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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------------------
(mark one)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Quarterly Period Ended October 31, 2005
or
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For transition period from ________________ to _________________
0-16438
(Commission File Number)
NATIONAL TECHNICAL SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
California 95-4134955
(State of Incorporation) (IRS Employer
Identification number)
24007 Ventura Boulevard, Suite 200, Calabasas, California
(Address of registrant's principal executive office)
(818) 591-0776 91302
(Registrant's telephone number) (Zip 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 period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES |X| NO |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
YES |_| NO |X|
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
YES |_| NO |X|
The number of shares of common stock, no par value, outstanding as of December
12, 2005 was 9,169,634.
NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES
Index
PART I. FINANCIAL INFORMATION
Page No.
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets as of
October 31, 2005 (unaudited) and January 31, 2005 3
Unaudited Condensed Consolidated Statements of Income
For the Nine months Ended October 31, 2005 and 2004 4
Unaudited Condensed Consolidated Statements of Income
For the Three Months Ended October 31, 2005 and 2004 5
Unaudited Condensed Consolidated Statements of Cash Flows
For the Nine months Ended October 31, 2005 and 2004 6
Notes to the Unaudited Condensed Consolidated Financial
Statements 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 10
Item 4. Controls and Procedures 20
PART II. OTHER INFORMATION & SIGNATURE
Item 6. Exhibits and Reports on Form 8-K 21
2
PART I - FINANCIAL
ITEM 1. FINANCIAL STATEMENTS
NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
October 31, January 31,
2005 2005
ASSETS (unaudited)
-------------------------------
CURRENT ASSETS:
Cash $ 2,917,000 $ 6,201,000
Accounts receivable, less allowance for doubtful accounts
of $1,045,000 at October 31, 2005 and $906,000 at January 31, 2005 21,268,000 18,618,000
Income taxes receivable -- 521,000
Inventories 2,260,000 1,612,000
Deferred tax assets 1,567,000 1,529,000
Prepaid expenses 890,000 666,000
-------------------------------
Total current assets 28,902,000 29,147,000
Property, plant and equipment, at cost 91,288,000 89,313,000
Less: accumulated depreciation (59,546,000) (58,073,000)
-------------------------------
Net property, plant and equipment 31,742,000 31,240,000
Goodwill 2,740,000 2,740,000
Other assets 3,893,000 3,542,000
-------------------------------
TOTAL ASSETS $ 67,277,000 $ 66,669,000
===============================
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 4,018,000 $ 3,512,000
Accrued expenses 4,129,000 3,755,000
Income taxes payable 274,000 --
Deferred income 932,000 424,000
Current installments of long-term debt 1,300,000 975,000
-------------------------------
Total current liabilities 10,653,000 8,666,000
Long-term debt, excluding current installments 17,245,000 20,557,000
Deferred income taxes 5,169,000 5,572,000
Deferred compensation 873,000 810,000
Minority interest 201,000 113,000
Commitments and contingencies
SHAREHOLDERS' EQUITY:
Preferred stock, no par value, 2,000,000 shares authorized; none issued -- --
Common stock, no par value. Authorized, 20,000,000 shares; issued and
outstanding, 9,167,000 as of October 31, 2005 and 9,025,000 as of January 31, 2005 14,545,000 14,184,000
Paid-in capital -- --
Current Earnings
Retained earnings 18,597,000 16,805,000
Accumulated other comprehensive income (6,000) (38,000)
-------------------------------
Total shareholders' equity 33,136,000 30,951,000
-------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 67,277,000 $ 66,669,000
===============================
See accompanying notes.
3
NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES
Unaudited Condensed Consolidated Statements of Income
for the Nine Months Ended October 31,
2005 2004
-------------------------------
Net revenues $ 82,707,000 $ 81,014,000
Cost of sales 63,046,000 63,411,000
-------------------------------
Gross profit 19,661,000 17,603,000
Selling, general and administrative expense 16,022,000 15,716,000
Equity (income) from non-consolidated subsidiary (180,000) (373,000)
-------------------------------
Operating income 3,819,000 2,260,000
Other expenses:
Interest expense, net (985,000) (787,000)
Other 163,000 157,000
-------------------------------
Total other expenses (822,000) (630,000)
Income before income taxes and minority interest 2,997,000 1,630,000
Income taxes 1,117,000 558,000
-------------------------------
Income before minority interest 1,880,000 1,072,000
Minority interest (88,000) 22,000
-------------------------------
Net income $ 1,792,000 $ 1,094,000
===============================
Net income per common share:
Basic $ 0.20 $ 0.12
===============================
Diluted $ 0.19 $ 0.11
===============================
Weighted average common shares outstanding 9,108,000 8,924,000
Dilutive effect of stock options 542,000 622,000
-------------------------------
Weighted average common shares outstanding,
assuming dilution 9,650,000 9,546,000
===============================
See accompanying notes.
