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MTS SYSTEMS CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) Forward-Looking Statements Forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from those in such statements. Factors that could cause actual results to differ from those discussed in the forward-looking statements include, but are not limited to, those factors described in Part I, Item 1A, "Risk Factors" of our Annual Report on Form 10-K for the fiscal year ended October 2, 2010 and in Part II, Item 1A, "Risk Factors" of this Quarterly Report on Form 10-Q. Such important factors include: · The Company's business is significantly international in scope, which poses multiple unique risks · Volatility in the global economy could adversely affect results · The Company's business is subject to strong competition · The Company may not achieve its growth plans for the expansion of the business · The Company may experience difficulties obtaining the services of skilled employees · The Company may fail to protect its intellectual property effectively, or may infringe upon the intellectual property of others · The business could be adversely affected by product liability and commercial litigation · The Company may experience difficulty obtaining materials or components for its products · Government regulation could impose significant costs and other constraints · The sales, delivery and acceptance cycle for many of the Company's products is irregular and may not develop as anticipated · The Company's customers are in cyclical industries · Interest rate fluctuations could adversely affect results · The Company may be required to recognize impairment charges for long-lived assets In addition to the risk factors listed above, the Company's business and results of operations may be adversely affected by government contracting risks. Such risks include modification or termination of such contracts, the results of the investigation currently being conducted by the U.S. Department of Commerce and the U.S. Attorney's Office of the District of Minnesota, and the loss of business related to the suspension from contracting with the U.S. Government (both as a prime contractor and subcontractor) and certain entities which receive U.S. Government funding and/or which are subject to the Federal Acquisition Regulations (FAR). In addition, the risks include loss of business related to those state government and commercial customers which decline to contract with entities suspended from government contracting. The performance of the Company's business and its securities may be adversely affected by these factors and by other factors common to other businesses and investments, or to the general economy. Forward-looking statements are qualified by some or all of these risk factors. Therefore, you should consider these risk factors with caution and form your own critical and independent conclusions about the likely effect of these risk factors on our future performance. Forward-looking statements speak only as of the date on which such statements are made, and we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made to reflect the occurrence of unanticipated events or circumstances. Readers should carefully review the disclosures and the risk factors described in this and other documents we file from time to time with the SEC, including our reports on Forms 10-Q and 8-K to be filed by the Company in fiscal year 2011. About MTS Systems Corporation MTS Systems Corporation is a leading global supplier of test systems and industrial position sensors. The Company's 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. MTS' high-performance position sensors provide controls for a variety of industrial and vehicular applications. MTS had 1,948 employees and revenue of $374 million for the fiscal year ended October 2, 2010. Summary of Financial Results Three Fiscal Months Ended July 2, 2011 ("Third Quarter of Fiscal 2011") Compared to Three Fiscal Months Ended July 3, 2010 ("Third Quarter of Fiscal 2010") 18-------------------------------------------------------------------------------- Table Of Contents Highlights for the Third Quarter of Fiscal 2011 compared to the Third Quarter of Fiscal 2010 include: · As was previously disclosed, in January 2011 the U.S. Department of Commerce ("DOC") and the U.S. Attorney's Office for the District of Minnesota ("USAO") notified the Company that they were investigating why the Company had not disclosed, on the Government's Online Representations and Certifications Application (ORCA Certification), that the Company had pled guilty in 2008 to two misdemeanors in regard to making false statements related to certain export matters in 2003. Further, in March 2011 the U.S. Department of the Air Force (the "Air Force") issued a notice suspending the Company from all U.S. Government contracting and from directly or indirectly receiving the benefits of federal assistance programs, based on the factual and legal issues underlying the investigation. The USAO also has recently expanded the scope of its inquiry to include the Company's general compliance record and practices in areas including export controls and government contracts. The Company has been responding to information requests from the USAO, DOC and Air Force, and the USAO has issued grand jury subpoenas to certain third party individuals. The Company will continue to review these matters and to cooperate fully with the Government's requests, as appropriate. The Company will experience a loss of revenue from contract opportunities lost or not allowed to bid and from contracts cancelled during the suspension. As of the suspension date, the Company had approximately $13 million of active market opportunities through July 2, 2011 affected by the suspension for which the Company believes it had a reasonable opportunity to compete, but which may or may not have been awarded to the Company. The Company estimates that it has lost approximately $6 million of such opportunities through July 2, 2011. Since the suspension, the Company is unable to submit bids on U.S. Government prime contracts and subcontracts (to the extent that such contracts exceed $30,000), or with certain state governments or with commercial customers which decline to contract with suspended government contractors. The Company is permitted, under applicable regulations, to continue performing work under existing Government contracts during the investigation and suspension. During the first nine months of fiscal 2011, existing customer orders totaling approximately $100,000 in the aggregate have been cancelled due to the suspension. Although revenue from U.S. Government contracts varies by year, such revenue as a percentage of the Company's total revenue was approximately 5% during the first nine months of fiscal 2011 and 7% for all of fiscal 2010. Further, the Company expects to incur additional General and Administrative expenses related to legal and consulting fees as part of the on-going investigation, as well as increased compliance costs. The Company incurred $2.6 million of costs related to this matter in the third quarter of fiscal 2011, and has incurred $3.4 million of such costs in the first nine months of fiscal 2011. An extended suspension or debarment from contracting with the U.S. Government could have a material impact on the results of operations and financial condition. The duration of the suspension or potential debarment is not known at this time so the Company is unable to estimate the potential impact on its results