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MTSC > SEC Filings for MTSC > Form 10-K on 27-Nov-2013All Recent SEC Filings

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Form 10-K for MTS SYSTEMS CORP


27-Nov-2013

Annual Report


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

About MTS Systems Corporation
MTS Systems Corporation is a leading global supplier of high performance test systems and position sensors. Our 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. Our position sensors provide controls for a variety of industrial and vehicular applications. We had 2,299 employees and revenue of $569 million for the fiscal year ended September 28, 2013.

Company Strategy
Our goal is to grow profitably, generate strong cash flow, and deliver a strong return on invested capital to our shareholders by leveraging our leadership position in the research and development, product development and industrial equipment global end markets. Our desire is to be the innovation leader in creating test and measurement solutions to enable our customers' success. Through innovation we believe we can create value for our customers which will drive our growth. There are four global macro trends that will help enable this growth: energy scarcity; environmental concerns; continued globalization and the development of the emerging markets; and global demographics. These macro trends have significant implications for our customers, such as increasing the demand for new and more innovative products and increasing our customers' organizational complexity. We believe we have an excellent geographic footprint and are well positioned in both Test and Sensors to take advantage of these macro trends and deliver significant profitable growth in the years ahead.

We are working toward our previously communicated goal of achieving $1 billion in annual revenue. Economic conditions and the competitive environment will impact the timing of when the $1 billion goal is achieved. Our three priorities to achieve this goal are:

Accelerating innovation;

Capturing opportunities in the rapidly emerging markets; and

Realizing the potential of the Test service business

Our business model supports achieving our $1 billion revenue milestone through both organic growth and strategic acquisitions, assuming we continue to move aggressively to build our infrastructure, expand our offerings and execute on our opportunities with our key customers around the world. In order to accelerate our revenue growth over the next few years, investments in infrastructure, sales support and field service capacity and capability are essential. We began investing in earnest in both fiscal years 2012 and 2013, and will continue investing in fiscal year 2014.

Fiscal Year
Our fiscal year ends on the Saturday closest to September 30. The fiscal years ended September 28, 2013, September 29, 2012 and October 1, 2011 each consisted of 52 weeks.

Foreign Currency

Approximately 75% of our revenue has historically been derived from customers outside of the United States. Our financial results are principally exposed to changes in exchange rates between the U.S. dollar and the Euro, the Japanese Yen and the Chinese Yuan. A change in foreign exchange rates could positively or negatively affect our reported financial results.

Financial Results

Fiscal Year 2013 Compared to Fiscal Year 2012


Table of Contents

Total Company

Orders and Backlog

The following is a comparison of fiscal year 2013 and fiscal year 2012 orders,
separately identifying the estimated impact of currency translation:


                           Estimated
                   Business      Currency
          2013      Change      Translation     2012
                    (expressed in millions)
Orders   $ 567.4   $     8.6   $        (6.5 ) $ 565.3

Orders totaled $567.4 million, an increase of $2.1 million, or 0.4%, including an estimated 1.1% unfavorable impact of currency translation, compared to orders of $565.3 million for fiscal year 2012. Fiscal year 2013 orders included three large (equal to or in excess of $5.0 million) European and two Large Americas' Test orders totaling approximately $22 million and $15 million, respectively. Fiscal year 2012 orders included two large Asian and two large European Test orders totaling approximately $32 million and $14 million, respectively. Excluding the large orders and currency, base orders increased 3.4%, reflecting 3.4% growth in Test, primarily in Europe and Asia, as well as 3.1% growth in Sensors, primarily in the Americas and Asia.

The following is a comparison of fiscal year 2013 and fiscal year 2012 orders by geography:

Geography       2013      2012      Variance     % Variance
                          (expressed in millions)
Americas       $ 169.0   $ 153.4   $     15.6           10.2 %
Europe           181.8     170.8         11.0            6.4 %
Asia             216.6     241.1        (24.5 )        -10.2 %
Total Orders   $ 567.4   $ 565.3   $      2.1            0.4 %

Backlog of undelivered orders at September 28, 2013 was $290.2 million, a decrease of $8.2 million, or 2.7%, compared to backlog of $298.4 million at September 29, 2012. We believe 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, we have not historically experienced a significant number of order cancellations. During fiscal year 2013, one custom order in Test totaling approximately $2 million was cancelled. This order was booked in a previous fiscal year. The cancellation reflects a decision made by the customer to postpone the order until such time as the design phase of a testing system project has been completed. During fiscal year 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 year 2012.


