- -------------------------------------------------------------------------------
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, 1999
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 [ ]
The number of shares of common stock, no par value, outstanding as of
September 13, 1999 was 8,352,206.
Exhibit Index on Page 20
1
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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, 1999 (unaudited) and January 31, 1999 3
Unaudited Condensed Consolidated Statements of Income
For the Six Months Ended July 31, 1999 and 1998 4
Unaudited Condensed Consolidated Statements of Income
For the Three Months Ended July 31, 1999 and 1998 5
Unaudited Condensed Consolidated Statements of Cash Flows
For the Six Months Ended July 31, 1999 and 1998 6
Notes to the Unaudited Condensed Consolidated Financial
Statements 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 9
PART II. OTHER INFORMATION & SIGNATURE
Item 1. Legal Proceedings 18
Item 4. Submission of Matters to a Vote of Security Holders 18
Item 6. Exhibits and Reports on Form 8-K 18
2
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
July 31, January 31,
1999 1999
(unaudited)
------------ -----------
ASSETS
CURRENT ASSETS:
Cash $ 2,344,000 $ 2,599,000
Accounts receivable, less allowance for doubtful
accounts of $892,000 at July 31, 1999 and
$904,000 at January 31, 1999 20,790,000 20,120,000
Income taxes receivable 56,000 56,000
Inventories 2,192,000 1,640,000
Deferred tax assets 915,000 919,000
Prepaid expenses 1,295,000 1,099,000
------------ ------------
Total current assets 27,592,000 26,433,000
Property, plant and equipment, at cost 56,991,000 54,223,000
Less: accumulated depreciation 34,742,000 33,402,000
------------ ------------
Net property, plant and equipment 22,249,000 20,821,000
Property held for sale 544,000 544,000
Intangible assets, net 848,000 544,000
Other assets 1,566,000 1,489,000
------------ ------------
TOTAL ASSETS $ 52,799,000 $ 49,831,000
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 3,099,000 $ 3,493,000
Accrued expenses 4,774,000 3,785,000
Income taxes payable 257,000 113,000
Current installments of long-term debt 2,209,000 2,091,000
------------ ------------
Total current liabilities 10,339,000 9,482,000
Long-term debt, excluding current installments 13,956,000 13,076,000
Deferred income taxes, net 2,568,000 2,565,000
Deferred compensation 585,000 555,000
Minority interest 51,000 51,000
Commitments and contingencies
SHAREHOLDERS' EQUITY:
Common stock, no par value. Authorized, 20,000,000;
issued and outstanding 8,350,000 as of July 31,
1999 and 8,319,000 as of January 31, 1999 11,538,000 11,472,000
Retained earnings 13,748,000 12,631,000
Accumulated other comprehensive income 14,000 (1,000)
------------ ------------
Total shareholders' equity 25,300,000 24,102,000
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 52,799,000 $ 49,831,000
============ ============
See accompanying notes
3
<PAGE>
NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES
Unaudited Condensed Consolidated Statements of Income
for the Six Months Ended July 31, 1999 and 1998
1999 1998
------------ ------------
Revenues $ 43,882,000 $ 44,822,000
Cost of sales 31,206,000 32,477,000
------------ ------------
Gross profit 12,676,000 12,345,000
Selling, general and administrative expense 9,663,000 8,402,000
------------ ------------
Operating income 3,013,000 3,943,000
Other expense:
Interest expense, net (651,000) (603,000)
Merger costs - (361,000)
Other 26,000 17,000
------------ ------------
(625,000) (947,000)
------------ ------------
Income before income taxes and minority interest 2,388,000 2,996,000
Income taxes 955,000 1,044,000
------------ ------------
Income before minority interest 1,433,000 1,952,000
Minority interest - (9,000)
------------ ------------
Income before cumulative effect of change in
start-up costs 1,433,000 1,943,000
Cumulative effect of change in accounting for
start-up costs, net of tax - (95,000)
------------ ------------
Net income $ 1,433,000 $ 1,848,000
============ ============
Basic earnings (loss) per common share:
Income before cumulative effect of change for
start-up costs $ 0.17 $ 0.24
Cumulative effect of change for start-up costs,
net of tax - (0.01)
------------ ------------
Net income $ 0.17 $ 0.23
============ ============
Diluted earnings (loss) per common share:
