10-Q 1 nts103310310q.txt QUARTERLY REPORT ON FORM 10-Q ================================================================================ FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 --------------------------- (mark one) [x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended October 31, 2003 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For transition period from ________________ to _________________ 0-16438 (Commission File Number) NATIONAL TECHNICAL SYSTEMS, INC. ------------------------------------------------------------- (Exact name of registrant as specified in its charter) California 95-4134955 ------------------------ ------------- (State of Incorporation) (IRS Employer Identification number) 24007 Ventura Boulevard, Suite 200, Calabasas, California --------------------------------------------------------- (Address of registrant's principal executive office) (818) 591-0776 91302 ------------------------------- ---------- (Registrant's telephone number) (Zip code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES |X| NO |_| Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). YES |_| NO |X| The number of shares of common stock, no par value, outstanding as of December 8, 2003 was 8,652,473. NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES Index PART I. FINANCIAL INFORMATION Page No. Item 1. Financial Statements: Condensed Consolidated Balance Sheets as of October 31, 2003 (unaudited) and January 31, 2003 3 Unaudited Condensed Consolidated Statements of Income For the Nine Months Ended October 31, 2003 and 2002 4 Unaudited Condensed Consolidated Statements of Income For the Three Months Ended October 31, 2003 and 2002 5 Unaudited Condensed Consolidated Statements of Cash Flows For the Nine Months Ended October 31, 2003 and 2002 6 Notes to the Unaudited Condensed Consolidated Financial Statements 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11 Item 4. Controls and Procedures 18 PART II. OTHER INFORMATION & SIGNATURE Item 6. Exhibits and Reports on Form 8-K 20 2 PART I - FINANCIAL ITEM 1. FINANCIAL STATEMENTS NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES Condensed Consolidated Balance Sheets

October 31, January 31, 2003 2003 ASSETS (unaudited) ------ ----------------------------- CURRENT ASSETS: Cash $ 4,245,000 $ 3,559,000 Accounts receivable, less allowance for doubtful accounts of $1,396,000 at October 31, 2003 and $1,298,000 at January 31, 2003 18,325,000 20,252,000 Income taxes receivable 247,000 110,000 Inventories 1,848,000 2,471,000 Deferred tax assets 1,302,000 1,469,000 Prepaid expenses 1,519,000 1,110,000 ----------------------------- Total current assets 27,486,000 28,971,000 Property, plant and equipment, at cost 80,436,000 77,634,000 Less: accumulated depreciation (52,365,000) (48,857,000) ----------------------------- Net property, plant and equipment 28,071,000 28,777,000 Goodwill 870,000 870,000 Other assets 3,072,000 2,716,000 ----------------------------- TOTAL ASSETS $ 59,499,000 $ 61,334,000 ============================= LIABILITIES AND SHAREHOLDERS' EQUITY ------------------------------------ CURRENT LIABILITIES: Accounts payable $ 3,385,000 $ 4,666,000 Accrued expenses 2,746,000 3,585,000 Deferred income 509,000 175,000 Current installments of long-term debt 1,144,000 1,253,000 ----------------------------- Total current liabilities 7,784,000 9,679,000 Long-term debt, excluding current installments 18,523,000 19,863,000 Deferred income taxes 4,748,000 4,428,000 Deferred compensation 863,000 796,000 Minority interest 180,000 151,000 Commitments and contingencies SHAREHOLDERS' EQUITY: Common stock, no par value. Authorized, 20,000,000 shares; issued and outstanding, 8,644,000 as of October 31, 2003 and 8,610,000 as of January 31, 2003 12,681,000 12,638,000 Retained earnings 14,771,000 13,830,000 Accumulated other comprehensive income (51,000) (51,000) ----------------------------- Total shareholders' equity 27,401,000 26,417,000 ----------------------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 59,499,000 $ 61,334,000 ============================= See accompanying notes.

3 NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES Unaudited Condensed Consolidated Statements of Income for Nine Months Ended October 31, 2003 and 2002

2003 2002 ---------------------------------- Net revenues $ 79,640,000 $ 58,858,000 Cost of sales 61,916,000 45,078,000 ---------------------------------- Gross profit 17,724,000 13,780,000 Selling, general and administrative expense 15,111,000 11,705,000 ---------------------------------- Operating income 2,613,000 2,075,000 Other income (expense): Interest expense, net (855,000) (925,000) Other 50,000 50,000 ---------------------------------- Total other expense (805,000) (875,000) Income before income taxes and minority interest 1,808,000 1,200,000 Income taxes 838,000 521,000 ---------------------------------- Income before minority interest 970,000 679,000 Minority interest (29,000) 16,000 ---------------------------------- Net income $ 941,000 $ 695,000 ================================== Net income per common share: Basic $ 0.11 $ 0.08 ================================== Diluted $ 0.10 $ 0.08 ================================== Weighted average common shares outstanding 8,629,000 8,661,000 Dilutive effect of stock options 531,000 21,000 ---------------------------------- Weighted average common shares outstanding, assuming dilution 9,160,000 8,682,000 ================================== See accompanying notes.

