UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10 - Q (Mark One) /X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1998 OR / / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to ----------- ------------ Commission file number 0-14224 IFR SYSTEMS, INC. (Exact name of registrant as specified in its charter) DELAWARE 48-1197645 (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 10200 WEST YORK STREET, WICHITA, KANSAS 67215 (Address and zip code of principal executive offices) (316) 522-4981 (Registrant's telephone number, including area code) Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----- ----- There were 8,206,015 shares of common stock, par value $.01 per share, of the Registrant outstanding as of October 20, 1998. IFR SYSTEMS, INC. FORM 10 - Q INDEX PAGE PART I -- FINANCIAL INFORMATION Item 1. Condensed Consolidated Financial Statements Condensed Consolidated Balance Sheets at September 30, 1998 and June 30, 1998 3 Condensed Consolidated Statements of Operations for the three months ended September 30, 1998 and 1997. 5 Condensed Consolidated Statements of Cash Flow for the three months ended September 30, 1998 and 1997 6 Notes to Condensed Consolidated Financial Statements 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 9 PART II -- OTHER INFORMATION Item 6. Exhibits and reports on Form 8-K 14 SIGNATURES 15 2 PART I -- FINANCIAL INFORMATION ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS IFR SYSTEMS, INC. CONDENSED CONSOLIDATED BALANCE SHEETS SEPTEMBER 30, JUNE 30, 1998 1998 ----------- --------- (UNAUDITED) (NOTE) (000'S OMITTED) ASSETS CURRENT ASSETS Cash and cash equivalents $ 2,073 $ 159 Accounts receivable, less $903 and $927 allowance for doubtful accounts, respectively 34,853 41,761 Inventories: Finished products 18,840 18,122 Work in process 10,974 9,556 Materials 19,948 19,298 --------- --------- 49,762 46,976 Prepaid expenses and sundry 4,389 4,083 Deferred income taxes 4,045 4,025 --------- --------- TOTAL CURRENT ASSETS 95,122 97,004 PROPERTY AND EQUIPMENT, LESS ALLOWANCES FOR DEPRECIATION (DEDUCTION) 26,821 27,425 PROPERTY UNDER CAPITAL LEASE, LESS ALLOWANCES FOR DEPRECIATION (DEDUCTION) 3,470 3,317 OTHER ASSETS Cost in excess of net assets acquired and other intangibles, less amortization of $6,462 and $5,928, respectively 41,976 42,454 Developed technology, less amortization of $624 and $390, respectively 18,176 18,410 Other 2,051 2,147 --------- --------- 62,203 63,011 --------- --------- $ 187,616 $ 190,757 --------- --------- --------- --------- Note: The balance sheet at June 30, 1998 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. 3 SEPTEMBER 30, JUNE 30, 1998 1998 ----------- --------- (UNAUDITED) (NOTE) (000'S OMITTED) LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES Short-term bank borrowings (Note 2) $ 11,000 $ 11,000 Accounts payable 11,446 11,168 Accrued compensation and payroll taxes 6,732 8,169 Other liabilities and accrued expenses 12,507 12,669 Federal and state income taxes and local taxes 65 621 Current maturity of capital lease obligations 185 185 Current maturity of long-term debt 3,750 3,500 --------- --------- TOTAL CURRENT LIABILITIES 45,685 47,312 CAPITAL LEASE OBLIGATIONS 3,534 3,580 LONG-TERM DEBT 95,375 96,500 DEFERRED INCOME TAXES 11,146 11,284 SHAREHOLDERS' EQUITY Preferred stock, $.01 par value---authorized 1,000,000 shares, none issued - - Common stock, $.01 par value---authorized 50,000,000 shares, issued 9,266,250 shares 93 93 Additional paid-in capital 7,094 7,121 Cost of common stock in treasury---1,060,235 and 1,065,313 shares, respectively (deduction) (8,638) (8,679) Cumulative translation adjustment 1,807 386 Retained earnings 31,520 33,160 --------- --------- 31,876 32,081 --------- --------- $ 187,616 $ 190,757 --------- --------- --------- --------- See notes to condensed consolidated financial statements. 4 IFR SYSTEMS, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) THREE MONTHS ENDED SEPTEMBER 30, -------------------------------------- 1998 1997 (000'S OMITTED, EXCEPT PER SHARE DATA) SALES $40,900 $25,521 COST OF PRODUCTS SOLD 22,467 14,584 ------- ------- GROSS PROFIT 18,433 10,937 OPERATING EXPENSES Selling 7,243 2,718 Administrative 5,027 1,899 Engineering 6,388 3,141 ------- ------- 18,658 7,758 ------- ------- OPERATING INCOME (LOSS) (225) 3,179 OTHER EXPENSE 2,313 47 ------- ------- INCOME (LOSS) BEFORE INCOME TAXES (2,538) 3,132 INCOME TAXES (BENEFIT) (898) 1,257 ------- ------- NET INCOME (LOSS) $(1,640) $1,875 ------- ------- ------- ------- NET INCOME (LOSS) PER COMMON SHARE $(0.20) $ 0.23 ------- ------- ------- ------- NET INCOME (LOSS) PER COMMON SHARE ASSUMING DILUTION $(0.20) $ 0.22 ------- ------- ------- ------- AVERAGE COMMON SHARES OUTSTANDING 8,205 8,168 ------- ------- ------- ------- DILUTIVE COMMON SHARES OUTSTANDING 8,205 8,562 ------- ------- ------- ------- See notes to condensed consolidated financial statements. 