4
NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES
Unaudited Condensed Consolidated Statements of Income
for the Three Months Ended October 31,
2005 2004
-------------------------------
Net revenues $ 28,508,000 $ 26,353,000
Cost of sales 21,684,000 20,601,000
-------------------------------
Gross profit 6,824,000 5,752,000
Selling, general and administrative expense 5,687,000 5,182,000
Equity (income) from non-consolidated subsidiary (68,000) (179,000)
-------------------------------
Operating income 1,205,000 749,000
Other expenses:
Interest expense, net (338,000) (264,000)
Other 147,000 (6,000)
-------------------------------
Total other expenses (191,000) (270,000)
Income before income taxes and minority interest 1,014,000 479,000
Income taxes 382,000 137,000
-------------------------------
Income before minority interest 632,000 342,000
Minority interest (42,000) (23,000)
-------------------------------
Net income $ 590,000 $ 319,000
===============================
Net income per common share:
Basic $ 0.06 $ 0.04
===============================
Diluted $ 0.06 $ 0.03
===============================
Weighted average common shares outstanding 9,166,000 8,969,000
Dilutive effect of stock options 589,000 521,000
-------------------------------
Weighted average common shares outstanding,
assuming dilution 9,755,000 9,490,000
===============================
See accompanying notes.
5
NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES
Unaudited Consolidated Statements of Cash Flows
for the Nine Months Ended October 31, 2005 and 2004
2005 2004
---------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,792,000 $ 1,094,000
Adjustments to reconcile net income from continuing operations to cash provided
by (used for) operating activities:
Depreciation and amortization 4,028,000 3,746,000
Provisions for losses (recoveries) on receivables 139,000 5,000
Gain on sale of assets (163,000) (158,000)
Undistributed earnings of affiliate 88,000 (22,000)
Deferred income taxes (441,000) 540,000
Changes in assets and liabilities (net of acquisition):
Accounts receivable (2,749,000) (395,000)
Inventories (648,000) 220,000
Prepaid expenses (224,000) (112,000)
Other assets and intangibles (269,000) (333,000)
Accounts payable 407,000 (760,000)
Accrued expenses 341,000 (38,000)
Income taxes payable 274,000 (23,000)
Deferred income 508,000 239,000
Deferred compensation 63,000 70,000
Income taxes receivable 521,000 (538,000)
---------------------------------
Cash provided by continuing operations 3,667,000 3,535,000
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property, plant and equipment (4,277,000) (4,464,000)
Sale of property, plant and equipment 543,000 311,000
Investment in life insurance -- (130,000)
Acquisition of business, net of cash (483,000) (1,033,000)
---------------------------------
Net cash used for investing activities (4,217,000) (5,316,000)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from current and long-term debt 1,076,000 1,994,000
Repayments of current and long-term debt (4,063,000) (1,167,000)
Proceeds from stock issuance 221,000 268,000
---------------------------------
Net cash provided by (used for) financing activities (2,766,000) 1,095,000
---------------------------------
Effect of exchange rate changes on cash and cash equivalents 32,000 19,000
---------------------------------
Net increase (decrease) in cash (3,284,000) (667,000)
Beginning cash balance 6,201,000 4,661,000
---------------------------------
ENDING CASH BALANCE $ 2,917,000 $ 3,994,000
=================================
See accompanying notes.
6
NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES
Notes to the Unaudited Condensed Consolidated Financial Statements
1. Basis of Presentation
In accordance with instructions to Form 10-Q, the accompanying
consolidated financial statements and footnotes of National Technical
Systems, Inc. (NTS or the Company) have been condensed and, therefore, do
not contain all disclosures required by accounting principles generally
accepted in the United States. These statements should not be construed as
representing pro rata results of the Company's fiscal year and should be
read in conjunction with the financial statements and notes thereto
included in the Company's Form 10-K for the year ended January 31, 2005.
Certain amounts in the prior year financial statements have been
reclassified to conform to the current year financial statement
presentation.
The statements presented as of and for the three and nine months ended
October 31, 2005 and 2004 are unaudited. In Management's opinion, all
adjustments have been made to present fairly the results of such unaudited
interim periods. All such adjustments are of a normal recurring nature.
The consolidated financial statements include the accounts of the Company
and its wholly owned and financially controlled subsidiaries. All
significant intercompany balances and transactions have been eliminated in
consolidation.
2. Income Taxes
Income taxes for the interim periods are computed using the effective tax
rates estimated to be applicable for the full fiscal year. The Company
recorded income tax expense of $382,000 and $1,117,000 for the three and
nine months ended October 31, 2005, respectively, and $137,000 and
$558,000 for the three and nine months ended October 31, 2004,
respectively.
3. Comprehensive Income
Accumulated other comprehensive income on the Company's Condensed
Consolidated Balance Sheets consists of cumulative equity adjustments from
foreign currency translation. During the nine months ended October 31,
2005 the foreign currency translation adjustment was $32,000. During the
nine months ended October 31,2004, the foreign currency translation
adjustment was $19,000.
4. Inventories
Inventories consist of accumulated costs applicable to uncompleted
contracts and are stated at actual cost which is not in excess of
estimated net realizable value.
5. Interest and Taxes
Cash paid for interest and taxes for the nine months ended October 31,
2005 was $1,000,000 and $757,000, respectively. Cash paid for interest and
taxes for the nine months ended October 31, 2004 was $823,000 and
$590,000, respectively.
6. Minority Interest
Minority interest in the Company's NQA, Inc. subsidiary is a result of 50%
of the stock of NQA, Inc. being issued to National Quality Assurance, Ltd.