4 NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES Unaudited Condensed Consolidated Statements of Income for Three Months Ended October 31, 2003 and 2002

2003 2002 ---------------------------------- Net revenues $ 25,591,000 $ 21,180,000 Cost of sales 19,791,000 16,660,000 ---------------------------------- Gross profit 5,800,000 4,520,000 Selling, general and administrative expense 5,087,000 4,024,000 ---------------------------------- Operating income 713,000 496,000 Other income (expense): Interest expense, net (250,000) (296,000) Other 43,000 15,000 ---------------------------------- Total other expense (207,000) (281,000) Income before income taxes and minority interest 506,000 215,000 Income taxes 236,000 102,000 ---------------------------------- Income before minority interest 270,000 113,000 Minority interest 3,000 21,000 ---------------------------------- Net income $ 273,000 $ 134,000 ================================== Net income per common share: Basic $ 0.03 $ 0.02 ================================== Diluted $ 0.03 $ 0.02 ================================== Weighted average common shares outstanding 8,637,000 8,657,000 Dilutive effect of stock options 588,000 51,000 ---------------------------------- Weighted average common shares outstanding, assuming dilution 9,225,000 8,708,000 ================================== See accompanying notes.

5 NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES Unaudited Condensed Consolidated Statements of Cash Flows for the Nine Months Ended October 31, 2003 and 2002

2003 2002 ---------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income from continuing operations $ 941,000 $ 695,000 Adjustments to reconcile net income from continuing operations to cash provided by operating activities: Depreciation and amortization 3,530,000 3,438,000 Provisions for losses on receivables 97,000 122,000 Undistributed earnings of affiliate 29,000 (16,000) Deferred income taxes 487,000 591,000 Tax benefit from stock options exercised 23,000 - Changes in assets and liabilities: Accounts receivable 1,830,000 (1,334,000) Inventories 623,000 (524,000) Prepaid expenses (409,000) (510,000) Other assets and intangibles (260,000) (110,000) Accounts payable (1,281,000) 404,000 Accrued expenses (839,000) 641,000 Deferred income 334,000 (61,000) Deferred compensation 67,000 73,000 Income taxes receivable (137,000) (219,000) ---------------------------------- Cash provided by continuing operations 5,035,000 3,190,000 CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property, plant and equipment (2,802,000) (2,596,000) Sale of property, plant and equipment - 544,000 Investment in life insurance (118,000) (122,000) Cash paid for acquisition - (1,500,000) ---------------------------------- Net cash used for investing activities (2,920,000) (3,674,000) CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from current and long-term debt 294,000 2,729,000 Repayments of current and long-term debt (1,743,000) (3,280,000) Proceeds from stock options exercised 125,000 - Common stock repurchase (105,000) (19,000) ---------------------------------- Net cash used for financing activities (1,429,000) (570,000) ---------------------------------- Net increase in cash 686,000 (1,054,000) Beginning cash balance 3,559,000 3,783,000 ---------------------------------- ENDING CASH BALANCE $ 4,245,000 $ 2,729,000 ================================== See accompanying notes

6 NATIONAL TECHNICAL SYSTEMS, INC. AND SUBSIDIARIES Notes to the Unaudited Condensed Consolidated Financial Statements 1. Basis of Presentation In accordance with instructions to Form 10-Q, the accompanying consolidated financial statements and footnotes of National Technical Systems, Inc. (NTS or the Company) have been condensed and, therefore, do not contain all disclosures required by accounting principles generally accepted in the United States. These statements should not be construed as representing pro rata results of the Company's fiscal year and should be read in conjunction with the financial statements and notes thereto included in the Company's Form 10-K for the year ended January 31, 2003. The statements presented as of and for the three and nine months ended October 31, 2003 and 2002 are unaudited. In Management's opinion, all adjustments have been made to present fairly the results of such unaudited interim periods. All such adjustments are of a normal recurring nature. The consolidated financial statements include the accounts of the Company and its wholly owned and financially controlled subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. 2. Income Taxes Income taxes for the interim periods are computed using the effective tax rates estimated to be applicable for the full fiscal year. The Company recorded income tax expense of $236,000 and $838,000 for the three and nine months ended October 31, 2003, respectively, and $102,000 and $521,000 for the three and nine months ended October 31, 2002, respectively. The Company's income tax expense for the three and nine months ended October 31, 2003 include a provision for U.S. taxes applicable to the income of a foreign subsidiary that was liquidated in the current fiscal year and had an estimated provision for taxes greater than the foreign tax credit. 3. Inventories Inventories consist of accumulated costs applicable to uncompleted contracts and are stated at actual cost which is not in excess of estimated net realizable value. 4. Interest and Taxes Cash paid for interest and taxes for the nine months ended October 31, 2003 was $872,000 and $523,000, respectively. Cash paid for interest and taxes for the nine months ended October 31, 2002 was $933,000 and $111,000, respectively. 