liabilities are frequently reviewed for their adequacy. As of November 30, 2002, the Company was subject to income tax audits for fiscal years 1998 through 2002. Included in these years subject to audit are the sales of the Color Printing and Imaging Division and the Video and Networking Division, which were complex transactions from a tax perspective. The liabilities associated with these years will ultimately be resolved when events such as the completion of audits by the taxing jurisdictions occur. To the extent the audits or other events result in a material adjustment to the accrued estimates, the effect would be recognized in Income tax (benefit) expense in the Condensed Consolidated Statement of Operations in the period of the event.
Subsequent to August 31, 2002, the Company negotiated a settlement with the United States Internal Revenue Service (“IRS”) with respect to their audit of the fiscal years 1998 through 2000. As a result of the audits settled and the current audit activity in progress, the Company revised its estimated liability for income taxes as of August 31, 2002. The revision resulted in a $12.5 million net reduction of previously estimated liabilities. This had the effect of reducing Accounts payable and accrued liabilities on the Condensed Consolidated Balance Sheet and decreased the Income tax expense on the Condensed Consolidated Statement of Operations in the first quarter of fiscal year 2003. With the completion of the IRS audit for fiscal years 1998 through 2000, the Company’s open years for United States federal purposes are now 2001 and 2002. As of November 30, 2002, the Company maintains estimated liabilities for open IRS and other taxing jurisdiction assessments, as discussed above. The settlement of additional open audits or changes in other circumstances could result in further material adjustment to the estimated liability and the associated tax expense in the period in which such events occur.
Judgment is also applied in determining whether deferred tax assets will be realized in full or in part. When it is more likely than not that all or some portion of specific deferred tax assets such as foreign tax credit carryovers or net operating loss carryforwards will not be realized, a valuation allowance must be established for the amount of the deferred tax assets that are determined not to be realizable. As of November 30, 2002, the Company had established a valuation allowance against deferred tax assets, and had not established valuation allowances against other deferred tax assets based on tax strategies planned to mitigate the risk of impairment to these assets. Accordingly, if the Company’s facts or financial results were to change thereby impacting the likelihood of realizing the deferred tax assets, judgment would have to be applied to determine changes to the amount of the valuation allowance required to be in place on the financial statements in any given period. The Company continually evaluates strategies that could allow the future utilization of its deferred tax assets, including those related to Tektronix Japan.
Beginning in fiscal year 2001 and continuing during fiscal year 2002, economic conditions have had a negative impact on many markets into which the Company sells products including, but not limited to, optical design and manufacturing, mobile handset manufacturing, automated test equipment, telecommunications and semiconductor design and manufacturing. Capital spending within these industries, the area that most impacts the Company, declined significantly in fiscal year 2002. The telecommunications and optical industries experienced the most substantial downturns during fiscal year 2002. These conditions adversely impacted the Company throughout fiscal year 2002, and have continued into fiscal year 2003. In response to the reduced level of orders and associated sales, the Company incurred business realignment costs of $27.0 million during fiscal year 2002. These costs were incurred in an effort to reduce fixed costs in future periods by reducing headcount and restructuring operations in certain foreign and domestic locations. During the first two quarters of fiscal year 2003, the Company incurred business realignment costs of $12.8 million, as discussed above. Management of the Company anticipates that business realignment costs will increase in the third quarter of fiscal year 2003 to approximately $15.0 million for that quarter. This increase is in part associated with the restructuring of the Japan subsidiary acquired through the Sony/Tektronix Acquisition. Management of the Company is unable to predict the ultimate severity and duration of the recent economic conditions or their impact on the Company.
Product orders consist of cancelable commitments to purchase currently produced products by customers with delivery scheduled generally within six months of being recorded. Consolidated product
orders for the second quarter of fiscal year 2003 were $181.0 million, an increase of $0.7 million from product orders of $180.3 million in the second quarter of fiscal year 2002. The slight increase is due to the $7.2 million incremental impact of orders recorded by the newly acquired Japan subsidiary, which was partially offset by the continued declining economic conditions as discussed above. Consolidated product orders for the first two quarters of fiscal year 2003 were $371.9 million, an increase of $27.0 million or 8% from product orders of $344.9 million in the first two quarters of fiscal year 2002. This increase was primarily due to an extra week of operations in the Company’s first quarter of fiscal year 2003, which had 14 weeks as compared to 13 weeks in the first quarter of the prior year, as well as higher than average cancellations in the first quarter of fiscal year 2002. Additionally, the incremental impact of $7.2 million from acquisition of the Japan subsidiary contributed to this increase over the prior year comparable period.