Effective with fiscal 2002, profits and losses are allocated 50.1% to NTS,
and 49.9% to National Quality Assurance, Ltd.
7. Earnings per share
Basic and diluted net income per common share is presented in conformity
with Statement of Financial Accounting Standards ("SFAS") No. 128,
"Earnings Per Share" for all periods presented. In accordance with SFAS
No. 128, basic earnings per share have been computed using the weighted
average number of shares of common stock outstanding during the year.
Basic earnings per share excludes any dilutive effects of options,
warrants and convertible securities.
7
8. Intangible Assets
The Company adopted the new rules on accounting for goodwill and other
intangible assets beginning in the first quarter of fiscal year 2003 in
accordance with SFAS No. 142, "Goodwill and Other Intangible Assets."
There have been no indications of any impairments through October 31,
2005.
As of October 31, 2005 and January 31, 2005, the Company had the following
acquired intangible assets:
October 31, 2005 January 31, 2005
--------------------------------------------- ------------------------------------------------
Gross Net Estimated Gross Net Estimated
Carrying Accum. Carrying Useful Carrying Accum. Carrying Useful
Amount Amort. Amount Life Amount Amort. Amount Life
Intangible assets subject
to amortization:
Covenant not to compete $ 148,000 $108,000 $ 40,000 3-5 years $ 148,000 $ 78,000 $ 70,000 3-5 years
================================= ==================================
Intangible assets not
subject to amortization:
Goodwill $3,537,000 $797,000 $2,740,000 $3,537,000 $797,000 $2,740,000
================================= ==================================
Amortization expense for intangible assets subject to amortization was
$30,000 and $30,000 for the three months ended October 31, 2005 and 2004,
respectively.
9. Stock-Based Compensation
As of October 31, 2005, the Company had outstanding stock options under
two stock-based employee compensation plans, the Amended and Restated 1994
stock option plan (which plan has expired by its terms and has no
remaining shares reserved for future grants) and the 2002 stock option
plan. The Company accounts for these plans under the intrinsic value
method recognition and measurement principles of Accounting Principles
Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees"
and related interpretations. No stock-based employee compensation cost is
reflected in net income, as all options granted under these plans had an
exercise price equal to the market value of the underlying common stock on
the date of grant. The following table illustrates the effect on net
income and net income per share as if the Company had applied the fair
value recognition provisions of SFAS No. 123, "Accounting for Stock-Based
Compensation," to stock-based employee compensation using the
Black-Scholes option pricing model:
Nine Months Ended Three Months Ended
October 31, October 31,
-------------------------- ----------------------
2005 2004 2005 2004
---- ---- ---- ----
Net Income
As reported $1,792,000 $1,094,000 $590,000 $319,000
Pro forma $1,500,000 $ 682,000 $515,000 $178,000
Basic earnings per common share
As reported $ 0.20 $ 0.12 $ 0.06 $ 0.04
Pro forma $ 0.16 $ 0.08 $ 0.06 $ 0.02
Diluted earnings per common share
As reported $ 0.19 $ 0.11 $ 0.06 $ 0.03
Pro forma $ 0.16 $ 0.07 $ 0.05 $ 0.02
10. Acquisition of Assets
On July 30, 2004, AETL Testing Inc. (a Canadian corporation), a
wholly-owned subsidiary of the Company ("AETL"), acquired substantially
all of the fixed assets of a Canadian test laboratory involved in the
testing of
8
telecommunication equipment, located in Calgary, Alberta, Canada, for a
total purchase price of $1,033,000.
On March 18, 2005, the Company acquired the outstanding stock of Phase
Seven Laboratories, located in Santa Rosa, California, for a total
purchase price of $652,000, paid in cash and NTS stock. Phase Seven
Laboratories provides carrier-class network interoperability,
functionality and performance testing for new and emerging technologies
and their integration with legacy systems. The results of operations of
the acquired business are included in the accompanying consolidated
statement of operations from March 18, 2005 to October 31, 2005.
9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Except for the historical information contained herein, the matters
addressed in this Item 2 contain forward-looking statements within the meaning
of the Private Securities Litigation Reform Act of 1995. Such statements can be
identified by the use of forward-looking words such as "may", "will", "expect",
"anticipate", "intend", "estimate", "continue", "behave" and similar words.
Financial information contained herein, to the extent it is predictive of
financial condition and results of operations that would have occurred on the
basis of certain stated assumptions, may also be characterized as
forward-looking statements. Although forward-looking statements are based on
assumptions made, and information believed by management to be reasonable, no
assurance can be given that such statements will prove to be correct. Such
statements are subject to certain risks, uncertainties and assumptions. Should
one or more of these risks or uncertainties occur, or should underlying
assumptions prove incorrect, actual results may vary materially from those
anticipated.
GENERAL
The Company is a diversified business to business services organization
that supplies technical services and solutions to a variety of industries
including aerospace, defense, automotive, power products, electronics, computers
and telecommunications. Through its wide range of testing facilities, technical
solutions and certification services, the Company provides its customers with
the ability to sell their products globally and enhance their overall
competitiveness. NTS is accredited by numerous national and international
technical organizations which allow the Company to have its test data accepted
in most countries.