5. Minority Interest Minority interest in the Company's NQA, Inc. subsidiary is a result of 50% of the stock of NQA, Inc. being issued to National Quality Assurance, Ltd. Effective with fiscal 2002, profits and losses are allocated 50.1% to NTS, and 49.9% to National Quality Assurance, Ltd. 6. Stock Repurchase On February 6, 2001, the Company's Board of Directors authorized the repurchase of shares in the Company's common stock in open market purchases. As of October 31, 2003, the Company had purchased 169,750 shares at an average price of $2.54 per share. The Company has recently elected to discontinue the repurchase of shares. 7 7. Earnings per share Basic and diluted net income per common share is presented in conformity with Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share" for all periods presented. In accordance with SFAS No. 128, basic earnings per share have been computed using the weighted average number of shares of common stock outstanding during the year. Basic earnings per share excludes any dilutive effects of options, warrants and convertible securities. 8. Intangible Assets The Company adopted the new rules on accounting for goodwill and other intangible assets beginning in the first quarter of fiscal year 2003 in accordance with SFAS No. 142, "Goodwill and Other Intangible Assets." Under SFAS No. 142, goodwill and intangible assets that have indefinite useful lives will no longer be amortized but will be 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. The first step of the test is a screen for potential impairment and the second step measures the amount of impairment, if any. SFAS No. 142 requires an entity to complete the first step of the transitional goodwill impairment test within six months of adopting the statement. The first step of the transitional 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. The Company adopted SFAS No. 142 in the first quarter of fiscal 2003. In accordance with SFAS No. 142, the Company identified two reporting units in the Engineering and Evaluation segment and one reporting unit in the Technical Solutions segment (formerly Technical Staffing), which constitute components of its business that include goodwill. The Company completed the goodwill impairment test as of January 31, 2003 and has determined that the fair value of each of the reporting units exceeded the reporting unit's carrying amount, and no impairment was indicated. There have been no indications of any impairments through October 31, 2003.

As of October 31, 2003 and January 31, 2003, the Company had the following acquired intangible assets subject to amortization: October 31, 2003 January 31, 2003 --------------------------------------------------- ------------------------------------------------ Gross Net Estimated Gross Net Estimated Carrying Accum. Carrying Useful Carrying Accum. Carrying Useful Amount Amort. Amount Life Amount Amort. Amount Life Intangible assets subject to amortization: Covenant not to compete $ 89,000 $ 31,000 $ 58,000 3 years $ 89,000 $ 9,000 $ 80,000 3 years ====================================== ==================================== Amortization expense for intangible assets subject to amortization was $22,000 and $2,000 for the nine months ended October 31, 2003 and 2002, respectively.

9. Long-Lived Assets: Adoption of Statement 144 In August 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," which is effective for fiscal years beginning after December 15, 2001. SFAS No. 144 supersedes FASB Statement No. 121, "Accounting for the Impairment or Disposal of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," and the accounting and reporting provisions relating to the disposal of a segment of a business of Accounting Principles Board Opinion No. 30. The Company has adopted SFAS No. 144 beginning in the first quarter of fiscal year 2003. The adoption had no impact on the Company's consolidated financial position or results of operations. 8 10. Stock-Based Compensation As of October 31, 2003, the Company had two stock-based employee compensation plans, the Amended and Restated 1994 stock option plan and the 2002 stock option plan. The Company accounts for these plans under the intrinsic value method recognition and measurement principles of Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees" and related Interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under this plan had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and net income per share as if the Company had applied the fair value recognition provisions of SFAS No. 123, "Accounting for Stock-Based Compensation," to stock-based employee compensation using the Black-Scholes option pricing model:

Nine Months Ended Three Months October 31, October 31, 2003 2002 2003 2002 Net Income As reported $941,000 $695,000 $273,000 $134,000 Stock compensation expense, net of tax (288,000) (259,000) (125,000) (78,000) ----------------------------------------------------------------------- Pro forma $653,000 $436,000 $148,000 $56,000 Basic earnings per common share As reported $0.11 $0.08 $0.03 $0.02 Pro forma $0.08 $0.05 $0.02 $0.01 Diluted earnings per common share As reported $0.10 $0.08 $0.03 $0.02 Pro forma $0.07 $0.05 $0.02 $0.01