Table of Contents

Results of Operations

The following is a comparison of fiscal year 2013 and fiscal year 2012 statements of operations (in millions, except per share data):

                              2013      2012      Variance        % Variance
Revenue                      $ 569.4   $ 542.3   $     27.1              5.0 %
Cost of sales                  337.5     306.1         31.4             10.3 %
Gross profit                   231.9     236.2         (4.3 )           -1.8 %
Gross margin                    40.7 %    43.6 %       -2.9 % pts

Operating expenses:
Selling and marketing           81.0      74.6          6.4              8.6 %
General administrative          48.1      51.4         (3.3 )           -6.4 %
Research and development        22.8      21.9          0.9              4.1 %
U.S. Government settlement         -       7.8         (7.8 )         -100.0 %
Total operating expenses       151.9     155.7         (3.8 )           -2.4 %
Income from operations          80.0      80.5         (0.5 )           -0.6 %
Interest expense, net           (0.3 )    (0.3 )          -              0.0 %
Other expense, net              (0.4 )    (0.4 )          -              0.0 %

Income before income taxes      79.3      79.8         (0.5 )           -0.6 %
Provision for income taxes      21.5      28.2         (6.7 )          -23.8 %
Net income                   $  57.8   $  51.6   $      6.2             12.0 %

Diluted earnings per share   $  3.64   $  3.21   $     0.43             13.4 %

The following is a comparison of fiscal year 2013 and fiscal year 2012 results of operations, separately identifying the estimated impact of currency translation:

                                               Estimated
                                        Business      Currency
                              2013       Change      Translation     2012
                                        (expressed in millions)
Revenue                      $ 569.4   $     35.2   $        (8.1 ) $ 542.3
Cost of sales                  337.5         37.1            (5.7 )   306.1
Gross profit                   231.9         (1.9 )          (2.4 )   236.2
Gross margin                    40.7 %                                 43.6 %

Operating expenses:
Selling and marketing           81.0          7.4            (1.0 )    74.6
General administrative          48.1         (3.2 )          (0.1 )    51.4
Research and development        22.8          0.9               -      21.9
U.S. Government settlement         -         (7.8 )             -       7.8
Total operating expenses       151.9         (2.7 )          (1.1 )   155.7
Income from operations       $  80.0   $      0.8   $        (1.3 ) $  80.5

Revenue
Revenue was $569.4 million, an increase of $27.1 million, or 5.0%, compared to revenue of $542.3 million for fiscal year 2012. This increase was driven by higher beginning backlog as well as a higher rate of backlog conversion into revenue in Test, partially offset by lower volume in Sensors, as well as an estimated $8.1 million unfavorable impact of currency translation. Test revenue increased 7.3% to $474.1 million, while Sensors revenue decreased 5.0% to $95.3 million.

The following is a comparison of fiscal year 2013 and fiscal year 2012 revenue by geography:

Geography        2013      2012      Variance    % Variance
                          (expressed in millions)
Americas        $ 165.6   $ 169.5   $     (3.9 )        -2.3 %
Europe            178.6     167.8         10.8           6.4 %
Asia              225.2     205.0         20.2           9.9 %
Total Revenue   $ 569.4   $ 542.3   $     27.1           5.0 %


Table of Contents

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 $231.9 million, a decrease of $4.3 million, or 1.8%, compared to gross profit of $236.2 million for fiscal year 2012. Gross profit as a percentage of revenue was 40.7%, a decrease of 2.9 percentage points from 43.6% for fiscal year 2012. This decrease reflects an unfavorable mix, primarily resulting from a higher proportion of lower-margin custom development products in Test. The gross profit rate was also negatively impacted by approximately 1 percentage point from continued investment in productivity and infrastructure initiatives in Test, and 1 percentage point from lower engineering labor utilization and higher warranty expense in Test. The productivity and infrastructure initiatives that impact gross profit are focused on the building of a scalable enterprise and include investments in our operating system and service delivery system. These investments will continue into fiscal year 2014.