In the second quarter, orders from the Americas were $79.1 million, a decrease of $7.7 million or 9% from the second quarter of the prior year. This decrease was primarily attributable to the United States, which decreased to $74.0 million, or 8%, from $80.1 million in the prior year. The decline in the United States as compared with the prior year is primarily related to the continued decline in the economic conditions of the end markets into which the Company sells its products. See the Economic Conditions section above.
Orders from Japan were $17.9 million, an increase of $5.2 million or 41% from the second quarter fiscal year 2002 orders. The increase in Japan is primarily due to the incremental impact of inclusion of orders from the newly acquired Japan subsidiary. In addition, orders from the Pacific, excluding Japan, were $39.6 million, up $5.7 million or 17% from the second quarter of the prior year. Orders from Europe declined to $44.4 million, a decrease of $2.4 million or 5% from the second quarter of fiscal year 2002 as a result of difficult economic conditions in the Europe region.
For the first two quarters of fiscal year 2003, orders from the Americas were $165.3 million, an increase of $8.7 million or 6% from the first quarter of the prior year, which was primarily due to the United States, which increased to $154.3 million, or 8%, from $142.7 million in the prior year. Growth in the United States as compared with the prior year is primarily attributable to the extra week in the current fiscal year as well as higher than average cancellations in the first quarter of fiscal year 2002. Orders from Japan were $40.6 million, an increase of $13.2 million or 48% from the first two quarters of fiscal year 2002. This increase in Japan orders is primarily due to the $7.2 million incremental impact from inclusion of orders from the newly acquired Japan subsidiary in the second quarter of fiscal year 2003. In addition, orders from the Pacific, excluding Japan, were $83.3 million, up $12.1 million or 17% from the first two quarters of the prior year. Orders from Europe declined to $82.7 million, a decrease of $7.1 million or 8% from the first two quarters of fiscal year 2002 as a result of continued difficult economic conditions in the Europe region.
Net Sales
Net sales for the second quarter of fiscal year 2003 were $204.6 million, a decrease of $3.0 million from net sales of $207.6 million in the second quarter of fiscal year 2002. Net sales for the first two quarters of fiscal year 2003 were $405.9 million, a decrease of $9.4 million from net sales of $415.3 million in the first two quarters of fiscal year 2002. The decreases in net sales are primarily attributable to continued weakness in the markets into which the Company sells it products as well as constrained backlog in the current year as compared with the prior year. As backlog levels are reduced, the Company becomes more reliant on the timing of order receipts within the quarter to convert orders to sales. The decline in sales was partially offset by a $6.2 million increase resulting from the incremental impact of consolidation of the newly acquired Japan subsidiary and $6.6 million of sales related to the sale of optical transmission test products described above in Recent Transactions.
In the second quarter of the current year, net sales from the Americas, including the United States, were $101.2 million, nearly flat with sales of $101.5 million in the second quarter of the prior year. Net sales from Japan were $18.2 million, an increase of $4.7 million or 35% from the second quarter fiscal year 2002 sales, primarily due to a $6.2 million increase resulting from the incremental impact of consolidation of the newly acquired Japan subsidiary. In addition, sales from the Pacific, excluding Japan, were $41.5 million, up $2.3 million or 6% from the second quarter of the prior year. Sales from Europe declined to $43.7 million, a decrease of $9.7 million or 18% from the second quarter of fiscal year
19
2002. The increase in sales in the Pacific, excluding Japan, and the decrease in Europe are consistent with the trend of orders in these regions during these comparative time frames.
For the first two quarters of fiscal year 2003, net sales from the Americas were $198.0 million, a decrease of $22.9 million or 10% from the first two quarters of the prior year. This decrease was comprised of the United States, which decreased to $187.0 million, down 9%, from $204.4 million in the prior year and the Other Americas, which decreased to sales of $11.0 million, down 33% from $16.5 million in the prior year. The decrease in the Americas was primarily the result of lower backlog levels, which constrained the Company’s ability to generate sales through the reduction of backlog. As noted above, orders in the Americas region increased slightly during this time frame.
Net sales from Japan were $37.9 million, an increase of $5.8 million or 18% from sales in the first two quarters of fiscal year 2002, primarily due to a $6.2 million increase resulting from the incremental impact of consolidation of the newly acquired Japan subsidiary In addition, sales from the Pacific, excluding Japan, were $83.5 million, up $16.8 million or 25% from the first two quarters of the prior year. This increase is the result of increased orders in this region during these comparative periods. Sales from Europe declined to $86.6 million, a decrease of $9.0 million or 9% from the first two quarters of fiscal year 2002 as a result of the decline in orders during these comparative periods.
