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MTSC > SEC Filings for MTSC > Form 10-K on 28-Nov-2012All Recent SEC Filings

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Form 10-K for MTS SYSTEMS CORP


28-Nov-2012

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

MTS Systems Corporation is a leading global supplier of high performance test systems and position sensors. The Company's testing hardware and software solutions help customers accelerate and improve their design, development, and manufacturing processes and are used for determining the mechanical behavior of materials, products, and structures. MTS' position sensors provide controls for a variety of industrial and vehicular applications. MTS had 2,147 employees and revenue of $542 million for the fiscal year ended September 29, 2012.

Fiscal Year
The Company's fiscal year ends on the Saturday closest to September 30. The fiscal years ended September 29, 2012, October 1, 2011 and October 2, 2010 each consisted of 52 weeks.

Fiscal Year 2012 Compared to Fiscal Year 2011

Summary of Financial Results

Significant Items for fiscal year 2012 compared to fiscal year 2011 include:

Orders increased 4.7% to a record-high $565.3 million, compared to $540.0 million for fiscal year 2011. Orders in fiscal year 2012 included four large (in excess of $5.0 million) Test orders totaling approximately $46 million, a decrease of $18 million compared to large Test orders in fiscal year 2011. Excluding the large orders, base orders increased 9.1%, reflecting 13.3% global growth in Test, partially offset by a 5.9% decline in Sensors. Backlog of $299.1 million is a record high, an increase of approximately $10.5 million compared to backlog at the end of fiscal year 2011.

Revenue increased 16.0% to a record-high $542.3 million, compared to $467.4 million for fiscal year 2011. This increase was comprised of 21.5% growth in Test, resulting primarily from 36.8% higher beginning backlog as well as strong base order growth, partially offset by a 3.1% decline in Sensors which was driven by an unfavorable impact of currency translation.

Income from operations increased 10.0% to a record-high $80.5 million, compared to $73.2 million for fiscal year 2011. This increase was primarily driven by higher gross profit, reflecting leverage from higher volume and productivity improvements in Test, net of $26.9 million higher operating expenses. The higher operating expenses principally resulted from continued investment in strategic and productivity initiatives, including research and development, higher headcount to support selling and compliance efforts, as well as the $7.8 million settlement cost related to the settlement of the U.S Government matters. See below for additional information regarding the U.S. Government matters during the current fiscal year.

Operating activities generated a record-high cash flow of $65.0 million, driven by earnings and reduced working capital requirements.

As was previously disclosed, on August 30, 2012, the Company reached an agreement with the U.S. Department of Commerce ("DOC") and the U.S. Attorney's Office for the District of Minnesota ("USAO"), settling for $7.8 million the DOC and USAO's investigation into the Company's past disclosures on its government certifications and its government contracting compliance policies, general compliance record and practices in areas including export controls and government contracts. For a more detailed discussion of the investigation by the DOC and USAO and the settlement agreement, please refer to Note 9 of the Notes to Consolidated Financial Statements under Item 8 of this Annual Report on Form 10-K.


Table of Contents

Detailed Financial Results

Total Company

Orders and Backlog

The following is a comparison of fiscal year 2012 and fiscal year 2011 orders,
separately identifying the estimated impact of currency translation:


                           Estimated
                    Business      Currency
          2012       Change      Translation     2011
                    (expressed in millions)
Orders   $ 565.3   $     35.3   $       (10.0 ) $ 540.0

Orders totaled $565.3 million, an increase of $25.3 million, or 4.7%, compared to orders of $540.0 million for fiscal year 2011. Fiscal year 2012 orders included $46 million of large Test orders, compared to $64 million in fiscal year 2011. Test orders increased $31.4 million to $468.0 million, driven by strong global base order growth, while Sensors orders decreased $6.1 million to $97.3 million, including an estimated $3.4 million unfavorable impact of currency translation.

The following is a comparison of fiscal year 2012 and fiscal year 2011 orders by geography:

                                                    %
Geography       2012      2011      Variance     Variance
                         (expressed in millions)
Americas       $ 153.4   $ 162.1   $     (8.7 )       -5.4 %
Europe           170.8     183.2        (12.4 )       -6.8 %
Asia             241.1     194.7         46.4         23.8 %
Total Orders   $ 565.3   $ 540.0   $     25.3          4.7 %

Backlog of undelivered orders at September 29, 2012 was a record-high $299.1 million, an increase of approximately $10.5 million, or 3.6%, compared to backlog of $288.6 million at October 1, 2011. The Company believes backlog is not an absolute indicator of future revenue because a portion of the orders in backlog could be cancelled at the customer's discretion. While the backlog is subject to order cancellations, the Company has not historically experienced a significant number of order cancellations. During fiscal 2012, two custom orders in Test totaling approximately $9 million were cancelled. These orders were booked in a previous fiscal year and were associated with a Test product line that was sold during fiscal 2012. During fiscal year 2011, one custom order in Test totaling approximately $0.5 million was cancelled. This order was booked in a previous fiscal year.