The Company operates in two segments: "Engineering & Evaluation" and
"Technical Solutions". The business of the Company is conducted by a number of
operating units, each with its own organization. Each segment is under the
direction of its own executive and operational management team. In making
financial and operational decisions, NTS relies on an internal management
reporting process that provides revenues and operating cost information for each
of its operating units. Revenues and booking activities are also tracked by
market type.
The Engineering & Evaluation segment is one of the largest independent
conformity assessment and management system registration organizations in the
U.S., with facilities throughout the United States and in Japan, Canada and
Germany, serving a large variety of high technology industries, including
aerospace, defense, automotive, power products, electronics, computers and
telecommunications. This segment provides highly trained technical personnel for
product certification, product safety testing and product evaluation to allow
customers to sell their products worldwide. In addition, it performs management
registration and certification services to ISO related standards.
The Technical Solutions segment provides professional and specialty
staffing services including contract services, temporary and full time
placements, offering specialty solutions services to its customers specifically
in the area of information technology, information systems, software engineering
and construction needs. Technical Solutions supplies professionals in support of
customers who need help-desk analysts and managers, relational database
administrators and developers, application and systems programmers,
configuration and project managers, engineering personnel and multiple levels of
system operations personnel.
The following discussion should be read in conjunction with the
consolidated quarterly financial statements and notes thereto. All information
is based upon operating results of the Company for the nine months ended October
31.
10
RESULTS OF OPERATIONS
REVENUES
Nine months ended October 31, 2005 % Change 2004
(Dollars in thousands) ---------------------------------
Engineering & Evaluation $ 52,610 12.0% $ 46,994
Technical Solutions 30,097 (11.5)% 34,020
-------- --------
Total revenues $ 82,707 2.1% $ 81,014
======== ========
For the nine months ended October 31, 2005, consolidated revenues
increased by $1,693,000 or 2.1% when compared to the same period in fiscal 2005.
Engineering & Evaluation:
For the nine months ended October 31, 2005, Engineering and Evaluation
revenues increased by $5,616,000 or 12.0% when compared to the same period in
fiscal 2005, primarily due to increased revenues derived from the defense,
aerospace and telecom markets and additional revenues of $1,155,000 from the
acquisition of the telecom test laboratory in Calgary, Canada on July 30, 2004
and $714,000 from the acquisition of Phase Seven Laboratories in Santa Rosa,
California on March 18, 2005. These increases were partially offset by a
decrease in the electronics and automotive testing revenues.
Technical Solutions:
For the nine months ended October 31, 2005, Technical Solutions revenues
decreased by $3,923,000 or 11.5% when compared to the same period in fiscal
2005, primarily due to the competitive environment in the general IT service
business and the discontinuance of certain services that did not fit the
Company's overall strategy. To offset this decline, the Company is deploying a
migration strategy focusing on meeting the anticipated increase in demand for
specialized compliance and engineering support services. This strategy is
initially being deployed by cross selling to clients currently being serviced by
the Engineering and Evaluation segment.
GROSS PROFIT
Nine months ended October 31, 2005 % Change 2004
(Dollars in thousands) ---------------------------------
Engineering & Evaluation $ 14,530 19.5% $ 12,162
% to segment revenue 27.6% 25.9%
Technical Solutions 5,131 (5.7)% 5,441
% to segment revenue 17.0% 16.0%
-------- --------
Total $ 19,661 11.7% $ 17,603
======== ========
% to total revenue 23.8% 21.7%
Total gross profit for the nine months ended October 31, 2005 increased by
$2,058,000 or 11.7% when compared to the same period in fiscal 2005.
Engineering & Evaluation:
For the nine months ended October 31, 2005, gross profit for the
Engineering & Evaluation Group increased by $2,368,000 or 19.5% when compared to
the same period in fiscal 2005, primarily as a result of the increase in
revenues discussed above. Gross profit as a percentage of revenues increased to
27.6% in the current period compared to 25.9% in the same period in the prior
year as the Company continues to improve efficiency in this segment.
11
Technical Solutions:
For the nine months ended October 31, 2005, gross profit decreased by
$310,000 or 5.7% in the Technical Solutions Group when compared to the same
period in fiscal 2005. This decrease was due to the lower revenues discussed
above and the competitive pricing pressures in the staffing industry. However
the Company was able to minimize this decrease by focusing on specialized
compliance and engineering support services which generally produce higher
margins. Gross profit, as a percentage of revenues, increased to 17.0% from
16.0% when compared to the same period in the prior year.
SELLING, GENERAL & ADMINISTRATIVE
Nine months ended October 31, 2005 % Change 2004
(Dollars in thousands) -------------------------------------
Engineering & Evaluation $ 11,276 3.5% $10,890
% to segment revenue 21.4% 23.2%
Technical Solutions 4,746 (1.7)% 4,826
% to segment revenue 15.8% 14.2%
--------- -------
Total $ 16,022 1.9% $15,716
========= =======
% to total revenue 19.4% 19.4%
Total selling, general and administrative expenses increased $306,000 or
1.9% for the nine months ended October 31, 2005 when compared to the same period
in fiscal 2005.
Engineering & Evaluation:
For the nine months ended October 31, 2005, selling, general and
administrative expenses increased by $386,000 or 3.5% when compared to the same
period in fiscal 2005, primarily due to increased compensation, legal and other
professional fees.