Income before cumulative effect of change for
start-up costs $ 0.17 $ 0.23
Cumulative effect of change for start-up costs,
net of tax - (0.01)
------------ ------------
Net income $ 0.17 $ 0.22
============ ============
Weighted average common shares outstanding 8,329,000 8,174,000
Dilutive effect of stock options 235,000 369,000
------------ ------------
Weighted average common shares outstanding,
assuming dilution 8,564,000 8,543,000
============ ============
See accompanying notes
4
<PAGE>
NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES
Unaudited Condensed Consolidated Statements of Income
for the Three Months Ended July 31, 1999 and 1998
1999 1998
------------ ------------
Revenues $ 22,063,000 $ 23,153,000
Cost of sales 15,640,000 16,833,000
------------ ------------
Gross profit 6,423,000 6,320,000
Selling, general and administrative expense 4,996,000 4,245,000
------------ ------------
Operating income 1,427,000 2,075,000
Other expense:
Interest expense, net (325,000) (315,000)
Merger costs - (361,000)
Other 32,000 19,000
------------ ------------
(293,000) (657,000)
------------ ------------
Income before income taxes and minority interest 1,134,000 1,418,000
Income taxes 453,000 520,000
------------ ------------
Income before minority interest 681,000 898,000
Minority interest 4,000 (2,000)
------------ ------------
Income before cumulative effect of change for
start-up costs 685,000 896,000
Cumulative effect of change in accounting for
start-up costs, net of tax - (95,000)
------------ ------------
Net income 685,000 801,000
============ ============
Basic earnings (loss) per common share:
Income before cumulative effect of change for
start-up costs $ 0.08 $ 0.11
Cumulative effect of change for start-up costs,
net of tax - (0.01)
------------ ------------
Net income $ 0.08 $ 0.10
============ ============
Diluted earnings (loss) per common share:
Income before cumulative effect of change for
start-up costs $ 0.08 $ 0.11
Cumulative effect of change for start-up costs,
net of tax - (0.01)
------------ ------------
Net income $ 0.08 $ 0.09
============ ============
Weighted average common shares outstanding 8,337,000 8,180,000
Dilutive effect of stock options 261,000 291,000
------------ ------------
Weighted average common shares outstanding,
assuming dilution 8,598,000 8,471,000
============ ============
See accompanying notes.
5
<PAGE>
NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES
Unaudited Condensed Consolidated Statements of Cash Flows
for the Six Months Ended July 31, 1999 and 1998
1999 1998
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income $ 1,433,000 $ 1,848,000
Adjustments to reconcile net income to cash
provided by operating activities:
Depreciation and amortization 1,579,000 1,398,000
Provision for losses on receivables (recoveries) 12,000 (103,000)
Loss on retirement of assets - 63,000
Earnings from merged entity not included in net
income - 181,000
Undistributed earnings of affiliate - 9,000
Deferred income taxes 7,000 16,000
Changes in assets and liabilities:
Accounts receivable (682,000) (649,000)
Inventories (552,000) (125,000)
Prepaid expenses (196,000) (357,000)
Other assets and intangibles (77,000) (287,000)
Accounts payable (394,000) (848,000)
Accrued expenses 989,000 779,000
Unearned revenue - (14,000)
Deferred compensation 30,000 (280,000)
Comprehensive income 4,000 -
Income taxes 125,000 319,000
----------- -----------
Net cash provided by operating activities 2,278,000 1,950,000
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property, plant and equipment (2,936,000) (2,058,000)
Investment in new business (375,000) -
----------- -----------
Net cash used for investing activities (3,311,000) (2,058,000)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from current and long-term debt 2,546,000 3,229,000
Repayments of current and long-term debt (1,548,000) (3,117,000)
Cash dividends paid (166,000) -
Distributions paid (120,000) (15,000)
Proceeds from stock options exercised 66,000 29,000
----------- -----------
Net cash provided by financing activities 778,000 126,000
----------- -----------
Net increase (decrease) in cash (255,000) 18,000
Beginning cash balance 2,599,000 2,510,000
----------- -----------
ENDING CASH BALANCE $ 2,344,000 $ 2,528,000
=========== ===========
See accompanying notes
6
<PAGE>
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 generally accepted accounting principles.
