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INTT > SEC Filings for INTT > Form 10-K on 27-Mar-2014All Recent SEC Filings

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Form 10-K for INTEST CORP


27-Mar-2014

Annual Report


Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Risk Factors and Forward-Looking Statements

In addition to historical information, this discussion and analysis contains statements relating to possible future events and results that are considered "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. These statements can often be identified by the use of forward-looking terminology such as "believes," "expects," "intends," "may," "will," "should" or "anticipates" or similar terminology. See Part I, Item 1 - "Business - Cautionary Statement Regarding Forward-Looking Statements" for examples of statements made in this report which may be "forward-looking statements." These statements involve risks and uncertainties and are based on various assumptions. Although we

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inTEST CORPORATION
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 2013

Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)

believe that our expectations are based on reasonable assumptions, investors and prospective investors are cautioned that such statements are only projections, and there cannot be any assurance that these events or results will occur. Information about the primary risks and uncertainties that could cause our actual future results to differ materially from our historic results or the results described in the forward-looking statements made in this report or presented elsewhere by Management from time to time are included in Part I, Item 1A - "Risk Factors."

Overview

This MD&A should be read in conjunction with the accompanying consolidated financial statements.

Our business and results of operations are substantially dependent upon the demand for ATE by semiconductor manufacturers and companies that specialize in the testing of ICs. Demand for ATE is driven by semiconductor manufacturers that are opening new, or expanding existing, semiconductor fabrication facilities or upgrading existing equipment, which in turn is dependent upon the current and anticipated market demand for semiconductors and products incorporating semiconductors. In the past, the semiconductor industry has been highly cyclical with recurring periods of oversupply, which often have a severe impact on the semiconductor industry's demand for ATE, including the products we manufacture. This can cause wide fluctuations in both our orders and net revenues and, depending on our ability to react quickly to these shifts in demand, can significantly impact our results of operations.

ATE market cycles are difficult to predict and in recent years have become more volatile and, in certain cases, shorter in duration. Because the market cycles are generally characterized by sequential periods of growth or declines in orders and net revenues during each cycle, year over year comparisons of operating results may not always be as meaningful as comparisons of periods at similar points in either up or down cycles. In addition, during both downward and upward cycles in our industry, in any given quarter, the trend in both our orders and net revenues can be erratic. This can occur, for example, when orders are canceled or currently scheduled delivery dates are accelerated or postponed by a significant customer or when customer forecasts and general business conditions fluctuate during a quarter. We believe that purchases of most of our products are typically made from semiconductor manufacturers' capital expenditure budgets. Certain portions of our business, however, are generally less dependent upon the capital expenditure budgets of the end users. For example, purchases of certain of our products, such as docking hardware, for the purpose of upgrading or improving the utilization, performance and efficiency of existing ATE, tend to be counter cyclical to sales of new ATE. Moreover, we believe a portion of our sales of thermal products results from the increasing need for temperature testing of circuit boards and specialized components that do not have the design or quantity to be tested in an electronic device handler.

As part of our diversification strategy to reduce the impact of ATE market volatility on our business operations, we market our Thermostream temperature management systems in markets outside the ATE market, such as the automotive, consumer electronics, defense/aerospace, energy, industrial and telecommunications markets. Because we are a recent market entrant in these markets, we have not yet developed meaningful market shares in these non-ATE markets. Consequently, we are continuing to evaluate customer buying patterns or market trends in these non-ATE markets. We believe that these markets usually are less cyclical than the ATE market.

