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NTSC > SEC Filings for NTSC > Form 10-Q on 11-Dec-2012All Recent SEC Filings

Show all filings for NATIONAL TECHNICAL SYSTEMS INC /CA/

Form 10-Q for NATIONAL TECHNICAL SYSTEMS INC /CA/


11-Dec-2012

Quarterly Report


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. These forward-looking statements involve risks and uncertainties, including those described in the Company's Annual Report on Form 10-K. Actual results, events and performance may differ materially from those anticipated in the forward looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements. See the note at the beginning of this report.

Overview

NTS is a leading provider of testing solutions and highly trained technical personnel for product design and evaluation, safety testing, certification and supply chain management to enable customers to sell their products in world markets. NTS is accredited by numerous national and international technical organizations which allow the Company to have its test data accepted in most countries. In addition, it performs management registration and certification services to ISO related standards.

NTS serves customers primarily in the aerospace, defense, telecommunications, automotive, energy, consumer products, commercial and industrial products and medical markets. The Company operates facilities throughout the United States and in Japan, Vietnam and Germany.

The following discussion should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in the Company's Annual Report on Form 10-K for the year ended January 31, 2012 and the consolidated quarterly financial statements and notes thereto contained in this report. All information in this report is based upon unaudited operating results of the Company for the three and nine-month periods ended October 31, 2012 and 2011.

Markets

Aerospace.

NTS offers integrated life cycle product services to the aerospace market. These services include engineering, testing and supply chain management. From concept development and design, through detail design, certification, production and in-service life, NTS provides support throughout the full life cycle of the aerospace product. These integrated services fill the capability gaps that have developed in the aerospace supply chains after years of large scale integration, outsourcing and globalization.

NTS' engineering services consist of design and analysis of aerospace structures, systems, components and detailed parts as part of customers' design teams or as a fixed-price work package. Specific capabilities include engineering program management, managed engineering services (on-site management of customer engineering teams), design engineering, analysis, test engineering, test system engineering, failure forensics and expert witnessing.

Testing services include a wide range of test capabilities for structures and airborne equipment. For structures, NTS has extensive capability and expertise in large component static and fatigue testing, including full scale airframe static and fatigue, sonic fatigue, vibration, modal, ground vibration, high pressure/high flow air and fluid compatibility. Airborne equipment testing spans the full range of RTCA DO-160 requirements, including static and dynamic, electromagnetic effects (EME, EMI, EMC), electrostatic discharge (ESD), environmental, material and system compatibility, high intensity radiated field (HIRF), indirect lightning effects and highly accelerated life testing/stress screening (HALT/HASS).

Supply chain management services span a wide range of development, oversight, and certification/accreditation activities including product inspection, production monitoring and expediting, test witnessing and support, corrective action follow-up, supplier surveillance, sub-tier supplier management, new supplier surveys, systems evaluations and audits (including special processes), development of quality assurance protocols, supplier development and improvement, quality management system audit, certification and registration.

The Company's initial sector focus in the aerospace market has been in the large commercial transport, general aviation, and space exploration sectors. In all sectors NTS tests components and systems for the supply chain supporting the manufacturers. Also, NTS is increasingly providing engineering services that design, develop, test, and integrate pods and payloads for unmanned aerial systems (UAS). This group has expanded from airborne platforms into ground, sea (surface and subsurface), and robotic platforms. NTS has conducted test programs for UAS components, systems, payloads and completely integrated air vehicles. NTS is actively engaged in a variety of unmanned system test programs, and has performed environmental, vibration and EMI testing on a number of UAS systems.


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Defense.

NTS plays an active role in numerous U.S. defense-related programs, performing a wide variety of defense technology research, development, test, and evaluation (RDT&E) services for the Department of Defense (DOD), military, government and commercial industry. These services evaluate the weapons, ordnance, munitions, avionics, electronics, hydraulic and pneumatic controls, engines and communication systems that make up the elements of today's modern battlefield. The Company's testing platforms for the defense industry include fixed wing aircraft, helicopters, submarines, aircraft carriers and other naval ships, tanks and other tracked vehicles, trucks and road vehicles, command, control and communication systems and missiles and weapons systems. Testing includes associated system and component level tests of structures, hardware, electronics, personal protective equipment, armor, weapons and ammunition.