Selling and Marketing Expense
Selling and marketing expense was $81.0 million, an increase of $6.4 million, or 8.6%, compared to $74.6 million for fiscal year 2012. This increase was primarily due to higher travel and other discretionary expenses to support current sales efforts, as well as higher compensation and benefits resulting from increased headcount, partially offset by an estimated $1.0 million favorable impact of currency translation. Selling and marketing expense as a percentage of revenue was 14.2%, compared to 13.8% for fiscal year 2012.

General and Administrative Expense
General and administrative expense was $48.1 million, a decrease of $3.3 million, or 6.4%, compared to $51.4 million for fiscal year 2012. This decrease was primarily driven by a lower level of investment in strategic and compliance initiatives, as well as expenses recognized in fiscal year 2012 related to a CEO transition, partially offset by higher compensation and benefits driven by increased headcount, as well as expenses associated with a senior management transition in Sensors. General and administrative expense as a percentage of revenue was 8.4%, compared to 9.5% for fiscal year 2012.

Research and Development Expense
Research and development expense was $22.8 million, an increase of $0.9 million, or 4.1%, compared to $21.9 million for fiscal year 2012. This increase was primarily driven by timing of planned expenditures in Test and higher compensation and benefits in Sensors resulting from increased headcount. In addition, we allocated certain of our resources to capitalized software development activities during fiscal year 2012. Total software development costs capitalized during fiscal year 2012 were $0.5 million. No software development costs were capitalized during fiscal year 2013. Research and development expense as a percentage of revenue was 4.0% on higher volume, flat compared to fiscal year 2012.

U.S. Government Settlement Expense
As previously disclosed in the fourth quarter of fiscal year 2012, we 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 our past disclosures on our government certifications and our government contracting compliance policies, general compliance record and practices in areas including export controls and government contracts. During fiscal year 2012, we accrued a loss contingency equal to the settlement amount. U.S. Government settlement expense as a percentage of revenue was 1.4% for fiscal year 2012.

For a more detailed discussion of the investigation by the DOC and USAO and the settlement agreement, please refer to Note 11 of the Notes to Consolidated Financial Statements under Item 8 of this Annual Report on Form 10-K.


Table of Contents

Income from Operations
Income from operations was $80.0 million, a decrease of $0.5 million, or 0.6%, compared to income from operations of $80.5 million for fiscal year 2012. Operating income for fiscal year 2012 included the previously mentioned $7.8 million of costs related to the U.S. Government matter. Excluding these costs, income from operations decreased $8.3 million, driven by lower gross profit and $4.1 million higher operating expenses. Operating income as a percentage of revenue was 14.0%, compared to 14.8% for fiscal year 2012.

Historically, our operating costs have been impacted by a level of inflation ranging from -1% to 4%. We use 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 our operating costs were to become subject to significant inflationary pressures, we may not be able to fully offset such higher costs.

Interest Expense, net
Interest expense, net was $0.3 million, flat compared to fiscal year 2012. Interest expense declined $0.3 million due to lower interest rates incurred on short-term borrowings as well as a relatively lower level of outstanding borrowings during fiscal year 2013. Interest income decreased $0.3 million primarily due to lower average cash balances maintained in interest-bearing accounts during fiscal year 2013.

Other Expense, net
Other expense, net was $0.4 million of net other expense, flat compared to fiscal year 2012.

Provision for Income Taxes
Provision for income taxes totaled $21.5 million, a decrease of $6.7 million, compared to $28.2 million for fiscal year 2012. This decrease was primarily due to a lower effective tax rate. The effective tax rate for the fiscal year was 27.1%, a decrease of 8.3 percentage points compared to 35.4% for fiscal year 2012. During fiscal year 2013, the tax rate was favorably impact by approximately 3.7 percentage points due to new favorable guidance and legislation related to the U.S. R&D tax credit. Also, the effective tax rate for fiscal year 2012 was unfavorably impacted by approximately 3.6 percentage points due to the recognition of the previously mentioned $7.8 million of costs related to the U.S. Government settlement which were nondeductible for income tax purposes.

Net Income
Net income was $57.8 million, an increase of $6.2 million, compared to $51.6 million for fiscal year 2012. The increase was primarily driven by a lower effective tax rate, partially offset by lower income from operations. Earnings per diluted share increased $0.43 to $3.64, compared to $3.21 for fiscal year 2012. Earnings per share for fiscal year 2012 included a $0.48 per diluted share negative impact from the previously mentioned settlement costs related to the U.S. Government matters. Additionally, the decrease in shares outstanding positively impacted earnings per diluted share by $0.04.

