially affect fair value estimates, existing models may not provide a reliable single measure of the fair value of employee stock options. Management will continue to assess the assumptions and methodologies used to calculate estimated fair value of stock-based compensation. Circumstances may change and additional data may become available over time that could result in changes to these assumptions and methodologies and thereby materially impact the fair value determination of future grants of stock-based payment awards. If factors change and the Company employs different assumptions in the application of SFAS No. 123R in future periods, the compensation expense recorded under SFAS No. 123R may differ significantly from the stock-based compensation expense recorded in the current period. See Note 2 to the Consolidated Financial Statements for additional information on stock-based compensation.
Comprehensive Income (Loss)
Comprehensive Income (Loss), a component of Shareholders’ Investment, for the fiscal years ended September 27, 2008, September 29, 2007 and September 30, 2006 consists of net income, pension benefit plan adjustments, derivative instrument gains or losses and foreign currency translation adjustments.
Effective September 29, 2007, the Company adopted the recognition and disclosure provisions of SFAS No. 158, which resulted in the recognition of the funded status of a defined benefit retirement plan located at one of its German subsidiaries. Upon adoption of SFAS No. 158, the unrealized portion of the incremental increase in the retirement plan liability was recognized as a component of Accumulated Other Comprehensive Income (Loss). See Note 7 to the Consolidated Financial Statements for additional information on the Company’s defined benefit retirement plan.
The accumulated balances for each component of Accumulated Other Comprehensive Income (Loss) were as follows:
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| | Derivative
Financial
Instrument
Unrealized
Gain (Loss) | | Minimum
Pension
Liability
and
FASB
Statement
No. 158
Adjustments | | Foreign
Currency
Translation
Adjustment | | Total
Accumulated
Other
Comprehensive
Income (Loss) | |
| (expressed in thousands) |
Balances at October 1, 2005 | | $ | 1,304 | | $ | (865 | ) | $ | 9,590 | | $ | 10,029 | |
Foreign exchange translation adjustments | | | — | | | — | | | 2,927 | | | 2,927 | |
Minimum pension liability adjustment, net of tax of $72 | | | — | | | 115 | | | — | | | 115 | |
Change in unrealized gain, net of tax of $371 | | | 621 | | | — | | | — | | | 621 | |
Realized gain, net of tax of ($945) | | | (1,582 | ) | | — | | | — | | | (1,582 | ) |
Balances at September 30, 2006 | | $ | 343 | | $ | (750 | ) | $ | 12,517 | | $ | 12,110 | |
Foreign exchange translation adjustments | | | — | | | (91 | ) | | 9,389 | | | 9,298 | |
Minimum pension liability adjustment, net of tax of $490 | | | — | | | 738 | | | — | | | 738 | |
Change in unrealized loss, net of tax of ($366) | | | (612 | ) | | — | | | — | | | (612 | ) |
Realized gain, net of tax of ($74) | | | (123 | ) | | — | | | — | | | (123 | ) |
Adjustment to initially apply FASB Statement No. 158, net of tax of ($431) | | | — | | | (998 | ) | | — | | | (998 | ) |
Balances at September 29, 2007 | | $ | (392 | ) | $ | (1,101 | ) | $ | 21,906 | | $ | 20,413 | |
Foreign exchange translation adjustments | | | — | | | (29 | ) | | 3,888 | | | 3,859 | |
Pension benefit plan adjustments, net of tax of $374 | | | — | | | 866 | | | — | | | 866 | |
Change in unrealized loss, net of tax of ($523) | | | (973 | ) | | — | | | — | | | (973 | ) |
Realized loss, net of tax of $892 | | | 1,293 | | | 24 | | | — | | | 1,317 | |
Balances at September 27, 2008 | | $ | (72 | ) | $ | (240 | ) | $ | 25,794 | | $ | 25,482 | |
Use of Estimates
The preparation of financial statements in accordance with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities as of the date of the financial statements, and reported amounts of revenue and expense during the reporting period. Ultimate results could differ from those estimates. Additionally, the Company frequently undertakes significant technological innovation on certain of its long-term contracts, involving performance risk that may result in delayed delivery of product and/or revenue and gross profit variation due to changes in the ultimate costs of these contracts versus estimates.
Recent Accounting Pronouncements
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS No. 157 clarifies the principle that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. Under this statement, fair value measurements are required to be separately disclosed, by level, within the fair value hierarchy. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. The Company does not expect the adoption of SFAS No. 157 to have a material impact on its consolidated financial statements.
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Table of Contents
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities Including an Amendment of SFAS No. 115, ‘Accounting for Certain Investments in Debt and Equity Securities.’” SFAS No. 159 allows entities to choose, at specified election dates, to measure eligible financial assets and liabilities at fair value in situations in which they are not otherwise required to be measured at fair value. If a company elects the fair value option for an eligible item, changes in that item’s fair value in subsequent reporting periods must be recognized in current period earnings. SFAS No. 159 also establishes presentation and disclosure requirements designed to draw comparison between entities that elect different measurement attributes for similar assets and liabilities. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. The Company does not expect the adoption of SFAS No. 157 to have a material impact on its consolidated financial statements.
In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations.” SFAS No. 141R expands the definition of a business combination and requires the fair value of the purchase price of an acquisition, including the issuance of equity securities, to be determined on the acquisition date. SFAS No. 141R also requires that all assets, liabilities, contingent considerations, and contingencies of an acquired business be recorded at fair value at the acquisition date. In addition, SFAS No. 141R requires that acquisition costs generally be expensed as incurred, restructuring costs generally be expensed in periods subsequent to the acquisition date and changes in accounting for deferred tax asset valuation allowances and acquired income tax uncertainties after the measurement period impact income tax expense. SFAS No. 141R is effective for the Company’s fiscal years beginning on or after December 15, 2008, with early adoption prohibited. The Company is evaluating the effect the adoption of SFAS No. 141R will have on its consolidated financial statements.
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements, an Amendment of ARB No. 51.” SFAS No. 160 requires minority interests to be recharacterized as noncontrolling interests and reported as a component of equity. In addition, SFAS No. 160 requires that purchases or sales of equity interests that do not result in a change in control be accounted for as equity transactions and, upon a loss of control, requires the interests sold, as well as any interests retained, to be recorded at fair value with any gain or loss recognized in earnings. SFAS No. 160 is effective for fiscal years beginning on or after December 15, 2008, with early adoption prohibited. The Company does not expect the adoption of SFAS No. 157 to have a material impact on its consolidated financial statements.
In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities, an Amendment to SFAS No. 133.” SFAS No. 161 requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative agreements. SFAS No. 161 is effective for fiscal years beginning after November 15, 2008. The Company does not expect the adoption of SFAS No. 157 to have a material impact on its consolidated financial statements.