NTS has facilities that are specially constructed to store, handle, and test ordnance, munitions and hazardous materials. Routine testing includes live fire, function, environmental, dynamics, safety, MIL-STD-901 shipboard shock, insensitive munitions (IM), hazard classification, transportation and packaging safety. These tests are done for prototype, developmental, qualification and production/lot acceptance testing (LAT). Multiple NTS facilities around the country provide 200 v/m up to 40 GHz EMI/EMC testing of electronic and communications equipment. Custom designed NTS data acquisition systems are capable of collecting data at speeds of 2,000,000 data points per second and digital photography capability of over 160,000 color photos per second.

NTS' defense group is expanding to include energetic and prototype engineering services, including 2D and 3D CAD modeling; technical data package (TDP) development and modification; finite element analysis (FEA), projectile design and analysis; interior and exterior ballistics analysis, and design and development of custom test hardware and fixtures. Other services include support of, and procurement and delivery of precision metal parts and explosive loading of prototype hardware. Additional defense services include design, development, fabrication, and fielding of specialized high speed instrumentation and diagnostics for energetics and hazardous materials and ordnance testing. This includes custom sensor suite design, fabrication and deployment, often through specialized test facility design.

Telecommunications.

NTS provides engineering design, test evaluation and certification services for manufacturers of a broad array of telecommunications networking and storage equipment intended for commercial data centers, central/telecom office and customer premise environments. The Company's services are performed in accordance with domestic and international regulatory standards, the network equipment building systems (NEBS) specifications and fiber optics general requirements (GRs) as required by the telecommunications industry. Globally, NTS represents the largest network of independent test laboratories (ITL) certified and recognized by most regional bell operating companies' (RBOCs) carriers. The Company is also certified and accredited to support formal witness testing on behalf of the RBOC carriers at approved manufacturer's internal test facilities. NTS has unique test capability in the Wireless telecom industry. As the wireless telecom industry continues to grow, globally, the need for engineering design, testing evaluation and certification services for faster and more robust backhaul networking equipment will continue to increase. The Company is well positioned to support this accelerated growth currently providing accredited ITL services at laboratories in California, Massachusetts, New Jersey, Texas, and Germany.

Automotive.

NTS supports the commercial and military vehicle industries with testing, including dynamometer operations on power train components, vibration and shock on mechanical and electrical assemblies, thermal and corrosion exposures on control and monitoring systems, pressure pulsing and burst on fluid handling items and fatigue and ultimate strength on mechanical components. NTS performs testing to support requirements in emerging markets of pure electric vehicles and electrical hybrid vehicles. This includes electric motors, integrated motor/transmissions, specialized high speed transmissions, batteries and control/distribution modules. It also performs highly accelerated life tests (HALT) and highly accelerated stress screen (HASS). These tests combine extremes of temperature, rapid temperature change, and multi-axis vibration to rapidly expose design weaknesses and process flaws. NTS is accredited to ISO 17025 through the American Accreditation of Laboratories Association (A2LA). This accreditation allows NTS automotive test reports to be accepted throughout the U.S. and internationally.


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Energy.

NTS offers multi-disciplinary expertise and capabilities to provide smart solutions to complex engineering, and scientific problems in the areas of nuclear energy, renewable energy, energy storage and smartgrid. The services provided are:

Technical functional knowledge of engineering fundamentals: mechanical, structural, electrical, reliability, and high technology communication and security software system test and monitoring solutions.

Testing on a variety of smart energy/smart grid products with a focus on the communications functionality and network protocols of smart meters, smart outlets, thermostats/in-home displays and smart appliances.

Supply chain management focusing on assuring product integrity through quality process and product auditing, supplier improvement plans, and management of quality systems.

Multi-disciplinary expertise in global compliance and certification for components, devices, communication products, software/hardware interoperability, and system security vulnerability assessments and validation.

Seismic, environmental, EMI/RFI, radiation, equipment qualification, commercial grade dedication, mechanical aging, thermal aging, vacuum testing, leak detection, and high expansion line breaks. Seismic and vibration simulation tests conducted on our single axis, dependent biaxial systems, or independent tri-axial and electro-mechanical shaker tables are used for a variety of customer products.

