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MEAS > SEC Filings for MEAS > Form 10-K on 5-Jun-2013All Recent SEC Filings

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Form 10-K for MEASUREMENT SPECIALTIES INC


5-Jun-2013

Annual Report


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

(Amounts in thousands, except per share data)

Overview: Measurement Specialties, Inc. is a diversified sensor technology company and a global leader in the design, development and manufacture of sensors and sensor-based systems for original equipment manufacturers ("OEM") and end users, based on a broad portfolio of proprietary technology and typically sold under the MEAS brand name. We believe we are among the leading manufacturers of sensor products in the markets we serve and we have a high degree of diversity when considering our geographic reach, broad range of products, number of end-use markets and breadth of customer base. The Company is a multi-national corporation with fifteen primary manufacturing facilities strategically located in the United States, China and Europe, enabling the Company to produce and market globally a wide range of sensors that use advanced technologies to measure precise ranges of physical characteristics. These sensors are used for engine and vehicle, medical, general industrial, consumer and home appliance, military/aerospace, environmental water monitoring, and test and measurement applications. The Company's products include sensors for measuring pressure, linear/rotary position, force, torque, piezoelectric polymer film sensors, custom microstructures, load cells, vibrations and acceleration, optical absorption, humidity, gas concentration, gas flow rate, temperature, fluid properties and fluid level. The Company's advanced technologies include piezoresistive silicon, polymer and ceramic piezoelectric materials, application specific integrated circuits, MEMS, foil strain gauges, electromagnetic force balance systems, fluid capacitive devices, linear and rotational variable differential transformers, anisotropic magneto-resistive devices, electromagnetic displacement sensors, hygroscopic capacitive structures, ultrasonic measurement systems, optical measurement systems, negative thermal coefficient ("NTC") ceramic sensors, 3-6 DOF (degree of freedom) force/torque structures, complex mechanical resonators, magnetic reed switches, high frequency multipoint scanning algorithms and high precision submersible hydrostatic level detection. We compete in growing global market segments driven by demand for products that are smarter, safer, more energy-efficient, and environmentally-friendly. We deliver a strong value proposition to our customers through our willingness to customize sensor solutions, leveraging our innovative portfolio of core technologies and exploiting our low-cost manufacturing model based on our 18 year presence in China.

Executive Summary: Our vision is to be the supplier of choice to OEMs and select end-users for all their physical sensing needs. To that end, MEAS continues to expand our market position as a leading global sensor supplier. Over the past ten years, the Compounded Annual Growth Rate ("CAGR") of our sales of 21% has exceeded overall market increases. (CAGR is calculated by taking the nth root of the total percentage growth rate, where n is the number of years in the period being considered or ($346,968 / $52,326)^(1/10)=21%).The Company's strong recovery since fiscal 2010 reflects the positive returns from our significant investments in research and development for new programs and the approximately $330,000 invested since June 2004 through April 2013 in our 21 acquisitions, expanding our product offerings and geographic reach.

The Company remains focused on creating long-term shareholder value through continued development of innovative technologies and strengthening our market position by expanding customer relationships. To accomplish this goal, we continue to take measures we believe will result in sales performance in excess of the overall market and generation of positive adjusted earnings before interest, tax, depreciation and amortization ("Adjusted EBITDA"). A core tenant of our long-term strategy to increase profitability is to grow the size and scale of the Company in order to improve our leverage of SG&A expenses. Accordingly, we believe we can achieve 20% Adjusted EBITDA Margin (Adjusted EBITDA as a percent of Net Sales) in fiscal 2014 and improve this metric as we grow sales at a higher rate than costs in fiscal 2015 and beyond. Additionally, as previously announced, we have negotiated an insourcing agreement with Sensata, our largest customer, that establishes minimum, declining volumes with MEAS through December 2015. Given Sensata carries a lower gross margin than our average, the decline in Sensata sales will improve our overall mix and associated margin. We expect this mix shift to improve our Adjusted EBITDA margin by 200 to 250 bps over the next three years. We have implemented aggressive actions that continue to position the Company for future growth in sales and profitability, all of which we ultimately expect to translate to enhanced shareholder value. As part of these continued measures to improve profitability, the Company has started implementing a restructuring to consolidate the Company's manufacturing operations in Scotland to other MEAS sites, which is expected to, among other things, improve operational efficiencies. The Company expects to record approximately $1,600 in restructuring charges associated with the restructuring of its Scotland operations; however, the Company expects to realize annual cost efficiencies of approximately $1,600 beginning in fiscal 2015. For a further discussion concerning the restructuring, please refer to Note 13 to the Consolidated Financial Statements. We believe we continue to have one of the strongest product development pipelines in the history of the Company, which we expect to lay the foundation for future sales growth. Research and development will continue to play a key role in our efforts to maintain product innovations for new sales and to improve profitability. Our broad range of products and geographic diversity provide the Company with a variety of opportunities to leverage technology, products, manufacturing base and our financial performance.

