================================================================================
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 July 31, 2006
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) (I.R.S. Employer
Identification No.)
24007 Ventura Boulevard, Suite 200, Calabasas, California
(Address of registrant's principal executive office)
(818) 591-0776 91302
(Registrant's telephone number including area code) (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 a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer |_| Accelerated filer |_| Non-accelerated filer |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
September 11, 2006 was 8,744,650
NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES
Index
PART I. FINANCIAL INFORMATION
Page No.
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets as of
July 31, 2006 (unaudited) and January 31, 2006 3
Unaudited Condensed Consolidated Statements of Income
For the Six Months Ended July 31, 2006 and 2005 4
Unaudited Condensed Consolidated Statements of Income
For the Three Months Ended July 31, 2006 and 2005 5
Unaudited Condensed Consolidated Statements of Cash Flows
For the Six Months Ended July 31, 2006 and 2005 6
Notes to the Unaudited Condensed Consolidated Financial
Statements 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk 22
Item 4. Controls and Procedures 22
PART II. OTHER INFORMATION & SIGNATURE
Item 1. Legal Proceedings 23
Item 1A. Risk Factors 23
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 23
Item 3. Defaults Upon Senior Securities 23
Item 4 Submission of Matters to a Vote of Security Holders 23
Item 5. Other Information 23
Item 6. Exhibits 24
2
PART I - FINANCIAL
ITEM 1. FINANCIAL STATEMENTS
NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
At At
July 31, January 31,
2006 2006
ASSETS (unaudited)
------ ----------------------------
CURRENT ASSETS:
Cash $ 2,717,000 $ 4,196,000
Accounts receivable, less allowance for doubtful accounts
of $926,000 at July 31, 2006 and $816,000 at January 31, 2006 22,678,000 20,425,000
Income taxes receivable 117,000 10,000
Inventories 2,115,000 2,184,000
Deferred income taxes 1,753,000 1,747,000
Prepaid expenses 1,144,000 769,000
----------------------------
Total current assets 30,524,000 29,331,000
Property, plant and equipment, at cost 97,066,000 93,887,000
Less: accumulated depreciation (63,589,000) (60,787,000)
----------------------------
Net property, plant and equipment 33,477,000 33,100,000
Goodwill 3,999,000 2,740,000
Other assets 4,707,000 3,962,000
----------------------------
TOTAL ASSETS $ 72,707,000 $ 69,133,000
============================
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES:
Accounts payable $ 5,468,000 $ 4,715,000
Accrued expenses 4,376,000 5,400,000
Income taxes payable -- 594,000
Deferred income 1,552,000 817,000
Current installments of long-term debt 2,696,000 1,529,000
----------------------------
Total current liabilities 14,092,000 13,055,000
Long-term debt, excluding current installments 19,884,000 15,579,000
Deferred income taxes 4,936,000 5,084,000
Deferred compensation 903,000 874,000
Minority interest 202,000 163,000
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, 8,615,000 as of July 31, 2006 and 9,176,000 as of January 31, 2006 12,356,000 14,624,000
Retained earnings 20,343,000 19,744,000
Accumulated other comprehensive income (9,000) 10,000
----------------------------
Total shareholders' equity 32,690,000 34,378,000
----------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 72,707,000 $ 69,133,000
============================
See accompanying notes to condensed consolidated financial statements.
3
NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES
Unaudited Condensed Consolidated Statements of Income
for Six Months Ended July 31, 2006 and 2005
2006 2005
----------------------------
Net revenues $ 56,589,000 $ 54,199,000
Cost of sales 43,772,000 41,362,000
----------------------------
Gross profit 12,817,000 12,837,000
Selling, general and administrative expense 11,157,000 10,335,000
Equity income from non-consolidated subsidiary (135,000) (112,000)
----------------------------
Operating income 1,795,000 2,614,000
Other income (expense):
Interest expense, net (812,000) (647,000)
Other 129,000 16,000
----------------------------
Total other expense, net (683,000) (631,000)
Income before income taxes and minority interest 1,112,000 1,983,000
Income taxes 474,000 735,000
----------------------------
Income before minority interest 638,000 1,248,000
Minority interest (39,000) (46,000)
----------------------------
Net income $ 599,000 $ 1,202,000
============================
Earnings per common share:
Basic $ 0.07 $ 0.13
============================
Diluted $ 0.06 $ 0.13
============================
Weighted average common shares outstanding 8,718,000 9,079,000
Dilutive effect of stock options 799,000 516,000
Weighted average common shares outstanding, ----------------------------
assuming dilution 9,517,000 9,595,000
============================
See accompanying notes to condensed consolidated financial statements.
4
NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES
Unaudited Condensed Consolidated Statements of Income
for Three Months Ended July 31, 2006 and 2005
2006 2005
----------------------------
Net revenues $ 28,438,000 $ 26,755,000
Cost of sales 21,859,000 20,516,000
----------------------------
Gross profit 6,579,000 6,239,000
Selling, general and administrative expense 5,747,000 5,120,000
Equity income from non-consolidated subsidiary (60,000) (35,000)
----------------------------
Operating income 892,000 1,154,000
Other income (expense):
Interest expense, net (451,000) (329,000)
Other income 123,000 16,000
----------------------------
Total other expense, net (328,000) (313,000)
Income before income taxes and minority interest 564,000 841,000
Income taxes 270,000 335,000
----------------------------
Income before minority interest 294,000 506,000
Minority interest (47,000) (38,000)
----------------------------
Net income $ 247,000 $ 468,000
============================
Earnings per common share
Basic $ 0.03 $ 0.05
============================
Diluted $ 0.03 $ 0.05
============================
Weighted average common shares outstanding 8,544,000 9,106,000
Dilutive effect of stock options 899,000 541,000
Weighted average common shares outstanding, ----------------------------
assuming dilution 9,443,000 9,647,000
============================
See accompanying notes to condensed consolidated financial statements.
