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NTSC > SEC Filings for NTSC > Form 10-K on 30-Apr-2013All Recent SEC Filings

Show all filings for NATIONAL TECHNICAL SYSTEMS INC /CA/

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


30-Apr-2013

Annual Report


ITEM 7. 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 7 contain forward-looking statements. These forward-looking statements involve risks and uncertainties, including risks associated with uncertainties pertaining to client orders, demand for services and products, development of markets for the Company's services and products and other risks identified in Item 1A included in this report. Actual results, events and performance may differ materially. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. The Company undertakes no obligation to release publicly the result of any revisions to these forward-looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. Please see "Special Note Regarding Forward Looking Statements" at the beginning of this report.

Overview

The Company provides testing, inspection and certification services to the defense, aerospace, telecommunications, automotive, energy and high technology markets. The Company is accredited by numerous national and international technical organizations which allows its test data to be accepted in most countries and provides its clients the ability to sell their products globally and enhance their overall competitiveness. The Company operates facilities throughout the United States and in Japan, Vietnam and Germany, providing highly trained technical personnel for engineering services, product certification, product safety testing and product evaluation. In addition, it performs management registration and certification services to ISO related standards.

Recent Developments

Revenues for fiscal 2013 were $184.5 million, up 18.8% compared to $155.4 million in the prior year. Gross margins for fiscal 2013 were 26.4% compared to 24.2% in fiscal 2012. Net income from continuing operations attributable to NTS for fiscal 2013 was $4.4 million compared to $872,000 for the prior year.

Significant factors affecting operations in fiscal 2013 were:

Strong revenue growth in the aerospace and energy markets, partially due to acquired businesses.

Slight increase in defense industry revenue, which slowed significantly in the last quarter of the year due to uncertainty regarding the U.S. budget and delays in the U.S. government's continuing resolution process.

Volume impact on gross margin, moderated by the underutilization of resources at NTS' facilities that service the defense industry in the latter half of the year.

Selling, general and administrative cost increases to support higher sales volume.

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' client 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 was due to the seller on April 17, 2013, but is being held pending finalization of certain review procedures. 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 if Garwood meets certain targets related to client 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 January 31, 2013. A working capital adjustment receivable of $198,000 has been recorded at January 31, 2013 and will be deducted from the payment of the promissory note. The Company's consolidated statement of operations includes the operations of Garwood from April 17, 2012 to January 31, 2013.

On November 8, 2012, the Company purchased the 49.9% minority interest of Unitek Technical Services, a consolidated subsidiary. The total purchase price of $4,500,000 was paid to NQA Inc. As part of the purchase agreement, NQA Inc. paid a dividend of $4,500,000 on a pro-rata basis to the Company and Ascertiva Group Limited, the noncontrolling shareholder. Unitek is a leading provider of supply chain management services to primarily aerospace and defense clients. As Unitek was already a fully consolidated subsidiary, the acquisition did not impact our financial reporting with the exception of equity.


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Critical Accounting Policies

The consolidated financial statements of the Company are prepared in accordance with U.S. generally accepted accounting principles (GAAP), which require the Company to make certain estimates and assumptions (see Note 1 to the consolidated financial statements in Item 8). Estimates are based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources.

Management believes the following critical accounting policies, among others, affect its more significant judgments and estimates used in the preparation of its consolidated financial statements.

Recognition of Revenue and Related Costs

The majority of the Company's revenues are derived from fixed price contracts. Revenues from fixed price testing contracts are generally recorded upon completion of the contracts, which are typically short-term, or upon completion of identifiable contractual tasks. At the time the Company enters into a contract that includes multiple tasks, the Company estimates the amount of actual labor and other costs that will be required to complete each task. Revenues from contracts which are time and materials based are recorded as effort is expended.

Billings in excess of amounts earned are deferred. Any anticipated losses on contracts are charged to income when identified and can be reasonably estimated. To the extent management does not accurately forecast the level of effort required to complete a contract, or individual tasks within a contract, and the Company is unable to negotiate additional billings with a client for cost over-runs, the Company may incur losses on individual contracts.

Reimbursements made to the Company by clients under contract provisions, including those related to travel and other out-of-pocket expenses are recorded as revenues. An equivalent amount of reimbursable expenses is recorded as cost of sales.

Allowance for Uncollectible Receivables

The Company maintains an allowance for doubtful accounts for estimated losses resulting from the inability of clients to make required payments. The Company uses a combination of write-off history, aging analysis and identification of any specific known troubled accounts in determining the allowance. If the financial condition of clients were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances could be required.

Unbilled receivables

Unbilled receivables consist of accumulated revenues, including amounts earned related to costs incurred, in excess of amounts billed to customers. Unbilled receivables for each contract are reviewed on a monthly basis over the life of the contract and additional write-downs of unbilled receivables are made if there are insufficient revenues remaining on the contract such that unbilled receivables are not in excess of estimated net realizable value.

Inventories

Inventories consist of accumulated costs including direct labor, material and overhead applicable to uncompleted contracts and are stated at actual cost, which is not in excess of estimated net realizable value. Such inventories for each contract are reviewed on a monthly basis over the life of the contract and additional write-downs of inventories are made if there are insufficient revenues remaining on the contract.