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, 1999.
On October 30, 1998, NTS completed its merger with XXCAL, Inc. and
acquisition of XXCAL Limited (together, "XXCAL"). All prior year financial
statements have been restated to reflect the pooling of interests method
of accounting pursuant to Opinion No. 16 of the Accounting Principles
Board (APB 16).
The statements presented as of and for the six months and three months
periods ended July 31, 1999 and 1998 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. Certain prior year amounts have been reclassified to
conform with the current year presentation.
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. However, the
combined tax provision is less than the expected statutory rate for the
six months and three months ended July 31, 1998 as XXCAL had elected to be
taxed as an S Corporation for the period preceding the merger.
3. Comprehensive Income
In fiscal 1999, the Company adopted Statement No. 130, "Reporting
Comprehensive Income" (SFAS No. 130). SFAS No.130 establishes new rules
for the reporting and display of comprehensive income and its components.
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, 1999
and 1998 total comprehensive income was $1,448,000 and $1,848,000,
respectively. For the three months ended July 31, 1999 and 1998 total
comprehensive income was $689,000 and $801,000, respectively. The reported
amount for total comprehensive income differs from net income due to
foreign currency translation adjustments.
7
<PAGE>
4. Segment Information
In fiscal 1999, the Company adopted Statement No. 131, "Disclosures about
Segments of an Enterprise and Related Information" (SFAS No.131). SFAS
No.131 supersedes Statement of Financial Accounting Standards No. 14,
"Financial Reporting for Segments of a Business Enterprise" replacing the
industry segment approach with the management approach. The management
approach designates the internal organization that is used by management
for making operating decisions and assessing performance as the source of
the Company's reportable segments. SFAS No.131 also requires disclosures
about products and services, geographic areas and major customers. The
adoption of SFAS No.131 did not affect results of operations or the
financial position of the Company. Management has reorganized the business
among the two core segments: Engineering and Evaluation Group consisting
of testing activities and IT Solutions Group consisting of the staff
augmentation activities. Certain historical segment information was
restated to properly reflect the management approach described above.
5. 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.
6. Interest and Taxes
Cash paid for interest and taxes for the six months ended July 31, 1999
was $626,000 and $852,000, respectively. Cash paid for interest and taxes
for the six months ended July 31, 1998 was $620,000 and $634,000,
respectively.
7. Minority Interest
Minority interest in the Company's NQA-USA, Inc. subsidiary is a result of
50% of the stock of NQA-USA, Inc. being issued to National Quality
Assurance, Ltd. Profits and losses are allocated 62% to NTS, Inc. and 38%
to National Quality Assurance, Ltd for the fiscal year ending January 31,
2000.
8. Dividends
On January 26, 1999, the Company's Board of Directors adopted a regular
annual dividend policy and declared an initial annual dividend of $0.04
per share, payable semi-annually. The initial semi-annual dividend of
$0.02 per share was paid on March 2, 1999 to shareholders of record at the
close of business on February 15, 1999. The second semi-annual dividend of
$0.02 per share was paid on August 4, 1999 to shareholders of record at
the close of business on July 15, 1999. In addition, On June 14, 1999, the
Company's Board of Directors declared a special cash dividend of $0.03 per
share which was paid on August 4, 1999 to shareholders of record at the
close of business on July 15, 1999 which brought the total cash dividends
for the twelve months ending August 4, 1999, to $0.07 per share.
In the prior year, the Company paid a cash dividend of $.07 per share on
August 4, 1998 to shareholders of record on July 15, 1998.