5
NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES
Unaudited Consolidated Statements of Cash Flows
for the Six Months Ended July 31, 2006 and 2005
2006 2005
----------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 599,000 $ 1,202,000
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization 2,819,000 2,664,000
Recoveries on receivables 111,000 73,000
Undistributed earnings of affiliate 39,000 46,000
Deferred income taxes (net of acquisition) (154,000) (294,000)
Tax benefit from stock options exercised 234,000 --
Share based compensation 319,000 --
Changes in operating assets and liabilities (net of acquisition):
Accounts receivable (2,116,000) (1,476,000)
Inventories 104,000 (224,000)
Prepaid expenses (343,000) (299,000)
Other assets and intangibles (554,000) (169,000)
Accounts payable 521,000 (531,000)
Accrued expenses (1,067,000) 99,000
Income taxes payable (594,000) --
Deferred income 682,000 986,000
Deferred compensation 29,000 33,000
Income taxes receivable (107,000) 505,000
----------------------------
Net cash provided by operations 522,000 2,615,000
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property, plant and equipment (3,083,000) (2,615,000)
Investment in life insurance (91,000) --
Acquisitions of businesses, net of cash (773,000) (483,000)
----------------------------
Cash used for investing activities (3,947,000) (3,098,000)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from current and long-term debt 10,292,000 1,075,000
Repayments of current and long-term debt (4,858,000) (2,906,000)
Proceeds from stock options exercised 424,000 193,000
Common stock repurchase (3,893,000) --
----------------------------
Net cash provided by (used for) financing activities 1,965,000 (1,638,000)
----------------------------
Effect of exchange rate changes on cash and cash equivalents (19,000) 4,000
----------------------------
Net decrease in cash (1,479,000) (2,117,000)
Beginning cash balance 4,196,000 6,201,000
----------------------------
ENDING CASH BALANCE $ 2,717,000 $ 4,084,000
============================
See accompanying notes to condensed consolidated financial statements.
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 U.S. generally accepted
accounting principles. These statements should not be construed as
representing pro rata results of the Company's fiscal year ending January
31, 2007 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, 2006.
The statements presented as of and for the three and six months ended July
31, 2006 and 2005 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, as adjusted for
any discrete taxable events that occur during the period. The Company
recorded income tax expense of $270,000 and $474,000 for the three and six
months ended July 31, 2006, respectively, and $335,000 and $735,000 for
the three and six months ended July 31, 2005, 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 six months ended July 31, 2006
the foreign currency translation adjustment resulted in a loss of $19,000
and total comprehensive income was $580,000. During the six months ended
July 31, 2005, the foreign currency translation adjustment was a gain of
$4,000 and total comprehensive income was $1,206,000.
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 six months ended July 31, 2006
was $822,000 and $1,053,000, respectively. Cash paid for interest and
taxes for the six months ended July 31, 2005 was $741,000 and $530,000,
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 accounts for goodwill and other intangible assets in
accordance with SFAS No. 142, "Goodwill and Other Intangible Assets."
There have been no indications of any impairment through July 31, 2006.
As of July 31, 2006 and January 31, 2006, the Company had the following acquired
intangible assets:
July 31, 2006
----------------------------------------------------------
Gross Net Estimated
Carrying Accum. Carrying Useful
Amount Amort. Amount Life
Intangible assets subject to
amortization:
Covenant not to compete $ 148,000 $ 115,000 $ 33,000 3-5 years
Customer relationships 105,000 -- 105,000 18 months
----------------------------------------------
Total $ 253,000 $ 115,000 $ 138,000
==============================================
Intangible assets not
subject to amortization:
Goodwill $ 4,796,000 $ 797,000 $ 3,999,000
==============================================
January 31, 2006
-----------------------------------------------------------
Gross Net Estimated
Carrying Accum. Carrying Useful
Amount Amort. Amount Life
Intangible assets subject to
amortization:
Covenant not to compete $ 148,000 $ 110,000 $ 38,000 3-5 years
Customer relationships -- -- --
-----------------------------------------------
Total $ 148,000 $ 110,000 $ 38,000
===============================================
Intangible assets not
subject to amortization:
Goodwill $ 3,537,000 $ 797,000 $ 2,740,000
===============================================
Goodwill increased by $1,259,000 due to the acquisitions of American
International Registrars Corporation and B & B Technologies, Inc. (see
note 11).
9. Employee Equity Incentive Plans
Effective February 1, 2006, the Company adopted the provisions of SFAS No.
123(R). SFAS No. 123(R) requires employee stock options and rights to
purchase shares under stock participation plans to be accounted for under
the fair value method and requires the use of an option pricing model for
estimating fair value. Accordingly, share-based compensation is measured
at grant date, based on the fair value of the award. The Company
previously accounted for awards granted under its equity incentive plans
under the intrinsic value method prescribed by Accounting Principles Board
(APB) Opinion No. 25, "Accounting for Stock Issued to Employees," and
related interpretations, and provided the required pro forma disclosures
prescribed by SFAS No. 123, "Accounting for Stock-Based Compensation," as
amended. The exercise price of options is equal to the market price of
National Technical Systems, Inc. common stock (defined as the closing
price reported by the NASDAQ stock market) on the date of grant.
Accordingly, no share-based compensation, other than acquisition-related
compensation, was recognized in the financial statements prior to January
31, 2006.
The Company used the modified prospective method of adoption for SFAS No.
123(R), under which the compensation cost recognized by the Company
beginning in fiscal 2007 includes (a) compensation cost for all equity
incentive awards granted prior to, but not yet vested as of February 1,
2006, based on the grant date fair value estimated in accordance with the
original provisions of SFAS No. 123, and (b) compensation cost for all
equity incentive awards granted subsequent to February 1, 2006, based on
the grant-date fair value estimated in accordance with the provisions of
SFAS No. 123(R). The Company uses the straight-line attribution method to
recognize share-based compensation costs over the service period of the
award. Upon exercise, cancellation, or expiration of stock options,
deferred tax assets for options with multiple vesting dates are eliminated
for each vesting period on a first-in, first-out basis as if each vesting
period was a separate award. To calculate the excess tax benefits
available for use in offsetting future tax shortfalls as of the date of
implementation, the Company followed the alternative transition method
discussed in FASB Staff Position No. 123(R)-3.