In April 2008, the FASB issued Staff Position (“FSP”) FAS 142-3 “Determination of the Useful Life of Intangible Assets.” FSP FAS 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of intangible assets under SFAS No. 142 “Goodwill and Other Intangible Assets.” FSP FAS 142-3 is intended to improve the consistency between the useful life of a recognized intangible asset under SFAS No. 142 and the period of the expected cash flows used to measure the fair value of the asset under SFAS No. 141R and other GAAP. FSP No. FAS 142-3 is effective for fiscal years beginning after December 15, 2008, with early adoption prohibited. The Company does not expect the adoption of FSP No. FAS 142-3 to have a material impact on its consolidated financial statements.
In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles.” SFAS No. 162 is intended to improve financial reporting by identifying a consistent framework, or hierarchy, for selecting accounting principles to be used in preparing financial statements that are presented in accordance with GAAP. SFAS No. 162 will be effective 60 days after the SEC approves the Public Company Accounting Oversight Board’s amendments to AU Section 411, “The Meaning of Present Fairly in Accordance With Generally Accepted Accounting Principles.” The Company does not expect the adoption of SFAS No. 162 to have a material impact on its consolidated financial statements.
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Table of Contents
In June 2008, the FASB issued FSP Emerging Issues Task Force (“EITF”) No. 03-6-1 “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities” FSP EITF No. 03-6-1 clarifies that all outstanding unvested share-based payment awards that contain rights to non-forfeitable dividends participate in undistributed earnings with common shareholders. Awards of this nature are considered participating securities and the two-class method of computing basic and diluted earnings per share must be applied. FSP EITF No. 03-6-1 is effective for fiscal years beginning after December 15, 2008. The Company does not expect the adoption of FSP EITF No. 03-6-1 to have a material impact on its consolidated financial statements.
In June 2008, the FASB issued EITF No. 07-5, “Determining Whether an Instrument (or an Embedded Feature) Is Indexed to an Entity’s Own Stock.” EITF No. 07-5 provides that an entity should use a two step approach to evaluate whether an equity-linked financial instrument (or embedded feature) is indexed to its own stock, including evaluating the instrument’s contingent exercise and settlement provisions. It also clarifies the impact of foreign currency denominated strike prices and market-based employee stock option valuation instruments on the evaluation. EITF No. 07-5 is effective for fiscal years beginning after December 15, 2008. The Company does not expect the adoption of EITF No. 07-5 to have a material impact on its consolidated financial statements.
2. Stock-Based Compensation:
The Company compensates officers, directors, and employees with stock-based compensation under four stock plans approved by the Company’s shareholders in 1994, 1997, 2002 and 2006, and administered under the supervision of the Company’s Board of Directors. During the years ended September 27, 2008, September 29, 2007, and September 30, 2006, the Company awarded stock options, employee stock purchase plan shares, and restricted stock under these plans. At September 27, 2008, a total of 1,767,209 shares were available for future grant under these plans.
Stock-Based Compensation Expense
The effect of recording stock-based compensation expense for the years ended September 27, 2008, September 29, 2007, and September 30, 2006 was as follows (in thousands, except per share data):
| | | | | | | | | | |
| | 2008 | | 2007 | | 2006 | |
| | | | | | | |
| | | | | | | | | | |
Stock-based compensation expense by type of award: | | | | | | | | | | |
Employee stock options | | $ | 3,591 | | $ | 4,388 | | $ | 4,056 | |
Employee stock purchase plan (ESPP) | | | 191 | | | 189 | | | 157 | |
Restricted stock units | | | 441 | | | 441 | | | 429 | |
Amounts capitalized as inventory | | | (938 | ) | | (1,080 | ) | | (977 | ) |
Amounts recognized in income for amounts previously capitalized as inventory | | | 914 | | | 1,085 | | | 712 | |
| | | | | | | | | | |
| | | | | | | | | | |
Total stock-based compensation included in income from operations | | | 4,199 | | | 5,023 | | | 4,377 | |
Income tax benefit on stock-based compensation | | | (1,421 | ) | | (1,669 | ) | | (1,165 | ) |
| | | | | | | | | | |
Net compensation expense included in net income | | $ | 2,778 | | $ | 3,354 | | $ | 3,212 | |
| | | | | | | | | | |
| | | | | | | | | | |
Earnings per share: | | | | | | | | | | |
Basic | | $ | 0.16 | | $ | 0.19 | | $ | 0.17 | |
Diluted | | $ | 0.16 | | $ | 0.18 | | $ | 0.17 | |
| | | | | | | | | | |
Tax effect on: | | | | | | | | | | |
Cash flows from operating activities | | $ | (925 | ) | $ | (2,123 | ) | $ | (1,249 | ) |
Cash flows from financing activities | | $ | 925 | | $ | 2,123 | | $ | 1,249 | |
At September 27, 2008, there was $3.8 million of total stock option expense related to non-vested awards not yet recognized, which is expected to be recognized over a weighted average period of approximately 1.4
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Table of Contents
years. At September 27, 2008, there was $0.3 million of total restricted stock expense related to non-vested awards not yet recognized, which is expected to be recognized over a weighted average period of approximately 1.7 years.
The fair value of stock options granted under stock-based compensation programs has been estimated as of the date of each grant using the multiple option form of the Black-Scholes valuation model, based on the grant price and assumptions regarding the expected grant life, stock price volatility, dividends, and risk-free interest rates. Each vesting period of an option award is valued separately, with this value being recognized evenly over the vesting period. While the multiple option form of the valuation model generally yields a lower valuation than the single option form, it also allocates proportionally more of the option expense to the early years of the option. The weighted average per share fair value of stock options granted during the fiscal years ended September 27, 2008, September 29, 2007 and September 30, 2006 was $7.53, $10.51 and $11.85, respectively. The weighted average assumptions used to determine fair value of stock options granted during those fiscal years were as follows:
| | | | | | | | | | |
| | 2008 | | 2007 | | 2006 | |
| | | | | | | | |
Expected life (in years) | | | 2.6 | | | 2.6 | | | 3.5 | |
Risk-free interest rate | | | 2.8 | % | | 4.9 | % | | 5.1 | % |
Expected volatility | | | 33.3 | % | | 31.1 | % | | 35.6 | % |
Dividend yield | | | 1.7 | % | | 1.0 | % | | 1.0 | % |
| | | | | | | | | | | |
The expected life represents the period that the stock option awards are expected to be outstanding. In fiscal year 2008 and 2007, the expected life was determined based on historical and anticipated future exercise and expiration patterns. In fiscal year 2006, the Company used the “simplified” method for determining the expected life, as specified in Staff Accounting Bulletin (“SAB”) No. 107, “Valuation of Share-Based Payment Arrangements for Public Companies,” which bases the expected life calculation on the average of the vesting term and the expiration of the awards. The risk-free interest rate used is based on the yield of constant maturity U.S. Treasury bonds on the grant date with a remaining term equal to the expected life of the grant. The Company estimates stock price volatility based on a historical weekly price observation. The dividend yield assumption is based on the annualized current dividend divided by the share price on the grant date.