5 IFR SYSTEMS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) THREE MONTHS ENDED SEPTEMBER 30, 1998 1997 ------- ------- (000'S OMITTED) OPERATING ACTIVITIES Net income (loss) $(1,640) $ 1,875 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation of property and equipment 1,481 657 Amortization of intangibles 768 152 Deferred income taxes (158) - Changes in operating assets and liabilities: Accounts receivable 8,080 263 Inventories (2,824) (93) Other current assets (306) (238) Accounts payable and accrued liabilities (2,034) (1,515) Other current liabilities (556) 1,001 ------- ------- NET CASH PROVIDED BY OPERATING ACTIVITIES 2,811 2,102 INVESTING ACTIVITIES Purchases of property and equipment (1,110) (1,006) Sundry 101 44 ------- ------- NET CASH USED IN INVESTING ACTIVITIES (1,009) (962) FINANCING ACTIVITIES Purchases of capital stock for treasury - (24) Principal payments on capital lease obligations (46) - Principal payments on long-term debt (875) - Principal payments on short-term bank borrowings - (1,435) Proceeds from short-term bank borrowings - 1,150 Proceeds from exercise of common stock options 14 441 Payment of dividends - (273) ------- ------- NET CASH USED IN FINANCING ACTIVITIES (907) (141) EFFECT OF EXCHANGE RATE CHANGES ON CASH 1,019 (43) ------- ------- INCREASE IN CASH AND CASH EQUIVALENTS 1,914 956 CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 159 2,379 ------- ------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 2,073 $ 3,335 ------- ------- ------- ------- See notes to condensed consolidated financial statements. 6 IFR SYSTEMS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) SEPTEMBER 30, 1998 NOTE 1 -- BASIS OF PRESENTATION The accompanying unaudited Condensed Consolidated Financial Statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three month period ended September 30, 1998 are not necessarily indicative of the results that may be expected for the year ending June 30, 1999. For further information, refer to the Consolidated Financial Statements and footnotes thereto included in the Company's Annual Report on Form 10-K for the year ended June 30, 1998. NOTE 2 -- BANK BORROWINGS In March 1998, the Company entered into an amended and restated Credit Agreement with the bank syndication (the Agreement) to provide available lines of credit aggregating $30,000,000. The Agreement expires on February 5, 2004. Under the terms of the Agreement, borrowings bear interest at a spread over LIBOR based on certain financial criteria. The total interest rate on the outstanding portion of the lines of credit was 7.82% at September 30, 1998. The Agreement also includes a counter indemnity with a foreign bank to provide letters of credit and overdraft facilities totaling $8,500,000. As of September 30, 1998, the Company has available lines of credit aggregating $10,500,000. On November 3, 1998, the Company completed an amendment to the Agreement which increases the interest rate by approximately 75 basis points. NOTE 3 -- ACQUISITIONS MARCONI INSTRUMENTS On February 6, 1998, IFR acquired for cash all of the issued and outstanding capital stock of Marconi Instruments Limited, Hertfordshire, U.K. (Marconi), from The General Electric Company, p.l.c. (GEC). The purchase price for Marconi was approximately $109,000,000, paid in cash funded primarily by debt. The acquired 7 business is engaged in the design, manufacture, distribution and sale of test and measurement equipment for the telecommunications and electronics industries. As a result of the acquisition, IFR acquired the foreign subsidiaries of Marconi which conduct business in France, Germany, Spain, and the United States. Marconi also has branches in the Netherlands, Singapore, Hong Kong, and China. The acquisition has been accounted for as a purchase and, accordingly, the net assets and results of operations are included in the consolidated financial statements from the effective date of acquisition. The purchase price was allocated to the assets and liabilities based on their estimated fair values at the date of acquisition. YORK SENSORS On December 22, 1997, the Company acquired York Sensors Ltd. in Hampshire, U.K. The acquired business is involved in the design and manufacture of distributed temperature sensing (DTS) equipment based on optical time domain reflectometer (OTDR) technology for the electric utility, oil exploration and other industries. The Company acquired assets of approximately $930,000 and assumed liabilities of approximately $1,902,000 for a nominal purchase price. This resulted in goodwill of approximately $972,000 which is being amortized over 10 years. The acquisition has been accounted for as a purchase and, accordingly, the net assets and results of operations are included in the consolidated financial statements from the effective date of acquisition. The purchase price was allocated to the assets and liabilities based on their estimated fair values at the date of acquisition. The following pro forma data presents the consolidated results of operations as if the acquisitions had