No options have been granted by the Company during the current fiscal
year. Options to be granted to existing and newly hired employees or
directors will generally vest over a four-year period from the date of
grant. The Company may also assume the equity incentive plans and the
outstanding equity awards of certain acquired companies. Once assumed, the
Company does not grant additional stock under these plans. The Company may
use other types of equity incentive awards, such as restricted stock. The
Company's equity incentive plan also
8
allows for performance-based vesting for equity incentive awards.
Share-based compensation recognized in fiscal year 2007 as a result of the
adoption of SFAS No. 123(R) as well as pro forma disclosures according to
the original provisions of SFAS No. 123 for periods prior to the adoption
of SFAS No. 123(R) is based on the Black-Scholes-Merton option pricing
model for estimating fair value of options granted under the Company's
equity incentive plans and rights to acquire stock granted under the
Company's stock participation plan.
The following table summarizes the effects of share-based compensation
resulting from the application of SFAS No. 123(R) to options granted under
the Company's equity incentive plans and rights to acquire stock granted
under the Company's stock participation plan:
Six Months Ended Three Months Ended
------------------------ -----------------------
July 31, July 31, July 31, July 31,
2006 2005 2006 2005
----------- --------- ---------- ----------
Cost of sales $ 80,000 $ -- $ 38,000 $ --
Selling, general and administrative expense 238,000 -- 112,000 --
----------- --------- ---------- ----------
Share-based compensation effect in income before taxes 318,000 -- 150,000 --
Income taxes (13,000) -- 44,000 --
----------- --------- ---------- ----------
Net share-based compensation effects in net income $ 305,000 $ -- $ 194,000 $ --
=========== ========= ========== ==========
Share-based compensation effects on basic earnings per common share $ 0.03 $ -- $ 0.02 $ --
=========== ========= ========== ==========
Share-based compensation effects on diluted earnings per common share $ 0.03 $ -- $ 0.02 $ --
=========== ========= ========== ==========
Share-based compensation effects on cash flow from operations $ -- $ -- $ -- $ --
=========== ========= ========== ==========
Share-based compensation effects on cash flow from financing activities $ -- $ -- $ -- $ --
=========== ========= ========== ==========
Weighted average common shares outstanding 8,718,000 9,079,000 8,544,000 9,106,000
Dilutive effect of stock options 799,000 516,000 899,000 541,000
----------- --------- ---------- ----------
Weighted average common shares outstanding, assuming dilution 9,517,000 9,595,000 9,443,000 9,647,000
=========== ========= ========== ==========
In accordance with SFAS No. 123(R), the Company adjusts share-based
compensation on a quarterly basis for changes to the estimate of expected
equity award forfeitures based on actual forfeiture experience. The effect
of adjusting the forfeiture rate for all expense amortization after
February 1, 2006 will be recognized in the period the forfeiture estimate
is changed. The effect of forfeiture adjustments in the six months ended
July 31, 2006 was immaterial.
Under the provisions of SFAS No. 123(R), $552,000 has been recorded as a
credit to common stock. During the six months ended July 31, 2006, the tax
benefit realized for the tax deduction from option exercises totaled
$234,000. As of August 1, 2006, there was $575,000 of total unrecognized
compensation costs related to stock options granted under the Company's
equity incentive plans. The unrecognized compensation cost is expected to
be recognized over a weighted average period of 42 months.
Pro forma information required under SFAS No. 123 for periods prior to
fiscal 2007 as if the Company had applied the fair value recognition
provisions of SFAS No. 123, to options granted under the Company's equity
incentive plans was as follows:
9
Six Months Ended Three Months Ended
July 31, 2005 July 31, 2005
-------------------------------------
Net income, as reported $ 1,202,000 $ 468,000
Less: total share-based employee compensation determined under
the fair value method for all awards, net of tax 217,000 99,000
-------------------------------------
Pro forma net income $ 985,000 $ 369,000
=====================================
Reported basic earnings per common share $ 0.13 $ 0.05
=====================================
Pro forma basic earnings per common share $ 0.11 $ 0.04
=====================================
Reported diluted earnings per common share $ 0.13 $ 0.05
=====================================
Pro forma diluted earnings per common share $ 0.10 $ 0.04
=====================================
The Company has two employee incentive stock option plans: the "2002 stock
option plan" and the "1994 stock option plan." The Company presented a new
equity incentive plan for shareholder vote at its June 29, 2006 annual
shareholders' meeting and it was approved by the shareholders. This new
equity incentive plan replaced the 2002 stock option plan, which was
terminated early and no further options will be granted under it.
A total of 300,000 new shares of common stock were reserved for issuance
under the new equity incentive plan.
Outstanding options under the 2002 and the 1994 stock option plans are
exercisable at 100% or more of fair market (as determined by the
compensation committee of the Board of Directors) at the date of grant.
The options are contingent upon continued employment and are exercisable,
unless otherwise specified, on a cumulative basis of one-fourth of the
total shares each year, commencing one year from the date of grant.
Options currently expire five to ten years from the date of grant.
Proceeds received by the Company from the exercises are credited to common
stock. Additional information with respect to the option plans as of July
31, 2006 is as follows:
Six months ended
July 31, 2006
-----------------------------
Weighted Avg.
Shares Exercise Price
-----------------------------
Beginning Balance 2,167,445 $3.78
Grants -- --
Exercises (152,720) 3.03
Canceled or expired (24,075) 3.74
-----------------------------
Ending balance 1,990,650 $3.84
=============================
Reserve for future grants at 7/31/2006 -- --
Exercisable 1,621,412 $3.67
=============================
The range of exercise prices for options outstanding at July 31, 2006 was
$1.35 to $7.00. The range of exercise prices for options is wide due
primarily to the fluctuating price of the Company's stock over the period
of the grants.
10
The following table summarizes information about options outstanding at
July 31, 2006:
Weighted Avg.