Table of Contents

Results of Operations

The following is a comparison of fiscal year 2012 and fiscal year 2011 statements of operations (in millions, except per share data):

                                                                        %
                                 2012      2011     Variance         Variance
Revenue                       $ 542.3   $ 467.4   $     74.9              16.0 %
Cost of sales                   306.1     265.4         40.7              15.3 %
Gross profit                    236.2     202.0         34.2              16.9 %
Gross margin                     43.6 %    43.2 %        0.4 %  pts

Operating expenses:
Selling and marketing            74.6      69.8          4.8               6.9 %
General administrative           59.2      44.2         15.0              33.9 %
Research and development         21.9      14.8          7.1              48.0 %
Total operating expenses        155.7     128.8         26.9              20.9 %
Income from operations           80.5      73.2          7.3              10.0 %
Interest expense                 (0.9 )    (1.3 )        0.4             -30.8 %
Interest income                   0.6       0.4          0.2              50.0 %
Other (expense) income, net      (0.4 )     1.0         (1.4 )              NM

Income before income taxes       79.8      73.3          6.5               8.9 %
Provision for income taxes       28.2      22.4          5.8              25.9 %
Net income                    $  51.6   $  50.9   $      0.7               1.4 %

Diluted earnings per share    $  3.21   $  3.24   $    (0.03 )            -0.9 %

The following is a comparison of fiscal year 2012 and fiscal year 2011 results of operations, separately identifying the estimated impact of currency translation:

                                             Estimated
                                      Business      Currency
                            2012       Change      Translation     2011
                                      (expressed in millions)
Revenue                    $ 542.3   $     83.4   $        (8.5 ) $ 467.4
Cost of sales                306.1         46.4            (5.7 )   265.4
Gross profit                 236.2         37.0            (2.8 )   202.0
Gross margin                  43.6 %                                 43.2 %

Operating expenses:
Selling and marketing         74.6          6.1            (1.3 )    69.8
General administrative        59.2         15.3            (0.3 )    44.2
Research and development      21.9          7.3            (0.2 )    14.8
Total operating expenses     155.7         28.7            (1.8 )   128.8
Income from operations     $  80.5   $      8.3   $        (1.0 ) $  73.2

Revenue
Revenue was $542.3 million, an increase of $74.9 million, or 16.0%, compared to revenue of $467.4 million for fiscal year 2011. This increase was driven by 34.4% higher beginning backlog as well as strong standard short-cycle orders in Test, partially offset by a decline in Sensors resulting from an unfavorable impact of currency translation. Test revenue increased 21.5% to $442.0 million, while Sensors revenue decreased 3.1% to $100.3 million.


Table of Contents

The following is a comparison of fiscal year 2012 and fiscal year 2011 revenue by geography:

                                                     %
Geography        2012      2011      Variance     Variance
                   (expressed in millions)
Americas        $ 169.5   $ 135.5   $     34.0         25.1 %
Europe            167.8     150.1         17.7         11.8 %
Asia              205.0     181.8         23.2         12.8 %
Total Revenue   $ 542.3   $ 467.4   $     74.9         16.0 %

Although selective product price changes were implemented during each of these fiscal years, the overall impact of pricing changes did not have a material effect on revenue.

Gross profit
Gross profit was $236.2 million, an increase of $34.2 million, or 16.9%, compared to gross profit of $202.0 million for fiscal year 2011. Gross profit as a percentage of revenue was 43.6%, an increase of 0.4 percentage points from 43.2% for fiscal year 2011. The increase reflects leverage on higher volume and improved productivity in Test, partially offset by the unfavorable impact of a higher proportion of Test revenue compared to total Company revenue.

Selling and Marketing Expense
Selling and marketing expense was $74.6 million, an increase of $4.8 million, or 6.9%, compared to $69.8 million for fiscal year 2011. This increase was primarily due to higher compensation and benefits driven by increased headcount, higher sales commissions, as well as higher travel and other discretionary expenses to support selling efforts. This was partially offset by an estimated $1.3 million favorable impact of currency translation. Selling and marketing expense as a percentage of revenue was 13.8% on higher volume, compared to 14.9% for fiscal year 2011.