Restricted stock awards are valued based on the market value of the Company’s shares at the date of grant. The value of restricted stock awards is allocated to expense evenly over the restricted period. Employee stock purchase plan share awards are valued based on the value of the discount feature plus the fair value of the optional features, which is determined as of the date of grant using the Black-Scholes valuation model. The value of these share awards is allocated to expense evenly over each purchase period.
Stock Options
Stock options are granted at exercise prices equal to the closing market price of the Company’s stock on the date of grant. Generally, options vest proportionally on the first three anniversaries of the grant date and expire five years from the grant date.
Stock option activity for the fiscal years ended September 27, 2008, September 29, 2007, and September 30, 2006 was as follows (in thousands, except per share amounts):
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Table of Contents
| | | | | | | | | | | | | | | | |
| | 2008 | | 2007 | | 2006 | |
| | | | | | | | |
| | Shares | | WAEP* | | Shares | | WAEP* | | Shares | | WAEP* | |
| | | | | | | | | | | | | | |
Options outstanding at beginning of year | | 1,588 | | $ | 34.60 | | 1,667 | | $ | 28.06 | | 1,686 | | $ | 22.63 | |
Granted | | 377 | | $ | 35.87 | | 416 | | $ | 45.49 | | 436 | | $ | 39.08 | |
Exercised | | (332 | ) | $ | 21.62 | | (426 | ) | $ | 20.08 | | (288 | ) | $ | 16.19 | |
Forfeited or expired | | (61 | ) | $ | 35.87 | | (69 | ) | $ | 31.92 | | (167 | ) | $ | 22.89 | |
| | | | | | | | | | | | | | | | |
Options outstanding at end of year | | 1,572 | | $ | 37.59 | | 1,588 | | $ | 34.60 | | 1,667 | | $ | 28.06 | |
| | | | | | | | | | | | | | | | |
Options eligible for exercise at year-end | | 821 | | $ | 35.68 | | 763 | | $ | 27.05 | | 780 | | $ | 20.13 | |
| | | | | | | | | | | | | | | | | |
*Weighted Average Exercise Price |
Options outstanding at September 27, 2008 had a weighted average remaining contractual term of 2.9 years, and an aggregate intrinsic value of $9.0 million. Options eligible for exercise at September 27, 2008 had a weighted average remaining contractual term of 2.0 years, and an aggregate intrinsic value of $6.0 million.
The total intrinsic value of stock options exercised during the fiscal years ended September 27, 2008, September 29, 2007, and September 30, 2006 were $5.8 million, $9.6 million and $6.7 million, respectively.
Restricted Stock
The Company awards directors and key employees restricted stock grants that vest over three years. Participants are entitled to cash dividends and voting rights on awarded shares, but the sale and transfer of these shares is restricted during the vesting period.
Restricted stock activity for the fiscal years ended September 27, 2008, September 29, 2007, and September 30, 2006 was as follows (in thousands, except per share amounts):
| | | | | | | | | | | | | | | | |
| | 2008 | | 2007 | | 2006 | |
| | | | | | | | |
| | Shares | | WAGDFV* | | Shares | | WAGDFV* | | Shares | | WAGDFV* | |
| | | | | | | | | | | | | | |
Unvested shares at beginning of year | | 22 | | $ | 38.64 | | 22 | | $ | 34.06 | | 19 | | $ | 25.97 | |
Granted | | 12 | | $ | 38.30 | | 11 | | $ | 42.49 | | 13 | | $ | 36.65 | |
Vested | | (11 | ) | $ | 36.62 | | (11 | ) | $ | 33.57 | | (9 | ) | $ | 21.55 | |
Forfeited | | (3 | ) | $ | 39.87 | | — | | $ | — | | (1 | ) | $ | 29.95 | |
| | | | | | | | | | | | | | | | |
Unvested shares at end of year | | 20 | | $ | 39.29 | | 22 | | $ | 38.64 | | 22 | | $ | 34.06 | |
| | | | | | | | | | | | | | | | | |
*Weighted Average Grant Date Fair Value |
Employee Stock Purchase Plan
The Company’s U.S. employees are eligible to participate in the Company’s Employee Stock Purchase Plan (“ESPP”). Employee purchases of Company stock are funded by payroll deductions over calendar six-month periods. The purchase price is 85% of the lower of the market price at either the beginning or end of the six-month period. The shares are required to be held by the employee for at least eighteen months subsequent to the purchase. Two purchase periods closed in fiscal year 2008 with the combined issuance of 20,733 shares at a weighted average price of $33.15. In fiscal years 2007 and 2006, purchases were 21,351 and 19,772 shares, respectively, with weighted average share prices of $32.83 and $29.19, respectively. At September 27, 2008, the number of shares remaining for issuance under the ESPP was 514,469.
3. Discontinued Operations:
On June 27, 2008, the Company sold substantially all of the net assets of its Nano Instruments product line, which was based in Oak Ridge, Tennessee. As a result of this sale, the Company recorded a gain of $2.4 million, net of tax of $3.6 million, in fiscal year 2008. The Nano Instruments product line was historically included in the Company’s Test segment for financial reporting. The results of operations of the Nano Instruments product line, including the gain on the sale, have been excluded from the results of operations of the Test segment and are reported as discontinued operations for the fiscal years ended September 27, 2008, September 29, 2007 and September 30, 2006.
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Table of Contents
In fiscal year 2005, the Company sold substantially all of the net assets of its engine test business, which represented the Company’s exit from that business. The engine test business was historically included in the Company’s Test segment for financial reporting. The results of operations of the engine test business are excluded from the results of operations of the Test segment and are reported as discontinued operations for the fiscal year ended September 30, 2006.
Also in fiscal year 2005, the Company closed its AeroMet subsidiary, a laser deposition technology business. The AeroMet subsidiary was historically included in the Company’s Industrial segment (now the “Sensors” segment) for financial reporting. The results of operations of the AeroMet business are excluded from the results of operations of the Sensors segment and are reported as discontinued operations for the fiscal year ended September 30, 2006.