Certification and evaluation services to nuclear utilities and suppliers worldwide.

A full range of products, engineering and testing services under our NUPIC and NIAC audited 10CFR50, Appendix B Quality Program.

Consumer Products.

NTS provides engineering design, test evaluation and domestic and international certification services for a broad array of consumer products normally procured for use in a residence, school and recreation environments. This typically includes personal computing, PC peripheral, residential networking and personal wireless devices. These products are subjected to a wide range of electromagnetic compatibility, product safety, reliability, usability, interoperability tests and certifications to assure market compliance, reliability and effective use. The Company has been approved as an exclusive independent test laboratory (ITL) to offer Internet TV Set-top Box multimedia over coax (MoCA) certification. The Company is the exclusive certifications provider for Sirius/XM Radio Ready program and holds a number of domestic and international test accreditations throughout its network of commercial laboratories. NTS is an accredited Telecommunication Certification Body (TCB) in North America and an appointed Notified Body for wireless devices in the European Union. With the increased integration of wireless technology into traditional consumer products, the dramatic population growth, income gains, global macroeconomic shifts and the urbanization in regions throughout Asia, Central and South America and Africa, NTS is well positioned to support the growing market spaces to which manufacturers are seeking to sell. The Company's service offerings offer a 'one-stop-shop' to the consumer product market, ensuring a shorter time to market in the fierce 'to market' race manufacturers find themselves competing within.

Commercial & Industrial.

NTS provides engineering design, testing evaluation and domestic and international certification services to manufacturers of a broad array of commercial and industrial products normally procured for light and heavy industrial applications. This covers a wide range of industries from shipbuilding, semiconductor manufacturing equipment, automation, robotics, laboratory and materials handling devices. Various types of commercial grade electronic, hydraulic and pneumatic systems are subjected to electrical, environmental and safety testing to ensure regulatory compliance and safe and reliable use. Special combined mechanical and environmental testing processes such as highly accelerated life testing (HALT) are used to accelerate the effects of aging and wear to allow manufacturers to produce a more reliable product. Once this has been accomplished, similar highly accelerated stress screening (HASS) testing can be used to ensure consistent quality on the production line. Market trends are showing increased integration of Wireless Local Area Network (WLAN) and Wide Wireless Access Network (WWAN) communication technologies in such product lines. NTS offers a complete turnkey engineering design, testing evaluation and domestic and international certification services for industrial products, including customer driven requirements.


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Medical.

NTS provides engineering design, testing evaluation and domestic and international certification services to manufacturers of a broad array of medical products typically including non-invasive devices. Services include electromagnetic compatibility, electrical product safety and quality control/risk analysis consultation. Through various industry partnerships, the Company has affiliations with consultants and Notified Bodies to support medical approval in North America and throughout the European Union. With the increased integration of wireless communications into traditional medical device products, NTS is also well equipped to support domestic and international testing and approvals.

Growth Strategy

Over the last few years, NTS restructured its executive leadership team and initiated a growth strategy to provide significant focus on corporate development activities within the mid-to longer-term time horizon, while continuing to drive efficiencies and market penetration within the shorter-term fiscal planning time horizon.

NTS' strategies for continued growth include:

increasing market share through superior service;

investing in human resources and physical assets to strengthen existing capabilities;

enhancing utilization of resources;

adding new, innovative service offerings;

identifying, qualifying and acquiring businesses with the potential to add significant value

Recent Developments

Consolidated revenues for the nine months ended October 31, 2012, were $140,703,000, an increase of $25,611,000 or 22.3% over the same period last year. The increased revenues combined with prudent cost controls resulted in net income for the period of $5,550,000.

During the fiscal quarter ended October 31, 2012, the Company continued the implementation of an integrated Enterprise Resource Planning or ERP solution across a number of its operating units. The ERP solution will provide a unified platform for financial and accounting information that allows aggregation of financial data, superseding a number of disparate legacy systems. The ERP solution will enable the Company to conduct more accounting operations on the system, and reduce the utilization of "off system" records such as accounting workpapers. Finally the system is designed to provide enhanced project management for open contracts, improving visibility into the status of completion and costs for longer term contracts. At October 31, 2012 the ERP system had been implemented at 26 facilities. The one remaining facility is expected to be integrated during fiscal 2013.