8
<PAGE>
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 following discussion should be read in conjunction with the
consolidated quarterly financial statements and notes thereto. All information
is based upon operating results of National Technical Systems, Inc. for the six
months ended July 31. All prior year financial statements have been restated to
reflect the pooling of interests method of accounting. They include the combined
financial statements of NTS and XXCAL.
RESULTS OF OPERATIONS
- ---------------------
REVENUES
Six months ended July 31, 1999 % Change 1998
(Dollars in thousands)
-----------------------------------
Engineering & Evaluation $25,358 (4.2)% $26,480
IT Solutions 18,524 1.0% 18,342
----------- ------------
Total revenues $43,882 (2.1)% $44,822
=========== ============
For the six months ended July 31, 1999, consolidated revenues decreased by
$940,000 or 2.1% when compared to the same period in 1998.
Engineering & Evaluation:
- -------------------------
In 1999, the Engineering and Evaluation segment revenues decreased by $1,122,000
or 4.2% primarily due to a decline in automotive and defense testing, partially
offset by an increase from telecommunications and computer hardware testing. The
decline in automotive and defense was primarily caused by delays in development
progress on certain major new projects. In addition, some of the Company's
aerospace customers are now retaining programs in-house and government
laboratories are becoming more aggressive in competing with private industry for
programs, thus increasing the pressure on revenue growth. The increase in
telecommunications and computer testing is a direct result of the strategic
focus by the Company on that fast growing market.
9
<PAGE>
IT Solutions:
- -------------
Revenues in the IT Solutions segment increased by $182,000 or 1.0% which was
affected by declining revenues during the second quarter of this fiscal year
primarily due to increased competition as more technical employees that were
hired for the Year 2000 project are becoming available.
GROSS PROFIT
Six months ended July 31, 1999 % Change 1998
(Dollars in thousands)
------------------------------
Engineering & Evaluation $7,750 1.2% $7,657
% to segment revenue 30.6% 28.9%
IT Solutions 4,926 5.1% 4,688
% to segment revenue 26.6% 25.6%
--------- ---------
Total gross profit $12,676 2.7% $12,345
========= =========
% to total revenue 28.9% 27.5%
Total gross profit for the six months ended July 31, 1999 increased by $331,000
or 2.7% when compared to the same period in 1998.
Engineering & Evaluation:
- -------------------------
Gross profit for the Engineering & Evaluation Group increased by $93,000 or 1.2%
for the six months ended July 31, 1999 when compared to the same period in 1998,
even though revenues decreased by 4.2%. This was due to the higher margin
contracts for testing telecommunications, network equipment and computer
testing. The increase in gross profit was partially offset by the decrease in
the Company's automotive and defense testing.
IT Solutions
- ------------
Gross profit as a percentage of net revenues in 1999 increased by $238,000 or
5.1% in the IT Solutions Group when compared to the same period in 1998 due to
overall higher gross margins as a percent of revenue.
SELLING, GENERAL & ADMINISTRATIVE
Six months ended July 31, 1999 % Change 1998
(Dollars in thousands)
--------------------------------
Engineering & Evaluation $4,877 19.5% $4,082
% to segment revenue 19.2% 15.4%
IT Solutions 4,786 10.8% 4,320
% to segment revenue 25.8% 23.6%
--------- ---------
Total S G & A $9,663 15.0% $8,402
========= =========
% to total revenue 22.0% 18.7%
Total selling, general and administrative expenses increased $1,261,000 or 15.0%
for the six months ended July 31, 1999 when compared to the same period in 1998.
10
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Engineering & Evaluation:
- -------------------------
The increase in the Engineering & Evaluation segment was due to efforts to
expand the base of business into new technology areas by engaging specialists in
these new areas to offset the declining opportunities in the Company's
traditional testing business. The Company is redirecting some of its sales
efforts to procure larger evaluation programs which require a greater depth of
technical knowledge. Thus, the Company has hired several such specialists which
has caused selling expenses to increase in advance of achieving results from
their work.
IT Solutions:
- -------------
The increase in the IT Solutions segment was due primarily to costs related to
the planned expansion of the sales and marketing capabilities through new
marketing programs and expansion efforts in new markets.