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Accounting for Income Taxes

Deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. We record a valuation allowance, if necessary, to reduce deferred tax assets to an amount management believes is more likely than not to be realized.

To the extent that we have deferred tax assets, we must assess the likelihood that our deferred tax assets will be recovered from taxable temporary differences, tax strategies or future taxable income and to the extent that we believe that recovery is not likely, we must establish a valuation allowance. There was no valuation allowance as of January 31, 2013. In the future, we may adjust our estimates of the amount of valuation allowance needed and such adjustment would impact our provision for income taxes in the period of such change.

Goodwill and Intangible Assets

Goodwill represents the excess of purchase price over fair value of assets of an acquired business. Goodwill and intangible assets acquired in a business combination and determined to have an indefinite useful life are not amortized. Intangible assets with estimable useful lives are amortized over their respective estimated useful lives.

Goodwill and intangible assets not subject to amortization are tested at least annually for impairment. The goodwill test for impairment consists of a two-step process that begins with an estimation of the fair value of the reporting unit using the discounted cash flow approach. The first step of the test is a screen for potential impairment and the second step measures the amount of impairment, if any. The first step of the goodwill impairment test includes a comparison of the fair value of each reporting unit that has associated goodwill with the carrying value of the reporting unit. Fair value determinations require considerable judgment and are sensitive to changes in underlying assumptions and factors including future revenue forecasts and discount rates. As a result, there can be no assurance that the estimates and assumptions made for purposes of the annual goodwill impairment test will prove to be an accurate prediction of the future. Significant inputs include discount rates and estimated future cash flows for each of the three reporting units.

During the year ended January 31, 2013, the Company's operations were reorganized to change the manner in which the regional operating vice presidents manage the business and nature of those operations. Management further decided that it is more appropriate to aggregate the testing laboratories and engineering centers into one reporting unit based on economic similarities, sharing of assets and resources such as testing equipment and back office shared service centers. At January 31, 2013, the Company now has three reporting units.

The Company performed a goodwill impairment assessment on the new reporting units and determined on the basis of the step one impairment test that the fair value of its testing laboratory and engineering centers, certification, and supply chain reporting units exceeded its carrying value, and no impairment was indicated. For the year ended January 31, 2012, the Company recorded a goodwill impairment loss of $1,791,000 due to lower than expected results related to an acquisition made in December 2010 and a $400,000 write-down of other intangible assets.

Recent Accounting Pronouncements

See Note 1 "Summary of Significant Accounting Policies" in the Notes to the consolidated financial statements, which is incorporated herein by reference.

Results of Operations

The following discussion should be read in conjunction with the consolidated financial statements and notes thereto contained in this report.


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Revenues

REVENUES
Years ended January 31, 2013 2012
(Dollars in thousands)

Total revenues $ 184,547 $ 155,407

For the year ended January 31, 2013, revenues increased by $29.1 million, or 18.8% as compared to the prior year. $9.9 million or 6.4% of this increase was derived from businesses acquired. Organic growth of $19.2 million or 12.4% was primarily due to growth in the aerospace and energy markets, with a slight increase in defense industry revenue, which slowed significantly in the fourth quarter due to uncertainty regarding the U.S. budget and delays in the U.S. government's continuing resolution process.

Gross profit

                   GROSS PROFIT
                   Years ended January 31,     2013         2012
                   (Dollars in thousands)

                   Total                     $ 48,708     $ 37,585
                   % to total revenues           26.4 %       24.2 %

For the year ended January 31, 2013, gross profit increased by $11.1 million or 29.6%. This increase was primarily a result of the increased revenue, moderated by the underutilization of assets at NTS' facilities that service the defense industry in the fourth quarter.

Selling General and Administrative Expenses

                  SELLING, GENERAL & ADMINISTRATIVE
                  Years ended January 31,       2013         2012
                  (Dollars in thousands)

                  Total                       $ 35,779     $ 30,272
                  % to total revenues             19.4 %       19.5 %

For the year ended January 31, 2013, selling, general and administrative expenses increased by $5.5 million, or 18.2%. The increase was primarily due to higher compensation and incentive related expense, especially in the sales and marketing areas with increased headcount 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

                    OPERATING INCOME
                    Years ended January 31,     2013        2012
                    (Dollars in thousands)

                    Total                     $ 12,694     $ 5,076
                    % to total revenues            6.9 %       3.3 %

For the year ended January 31, 2013, operating income of $12.7 million or 6.9% of revenue, more than doubled from the previous year total of $5.1 million or 3.3% of revenue. This increase is primarily due to increased revenues, partially offset by higher operating costs noted above. The prior year was also impacted by an impairment loss in the amount of $2.2 million, which consisted of $1.8 million in goodwill impairment, and a $400,000 write-down of other intangible assets.


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Interest Expense

Interest expense increased by $1 million to $3.5 million in fiscal 2013 when compared to fiscal 2012. This was primarily due to payment of a full year interest expense relating to the Mill Road Capital financing which closed in June 2011, and slightly higher average outstanding debt balances on the Company's senior secured credit facility.