While the majority of our orders and net revenues are derived from the ATE market, our operating results do not always follow the overall trend in the ATE market in any given period. We believe that these anomalies may be driven by a variety of changes within the ATE market, including, for example, changing product requirements, longer time periods between new product offerings by OEMs and changes in customer buying patterns. In particular, demand for our mechanical and electrical products, which are sold exclusively within the ATE market, and our operating margins in these product segments have been affected by shifts in the competitive landscape, including (i) customers placing heightened emphasis on shorter lead times (which places increased demands on our available engineering and production capacity increasing unit costs) and ordering in smaller quantities (which prevents us from acquiring component materials in larger volumes at lower cost and increasing unit costs), (ii) the practice of OEM manufacturers to specify other suppliers as primary vendors, with less frequent opportunities to compete for such designations, (iii) the role of third-party test and assembly houses in the ATE market and their requirement of products with a greater range of use at the lowest cost,
(iv) customer supply chain management groups demanding lower prices and spreading purchases across multiple vendors, and (v) certain competitors aggressively reducing their products' sales prices (causing us to either reduce our products' sales price to be successful in obtaining the sale or causing loss of the sale).

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inTEST CORPORATION
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 2013

Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)

In addition, in recent periods we have seen instances where demand for ATE is not consistent for each of our product segments or for any given product within a particular product segment. This inconsistency in demand for ATE can be driven by a number of factors, but in most cases we have found the primary reason is unique customer-specific changes in demand for certain products driven by the needs of their customers or markets served. These shifts in market practices and customer-specific needs have had, and may continue to have, varying levels of impact on our operating results and are difficult to quantify or predict from period to period. Management has taken, and will continue to take, such actions it deems appropriate to adjust our strategies, products and operations to counter such shifts in market practices as they become evident.

     Orders and Backlog

     The following table sets forth, for the periods indicated, a breakdown of
     the orders received from unaffiliated customers both by product segment and
     market.

                                             Years Ended        Change
                                            December 31,
      Orders from unaffiliated customers:   2013     2012   $ Amount   %
      Thermal Products                    $21,953  $23,844  $(1,891)   (8)%
      Mechanical Products                  10,115    9,473      642     7
      Electrical Products                   6,291    9,441   (3,150) (33)
                                          $38,359  $42,758  $(4,399)  (10)%

      ATE market                          $28,896  $35,756  $(6,860)  (19)%
      Non-ATE market                        9,463    7,002    2,461    35
                                          $38,359  $42,758  $(4,399)  (10)%

Total consolidated orders for the year ended December 31, 2013 were $38.4 million compared to $42.8 million for 2012. The decline in consolidated orders reflected the weakened ATE demand that we began to experience in early 2012 and that continued throughout 2013. ATE orders declined $6.9 million or 19% during 2013 as compared to 2012. Both our Thermal and Electrical Products segments experienced declines in their orders during 2013 as compared to 2012, however, each segment saw differing levels of reduction in demand. Our Thermal Products segment experienced a decline in demand from their ATE customers; however, this decline was partially offset by an increase in demand from customers in markets outside the ATE market, including the telecommunications, industrial and defense/aerospace markets. We attribute the higher percentage decrease in 2013 as compared to 2012 for our Electrical Products segment to the fact that during 2012, our Electrical Products segment experienced an unusually high level of demand from one particular OEM customer that was non-recurring.

The Mechanical Products segment experienced an increase in demand in 2013, reflecting increased demand from certain customers in the fourth quarter of 2013 as compared to the same period in 2012. We believe this increase in demand, although primarily driven by certain specific customers, also signals the beginning of a period of improved demand within the ATE market generally. Although we have experienced fluctuating levels of demand in the fourth quarter of 2013 and in the first quarter of 2014 for all of our products segments, we currently expect that demand in the ATE market will improve for all of our product segments during 2014. However, we cannot be certain how long this trend will continue nor can we be certain how significant the increases in demand will be for any future period for any of our product segments.

Orders from customers in various markets outside of the ATE market for the year ended December 31, 2013, grew by 35% during 2013 as compared to 2012 and increased from 16% of our consolidated orders in 2012 to 25% in 2013. We believe the increases in both our orders from customers in various markets outside the ATE market and those orders as a percentage of our consolidated orders reflect improved demand from the customers we serve in several of the markets outside the ATE market, including the telecommunications, industrial and defense/aerospace markets. The level of our orders in these non-ATE markets has varied in the past, and we expect it will vary significantly in the future as we build our presence in these markets and establish new markets for our products.