Gross Profit and Gross Margin
Consolidated gross profit was $101.1 million for the second quarter of fiscal year 2003, a decrease of 2% from gross profit of $103.1 million for the second quarter of fiscal year 2002. This decrease was primarily due to the lower sales volume in the current quarter and to a lesser degree a slight reduction in gross margin from 49.7% in the second quarter of fiscal year 2002 to 49.4% in the second quarter of the current year. This decrease in gross margin is the net effect of the negative impact of $6.6 million of sales with zero gross profit, offset by the favorable impact from incremental margins resulting from the consolidation of the newly acquired Japan subsidiary. The $6.6 million of sales with zero associated gross profit was generated by the sale of the inventory and related technology of the optical transmission test products to DLI noted above in recent transactions.
Operating Expenses
For the second quarter of fiscal year 2003, operating expenses were $95.9 million, an increase of $2.7 million from $97.7 million for the second quarter of fiscal year 2002. This resulted in operating income of $6.1 million, or 3% of net sales during the second quarter of the current year, compared with operating income of $5.4 million, or 3% of net sales in the same quarter of the prior year.
For the first two quarters of fiscal year 2003, operating expenses were $187.2 million, a decrease of $6.9 million from $194.1 million for the first two quarters of fiscal year 2002. This resulted in operating income of $13.6 million, or 3% of net sales during the first two quarters of the current year, compared with operating income of $12.6 million, or 3% of net sales in the same period of the prior year.
During the quarter and two quarters ended November 30, 2002, the Company’s operating expenses included $10.6 million of incremental operating expenses resulting from the consolidation of the newly acquired Japan subsidiary. Included in operating expenses is Equity in business ventures loss, which represents Tektronix’ percentage share of net income for investments accounted for under the equity method. For the periods presented, Equity in business ventures’ loss included only Tektronix’ 50% share of income from Sony/Tektronix. As the results of Sony/Tektronix will now be consolidated into the Tektronix results of operations. Equity in business ventures’ loss in future periods will not include the results attributable to Sony/Tektronix.
Research and development expenses were $25.1 million during the second quarter of fiscal year 2003, a decrease of $4.9 million from $30.0 million in the same quarter in the prior year. As a percentage of net sales, research and development expenses decreased to 12% in the second quarter of the current year from 14% a year ago. During the first two quarters of fiscal year 2003, Research and development expenses were $50.0 million or 12% of net sales, as compared with $62.2 million or 15% of net sales in the same period of the prior year. These decreases are the net result of higher spending associated with the timing of new product launches in the first two quarters of fiscal year 2002 partially offset by an extra week of operations
20
in the first quarter of fiscal year 2003 and $1.7 million from the incremental impact of consolidating the newly acquired Japan subsidiary.
Selling, general and administrative expenses were $63.8 million or 31% of net sales for the second quarter of fiscal year 2003, an increase of $4.5 million from $59.3 million, or 29% of net sales for the prior year. The increase was primarily due to $7.7 million of incremental expenses incurred by Tektronix Japan as well as the impact of pay raises granted to employees in the current quarter, partially offset by the positive impact of continued cost reduction actions taken during fiscal year 2002 and the first two quarters of fiscal year 2003. During the first two quarters of fiscal year 2003, Selling, general and administrative expenses were $120.2 million or 30% of net sales, as compared with $114.1 million or 28% in the same period in the prior year. The increase was primarily due to higher labor related spending as a result of the extra week of operations included in the first quarter of fiscal year 2003, raises granted to employees in the current quarter and the $7.7 million of incremental expenses associated with the consolidation of Tektronix Japan. These increases were partially offset by the positive impact of cost reduction actions taken during fiscal year 2002 and the first two quarters of fiscal year 2003.
Equity in business ventures’ loss represents the Company’s 50% share of net loss from Sony/Tektronix. During the second quarter of fiscal year 2003, the Company completed the acquisition of Sony/Tektronix. Results prior to the date of acquisition are included in Equity in business ventures’ loss at Tektronix’ ownership percentage. Results subsequent to the acquisition date have been consolidated in the operating results of the Company. See the discussion in Recent Transactions section of the Management’s Discussion and Analysis for further information on this acquisition. Equity in business ventures’ loss was $1.4 million for the second quarter of fiscal year 2003, compared with equity losses of $0.6 million in the same quarter a year ago. In the first two quarters of fiscal year 2003, Equity in business ventures’ loss was $2.9 million as compared with $1.6 million in the first two quarters of fiscal year 2002. These increases are the result of increased losses at Sony/Tektronix as a result of the continued weakening of economic conditions in the Japan region.