General and Administrative Expense
General and administrative expense was $59.2 million, an increase of $15.0 million, or 33.9%, compared to $44.2 million for fiscal year 2011. This increase was primarily driven by higher investment in strategic, productivity and compliance initiatives, as well as higher compensation and benefits driven by increased headcount, and includes the previously mentioned $7.8 million settlement cost related to the settlement of the U.S. Government matters. General and administrative expense as a percentage of revenue was 10.9%, compared to 9.5% for fiscal year 2011.

Research and Development Expense
Research and development expense was $21.9 million, an increase of $7.1 million, or 48.0%, compared to $14.8 million for fiscal year 2011. Planned expenditures were higher in both segments. In addition, the Company allocated certain of its resources towards capitalized software development activities during fiscal year 2012 and 2011. Total software development costs capitalized during fiscal years 2012 and 2011 were $0.5 million and $3.7 million, respectively. Research and development expense as a percentage of revenue was 4.0%, compared to 3.2% for fiscal year 2011.

Income from Operations
Income from operations was $80.5 million, an increase of $7.3 million, or 10.0%, compared to income from operations of $73.2 million for fiscal year 2011. This increase was primarily driven by higher volume and gross profit rate, partially offset by increased operating expenses, including the previously mentioned $7.8 million U.S. Government settlement costs. Operating income as a percentage of revenue was 14.8%, compared to 15.7% for fiscal year 2011.

Historically, the Company's operating costs have been impacted by a level of inflation ranging from -1% to 4%. The Company uses a number of strategies to mitigate the effects of cost inflation including cost productivity initiatives such as global procurement strategies, as well as price increases. However, if the Company's operating costs were to become subject to significant inflationary pressures, it may not be able to fully offset such higher costs.


Table of Contents

Interest Expense, net
Interest expense, net was $0.3 million, a decrease of $0.6 million, compared to $0.9 million for fiscal year 2011. Interest expense declined $0.4 million due to lower interest rates incurred on short-term borrowings as well as a reduction in the accrued interest liability associated with the Company's uncertain tax positions. Interest income increased $0.2 million primarily due to interest earned on higher average cash balances maintained in interest-bearing accounts.

Other (Expense) Income, net
Other (expense) income, net was $0.4 million of net other expense, compared to $1.0 million of net other income in fiscal year 2011. The decrease was primarily due to $1.1 million of net losses on foreign currency transactions in fiscal year 2012 compared to $0.2 million of net gains on foreign currency transactions in fiscal year 2011.

Provision for Income Taxes
Provision for income taxes totaled $28.2 million, an increase of $5.8 million, compared to $22.4 million for the fiscal year 2011. This increase was primarily due to increased income before taxes as well as a higher effective tax rate. The effective tax rate for the fiscal year was 35.4%, an increase of 4.9 percentage points compared to 30.5% for fiscal year 2011. This increase was primarily driven by the previously mentioned settlement cost related to the U.S. Government matters, which is nondeductible for tax purposes, as well as a reduction in U.S. research and development tax credits. The enactment of legislation in the first quarter of fiscal year 2011 that retroactively extended the U.S. research and development tax credits provided a tax benefit of $1.0 million during fiscal year 2011. The U.S. research and development tax credit legislation expired as of the end of the first quarter of fiscal year 2012.

Net Income
Net income was $51.6 million, an increase of $0.7 million, compared to $50.9 million for fiscal year 2011. The increase was primarily driven by higher income from operations, partially offset by a higher effective tax rate and increased net losses on foreign currency transactions. Earnings per diluted share decreased $0.03 to $3.21, compared to $3.24 for fiscal year 2011. The decrease was primarily driven by the $0.48 per diluted share negative impact from the previously mentioned settlement cost related to the U.S. Government matters. Additionally, the increase in shares outstanding negatively impacted earnings per diluted share by $0.07.

Segment Results

Test Segment

Orders and Backlog

The following is a comparison of fiscal year 2012 and fiscal year 2011 orders
for Test, separately identifying the estimated impact of currency translation:


                           Estimated
                    Business      Currency
          2012       Change      Translation     2011
                    (expressed in millions)
Orders   $ 468.0   $     38.0   $        (6.6 ) $ 436.6

Orders totaled $468.0 million, an increase of $31.4 million, or 7.2%, including an estimated 1.5% unfavorable impact of currency translation, compared to orders of $436.6 million for fiscal year 2011. Fiscal year 2012 orders included four large orders totaling approximately $46 million, of which $41 million was in the structures market and $5 million was in the ground vehicles market. Fiscal year 2011 orders included five large orders totaling approximately $64 million, of which $35 million was in the structures market and $29 million was in the ground vehicles market. Excluding the large orders, base orders increased 13.3%, reflecting strong growth in the ground vehicles, materials and structures markets. Test accounted for 82.8% of total Company orders, compared to 80.9% for fiscal year 2011.