Technical Solutions:
For the nine months ended October 31, 2005, selling, general and
administrative expenses decreased by $80,000 or 1.7% when compared to the same
period in fiscal 2005, primarily due to the reduction in selling costs
associated with the lower revenues discussed above.
Equity Income from Non-Consolidated Subsidiary:
Engineering & Evaluation:
For the nine months ended October 31, 2005, equity income from XXCAL Japan
was $180,000, compared to $373,000 for the same period in fiscal 2005. The
decrease of $193,000 was primarily due to lower revenues caused by a reduction
in test requirements from a major Japanese client and increased operating costs
related to hiring and training additional technical personnel for new testing
initiatives. XXCAL Japan is 50% owned by NTS and is accounted for under the
equity method since NTS does not have management or board control.
12
OPERATING INCOME
Nine months ended October 31, 2005 % Change 2004
(Dollars in thousands) ------------------------------------
Engineering & Evaluation $ 3,434 108.8% $1,645
% to segment revenue 6.5% 3.5%
Technical Solutions 385 (37.4)% 615
% to segment revenue 1.3% 1.8%
-------- ------
Total $ 3,819 69.0% $2,260
======== ======
% to total revenue 4.6% 2.8%
Operating income for the nine months ended October 31, 2005 increased by
$1,559,000 or 69.0% when compared to the same period in fiscal 2005.
Engineering & Evaluation:
For the nine months ended October 31, 2005, operating income in the
Engineering & Evaluation Group increased by $1,789,000 or 108.8% when compared
to the same period in fiscal 2005, as a result of the increase in gross profit,
partially offset by the decrease in Equity Income from XXCAL Japan and the
increase in selling, general and administrative expenses.
Technical Solutions:
For the nine months ended October 31, 2005, operating income in the
Technical Solutions Group decreased by $230,000 or 37.4% when compared to the
same period in fiscal 2005, as a result of the decrease in gross profit,
partially offset by the decrease in selling, general and administrative expenses
discussed above.
INTEREST EXPENSE
Net interest expense increased by $198,000 to $985,000 in the nine months
ended October 31, 2005 when compared to the same period in fiscal 2005. This
increase was principally due to higher interest rate levels for the nine months
ended October 31, 2005, partially offset by lower average debt balances for the
nine months ended October 31, 2005 when compared to the same period last year.
OTHER INCOME
Other income of $163,000 in the nine months ended October 31, 2005 and
$157,000 in the nine months ended October 31, 2004 consisted primarily of
profits from the sale of real estate.
INCOME TAXES
The income tax provision rate of 37.3% for the nine months ended October
31, 2005 is slightly lower than the federal and state statutory rates, primarily
due to the earnings associated with the Company's equity interest in its foreign
subsidiary. Earnings for this foreign subsidiary are reported on the equity
method, net of tax and are included in income before income taxes. The
associated tax is not separately stated in income taxes. This rate is based on
the estimated provision accrual for fiscal year ending January 31, 2006.
Management has determined that it is more likely than not that the deferred tax
asset will be realized on the basis of offsetting it against deferred tax
liabilities. It is the Company's intention to assess the need for a valuation
account by evaluating the realizability of the deferred tax asset quarterly,
based upon projected future taxable income of the Company.
NET INCOME
Net income for the nine months ended October 31, 2005 was $1,792,000, an
increase of $698,000 or 63.8% compared to the same period in fiscal 2005. This
increase was primarily due to the higher operating income, partially
13
offset by higher interest expense, higher income taxes and lower minority
interest during the nine months ended October 31, 2005.
The following information is based upon results for National Technical
Systems, Inc. for the three months ended October 31.
RESULTS OF OPERATIONS
REVENUES
Three months ended October 31, 2005 % Change 2004
(Dollars in thousands) ------------------------------------
Engineering & Evaluation $ 18,108 17.3% $ 15,438
Technical Solutions 10,400 (4.7)% 10,915
-------- --------
Total revenues $ 28,508 8.2% $ 26,353
======== ========
For the three months ended October 31, 2005, consolidated revenues
increased by $2,155,000 or 8.2% when compared to the same period in fiscal 2005.
Engineering & Evaluation:
For the three months ended October 31, 2005, Engineering and Evaluation
revenues increased by $2,670,000 or 17.3% when compared to the same period in
fiscal 2005, primarily due to increased revenues derived from the defense,
aerospace and telecom markets and additional revenues of $277,000 from the
acquisition of the telecom test laboratory in Santa Rosa, California on March
18, 2005. These increases were partially offset by a decrease in testing
revenues from the automotive business.
Technical Solutions:
For the three months ended October 31, 2005, Technical Solutions revenues
decreased by $515,000 or 4.7% when compared to the same period in fiscal 2005,
primarily due to the competitive environment in the general IT service business
and the discontinuance of certain services that did not fit the Company's
overall strategy. To offset this decline, the Company is focusing on the
anticipated increase in demand for specialized compliance and engineering
support services. This is initially being carried out by cross selling to
clients currently being serviced by the Engineering and Evaluation segment.