During the second quarter of fiscal year 2003, the Company incurred $3.3 million of business realignment costs including $0.8 million resulting from the impairment of an intangible asset and $4.8 million of severance resulting from actions to realign the Company’s cost structure, offset by $2.3 million of reversals related to previously recorded business realignment costs. The intangible asset impairment relates to acquired Bluetooth technology and was impaired due to a lower than previously anticipated market potential for the Company's products related to this technology. The impairment was determined using the present value of estimated cash flows related to the asset. The $4.8 million of severance related business realignment costs resulted from the termination of 150 employees. The $2.3 million reversal was primarily the result of previously accrued expenditures, which have been mitigated by the sale of the Company’s optical transmission test product line. These reversal items are primarily facilities related.
During the first two quarters of fiscal year 2003, the Company incurred $12.8 million of business realignment costs including $9.1 million resulting from the impairment of the intangible asset discussed above, $6.3 million of severance for the termination of 187 employees resulting from actions to realign the Company’s cost structure, and $0.4 million of costs associated with the closure of certain facilities. These costs were offset by $3.0 million of reversals of previous business realignment costs.
During the second quarter of fiscal year 2003, the Company incurred $1.8 million of Acquisition related costs. These costs relate to the Sony/Tektronix Acquisition completed during the second quarter of fiscal year 2003. See the discussion in Recent Transactions section of the Management’s Discussion and Analysis for further information on this acquisition.
For the second quarter and the two quarters ended November 30, 2002, the Company recognized a gain on disposal of fixed assets of $0.5 million. This compares with a loss on sale of fixed assets of $3.4 million for the second quarter of the prior year and $3.8 million for the first two quarters of the prior fiscal year. The change from these prior year comparative periods is due to the $3.6 million impairment of a building in the second quarter of the prior fiscal year.
Non-Operating Income / Expense
Interest expense was $1.3 million for the second quarter of fiscal year 2003, as compared with $2.6 million in the same quarter of the prior year. For the two quarters ended November 30, 2002, interest expense was $3.3 million as compared with $5.3 million in the same period of the prior year. The overall decrease in interest expense is due to a reduction in the average balance of outstanding debt due to the Company’s retirement of outstanding long-term debt and the extinguishment of $41.8 million of long-term debt at the scheduled payment date of August 15, 2002.
21
Interest income was $7.3 million in the second quarter of fiscal year 2003 as compared with $8.5 million in the same quarter a year ago. For the two quarters ended November 30, 2002, interest income was $14.9 million as compared with $18.6 million in the same period of the prior year. The decrease in interest income can be primarily attributed to lower returns on investments in the first two quarters of fiscal year 2003 as compared to investment returns in the same period of fiscal year 2002 due to decreases in interest rates and to a lesser degree, a lower average balance of cash and marketable investments during the comparative periods.
Other expense, net was $1.5 million in the second quarter of fiscal year 2003 as compared with zero in the prior year. For the two quarters ended November 30, 2002, other expense was $2.0 million as compared with $3.6 million in the same period of the prior year. This includes items such as foreign currency translation and other miscellaneous fees and expenses.
Income Taxes
Income tax (benefit) expense from continuing operations was an expense of $3.7 million in the second quarter of fiscal year 2003 as compared with expense of $3.9 million in the same quarter of the prior year. For the first two quarters of fiscal year 2003, the income tax benefit was $4.4 million as compared with expense of $7.8 million in the first two quarters of fiscal year 2002. The benefit recognized in the first quarter of fiscal year 2003 was a $12.5 million income tax benefit resulting from the settlement of the IRS audit of the Company’s fiscal years 1998, 1999 and 2000. The effective tax rate in both periods, excluding the IRS settlements, was 35%. Included in the Company’s income tax expense (benefit) for the quarter and two quarters ended November 30, 2002, were $1.6 million of income tax benefits related to the operations of Tektronix Japan acquired in the second quarter of fiscal year 2003. For further discussion on this acquisition see the Recent Transactions section of this Management’s Discussion and Analysis.
Discontinued Operations
In the second quarter of fiscal year 2003, the Company recognized loss from discontinued operations of $2.2 million related to the VT.c subsidiary, which was sold on November 7, 2002 as described in the Recent Transactions section above. $0.4 million of this loss was the result of the sale of the operations while the remaining $1.8 million was the actual operations for VT.c during the quarter prior to the sale. For the quarter ended November 24, 2001, VT.c had earnings of $0.6 million which were classified as discontinued operations.
For the first two quarters of fiscal year 2003, the Company recognized loss from discontinued operations of $3.0 million related to the VT.c subsidiary. $0.4 million of this loss was the result of the sale of the operations while the remaining $2.6 million was the actual operations for VT.c during the year prior to the sale. For the two quarters ended November 24, 2001, VT.c had net earnings of $0.8 million which were classified as discontinued operations. The Company also reached settlement on certain outstanding contingencies related to the sale of the Color Printing and Imaging division to Xerox Corporation. The settlement of these contingencies resulted in an additional gain on the sale of $0.9 million net of tax.