Range of exercise Outstanding at Remaining contract Weighted Avg. Number Weighted Avg.
prices July 31, 2006 life in yrs. Exercise Price Exercisable Exercise Price
- ---------------------------------------------------------------------------------------------------------------------
$1.00 to $2.00 123,250 5.3 $ 1.61 123,250 $ 1.61
$2.01 to $3.00 613,319 4.2 $ 2.62 597,069 $ 2.61
$3.01 to $4.00 213,283 3.3 $ 3.30 212,783 $ 3.30
$4.01 to $5.00 661,075 7.3 $ 4.61 340,837 $ 4.60
$5.01 to $6.00 345,306 3.1 $ 5.42 313,056 $ 5.45
$6.01 to $7.00 34,417 2.1 $ 6.36 34,417 $ 6.36
----------------- --------------
1,990,650 1,621,412
================= ==============
These options will expire if not exercised at specific dates ranging from
September 2006 to December 2015. During the six months ended July 31,
2006, 152,720 options were exercised at prices from $1.35 to $5.50 per
share.
10. Repurchase of Common Stock
On March 28, 2006, the Company exercised an option to repurchase 792,266
shares of its common stock from an executive officer and director of the
Company. The total cash purchase price of $3,893,000, or $4.914 per share,
represented the average closing price of the Company's common stock for
the five trading days prior to the option exercise date minus 10%, in
accordance with an agreement between the Company and the executive officer
and director entered into in September 2001. The shares repurchased in
this private transaction represented approximately 8.6% of the Company's
outstanding common stock on the date of exercise.
On March 29, 2006, the Company entered into an agreement with its banks,
Comerica Bank and First Bank (together, the "Banks"), to expand the
existing credit facility by $3.9 million effective March 29, 2006.
Interest is at the bank's prime rate less 25 basis points or at the Libor
rate, at the election of the Company. Principal and interest payments are
due monthly until the loan matures on March 29, 2010. The Company entered
into the credit facility to fund the repurchase of the 792,266 shares
discussed above.
11. Acquisitions of Businesses
On April 12, 2006, NQA, USA, a 50% owned consolidated subsidiary of NTS,
acquired the existing business of American International Registrars
Corporation ("AIR"), located in Ventura, California, for a total purchase
price of $386,000, payable in cash. All existing AIR clients and
associated certifications and backlog were transferred to NQA, USA. The
purchase was recorded $105,000 to customer relationships and $281,000 to
goodwill.
On June 9, 2006, NTS Technical Systems, a wholly owned subsidiary of NTS,
acquired the assets and the existing business of B & B Technologies, Inc.
(BBT), a systems integration firm headquartered in Albuquerque, New Mexico
for a total purchase price of $1,038,000, payable in cash and 83,243
shares in NTS common stock, valued using the closing price of the
Company's stock. BBT designs and integrates test, measurement, automation,
data acquisition and control systems utilizing diverse hardware platforms,
operating systems, and instrumentation standards. The results of
operations of the acquired business are included in the accompanying
consolidated statement of operations from June 9, 2006 to July 31, 2006.
11
The preliminary allocation of the purchase price of BBT was as follows:
Purchase price:
---------------
Cash $ 3,000
Accounts receivable 248,000
Inventory 35,000
Property, plant and equipment 108,000
Prepaid expenses 33,000
Goodwill 977,000
Accounts payable (232,000)
Other assumed liabilities (134,000)
------------
Purchase price $ 1,038,000
============
Cash flow:
----------
Purchase price $ 1,038,000
Common stock issued (648,000)
Cash acquired (3,000)
The purchase price allocations for AIR and BBT have not yet been
finalized.
12. Recent Accounting Pronouncements
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections." SFAS No. 154 replaces APB Opinion No. 20, "Accounting
Changes," and SFAS No. 3, "Reporting Accounting Changes in Interim
Financial Statements," and is effective for fiscal years beginning after
December 15, 2005, i.e. fiscal year ending January 31, 2007. SFAS No. 154
requires retrospective application to prior periods' financial statements
of changes in accounting principle, unless it is impracticable to
determine either the period-specific effects or the cumulative effect of
the change. The Company does not expect the adoption of SFAS No. 154 to
have a material impact on its condensed consolidated financial statements.
In June 2006, the Financial Accounting Standards Board issued
Interpretation No. 48, "Accounting for Uncertainty in Income Taxes", an
interpretation of FAS109, Accounting for Income Taxes (FIN 48), to create
a single model to address accounting for uncertainty in tax positions. FIN
48 clarifies the accounting for income taxes, by prescribing a minimum
recognition threshold a tax position is required to meet before being
recognized in the financial statements. FIN 48 also provides guidance on
derecognition, measurement, classification, interest and penalties,
accounting in interim periods, disclosure and transition. FIN 48 is
effective for fiscal years beginning after December 15, 2006. The Company
will adopt FIN 48 effective February 1, 2007, as required. The cumulative
effect of adopting FIN 48, if any, will be recorded in retained earnings
and other accounts as applicable. The Company does not expect that the
adoption of FIN 48 will have a significant impact on the Company's
financial position, cash flows, or results of operations.
13. Subsequent events
On August 1, 2006, the Company acquired the assets and the existing
business of Dynamic Labs, an EMI and environmental testing laboratory with
locations in Phoenix, Arizona and Austin, Texas. The Phoenix laboratory
offers EMI, environmental and dynamics testing for the aerospace and
defense industries, The Austin facility also offers aerospace,
environmental, and dynamic testing. The Phoenix facility will be relocated
to the NTS Tempe, Arizona laboratory and the Austin facility will be
relocated to NTS Plano, Texas laboratory and other NTS laboratories.
12
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, solutions
and certification services, the Company provides its customers the ability to
sell their products globally and enhance their overall competitiveness. NTS is
accredited by numerous national and international technical organizations which
allow the Company to have its test data accepted in most countries.
The Company operates 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 in world markets. 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 three and six month
periods ended July 31.
13
RESULTS OF OPERATIONS
- ---------------------
REVENUES
Six months ended July 31, 2006 % Change 2005 Diff
-----------------------------------------------
(Dollars in thousands)
Engineering & Evaluation $ 38,354 11.2% $ 34,502 $ 3,852
Technical Solutions 18,235 (7.4)% 19,697 (1,462)
-------- -----------------------
Total revenues $ 56,589 4.4% $ 54,199 $ 2,390
======== =======================
For the six months ended July 31, 2006, consolidated revenues increased by
$2,390,000 or 4.4% when compared to the same period in fiscal 2006.