of operations and financial condition. · Orders increased 59.6% to $149.5 million, compared to $93.7 million for the Third Quarter of Fiscal 2010. This increase is comprised of 69.0% growth in the Test segment, primarily in Europe and Asia, 28.1% worldwide growth in the Sensors segment, and an estimated 11% favorable impact of currency translation. Orders in the quarter included three large (in excess of $5.0 million) Test segment orders totaling approximately $35 million, an increase of $29 million compared to large Test segment orders in the Third Quarter of Fiscal 2010. · Backlog of undelivered orders was a record high $288.7 million, an increase of 53.9% compared to $187.6 million at the end of the Third Quarter of Fiscal 2010. · Revenue increased 37.6% to $116.8 million, compared to $84.9 million for the Third Quarter of Fiscal 2010. This increase was comprised of 38.2% growth in the Test Segment and 35.5% growth in Sensors, driven by higher beginning backlog and order volume in the quarter. In addition, currency translation favorably impacted revenue by an estimated 7%. · Income from operations was $15.6 million, compared to a loss from operations of $1.5 million for the Third Quarter of Fiscal 2010. This increase was primarily driven by higher gross profit from higher volume. As previously mentioned, operating expenses included legal and consulting expenses of $2.6 million related to the U.S. Government matter. Operating expenses in the Third Quarter of Fiscal 2010 included legal settlement costs of $6.3 million. 19-------------------------------------------------------------------------------- Table Of Contents · Earnings per diluted share were $0.69, compared to $0.00 for the Third Quarter of Fiscal 2010 primarily driven by higher income from operations. Nine Fiscal Months Ended July 2, 2011 ("First Nine Fiscal Months of 2011") Compared to Nine Fiscal Months Ended July 3, 2010 ("First Nine Fiscal Months of 2010") Highlights for the First Nine Fiscal Months of 2011 include: · Orders increased 38.2% to $407.5 million, compared to $294.8 million for the First Nine Fiscal Months of 2010. This increase is comprised of 40.3% worldwide growth in the Test segment and 30.2% worldwide growth in the Sensors segment. Orders in the First Nine Fiscal Months of 2011 included five large (in excess of $5.0 million) Test segment orders totaling approximately $64 million, an increase of $38 million compared to large Test segment orders in the First Nine Fiscal Months of 2010. · Revenue increased 25.2% to $335.8 million, compared to $268.2 million for the First Nine Fiscal Months of 2010. This increase was comprised of 22.1% growth in the Test Segment, resulting from a 26.7% higher beginning backlog and order volume, and 36.7% growth in Sensors driven by increased order volume. · Income from operations was $52.0 million, compared to $15.0 million for the First Nine Fiscal Months of 2010. This increase was primarily driven by higher gross profit from increased volume, net of $1.5 million higher operating expenses. Operating expenses in the First Nine Months of 2011 included legal and consulting expenses of $3.4 million related to the previously mentioned U.S. Government matter. Operating expenses in the First Nine Months of Fiscal 2010 included the previously mentioned $6.3 million of legal settlement costs. · Earnings per diluted share increased to $2.29, compared to $0.61 for the First Nine Fiscal Months of Fiscal 2010. In addition to the benefit of higher income from operations, the reduction in the number of shares outstanding, resulting from the Company's share purchases, positively impacted earnings per diluted share by $0.11. Detailed Financial Results Total Company Orders and Backlog Third Quarter of Fiscal 2011 Compared to Third Quarter of Fiscal 2010 The following is a comparison of Third Quarter of Fiscal 2011 and Third Quarter of Fiscal 2010 orders, separately identifying the estimated impact of currency translation (in millions): Three Fiscal Three Fiscal Months Ended Estimated Months Ended July 2, Business Currency July 3, 2011 Change Translation 2010 Orders $ 149.5 $ 45.8 $ 10.0 $ 93.7 Orders totaled $149.5 million, an increase of $55.8 million, or 59.6%, compared to orders of $93.7 million for the Third Quarter of Fiscal 2010. This increase was primarily due to higher order volume in Europe and Asia in the Test segment and higher volume across all geographies in the Sensors segment, including the previously mentioned $29 million increase in large Test segment orders. Additionally, orders for the Third Quarter of Fiscal 2011 include an estimated $10.0 million favorable impact of currency translation. Backlog of undelivered orders at the end of the third quarter was $288.7 million, an increase of 53.9% from backlog of $187.6 million at the end of the Third Quarter of Fiscal 2010. While the Company's backlog is subject to order cancellations, the Company seldom experiences order cancellations larger than $1.0 million. 20-------------------------------------------------------------------------------- Table Of Contents Results of Operations Third Quarter of Fiscal 2011 Compared to Third Quarter of Fiscal 2010 The following is a comparison of Third Quarter of Fiscal 2011 and Third Quarter of Fiscal 2010 statements of operations (in millions, except per share data): Three Fiscal Months Ended July 2, July 3, 2011 2010 Variance % Variance Revenue $ 116.8 $ 84.9 $ 31.9 37.6 % Cost of sales 67.0 51.7 15.3 29.6 % Gross profit 49.8 33.2 16.6 50.0 % Gross margin 42.7 % 39.1 % 3.6 pts Operating expenses: Selling and marketing 17.4 16.0 1.4 8.7 % General administrative 12.9 14.6 (1.7 ) -11.6 % Research and development 3.9 4.1 (0.2 ) -4.9 % Total operating expenses 34.2 34.7 (0.5 ) -1.4 % Income (loss) from operations 15.6 (1.5 ) 17.1 NM Interest expense (0.2 ) (0.1 ) (0.1 ) 100.0 % Interest income 0.1 0.1 - 0.0 % Other income (expense), net 0.9 (0.1 ) 1.0 NM Income (loss) before income taxes 16.4 (1.6 ) 18.0 NM Income tax provision (benefit) 5.4 (1.6 ) 7.0 NM Net income $ 11.0 $ - $ 11.0 NM Diluted earnings per share $ 0.69 $ 0.00 $ 0.69 NM "NM" represents comparisons that are not meaningful to this analysis. The following is a comparison of Third Quarter of Fiscal 2011 and Third Quarter of Fiscal 2010 results of operations, separately identifying the estimated impact of currency translation (in millions): Three Fiscal Three Fiscal Months Ended Estimated Months Ended July 2, Business Currency July 3, 2011 Change Translation 2010 Revenue $ 116.8 $ 25.7 $ 6.2 $ 84.9 Cost of sales 67.0 11.5 3.8 51.7 Gross profit 49.8 14.2 2.4 33.2 Gross margin 42.7 % 39.1 % Operating expenses: Selling and marketing 17.4 0.6 0.8 16.0 General administrative 12.9 (2.2 ) 0.5 14.6 Research and development 3.9 (0.3 ) 0.1 4.1 Total operating expenses 34.2 (1.9 ) 1.4 34.7 Income (loss) from operations $ 15.6 $ 16.1 $ 1.0 $ (1.5 ) 21 -------------------------------------------------------------------------------- Table Of Contents Revenue was $116.8 million, an increase of $31.9 million, or 37.6%, compared to revenue of $84.9 million for the Third Quarter of Fiscal 2010. The increase was driven by a 40.6% higher beginning backlog as well as increased order volume, and an estimated $6.2 million favorable impact of currency translation. Gross profit was $49.8 million, an increase of $16.6 million, or 50.0%, compared to gross profit of $33.2 million for the Third Quarter of Fiscal 2010. Gross profit as a percentage of revenue was 42.7%, an increase of 3.6 percentage points from 39.1% for the Third Quarter of Fiscal 