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inTEST CORPORATION
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 2013

Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)

At December 31, 2013, our backlog of unfilled orders for all products was approximately $3.1 million compared with approximately $4.2 million at December 31, 2012. Our backlog includes customer orders which we have accepted, substantially all of which we expect to deliver in 2014. While backlog is calculated on the basis of firm purchase orders, a customer may cancel an order or accelerate or postpone currently scheduled delivery dates. Our backlog may be affected by the tendency of customers to rely on short lead times available from suppliers, including us, in periods of depressed demand. In periods of increased demand, there is a tendency towards longer lead times that has the effect of increasing backlog. As a result, our backlog at a particular date is not necessarily indicative of sales for any future period.

     Net Revenues

     The following table sets forth, for the periods indicated, a breakdown of
     the net revenues from unaffiliated customers both by product segment and
     market.

                                                   Years Ended        Change
                                                  December 31,
      Net revenues from unaffiliated customers:   2013     2012   $ Amount   %
      Thermal Products                          $22,962  $24,307  $(1,345)   (6)%
      Mechanical Products                         9,962    9,904       58     1
      Electrical Products                         6,502    9,165   (2,663) (29)
                                                $39,426  $43,376  $(3,950)   (9)%

      ATE market                                $29,349  $35,554  $(6,205)  (17)%
      Non-ATE market                             10,077    7,822    2,255    29
                                                $39,426  $43,376  $(3,950)   (9)%

The trends in our consolidated net revenues in 2013 were similar to the trends previously discussed with regard to our orders. We believe the reduced level of net revenues from the ATE market in 2013 as compared to 2012, primarily for our Thermal and Electrical Products segments, are indicative of weakened demand in the ATE market. We believe the increased level of net revenues from customers outside the ATE market reflects increased penetration into these new markets.

In addition, in the past several years we have seen a developing trend towards increasing captive manufacturing of manipulators by some tester manufacturers. While this trend began several years ago, it is only since 2012 that this action began to significantly reduce the size of the available market for non-captive manufactured manipulator products. This trend has resulted in reduced levels of net revenues in our Mechanical Products segment in 2012 and 2013 as compared to prior years. As a result, our Mechanical Products segment has experienced significant operating losses in both 2012 and 2013. We are currently exploring various options with a goal of both increasing our level of net revenues as well as reducing our overall level of variable and fixed costs for this product segment.

Although we have seen a similar trend towards increasing captive manufacturing develop in the available markets for docking hardware and tester interface products as well, our net revenues for docking hardware and tester interface products have not been as negatively affected by this trend as those of our manipulator products.

Product/Customer Mix

Our three product segments each have multiple products that we design, manufacture and market to our customers. Due to a number of factors, our products have varying levels of gross margin. The mix of products we sell in any period is ultimately determined by our customers' needs. Therefore, the mix of products sold in any given period can change significantly from the prior period. As a result, our consolidated gross margin can be significantly impacted in any given period by a change in the mix of products sold in that period.

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inTEST CORPORATION
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 2013

Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)

We sell most of our products to semiconductor manufacturers and third-party test and assembly houses (end user sales) and to ATE manufacturers (OEM sales) who ultimately resell our equipment with theirs to semiconductor manufacturers. Our Thermal Products segment also sells into a variety of other markets including the automotive, consumer electronics, defense/aerospace, energy, industrial and telecommunications markets. The mix of customers during any given period will affect our gross margin due to differing sales discounts and commissions. For the years ended December 31, 2013 and 2012, our OEM sales as a percentage of net revenues were 12% and 16%, respectively.

OEM sales generally have a lower gross margin than end user sales, as OEM sales historically have had a more significant discount. Our current net operating margins on most OEM sales, however, are only slightly less than margins on end user sales because of the payment of third party sales commissions on most end user sales. We have also continued to experience demands from our OEM customers' supply line managers to reduce our sales prices to them. If we cannot further reduce our manufacturing and operating costs, these pricing pressures will negatively affect our gross and operating margins.