occurred on July 1, 1997, after giving effect to certain adjustments including amortization of intangibles, increased interest expense and related income tax effects. The pro forma data does not include non-recurring charges related to acquired research and development ($15,700,000) and inventory valuations ($11,844,000). The pro forma results have been prepared for comparative purposes only and do not purport to indicate the results of operations which would actually have occurred had the acquisitions been in effect on the date indicated or which may occur in the future. (in thousands, except per share data) Three Months Ended September 30, 1997 ------------------ Sales $53,855 Net income $ 1,280 Net income per common share $ 0.16 Net income per common share assuming dilution $ 0.15 8 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD LOOKING STATEMENTS In addition to historical information, this report contains forward-looking statements and information that is based on management's beliefs and assumptions, as well as information currently available to management. When used in this document, the words "anticipate", "estimate", "expect", "intend", "believe", and similar expressions are intended to identify forward-looking statements. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable and are based on reasonable assumptions within the bounds of its knowledge of its business and operations, it can give no assurance that such expectations will prove to be correct and that actual results will not differ materially from the Company's expectations. Such forward-looking statements speak not only as of the date of this report, and the Company cautions readers not to place undue reliance on such statements. Factors that could cause actual results to differ from expectations include: (1) the degree and nature of competition, including pricing pressure and the development of new products or discoveries of new technologies by competitors, (2) fluctuations in the global economy and various foreign countries including recent developments adversely affecting the economies of various Asian countries, (3) demand for the Company's products, (4) loss of significant customers, (5) the Company experiencing delays in developing new products and technologies, (6) the ability of the Company to continue the transition to digital technologies in the communications test equipment products, (7) the failure of such technologies or products to perform according to expectations, (8) difficulties in manufacturing new products so they may be profitably priced on a competitive basis, (9) lack of adequate market acceptance of new products or technologies, (10) changes in products or sales mix and the related effects on gross margins, (11) availability of components, parts, and supplies from third party suppliers on a timely basis and at reasonable prices, (12) currency fluctuations, (13) inventory risks due to changes in market demand of the Company's business strategies, (14) unanticipated problems arising from the failure of one or more suppliers or customers of the Company or others to be able to maintain normal business operations after 1999 because of "Year 2000" computer difficulties, (15) inability to hire sufficient personnel at reasonable levels of compensation and other labor problems, (16) inability to realize anticipated efficiencies and savings from the Company's recent acquisition of Marconi Instruments Limited, and (17) other risks described herein. 9 YEAR 2000 MATTERS The Company, like all other companies, is confronted with so-called "Year 2000" issues that might arise as a result of existing computer programs and systems not being able to properly recognize a date in a year that begins with "20" rather than "19". Year 2000 problems can arise (a) because the operating, manufacturing, and the information technology equipment operated by the Company fails to operate properly after December 31, 1999 (is not "Year 2000 compliant"), (b) because the Company's products will not operate properly after that date, or (c) because material customers and vendors of the Company, or public utilities, financial systems, or others on whom the Company is dependent are unable to conduct their business operations normally because of Year 2000 problems. Because of the pervasive nature of computers and computer systems in the Company's products and equipment, as well as throughout the nation and world, it is impossible for the Company to provide any assurance that its efforts at identifying and remedying Year 2000 issues will be totally effective or that Year 2000 problems of others will not have a material adverse effect on the Company's operations and profits notwithstanding any efforts the Company may make. Accordingly, the following discussion contains numerous "forward looking" statements that are subject to the qualifications and cautionary statements contained in this report under the heading "Forward Looking Statements". Based on the results to date of