The Company does not allocate interest income or interest expense to discontinued operations. Operating results of the discontinued operations included in the Company’s results for the fiscal years ended September 27, 2008, September 29, 2007, and September 30, 2006 were as follows:
| | | | | | | | | | |
| | 2008 | | 2007 | | 2006 | |
| | | | | | | | |
| | (expressed in thousands) | |
Revenue | | $ | 6,106 | | $ | 10,413 | | $ | 8,861 | |
(Loss) income on discontinued operations before taxes and gain on sale | | | (628 | ) | | 1,576 | | | 2,082 | |
(Benefit) provision for income taxes | | | (260 | ) | | 621 | | | 728 | |
| | | | | | | | | | | |
(Loss) income from discontinued operations, net of tax | | $ | (368 | ) | $ | 955 | | $ | 1,354 | |
| | | | | | | | | | | |
The assets and liabilities of discontinued operations at September 27, 2008 and September 29, 2007 were as follows:
| | | | | | | |
| | 2008 | | 2007 | |
| | | | | |
| | (expressed in thousands) | |
Accounts receivable, net of allowances for doubtful accounts | | $ | 149 | | $ | 2,354 | |
Unbilled accounts receivable | | | 88 | | | — | |
Inventories | | | — | | | 1,099 | |
Prepaid expenses & other current assets | | | — | | | 69 | |
Current deferred tax assets | | | 143 | | | 473 | |
| | | | | | | |
Current assets of discontinued operations | | | 380 | | | 3,995 | |
| | | | | | | |
Machinery and equipment | | | — | | | 2,478 | |
Accumulated depreciation | | | — | | | (1,325 | ) |
Goodwill | | | — | | | 2,929 | |
| | | | | | | |
Long-lived assets of discontinued operations | | | — | | | 4,082 | |
| | | | | | | |
| | | | | | | |
Total assets of discontinued operations | | $ | 380 | | $ | 8,077 | |
| | | | | | | |
| | | | | | | |
Accounts payable | | $ | — | | $ | 472 | |
Accrued payroll-related costs | | | — | | | 399 | |
Advance payments from customers | | | — | | | 391 | |
Accrued warranty costs | | | — | | | 60 | |
Accrued income taxes | | | 177 | | | 612 | |
Other accrued liabilities | | | — | | | 10 | |
| | | | | | | |
Total liabilities of discontinued operations | | $ | 177 | | $ | 1,944 | |
| | | | | | | |
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4. Business Segment Information:
The Company’s Chief Executive Officer and management regularly review financial information for the Company’s two discrete business units. Based on similarities in the economic characteristics, nature of products and services, production processes, type or class of customer served, method of distribution and regulatory environments, the operating units have been categorized for financial statement purposes into two reportable segments, “Test” and “Sensors.” The Test segment provides testing equipment, systems, and services to the ground vehicles, aerospace, and infrastructure markets. The Sensors segment provides high-performance position sensors for a variety of industrial and vehicular applications.
In evaluating each segment’s performance, management focuses on income from operations. This measure excludes interest income and expense, income taxes and other non-operating items. Corporate expenses, including costs associated with various support functions such as human resources, information technology, finance and accounting, and general and administrative costs, are allocated to the reportable segments primarily on the basis of revenue.
Financial information by reportable segment for the fiscal years ended September 27, 2008, September 29, 2007, and September 30, 2006, were as follows:
| | | | | | | | | | |
| | 2008 | | 2007 | | 2006 | |
| | | | | | | | |
| | (expressed in thousands) | |
Revenue | | | | | | | | | | |
Test | | $ | 364,068 | | $ | 333,185 | | $ | 323,700 | |
Sensors | | | 96,447 | | | 76,906 | | | 64,224 | |
| | | | | | | | | | | |
Total Revenue | | $ | 460,515 | | $ | 410,091 | | $ | 387,924 | |
| | | | | | | | | | | |
Income from Operations | | | | | | | | | | |
Test | | $ | 41,108 | | $ | 39,215 | | $ | 43,278 | |
Sensors | | | 20,653 | | | 14,757 | | | 11,108 | |
| | | | | | | | | | | |
Total Income from Operations | | $ | 61,761 | | $ | 53,972 | | $ | 54,386 | |
| | | | | | | | | | | |
Identifiable Assets | | | | | | | | | | |
Test | | $ | 301,346 | | $ | 261,040 | | $ | 249,153 | |
Sensors | | | 97,431 | | | 83,864 | | | 67,278 | |
Discontinued Operations | | | 380 | | | 8,077 | | | 7,692 | |
| | | | | | | | | | | |
Total Assets | | $ | 399,157 | | $ | 352,981 | | $ | 324,123 | |
| | | | | | | | | | | |
Other Segment Data | | | | | | | | | | |
Test: | | | | | | | | | | |
Capital expenditures | | $ | 7,643 | | $ | 8,908 | | $ | 5,349 | |
Depreciation and amortization | | $ | 7,317 | | $ | 6,290 | | $ | 5,728 | |
| | | | | | | | | | | |
Sensors: | | | | | | | | | | |
Goodwill | | $ | 1,668 | | $ | 1,642 | | $ | 1,537 | |
Capital expenditures | | $ | 2,109 | | $ | 3,132 | | $ | 1,838 | |
Depreciation and amortization | | $ | 1,890 | | $ | 1,695 | | $ | 1,574 | |
| | | | | | | | | | | |
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| | | | | | | | | | |
Geographic information was as follows: |
| | | | | | | | | | |
| | 2008 | | 2007 | | 2006 | |
| | | | |
| | (expressed in thousands) | |
Revenue | | | | | | | | | | |
United States | | $ | 147,766 | | $ | 134,889 | | $ | 116,344 | |
Germany | | | 58,962 | | | 49,597 | | | 54,161 | |
Europe, excluding Germany | | | 92,995 | | | 97,867 | | | 85,772 | |
Japan | | | 48,802 | | | 42,600 | | | 61,283 | |
Asia, excluding Japan | | | 90,721 | | | 70,751 | | | 53,872 | |
Other | | | 21,269 | | | 14,387 | | | 16,492 | |
| | | | | | | | | | | |
Total Revenue | | $ | 460,515 | | $ | 410,091 | | $ | 387,924 | |
| | | | | | | | | | | |
Property and Equipment, Net | | | | | | | | | | |
United States | | $ | 38,915 | | $ | 35,312 | | $ | 31,373 | |
Europe | | | 10,085 | | | 12,403 | | | 10,570 | |
Asia | | | 1,534 | | | 2,032 | | | 1,029 | |
| | | | | | | | | | | |
Total Property and Equipment, Net | | $ | 50,534 | | $ | 49,747 | | $ | 42,972 | |
| | | | | | | | | | | |
Revenue by geographic area is presented based on customer location. No countries other than the United States, Germany and Japan had revenue in excess of 10% of the Company’s total revenue. No single customer accounted for 10% or more of the Company’s consolidated revenue for any of the periods presented.
5. Financing:
Short-term borrowings at September 27, 2008 and September 29, 2007 consist of the following:
| 2008 | | | 2007 | |
| (expressed in thousands) | |
Bank line of credit, monthly U.S. LIBOR plus 45 basis points (2.95% rate in effect at September 27, 2008), maturing
October 2008, with optional month-to-month term renewal and loan repricing until December 2012 | | $ | 11,000 | | | | $ | — | |
Bank line of credit, monthly U.S. LIBOR plus 45 basis points (3.70% rate in effect at September 27, 2008), maturing
October 2008, with optional month-to-month term renewal and loan repricing until December 2012 | | | 13,000 | | | | | — | |
Notes payable, non-interest bearing | | | 338 | | | | | 265 | |
Total Short-Term Borrowings | | $ | 24,338 | | | | $ | 265 | |
On December 18, 2007, the Company entered into a five-year unsecured credit agreement (“Credit Facility”). The Credit Facility provides for up to $75.0 million for working capital financing, acquisitions, share purchases, or other general corporate purposes until December 2012. At September 27, 2008, outstanding borrowings under the Credit Facility aggregated $24.0 million. Commitment fees are payable on the unused portion of the Credit Facility at rates between 0.09% and 0.18%, based on the Company’s leverage ratio. During the fiscal year ended September 27, 2008, commitment fees incurred on the Credit Facility were less than $0.1 million.