Acquisitions are a key component of the Company's growth strategy. Consistent with this strategy, the Company made six acquisitions since April 1, 2011. On April 17, 2013, the Company acquired the capital stock of Spectrum, a leader in the design and manufacture of custom temperature probes, high reliability encoders and inertial sensors. On October 1, 2012, the Company acquired certain assets of RTD, a designer and manufacturer of temperature sensors and probes based in Ham Lake, Minnesota. On April 2, 2012, the Company acquired the assets of Cosense, a Long Island, New York based manufacturer of ultrasonic sensors and switches used in semiconductor, medical, aerospace and industrial applications. On October 31, 2011, the Company completed the acquisition of all of the capital stock of Timesquest Limited, a holding company and the sole shareholder of Gentech, a designer and manufacturer of position sensors used largely for tank liquid level measurement, including urea tank level in heavy truck SCR systems sensor based in Ayrshire, Scotland. On September 30, 2011, the Company purchased the stock of Celesco, a manufacturer of a range of position sensors, including short and long stroke "string pot," linear potentiometer and rotary sensors. On July 8, 2011, the Company purchased the assets of Eureka, a manufacturer of a multi-probe sensor for monitoring water quality.

Trends: There are a number of trends that we expect to materially affect our future operating results, including changing global economic conditions with the resulting impact on our sales, profitability, and capital spending, changes in foreign currency exchange rates relative to the U.S. dollar, shifts in our taxable income between tax jurisdictions and the resulting impact on our overall effective tax rate, changes in our debt levels and applicable interest rates, and prices of raw materials and other costs, such as labor. Additionally, our earnings could be impacted by changes in the fair value of acquisition earn-out contingencies and furthermore, sales and results of operations could be impacted by additional acquisitions and the impact of restructurings.

Overall, the Company expects solid sales growth for fiscal 2014, in spite of the impact of an in-sourcing arrangement with Sensata and the continued effect on sales since many customers remain cautious due to challenging economic conditions with, among other factors, the euro-zone debt crisis and continued slow economic growth in certain markets. As discussed in Item 2 of our Quarterly Report on Form 10-Q filed on February 5, 2013, the Company has worked closely with Sensata, our largest customer and a large automotive supplier, on an in-sourcing program, whereby a majority of our business will be manufactured by Sensata under a royalty arrangement. The agreement with Sensata is expected to result in an overall improvement in our gross margins by approximately 200 to 250 basis points over the next two to three years. The impact on our sales in fiscal 2014 is expected to be a decrease of approximately $5,000 in net sales. As a result of continued limited customer visibility in product demand and the impact of the long-term supply agreement with Sensata, we have set our outlook for sales accordingly: Including acquisitions made in fiscal 2013 and the recent acquisition of Spectrum made in April 2013, the Company expects to generate sales of approximately $400,000 to $405,000 for fiscal 2014.

We remain positive with regard to sales contribution coming from product developments and expect solid contributions over the next several years driven by key development programs, including urea level/quality sensors, digital temperature sensors and new barometric pressure sensors, which we have discussed on our past several investor calls. One key development program in particular relates to increased diesel emission standards. All diesel truck (and eventually passenger car) OEMs are migrating to selective catalytic reduction systems (SCR), which inject urea into the exhaust stream to reduce NOx emissions. We expect OEMs to implement urea quality sensors over the next 3 years in the U.S. In Europe, to achieve new standards set in euro 6c (in 2016), we believe EU OEMs will integrate urea quality monitoring (as well as push for continuous level in tank) as ways to improve system efficiency and close the monitoring/dosing loop. China is several years behind U.S. and EU emission standards, so requirements for urea quality in China should phase in after 2016.

Additionally, we expect the sensor market will continue to perform well relative to the overall economy as a result of the increase in sensor content in various products across most end markets in the U.S., Europe and Asia. Sensor content continues to increase at a faster rate than overall product unit growth, as OEMs add "intelligence" in products across most market verticals to promote improved energy efficiency and cleaner technologies, to meet regulatory compliance requirements and to improve user safety and convenience.

The following graph details the Company's quarterly net sales and adjusted EBITDA over the previous two years.