Engineering & Evaluation:
For the six months ended July 31, 2006, Engineering and Evaluation
revenues increased by $3,852,000 or 11.2% when compared to the same period in
fiscal 2006, primarily due to additional revenues of $718,000 from the
acquisition on June 9, 2006 of B&B Technologies, an engineering systems
integration company located in Albuquerque, New Mexico, $1.5 million in
increased aerospace revenues from the Santa Clarita laboratory as a result of
the enhanced capability and capacity at that facility and increases in overall
revenues from telecommunications, electronics and registration markets. These
increases were partially offset by a decrease in the transportation testing
business.
Technical Solutions:
For the six months ended July 31, 2006, Technical Solutions revenues
decreased by $1,462,000 or 7.4% when compared to the same period in fiscal 2006,
as a result of the lower demand in outplacement services and permanent
placements in the general IT service business, primarily due to increased price
compression in this market and competition from off-shore companies.
GROSS PROFIT
Six months ended July 31, 2006 % Change 2005 Diff
-----------------------------------------------
(Dollars in thousands)
Engineering & Evaluation $ 9,762 0.4% $ 9,726 $ 36
% to segment revenue 25.5% 28.2% -2.7%
Technical Solutions 3,055 (1.8)% 3,111 (56)
% to segment revenue 16.8% 15.8% 1.0%
-------- ----------------------
Total $ 12,817 (0.2)% $ 12,837 $ (20)
======== ======================
% to total revenue 22.6% 23.7% -1.0%
Total gross profit for the six months ended July 31, 2006 decreased by
$20,000 or 0.2% when compared to the same period in fiscal 2006.
Engineering & Evaluation:
For the six months ended July 31, 2006, gross profit for the Engineering &
Evaluation Group increased by $36,000 or 0.4% and gross profit as a percentage
of revenues decreased by 2.7% when compared to the same period in fiscal 2006,
primarily due to the continued weakness in the automotive industry, program
delays at the Camden, Arkansas facility and the continued reduction in gross
margin at the Company's New Jersey and Santa Rosa, California facilities as a
result of the investments made for expansion at these facilities and not
achieving the desired revenues. However the Company expects the performance at
these facilities to improve due to the increased capacity and capability. Gross
profit was also impacted by high energy costs, particularly at the Santa
Clarita, California facility and losses from one program at Santa Clarita due to
contractual issues. The performance at the Company's Fullerton, California
facility was negatively impacted during the second quarter as a result of a
quality system deficiency in the Company's "NEBS" (Network Equipment Building
Specification) testing under the "ITL" (Independent Test Laboratory) program and
suspended testing under this program. The testing has recently been reinstated
after the Company took the necessary corrective
14
actions. Additionally, share-based compensation expense included in cost of
sales for the six months ended July 31, 2006 was $80,000, compared with no
share-based compensation expense in fiscal 2006.
Technical Solutions:
For the six months ended July 31, 2006, gross profit decreased by $56,000
or 1.8% in the Technical Solutions Group when compared to the same period in
fiscal 2006. This decrease was due to the lower revenues discussed above. Gross
profit as a percentage of revenues increased to 16.8% from 15.8% when compared
to the same period in the prior year.
SELLING, GENERAL & ADMINISTRATIVE
Six months ended July 31, 2006 % Change 2005 Diff
-----------------------------------------------
(Dollars in thousands)
Engineering & Evaluation $ 8,182 12.4% $ 7,281 $ 901
% to segment revenue 21.3% 21.1% 0.2%
Technical Solutions 2,975 (2.6)% 3,054 (79)
% to segment revenue 16.3% 15.5% 0.8%
-------- ----------------------
Total $ 11,157 8.0% $ 10,335 $ 822
======== ======================
% to total revenue 19.7% 19.1% 0.6%
Total selling, general and administrative expenses increased $822,000 or
8.0% for the six months ended July 31, 2006 when compared to the same period in
fiscal 2006.
Engineering & Evaluation:
For the six months ended July 31, 2006, selling, general and
administrative expenses increased by $901,000 or 12.4% when compared to the same
period in fiscal 2006, primarily due to the effects of share-based compensation
expense resulting from the application of SFAS No. 123(R) and increased use of
outside services related to the improvement of the Company's internal IT
infrastructure and data automation and increased travel and conference expenses.
Technical Solutions:
For the six months ended July 31, 2006, selling, general and
administrative expenses decreased by $79,000 or 2.6% when compared to the same
period in fiscal 2006, 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 six months ended July 31, 2006, equity income from XXCAL Japan was
$135,000, compared to $112,000 for the same period in fiscal 2006. 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
Six months ended July 31, 2006 % Change 2005 Diff
-----------------------------------------------
(Dollars in thousands)
Engineering & Evaluation $ 1,715 (32.9)% $ 2,557 $ (842)
% to segment revenue 4.5% 7.4% (2.9)%
Technical Solutions 80 40.4% 57 23
% to segment revenue 0.4% 0.3% 0.1%
-------- ----------------------
Total $ 1,795 (31.3)% $ 2,614 $ (819)
======== ======================
% to total revenue 3.2% 4.8% -1.7%
Operating income for the six months ended July 31, 2006 decreased by
$819,000 or 31.3% when compared to the same period in fiscal 2006.
Engineering & Evaluation:
For the six months ended July 31, 2006, operating income in the
Engineering & Evaluation Group decreased by $842,000 or 32.9% when compared to
the same period in fiscal 2006, primarily as a result of the decrease in gross
profit and the increase in selling, general and administrative expenses,
partially offset by the increase in equity income from non-consolidated
subsidiary.
Technical Solutions:
For the six months ended July 31, 2006, operating income in the Technical
Solutions Group increased by $23,000 or 40.4% when compared to the same period
in fiscal 2006, as a result of the decrease in selling, general and
administrative expenses, partially offset by the decrease in gross profit
discussed above.