Net Earnings
The Company recognized consolidated net earnings of $4.7 million for the quarter ended November 30, 2002, down from $8.0 million for the quarter ended November 24, 2001. This decrease was primarily due to the $2.2 million loss associated with discontinued operations recorded in the second quarter of fiscal year 2003. For the two quarters ended November 30, 2002, the Company recognized consolidated net earnings of $24.5 million, up from $16.2 million recorded for the same period in the prior year. This increase was primarily due to the $12.5 million income tax benefit recorded in fiscal year 2003, partially offset by $3.0 million of loss associated with discontinued operations recorded in the two quarters ended November 30, 2002.
22
Earnings Per Share
For the quarter ended November 30, 2002, the Company recognized $0.05 net earnings per basic and diluted share. For the quarter ended November 24, 2001, the Company recognized basic and diluted earnings per share of $0.09. The decrease in earnings per share is a result of decreased net earnings discussed above, partially offset by a decrease in the weighted average basic and diluted shares outstanding due to shares repurchased by the Company during fiscal year 2002 and the first two quarters of fiscal year 2003.
For the two quarters ended November 30, 2002, the Company recognized $0.28 net earnings per basic and diluted share. For the two quarters ended November 24, 2001, the Company recognized basic and diluted earnings per share of $0.18. The increase in earnings per share is a result of increased net earnings discussed above and a decrease in the weighted average basic and diluted shares outstanding due to shares repurchased by the Company during fiscal year 2002 and the first two quarters of fiscal year 2003.
23
Financial Condition, Liquidity and Capital Resources
Financial Condition
At November 30, 2002, the Company’s working capital was $356.9 million, a decrease of $119.6 million from the end of fiscal year 2002. Current assets decreased $119.6 million primarily due to a decrease in cash and cash equivalents as the Company converted $70.3 million of its cash and cash equivalents to long-term marketable investments. In addition, the Company extinguished $41.8 million of debt at its due date in August 2002 and repurchased $69.3 million of its common stock. The Company also had $14.4 million of assets related to the VT.c subsidiary as of May 25, 2002, which was sold during the quarter ended November 30, 2002. These decreases were partially offset by $34.5 million in cash provided by operations and $66.2 million of current assets consolidated as a result of the Sony/Tektronix Acquisition. Inventories decreased $8.8 million to $112.8 million as a result of reduction of inventory related to the sale of the optical transmission test products described above in Recent Transactions, the Company’s ongoing efforts to reduce levels of demonstration equipment, improve inventory turns, and to a lesser extent, inventory write-offs incurred during the first two quarters. This was partially offset by the addition of $17.3 million of inventory consolidated as a result of the Sony/Tektronix Acquisition. Current liabilities remained flat at $273.4 million as of November 30, 2002. Accounts payable decreased $14.3 million due to a reduction in the taxes payable and relatively lower operating expenses during the period. This was offset by the assumption of $22.4 million in accounts payable and accrued liabilities consolidated as a result of the Sony/Tektronix Acquisition. Accrued compensation increased to $59.3 million in the first two quarters of fiscal year 2003 due to $5.1 million of accrued compensation from the Sony/Tektronix Acquisition offset by the payment of incentive compensation earned in the prior year. The Current portion of long-term debt increased $15.9 million, which is primarily due to the reclassification from long-term to short-term of the $57.3 million due August 2003, reduced by the $41.8 million payment of debt on August 15, 2002.
Property, plant and equipment, net, increased $23.6 million during the first two quarters of fiscal year 2003 to $164.0 million. The increase was due mainly to $36.8 million of fixed assets acquired in the Sony/Tektronix Acquisition and approximately $7.8 million in capital expenditures during the same period. This increase was partially offset by $16.4 million of depreciation expense and $3.4 million disposed of in the sale of the optical transmission test product line.
The Company funded the U.S. pension plan with $15.0 million during the first quarter of fiscal year 2003 based on an agreement with the Pension Benefit Guaranty Company. This funding reduced Other long-term liabilities on the Condensed Consolidated Balance Sheet. The Company consolidated additional pension liability of $61.1 million from the Sony/Tektronix Acquisition, which is included in Other long-term liabilities in the Condensed Consolidated Balance Sheet.
On March 15, 2000, the Board of Directors authorized the purchase of up to $550.0 million of the Company’s common stock on the open market or through negotiated transactions. During the second quarter of fiscal year 2003, the Company repurchased 1.1 million shares for $19.6 million. During the first two quarters of fiscal year 2003, the Company has repurchased a total of 3.8 million shares for $69.3 million. As of November 30, 2002, the Company has repurchased a total of 12.1 million shares at an average price of $22.92 per share totaling $277.4 million under this authorization. The Company will continue to repurchase shares under this authorization when deemed economically beneficial.