GROSS PROFIT
Three months ended October 31, 2005 % Change 2004
(Dollars in thousands) ------------------------------------
Engineering & Evaluation $ 4,804 21.7% $ 3,947
% to segment revenue 26.5% 25.6%
Technical Solutions 2,020 11.9% 1,805
% to segment revenue 19.4% 16.5%
-------- --------
Total $ 6,824 18.6% $ 5,752
======== ========
% to total revenue 23.9% 21.8%
Total gross profit for the three months ended October 31, 2005 increased
by $1,072,000 or 18.6% when compared to the same period in fiscal 2005.
Engineering & Evaluation:
For the three months ended October 31, 2005, gross profit for the
Engineering & Evaluation Group increased by $857,000 or 21.7% when compared to
the same period in fiscal 2005, primarily as a result of the increase in
revenues
14
discussed above and an increase in gross profit as a percentage of revenues to
26.5% in the current period compared to 25.6% in the same period in the prior
year, as a result of the continued improvement in operations efficiencies.
Technical Solutions:
For the three months ended October 31, 2005, gross profit increased by
$215,000 or 11.9% in the Technical Solutions Group when compared to the same
period in fiscal 2005. This increase was due to the increased business in
specialized compliance and engineering support services which generally produce
higher margins and the increase in permanent placement revenues. Gross profit,
as a percentage of revenues, increased to 19.4% from 16.5% when compared to the
same period in the prior year.
SELLING, GENERAL & ADMINISTRATIVE
Three months ended October 31, 2005 % Change 2004
(Dollars in thousands) -------------------------------------
Engineering & Evaluation $ 3,995 8.9% $ 3,670
% to segment revenue 22.1% 23.8%
Technical Solutions 1,692 11.9% 1,512
% to segment revenue 16.3% 13.9%
-------- --------
Total $ 5,687 9.7% $ 5,182
======== ========
% to total revenue 19.9% 19.7%
Total selling, general and administrative expenses increased $505,000 or
9.7% for the three months ended October 31, 2005 when compared to the same
period in fiscal 2005.
Engineering & Evaluation:
For the three months ended October 31, 2005, selling, general and
administrative expenses increased by $325,000 or 8.9% when compared to the same
period in fiscal 2005, primarily due to increased compensation, legal and other
consulting fees.
Technical Solutions:
For the three months ended October 31, 2005, selling, general and
administrative expenses increased by $180,000 or 11.9% when compared to the same
period in fiscal 2005, primarily due to increases in selling costs and group
insurance costs.
Equity Income from Non-Consolidated Subsidiary:
Engineering & Evaluation:
For the three months ended October 31, 2005, equity income from XXCAL
Japan was $68,000, compared to $179,000 for the same period in fiscal 2005. The
decrease of $111,000 was primarily due to lower revenues caused by a reduction
in test requirements from a major Japanese client and increased operating costs
related to hiring and training additional technical personnel for new testing
initiatives. XXCAL Japan is 50% owned by NTS and is accounted for under the
equity method since NTS does not have management or board control.
15
OPERATING INCOME
Three months ended October 31, 2005 % Change 2004
(Dollars in thousands) -----------------------------------
Engineering & Evaluation $ 877 92.3% $ 456
% to segment revenue 4.8% 3.0%
Technical Solutions 328 11.9% 293
% to segment revenue 3.2% 2.7%
-------- --------
Total $ 1,205 60.9% $ 749
======== ========
% to total revenue 4.2% 2.8%
Operating income for the three months ended October 31, 2005 increased by
$456,000 or 60.9% when compared to the same period in fiscal 2005.
Engineering & Evaluation:
For the three months ended October 31, 2005, operating income in the
Engineering & Evaluation Group increased by $421,000 or 92.3% when compared to
the same period in fiscal 2005, as a result of the increase in gross profit,
partially offset by the increase in selling, general and administrative expenses
and the decrease in Equity Income from XXCAL Japan.
Technical Solutions:
For the three months ended October 31, 2005, operating income in the
Technical Solutions Group increased by $35,000 or 11.9% when compared to the
same period in fiscal 2005, as a result of the increase in gross profit,
partially offset by the increase in selling, general and administrative expenses
discussed above.
INTEREST EXPENSE
Net interest expense increased by $74,000 to $338,000 in the three months
ended October 31, 2005 when compared to the same period in fiscal 2005. This
increase was principally due to higher interest rate levels for the three months
ended October 31, 2005, partially offset by lower average debt balances for the
three months ended October 31, 2005 when compared to the same period last year.
OTHER INCOME
Other income increased by $153,000 to $147,000 in the three months ended
October 31, 2005 when compared to the same period in fiscal 2005, due to the
inclusion of a gain of $163,000 on the sale of real estate.
INCOME TAXES
The income tax provision rate of 37.7% for the three months ended October
31, 2005 is based on the estimated provision accrual for fiscal year ending
January 31, 2006. Management has determined that it is more likely than not that
the deferred tax asset will be realized on the basis of offsetting it against
deferred tax liabilities. It is the Company's intention to assess the need for a
valuation account by evaluating the realizability of the deferred tax asset
quarterly based upon projected future taxable income of the Company.
NET INCOME
Net income for the three months ended October 31, 2005 was $590,000, an
increase of $271,000 or 85.0% compared to the same period in fiscal 2005. This
increase was primarily due to the higher operating income and higher other
income, partially offset by higher interest expense, higher income taxes and
lower minority interest during the three months ended October 31, 2005.