INTEREST EXPENSE
Net interest expense increased by $165,000 to $812,000 in the six months
ended July 31, 2006 when compared to the same period in fiscal 2006. This
increase was principally due to higher interest rate levels for the six months
ended July 31, 2006 and higher average debt balances for the six months ended
July 31, 2006 when compared to the same period last year.
OTHER INCOME
Other income increased by $113,000 to $129,000 in the six months ended
July 31, 2006 when compared to the same period in fiscal 2006, primarily due to
the reduction in deferred compensation expense.
INCOME TAXES
The income tax provision rate of 42.6% for the six months ended July 31,
2006 is higher than the 37.1% income tax rate in the prior year, primarily due
to non-deductible share-based compensation expense recorded for the six months
ended July 31, 2006 as compared to none for the same period in the prior year.
This rate is based on the estimated provision accrual for fiscal year ending
January 31, 2007. Management has determined that it is more likely than not that
the deferred tax assets will be realized on the basis of offsetting them against
the reversal of deferred tax liabilities. 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 six months ended July 31, 2006 was $599,000, a decrease
of $603,000 compared to the same period in fiscal 2006. This decrease was
primarily due to the lower operating income, higher interest expense, higher
income tax rate, partially offset by higher other income and lower minority
interest expense.
16
The following information is based upon results for National Technical
Systems, Inc. for the three months ended July 31.
RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
- ---------------------
REVENUES
Three months ended July 31, 2006 % Change 2005 Diff
-----------------------------------------------
(Dollars in thousands)
Engineering & Evaluation $ 19,230 11.6% $ 17,231 $ 1,999
Technical Solutions 9,208 (3.3)% 9,524 (316)
-------- -----------------------
Total revenues $ 28,438 6.3% $ 26,755 $ 1,683
======== =======================
For the three months ended July 31, 2006, consolidated revenues increased
by $1,683,000 or 6.3% when compared to the same period in fiscal 2006.
Engineering & Evaluation:
For the three months ended July 31, 2006, Engineering and Evaluation
revenues increased by $1,999,000 or 11.6% when compared to the same period in
fiscal 2006, primarily due to additional revenues of $718,000 from the
acquisition on June 9, 2006 of B&B Technologies, an engineering systems
integration company located in Albuquerque, New Mexico, $610,000 in increased
aerospace revenues from the Santa Clarita laboratory as a result of the enhanced
capability and capacity at that facility and increases in overall revenues from
telecommunications, electronics and registration markets. These increases were
partially offset by a decrease in the transportation testing business.
Technical Solutions:
For the three months ended July 31, 2006, Technical Solutions revenues
decreased by $316,000 or 3.3% when compared to the same period in fiscal 2006,
as a result of the lower demand in outplacement services and permanent
placements in the general IT service business, primarily due to increased price
compression in this market and competition from off-shore companies.
GROSS PROFIT
Three months ended July 31, 2006 % Change 2005 Diff
-----------------------------------------------
(Dollars in thousands)
Engineering & Evaluation $ 4,928 5.0% $ 4,695 $ 233
% to segment revenue 25.6% 27.2% -1.6%
Technical Solutions 1,651 6.9% 1,544 107
% to segment revenue 17.9% 16.2% 1.7%
-------- ----------------------
Total $ 6,579 5.4% $ 6,239 $ 340
======== ======================
% to total revenue 23.1% 23.3% -0.2%
Total gross profit for the three months ended July 31, 2006 increased by
$340,000 or 5.4% when compared to the same period in fiscal 2006.
Engineering & Evaluation:
For the three months ended July 31, 2006, gross profit for the Engineering &
Evaluation Group increased by $233,000 or 5.0% when compared to the same period
in fiscal 2006, primarily as a result of the increase in revenues discussed
above. Gross profit as a percentage of revenues decreased by 1.6% for the three
months ended July 31, 2006, compared with the same period last year. This
decrease was primarily due to the continued weakness in the automotive industry,
program delays at the Camden, Arkansas facility and the continued reduction in
gross margin at the Company's New Jersey and Santa Rosa, California facilities
as a result of the investments made for expansion at these facilities and not
achieving the desired revenues. However the Company expects the performance at
these facilities to improve due to the increased
17
capacity and capability. Gross profit was also impacted by high energy costs,
particularly at the Santa Clarita, California facility and losses from one
program at Santa Clarita due to contractual issues. The performance at the
Company's Fullerton, California facility was negatively impacted during the
second quarter as a result of a quality system deficiency in the Company's
"NEBS" (Network Equipment Building Specification) testing under the "ITL"
(Independent Test Laboratory) program and suspended testing under this program.
The testing has recently been reinstated after the Company took the necessary
corrective actions. Additionally, share-based compensation expense included in
cost of sales for the three months ended July 31, 2006 was $38,000, compared
with no share-based compensation expense in fiscal 2006.
Technical Solutions:
For the three months ended July 31, 2006, gross profit increased by
$107,000 or 6.9% in the Technical Solutions Group when compared to the same
period in fiscal 2006. This increase was due to the increased focus in
specialized compliance and engineering support services which generally produce
higher margins. Gross profit as a percentage of revenues increased for the three
months ended July 31, 2006 to 17.9% from 16.2% for the same period in the prior
year.
SELLING, GENERAL & ADMINISTRATIVE
Three months ended July 31, 2006 % Change 2005 Diff
-----------------------------------------------
(Dollars in thousands)
Engineering & Evaluation $ 4,214 17.6% $ 3,582 $ 632
% to segment revenue 21.9% 20.8% 1.1%
Technical Solutions 1,533 (0.3)% 1,538 (5)
% to segment revenue 16.6% 16.1% 0.5%
-------- ----------------------
Total $ 5,747 12.2% $ 5,120 $ 627
======== ======================
% to total revenue 20.2% 19.1% 1.1%
Total selling, general and administrative expenses increased $627,000 or
12.2% for the three months ended July 31, 2006 when compared to the same period
in fiscal 2006.
Engineering & Evaluation:
For the three months ended July 31, 2006, selling, general and
administrative expenses increased by $632,000 or 17.6% when compared to the same
period in fiscal 2006, primarily due to the effects of share-based compensation
resulting from the application of SFAS No. 123(R) and increased use of outside
services related to the improvement of the Company's internal IT infrastructure
and data automation and increased travel and conference expenses.