OPERATING INCOME
Six months ended July 31, 1999 % Change 1998
(Dollars in thousands)
---------------------------------
Engineering & Evaluation $2,873 (19.6)% $3,575
% to segment revenue 11.3% 13.5%
IT Solutions 140 (62.0)% 368
% to segment revenue 0.8% 2.0%
--------- ----------
Total S G & A $3,013 (23.6)% $3,943
========= ==========
% to total revenue 6.9% 8.8%
Operating income for the six months ended July 31, 1999 decreased by $930,000
when compared to the same period in1998.
Operating income for the six months ended July 31, 1999 for the Engineering &
Evaluation Group decreased by $702,000 when compared to the same period in 1998
primarily as a result of the net decreases in revenues and increases in selling,
general and administrative expenses.
Operating income for the six months ended July 31, 1999 decreased by $228,000 in
the IT Solutions Group when compared to the same period in 1998 primarily as a
result of the increases in selling, general and administrative expenses.
INTEREST EXPENSE
Net interest expense increased $48,000 in the six months ended July 31, 1999
when compared to the same period in 1998. This increase was principally due to
higher average debt balances for the six months ended July 31, 1999, when
compared to the same period last year.
11
<PAGE>
INCOME TAXES
The income tax provisional rate of 40.0% for the six months ended July 31, 1999
reflects a rate in excess of the U.S. federal statutory rate primarily due to
the inclusion of state income taxes. This rate is based on the estimated
provision accrual for fiscal year ending January 31, 2000. The income tax rate
of 34.8% for the six months ended July 31, 1998 is lower due to XXCAL's election
to be taxed as an S Corporation for the period preceding the merger. 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 evaluate the realizability of the deferred tax
asset quarterly by assessing the need for a valuation account based upon future
net income of the Company.
NET INCOME
The decrease in net income for the six months ended July 31, 1999, compared to
the same period in 1998, was primarily due to the decrease in revenues and
increase in selling, general and administrative expenses. This was partially
offset by merger costs incurred in 1998, but not incurred in 1999.
The following information is based upon results for National Technical Systems,
Inc. for the three months ended July 31.
RESULTS OF OPERATIONS
REVENUES
Three months ended July 31, 1999 % Change 1998
(Dollars in thousands)
-----------------------------------
Engineering & Evaluation $13,025 (1.5)% $13,220
IT Solutions 9,038 (9.0)% 9,933
----------- ------------
Total revenues $22,063 (4.7)% $23,153
=========== ============
For the three months ended July 31,1999, consolidated revenues decreased by
$1,090,000 or 4.7% when compared to the same period in 1998.
Engineering & Evaluation:
- -------------------------
In 1999, the Engineering and Evaluation segment revenues decreased by $195,000
primarily due to a decline in automotive and defense testing revenues which was
partially offset by increases in telecommunications and computer hardware
testing revenues. The decline in automotive and defense was mostly caused by
delays in development progress on some major new projects. In addition, some of
the Company's aerospace customers are now retaining programs in-house and
government laboratories are becoming more aggressive in competing with private
industry for programs, thus increasing the pressure on revenues. The increase in
telecommunications and computer testing is a direct result of the strategic
focus on that fast growing market.
IT Solutions:
- -------------
Revenues in the IT Solutions segment decreased by $895,000 or 9.0% due to a
softening in temporary personnel placements and increased competition as more
technical employees that were hired for the Year 2000 project are becoming
available.
12
<PAGE>
GROSS PROFIT
Three months ended July 31, 1999 % Change 1998
(Dollars in thousands)
------------------------------
Engineering & Evaluation $3,959 4.2% $3,801
% to segment revenue 30.4% 28.8%
IT Solutions 2,464 (2.2)% 2,519
% to segment revenue 27.3% 25.4%
--------- ---------
Total gross profit $6,423 1.6% $6,320
========= =========
% to total revenue 29.1% 27.3%
Total gross profit for the three months ended July 31, 1999 increased by
$103,000 or 1.6% when compared to the same period in 1998.