On April 17, 2012, the Company acquired all of the outstanding common stock of Garwood Laboratories, Inc. (Garwood), with testing facilities in Pico Rivera and San Clemente, CA. The acquisition expands NTS' customer relationships and market share in Southern California as well as the greater Western U.S. region. The aggregate purchase price was $5,092,000. Cash paid at closing was $3,165,000, and was funded by a draw down on the Company's acquisition line of credit under its senior credit facility. The Company also issued a promissory note for $1,175,000 which is due to the seller on April 17, 2013. The Company has withheld $750,000 of the purchase price for 18 months after closing to secure Garwood's indemnification obligations under the purchase agreement. In addition to the base purchase price, the Company agreed to pay an additional earn-out up to a maximum amount of $450,000 (earn-out) if Garwood meets certain targets related to customer retention and revenues for the 24 months following the purchase date. A liability of $200,000 has been recorded as an estimated fair value of the earn-out liability at October 31, 2012. A working capital adjustment receivable has been recorded at a preliminary amount of $198,000. The Company's consolidated statement of operations includes the operations of Garwood from April 17, 2012 to October 31, 2012.

On November 8, 2012, after the period covered by this report, the Company purchased the 49.9% minority interest of Unitek Technical Systems, Inc., consolidated subsidiary, for $2,245,000. Unitek is a leading provider of supply chain management services to primarily aerospace and defense clients.


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Unaudited Results of Operations for the Nine Months Ended October 31, 2012

REVENUES
Nine months ended October 31, 2012 2011 Diff % Change
(Dollars in thousands)

Total revenues $ 140,703 $ 115,092 $ 25,611 22.3 %

For the nine months ended October 31, 2012, consolidated revenues increased by $25,611,000 or 22.3% when compared to the same period in the prior year. Organic revenues (revenues from businesses owned throughout both reporting periods) increased by $16,826,000 or 14.6% which was primarily related to an increase in the aerospace, energy and defense markets. Revenues from acquisitions increased by $8,785,000 or 7.6% from the purchase of Ingenium Testing on July 20, 2011, Lightning Technologies on September 1, 2011, and Garwood Laboratories on April 17, 2012.

      GROSS PROFIT
      Nine months ended October 31,     2012         2011         Diff        % Change
      (Dollars in thousands)

      Total                           $ 38,108     $ 27,797     $ 10,311           37.1 %
      % to total revenues                 27.1 %       24.2 %

Gross profit for the nine months ended October 31, 2012 increased by $10,311,000 or 37.1% when compared to the same period in the prior year. Gross profit as a percentage of revenue, or gross margin, increased to 27.1% from 24.2% in the prior year. This increase in gross profit was primarily due to better leverage of fixed costs with the increased level in revenues, somewhat offset by pricing pressure in some markets.

       SELLING, GENERAL & ADMINISTRATIVE
       Nine months ended October 31,     2012         2011        Diff        % Change
       (Dollars in thousands)

       Total                           $ 26,373     $ 22,537     $ 3,836           17.0 %
       % to total revenues                 18.7 %       19.6 %

Total selling, general and administrative expenses increased by $3,836,000 or 17.0% for the nine months ended October 31, 2012 when compared to the same period in the prior year. The increase was primarily due to higher compensation and incentive related expense, especially in the sales and marketing areas to support the increasing sales levels, as well as increased amortization expense as a result of recent acquisitions, partially offset by a decrease in legal and other expenses.

       OPERATING INCOME
       Nine months ended October 31,     2012        2011        Diff        % Change
       (Dollars in thousands)

       Total                           $ 11,520     $ 5,250     $ 6,270          119.4 %
       % to total revenues                  8.2 %       4.6 %

Operating income for the nine months ended October 31, 2012 increased by $6,270,000 or 119.4% when compared to the same period in the prior year, primarily as a result of the increase in gross profit, partially offset by the increase in selling, general and administrative expense.