Table of Contents

The following is a comparison of fiscal year 2012 and fiscal year 2011 orders for Test by geography:

Geography       2012      2011      Variance    % Variance
                  (expressed in millions)
Americas       $ 127.4   $ 133.9   $     (6.5 )        -4.9 %
Europe           121.9     132.0        (10.1 )        -7.7 %
Asia             218.7     170.7         48.0          28.1 %
Total Orders   $ 468.0   $ 436.6   $     31.4           7.2 %

Backlog of undelivered orders at September 29, 2012 was $285.3 million, an increase of 5.2% from backlog of $271.2 million at October 1, 2011. As previously mentioned, backlog at the end of fiscal 2012 was negatively impacted by the cancellation of two custom orders totaling approximately $9 million. Also, as previously mentioned, backlog at the end of fiscal 2011 was negatively impacted by the cancellation of a custom order totaling approximately $0.5 million.

Results of Operations

The following is a comparison of fiscal year 2012 and fiscal year 2011 results
of operations for Test separately identifying the estimated impact of currency
translation:


                                             Estimated
                                      Business      Currency
                            2012       Change      Translation     2011
                                      (expressed in millions)
Revenue                    $ 442.0   $     83.3   $        (5.2 ) $ 363.9
Cost of sales                262.1         45.0            (4.2 )   221.3
Gross profit                 179.9         38.3            (1.0 )   142.6
Gross margin                  40.7 %                                 39.2 %

Operating expenses:
Selling and marketing         59.6          6.6            (0.9 )    53.9
General administrative        45.2         12.8               -      32.4
Research and development      16.8          6.7               -      10.1
Total operating expenses     121.6         26.1            (0.9 )    96.4
Income from operations     $  58.3   $     12.2   $        (0.1 ) $  46.2

Revenue
Revenue was $442.0 million, an increase of $78.1 million, or 21.5%, compared to revenue of $363.9 million for fiscal year 2011. The increase was primarily due to 36.8% higher beginning backlog and strong base order growth, partially offset by an estimated $5.2 million unfavorable impact of currency translation.


Table of Contents

The following is a comparison of fiscal year 2012 and fiscal year 2011 revenue for Test by geography:

Geography        2012      2011      Variance    % Variance
                   (expressed in millions)
Americas        $ 141.0   $ 108.2   $     32.8          30.3 %
Europe            119.1      98.6         20.5          20.8 %
Asia              181.9     157.1         24.8          15.8 %
Total Revenue   $ 442.0   $ 363.9   $     78.1          21.5 %

Gross Profit
Gross profit was $179.9 million, an increase of $37.3 million, or 26.2%, compared to gross profit of $142.6 million for fiscal year 2011. Gross profit as a percentage of revenue was 40.7%, an increase of 1.5 percentage points from 39.2% for fiscal year 2011. This increase was driven by leverage on higher volume and improved productivity.

Selling and Marketing Expense
Selling and marketing expense was $59.6 million, an increase of $5.7 million, or 10.6%, compared to $53.9 million for fiscal year 2011. This increase was primarily due to higher compensation and benefits driven by increased headcount, higher sales commissions, and higher travel and other discretionary expenses to support selling efforts. Also included was increased investment in marketing initiatives, partially offset by an estimated $0.9 million favorable impact of currency translation. Selling and marketing expense as a percentage of revenue was 13.5% on higher volume, compared to 14.8% for fiscal year 2011.

General and Administrative Expense
General and administrative expense was $45.2 million, an increase of $12.8 million, or 39.5%, compared to $32.4 million for fiscal year 2011. This increase was primarily driven by higher investment in strategic, productivity and compliance initiatives, as well as higher compensation and benefits driven by increased headcount. Also included was $6.1 million of the $7.8 million settlement costs related to the previously mentioned U.S. Government matters. General and administrative expense as a percentage of revenue was 10.2%, compared to 8.9% for fiscal year 2011.