Liquidity and Capital Resources
As of November 30, 2002, the Company held $713.1 million in cash and cash equivalents and marketable investments excluding corporate equity securities, a decrease of $43.0 million from the balance of $756.1 million at May 25, 2002. Activity during the first two quarters of fiscal year 2003 included the repurchase of common stock, the extinguishment of debt and the funding of the pension plan. These uses of cash were offset by net earnings and other positive operating cash flows.
The Company consolidated $53.1 million of long-term debt through the Sony/Tektronix Acquisition, which is due on September 29, 2006. At November 30, 2002, the Company maintained unsecured bank credit facilities totaling $146.0 million, of which $91.2 million was unused.
Cash on hand, cash flows from operating activities and current borrowing capacity are expected to be sufficient to fund operations, acquisitions and potential acquisitions, capital expenditures and contractual obligations for the next 12 months.
24
Recent Accounting Pronouncements
In August 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” This Statement supersedes FASB Statement No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,” and the accounting and reporting provisions of APB Opinion No. 30, “Reporting the Results of Operations--Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Acquisitions,” for the disposal of a segment of a business. SFAS No. 144 maintains the method for recording an impairment on assets to be held under SFAS No. 121 and establishes a single accounting model based on the framework established in SFAS No. 121 for long-lived assets to be disposed of by sale. This statement also broadens the presentation of discontinued operations to include more disposal activities. The provisions of SFAS No. 144 are effective for financial statements issued for fiscal year 2003. The Company adopted the provisions of this statement, which did not have a material impact on the financial results of the Company, as of the beginning of the first quarter of fiscal year 2003.
In July 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” The standard requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. Costs covered by the standard include lease termination costs and certain employee severance costs that are associated with a restructuring, discontinued operation, plant closing, or other exit or disposal activity. This statement is to be applied prospectively to exit or disposal activities initiated after December 31, 2002. Management believes the adoption of the provisions of this statement will not have a material effect on the Company’s consolidated financial statements.
In October 2002, the Emerging Issues Task Force (“EITF”) issued EITF 00-21, “Accounting for Revenue Arrangements with Multiple Deliverables.” This standard addresses revenue recognition accounting by a vendor for arrangements under which it will perform multiple revenue-generating activities. This statement is to be effective for the Company’s fiscal year 2004. Management believes the adoption of the provisions of this statement will not have a material effect on the Company’s consolidated financial statements.
Risks and Uncertainties
Described below are some of the risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward-looking statements contained in this report. See “Forward-Looking Statements” at the beginning of this Item 2.
Market Risk and Cyclical Downturns in the Markets in Which Tektronix Competes
Tektronix’ business depends on capital expenditures of manufacturers in a wide range of industries, including the telecommunications, semiconductor, and computer industries. Each of these industries has historically been very cyclical and has experienced periodic downturns, which have had a material adverse impact on the industries’ demand for equipment, including test and measurement equipment manufactured and marketed by Tektronix. In particular, the telecommunications industry, including but not limited to the optical segment, have experienced a more dramatic decline than other industries. In addition, the severity and length of the downturn may also affect overall access to capital which could adversely affect the Company’s customers across many industries. During periods of reduced and declining demand, Tektronix may need to rapidly align its cost structure with prevailing market conditions while at the same time motivating and retaining key employees. As discussed above in this Item 2, the Company’s sales and orders have been affected by the current downturn in its markets. The ultimate severity of this downturn, and how long it will last, is unknown. No assurance can be given that Tektronix’ net sales and operating results will not be further adversely impacted by the current or any future downturns or slowdowns in the rate of capital investment in these industries.
25
Timely Delivery of Competitive Products
Tektronix sells its products to customers that participate in rapidly changing high technology markets, which are characterized by short product life cycles. The Company’s ability to deliver a timely flow of competitive new products and market acceptance of those products, as well as the ability to increase production or to develop and maintain effective sales channels, is essential to growing the business. Because Tektronix sells test and measurement products that enable its customers to develop new technologies, the Company must accurately predict the ever-evolving needs of those customers and deliver appropriate products and technologies at competitive prices to meet customer demands. The Company’s ability to deliver such products could be affected by engineering or other development program delays as well as the availability of parts and supplies from third party providers on a timely basis and at reasonable prices. Failure to deliver competitive products in a timely manner and at a reasonable price could have an adverse effect on the results of operations, financial condition or cash flows of the Company.