Technical Solutions:
For the three months ended July 31, 2006, selling, general and
administrative expenses decreased by $5,000 or 0.3% when compared to the same
period in fiscal 2006, 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 three months ended July 31, 2006, equity income from XXCAL Japan
was $60,000, compared $35,000 for the same period in fiscal 2006. XXCAL Japan is
50% owned by NTS and is accounted for under the equity method since NTS does not
have management or board control.
18
OPERATING INCOME
Three months ended July 31, 2006 % Change 2005 Diff
-----------------------------------------------
(Dollars in thousands)
Engineering & Evaluation $ 774 (32.6)% $ 1,148 $ (374)
% to segment revenue 4.0% 6.7% (2.6)%
Technical Solutions 118 1866.7% 6 112
% to segment revenue 1.3% 0.1% 1.2%
------- ----------------------
Total $ 892 (22.7)% $ 1,154 $ (262)
======= ======================
% to total revenue 3.1% 4.3% -1.2%
Operating income for the three months ended July 31, 2006 decreased by $262,000
or 22.7% when compared to the same period in fiscal 2006.
Engineering & Evaluation:
For the three months ended July 31, 2006, operating income in the
Engineering & Evaluation Group decreased by $374,000 or 32.6% when compared to
the same period in fiscal 2006, primarily as a result of the increase in
selling, general and administrative expenses, partially offset by the increase
in gross profit and increase in equity income from non-consolidated subsidiary.
Technical Solutions:
For the three months ended July 31, 2006, operating income in the
Technical Solutions Group increased by $112,000 when compared to the same period
in fiscal 2006, as a result of the increase in gross profit and the decrease in
selling, general and administrative expenses discussed above.
INTEREST EXPENSE
Net interest expense increased by $122,000 to $451,000 in the three months
ended July 31, 2006 when compared to the same period in fiscal 2006. This
increase was principally due to higher interest rate levels for the three months
ended July 31, 2006 and the higher average debt balances for the three months
ended July 31, 2006 when compared to the same period last year.
OTHER INCOME
Other income increased by $107,000 to $123,000 in the three months ended
July 31, 2006 when compared to the same period in fiscal 2006, primarily due to
the reduction in deferred compensation expense.
INCOME TAXES
The income tax provision rate of 47.9% for the three months ended July 31,
2006 is higher than the 39.8% income tax rate in the prior year, primarily due
to non-deductible share-based compensation expense and certain other
non-deductible expenses recorded for the three months ended July 31, 2006 as
compared to none for the same period in the prior year. 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
assets will be realized on the basis of offsetting them against the reversal of
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 July 31, 2006 was $247,000, a
decrease of $221,000, compared to the same period in fiscal 2006. This decrease
was primarily due to the lower operating income, higher interest expense, higher
income tax rate and higher minority interest expense, partially offset by higher
other income.
19
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 generate approximately 60% of the
overall Engineering and Evaluation revenues. In recent years, domestic and
worldwide political and economic developments have impacted positively the
market demands for defense and advanced technology systems. Government R&D
funding specifically for defense has increased this year. Also, the increase in
government outsourcing activity has created additional opportunities for NTS.
The Company has ten fully equipped defense and aerospace environmental
simulation laboratories located throughout the United States and is well
equipped to handle this increase in demand. The Company has seen an increase in
demand for the evaluation of military equipment and weapons systems, which has
positively affected business at its laboratories. In addition, NASA Space
exploration R&D budgeting is up 6.2% this year. This increase in R&D should have
a positive impact on the aerospace test and evaluation business for the
foreseeable future. Currently the Company is experiencing a slight increase in
its aerospace business this year.
The trend in the telecommunications market appears to be stable in the
short term and growing in the future. Carriers are deploying voice, video and
data using fiber networks. This should increase the demand for certification of
suppliers' premises equipment, fiber component certification and certification
of additional central office equipment. The Company has been approved as an
Independent Test laboratory (ITL) by the regional bell operating companies
(RBOCs) to test and certify central office equipment developed by manufactures
to the Network Equipment Building Specifications (NEBS). The Company is
currently providing this service at Laboratories in California, Massachusetts,
Texas, Alberta, Canada and Germany. The Company has been approved as an (ITL) to
offer a complete suite of passive fiber components certifications and Digital
Subscriber Line (DSL) certification. This service currently is being provided at
laboratories in California. The Company expects an increase in business demand
as RBOCs upgrade networks packet-based Voice Over Internet Protocol (VOIP)
devices. 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 demand as carriers
begin to deploy "triple play" (voice, video, and broadband) offerings over FTTP
(fiber to the premises) passive fiber networks (PON). The Company recently
acquired a network architecture and interoperability laboratory in Northern
California. This laboratory was acquired to extend the Company's service
offering to handle the anticipated demand for interoperability testing and the
FTTP deployment.
The transportation market and power markets have been stable with the
Company continuing to experience a slight decrease in the transportation
business, while the Company continues to experience a slight increase in the
power business.
The computer and electronics markets have been stable. The Company
anticipates growth in these markets as it captures additional market share due
to the planned international expansion. NTS has signed cooperative agreements in
Taiwan and Korea with SGS and STC in Hong Kong and mainland China. The
cooperative agreements will focus on providing USB, USB on the go, Connector and
Zigbee certification to device manufacturers and industrial products
manufactured in Asia. The Company believes that the demand for these
certification activities will increase 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 and engineering. As the IT general services business went off-shore
and became treated as commodity by the larger organizations the Company deployed
a transformation strategy in 2003 which focused on meeting the anticipated
increase in demand for specialized IT, compliance, engineering support services
at Company locations as well as taking advantage of offshore opportunities. As
part of this transformation, the Company developed a proprietary database and
put in place a customer service team which maintains relationships and manages
the availability of the technical experts which support these specialized
services. The Company has also set up a test and compliance laboratory in
Vietnam to support the needs of a major US Fortune 500 computer company and to
take advantage of the low cost highly skilled labor in Vietnam. The Company is
now expanding this offshore offering to additional clients. TS continues to
differentiate itself from its competitors by using NTS' testing, engineering and
compliance capabilities to maximize its customers' return on human assets.