Other Income

For the year ended January 31, 2013, other income was $1.0 million, compared to $1.2 million in the prior year. Other income in both years was primarily due to the net gain recognized from insurance recovery related to the fire at the Company's Fullerton facility in November of 2009.

Income Taxes

The effective tax rate for fiscal year 2013 is 47.1%, compared to 54.9% in the prior year. The higher income tax rate in fiscal 2012 was primarily due to a non-tax deductible impairment cost of $2.2 million. See Note 4 to the consolidated financial statements for a reconciliation of the provision for income taxes from continuing operations at the statutory rate to the provision for income taxes from continuing operations.

Management has determined that it is more likely than not that the Company's deferred tax asset will be realized on the basis of offsetting it against deferred tax liabilities and future income. The Company analyzes the value of the deferred income tax asset quarterly in conjunction with external reporting.

Net Income

For the year ended January 31, 2013, net income from continuing operations was $5.4 million compared to $1.7 million for the prior year. This increase was due to items noted above.

On October 31, 2011, the Company closed its Calgary facility. Net loss from the discontinued Calgary operations was $3,000 for the year ended January 31, 2013 and was $381,000 for the year ended January 31, 2012.

For the year ended January 31, 2013, net income attributable to noncontrolling interests was $976,000 compared to $866,000 in the prior year, an increase of 12.7%. This increase was due to higher net income for the Company's 50% owned NQA, Inc. subsidiary in the current year, slightly offset by the Company's purchase of Unitek on November 8, 2012.

Net income attributable to NTS for the year ended January 31, 2013 was $4.4 million compared to $491,000 in the prior year. This increase was primarily due to higher net income partially offset by the increase in net income attributable to non-controlling interests.

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 $24.7 million for the year ended January 31, 2013 compared to $17.4 million 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 fiscal years ended January 31, 2013 and 2012 is included in the table below.


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                                             (Dollars in thousands)
                                                   Years ended
                                                   January 31,
                                               2013             2012

                Net Income                 $      5,420       $  1,357
                Add
                Interest                          3,471          2,465
                Taxes                             4,827          2,111
                Depreciation                      7,908          7,108
                Amortization                      2,037          1,607
                EBITDA                           23,663         14,648
                Add
                Share based compensation            988            554
                Impairment loss                       -          2,208
                Adjusted EBITDA            $     24,651       $ 17,410

Liquidity and Capital Resources

Liquidity

A summary of key balance sheet items affecting liquidity at January 31, 2013 and
2012 is as follows:

                                               (Dollars in thousands)
                                         January 31,         January 31,
                                             2013               2012
             Cash and cash equivalents   $      8,875       $       4,335
             Investments                 $      3,410       $       3,318
             Accounts receivable         $     33,573       $      33,480
             Working capital             $     33,338       $      30,898



Summary of cash flows:

                                                       (Dollars in thousands)
                                             January 31,       January 31,       Change
                                                2013              2012
Net cash provided by operating activities   $      15,060     $      11,314     $   3,746
Net cash used in investing activities             (12,105 )         (29,353 )      17,248
Net cash provided by financing activities           1,539            13,491       (11,952 )
Effect of exchange rate changes on cash                46               (41 )          87
Net increase (decrease) in cash             $       4,540     $      (4,589 )   $   9,129

Net cash provided by operating activities was $15.0 million in the year ended January 31, 2013 and primarily consisted of net income of $5.4 million, depreciation and amortization of $10.5 million and share-based compensation of $1.0 million, offset by changes in working capital.

Net cash used in investing activities in the year ended January 31, 2013 was $12.1 million, of which $8.9 million related to capital expenditures and $3.1 million was used for the acquisition of Garwood.


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Net cash provided by financing activities in the year ended January 31, 2013 was $1.5 million and consisted of net borrowings of $3.5 million under the Company's revolving credit facility, and proceeds from stock options exercised of $418,000, partially offset by a $2.2 million dividend paid to the noncontrolling shareholder related to the purchase of non-controlling interest in Unitek.

Capital Resources

At January 31, 2013, the Company had cash and cash equivalents of $8.9 million and working capital of $33.3 million. In addition to its cash and cash generated from operations, the Company has an existing credit facility under which the Company can draw based on established guidelines.

As more fully discussed in Note 3 to the consolidated financial statements, the Company secured a senior credit facility of up to $65 million from a banking group led by Comerica Bank that includes Bank of the West and U.S. Bank. The credit facility includes a $25 million revolving credit line, a $20 million term loan, and a $20 million acquisition line.

Under the revolving credit line the Company can borrow up to 85% of eligible accounts receivable. At January 31, 2013, 85% of eligible accounts receivable was $19,264,000 and the amount of available credit under the revolving credit line on that date was $10,764,000.

The term loan and the acquisition line have been fully utilized as of January 31, 2013 and the Company is making periodic payments as required by the credit facility.

Off-Balance Sheet Arrangements

The Company does not have any special purpose entities or off-balance sheet financing arrangements.

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