11. Recently Issued Accounting Standards In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statement No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections". This statement, among other amendments and corrections, rescinds Statement 4, "Reporting Gains and Losses from Extinguishment of Debt - an amendment of APB Opinion 30," which required all gains and losses from extinguishment of debt to be aggregated and, if material, classified as an extraordinary item, net of related income tax effect. SFAS No. 145 is effective for fiscal years beginning after May 15, 2002, with early application encouraged. The Company adopted SFAS No. 145 the first quarter of fiscal 2004. The impact of its application requires the reclassification of the loss related to early retirement of debt, which occurred in fiscal 2002, into other income (expense). In June 2002, the FASB issued SFAS No. 146,"Accounting for Costs Associated with Exit or Disposal Activities". SFAS No. 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force ("EITF") Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity" (including Certain Costs Incurred in a Restructuring). SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. SFAS No. 146 is effective for exit or disposal activities that are initiated after December 31, 2002 and did not have a material impact on the results of operations or the financial position of the Company. In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation--Transition and Disclosure--an amendment of FASB Statement No. 123". SFAS No. 148 amends SFAS No. 123, "Accounting for Stock-Based Compensation," to provide three alternative methods of transition for an entity that voluntarily adopts the fair value based method of accounting for stock-based employee compensation. SFAS No. 148 also amends the disclosure provisions of SFAS No. 123 to require prominent disclosure about the effects on reported net income of an entity's accounting policy decisions with respect to stock-based employee compensation. Finally, SFAS No. 148 amends APB Opinion No. 28, "Interim Financial Reporting," to require disclosure about those effects in interim financial information. The provisions related to the alternative transition methods and the new disclosure requirements were effective for the Company as of December 31, 2002. There was no impact on the Company's 9 financial condition or results of operations as a result of the adoption of SFAS No. 148, but the Company's disclosures related to stock-based compensation have been modified in accordance with the new requirements. The interim reporting provisions of SFAS No. 148 were effective for the Company as of April 30, 2003, and management has modified the Company's quarterly disclosures in accordance with the new requirements. In January 2003, the FASB issued FASB Interpretation No. 46, "Consolidation of Variable Interest Entities", effective as of the first interim period beginning after June 15, 2003. The impact upon adoption of the standard is not expected to have a material impact on the results of operations or the financial position of the Company or on related disclosures. 10 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Except for the historical information contained herein, the matters addressed in this Item 2 contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements can be identified by the use of forward-looking words such as "may", "will", "expect", "anticipate", "intend", "estimate", "continue", "behave" and similar words. Financial information contained herein, to the extent it is predictive of financial condition and results of operations that would have occurred on the basis of certain stated assumptions, may also be characterized as forward-looking statements. Although forward-looking statements are based on assumptions made, and information believed by management to be reasonable, no assurance can be given that such statements will prove to be correct. Such statements are subject to certain risks, uncertainties and assumptions. Should one or more of these risks or uncertainties occur, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated. GENERAL ------- The Company is a diversified business to business services organization that supplies technical services and solutions to a variety of industries including aerospace, defense, automotive, power products, electronics, computers and telecommunications. Through its wide range of testing facilities, solutions and certification services, the Company provides its customers the ability to sell their products globally and enhance their overall competitiveness. NTS is accredited by numerous national and international technical organizations which allows the Company to become the gateway for customers to sell their regulated products in world markets. The Company operates in two segments: "Engineering & Evaluation" and "Technical Solutions" (formerly Technical Staffing). The business of the Company is conducted by a number of operating units, each with its own organization. Each segment is under the direction of its own executive and operational management team. The Engineering & Evaluation segment is one of the largest independent conformity assessment and management system registration organizations in the U.S., with facilities throughout the United States and in Japan and Germany serving a large variety of high technology industries, including aerospace, defense, automotive, power products, electronics, computers and telecommunications. This segment provides highly trained technical personnel for product certification, product safety testing and product evaluation to allow customers to sell their products in world markets. In addition, it performs management registration and certification services to ISO related standards. The Technical Solutions segment is a national provider of professional and specialty staffing services including contract services, temporary and full time placements, providing specialty solutions services to its customers specifically in the area of information technology, information systems, software engineering and construction needs. Technical Solutions supplies professionals in support of customers who need help-desk analysts and managers, relational database administrators and developers, application and systems programmers, configuration and project managers, engineering personnel and multiple levels of system operations personnel. The following discussion should be read in conjunction with the consolidated quarterly financial statements and notes thereto. All information is based upon operating results of the Company for the nine months ended October 31. RESULTS OF OPERATIONS --------------------- REVENUES Nine months ended