At the Company’s election, future borrowings under the Credit Facility can be structured to bear interest at either an alternate base rate (“ABR”) or an adjusted LIBOR plus an applicable margin. The ABR is the greater of the Prime Rate or the Federal Funds Effective Rate plus 0.5%. At September 27, 2008, the prime rate of 5.0% was the applicable ABR. The adjusted LIBOR is generally determined based on the multiple of
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the applicable LIBOR and a statutory reserve factor, considering the projected period of use of the loan proceeds. The applicable margin applied to adjusted LIBOR on borrowings varies based on the Company’s leverage ratio. At September 27, 2008, the spread of the adjusted LIBOR plus the applicable margin ranged from 4.15% to 4.33%.
The weighted average interest rate on outstanding borrowings under the Credit Facility during the fiscal year ended September 27, 2008 was 2.95%. In July 2008, in order to mitigate its exposure to interest rate increases on $13 million of its floating rate indebtedness, the Company entered into a four-year floating to fixed interest rate swap. See Note 1 to the Consolidated Financial Statements for additional information on the interest rate swap.
Notes payable at September 27, 2008 and September 29, 2007 consisted of non-interest bearing notes payable to vendors by the Company’s Japanese Sensors subsidiary.
Long-term debt at September 27, 2008 and September 29, 2007 was as follows:
| | | | | | | |
| | 2008 | | 2007 | |
| | | | | | |
| | (expressed in thousands) | |
7.5% note, unsecured, due in semi-annual installments of $1,154, maturing July 2009 | | $ | 2,308 | | $ | 4,616 | |
6.6% notes, unsecured, due in annual installments of $4,375, expired July 2008 | | | — | | | 4,375 | |
| | | | | | | | |
Total Long-Term Debt | | | 2,308 | | | 8,991 | |
Less Current Maturities of Long-Term Debt | | | (2,308 | ) | | (6,683 | ) |
| | | | | | | | |
Total Long-Term Debt, Less Current Maturities | | $ | — | | $ | 2,308 | |
| | | | | | | | |
The 7.5% note contains pre-payment penalties that make early repayment economically disadvantageous to the Company based on current market interest rates. The Company estimates the difference between the fair market value and the carrying value of its long-term debt portfolio is less than $0.1 million at September 27, 2008.
The Company is subject to financial covenants, among other restrictions, under both the Credit Facility and the 7.5% note agreement, including, among other covenants, minimum net worth, the ratio of consolidated total indebtedness to consolidated EBITDA, as well as the ratio of consolidated EBITDA to consolidated interest expense. These covenants restrict the Company’s ability to pay dividends and purchase outstanding shares of common stock. At September 27, 2008 and September 29, 2007, the Company was in compliance with these financial covenants.
At September 27, 2008, the Company had outstanding letters of credit and guarantees totaling $41.4 million and $3.0 million, respectively, primarily to bond advance payments and performance related to customer contracts in the Test segment.
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6. Income Taxes:
The components of income before income taxes and discontinued operations for the fiscal years ended September 27, 2008, September 29, 2007, and September 30, 2006 were as follows:
| | | | | | | | | | |
| | 2008 | | 2007 | | 2006 | |
| | | | | | | | |
| | (expressed in thousands) | |
Income before income taxes and discontinued operations: | | | | | | | | | | |
Domestic | | $ | 29,745 | | $ | 31,211 | | $ | 37,264 | |
Foreign | | | 35,715 | | | 25,379 | | | 20,042 | |
| | | | | | | | | | | |
Total | | $ | 65,460 | | $ | 56,590 | | $ | 57,306 | |
| | | | | | | | | | | |
The provision for income taxes from continuing operations for the fiscal years ended September 27, 2008, September 29, 2007, and September 30, 2006 was as follows:
| | | | | | | | | | |
| | 2008 | | 2007 | | 2006 | |
| | | | |
| | (expressed in thousands) | |
Current provision (benefit): | | | | | | | | | | |
Federal | | $ | 9,016 | | $ | 7,791 | | $ | 8,301 | |
State | | | 1,080 | | | 1,530 | | | 1,330 | |
Foreign | | | 11,943 | | | 10,425 | | | 6,946 | |
Deferred | | | (3,689 | ) | | (4,197 | ) | | 2,760 | |
| | | | | | | | | | | |
Total provision | | $ | 18,350 | | $ | 15,549 | | $ | 19,337 | |
| | | | | | | | | | | |
A reconciliation from the federal statutory income tax rate to the Company’s effective income tax rate for the fiscal years ended September 27, 2008, September 29, 2007, and September 30, 2006 is as follows:
| | | | | | | | | | |
| | 2008 | | 2007 | | 2006 | |
| | | | | | | | | | | |
| | | | | | | | | | |
United States federal statutory income tax rate | | | 35 | % | | 35 | % | | 35 | % |
Tax benefit of export sales | | | — | | | (1 | ) | | (2 | ) |
Foreign provision (less than) greater than of U.S. tax rate | | | (1 | ) | | (2 | ) | | 2 | |
Settlement of audits, favorable resolution of accrued tax matters | | | (2 | ) | | — | | | (3 | ) |
State income taxes, net of federal benefit | | | 1 | | | 1 | | | 2 | |
Research and development tax credits | | | — | | | (5 | ) | | — | |
Domestic production activities deduction | | | (1 | ) | | (1 | ) | | (1 | ) |
Foreign tax credits | | | (5 | ) | | — | | | — | |
Tax exempt income | | | — | | | (1 | ) | | (1 | ) |
Nondeductible stock option expense and other permanent items | | | 1 | | | 2 | | | 2 | |
| | | | | | | | | | | |
Effective income tax rate | | | 28 | % | | 28 | % | | 34 | % |
| | | | | | | | | | | |
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A summary of the deferred tax assets and liabilities for the fiscal years ended September 27, 2008, September 29, 2007, and September 30, 2006 is as follows:
| | | | | | | | | | |
| | 2008 | | 2007 | | 2006 | |
| | | | | | | | |
| | (expressed in thousands) | |
Deferred Tax Asset: | | | | | | | | | | |
Accrued compensation and benefits | | $ | 7,887 | | $ | 6,907 | | $ | 5,382 | |
Inventory reserves | | | 1,679 | | | 2,466 | | | 2,567 | |
Intangible assets | | | — | | | (61 | ) | | 63 | |
Allowance for doubtful accounts | | | 163 | | | 215 | | | 175 | |
Other assets | | | 3,323 | | | 655 | | | 425 | |
Net operating loss carryovers | | | 2,555 | | | 1,483 | | | 1,720 | |
Unrealized derivative instrument losses | | | 82 | | | 119 | | | — | |
Capital loss carryovers | | | — | | | 34 | | | — | |
Research and development and foreign tax credits | | | 2,713 | | | 305 | | | — | |
| | | | | | | | | | | |
Total deferred tax asset before valuation allowance | | | 18,402 | | | 12,123 | | | 10,332 | |
Less valuation allowance | | | (809 | ) | | (781 | ) | | (669 | ) |
| | | | | | | | | | | |
Total Deferred Tax Asset | | $ | 17,593 | | $ | 11,342 | | $ | 9,663 | |
| | | | | | | | | | | |
| | | | | | | | | | |
Deferred Tax Liability: | | | | | | | | | | |
Property and equipment | | $ | 4,193 | | $ | 3,784 | | $ | 4,481 | |
Intangible Assets | | | 40 | | | — | | | — | |
Unrealized derivative instrument gains | | | — | | | — | | | 811 | |
Foreign deferred revenue and other | | | 4,300 | | | 4,197 | | | 5,236 | |
| | | | | | | | | | | |
Total Deferred Tax Liability | | $ | 8,533 | | $ | 7,981 | | $ | 10,528 | |
| | | | | | | | | | | |
Net Deferred Tax Asset (Liability) | | $ | 9,060 | | $ | 3,361 | | $ | (865 | ) |
| | | | | | | | | | | |
As of September 27, 2008, the Company’s French, Swedish, Chinese and one of its German subsidiaries had net operating loss carryovers of $3.9 million, $0.9 million, $0.9 million and $2.0 million, respectively. These net operating loss carryovers will not expire under local tax law. The Company determined that the benefit of the German subsidiary’s net operating loss carryover of $2.0 million is not likely to be realized. Accordingly, as of September 27, 2008, the Company had a full valuation allowance against the German subsidiary’s deferred tax asset in the amount of $0.8 million.