2010. This increase was driven by leverage on higher volume and favorable product mix, and includes a 0.6 percentage point increase due to lower warranty expense in the Test segment. Selling and marketing expense was $17.4 million, an increase of $1.4 million, or 8.7%, compared to $16.0 million for the Third Quarter of Fiscal 2010. This increase was primarily due to an estimated $0.8 million unfavorable impact of currency translation as well as higher compensation, benefits and sales commissions. Selling and marketing expense as a percentage of revenue was 14.9% on higher volume, compared to 18.8% for the Third Quarter of Fiscal 2010. General and administrative expense was $12.9 million, a decrease of $1.7 million, or 11.6%, compared to $14.6 million for the Third Quarter of Fiscal 2010. This decrease was primarily driven by decreased legal and consulting expenses, partially offset by increased other professional fees, higher compensation and benefits as well as an estimated $0.5 million unfavorable impact of currency translation. Legal and consulting expenses for the Third Quarter of Fiscal 2011 included $2.6 million related to the previously mentioned U.S. Government matter, of which $1.9 million and $0.7 million was allocated to the Test segment and Sensors segment, respectively. Legal expenses for the Third Quarter of Fiscal 2010 included $6.3 million of costs associated with a legal settlement. General and administrative expense as a percentage of revenue was 11.0% on higher volume, compared to 17.2% for the Third Quarter of Fiscal 2010. Research and development expense was $3.9 million, a decrease of $0.2 million, or 4.9%, compared to $4.1 million for the Third Quarter of Fiscal 2010, driven by a planned reduction in expenditures in the Test segment. Research and development expense as a percentage of revenue was 3.3% on higher volume, compared to 4.8% for the Third Quarter of Fiscal 2010. Income (loss) from operations was income of $15.6 million, compared to a loss of $1.5 million for the Third Quarter of Fiscal 2010. This increase was primarily driven by higher gross profit. Operating income as a percentage of revenue was 13.4% for the Third Quarter of Fiscal 2011, compared to operating loss as a percentage of revenue was 1.8% for the Third Quarter of Fiscal 2010. Interest expense, net was $0.1 million, relatively flat compared to the Third Quarter of Fiscal 2010. Other income (expense), net was $0.9 million of income, an increase of $1.0 million, compared to $0.1 million of expense in the Third Quarter of Fiscal 2010. This increase was primarily due to net gains on foreign currency transactions compared to net losses on foreign currency transactions in the Third Quarter of Fiscal 2010, as well as $0.2 million higher royalty income. Income tax provision (benefit) was a provision of $5.4 million for the Third Quarter of Fiscal 2011, an increase of $7.0 million compared to a benefit of $1.6 million for the Third Quarter of Fiscal 2010. The increase was primarily due to increased income before income taxes. The tax benefit for the Third Quarter of Fiscal 2010 included favorable tax benefits associated with the release of certain contingencies and the cash repatriation of earnings. Net income was $11.0 million, compared to less than $0.1 million for the Third Quarter of Fiscal 2010. Earnings per diluted share was $0.69, compared to $0.00 for the Third Quarter of Fiscal 2010. This increase was primarily driven by increased gross profit. Segment Result Test Segment Orders and Backlog 22-------------------------------------------------------------------------------- Table Of Contents Third Quarter of Fiscal 2011 Compared to Third Quarter of Fiscal 2010 The following is a comparison of Third Quarter of Fiscal 2011 and Third Quarter of Fiscal 2010 orders for the Test segment, separately identifying the estimated impact of currency translation (in millions): Three Fiscal Three Fiscal Months Ended Estimated Months Ended July 2, Business Currency July 3, 2011 Change Translation 2010 Orders $ 121.7 $ 42.1 $ 7.6 $ 72.0 Orders totaled $121.7 million, an increase of $49.7 million, or 69.0%, compared to orders of $72.0 million for the Third Quarter of Fiscal 2010, primarily driven by increased volume in Europe and Asia, and an estimated $7.6 million favorable impact of currency translation. Third Quarter of Fiscal 2011 orders included three large orders in the structures market totaling approximately $35 million while Third Quarter of Fiscal 2010 included one large ground vehicle order of approximately $6 million. The Test segment accounted for 81.4% of total Company orders, compared to 76.9% for the Third Quarter of Fiscal 2010. Backlog of undelivered orders at the end of the quarter was $270.8 million, an increase of 56.3% from backlog of $173.3 million at the end of the Third Quarter of Fiscal 2010. Results of Operations Third Quarter of Fiscal 2011 Compared to Third Quarter of Fiscal 2010 The following is a comparison of Third Quarter of Fiscal 2011 and Third Quarter of Fiscal 2010 results of operations for the Test segment, separately identifying the estimated impact of currency translation (in millions): Three Fiscal Three Fiscal Months Ended Estimated Months Ended July 2, Business Currency July 3, 2011 Change Translation 2010 Revenue $ 89.3 $ 20.9 $ 3.8 $ 64.6 Cost of sales 55.3 9.4 2.8 43.1 Gross profit 34.0 11.5 1.0 21.5 Gross margin 38.1 % 33.3 % Operating expenses: Selling and marketing 13.0 - 0.5 12.5 General administrative 9.4 (3.4 ) 0.2 12.6 Research and development 2.7 (0.4 ) - 3.1 Total operating expenses 25.1 (3.8 ) 0.7 28.2 Income (loss) from operations $ 8.9 $ 15.3 $ 0.3 $ (6.7 ) Revenue was $89.3 million, an increase of $24.7 million, or 38.2%, compared to revenue of $64.6 million for the Third Quarter of Fiscal 2010. The increase was driven by a 41.5% higher beginning backlog and an estimated $3.8 million favorable impact of currency translation. Gross profit was $34.0 million, an increase of $12.5 million, or 58.1%, compared to gross profit of $21.5 million for the Third Quarter of Fiscal 2010. Gross profit as a percentage of revenue was 38.1%, an increase of 4.8 percentage points from 33.3% for the Third Quarter of Fiscal 2010, primarily from leverage on higher volume, favorable product mix and lower warranty expense. 23-------------------------------------------------------------------------------- Table Of Contents Selling and marketing expense was $13.0 million, an increase of $0.5 million, or 4.0%, compared to $12.5 million for the Third Quarter of Fiscal 2010. This increase was primarily due to an estimated $0.5 million unfavorable impact of currency translation, as increased sales commissions were offset by reduced discretionary spending. Selling and marketing expense as a percentage of revenue was 14.6% on higher volume, compared to 19.3% for the Third Quarter of Fiscal 2010. General and administrative expense was $9.4 million, a decrease of $3.2 million, or 25.4%, compared to $12.6 million for the Third Quarter of Fiscal 2010. This decrease was primarily driven by decreased legal expenses, partially offset by increased other professional fees and higher compensation and benefits. As previously mentioned, legal and consulting expenses for the Third Quarter of Fiscal 2011 included $1.9 million related to the U.S. Government matter while legal expenses for the Third Quarter of Fiscal 2010 included legal settlement costs of $6.3 million. General and administrative expense as a percentage of revenue was 10.5% on higher volume, compared to 19.5% for the Third Quarter