Competition
In general, Tektronix competes with a number of companies in specialized areas of other test and measurement products and one large broad line measurement products supplier, Agilent Technologies. Other competitors include Acterna Corporation, Anritsu, LeCroy Corporation, Spirent, Yokogawa and many other smaller companies. Competition in the Company’s business is based primarily on product performance, technology, customer service, product availability and price. Some of the Company’s competitors may have greater resources to apply to each of these factors and in some cases have built significant reputations with the customer base in each market in which Tektronix competes. The Company may face pricing pressures that may have an adverse impact on the Company’s earnings. If the Company is unable to compete effectively on these and other factors, it could have a material adverse effect on the Company’s results of operations, financial condition or cash flows.
Supplier Risks
The Company’s manufacturing operations are dependent on the ability of suppliers to deliver quality components, subassemblies and completed products in time to meet critical manufacturing and distribution schedules. The Company periodically experiences constrained supply of certain component parts in some product lines as a result of strong demand in the industry for those parts. Such constraints, if persistent, may adversely affect operating results until alternate sourcing can be developed. Volatility in the prices of these component parts, an inability to secure enough components at reasonable prices to build new products in a timely manner in the quantities and configurations demanded or, conversely, a temporary oversupply of these parts, could adversely affect the Company’s future operating results. In addition, the Company uses certain sole sourced components which are integral to a variety of products. Disruption in key sole sourced suppliers could have a significant adverse effect on the Company’s results of operations.
Worldwide Economic and Market Conditions
The Company maintains operations in four major geographies: the Americas, including the United States, Mexico, Canada and South America; Europe, including the Middle East and Africa; the Pacific, excluding Japan; and Japan. During the last fiscal year, nearly one half of the Company’s revenues were from international sales. In addition, some of the Company’s manufacturing operations and key suppliers are located in foreign countries. As a result, the business is subject to the worldwide economic and market conditions risks generally associated with doing business globally, such as fluctuating exchange rates, the stability of international monetary conditions, tariff and trade policies, domestic and foreign tax policies, foreign governmental regulations, political unrest, wars and other acts of terrorism and changes in other economic or political conditions. These factors, among others, could influence the Company’s ability to sell in global markets, as well as its ability to manufacture products or procure supplies. A significant downturn in the global economy could adversely affect the Company’s results of operations, financial position or cash flows.
26
Intellectual Property Risks
As a technology-based company, Tektronix’ success depends on developing and protecting its intellectual property. Tektronix relies generally on patent, copyright, trademark and trade secret laws in the United States and abroad. Electronic equipment as complex as most of the Company’s products, however, is generally not patentable in its entirety. Tektronix also licenses intellectual property from third parties and relies on those parties to maintain and protect their technology. The Company cannot be certain that actions the Company takes to establish and protect intellectual property rights will be adequate. If the Company is unable to adequately protect its technology, or if the Company is unable to continue to obtain or maintain licenses for protected technology from third parties, it could have a material adverse affect on the Company’s results of operations, financial position or cash flows. From time to time in the usual course of business, the Company receives notices from third parties regarding intellectual property infringement or takes action against others with regard to intellectual property rights. Even where the Company is successful in defending or pursuing such claims, the Company may incur significant costs. In the event of a successful claim against the Company, Tektronix could lose its rights to needed technology or be required to pay license fees for the infringed rights, either of which could have an adverse impact on the Company’s business.
Environmental Risks
Tektronix is subject to a variety of federal, state, local and foreign environmental regulations relating to the use, storage, discharge and disposal of its hazardous chemicals used during the Company’s manufacturing process. The Company has operated and is in the process of closing a licensed hazardous waste management facility at its Beaverton, Oregon campus. If Tektronix fails to comply with any present and future regulations, the Company could be subject to future liabilities or the suspension of production. In addition, such regulations could restrict the Company’s ability to expand its facilities or could require Tektronix to acquire costly equipment, or to incur other significant expenses to comply with environmental regulations.
Sony/Tektronix Corporation Acquisition
Acquisition of Sony Corporation’s 50% interest in Sony/Tektronix Corporation was completed at the end of September 2002. Upon completion of the acquisition, the Company’s ownership of Sony/Tektronix increased from 50% to 100%, and the Company is now exposed to a greater financial impact from Sony/Tektronix operations. The acquisition will likely negatively impact the Company’s results of operations during fiscal year 2003. In addition, operation of Sony/Tektronix as a wholly owned business will involve additional risks, including integration risks, the risks of doing business as a foreign owner in Japan and risks related to the economic environment in Japan.
Possible Volatility of Stock Price
The price of the Company’s common stock may be subject to wide, rapid fluctuations. Such fluctuations may be due to factors specific to the Company, such as changes in operating results or changes in analysts' estimates regarding earnings. Fluctuations in the stock price may also be due to factors relating to the telecommunications, semiconductor, and computer industries or to the securities markets in general. Fluctuations in the stock price have often been unrelated to the operating performance of the specific companies whose stocks are traded. Shareholders should be willing to incur the risk of such fluctuations.