During fiscal year 2008, the Company repatriated $20.2 million of historic earnings from its Japanese subsidiaries. The Company recorded $3.5 million of net tax benefit during fiscal year 2008 related to these dividends. Also during fiscal year 2008, the Company was only allowed to recognize research and development credits on applicable spending during the first quarter, as the provision in the U.S. tax law allowing for these credits expired on December 31, 2007. The Company’s German subsidiaries benefited from tax legislation passed during fiscal year 2007. The German subsidiaries recorded $2.4 million of tax benefits during fiscal year 2007 related to this legislation. The legislation decreased the German tax rate applicable to future taxable temporary differences and entitled the primary German subsidiary to a corporate tax refund. U.S. research and development tax credit legislation was also extended during fiscal year 2007 with an effective date retroactive to January 1, 2006. This legislation allowed the Company to recognize $1.2 million of tax benefits in fiscal year 2007, due to tax credits available on applicable research and development spending by the Company during the last three fiscal quarters of fiscal year 2006. During fiscal year 2006, the Company favorably resolved tax audits and other previously accrued tax matters and accordingly released $1.8 million of previously accrued tax contingencies. The decrease in the Company’s effective income tax rate for fiscal year 2007 compared to the effective income tax rate for fiscal year 2006 was primarily due to the favorable tax legislation passed during fiscal year 2007 in the U.S. and Germany and expanded R&D tax credits.
According to Accounting Principles Bulletin (“APB”) 23, “Accounting for Income Taxes – Special Areas,” U.S. income taxes are not provided on undistributed earnings of international subsidiaries that are
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permanently reinvested. At September 27, 2008, undistributed earnings permanently reinvested in international subsidiaries were approximately $109 million. The Company has not provided for U.S. income taxes, or any of the related foreign tax credits, on these earnings.
In the fiscal years ended September 27, 2008, September 29, 2007, and September 30, 2006, the Company recognized tax benefits of $1.3 million, $2.7 million, and $1.7 million, respectively, related to the Company’s equity compensation plans. These benefits were directly allocated to Shareholders’ Investment on the Consolidated Balance Sheet. Additionally, the deferred tax asset or liability related to the Company’s unrealized gain or loss associated with derivative instruments was directly allocated to Accumulated Other Comprehensive Income (Loss) within Shareholders’ Investment. Under SFAS No. 87, “Employer’s Accounting for Pensions” and SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Post Retirement Plans” – an Amendment of FASB Statements No. 87, “Employers’ Accounting for Pensions,” SFAS No. 88, “Employers’ Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits,” SFAS No. 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions,” and SFAS No. 132(R), “Employers’ Disclosures about Pensions and Other Postretirement Benefits,” the deferred tax asset associated with the defined benefit pension plan of one of the Company’s German subsidiaries was also directly allocated to Accumulated Other Comprehensive Income (Loss) within Shareholders’ Investment.
Effective September 30, 2007, the Company adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes,” and prescribes a threshold for recognizing and measuring attributes for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Additionally, FIN 48 provides guidance on subsequent de-recognition of tax positions, financial statement classification, recognition of interest and penalties, accounting in interim periods and disclosure and transition requirements.
The adoption of FIN 48 had no material impact on the Company’s liability for unrecognized tax benefits or retained earnings. Consistent with the provisions of FIN 48, the Company reclassified the reserves for uncertain tax positions from other current liabilities to non-current liabilities, unless the liability was expected to be paid within one year. At September 30, 2007, the Company’s liability for unrecognized tax benefits was $5.3 million.
A summary of changes in the Company’s liability for unrecognized tax benefits from adoption through September 27, 2008 is as follows
| | | | |
| | 2008 | |
| | | | |
| | (expressed in thousands) | |
Beginning balance | | $ | 5,252 | |
Increase due to tax positions related to the current year | | | 162 | |
Decrease due to settlement of tax positions related to prior years | | | (867 | ) |
Decrease due to lapse of statute of limitations | | | (575 | ) |
Exchange rate change | | | 37 | |
| | | | | |
Ending balance | | $ | 4,009 | |
| | | | | |
Included in the balance of unrecognized tax benefits at September 27, 2008 are potential benefits of $1.3 million that, if recognized, would favorably impact the effective tax rate on continuing operations.
At September 27, 2008, the Company had accrued approximately $0.5 million of interest related to uncertain income tax positions. No accrual for penalties related to uncertain tax positions existed at September 27, 2008. Upon adoption of FIN 48, the Company elected to classify interest and penalties related to uncertain tax positions in Interest Expense and General and Administrative Expense, respectively, on the Consolidated Statements of Income. Previously, the Company recognized interest and penalties in Provision for Income Taxes on the Consolidated Statements of Income.
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The Company is subject to U.S. federal income tax as well as income tax of numerous state and foreign jurisdictions. The Company is no longer subject to U.S. federal tax examinations for fiscal years before 2006 and with limited exceptions, state and foreign income tax examinations for fiscal years before 2005. The Company’s Japanese and French tax returns have been examined by the tax authorities through fiscal year 2006. The Company’s German tax returns have been examined by the tax authorities through fiscal year 2005. As of September 27, 2008, the Company does not expect significant changes in the amount of unrecognized tax benefits during the next twelve months.