of Fiscal 2010. Research and development expense was $2.7 million, a decrease of $0.4 million, or 12.9%, compared to $3.1 million for the Third Quarter of Fiscal 2010, due to a lower level of planned expenditures. Research and development expense as a percentage of revenue was 3.0% on higher volume, compared to 4.8% for the Third Quarter of Fiscal 2010. Income (loss) from operations was an income from operations of $8.9 million, an increase of $15.6 million, compared to a loss from operations of $6.7 million for the Third Quarter of Fiscal 2010. The increase reflects higher revenue and gross profit as well as lower operating expenses. Operating income as a percentage of revenue was 10.0% for the Third Quarter of Fiscal 2011, compared to operating loss as a percentage of revenue of 10.4% for the Third Quarter of Fiscal 2010. Sensors Segment Orders and Backlog Third Quarter of Fiscal 2011 Compared to Third Quarter of Fiscal 2010 The following is a comparison of Third Quarter of Fiscal 2011 and Third Quarter of Fiscal 2010 orders for the Sensors segment, separately identifying the estimated impact of currency translation (in millions): Three Fiscal Three Fiscal Months Ended Estimated Months Ended July 2, Business Currency July 3, 2011 Change Translation 2010 Orders $ 27.8 $ 3.7 $ 2.4 $ 21.7 Orders totaled $27.8 million, an increase of $6.1 million, or 28.1%, compared to orders of $21.7 million for the Third Quarter of Fiscal 2010, primarily due to higher volume across all geographies, and an estimated $2.4 million favorable impact of currency translation. The Sensors segment accounted for 18.6% of total Company orders, compared to 23.1% for the Third Quarter of Fiscal 2010. Backlog of undelivered orders at the end of the quarter was $17.9 million, an increase of 25.2% from backlog of $14.3 million at the end of the Third Quarter of Fiscal 2010. Results of Operations Third Quarter of Fiscal 2011 Compared to Third Quarter of Fiscal 2010 The following is a comparison of Third Quarter of Fiscal 2011 and Third Quarter of Fiscal 2010 results of operations for the Sensors segment, separately identifying the estimated impact of currency translation (in millions): 24-------------------------------------------------------------------------------- Table Of Contents Three Fiscal Three Fiscal Months Ended Estimated Months Ended July 2, Business Currency July 3, 2011 Change Translation 2010 Revenue $ 27.5 $ 4.8 $ 2.4 $ 20.3 Cost of sales 11.7 2.1 1.0 8.6 Gross profit 15.8 2.7 1.4 11.7 Gross margin 57.4 % 57.7 % Operating expenses: Selling and marketing 4.4 0.6 0.3 3.5 General administrative 3.5 1.2 0.3 2.0 Research and development 1.2 0.1 0.1 1.0 Total operating expenses 9.1 1.9 0.7 6.5 Income from operations $ 6.7 $ 0.8 $ 0.7 $ 5.2 Revenue was $27.5 million, an increase of $7.2 million, or 35.5%, compared to revenue of $20.3 million for the Third Quarter of Fiscal 2010. This increase was primarily driven by increased worldwide order volume and an estimated $2.4 million favorable impact of currency translation. Gross profit was $15.8 million, an increase of $4.1 million, or 35.0%, compared to gross profit of $11.7 million for the Third Quarter of Fiscal 2010. Gross profit as a percentage of revenue was 57.4%, a decrease of 0.3 percentage points from 57.7% for the Third Quarter of Fiscal 2010, primarily due to increased material costs and certain labor inefficiencies. Selling and marketing expense was $4.4 million, an increase of $0.9 million, or 25.7%, compared to $3.5 million for the Third Quarter of Fiscal 2010. The increase was driven by higher compensation, benefits and incentives, increased expenditures on marketing initiatives as well as an estimated $0.3 million unfavorable impact of currency translation. Selling and marketing expense as a percentage of revenue was 16.0% on higher volume, compared to 17.2% for the Third Quarter of Fiscal 2010. General and administrative expense was $3.5 million, an increase of $1.5 million, or 75.0%, compared to the Third Quarter of Fiscal 2010. This increase is primarily due to previously mentioned $0.7 million legal and consulting expenses related to the U.S. Government matter, increased discretionary spending, as well as an estimated $0.3 million unfavorable impact of currency translation. General and administrative expense as a percentage of revenue was 12.7% on higher volume, compared to 9.9% for the Third Quarter of Fiscal 2010. Research and development expense was $1.2 million, an increase of $0.2 million, or 20.0%, compared to the Third Quarter of Fiscal 2010 due to a planned increase in spending. Research and development expense as a percentage of revenue was 4.4% on higher volume, compared to 4.9% for the Third Quarter of Fiscal 2010. Income from operations was $6.7 million, an increase of $1.5 million, compared to income from operations of $5.2 million for the Third Quarter of Fiscal 2010. This increase was due to higher gross profit, partially offset by increased operating expenses. Operating income as a percentage of revenue was 24.4% compared to 25.6% for the Third Quarter of Fiscal 2010. Detailed Financial Results Total Company Orders and Backlog 25-------------------------------------------------------------------------------- Table Of Contents First Nine Fiscal Months of 2011 Compared to First Nine Fiscal Months of 2010 The following is a comparison of First Nine Fiscal Months of 2011 and First Nine Fiscal Months of 2010 orders, separately identifying the estimated impact of currency translation (in millions): Nine Fiscal Nine Fiscal Months Ended Estimated Months Ended July 2, Business Currency July 3, 2011 Change Translation 2010 Orders $ 294.8 $ (4.2 ) $ 4.2 $ 294.8 Orders totaled $407.5 million, an increase of $112.7 million, or 38.2%, compared to orders of $294.8 million for the First Nine Months of Fiscal 2010. This increase was driven by increased volume across all geographies in both segments, including the previously mentioned $38 million increase in large Test segment orders, as well as an estimated $10.2 million favorable impact of currency translation. Backlog of undelivered orders at the end of the First Nine Fiscal Months of 2011 was $288.7 million, an increase of 53.9% from backlog of $187.6 million at the end of the First Nine Fiscal Months of 2010. Results of Operations First Nine Fiscal Months of 2011 Compared to First Nine Fiscal Months of 2010 The following is a comparison of First Nine Fiscal Months of 2011 and First Nine Fiscal Months of 2010 statements of operations (in millions, except per share data): Nine Fiscal Months Ended July 2, July 3, 2011 2010 Variance % Variance Revenue $ 335.8 $ 268.2 $ 67.6 25.2 % Cost of sales 190.4 161.2 29.2 18.1 % Gross profit 145.4 107.0 38.4 35.9 % Gross margin 43.3 % 39.9 % 3.4 pts Operating expenses: Selling and marketing 51.2 48.3 2.9 6.0 % General administrative 31.7 32.5 (0.8 ) -2.5 % Research and development 10.5 11.2 (0.7 ) -6.2 % Total operating expenses 93.4 92.0 1.4 1.5 % Income from operations 52.0 15.0 37.0 246.7 % Interest expense (1.0 ) (1.1 ) 0.1 -9.1 % Interest income 0.2 0.3 (0.1 ) -33.3 % Other income (expense), net 1.0 (0.4 ) 1.4 NM Income before income taxes 52.2 13.8 38.4 278.3 % Income tax provision 16.1 3.8 12.3 323.7 % Net income $ 36.1 $ 10.0 $ 26.1 261.0 % Diluted earnings per share $ 2.29 $ 0.61 $ 1.68 275.4 % "NM" represents comparisons that are not meaningful to this analysis. 