Results of Operations

The results of operations for our three product segments are generally affected by the same factors. Separate discussions and analyses for each product segment would be repetitive and obscure any unique factors that affected the results of operations of our different product segments. The discussion and analysis that follows, therefore, is presented on a consolidated basis and includes discussion of factors unique to each product segment where significant to an understanding of that segment.

Year Ended December 31, 2013 Compared to Year Ended December 31, 2012

Net Revenues. Net revenues were $39.4 million for the year ended December 31, 2013 compared to $43.4 million for the same period in 2012, a decrease of $4.0 million or 9%. For the year ended December 31, 2013, the net revenues of our Thermal and Electrical Products segments decreased $1.3 million or 6% and $2.7 million or 29%, respectively, while the net revenues of our Mechanical Products segment were relatively unchanged as compared to the same period in 2012. We believe the decrease in our net revenues during 2013 primarily reflects the factors previously discussed in the Overview.

Gross Margin. Gross margin was 48% for the year ended December 31, 2013 compared to 44% for the same period in 2012. The improvement in the gross margin was primarily the result of a reduction in our component material costs as a percentage of net revenues, which decreased from 36% of net revenues for 2012 to 34% of net revenues for 2013. We attribute the decrease to changes in customer and product mix. In addition, the improvement in gross margin reflects a $377,000 reduction in the level of charges for obsolete and excess inventory in 2013 as compared to 2012. The reduction in these charges primarily reflects fewer items falling into our standard objective criteria. Finally, our fixed operating costs decreased from 16% of net revenues in 2012 to 15% of net revenues in 2013. In absolute dollar terms, these costs declined $979,000 in 2013 as compared to 2012. This decrease primarily reflects reduced headcount in our Thermal and Mechanical Products segments.

Selling Expense. Selling expense was relatively unchanged at $5.4 million for each of the years ended December 31, 2013 and 2012, respectively. During 2013, commissions paid to our internal sales staff in our Thermal and Electrical Products segments declined $148,000 reflecting the lower revenues levels in these segments during 2013 as compared to 2012. To a lesser extent, there were reductions in warranty related expenses, freight and installation costs, also driven by the reduced sales levels in 2013. These decreases were almost fully offset by a $255,000 increase in salary and benefits expense primarily as a result of an increase in our sales staff in our Thermal and Electrical Products segments.

Engineering and Product Development Expense. Engineering and product development expense was $3.7 million for the year ended December 31, 2013 compared to $3.9 million for the same period in 2012, a decrease of $212,000 or 5%. The decrease primarily reflects a reduction in the use of third party product development consultants and related development supplies in our Thermal Products segment. These decreases were partially offset by an increase in patent legal costs in our Mechanical and Thermal Products segments.

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inTEST CORPORATION
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 2013

Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)

General and Administrative Expense. General and administrative expense was $6.0 million for the year ended December 31, 2013 compared to $6.4 million for the same period in 2012, a decrease of $455,000 or 7%. During 2012, we recorded $337,000 in costs associated with the acquisition of Thermonics and $55,000 in costs related to the relocation of our Electrical Products segment's operation in California. There were no similar costs recorded in 2013. To a lesser extent, the decrease also reflects lower levels of professional fees.

Restructuring and Other Charges. Restructuring and other charges were $313,000 for 2012. There were no similar charges for 2013. The restructuring and other charges recorded during 2012 represent facility closure costs related to the closure of the Sunnyvale, California facility occupied by Thermonics at the time of our acquisition of this operation.