October 31, 2003 % Change 2002 ------------------------------- (Dollars in thousands) Engineering & Evaluation $ 44,073 6.8% $ 41,274 Technical Solutions 35,567 102.3% 17,584 ----------- ---------- Total revenues $ 79,640 35.3% $ 58,858 =========== ========== For the nine months ended October 31, 2003, consolidated revenues increased by $20,782,000 or 35.3% when compared to the same period in the prior year. 11 Engineering & Evaluation: ------------------------- For the nine months ended October 31, 2003, Engineering and Evaluation revenues increased by $2,799,000 or 6.8% when compared to the same period in the prior year, primarily due to an increase in military spending by the Department of Defense, an increasing trend in the use of passive fiber optics on switches in central offices of the major communication companies and an increase in the Company's ISO registration and certification business, partially offset by a decrease in the computer testing business and the negative effect on revenues caused by the taking of a portion of the Company's land by eminent domain for a new highway at the Company's Santa Clarita facility (see Business Environment). Technical Solutions: -------------------- For the nine months ended October 31, 2003, revenues in Technical Solutions increased by $17,983,000 or 102.3% when compared to the same period in the prior year, due to the acquisition of the staffing and engineering business of TRS Staffing Solutions which was effective on October 14, 2002. GROSS PROFIT Nine months ended October 31, 2003 % Change 2002 -------------------------------- (Dollars in thousands) Engineering & Evaluation $ 12,160 15.9% $ 10,490 % to segment revenue 27.6% 25.4% Technical Solutions 5,564 69.1% 3,290 % to segment revenue 15.6% 18.7% ----------- ---------- Total $ 17,724 28.6% $ 13,780 =========== ========== % to total revenue 22.3% 23.4% Total gross profit for the nine months ended October 31, 2003 increased by $3,944,000 or 28.6% when compared to the same period in the prior year. Engineering & Evaluation: ------------------------- For the nine months ended October 31, 2003, gross profit for the Engineering & Evaluation Group increased by $1,670,000 or 15.9% when compared to the same period in the prior year, primarily as a result of the revenue increase in military spending, offset by the decrease in the computer testing business and the decrease in revenue at the Santa Clarita facility discussed above. Gross profit as a percentage of revenue increased to 27.6% from 25.4% when compared to the same period in the prior year. Technical Solutions: -------------------- For the nine months ended October 31, 2003, gross profit increased by $2,274,000 or 69.1% in the Technical Solutions Group when compared to the same period in the prior year. This increase was due to the acquisition of the staffing and engineering business of TRS Staffing Solutions. Gross profit as a percentage of revenue decreased to 15.6 % from 18.7% when compared to the same period in the prior year, primarily due to the competitive pricing pressures in the staffing industry. 12 SELLING, GENERAL & ADMINISTRATIVE Nine months ended October 31, 2003 % Change 2002 ------------------------------- (Dollars in thousands) Engineering & Evaluation $ 9,726 11.0% $ 8,760 % to segment revenue 22.1% 21.2% Technical Solutions 5,385 82.9% 2,945 % to segment revenue 15.1% 16.7% ----------- ---------- Total $ 15,111 29.1% $ 11,705 =========== ========== % to total revenue 19.0% 19.9% Total selling, general and administrative expenses increased $3,406,000 or 29.1% for the nine months ended October 31, 2003 when compared to the same period in the prior year. Engineering & Evaluation: ------------------------- For the nine months ended October 31, 2003, selling, general and administrative expenses increased by $966,000 or 11.0% when compared to the same period in the prior year, primarily due to the increase in selling costs related to the restructuring of the sales organization which is designed to more effectively bring new customers to the Company and the addition of customer service personnel within the facilities to provide enhanced customer service and customer retention. Technical Solutions: -------------------- For the nine months ended October 31, 2003, selling, general and administrative expenses increased by $2,440,000 or 82.9% when compared to the same period in the prior year, due to the additional expenses related to the newly acquired staffing and engineering business of TRS Staffing Solutions which has allowed Technical Solutions to expand into new geographic markets with a significantly expanded sales force. The Company has recently restructured its sales and operations units in an effort to streamline the business to reduce selling and administrative costs and improve performance. OPERATING INCOME Nine months ended October 31, 2003 % Change 2002 ------------------------------- (Dollars in thousands) Engineering & Evaluation $ 2,434 40.7% $ 1,730 % to segment revenue 5.5% 4.2% Technical Solutions 179 (48.1)% 345 % to segment revenue 0.5% 2.0% ----------- ---------- Total $ 2,613 25.9% $ 2,075 =========== ========== % to total revenue 3.3% 3.5% Operating income for the nine months ended October 31, 2003 increased by $538,000 or 25.9% when compared to the prior year. Engineering & Evaluation: ------------------------- For the nine months ended October 31, 2003, operating income in the Engineering & Evaluation Group increased by $704,000 or 40.7% when compared to the same period in the prior year, as a result of the increase in gross profit, partially offset by the increase in selling, general and administrative expenses discussed above. Technical Solutions: -------------------- For the nine months ended October 31, 2003, operating income in the Technical Solutions Group decreased by $166,000 or (48.1)% when compared to the same period in the prior year, as a result of the lower gross margins, the increase in selling and general and administrative expenses discussed above, partially offset by the increase in gross profit discussed above. 