Engineering & Evaluation:
- -------------------------
Gross profit for the Engineering & Evaluation Group increased by $158,000 or
4.2% for the three months ended July 31, 1999 when compared to the same period
in 1998, even though revenues decreased by 1.5%. This was due to the higher
margin contracts for telecommunications, network equipment and computer hardware
testing.
IT Solutions
- ------------
Gross profit in 1999 decreased by $55,000 or 2.2% in the IT Solutions Group when
compared to the same period in 1998 due to lower revenues, partially offset by
higher gross margin percentages.
SELLING, GENERAL & ADMINISTRATIVE
Three months ended July 31, 1999 % Change 1998
(Dollars in thousands)
--------------------------------
Engineering & Evaluation $2,583 34.5% $1,920
% to segment revenue 19.8% 14.5%
IT Solutions 2,413 3.8% 2,325
% to segment revenue 26.7% 23.4%
--------- ---------
Total S G & A $4,996 17.7% $4,245
========= =========
% to total revenue 22.6% 18.3%
Total selling, general and administrative expenses increased $751,000 or 17.7%
for the three months ended July 31, 1999 when compared to the same period in
1998.
13
<PAGE>
Engineering & Evaluation:
- -------------------------
Selling, general and administrative expenses increased $663,000 or 34.5% due to
efforts to expand the base of business into new technology areas by engaging
specialists in these new areas to offset the weakness in the basic aerospace and
automotive testing business. The Company is redirecting some of its sales
efforts to procure larger evaluation programs which require a greater depth of
technical knowledge. Thus the Company has hired a number of such specialists
which has caused selling expenses to increase in advance of achieving results
from their work.
IT Solutions:
- -------------
Selling, general and administrative expenses increased by $88,000 or 3.8% in the
IT Solutions segment due primarily to costs related to the planned expansion of
the sales and marketing capabilities through new marketing programs and
expansion efforts in new markets.
OPERATING INCOME
Three months ended July 31, 1999 % Change 1998
(Dollars in thousands)
--------------------------------
Engineering & Evaluation $1,376 (26.8)% $1,881
% to segment revenue 10.6% 14.2%
IT Solutions 51 (73.7)% 194
% to segment revenue 0.6% 2.0%
--------- ---------
Total S G & A $1,427 (31.2)% $2,075
========= =========
% to total revenue 6.5% 9.0%
Operating income for the three months ended July 31, 1999 decreased by $648,000
or 31.2% when compared to the same period in1998.
Operating income for the three months ended July 31, 1999 for the Engineering &
Evaluation Group decreased by $505,000 when compared to the same period in 1998
primarily as a result of the increased selling, general and administrative
expenses in the Engineering & Evaluation Group discussed above.
Operating income for the three months ended July 31, 1999 decreased by $143,000
in the IT Solutions Group when compared to the same period in 1998 primarily as
a result of the decreased revenues and increased selling, general and
administrative expenses.
INTEREST EXPENSE
Net interest expense increased $10,000 in the three months ended July 31, 1999
when compared to the same period in 1998. This increase was principally due to
higher average debt balances for the three months ended July 31, 1999, when
compared to the same period last year.
14
<PAGE>
INCOME TAXES
The income tax provisional rate of 40.0% for the three months ended July 31,
1999 reflects a rate in excess of the U.S. federal statutory rate primarily due
to the inclusion of state income taxes. This rate is based on the estimated
provision accrual for fiscal year ending January 31, 2000. The income tax rate
of 36.7% for the three months ended July 31, 1998 is lower due to XXCAL's
election to be taxed as an S Corporation for the period preceding the merger.
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 evaluate the realizability of the
deferred tax asset quarterly by assessing the need for a valuation account based
upon future net income of the Company.
NET INCOME
The decrease in net income for the three months ended July 31, 1999, compared to
the same period in 1998, was primarily due to lower revenues and higher overall
selling, general and administrative expenses. This was partially offset by
merger costs incurred in 1998, but not incurred in 1999.