26-------------------------------------------------------------------------------- Table Of Contents The following is a comparison of First Nine Fiscal Months of 2011 and First Nine Fiscal Months of 2010 results of operations, separately identifying the estimated impact of currency translation (in millions): Nine Fiscal Nine Fiscal Months Ended Estimated Months Ended July 2, Business Currency July 3, 2011 Change Translation 2010 Revenue $ 335.8 $ 60.6 $ 7.0 $ 268.2 Cost of sales 190.4 24.9 4.3 161.2 Gross profit 145.4 35.7 2.7 107.0 Gross margin 43.3 % 39.9 % Operating expenses: Selling and marketing 51.2 2.0 0.9 48.3 General administrative 31.7 (1.3 ) 0.5 32.5 Research and development 10.5 (0.8 ) 0.1 11.2 Total operating expenses 93.4 (0.1 ) 1.5 92.0 Income from operations $ 52.0 $ 35.8 $ 1.2 $ 15.0 Revenue was $335.8 million, an increase of $67.6 million, or 25.2%, compared to revenue of $268.2 million for the First Nine Fiscal Months of 2010. This increase was primarily due to a 27.8% higher beginning backlog as well as increased order volume, and an estimated $7.0 million favorable impact of currency translation. Gross profit was $145.4 million, an increase of $38.4 million, or 35.9%, compared to gross profit of $107.0 million for the First Nine Fiscal Months of 2010. Gross profit as a percentage of revenue was 43.3%, an increase of 3.4 percentage points from 39.9% for the First Nine Fiscal Months of 2010. This increase was driven by leverage on higher volume and favorable product mix, and includes a 0.5 percentage point increase due to lower warranty expense in the Test segment. Selling and marketing expense was $51.2 million, an increase of $2.9 million, or 6.0%, compared to $48.3 million for the First Nine Fiscal Months of 2010. The increase was primarily due to higher sales commissions, increased compensation and benefits, higher bad debt expense as well an estimated $0.9 million unfavorable impact of currency translation. Bad debt expense for the First Nine Fiscal Months 2010 included a $0.4 million reduction associated with the collection of customer receivables previously written off. Selling and marketing expense as a percentage of revenue was 15.2% on higher volume, compared to 18.0% for the First Nine Fiscal Months of 2010. General and administrative expense was $31.7 million, a decrease of $0.8 million, or 2.5%, compared to $32.5 million for the First Nine Fiscal Months of 2010. The decrease was driven by lower legal and consulting expense, partially offset by higher compensation and benefits, as well as other discretionary spending. Legal expenses for the First Nine Fiscal Months of 2011 included $3.4 million related to the previously mentioned U.S. Government matter, of which $2.7 million and $0.7 million was allocated to the Test and Sensors segment, respectively. Legal expenses for the Third Quarter of Fiscal 2010 included $6.3 million of costs associated with a legal settlement. General and administrative expense as a percentage of revenue was 9.4% on higher volume, compared to 12.1% for the First Nine Fiscal Months of 2010. Research and development expense was $10.5 million, a decrease of $0.7 million, or 6.2%, compared to $11.2 million for the First Nine Fiscal Months of 2010, driven by a planned reduction in expenditures in the Test segment. Research and development expense as a percentage of revenue was 3.1% on higher volume, compared to 4.2% for the First Nine Fiscal Months of 2010. Income from operations was $52.0 million, an increase of $37.0 million, compared to income from operations of $15.0 million for the First Nine Fiscal Months of 2010. This increase was primarily driven by higher gross profit. Operating income as a percentage of revenue was 15.5% on higher volume, compared to 5.6% for the First Nine Fiscal Months of 2010. Interest expense, net was $0.2 million, flat compared to the First Nine Fiscal Months of 2010. Other income (expense), net was $1.0 million of income, an increase of $1.4 million, compared to $0.4 million of expense for the First Nine Fiscal Months of 2010. This increase was primarily due to net gains on foreign currency transactions compared to net losses on foreign currency transactions in the Third Quarter of Fiscal 2010, as well as $0.3 million higher royalty income. 27-------------------------------------------------------------------------------- Table Of Contents Income tax provision totaled $16.1 million for the First Nine Fiscal Months of 2011, an increase of $12.3 million compared to $3.8 million for the First Nine Fiscal Months of 2010 primarily due to increased income before income taxes. The effective tax rate for the First Nine Fiscal Months of 2011 was 30.8%, an increase of 3.4 percentage points compared to a tax rate of 27.4% for the First Nine Fiscal Months of 2010. The increase was primarily due to increased income before income taxes as well as the geographic mix of earnings. Net income was $36.1 million, an increase of $26.1 million compared to $10.0 million for the First Nine Fiscal Months of 2010. Earnings per diluted share increased $1.68 to $2.29, compared to $0.61 for the First Nine Fiscal Months of 2010. The increase was primarily driven by increased gross profit. In addition, the reduction in the number of shares outstanding, resulting from the Company's share purchases, positively impacted earnings per share by $0.11 for the First Nine Fiscal Months of 2011. Segment Results Test Segment Orders and Backlog First Nine Fiscal Months of 2011 Compared to First Nine Fiscal Months of 2010 The following is a comparison of First Nine Fiscal Months of 2011 and First Nine Fiscal Months of 2010 orders for the Test segment, separately identifying the estimated impact of currency translation (in millions): Nine Fiscal Nine Fiscal Months Ended Estimated Months Ended July 2, Business Currency July 3, 2011 Change Translation 2010 Orders $ 329.1 $ 87.0 $ 7.5 $ 234.6 Orders totaled $329.1 million, an increase of $94.5 million, or 40.3%, compared to orders of $234.6 million for the First Nine Fiscal Months of 2010, primarily due to increased demand across all geographies, as well as an estimated $7.5 million favorable impact of currency translation. First Nine Fiscal Months of 2011orders included five large orders totaling approximately $64 million, of which $35 million was associated with the materials and structures markets and $29 million was associated with the ground vehicles market. First Nine Fiscal Months of 2010 orders included three large orders totaling approximately $26 million, of which $20 million was associated with the materials and structures markets and $6 million was associated with the ground vehicles market. The Test segment accounted for 80.8% of total Company orders, compared to 79.6% for the First Nine Fiscal Months of 2010. Backlog of undelivered orders at the end of the First Nine Fiscal Months of 2011 was $270.8 million, an increase of 56.3% from backlog of $173.3 million at the end of the First Nine Fiscal Months of 2010. Results of Operations First Nine Fiscal Months of 2011 Compared to First Nine Fiscal Months of 2010 The following is a comparison of First Nine Fiscal Months of 2010 and First Nine Fiscal Months of 2010 results of operations for the Test segment, separately identifying the estimated impact of currency translation (in millions): 28-------------------------------------------------------------------------------- Table Of Contents Nine Fiscal Nine Fiscal Months Ended Estimated Months Ended July 2, Business Currency July 3, 2011 Change Translation 2010 Revenue $ 258.7 $ 42.4 $ 4.5 $ 211.8 Cost of sales 157.6 18.3 3.3 136.0 Gross profit 101.1 24.1 1.2 75.8 Gross margin 39.1 % 35.8 % Operating expenses: Selling and marketing 39.0 0.2 0.6 38.2 General