13 INTEREST EXPENSE Net interest expense decreased by $70,000 in the nine months ended October 31, 2003 when compared to the same period in the prior year. This decrease was principally due to lower interest rate levels for the nine months ended October 31, 2003 offset by slightly higher average debt balances during the nine months ended October 31, 2003 when compared to the same period last year. INCOME TAXES The income tax provisional rate of 46.3% for the nine months ended October 31, 2003 reflects a rate in excess of the U.S. federal statutory rate primarily due to the inclusion of state income taxes, certain non-deductible expenses and a provision for U.S. taxes applicable to the income of a foreign subsidiary that was liquidated in the current fiscal year and had an estimated provision for taxes greater than the foreign tax credit. This rate is based on the estimated provision for fiscal year ending January 31, 2004. Management has determined that it is more likely than not that the deferred tax asset will be realized on the basis of offsetting it against deferred tax liabilities. It is the Company's intention to assess the need for a valuation account by evaluating the realizability of the deferred tax asset quarterly based upon projected future taxable income of the Company. NET INCOME The increase in net income for the nine months ended October 31, 2003, compared to the same period in the prior year, was primarily due to the increase in gross profit, partially offset by higher selling and administrative expenses and higher income taxes. The following information is based upon results for National Technical Systems, Inc. for the three months ended October 31. RESULTS OF OPERATIONS --------------------- REVENUES Three months ended October 31, 2003 % Change 2002 -------------------------------- (Dollars in thousands) Engineering & Evaluation $ 14,196 (0.4)% $ 14,257 Technical Solutions 11,395 64.6% 6,923 ----------- ----------- Total revenues $ 25,591 20.8% $ 21,180 =========== =========== For the three months ended October 31, 2003, consolidated revenues increased by $4,411,000 or 20.8% when compared to the same period in the prior year. Engineering & Evaluation: ------------------------- For the three months ended October 31, 2003, Engineering and Evaluation revenues decreased by $61,000 or (0.4)% when compared to the same period in the prior year, primarily due to a decrease in telecom and computer testing businesses, partially offset by an increase in the Company's defense related testing business. Technical Solutions: -------------------- For the three months ended October 31, 2003, Technical Solutions revenues increased by $4,472,000 or 64.6% when compared to the same period in the prior year, due to the acquisition of the staffing and engineering business of TRS Staffing Solutions effective October 14, 2002. 14 GROSS PROFIT Three months ended October 31, 2003 % Change 2002 -------------------------------- (Dollars in thousands) Engineering & Evaluation $ 4,045 20.2% $ 3,365 % to segment revenue 28.5% 23.6% Technical Solutions 1,755 51.9% 1,155 % to segment revenue 15.4% 16.7% ----------- --------- Total $ 5,800 28.3% $ 4,520 =========== ========= % to total revenue 22.7% 21.3% Total gross profit for the three months ended October 31, 2003 increased by $1,280,000 or 28.3% when compared to the same period in the prior year. Engineering & Evaluation: ------------------------- For the three months ended October 31, 2003, gross profit for the Engineering & Evaluation Group increased by $680,000 or 20.2% when compared to the same period in the prior year, primarily as a result of the revenue increase in military spending and improvements in margins. Gross profit as a percentage of revenue increased to 28.5% from 23.6% when compared to the same period in the prior year. Technical Solutions: -------------------- For the three months ended October 31, 2003, gross profit increased by $600,000 or 51.9% in the Technical Solutions Group when compared to the same period in the prior year. This increase was due to the acquisition of the ongoing information technology staffing and engineering business of TRS Staffing Solutions. Gross profit as a percentage of revenue decreased to 15.4 % from 16.7% when compared to the same period in the prior year, primarily due to the competitive pricing pressures in the staffing industry. SELLING, GENERAL & ADMINISTRATIVE Three months ended October 31, 2003 % Change 2002 -------------------------------- (Dollars in thousands) Engineering & Evaluation $ 3,348 13.5% $ 2,950 % to segment revenue 23.6% 20.7% Technical Solutions 1,739 61.9% 1,074 % to segment revenue 15.3% 15.5% ----------- --------- Total $ 5,087 26.4% $ 4,024 =========== ========= % to total revenue 19.9% 19.0% Total selling, general and administrative expenses increased $1,063,000 or 26.4% for the three months ended October 31, 2003 when compared to the same period in the prior year. Engineering & Evaluation: ------------------------- For the three months ended October 31, 2003, selling, general and administrative expenses increased by $398,000 or 13.5% when compared to the same period in the prior year, primarily due to the increase in selling costs related to the restructuring of the sales organization which is designed to more effectively bring new customers to the Company and the addition of customer service personnel within the facilities to provide enhanced customer service and customer retention. Technical Solutions: -------------------- For the three months ended October 31, 2003, selling, general and administrative expenses increased by $665,000 or 61.9% when compared to the same period in the prior year, due