Segment Results

Test Segment

Orders and Backlog

The following is a comparison of fiscal year 2013 and fiscal year 2012 orders
for Test, separately identifying the estimated impact of currency translation:


                           Estimated
                   Business      Currency
          2013      Change      Translation     2012
                    (expressed in millions)
Orders   $ 470.0   $     5.5   $        (3.5 ) $ 468.0


Table of Contents

Orders totaled $470.0 million, an increase of $2.0 million, or 0.4%, including an estimated 0.7% unfavorable impact of currency translation, compared to orders of $468.0 million for fiscal year 2012. Fiscal year 2013 orders included three large European orders in the ground vehicles market totaling approximately $22 million, one of which was for a rolling road wind tunnel measurement system, one was for a transmission test system and the other was for a tire testing system. In addition, fiscal year 2013 orders included two large Americas' orders totaling approximately $15 million, one of which was for a vehicle motion simulator in the structures market and the other for an aerodynamic test system in the ground vehicles market. Fiscal year 2012 orders included two large Asian orders in the structures market totaling approximately $32 million. In addition, fiscal year 2012 orders included two large European orders totaling approximately $14 million, one of which was in the ground vehicles market and the other was in the structures market. Excluding the large orders and currency, base orders increased 3.4%, driven by strong ground vehicles orders in Asia and Europe. Test accounted for 82.8% of our total orders, flat compared to fiscal year 2012.

The following is a comparison of fiscal year 2013 and fiscal year 2012 orders for Test by geography:

Geography       2013      2012      Variance     % Variance
                          (expressed in millions)
Americas       $ 140.4   $ 127.4   $     13.0           10.2 %
Europe           133.9     121.9         12.0            9.8 %
Asia             195.7     218.7        (23.0 )        -10.5 %
Total Orders   $ 470.0   $ 468.0   $      2.0            0.4 %

Backlog of undelivered orders at September 28, 2013 was $275.0 million, a decrease of 3.6% from backlog of $285.3 million at September 29, 2012. As previously mentioned, backlog at the end of fiscal year 2013 was negatively impacted by the cancellation of one custom order totaling approximately $2 million. Also, as previously mentioned, backlog at the end of fiscal year 2012 was negatively impacted by the cancellation of two custom orders totaling approximately $9 million.

Results of Operations

The following is a comparison of fiscal year 2013 and fiscal year 2012 results
of operations for Test separately identifying the estimated impact of currency
translation:


                                               Estimated
                                        Business      Currency
                              2013       Change      Translation     2012
                                        (expressed in millions)
Revenue                      $ 474.1   $     37.4   $        (5.3 ) $ 442.0
Cost of sales                  296.1         38.6            (4.6 )   262.1
Gross profit                   178.0         (1.2 )          (0.7 )   179.9
Gross margin                    37.5 %                                 40.7 %

Operating expenses:
Selling and marketing           63.4          4.2            (0.4 )    59.6
General administrative          36.3         (3.0 )           0.2      39.1
Research and development        17.3          0.5               -      16.8
U.S. Government settlement         -         (6.1 )             -       6.1
Total operating expenses       117.0         (4.4 )          (0.2 )   121.6
Income from operations       $  61.0   $      3.2   $        (0.5 ) $  58.3


Table of Contents

Revenue
Revenue was $474.1 million, an increase of $32.1 million, or 7.3%, compared to revenue of $442.0 million for fiscal year 2012. The increase was primarily driven by a higher beginning backlog and a higher rate of backlog conversion into revenue, partially offset by an estimated $5.3 million unfavorable impact of currency translation. The backlog conversion rate benefited from the implementation of operational process improvements.