BUSINESS ENVIRONMENT
The business climate in the Engineering & Evaluation segment which has in the
past shown signs of uncertainty and which had appeared to stabilize last year,
has again become uncertain in the aerospace and defense industries. This has
occurred due to program delays in new research and development projects caused
by technical difficulties being experienced by the Company's aerospace and
defense clients. In addition, the trend to outsourcing, which started when many
aerospace contractors began downsizing, has begun to reverse. Some of the
Company's aerospace customers are now retaining programs in-house. Also,
government laboratories are becoming more aggressive in competing with private
industry for programs. All these factors have rendered the market more
competitive with an attendant pressure on profits.
On the other hand, the business climate in the information technology (IT)
business has been improving in the United States and abroad. The Company
services this market through its high technology laboratories and its software
and computer hardware evaluation laboratories. Areas that are showing
significant growth are the telecommunications and electronics industries. The
Company has been purchasing capital equipment to establish its position in these
rapidly growing markets and has recently received Nationally Recognized Test
Laboratory (NRTL) approval which gives it opportunity to provide accreditation
as a third party agency. The Company also has been approved to perform
"Bellcore" testing and performs these tests at two of its laboratories. The
Company believes these industries have much higher profit margins and the
increase of sales in these industries will offset the decline in the traditional
aerospace market. The Company also believes that in the future, both sales and
higher margins will continue in the information technology industries,
especially the computer, software and telecommunications sector. Thus, the
Company believes it will be in a better position to service these markets as the
capital equipment and facilities come on line, which are expected to initially
occur in the latter half of the year and are expected to positively affect
financial results next year.
15
<PAGE>
The Company also believes demand for ISO registration will continue to increase
as more companies must compete for business in the global market place.
The Company is pursuing additional business in the growing IT staffing market.
The Company supplies IT 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 and
multiple levels of system operations personnel. The Company believes the growth
in this sector will be accompanied by higher margins that will contribute
favorably to the overall product mix.
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.
LIQUIDITY AND CAPITAL RESOURCES
For the six months ended July 31, 1999, cash provided by operations increased by
$328,000 when compared to the same period in 1998. This increase was primarily
due to the effect of changes in prepaid expenses, accounts payable, accrued
expenses and depreciation partially offset by lower net income and the effect of
changes in income taxes and inventories.
Net cash used in investing activities in the six-month period ended July 31,
1999 increased $1,253,000 over the same period in 1998 due to capital purchases
of telecommunications testing equipment, the upgrading of the computer
systems and the acquisition of two quality-registration and certification
services companies. The actual level of capital spending will be dependent on a
variety of factors, including general economic conditions, bank covenants and
the Company's operating requirements.
In the six-month period ended July 31, 1999, net cash used for financing
activities consisted of debt reduction on lines of credit and short term and
long term debt of $1,548,000 and cash dividends paid of $166,000 and
distributions to S corporation stockholders of $120,000, offset by increases in
lines of credit and term loans of $2,546,000 and proceeds from the exercise of
stock options of $66,000. In September 1997, the Company negotiated with Sanwa
Bank California, as agent, and Mellon Bank for a new credit agreement which
includes a $6,000,000 revolving line of credit at an interest rate equal to the
Bank's reference rate plus 0.25%. Also included in the agreements is a
$6,500,000 term loan at an interest rate of 8.31%, which expires in January
2003. On October 30, 1998, the credit agreement was amended: 1) to extend the
term of the revolving line to September 8, 2000, 2) to increase the revolving
line amount from $6,000,000 to $8,000,000 at an interest rate equal to the
Bank's reference rate and 3) to add a new term loan for $2,000,000 at an
interest rate equal to the Bank's reference rate plus 0.25% and a maturity date
of November 1, 2003.
The Company is currently negotiating an increase in its lines of credit in the
aggregate amount of approximately $5,000,000 to be able to meet its strategic
growth plan. Management believes this will not materially affect the short or
long-term liquidity of the Company. The current bank revolving line of credit
had $2,443,000 available at July 31, 1999.