16
BUSINESS ENVIRONMENT
In the Engineering & Evaluation segment, the Company tests and certifies
high tech products for seven distinct markets: defense, aerospace,
telecommunications, transportation, power, computer and electronics. The Company
also provides ISO 9000 Quality Management System Registration.
The defense and aerospace markets continue to generate the majority of the
revenues of the overall Engineering and Evaluation revenues. The Company has
experienced steady revenue growth in the defense market during the first nine
months of this year compared to the same period last year. The aerospace market
has shown slight revenue growth in the first nine months of this year compared
to the same period last year. The Company has ten well-equipped defense and
aerospace environmental simulation laboratories located throughout the United
States and is well equipped to handle the increase in demand. The Company
continues to experience an increase in demand for the evaluation of military
equipment and weapons systems, and this demand has positively impacted the new
business booked mainly at the Company's Arkansas facility. NTS has installed a
new rocket firing range and has upgraded its capability to handle large weapons
systems and maintains shock machines, centrifuges, acoustical chambers and
hydraulic and electro-dynamic vibration equipment at this facility. The Company
also has plans to install a munitions arena test site and a small caliber range
to handle the increased demand for this type of test activity. The Company
anticipates that the demand for defense testing will continue to increase for
the foreseeable future.
The telecommunications market for the first nine months of this year has
also generated increased revenues compared to the same period last year.. The
outlook for the future continues to be favorable due to the increase in product
certification outsourcing by the major Regional Bell Operating Companies (RBOCs)
as they develop plans for upgrading their central office technology, mainly in
the Voice Over Internet Protocol (VoiP) area. The Company is currently providing
telecom test and certification services at laboratories in California,
Massachusetts, Texas, Canada and Germany. As service providers gradually convert
to VoiP architectures, interoperability becomes critical to ensure a seamless
transition to next generation networks. The Company also expects an increase in
testing and certification demand as carriers begin to deploy "triple play"
(voice, video, and broadband) offerings over FTTP (fiber to the premise) passive
fiber networks. The Company recently acquired a network architecture and
interoperability laboratory in Northern California, Phase Seven Laboratories, to
extend the Company's service offering to handle the anticipated demand for
interoperability testing related to the FTTP deployment. The Company is in the
process of consolidating its DSL certification testing into the Santa Rosa,
California facility to better serve the certification demand for this
technology.
The quality registration and power markets have been stable throughout the
first nine months of the current year. The Company anticipates that these two
markets will remain stable with no significant external growth.
The transportation market has experienced a slight decrease in revenues
during the first nine months of the current year. This market remains
competitive. However, the major automotive companies and suppliers continue to
outsource test and compliance work and the Company continues to provide a
quality service to handle this demand. The Company expects the demand for this
work to remain stable or slightly decrease in the foreseeable future.
Revenues derived from the computer market experienced a slight increase
during the first nine months of the current year, compared to the same period
last year. Revenues derived from the electronics market experienced a decline
during the first nine months of this year, compared to the same period last
year. The Company experienced a decline in revenues and margins in the Japan
operation. The decline in Japan revenues and margins is attributed to a
reduction in test requirements from a major Japanese client. However, the
Company anticipates growth in these markets as the international expansion
strategy is deployed in fiscal year 2006 to provide testing and certification
services in Taiwan, Korea, Hong Kong and mainland China. The services will be
provided through cooperative agreements entered into with SGS to cover Taiwan
and Korea and with Hong Kong Standards and Testing Centre to cover China and
Hong Kong. The focus will be on providing USB Device and Hub, USB on the go,
Microsoft Windows Hardware Quality Laboratory (WHQL) and Zigbee and firewall
certification to device manufacturers and industrial products manufactured in
Asia.
In the Technical Solutions segment, the Company provides a variety of
staffing and workforce management services and solutions, including contract,
contract-to-hire and full time placements to meet its customers' needs with a
focus on IT development. The IT general services business continues to remain
extremely competitive with an increasing portion of this work being outsourced
to off-shore providers. The Company continues to experience a decline in the
general service IT business revenues as a result of the current adverse market
trends. To offset this competitive environment, the Company is deploying a
migration strategy focusing on meeting the anticipated increase in demand for
specialized compliance and engineering support services at Company locations as
well as taking advantage of offshore
17
opportunities. The Company is now offering a specialized niche-oriented
compliance and engineering service. This service is being deployed by cross
selling to clients currently being serviced by the Engineering and Evaluation
segment. The Company has also set up a test and compliance laboratory in Vietnam
for a major US Fortune 500 computer company to take advantage of the low-cost,
highly-skilled labor in Vietnam. For the nine months in the current year, the
Company has experienced an increase in gross profit percentage on the declining
revenues compared to the same period last year. This increase is a result of
increased permanent placement activity and some marginal increase in engineering
support services. The Company believes it has a competitive advantage because of
the existing relationships with the Engineering and Evaluation clients and
anticipates the specialized compliance and engineering services will continue to
grow both domestically and internationally as a result of the continued
outsourcing trend.
Notwithstanding the foregoing, and because of factors affecting the
Company's operating results, past financial performance should not be considered
to be a reliable indicator of future performance.
18
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities of $3,667,000 in the nine months
ended October 31, 2005 consisted of net income of $1,792,000 adjusted for
non-cash items of $4,028,000 in depreciation and amortization offset, primarily
by changes in working capital of $2,153,000. Net cash provided by operating
activities in the nine months ended October 31, 2004 was $3,535,000.