The following is a comparison of fiscal year 2013 and fiscal year 2012 revenue for Test by geography:

Geography        2013      2012      Variance    % Variance
                   (expressed in millions)
Americas        $ 138.3   $ 141.0   $     (2.7 )        -1.9 %
Europe            131.2     119.1         12.1          10.2 %
Asia              204.6     181.9         22.7          12.5 %
Total Revenue   $ 474.1   $ 442.0   $     32.1           7.3 %

Gross Profit
Gross profit was $178.0 million, a decrease of $1.9 million, or 1.1%, compared to gross profit of $179.9 million for fiscal year 2012. Gross profit as a percentage of revenue was 37.5%, a decrease of 3.2 percentage points from 40.7% for fiscal year 2012. Of the reduced gross profit rate, approximately 2 percentage points resulted from an unfavorable mix of lower-margin products and services, 1 percentage point resulted from increased warranty expense, and 1 percentage point resulted from continued investment in productivity and infrastructure initiatives. These decreases were partially offset by increased leverage on higher volume. As previously mentioned, the productivity and infrastructure initiatives that impact gross profit are focused on the building of a scalable enterprise and include investments in our operating system and service delivery system. These investments will continue into fiscal year 2014.

Selling and Marketing Expense
Selling and marketing expense was $63.4 million, an increase of $3.8 million, or 6.4%, compared to $59.6 million for fiscal year 2012. This increase was primarily driven by higher compensation and benefits resulting from increased headcount, as well as increased travel and other discretionary expenses to support selling efforts, partially offset by reduced bad debt expense. Selling and marketing expense as a percentage of revenue was 13.4% on higher volume, compared to 13.5% for fiscal year 2012.

General and Administrative Expense
General and administrative expense was $36.3 million, a decrease of $2.8 million, or 7.2%, compared to $39.1 million for fiscal year 2012. This decrease was primarily driven by a lower level of investment in strategic and compliance initiatives, as well as expenses recognized in fiscal year 2012 related to a CEO transition, partially offset by higher compensation and benefits resulting from increased headcount. General and administrative expense as a percentage of revenue was 7.7%, compared to 8.8% for fiscal year 2012.

Research and Development Expense
Research and development expense was $17.3 million, an increase of $0.5 million, or 3.0%, compared to $16.8 million for fiscal year 2012. As previously mentioned, $0.5 million of costs associated with software development activities were capitalized in fiscal year 2012. No software development costs were capitalized during fiscal year 2013. Research and development expense as a percentage of revenue was 3.6% on higher volume, compared to 3.8% for fiscal year 2012.


Table of Contents

U.S. Government Settlement Expense
U.S. Government settlement expense in fiscal year 2012 includes $6.1 million of the $7.8 million costs related to the previously mentioned U.S. Government matter that was settled during fiscal year 2012. U.S. Government settlement expense as a percentage of revenue was 1.4% for fiscal year 2012.

Income from Operations
Income from operations was $61.0 million, an increase of $2.7 million, or 4.6%, compared to income from operations of $58.3 million for fiscal year 2012. Operating income for fiscal year 2012 included the previously mentioned $6.1 million of costs related to the U.S. Government matter. Excluding these costs, income from operations decreased $3.4 million, driven by lower gross profit and $1.5 million higher operating expenses. Operating income as a percentage of revenue was 12.9% on higher volume, compared to 13.2% for fiscal year 2012.

Sensors Segment

Orders and Backlog

The following is a comparison of fiscal year 2013 and fiscal year 2012 orders
for Sensors, separately identifying the estimated impact of currency
translation:


                          Estimated
                  Business      Currency
          2013     Change      Translation     2012
                   (expressed in millions)
Orders   $ 97.4   $     3.1   $        (3.0 ) $ 97.3

Orders totaled $97.4 million, flat compared to orders of $97.3 million for fiscal year 2012, including an estimated 3.1% unfavorable impact of currency translation. Excluding currency, orders increased 3.2%, driven by stronger demand in the global industrial markets. Sensors accounted for 17.2% of our total orders, flat compared to fiscal year 2012.

The following is a comparison of fiscal year 2013 and fiscal year 2012 orders for Sensors by geography:

Geography        2013      2012     Variance    % Variance
                  (expressed in millions)
Americas       $   28.6   $ 26.0   $      2.6          10.0 %
Europe             47.9     48.9         (1.0 )        -2.0 %
Asia               20.9     22.4         (1.5 )        -6.7 %
Total Orders   $   97.4   $ 97.3   $      0.1           0.1 %

Backlog of undelivered orders at September 28, 2013 was $15.2 million, an increase of 16.0% from backlog of $13.1 million at September 29, 2012.


Table of Contents

Results of Operations

The following is a comparison of fiscal year 2013 and fiscal year 2012 results
. . .
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