7. Employee Benefit Plans:
The Company offers a retirement plan that has two components: (1) a 401(k) component with a Company match and (2) a fiscal year Company contribution.
The 401(k) component of the retirement plan allows eligible employees to contribute a portion of their pre-tax income to the plan each pay period. The Company matches 50% of employees’ pre-tax contributions (excluding “catch-up” contributions that employees age 50 or older may make to the plan), up to 6% of compensation, subject to limitations imposed by federal law. The Company’s matching contributions were $2.2 million, $1.9 million, and $1.8 million in fiscal years 2008, 2007, and 2006, respectively. Employees may also contribute a percentage of their salary to the plan on an after-tax basis.
The Company also provides an annual fiscal year contribution to the retirement plan for eligible employees. Employees who are active as of the end of the fiscal year and whom have been paid for 1,000 hours or more of service during a plan year are eligible for a fiscal year contribution. After three years as a participant, employees have a vested interest equal to 100% of the total Company fiscal year contributions. The plan provides for a minimum fiscal year contribution of 3% of participant compensation below the Social Security taxable wage base and 6% of participant compensation in excess of the Social Security taxable wage base, up to the maximum contribution allowed by federal law. The Company’s Board of Directors approves any changes to the contribution levels under the plan. The Company’s fiscal year contributions under the plan totaled $2.7 million, $2.7 million, and $2.5 million in fiscal years 2008, 2007, and 2006, respectively.
One of the Company’s German subsidiaries has a non-contributory, defined benefit retirement plan for eligible employees. This plan provides benefits based on the employee’s years of service and compensation during the years immediately preceding retirement, early retirement, termination, disability, or death, as defined in the plan. The Company uses a September 30 measurement date for this defined benefit retirement plan.
On September 14, 2008, the Company made a discretionary contribution of $12.9 million to the defined benefit retirement plan. This contribution resulted in a re-measurement of the plan assets, benefit obligation, and projected net periodic benefit cost as of that date.
Effective September 29, 2007, the Company adopted the recognition and disclosure provisions of SFAS No. 158. SFAS No. 158 requires employers to recognize the funded status of each defined benefit pension and other postretirement plans in its statement of financial position, recognize changes in that funded status in the year in which the changes occur through comprehensive income, and measure a plan’s assets and its obligations that determine its funded status as of the end of the employer’s fiscal year.
The pretax amounts recognized in Accumulated Other Comprehensive Income as of September 27, 2008 and September 29, 2007 consist of the following:
| | | | | | | |
| | 2008 | | 2007 | |
| | | | | |
| | (expressed in thousands) | |
Actuarial net loss | | $ | 329 | | $ | 1,547 | |
Prior service cost | | | 15 | | | 30 | |
| | | | | | | |
| | $ | 344 | | $ | 1,577 | |
| | | | | | | |
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The portion of the pretax amount in Accumulated Other Comprehensive Income (Loss) at September 29, 2007 that was recognized during the fiscal year ended September 27, 2008 was less than $0.1 million. The portion of the pretax amount in Accumulated Other Comprehensive Income (Loss) at September 27, 2008 that is expected to be recognized as a component of net periodic retirement cost during the next fiscal year is less than $0.1 million.
The following is a summary of the changes in benefit obligations and plan assets during the fiscal years ended September 27, 2008 and September 29, 2007:
| | | | | | | |
| | 2008 | | 2007 | |
| | | | |
| | (expressed in thousands) | |
Change in benefit obligation: | | | | | | | |
Projected benefit obligation, beginning of year | | $ | 13,117 | | $ | 11,987 | |
Service cost | | | 551 | | | 513 | |
Interest cost | | | 740 | | | 562 | |
Exchange rate change | | | 361 | | | 1,428 | |
Actuarial gain | | | (1,439 | ) | | (1,116 | ) |
Benefits paid | | | (310 | ) | | (257 | ) |
| | | | | | | | |
Projected benefit obligation, end of year | | $ | 13,020 | | $ | 13,117 | |
| | | | | | | | |
| | | | | | | |
Change in plan assets: | | | | | | | |
Fair value of plan assets, beginning of year | | $ | — | | $ | — | |
Actual return on plan assets | | | (116 | ) | | — | |
Exchange rate change | | | 3 | | | — | |
Employer contributions | | | 13,198 | | | 257 | |
Benefits paid | | | (310 | ) | | (257 | ) |
| | | | | | | | |
Fair value of plan assets, end of year | | $ | 12,775 | | $ | — | |
| | | | | | | | |
The following is a summary of the funded status of the defined benefit retirement plan and amounts recognized in the Company’s Consolidated Balance Sheets at September 27, 2008 and September 29, 2007:
| | | | | | | |
| | 2008 | | 2007 | |
| | | | |
| | (expressed in thousands) | |
Funded status: | | | | | | | |
Funded status, end of year | | $ | (245 | ) | $ | (13,117 | ) |
Accumulated other comprehensive loss | | | 344 | | | 1,577 | |
| | | | | | | | |
Net amount recognized | | $ | 99 | | $ | (11,540 | ) |
| | | | | | | | |
| | | | | | | |
Amounts recognized in consolidated balance sheets: | | | | | | | |
Accrued payroll and related costs | | $ | — | | $ | (340 | ) |
Pension benefit plan | | | (245 | ) | | (12,777 | ) |
| | | | | | | | |
Total accrued benefit liability | | | (245 | ) | | (13,117 | ) |
Deferred income taxes | | | 104 | | | 476 | |
Accumulated other comprehensive income, net of tax | | | 240 | | | 1,101 | |
| | | | | | | | |
Net amount recognized | | $ | 99 | | $ | (11,540 | ) |
| | | | | | | | |
The weighted average assumptions used to determine the defined benefit retirement plan obligation at September 27, 2008 and September 29, 2007, and also the net periodic benefit cost for the following fiscal year, were as follows:
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| | | | | |
| | 2008 | | 2007 | |
| | | | | | |
Discount rate | | 6.4 | % | 5.4 | % |
Expected rate of return on plan assets | | 5.9 | % | N/A | |
Expected rate of increase in future compensation levels | | 3.2 | % | 3.2 | % |
| | | | | | |
The discount rate is calculated based on zero-coupon bond yields published by the Deutsche Bundesbank for maturities that match the weighted average duration of the pension liability, adjusted for the average credit spread of corporate bond rates above the government bond yields.
The objective of the Company’s investment policy for the defined benefit retirement plan is earn the highest possible total returns consistent with the preservation of capital and anticipated liquidity requirements while minimizing the volatility of returns. The plan fiduciaries set the long-term strategic investment objectives for the defined benefit retirement plan assets. The objectives include preserving the funded status of the trust and balancing risk and return. Investment performance and plan asset mix are reviewed periodically. Plan assets are currently allocated to fixed income, equity, cash and cash equivalent, and other categories (see table below). Within these categories, investments are allocated to multiple investment classes. Any decisions to change to the asset allocation are made by the plan fiduciaries however, investment into equity securities is limited to a maximum of 40% of total plan assets. The expected long-term rate of return of plan assets of 5.9% for the fiscal year ended September 27, 2008 was determined by considering historical and expected returns for each asset class and the effect of periodic asset rebalancing and reallocation. While historical returns are not guarantees of future performance, current and future allocations are expected to meet the objectives of the defined benefit retirement plan.