administrative 23.3 (3.4 ) 0.3 26.4 Research and development 7.2 (1.2 ) - 8.4 Total operating expenses 69.5 (4.4 ) 0.9 73.0 Income from operations $ 31.6 $ 28.5 $ 0.3 $ 2.8 Revenue was $258.7 million, an increase of $46.9 million, or 22.1%, compared to revenue of $211.8 million for the First Nine Fiscal Months of 2010. The increase was driven by a 26.7% higher beginning backlog and increased order volume, and an estimated $4.5 million favorable impact of currency translation. Gross profit was $101.1 million, an increase of $25.3 million, or 33.4%, compared to gross profit of $75.8 million for the First Nine Fiscal Months of 2010. Gross profit as a percentage of revenue was 39.1%, an increase of 3.3 percentage points from 35.8% for the First Nine Fiscal Months of 2010. This increase was primarily due to increased volume, favorable product mix and lower warranty expense in the First Nine Months for Fiscal 2011. Selling and marketing expense was $39.0 million, an increase of $0.8 million, or 2.1%, compared to $38.2 million for the First Nine Fiscal Months of 2010. This increase was primarily due to an estimated $0.6 million unfavorable impact of currency translation, increased sales commissions and higher bad debt expense, partially offset by lower compensation and benefits and reduced discretionary spending on marketing initiatives. Bad debt expense for the First Half of Fiscal 2010 included a $0.4 million reduction associated with the collection of customer receivables previously written off. Selling and marketing expense as a percentage of revenue was 15.1% on higher volume, compared to 18.0% for the First Nine Fiscal Months of 2010. General and administrative expense was $23.3 million, a decrease of $3.1 million, or 11.7%, compared to $26.4 million for the First Nine Fiscal Months of 2010. The decrease was driven by lower legal expenses, partially offset by higher compensation and benefits and discretionary spending. As previously mentioned, legal and consulting expenses for the First Nine Months of Fiscal 2011 included $2.7 million related to the U.S. Government matter while legal expenses for the First Nine Months of Fiscal 2010 included legal settlement costs of $6.3 million. General and administrative expense as a percentage of revenue was 9.0% on higher volume, compared to 12.5% for the First Nine Fiscal Months of 2010. Research and development expense was $7.2 million, a decrease of $1.2 million, or 14.3%, compared to $8.4 million for the First Nine Fiscal Months of 2010, due to a lower level of planned expenditures. Research and development expense as a percentage of revenue was 2.8% on higher volume, compared to 4.0% for the First Nine Fiscal Months of 2010. Income from operations was $31.6 million, an increase of $28.8 million compared to income of $2.8 million for the First Nine Fiscal Months of 2010. The increase reflects higher gross profit. Operating income as a percentage of revenue was 12.2% on higher volume, compared to 1.3% for the First Nine Fiscal Months of 2010. Sensors Segment Orders and Backlog 29-------------------------------------------------------------------------------- Table Of Contents First Nine Fiscal Months of 2011 Compared to First Nine Fiscal Months of 2010 The following is a comparison of First Nine Fiscal Months of 2011 and First Nine Fiscal Months of 2010 orders for the Sensors segment, separately identifying the estimated impact of currency translation (in millions): Nine Fiscal Nine Fiscal Months Ended Estimated Months Ended July 2, Business Currency July 3, 2011 Change Translation 2010 Orders $ 78.4 $ 15.5 $ 2.7 $ 60.2 Orders totaled $78.4 million, an increase of $18.2 million, or 30.2%, compared to orders of $60.2 million for the First Nine Fiscal Months of 2010, primarily due to higher volume across all geographies as well as an estimated $2.7 million favorable impact of currency translation. The Sensors segment accounted for 19.2% of total Company orders, compared to 20.4% for the First Nine Fiscal Months of 2010. Backlog of undelivered orders at the end of the First Nine Fiscal Months of 2011 was $17.9 million, an increase of 25.2% from backlog of $14.3 million at the end of the First Nine Fiscal Months of 2010. Results of Operations First Nine Fiscal Months of 2011 Compared to First Nine Fiscal Months of 2010 The following is a comparison of First Nine Fiscal Months of 2011 and First Nine Fiscal Months of 2010 results of operations for the Sensors segment, separately identifying the estimated impact of currency translation (in millions): Nine Fiscal Nine Fiscal Months Ended Estimated Months Ended July 2, Business Currency July 3, 2011 Change Translation 2010 Revenue $ 77.1 $ 18.2 $ 2.5 $ 56.4 Cost of sales 32.8 6.6 1.0 25.2 Gross profit 44.3 11.6 1.5 31.2 Gross margin 57.4 % 55.3 % Operating expenses: Selling and marketing 12.2 1.8 0.3 10.1 General administrative 8.4 2.1 0.2 6.1 Research and development 3.3 0.4 0.1 2.8 Total operating expenses 23.9 4.3 0.6 19.0 Income from operations $ 20.4 $ 7.3 $ 0.9 $ 12.2 Revenue was $77.1 million, an increase of $20.7 million, or 36.7%, compared to $56.4 million for the First Nine Fiscal Months of 2010. This increase was primarily driven by increased worldwide order volume and an estimated $2.5 million favorable impact of currency translation. Gross profit was $44.3 million, an increase of $13.1 million, or 42.0%, compared to gross profit of $31.2 million for the First Nine Fiscal Months of 2010. Gross profit as a percentage of revenue was 57.4%, an increase of 2.1 percentage points from 55.3% for the First Nine Fiscal Months of 2010, primarily due to improved leverage on higher volume. Selling and marketing expense was $12.2 million, an increase of $2.1 million, or 20.8%, compared to $10.1 million for the First Nine Fiscal Months of 2010. The increase was driven by higher compensation, benefits and incentives as well as expenditures on marketing initiatives. Selling and marketing expense as a percentage of revenue was 15.8% compared to 17.9% for the First Nine Fiscal Months of 2010. 30-------------------------------------------------------------------------------- Table Of Contents General and administrative expense was $8.4 million, an increase of $2.3 million, or 37.7%, compared to $6.1 million for the First Nine Fiscal Months of 2010, primarily due to higher compensation and benefits and increased discretionary spending, as well the previously mentioned $0.7 million of legal and consulting expenses related to the U.S. Government matter. General and administrative expense as a percentage of revenue was 10.9% compared to 10.8% for the First Nine Fiscal Months of 2010. Research and development expense was $3.3 million, an increase of $0.5 million, or 17.9%, compared to $2.8 million for the First Nine Fiscal Months of 2010, due to a higher level of planned expenditures. Research and development expense as a percentage of revenue was 4.3% compared to 5.0% for the First Nine Fiscal Months of 2010. Income from operations was $20.4 million, an increase of $8.2 million, or 67.2%, compared to income from operations of $12.2 million for the First Nine Fiscal Months of 2010. This increase was primarily due to higher gross profit, partially offset by increased operating expenses. Operating income as a percentage of revenue was 26.5% compared to 21.6% for the First Nine Fiscal Months of 2010. Capital Resources and Liquidity The Company had cash and cash equivalents of $101.3 million at the end of the Third Quarter of Fiscal 2011. Of this amount, $25.9 million was located in North America, $53.3 