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.
20
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities of $522,000 in the six months
ended July 31, 2006 primarily consisted of net income of $599,000 adjusted for
non-cash items of $2,819,000 in depreciation and amortization, share based
compensation of $319,000, other non cash items of $230,000, partially offset by
changes in working capital of $3,445,000. Net cash provided by operating
activities in the six months ended July 31, 2005 was $2,615,000. Net cash
provided by operating activities decreased from the six months ended July 31,
2005 to the six months ended July 31, 2006 by $2,093,000, primarily as a result
of the increase in accounts receivable and the decrease in net income, accrued
expenses and income taxes payable.
Cash used for investing activities in the six months ended July 31, 2006
of $3,947,000 was attributable to capital spending of $3,083,000, cash used to
acquire American International Registrars Corporation ("AIR") of $386,000, cash
used to acquire B&B Technologies of $387,000 and investment in life insurance of
$91,000. Capital spending is generally comprised of purchases of machinery and
equipment, building, leasehold improvements, computer hardware, software and
furniture and fixtures. Cash used for investing activities in the six months
ended July 31, 2005 was $3,098,000.
Net cash provided by financing activities in the six months ended July 31,
2006 of $1,965,000 consisted of proceeds from borrowings of $10,292,000,
proceeds from stock options exercised of $424,000, partially offset by repayment
of debt of $4,858,000, and common stock repurchase of $3,893,000 from an
executive officer and director of the Company. Net cash used for financing
activities for the six months ended July 31, 2005 was $1,638,000.
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 maximum line of credit available 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. On March 29, 2006, the
Company increased the term loan by an additional $3,900,000 to fund the
repurchase of 792,266 shares of common stock from an executive officer and
director, as discussed above. The outstanding balance on the term loan at July
31, 2006 was $5,533,000. The outstanding balance on the revolving line of credit
at July 31, 2006 was $10,993,000. This balance is reflected in the accompanying
condensed consolidated balance sheets as long-term. The amount available on the
line of credit was $5,507,000 as of July 31, 2006. The amendment also includes
an additional equipment line of credit for $2,000,000. The outstanding balance
on the equipment line of credit at July 31, 2006 was $2,000,000. 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 at July
31, 2006. The Company is in the process of renewing its existing lines of credit
with its banks.
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 July 31,
2006 was $1,504,000. The balance of other notes payable collateralized by land
and building was $2,512,000 and the balance of unsecured notes was $38,000 at
July 31, 2006.
21
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes in the Company's quantitative and
qualitative market risk since the disclosure in the Company's Annual Report on
Form 10-K for the year ended January 31, 2006, filed with the Securities and
Exchange Commission on April 28, 2006.
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 were effective.
Changes in Internal Controls Over Financial Reporting
As required by Rule 13a-15(d), the Company's Chief Executive Officer and
Chief Financial Officer, with the participation of the Company's management,
also conducted an evaluation of the Company's internal controls over financial
reporting to determine whether any changes occurred during the six months ended
July 31, 2006 that have materially affected, or are reasonably likely to affect,
the Company's internal controls over financial reporting. Based on that
evaluation, there has been no such change during the six months ended July 31,
2006.
Limitations of the Effectiveness
A control system, no matter how well conceived and operated, can provide
only reasonable, not absolute, assurance that the objectives of the internal
control system are met. Because of the inherent limitations of any internal
control system, no evaluation of controls can provide absolute assurance that
all control issues, if any, within a company have been detected. Notwithstanding
these limitations, the Company's disclosure controls and procedures are designed
to provide reasonable assurance of achieving their objectives. The Company's
Chief Executive Officer and Chief Financial Officer have concluded that the
Company's disclosure controls and procedures are, in fact, effective at the
"reasonable assurance" level.
22
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
From time to time the Company may be involved in judicial or
administrative proceedings concerning matters arising in the ordinary
course of business. Management does not expect that any of these
matters, individually or in the aggregate, will have a material adverse
effect on the Company's business, financial condition, cash flows or
results of operation.
Item 1A. Risk Factors
There have been no material changes in the Company's risk factors since
the disclosure in the Company's Annual Report on Form 10-K for the year
ended January 31, 2006 filed with the Securities and Exchange
Commission on April 28, 2006.
Item 2. Unregistered Sales of Equity Securities
The Company issued .83,243 shares in NTS common stock in conjunction
with the acquisition of B&B Technologies, Inc. (see note 11). These
shares were issued pursuant to to the exemption provided in "Section
4(2)" of the securities act of 1933.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
At the Company's Annual Meeting of shareholders held on June 29, 2006, two
nominees of the Board of Directors were elected directors for three year
terms as Class I Directors expiring on the date of the annual meeting in
2009. The votes were as follows:
---------------------------------------------------------
For Withheld
---------------------------------------------------------
William McGinnis 7,131,256 827,681
---------------------------------------------------------
John Gibbons 7,239,081 719,856
---------------------------------------------------------
The shareholders of the Company voted to approve the adoption of the 2006
Equity Incentive Plan. The results of the vote of the shareholders were as
follows:
-------------------------------------------------------------------
For Against Abstain
-------------------------------------------------------------------
Approve the 2006 Equity
Incentive Plan 3,542,645 1,322,649 5,140
-------------------------------------------------------------------
The shareholders of the Company voted to ratify Ernst & Young LLP as
auditors for the year ending January 31, 2007. The results of the vote of
the shareholders were as follows:
-------------------------------------------------------------------
For Against Abstain
-------------------------------------------------------------------
Ratify Ernst & Young LLP as
auditors for the year ending
January 31, 2007 7,330,581 622,526 5,830
-------------------------------------------------------------------
Item 5. Other Information
None.
23
Item 6. Exhibits
3.3 - Bylaws of National Technical Systems, Inc., a California
corporation, as adopted on December 14, 2004.
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.
24
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: September 13, 2006 By: /s/ Lloyd Blonder
-------------------
Lloyd Blonder
Senior Vice President
Chief Financial Officer
(Signing on behalf of the
registrant and as principal
financial officer)
25