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Adjusted EBITDA is a non-GAAP financial measure that is not in accordance with, or an alternative to, measures prepared in accordance with GAAP. The Company believes certain financial measures which meet the definition of non-GAAP financial measures provide important supplemental information. The Company considers Adjusted EBITDA an important financial measure because it provides a financial measure of the quality of the Company's earnings from a cash flow perspective (prior to taking into account the effects of changes in working capital and purchases of property and equipment and debt service). Other companies may calculate Adjusted EBITDA differently than we do, which might limit its usefulness as a comparative measure. Adjusted EBITDA is used by management in addition to and in conjunction with the results presented in accordance with GAAP. Additionally, we believe quarterly Adjusted EBITDA provides the current run-rate for trending purposes rather than a trailing twelve month historical amount. The following table details quarterly net sales and also provides a non-GAAP reconciliation of quarterly Adjusted EBITDA to the applicable GAAP financial measures.

                                             Quarterly       Income (Loss)                       Foreign
                              Quarterly       Adjusted           from                           Currency         Depreciation
 Quarter                      Adjusted        EBITDA*         Continuing                        Exchange              and           Income       Share-based
  Ended       Net Sales        EBITDA*         Margin        Operations **      Interest       Loss (Gain)        Amortization       Taxes      Compensation       Other*
3/31/2011    $    76,766     $    15,691             20 %   $         8,330     $     650     $         305     $         3,667     $ 1,383     $       1,356     $      -
6/30/2011    $    77,184     $    15,277             20 %   $         8,008     $     579     $         399     $         3,520     $ 1,453     $       1,245     $     73
9/30/2011    $    73,243     $    13,685             19 %   $         6,656     $     548     $        (378 )   $         3,581     $ 1,630     $       1,254     $    394
12/31/2011   $    76,341     $    13,057             17 %   $         4,695     $     806     $          27     $         4,847     $ 1,187     $       1,162     $    333
3/31/2012    $    86,436     $    16,625             19 %   $         8,345     $     642     $        (222 )   $         4,787     $ 1,883     $         602     $    588
6/30/2012    $    88,613     $    17,150             19 %   $         8,568     $     722     $          39     $         4,388     $ 2,566     $         856     $     11
9/30/2012    $    87,758     $    17,671             20 %   $        10,406     $     662     $         202     $         4,316     $ 3,503     $       1,388     $ (2,806 )
12/31/2012   $    81,628     $    14,015             17 %   $         6,096     $     688     $          (7 )   $         4,523     $ 1,075     $       1,500     $    140
3/31/2013    $    88,969     $    16,168             18 %   $         9,123     $     621     $        (345 )   $         4,659     $ 1,202     $         989     $    (81 )

* - Adjusted EBITDA = Income from Continuing Operations before Interest, Foreign Currency Exchange Loss (Gain), Depreciation and Amortization, Income Taxes, Share-based Compensation and Other. Other represents legal fees incurred related to certain International Traffic in Arms Regulations matters, professional fees related to acquisitions, impairment of asset held for sale, restructuring and fair value adjustments to earn-out contingencies. Adjusted EBITDA Margin = Adjusted EBITDA divided by Net Sales. For the quarter ended September 30, 2012, professional fees were $185, impairment of asset held for sale $489, restructuring costs of $242 and income from the fair value adjustments to earn-out contingencies was $3,722. For the quarter ended December 31, 2012, restructuring costs totaled $120 and professional fees were $20. For the quarter ended March 31, 2013, restructuring costs totaled $396, professional fees were $185 and income from fair value adjustments to earn-outs of $662.

The primary factors that impact our costs of sales include production and sales volumes, product sales mix, foreign currency exchange rates, changes in the price of raw materials, China wage rate increases and the impact of various cost control measures. Although we expect continued pressures on our gross margins given our expectation that costs, including raw material and labor costs, will increase, we expect product mix to improve, largely due to lower Sensata sales and sales growth of other more profitable product lines, and expect to continue to increase leverage of our fixed manufacturing overhead. Also impacting our costs, as part of the Company's ongoing efforts to review our business for opportunities to reduce operating expenses and leverage core competencies, the Company has started implementing a restructuring to consolidate all of the Company's manufacturing operations in Scotland to other MEAS sites. The restructuring includes initiatives designed to centralize certain operating activities, and is expected to, among other things, improve operational efficiencies and performance. The Scottish restructuring could change but is expected to be implemented over the next 12 to 24 months. Costs associated with this restructuring will include payments for severance charges, costs for termination of benefits and other related activities, in addition to possible contract termination, all of which will be reported in the statement of operations as restructuring costs. At March 31, 2013, the Company recorded a liability for an estimate of $396 for severance costs related to the facility closure in Scotland, and the Company expects to incur additional severance costs with the Scottish restructuring plan of approximately $800 during the next twelve months. Costs for the Scottish restructurings incurred through March 31, 2013 total $396, and total cumulative restructuring costs are expected to total approximately $1,600. For a further discussion concerning the Scottish restructuring, please refer to Note 13 to the Consolidated Financial Statements. We expect our overall gross margins, excluding costs associated with the restructuring in Scotland, to range from approximately 41% to 43%, during fiscal 2014, though gross margins for certain quarters could be outside this expected range. As with all manufacturers, our gross margins are sensitive to the overall volume of business (i.e., economies of scale) in that certain costs are fixed. During the year ended March 31, 2013, the RMB appreciated approximately 0.7%, and during fiscal 2012, the RMB appreciated approximately 3.6% relative to the U.S. dollar. There are indications this trend may continue in the near term. We estimate in 2014 for every 10% increase in the value of the RMB relative to the U.S. dollar, our gross margins decline by approximately $3,805.