its assessment of the Year 2000 issues of which the Company is aware at this time, the Company does not believe Year 2000 problems will have a materially adverse effect on the Company or its operations. No assurance can be given, however, that the Company has been able to identify all potential Year 2000 problems or that if Year 2000 problems are discovered by the Company in the future, it will be able to resolve them satisfactorily and at an affordable cost. IFR PRODUCTS. The Company has evaluated all of its existing products and is currently evaluating those used by customers and has concluded such products now being manufactured will not require modification in order to be Year 2000 compliant. The Company is still performing an assessment of products in the field that may require modifications. IFR'S OPERATING AND MANUFACTURING EQUIPMENT. IFR has conducted an assessment of the majority of its manufacturing and other operating equipment and has either upgraded or made arrangements for the upgrading of all material items of equipment that are found not to be Year 2000 compliant. To date, the Company has incurred approximately $200,000 in Year 2000 equipment upgrade expenditures and anticipates spending approximately $100,000 to complete the upgrade process. IFR does not anticipate any serious difficulty in completing the upgrade process and testing its equipment prior to December 31, 1999. 10 INFORMATION TECHNOLGY AND ACCOUNTING SYSTEMS. IFR is also completing its assessment of its material information technology and principal accounting systems and believes it has made a substantial portion of the modifications for them to be Year 2000 compliant. Total expenditures to date for such modifications have been approximately $1,300,000 of which approximately $1,100,000 was spent to acquire new equipment or software prior to the time it would otherwise have been acquired. It is anticipated that the Company will incur additional expenditures of approximately $300,000 to upgrade its information technology and accounting systems in order to make them Year 2000 compliant. SUPPLIERS AND CUSTOMERS. The Company has written certain of its customers and vendors whose failure to be able to conduct business normally after December 31, 1999, because of Year 2000 problems might materially affect IFR, requesting written information as to their Year 2000 compliance and preparation. The Company has received written responses from most of such customers and vendors that appear to indicate generally they are or expect to be sufficiently Year 2000 compliant. The Company intends to continue to closely monitor the Year 2000 compliance and preparation of its material customers and vendors. This portion of the Company's Year 2000 compliance and assessment program has not resulted in the incurrence of material expenditures by IFR and is not anticipated to do so. POTENTIAL EFFECTS OF YEAR 2000 PROBLEMS. The Company is unable to predict with any degree of certainty the potential consequences to it of Year 2000 issues. Obviously, any sort of major prolonged inability of public utilities or financial systems in any portion of the world where the Company operates manufacturing facilities or has substantial customers or vendors could materially adversely impact the Company's revenue or delay the receipt of revenue and could, theoretically, even cause a national or global economic crisis or downturn. Similarly, the inability of a significant number of the Company's customers or vendors to operate normally, either because of their own Year 2000 problems or because of Year 2000 problems of persons on whom they, in turn, are dependent, could have a material adverse impact on the Company. There is also some likelihood that an inability of the Company to deliver its products in the normal manner might cause it to lose customers or incur contractual liability to customers. While the Company has no reason to believe that any of such matters will occur in such a manner as to produce severe economic consequences to the Company, all of these matters are beyond the ability of the Company to predict or quantify with any assurance. CONTINGENCY PLANS. The Company has not adopted any Year 2000 contingency plan. It has not decided whether to do so. 11 RESULTS OF OPERATIONS Sales for the first quarter ended September 30, 1998 were $40,900,000 compared to $25,521,000 in the first quarter of the prior year. This represents an increase of 60.3% or $15,379,000. The current year includes sales valued at $21,092,000 from the acquisition of IFR Ltd., formerly Marconi Instruments Ltd., which was completed on February 6, 1998. Excluding the acquisition, sales declined by $5,713,000 or 22.4% due to lower sales of communication test instruments to government and commercial customers and lower sales of production and lab test equipment to fiber optic manufacturers. Gross margins increased to 45.1% for the current year quarter as compared to 42.9% in the previous year quarter. This increase is due