to the additional expenses related to the newly acquired staffing and engineering business of TRS Staffing Solutions which has allowed Technical Solutions to expand into new geographic markets with a significantly 15 expanded sales force. The Company has recently restructured its sales and operations units in an effort to streamline the business to reduce selling and administrative costs and improve performance. OPERATING INCOME Three months ended October 31, 2003 % Change 2002 -------------------------------- (Dollars in thousands) Engineering & Evaluation $ 697 68.0% $ 415 % to segment revenue 4.9% 2.9% Technical Solutions 16 (80.2)% 81 % to segment revenue 0.1% 1.2% ----------- ------- Total $ 713 43.8% $ 496 =========== ======= % to total revenue 2.8% 2.3% Operating income for the three months ended October 31, 2003 increased by $217,000 or 43.8% when compared to the prior year. Engineering & Evaluation: ------------------------- For the three months ended October 31, 2003, operating income in the Engineering & Evaluation Group increased by $282,000 or 68.0% when compared to the same period in the prior year, as a result of the increase in gross profit, partially offset by the increase in selling and general and administrative expenses discussed above. Technical Solutions: -------------------- For the three months ended October 31, 2003, operating income in the Technical Solutions Group decreased by $65,000 or (80.2)% when compared to the same period in the prior year, as a result of a larger increase in selling and general and administrative expenses than the increase in gross profit discussed above. INTEREST EXPENSE Net interest expense decreased by $46,000 in the three months ended October 31, 2003 when compared to the same period in the prior year. This decrease was principally due to lower interest rate levels for the three months ended October 31, 2003 offset by slightly higher average debt balances for the three months ended October 31, 2003 when compared to the same period last year. INCOME TAXES The income tax provisional rate of 46.6% for the three months ended October 31, 2003 reflects a rate in excess of the U.S. federal statutory rate primarily due to the inclusion of state income taxes, certain non-deductible expenses and a provision for U.S. taxes applicable to the income of a foreign subsidiary that was liquidated in the current fiscal year and had an estimated provision for taxes greater than the foreign tax credit. This rate is based on the estimated provision for fiscal year ending January 31, 2004. Management has determined that it is more likely than not that the deferred tax asset will be realized on the basis of offsetting it against deferred tax liabilities. It is the Company's intention to assess the need for a valuation account by evaluating the realizability of the deferred tax asset quarterly based upon projected future taxable income of the Company. NET INCOME The increase in net income for the three months ended October 31, 2003, compared to the same period in the prior year, was primarily due to the higher gross 16 profit, partially offset by higher selling and administrative expenses and higher income taxes. BUSINESS ENVIRONMENT Engineering & Evaluation: ------------------------- The Company provides product certification, product safety testing and product evaluation to ensure its customers' products meet established specifications or standards. In recent years, domestic and worldwide political and economic developments have significantly affected the markets for defense and advanced technology systems. Homeland security and defeating terrorism are among the U.S. government's main initiatives. The Company anticipates Federal budget increases for operational readiness spending as well as research and development spending. The Company has realized a significant increase in sales at its military/aerospace facilities since the September 11, 2001 catastrophe. The Company's Camden facility has experienced a major increase in bookings of important military weapons testing. During the first quarter, based upon these programs, Camden revenues have more than doubled. The Company's Santa Clarita facility, its largest military/aerospace facility, has, however, experienced a decline in sales during this period, following construction of a public highway immediately adjacent to the Santa Clarita facility. A portion of the highway was built on real property taken from the Company by eminent domain. The Company is seeking, through the appeal process, appropriate compensation for the taking of the Company's property. In an effort to maintain the economic viability of the facility, several new capabilities have been added which include fuel cell testing, upgraded acoustical testing, clean environment satellite testing and installation of a high pressure air system. Although the Company expects, based on its recent bookings, to have increased military weapons testing activity, especially at its Camden location, growth for the balance of the year will be largely dependent on improved demand in telecommunications equipment for use in central stations and increased demand of consumer electronic products. Technical Solutions: -------------------- The Company provides a variety of staffing and workforce management services and solutions, including contract, contract-to-hire and full time placements to meet its customers' needs. One of the strategies for growth is to extend the offering of the Company's technical solutions services to the Engineering & Evaluations segment's customers to provide them with technical and engineering personnel as part of a complete suite of certification, registration and test services. The goal is to offer a complete solution to the customers' product development needs, which will include consultants and technical experts provided by the Technical Solutions segment. Notwithstanding the foregoing, and because of factors affecting the Company's operating results, past financial performance should not be considered to be a reliable indicator of future performance. 