Total selling, general and administrative expenses ("Total SG&A") as a percentage of net sales were higher in fiscal 2013 as compared to the prior year, mainly reflecting increases in acquisition related expenses and amortization of acquired intangible assets, as well as restructuring costs. Long-term, the Company plans to continue to control costs and leverage our SG&A expenses by growing sales at a higher rate than SG&A expenses. As a percent of sales, Total SG&A was approximately 29.3%, 28.7% and 28.6% in fiscal years 2013, 2012 and 2011, respectively. In 2014, we expect a decrease in our SG&A expenses as a percentage of net sales, assuming no new acquisitions, mainly due to higher sales, which we expect to be partially offset by continued investment in R&D for new programs, increased amortization expense from recent acquisitions and restructuring costs.

Amortization of acquired intangible assets and deferred financing costs increased over the past three years mainly due to acquisitions. Amortization is disproportionately loaded more in the initial years of the acquisition, and therefore amortization expense is higher in the quarters immediately following a transaction, and declines in later years based on how various intangible assets are valued and the differing useful lives for which the respective intangible assets are amortized. For example, backlog is amortized over a period less than 1 year and patents are amortized over a weighted average life of 15 years. Amortization of acquired intangible assets for fiscal 2014 is expected to approximate the level of amortization expense in fiscal 2013, excluding amortization of intangible assets acquired in business acquisitions in fiscal 2014 and no significant changes in foreign currency exchange rates.

In addition to margin exposure, the Company also has foreign currency exchange exposures related to balance sheet accounts. When foreign currency exchange rates fluctuate, there is a resulting revaluation of assets and liabilities denominated and accounted for in foreign currencies other than the subsidiary's functional currency, resulting in foreign currency exchange ("fx") losses or gains. For example, our Swiss company, which uses the Swiss franc or "CHF" as its functional currency, holds cash denominated in foreign currencies (U.S. dollar and Euro). As the Swiss franc appreciates against the U.S. dollar and/or Euro, the cash balances held in those denominations are devalued when stated in terms of Swiss francs. These fx transaction gains and losses are reflected in our "Foreign Currency Exchange Gain or Loss." Aside from cash, our foreign and domestic entities hold receivables and payables in foreign currencies. Foreign currency exchange losses or gains due to the revaluation of local subsidiary balance sheet accounts with realized and unrealized fx transactions fluctuated from a loss last year to a net gain this year. During the year ended March 31, 2013, the Company recorded net fx gain of $110, which reflects fx gains in Europe resulting from the fluctuation of the Euro relative to the U.S. dollar offset by fx losses in Asia with the appreciation of the RMB. We recorded net fx gains of $175 in 2012 and net fx losses of $439 in 2011. The Company's operations outside of the U.S. and the volume of business denominated in other currencies have expanded over the years from acquisitions. We expect to see continued fx losses or gains associated with volatility of foreign currency exchange rates.

The Company uses and may continue to use foreign currency contracts to hedge these fx exposures. The Company does not hedge all of its fx exposures, but has accepted some exposure to exchange rate movements. The Company does not apply hedge accounting when derivative financial instruments are used to manage these fx exposures. Since the Company does not apply hedge accounting, the changes in the fair value of those derivative financial instruments are reported in earnings in the fx gains or losses caption. We expect the value of the U.S. dollar will continue to fluctuate relative to the RMB, Euro, Swiss franc and British pound. Therefore, both positive and negative movements in currency exchange rates relative to the U.S. dollar will continue to affect the reported amounts of sales, profits, and assets and liabilities in the Company's consolidated financial statements.