Income Tax Expense. For the year ended December 31, 2013, we recorded income tax expense of $931,000 compared to $897,000 for the same period in 2012. Our effective tax rate was 23% for 2013 compared to 29% for 2012. On a quarterly basis, we record income tax expense or benefit based on the expected annualized effective tax rate for the various taxing jurisdictions in which we operate our businesses. The reduction in our effective tax rate in 2013 as compared to 2012 primarily reflects the recording of the effect of the reinstatement of certain domestic research and development tax credits which was enacted in January 2013, as well as the recording of additional benefits in connection with the finalization of an audit of our German operation and, to a lesser extent, additional foreign tax credits determined as a part of the process of finalizing and filing our 2012 federal income tax return, both of which occurred in September 2013.

Liquidity and Capital Resources

As discussed more fully in the Overview, our business and results of operations are substantially dependent upon the demand for ATE by semiconductor manufacturers and companies that specialize in the testing of ICs. The cyclical and volatile nature of demand for ATE makes estimates of future revenues, results of operations and net cash flows difficult.

Our primary historical source of liquidity and capital resources has been cash flow generated by our operations and we manage our businesses to maximize operating cash flows as our primary source of liquidity. We use cash to fund growth in our operating assets, for new product research and development and for acquisitions.

Liquidity

Our cash and cash equivalents and working capital were as follows:

December 31,
2013 2012
Cash and cash equivalents $19,018 $15,576 Working capital $24,749 $21,000

As of December 31, 2013, $2.3 million of our cash and cash equivalents was held by our foreign subsidiaries. If these funds are needed for our operations in the U.S., we may be required to accrue and pay U.S. taxes if we repatriate certain of these funds. Our intent is to indefinitely reinvest these funds in our foreign operations and we have no current plans that would require us to repatriate these funds to the U.S.

We currently expect our cash and cash equivalents and projected future cash flow to be sufficient to support our short term working capital requirements. We do not currently have any credit facilities under which we can borrow to help fund our working capital or other requirements.

Cash Flows

Operating Activities. Net cash provided by operations for the year ended December 31, 2013 was $3.8 million. During 2013, we recorded net earnings of $3.1 million, which included non-cash charges of $847,000 for depreciation and amortization, $311,000 for excess and obsolete inventory charges and $307,000 of deferred income tax expense. During 2013, accounts receivable and inventories increased $233,000 and $416,000, respectively, compared to the levels at the end of 2012. These

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inTEST CORPORATION
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 2013

Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)

increases primarily reflect increased business activity during the fourth quarter of 2013 as compared to the fourth quarter of 2012. During 2013, deferred revenue and customer deposits decreased $182,000 primarily reflecting the completion during 2013 of certain long-term projects that had been ongoing at the end of 2012 in our Thermal Products segment.

Investing Activities. During 2013 purchases of property and equipment were $424,000 which primarily represent additions to leased systems in our Thermal Products segment. We have no significant commitments for capital expenditures for 2014, however, depending upon changes in market demand, we may make such purchases as we deem necessary and appropriate.

Financing Activities. During 2013 there were no significant cash flows from financing activities.

New or Recently Adopted Accounting Standards

See Note 2 to the consolidated financial statements for information concerning the implementation and impact of new or recently adopted accounting standards.

Critical Accounting Policies

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States ("U.S. GAAP") requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to inventories, long-lived assets, goodwill, identifiable intangibles and deferred income tax valuation allowances. We base our estimates on historical experience and on appropriate and customary assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Some of these accounting estimates and assumptions are particularly sensitive because of their significance to our consolidated financial statements and because of the possibility that future events affecting them may differ markedly from what had been assumed when the financial statements were prepared.

Inventory Valuation

Inventories are valued at cost on a first-in, first-out basis, not in excess of market value. On a quarterly basis, we review our inventories and record excess and obsolete inventory charges based upon our established objective excess and obsolete inventory criteria. These criteria identify material that has not been used in a work order during the prior twelve months and the quantity of material on hand that is greater than the average annual usage of that material over the prior three years. In certain cases, additional excess and obsolete inventory charges are recorded based upon current market conditions, anticipated product life cycles, new product introductions and expected future use of the inventory. The excess and obsolete inventory charges we record establish a new cost basis for the related inventories. During 2013 and 2012, we recorded . . .

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