million in Europe, and $22.1 million in Asia. The North American balance was primarily invested in money market funds and bank deposits. In Europe, the balances were primarily invested in Euro money market funds and bank deposits. In Asia, the balances were primarily invested in bank deposits. In accordance with its investment policy, the Company places cash equivalent investments with issuers who have high-quality investment credit ratings. In addition, the Company limits the amount of investment exposure it has with any particular issuer. The Company's investment objectives are to preserve principal, maintain liquidity, and achieve the best available return consistent with its primary objectives of safety and liquidity. At the end of the Third Quarter of Fiscal 2011, the Company held no short-term investments. Total cash and cash equivalents increased $24.7 million in the First Nine Fiscal Months of 2011, primarily due to earnings and proceeds from the exercise of stock options, partially offset by increased working capital requirements, payment to settle an accelerated share repurchase agreement, dividend payments, and investment in property and equipment. Total cash and cash equivalents decreased $14.2 million in the First Nine Fiscal Months of 2010, primarily due to an unfavorable impact of currency translation, purchases of company stock, dividend payments, investment in property and equipment, and deferred payments for the SANS acquisition, partially offset by earnings and decreased working capital requirements. The Company believes that its liquidity, represented by funds available from cash, cash equivalents, the credit facility, and anticipated cash from operations are adequate to fund ongoing operations, internal growth opportunities, capital expenditures, dividends, share purchases, as well as to fund strategic acquisitions. Cash flows from operating activities provided cash totaling $35.5 million for the First Nine Fiscal Months of 2011, compared to cash provided of $33.3 million for the First Nine Fiscal Months of 2010. Cash provided for the First Nine Fiscal Months of 2011 was primarily due to earnings and $17.8 million increased advance payments received from customers driven by higher custom orders, and $7.1 million increased accounts payable resulting from general timing of purchases and payments, partially offset by $29.7 million increased accounts and unbilled receivables resulting from higher volume as well as the general timing of billing and collections, and $13.7 million increased inventories to support future revenue. Cash provided for the First Nine Fiscal Months of 2010 was primarily due to earnings and $13.7 million decreased accounts and unbilled receivables resulting from lower revenue and the general timing of billing and collections as well as lower volume. Cash flows from investing activities required the use of cash totaling $7.6 million for the First Nine Fiscal Months of 2011, compared to the use of cash totaling $15.2 million for the First Nine Fiscal Months of 2010. The cash usage for the First Nine Fiscal Months of 2011 reflects a $7.6 million investment in property and equipment. The cash usage for the First Nine Fiscal Months of 2010 reflects a $8.4 million investment in property and equipment, and $6.7 million of deferred payments for the SANS acquisition. Cash flows from financing activities required the use of cash totaling $6.6 million for the First Nine Fiscal Months of 2011, compared to the use of cash totaling $19.7 million for the First Nine Fiscal Months of 2010. The cash usage for the First Nine Fiscal Months of 2011 was primarily due to the use of $9.6 million to settle an accelerated share purchase agreement that was initially entered into in during the fourth quarter of fiscal 2010, and payment of cash dividends of $9.3 million. These cash usages were partially offset by $10.7 million received in connection with stock option exercises. The cash usage for the First Nine Fiscal Months of 2010 was primarily due to the use of $10.7 million to purchase approximately 369,300 shares of the Company's common stock, and payment of cash dividends of $9.8 million. 31-------------------------------------------------------------------------------- Table Of Contents Under the terms of its borrowing agreements, the Company has agreed to certain financial covenants. At the end of the Third Quarter of Fiscal 2011, the Company was in compliance with the financial terms and conditions of those agreements. Off-Balance Sheet Arrangements As of July 2, 2011, the Company had no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the Company's financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors. Critical Accounting Policies The Consolidated Financial Statements are prepared in accordance with U.S. generally accepted accounting principles, which require the Company to make estimates and assumptions in certain circumstances that affect amounts reported. In preparing these financial statements, management has made its best estimates and judgments of certain amounts, giving due consideration to materiality. The Company believes that of its significant accounting policies, the following are particularly important to the portrayal of the Company's results of operations and financial position, may require the application of a higher level of judgment by the Company's management, and as a result, are subject to an inherent degree of uncertainty. Further information is provided in Note 1 in the Condensed Notes to Consolidated Financial Statements in this Quarterly Report on Form 10-Q. Revenue Recognition. The Company is required to comply with a variety of technical accounting requirements in order to achieve consistent and accurate revenue recognition. The most significant area of judgment and estimation is percentage of completion contract accounting. The Company develops cost estimates that include materials, component parts, labor and overhead costs. Detailed costs plans are developed for all aspects of the contracts during the bidding phase of the contract. Cost estimates are largely based on actual historical performance of similar projects combined with current knowledge of the projects in progress. Significant factors that impact the cost estimates include technical risk, inflationary cost of materials and labor, changes in scope and schedule, and internal and subcontractor performance. Actual costs incurred during the project phase are monitored and compared to the estimates on a monthly basis. Cost estimates are revised based on changes in circumstances. Anticipated losses on long-term contracts are recognized when such losses become evident. Inventories. The Company maintains a material amount of inventory to support its engineering and manufacturing operations. The Company establishes valuation reserves for excess, slow moving, and obsolete inventory based on inventory levels, expected product life, and forecasted sales demand. It is possible that an increase in the Company's inventory reserves may be required in the future if there is a significant decline in demand for the Company's products and the Company does not adjust its manufacturing production accordingly. Impairment of Long-Lived Assets. The Company reviews the carrying value of long-lived assets or asset groups, such as property and equipment and intangibles subject to amortization, when events or changes in circumstances such as market value, asset utilization, physical change, legal factors, or other matters indicate that the carrying value may not be recoverable. When this