to a more favorable product mix. Operating expenses increased 15.2% to 45.6% of sales for the current quarter. Selling expenses increased 7.0% as a percentage of sales due to the utilization of a direct sales force after the purchase of Marconi and increased product marketing communications. Administrative expenses increased 4.9% as a percentage of sales primarily due to recurring amortization charges related to the acquisition. Engineering expenses increased 3.3% in support of the development of new test instruments for the fiber optics and emerging wireless digital telecommunications markets. Operating expenses in general increased as a percent of sales because of the lower sales volume. The Company is implementing a program to bring costs in line with current sales, including reductions in personnel, wage freezes and other cost reductions. When fully implemented, these cost reductions are expected to reduce expenses by approximately $6,000,000 annually. Other expenses increased $2,266,000 compared to the prior year quarter as the result of higher interest expense related to the debt incurred to fund the acquisition. The estimated effective income tax rate was approximately 35.4% for the current period and 40.1% for the previous year period. The decrease represents the impact of the foreign subsidiaries and their related tax rates. 12 LIQUIDITY AND CAPITAL RESOURCES Cash flows provided by operations were $2,811,000 and $2,102,000 for the three months period ended September 30, 1998 and 1997, respectively. The increase in funds provided was due to a decrease in accounts receivable and an increase in depreciation and amortization of intangibles. Partially offsetting these items was an increase in inventories, a decrease in accrued liabilities and a decrease in operating income. Cash flows used in financing activities were $907,000 and $141,000 for the three months period ended September 30, 1998 and 1997, respectively. The increase in funds used is due primarily to principal payments on long-term debt. A $.033 per share cash dividend was authorized by the Board of Directors and paid in the first quarter of fiscal 1998. Certain restrictive payments concerning the debt incurred with the purchase of Marconi allow for cash dividends to be paid only when certain leverage ratios are obtained. Working capital decreased from $49,692,000 at June 30, 1998 to $49,437,000 at September 30, 1998. On September 20, 1996, the Board of Directors of the Company authorized the repurchase of up to 750,000 shares of the Company's common stock. The main purpose of the shares buyback program is to offset stock option exercises from treasury stock and as a utilization of the anticipated excess cash flow during the year. As of September 30, 1998, the Company had purchased an aggregate of 470,000 shares under the program. Certain restrictive covenants concerning the debt incurred with the purchase of Marconi limit the amount of capital stock allowed to be purchased. At September 30, 1998, $11,000,000 was outstanding under the lines of credit. On November 3, 1998, the Company signed and completed negotiations on an amendment to its primary credit agreement (the Agreement). The amendment includes a waiver for a violation of the leverage ratio financial covenant for the period ending September 30, 1998. In addition, the leverage ratio test is suspended through the fiscal quarters ending on March 31, 1999. The Company anticipates the negotiations of new financial covenants after this date. The Company anticipates that available lines of credit and funds generated from operations will be adequate to meet capital asset expenditures and working capital needs for the current fiscal year ending June 30, 1999. 13 OUTLOOK The Company expects the current softness in orders and sales to continue for several quarters. During the second quarter, the Company's cost reduction program will be in effect and management expects profits to resume in the second half of the fiscal year. In addition to efforts on the cost side, management is committed to the development of new products. A number of new products were launched during the first quarter, including test instruments for GSM digital protocols. More new products are scheduled to be introduced during the year. PART II -- OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 10.0 Amendment No. 1 and Waiver (dated as of November 3, 1998) to the Amended and Restated Credit Agreement 11.0 Statement Re: Computation of Per Share Earnings 27.0 Financial Data Schedule (b) No Form 8-K was filed during the quarter ended September 30, 1998. 14 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. IFR SYSTEMS, INC. Date: November 9, 1998 /s/ Alfred H. Hunt, III ----------------- ------------------------------ Alfred H. Hunt, III, President and CEO (Duly authorized officer) /s/ Jeffrey A. Bloomer ------------------------------- Jeffrey A. Bloomer, Chief Financial Officer and Treasurer (Principal financial and chief accounting officer) 15