16
<PAGE>
YEAR 2000
The Year 2000 problem is the result of computer programs being written using two
digits (rather than four) to define the applicable year. Any of the Company's
programs that have time-sensitive software may recognize a date using "00" as
the Year 1900 rather than the Year 2000.
The Company has assessed and identified to the best of its knowledge all
requirements needed to correct potential problems related to the Year 2000
issue. This includes: (1) the Company's business software and hardware at all of
its locations, (2) the Company's test equipment used in all the laboratories and
(3) communications with third party vendors to ensure they will meet their Year
2000 requirements.
Much of the hardware and software used by the Company has already been upgraded
to be Year 2000 compliant. Certain test equipment at the laboratories has been
identified to be date sensitive and vendors are supplying new Year 2000
compliant software. In situations where the software is not available, the
Company is replacing the equipment. To complete the necessary remediation of its
business systems software, the Company has identified new Year 2000 compliant
software that will replace certain crucial software applications it currently
uses. All other identified existing systems will be fixed internally. The
Company completed its software remediation and expects to have all testing and
implementation completed by October 31, 1999.
The estimated total cost for the Year 2000 project is approximately $400,000 for
new hardware, software and in-house programming. The Company has incurred
approximately $380,000 through July 31, 1999. The Company does not expect these
costs to have a material impact on its financial position, results of operations
or cash flows. The Company has funded and will continue to fund these costs from
its operating and financing cash flows.
The Company has also contacted its major third-party vendors and is in the
process of obtaining assurances that their systems are Year 2000 compliant.
Although the Company does not anticipate any material problems resulting from
the Year 2000 issues, it is taking steps to establish a contingency plan prior
to October 31, 1999 in the event of system failures beyond the Company's control
or in the event of failure by other companies or governmental entities to
remediate their own systems.
17
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
On or about April 30, 1999, TECSTAR, Inc., a manufacturer of flight
hardware for use in satellites filed a complaint against the Company in
the Superior Court of the State of California for Los Angeles County,
Case No. BC 209645. The complaint alleges that TECSTAR contracted with
the Company to test hardware in accordance with certain agreed upon test
specifications. TECSTAR alleges that during a test cycle the temperature
of the hardware exceeded the specifications and that as a result the
hardware was rejected by TECSTAR's customer as allegedly being
unsuitable for flight. As a consequence TECSTAR asserts that it scrapped
the hardware.
The complaint alleges breach of contract, breach of implied warranty,
breach of bailment agreement, negligence, negligent bailment and
professional negligence. The complaint seeks monetary damages of
$2,488,700 plus costs of suit and interest, including prejudgment
interest, as provided by law. The Company believes that the damages
claimed by TECSTAR greatly exceed the cost of replacing the hardware.
The Company has filed and served a cross-complaint against Research,
Inc., manufacturer of a temperature control device utilized during the
test.
The Company believes that it has meritorious defenses to the complaint
and intends to vigorously defend against TECSTAR's claims. The Company
has also submitted the TECSTAR claims to its property loss insurance
carrier for coverage determination.
Item 4. Submission of Matters to a Vote of Security Holders
At the Company's Annual Meeting of shareholders held on June 25, 1999,
the shareholders of the Company voted to approve amendments to the
Company's Bylaws to provide for a range as to the number of directors.
As of the record date, there were 8,321,046 shares outstanding and
eligible to vote. The results of the vote of the shareholders were as
follows:
For Against Abstain
-------------------------------
Amendments to the Company's Bylaws to
provide for a range as to the number
of directors 7,329,578 113,633 16,217
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit 27 - Financial Data Schedule
(b) Form 8-K
During the quarter ended July 31, 1999 the registrant did not file a
current report on Form 8-K.
18
<PAGE>
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, 1999 By: /s/ Lloyd Blonder
-------------------------
Lloyd Blonder
Senior Vice President
Chief Financial Officer
(Signing on behalf of the
registrant and as principal
financial officer)
19
<PAGE>
Exhibit Index
Exhibit No. Description Page No.
- --------------------------------------------------------------------------------
27 Financial Data Schedule 21
20
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