Other Risk Factors
Other risk factors include but are not limited to changes in the mix of products sold, regulatory and tax legislation, changes in effective tax rates, inventory risks due to changes in market demand or the Company’s business strategies, potential litigation and claims arising in the normal course of business, credit risk of customers, the fact that a substantial portion of the Company’s sales are generated from orders received during each quarter and other risk factors.
27
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Financial Market Risk
The Company is exposed to financial market risks, including interest rate, equity price and foreign currency exchange rate risks.
The Company maintains a short-term and long-term investment portfolio consisting of fixed rate commercial paper, corporate notes and bonds, asset backed securities and mortgage securities. The weighted average maturity of the portfolio, excluding mortgage securities, is two years or less. Mortgage securities may have a weighted average life of less than seven years and are managed consistent with the Lehman Mortgage Index. An increase in interest rates would decrease the value of certain of these investments. A 10% adverse change in interest rates would reduce the market value by $2.4 million, which would be reflected in Other comprehensive loss on the Condensed Consolidated Balance Sheets until sold.
At November 30, 2002, the Company’s bond debt obligation had a fixed interest rate. The fair value of the bond debt instrument at November 30, 2002 was $59.0 million compared to the carrying value of $57.3 million. The Company’s bank loan obligation has a variable interest rate. The fair value of the bank loan approximates the carrying value. A hypothetical 10% adverse change in interest rates would have a $0.1 million negative impact on the combined fair value, which would not be reflected in the Company’s financial statements.
The Company is exposed to equity price risk primarily through its marketable equity securities portfolio, including investments in Merix Corporation, Tut Systems, Inc., and other companies. The Company has not entered into any hedging programs to mitigate equity price risk. In management’s opinion, an adverse change of 20% in the value of these securities would reduce the market value by $2.7 million, which would be reflected in Other comprehensive loss on the Condensed Consolidated Balance Sheets until sold.
The Company is exposed to foreign currency exchange rate risk primarily through acquisitions and commitments denominated in foreign currencies. The Company utilizes derivative financial instruments, primarily forward foreign currency exchange contracts, generally with maturities of one to three months, to mitigate this risk where natural hedging strategies cannot be employed. The Company’s policy is to only enter into derivative acquisitions when the Company has an identifiable exposure to risk, thus not creating additional foreign currency exchange rate risk. The potential loss in fair value at November 30, 2002, for such contracts resulting from a hypothetical 10% adverse change in all foreign currency exchange rates is approximately $2.4 million. This loss would be mitigated by corresponding gains on the underlying exposures.
Item 4. Controls and Procedures
(a) Evaluation of disclosure controls and procedures. The Company’s chief executive officer and chief financial officer, after evaluating the effectiveness of the Company’s “disclosure controls and procedures” (as defined in the Securities Exchange Act of 1934 Rules 13a-14(c) and 15-d-14(c)) as of a date (the “Evaluation Date”) within 90 days before the filing date of this quarterly report, have concluded that as of the Evaluation Date, the Company’s disclosure controls and procedures were effective and designed to ensure that material information relating to the Company and the Company’s consolidated subsidiaries would be made known to them by others within those entities.
(b) Changes in internal controls. There were no significant changes in the Company’s internal controls or in other factors that could significantly affect those controls subsequent to the Evaluation Date.
28
Part II OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
(99.1) Certification of Richard H. Wills
(99.2) Certification of Colin L. Slade
(b) No reports on Form 8-K have been filed during the quarter for which this report is filed.
29
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| December 26, 2002 | TEKTRONIX, INC. |
| | | |
| | By | /s/ COLIN SLADE |
| | |
|
| | | Colin Slade
Senior Vice President and
Chief Financial Officer |
30
I, Richard H. Wills, President and Chief Executive Officer of the Company, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Tektronix, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
| Date: December 26, 2002 | | |
| | /s/ RICHARD H. WILLS | |
| |
| |
| | Richard H. Wills
President and Chief Executive Officer | |
31
I, Colin L. Slade, Senior Vice President and Chief Financial Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Tektronix, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
| Date: December 26, 2002 | | |
| | /s/ COLIN L. SLADE | |
| |
| |
| | Colin L. Slade
Senior Vice President and Chief Financial Officer | |
32
EXHIBIT INDEX
Exhibits No. | Exhibit Description |
| |
(99.1) | Certification of Richard H. Wills, Principal Executive Officer of Tektronix, Inc. Pursuant to 18 U.S.C. Section 1350 As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| |
(99.2) | Certification of Colin L. Slade, Principal Financial Officer of Tektronix, Inc. Pursuant to 18 U.S.C. Section 1350 As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