Research and Development Expense
Research and development expense was $16.8 million, an increase of $6.7 million, or 66.3%, compared to $10.1 million for fiscal year 2011, due to a higher level of planned expenditures. As previously mentioned, $0.5 million and $3.7 million of costs associated with software development activities were capitalized in fiscal year 2012 and 2011, respectively. Research and development expense as a percentage of revenue was 3.8%, compared to 2.8% for fiscal year 2011.

Income from Operations
Income from operations was $58.3 million, an increase of $12.1 million, or 26.2%, compared to income from operations of $46.2 million for fiscal year 2011. This increase reflects higher revenue and gross profit, partially offset by increased operating expenses. Operating income as a percentage of revenue was 13.2%, compared to 12.7% for fiscal year 2011.


Table of Contents

Sensors Segment

Orders and Backlog

The following is a comparison of fiscal year 2012 and fiscal year 2011 orders
for Sensors, separately identifying the estimated impact of currency
translation:


                          Estimated
                   Business      Currency
          2012      Change      Translation     2011
                    (expressed in millions)
Orders   $ 97.3   $     (2.7 ) $        (3.4 ) $ 103.4

Orders totaled $97.3 million, a decrease of $6.1 million, or 5.9%, including an estimated 3.3% unfavorable impact of currency translation, compared to orders of $103.4 million for fiscal year 2011, primarily due to weaker global demand in the industrial market. Sensors accounted for 17.2% of total Company orders, compared to 19.1% for fiscal year 2011.

The following is a comparison of fiscal year 2012 and fiscal year 2011 orders for Sensors by geography:

                                                    %
Geography       2012      2011      Variance     Variance
                  (expressed in millions)
Americas       $  26.0   $  28.2   $     (2.2 )       -7.8 %
Europe            48.9      51.2         (2.3 )       -4.5 %
Asia              22.4      24.0         (1.6 )       -6.7 %
Total Orders   $  97.3   $ 103.4   $     (6.1 )       -5.9 %

Backlog of undelivered orders at September 29, 2012 was $13.8 million, a decrease of 20.7% from backlog of $17.4 million at October 1, 2011.

Results of Operations

The following is a comparison of fiscal year 2012 and fiscal year 2011 results
of operations for the Sensors segment, separately identifying the estimated
impact of currency translation:


                                             Estimated
                                      Business      Currency
                            2012       Change      Translation     2011
                                      (expressed in millions)
Revenue                    $ 100.3   $      0.1   $        (3.3 ) $ 103.5
Cost of sales                 44.0          1.4            (1.5 )    44.1
Gross profit                  56.3         (1.3 )          (1.8 )    59.4
Gross margin                  56.2 %                                 57.4 %

Operating expenses:
Selling and marketing         15.0         (0.5 )          (0.4 )    15.9
General administrative        14.0          2.5            (0.3 )    11.8
Research and development       5.1          0.6            (0.2 )     4.7
Total operating expenses      34.1          2.6            (0.9 )    32.4
Income from operations     $  22.2   $     (3.9 ) $        (0.9 ) $  27.0

Revenue
Revenue was $100.3 million, a decrease of $3.2 million, or 3.1%, compared to revenue of $103.5 million for the fiscal year 2011. This decrease was primarily driven by an estimated $3.3 million unfavorable impact of currency translation.


Table of Contents

The following is a comparison of fiscal year 2012 and fiscal year 2011 revenue for the Sensors segment by geography:

                                                     %
Geography        2012      2011      Variance     Variance
                   (expressed in millions)
Americas        $  28.5   $  27.3   $      1.2          4.4 %
Europe             48.7      51.5         (2.8 )       -5.4 %
Asia               23.1      24.7         (1.6 )       -6.5 %
Total Revenue   $ 100.3   $ 103.5   $     (3.2 )       -3.1 %

Gross Profit
Gross profit was $56.3 million, a decrease of $3.1 million, or 5.2%, compared to gross profit of $59.4 million for fiscal year 2011. Gross profit as a percentage of revenue was 56.2%, a decrease of 1.2 percentage points from 57.4% for fiscal year 2011, primarily due to decreased leverage on lower volume.

Selling and Marketing Expense
Selling and marketing expense was $15.0 million, a decrease of $0.9 million, or 5.7%, compared to $15.9 million for fiscal year 2011. The decrease was driven by lower expenditures on marketing initiatives, as well as an estimated $0.4 million favorable impact of currency translation. Selling and marketing expense as a percentage of revenue was 15.0%, compared to 15.4% for fiscal year 2011.

General and Administrative Expense
General and administrative expense was $14.0 million, an increase of $2.2 . . .

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