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Interest Expense

Net interest expense was $2,645,000 in the nine months ended October 31, 2012, an increase of $1,084,000 when compared to the same period in the prior year. The increase was due to interest on additional borrowings, higher overall interest rates, as well as $395,000 in debt issuance cost and debt discount amortization related to the Mill Road Capital financing and the Comerica senior credit facility.

Other Income

Other income was $827,000 for the nine months ended October 31, 2012, consisting primarily of a gain from insurance recovery related to the fire at the Company's Fullerton facility in November of 2009.

Income Taxes

The income tax provision rate for the nine months ended October 31, 2012 was 42.8% compared to 39.9% for the same period in the prior year. The higher income tax rate in the current year is primarily due to higher estimated permanent book to tax differences in the current year. 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. The Company analyzes the value of the deferred income tax asset quarterly.

Net Income

Net income from continuing operations for the nine months ended October 31, 2012 was $5,553,000 compared to $2,091,000 for the same period in the prior year. This increase was primarily due to higher operating income and other income, partially offset by higher interest expense and income taxes.

On October 31, 2011, the Company closed its Calgary facility. Net loss from the discontinued Calgary operation for the nine months ended October 31, 2012 was $3,000 compared to $322,000 in the same period in the prior year.

Net income for the nine months ended October 31, 2012 was $5,550,000 compared to $1,769,000 for the same period in the prior year.

For the nine months ended October 31, 2012, net income attributable to noncontrolling interests was $808,000 compared to $660,000 for the same period in the prior year, an increase of $148,000 or 22.4%. This increase was due to higher net income for the Company's 50% owned NQA, Inc. subsidiary in the current year.

Net income attributable to NTS for the nine months ended October 31, 2012 was $4,742,000 compared to $1,109,000 for the same period in the prior year.

Adjusted EBITDA

EBITDA (earnings before interest, taxes, depreciation and amortization) as adjusted to remove the effect of share based compensation expense or "adjusted EBITDA", was $20,617,000 for the first nine months of fiscal 2013 compared to $11,567,000 in the same period for the prior year.

Management uses adjusted EBITDA to evaluate the Company's core operations without reference to the impact of interest and tax payments resulting from its capital structure and tax jurisdictions, or depreciation and amortization which can fluctuate based on acquisition activity. The Company's senior credit facility also includes covenants related to adjusted EBITDA.

Adjusted EBITDA is a non-GAAP financial measure. The Company calculates adjusted EBITDA by taking net income, and adding back the expenses related to interest, taxes, depreciation, amortization, share based compensation expense and non-cash impairment loss, as each of those elements are calculated in accordance with GAAP. A reconciliation of the Company's adjusted EBITDA to net income for the nine months ended October 31, 2012 and 2011 is included in the table below.


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                                                Nine months ended
                                                   October 31,
                                              2012             2011

               Net Income                 $  5,550,000     $  1,769,000
               Add
               Interest                      2,645,000        1,561,000
               Taxes                         4,149,000        1,387,000
               Depreciation                  5,906,000        5,238,000
               Amortization                  1,508,000        1,100,000
               EBITDA                       19,758,000       11,055,000
               Add
               Share based compensation        859,000          512,000
               Adjusted EBITDA            $ 20,617,000     $ 11,567,000

Unaudited Results of Operations for the Three Months Ended October 31, 2012

REVENUES
Three months ended October 31, 2012 2011 Diff % Change
(Dollars in thousands)

Total revenues $ 49,921 $ 40,498 $ 9,423 23.3 %

For the three months ended October 31, 2012, consolidated revenues increased by $9,423,000 or 23.3% when compared to the same period in the prior year. Organic revenues (revenues from businesses owned throughout both reporting periods) increased by $6,792,000 or 16.8% which was primarily related to an increase in the aerospace, energy and defense markets. Revenues from acquisitions increased by $2,631,000 or 6.5% from the purchase of Ingenium Testing on July 20, 2011, Lightning Technologies on September 1, 2011, and Garwood Laboratories on April 17, 2012.

       GROSS PROFIT
       Three months ended October 31,     2012        2011        Diff        % Change
       (Dollars in thousands)
. . .
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