17 LIQUIDITY AND CAPITAL RESOURCES For the nine month ended October 31, 2003, cash provided by operations increased by $1,845,000 when compared to the same period in the prior year. This increase was primarily due to an increase in accounts receivable collections and an increase in the change in inventories and deferred income, partially offset by an increase in accounts payable disbursements and an increase in the change in accrued expenses. Net cash used in investing activities in the nine month period ended October 31, 2003 decreased by $754,000 when compared to the same period in the prior year, primarily due to no payments for acquisitions during the nine month period ended October 31, 2003 compared to $1,500,000 paid during the nine month period ended October 31, 2002, partially offset by the inclusion of proceeds of $544,000 from the sale of property during the nine month period ending October 31, 2002. In the nine month period ended October 31, 2003, net cash used by financing activities increased by $859,000 over the same period in the prior year. Net cash used by financing activities consisted of the repayment of lines of credit and short term and long term debt of $1,743,000 and common stock repurchase of $105,000, partially offset by proceeds from stock options exercised of $125,000 and proceeds from lines of credit and term loans of $294,000. On November 21, 2001, the Company replaced the outstanding debt to United California Bank and Mellon Bank with a $16,000,000 reducing revolving line of credit with Comerica Bank California and First Bank, expiring on August 1, 2005. On November 25, 2002, the Company amended the revolving line of credit with Comerica Bank California and First Bank increasing it to $20,000,000. Comerica Bank California, as the agent Bank, retained 60% of the line with First Bank, as the participant Bank, holding 40% of the line. The revolving line of credit was reduced by $1,750,000 on August 1, 2003 and will be reduced by $1,750,000 each year thereafter. If during any fiscal year, the Company's net income equals or exceeds $2,000,000, there will be no required reduction in the revolving line of credit. The interest rate is at the agent bank's prime rate, with an option for the Company to convert to loans at the Libor rate plus 250 basis points for 30, 60, 90, 180 or 365 days, with minimum advances of $1,000,000. The Company paid a 0.5% commitment fee of the total line amount and is paying an additional 0.25% of the commitment amount annually and a 0.25% fee for any unused line of credit. The outstanding balance on the revolving line of credit at October 31, 2003 was $14,002,000. This balance is reflected in the accompanying condensed consolidated balance sheets as long-term. This agreement is subject to certain covenants, which require the maintenance of certain working capital, debt-to-equity, earnings-to-expense and cash flow ratios. The amount available on the line of credit is $4,248,000 as of October 31, 2003. The Company was in full compliance with all of the covenants with its banks as of October 31, 2003. The Company has additional equipment line of credit agreements (at interest rates of 7.60 % to 10.21%) to finance various test equipment with terms of 60 months for each equipment schedule. The outstanding balance at October 31, 2003 was $1,690,000. At October 31, 2003, the balance of other notes payable collateralized by land and building was $3,292,000, and the balance of unsecured notes was $683,000. ITEM 4. CONTROLS AND PROCEDURES Evaluation Of Disclosure Controls And Procedures The Company's Chief Executive Officer and Chief Financial Officer carried out an evaluation with the participation of the Company's management, of the effectiveness of the design and operation of the Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, the Company's disclosure controls and procedures are effective in timely alerting them to 18 material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company's Exchange Act filings. Disclosure controls and procedures, no matter how well designed and implemented, can provide only reasonable assurance of achieving an entity's disclosure objectives. The likelihood of achieving such objectives is affected by limitations inherent in disclosure controls and procedures. These include the fact that human judgment in decision-making can be faulty and that breakdowns in internal control can occur because of human failures such as simple errors or mistakes or intentional circumvention of the established process. Changes in Internal Controls There was no change in the Company's internal control over financial reporting, known to the Chief Executive Officer or Chief Financial Officer that occurred during the period covered by this report that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. 19 PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K (a) Exhibits 31.1 - Certification of the Principal Executive Officer pursuant to rule 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 - Certification of the Principal Financial Officer pursuant to rule 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 - Certification of the Principal Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 - Certification of the Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (b) Reports on Form 8-K None. SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934 the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. NATIONAL TECHNICAL SYSTEMS, INC. Date: December 10, 2003 By: /s/ Lloyd Blonder ----------------- ---------------------- Lloyd Blonder Senior Vice President Chief Financial Officer (Signing on behalf of the registrant and as principal financial officer) 20