review indicates the carrying value of an asset or asset group exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset or asset group, the Company recognizes an asset impairment charge against operations. The amount of the impairment loss recorded is the amount by which the carrying value of the impaired asset or asset group exceeds its fair value. Goodwill. The Company tests goodwill at least annually for impairment. Goodwill is also tested for impairment as changes in circumstances occur indicating that the carrying value may not be recoverable. Goodwill impairment testing first requires a comparison of the fair value of each reporting unit to the carrying value. If the carrying value of the reporting unit exceeds fair value, goodwill is considered impaired. The Company has three discrete reporting units, two of which are assigned goodwill. At July 2, 2011, one reporting unit was assigned $14.3 million of goodwill while another was assigned $1.7 million. The fair value of a reporting unit is estimated using a discounted cash flow model that requires input of certain estimates and assumptions requiring management judgment, including projections of economic conditions and customer demand, revenue and margins, changes in competition, operating costs, and new product introductions. At the end of the prior fiscal year, the estimated fair value of the reporting unit assigned $1.7 million of goodwill was substantially in excess of its carrying value, while the estimated fair value of the reporting unit assigned $14.3 million of goodwill exceeded its carrying value by approximately 8 percent. While the Company believes the estimates and assumptions used in determining the fair value of its reporting units are reasonable, significant changes in estimates of future cash flows, such as those caused by unforeseen events or changes in market conditions could materially impact the fair value of a reporting unit which could result in the recognition of a goodwill impairment charge. 32-------------------------------------------------------------------------------- Table Of Contents Software Development Costs. The Company incurs costs associated with the development of software to be sold, leased, or otherwise marketed. Software development costs are expensed as incurred until technological feasibility has been established, at which time future costs incurred are capitalized until the product is available for general release to the public. A certain amount of judgment and estimation is required to assess when technological feasibility is established, as well as the ongoing assessment of the recoverability of capitalized costs. In evaluating the recoverability of capitalized software costs, the Company compares expected product performance, utilizing forecasted revenue amounts, to the total costs incurred to date and estimates of additional costs to be incurred. If revised forecasted product revenue is less than, and/or revised forecasted costs are greater than, the previously forecasted amounts, the net realizable value may be lower than previously estimated, which could result in the recognition of an impairment charge in the period in which such a determination is made. Warranty Obligations. The Company is subject to warranty guarantees on sales of its products. A certain amount of judgment is required in determining appropriate reserve levels for anticipated warranty claims. While these reserve levels are based on historical warranty experience, they may not reflect the actual claims that will occur over the upcoming warranty period, and additional warranty reserves may be required. Income Taxes. The Company records a tax provision for the anticipated tax consequences of the reported results of operations. Deferred tax assets and liabilities are measured using the currently enacted tax rates that apply to taxable income in effect for the years in which those deferred tax assets and liabilities are expected to be realized or settled. The Company records a valuation allowance to reduce deferred tax assets to the amount that is believed more likely than not to be realized. The Company believes it is more likely than not that forecasted income, including income that may be generated as a result of certain tax planning strategies, together with the tax effects of the deferred tax liabilities, will be sufficient to fully recover the remaining net realizable value of its deferred tax assets. In the event that all or part of the net deferred tax assets are determined not to be realizable in the future, an adjustment to the valuation allowance would be charged to earnings in the period such determination is made. In addition, the calculation of tax liabilities involves significant judgment in estimating the impact of uncertainties in the application of complex tax laws. Resolution of these uncertainties in a manner inconsistent with management's expectations could have a material impact on the Company's financial condition and operating results. Recent Accounting Pronouncements In June 2011, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2011-05, "Comprehensive Income (Topic 220) - Presentation of Comprehensive Income." ASU 2011-05 amends Topic 220, "Comprehensive Income," to allow an entity the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in shareholders' investment. The amendments to the Codification in the ASU do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. The provisions of ASU 2011-05 should be applied retrospectively and are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011 which, for the Company, will be the beginning of fiscal year 2013. Early adoption is permitted. The Company is currently evaluating the impact of this new guidance, but does not expect the adoption of ASU 2011-05 to have a material impact on its consolidated financial statements. In May 2011, the FASB issued ASU 2011-04, "Fair Value Measurement (Topic 820) - Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs." This ASU represents the converged guidance of the FASB and the IASB (the Boards) on fair value measurement. The collective efforts of the Boards and their staffs, reflected in ASU 2011-04, have resulted in common requirements for measuring fair value and for disclosing information about fair value measurements, including a consistent meaning of the term "fair value."ASU 2011-04 amends ASC 820, "Fair Value Measurements and Disclosures" to provide guidance on how fair value measurement should be applied where existing U.S. GAAP already requires or permits fair value measurements. This ASU does not extend the use of fair value, but rather provides guidance on application. In addition, ASU 2011-04 requires expanded disclosures regarding fair value measurements. The provisions of ASU 2011-4 are effective prospectively for interim and annual periods beginning after December 15, 2011 which, for the Company, will be the second quarter of fiscal year 2012. Early adoption is not permitted. The Company is currently evaluating the impact of this new guidance, but does not expect the adoption of ASU 2011-04 to have a material impact on its consolidated financial statements. 33-------------------------------------------------------------------------------- Table Of Contents Other Matters The Company's dividend policy is to maintain a payout ratio that allows dividends to increase with the long-term growth of earnings per share, while sustaining dividends through economic cycles. The Company's dividend practice is to target over time a payout ratio of approximately 40% of net earnings per share. |