The actual defined benefit retirement plan asset allocation at September 27, 2008, by asset category, is as follows:
| | | |
| | 2008 | |
| | | | |
Fixed income securities | | 76.3 | % |
Equity securities | | 9.6 | % |
Cash and cash equivalents | | 8.6 | % |
Other | | 5.5 | % |
| | | | |
| | 100.0 | % |
| | | | |
Net periodic benefit cost for the Company’s defined retirement plan for the fiscal years ended September 27, 2008, September 29, 2007, and September 30, 2006 included the following components:
| | | | | | | | | | |
| | 2008 | | 2007 | | 2006 | |
| | | | | | | | |
| | (expressed in thousands) | |
Service cost | | $ | 551 | | $ | 513 | | $ | 474 | |
Interest cost | | | 740 | | | 562 | | | 466 | |
Expected return on plan assets | | | (44 | ) | | — | | | — | |
Net amortization and deferral | | | 35 | | | 133 | | | 139 | |
| | | | | | | | | | | |
Net periodic benefit cost | | $ | 1,282 | | $ | 1,208 | | $ | 1,079 | |
| | | | | | | | | | | |
The accumulated benefit obligation of the Company’s defined benefit retirement plan as of September 27, 2008 and September 29, 2007 was $11.8 million and $11.7 million, respectively. Prior to the adoption of SFAS No. 158, the Company was required, under SFAS No. 87, to recognize an additional minimum pension liability if the fair value of pension plan assets were less than the accumulated benefit obligation at the end of the plan year. For the fiscal year ended September 29, 2007, the Company recorded a non-cash adjustment to Accumulated Other Comprehensive Income of $0.7 million, or $1.2 million on a pre-tax basis.
The future pension benefit payments, which reflect expected future service, for the next five fiscal years, and the combined five fiscal years thereafter, are as follows:
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Future Benefit payments:
| | | | |
Fiscal Year | | Pension
Benefits | |
| | | | |
| | (expressed in thousands) | |
2009 | | $ | 415 | |
2010 | | | 545 | |
2011 | | | 606 | |
2012 | | | 659 | |
2013 | | | 701 | |
2014 through 2018 | | | 4,458 | |
| | | | |
| | $ | 7,384 | |
| | | | |
8. Commitments and Contingencies:
Litigation: The Company is subject to various claims, legal actions, and complaints arising in the ordinary course of business. The Company believes the final outcome of these matters will not have a material adverse effect on its consolidated financial position or results of operations. The Company expenses legal costs as incurred.
Leases: Total lease expense associated with continuing operations was $5.4 million, $5.4 million, and $5.1 million for fiscal years 2008, 2007, and 2006, respectively. The Company has operating lease commitments for equipment, land, and facilities that expire on various dates through 2052. Minimum annual rental commitments for the next five fiscal years and thereafter are as follows:
| | | | |
Year | | Payments | |
| | | | |
| | (expressed in thousands) | |
2009 | | $ | 4,790 | |
2010 | | | 3,626 | |
2011 | | | 2,909 | |
2012 | | | 1,649 | |
2013 | | | 623 | |
Thereafter | | | 2,667 | |
| | | | |
| | $ | 16,264 | |
| | | | |
9. Related Party Transactions:
During the fiscal years ended September 27, 2008, September 29, 2007, and September 30, 2006, MTS Sensors purchased mechanical components and remote-mechanic workbench services from Mark-Tronik GmbH (“Mark-Tronik”) aggregating approximately $1.6 million, $1.4 million and $1.2 million, respectively. MTS Sensors is owned by MTS Systems GmbH, a wholly-owned subsidiary of the Company. The owner and general manager of Mark-Tronik is a related party to management of the Company. At September 27, 2008 and September 29, 2007, net outstanding payments due to Mark-Tronik by MTS Sensors were less than $0.1 million.
10. Subsequent Events:
Business Acquisition
On September 28, 2008, the Company acquired substantially all of the assets of SANS for an estimated purchase price of approximately $47.1 million (after post-acquisition adjustments), plus $2.7 million of acquisition costs. SANS, headquartered in Shenzhen, China, manufactures material testing solutions and offers a variety of products, including electro-mechanical and static-hydraulic testing machines. The results of operations of SANS are expected to be reported within the Company’s Test segment. During the fiscal year ended September 27, 2008, the Company made an initial investment in SANS of $13.7 million, which is reported in Other Assets on the Consolidated Balance Sheets. As of September 27, 2008, this investment
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did not provide the Company with any beneficial risks and rewards of ownership, as the Company was not entitled to participate in any profits or losses incurred by SANS, and the Company did not have any control over the operations or any assets of SANS after this investment. The Company anticipates funding the remaining portion of the cost of acquisition through cash and cash equivalents or use of its credit facility.
Income Tax Legislation
Legislation was enacted in October of fiscal year 2009 that extended United States R&D credits, with an effective date that is retroactive to January 1, 2008. The Company recognized only one quarter of the R&D tax credit for fiscal year 2008 and will recognize the other three quarters of benefit of approximately $1.2 million in the first quarter of fiscal year 2009.
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MTS SYSTEMS CORPORATION AND SUBSIDIARIES
SCHEDULE II - SUMMARY OF CONSOLIDATED ALLOWANCES
FOR DOUBTFUL ACCOUNTS AND RESTRUCTURING RESERVES
FOR THE FISCAL YEARS ENDED SEPTEMBER 27, 2008, SEPTEMBER 29, 2007,
AND SEPTEMBER 30, 2006
(expressed in thousands)
| | Balance
Beginning
of Year | | Provisions/
(Recoveries) | | Amounts
Written-Off/
Payments | | Balance
End of
Year | |
Allowance for Doubtful Accounts: | | | | | | | | | | | | | |
| | | | | | | | | | | | | |
2008 | | $ | 1,518 | | $ | (111 | ) | $ | (399 | ) | $ | 1,008 | |
| | | | | | | | | | | | | |
2007 | | | 1,350 | | | 320 | | | (152 | ) | | 1,518 | |
| | | | | | | | | | | | | |
2006 | | | 1,208 | | | 354 | | | (212 | ) | | 1,350 | |
| | | | | | | | | | | | | |
Restructuring Reserves: | | | | | | | | | | | | | |
| | | | | | | | | | | | | |
2008 | | $ | — | | $ | — | | $ | — | | $ | — | |
| | | | | | | | | | | | | |
2007 | | | 40 | | | — | | | (40 | ) | | — | |
| | | | | | | | | | | | | |
2006 | | | 1,319 | | | 30 | | | (1,309 | ) | | 40 | |
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