Net cash used for investing activities in the nine months ended October
31, 2005 of $4,217,000 was attributable to capital spending of $4,277,000 and
cash used to acquire Phase Seven Laboratories of $483,000, partially offset by
proceeds from the sale of property of $543,000. Capital spending is generally
comprised of purchases of machinery and equipment, building, leasehold
improvements, computer hardware, software and furniture and fixtures. Cash used
in investing activities decreased from the nine months ended October 31, 2004 to
the nine months ended October 31, 2005 by $1,099,000, primarily as a result of
the acquisition of the Canadian test laboratory in the nine months ended October
31, 2004, lower proceeds from the sale of property and higher capital spending
in the nine months ended October 31, 2004.
Net cash used by financing activities in the nine months ended October 31,
2005 of $2,766,000 consisted of repayment of debt of $4,063,000, offset by cash
provided by borrowings of $1,076,000 and proceeds from stock options exercised
of $221,000. Net cash used by financing activities increased from the nine
months ended October 31, 2004 to the nine months ended October 31, 2005 by
$3,861,000, primarily as a result of the increased repayment of debt and
reduction in borrowings.
On November 25, 2002, the Company increased the revolving line of credit
under its credit agreement with Comerica Bank California and First Bank to
$20,000,000. Comerica Bank California, as the agent, retained 60% of the line
with First Bank, as the participant, holding 40% of the line. The revolving line
of credit was reduced by $1,750,000 on August 1, 2003 and was reduced again on
August 1, 2004 by $1,750,000, bringing the line of credit balance down to
$16,500,000. The interest rate is at the agent's prime rate, with an option for
the Company to convert to loans at the Libor rate plus 250 basis points for 30,
60, 90, 180 or 365 days, with minimum advances of $1,000,000. The Company paid a
0.5% commitment fee of the total line amount and is paying an additional 0.25%
of the commitment amount annually and a 0.25% fee for any unused line of credit.
On July 1, 2005, the agreement was amended to include a $2,500,000 term
loan to be repaid in 60 equal monthly payments. The proceeds were used to pay
down the line of credit. In addition, the requirement of the $1,750,000
reduction of the line was removed from the agreement. The outstanding balance on
the term loan at October 31, 2005 was $2,333,000.The outstanding balance on the
revolving line of credit at October 31, 2005 was $11,152,000. This balance is
reflected in the accompanying condensed consolidated balance sheets as
long-term. The amount available on the line of credit was $5,348,000 as of
October 31, 2005. The amendment also includes an additional equipment line of
credit for $2,000,000. The outstanding balance on the equipment line of credit
at October 31, 2005 was $426,000, leaving available borrowings of $1,574,000 on
the equipment line of credit. This agreement is subject to certain covenants,
which require the maintenance of certain working capital, debt-to-equity,
earnings-to-expense and cash flow ratios. The Company was in full compliance
with all of the covenants with its banks as of October 31, 2005.
The Company has additional equipment line of credit agreements (at
interest rates of 5.56% to 9.82%) to finance various test equipment with terms
of 60 months for each equipment schedule. The outstanding balance at October 31,
2005 was 1,983,000. The balance of other notes payable collateralized by land
and building was $2,646,000, and the balance of unsecured notes was $5,000 at
October 31, 2005.
19
ITEM 4. CONTROLS AND PROCEDURES
Evaluation Of Disclosure Controls And Procedures
The Company's Chief Executive Officer and Chief Financial Officer carried
out an evaluation with the participation of the Company's management, of the
effectiveness of the design and operation of the Company's disclosure controls
and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities
Exchange Act of 1934, as amended (the "Exchange Act")). Based upon that
evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that, as of the end of the period covered by this report, the Company's
disclosure controls and procedures are effective in timely alerting them to
material information relating to the Company (including its consolidated
subsidiaries) required to be included in the Company's Exchange Act filings.
Disclosure controls and procedures, no matter how well designed and
implemented, can provide only reasonable assurance of achieving an entity's
disclosure objectives. The likelihood of achieving such objectives is affected
by limitations inherent in disclosure controls and procedures. These include the
fact that human judgment in decision-making can be faulty and that breakdowns in
internal control can occur because of human failures such as simple errors or
mistakes or intentional circumvention of the established process.
Changes in Internal Controls
There was no change in the Company's internal control over financial
reporting, known to the Chief Executive Officer or Chief Financial Officer that
occurred during the period covered by this report that has materially affected,
or is reasonably likely to materially affect, the Company's internal control
over financial reporting.
20
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
31.1 - Certification of the Principal Executive Officer pursuant to
rule 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934,
as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
31.2 - Certification of the Principal Financial Officer pursuant to
rule 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934,
as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
32.1 - Certification of the Principal Executive Officer pursuant to
18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 - Certification of the Principal Financial Officer pursuant to
18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
None.
21
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.
NATIONAL TECHNICAL SYSTEMS, INC.
Date: December 13, 2005 By: /s/ Lloyd Blonder
----------------------- ---------------------------------
Lloyd Blonder
Senior Vice President
Chief Financial Officer
(Signing on behalf of the
registrant and as principal
financial officer)
22