We believe the Company has a relatively low overall effective cash tax rate with the utilization of our NOLs, as well as an overall low effective tax rate due to the low tax rates afforded to the Company in several tax jurisdictions in which we operate, including China, Ireland and Switzerland. Our overall effective tax rate will continue to fluctuate as a result of the shift in earnings among the various taxing jurisdictions in which we operate and their varying tax rates. This is particularly challenging due to the different timing and rates of economic activity around the world. We expect our 2014 overall estimated effective tax rate without discrete tax adjustments to range from approximately 21% to approximately 24%, an increase as compared to the prior year. The increase in the estimated overall effective tax rate mainly reflects a higher proportion of taxable earnings to tax jurisdictions with higher tax rates. The overall estimated effective tax rate is based on expectations and other estimates and involves complex domestic and foreign tax issues, which the Company monitors closely, but are subject to change.

The Company's subsidiary in China, MEAS China, received approval from the Chinese authorities for High New Technology Enterprise ("HNTE") status through December 31, 2014. HNTE status decreased the tax rate for MEAS China from 25% to 15%. To qualify for this reduced rate the Company must continue to meet various criteria in regard to its operations related to sales, research and development activity, and intellectual property rights. If the Company does not continue to receive HNTE status, the Company's income tax rate in China would increase to 25%.

The Company plans to continue investing in various capital projects in fiscal 2014 to generate higher sales in new and expanded programs, and expects these expenditures to range between 3.5% and 4.5% of sales. This range of expected capital expenditures excludes investments in the new Greenfield manufacturing facility in China and other such facility investments, such as the purchase of a facility to replace a leased facility or to expand an existing facility. There is no specific timeline or commitment to acquire a facility, but the Company does from time to time contemplate making such facility investments. The Company's investment in the new Greenfield manufacturing facility in Chengdu, China will continue through fiscal 2016. The Chengdu facility is expected to be cost approximately $6,000, excluding VAT, of which $371has been incurred to date. As part of the transition to new facility, the Company expects to temporarily increase certain inventory levels.

Asset Held for Sale and Impairment of Asset Held for Sale: With the purchase of PSI, the Company acquired an additional facility in Hampton, Virginia. The Company completed the consolidation of the former PSI facility into the existing MEAS Hampton facility. Since May 2011, the PSI facility was no longer utilized for manufacturing and is held for sale. Accordingly, the former PSI facility is classified as an asset held for sale since it meets the held for sale criteria under the applicable accounting guidelines.

In the fourth quarter of fiscal 2012, the Company concluded it had a triggering event requiring assessment of impairment since the former PSI facility had not been sold and overall economic trends and market conditions not being positive for commercial real estate. As a result, the Company reviewed the asset for impairment and recorded a $400 impairment charge. Based on continued softening of the real-estate market in Hampton, Virginia, the Company re-assessed the market value of the asset held for sale and as a result, the Company recorded an additional impairment charge of $489 during the three months ended September 30, 2012 to write-down the asset to its estimated fair value. The inputs utilized in the analysis are classified as Level 2 inputs within the fair value hierarchy as defined in the related accounting standards for fair value measurements and disclosures. The carrying value of the former PSI facility is $940 as of March 31, 2013, and approximates fair value less cost to sell.

Changes in Our Business

Acquisitions, Divestures and Restructurings: As described in the Executive Summary above, the Company made six acquisitions through April 2013 since April 1, 2011.

See "Item I. Business" of this Annual Report on Form 10-K for further details concerning the sale of the Consumer segment to Fervent Group Limited (FGL), effective December 1, 2005. Accordingly, the related financial statements detailed in "Item 6. Select Financial Data" of this Annual Report on Form 10-K for the Consumer segment are reported as discontinued operations. All comparisons in Management's Discussion and Analysis for consolidated statements of operations and consolidated statements of cash flows for each of the fiscal years ended March 31, 2013, 2012 and 2011, and consolidated balance sheets as of March 31, 2013 and 2012, exclude the results of these discontinued operations.

The Company has started implementing a restructuring to consolidate all of the Company's manufacturing operations in Scotland to other MEAS sites. These restructuring activities are expected to, among other things, improve operational efficiencies. For a further discussion concerning the Scottish restructuring, please refer to Note 13 to the Consolidated Financial Statements.

Recent Accounting Pronouncements

Recently Adopted Accounting Standards: In June 2011, the FASB issued new accounting standards for reporting comprehensive income. The new accounting standards revise only the presentation of comprehensive income in financial statements and require that net income and other comprehensive income be reported either in a single, continuous statement of comprehensive income or in two separate, but consecutive, statements. Presentation of components of comprehensive income in the statements as changes in stockholders' equity will no longer be allowed. In December 2011, the FASB issued an amendment to the new . . .

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