INTEST CORP - Quarter Report: 2000 September (Form 10-Q)

inTEST Corporation (the "Company") is a leading independent designer, manufacturer and marketer of interface solutions and temperature management products that semiconductor manufacturers use in conjunction with automatic test equipment, or ATE, in the testing of integrated circuits, or ICs. The Company's interface solutions products include manipulator, docking hardware, and tester interface products.

The consolidated entity is comprised of inTEST Corporation (parent) and its nine 100% owned subsidiaries: inTEST Limited (Thame, UK), inTEST Kabushiki Kaisha (Kichijoji, Japan), inTEST PTE, Limited (Singapore), inTEST Sunnyvale Corp. (Delaware), Temptronic Corporation (Delaware), inTEST GmbH (Germany)(operations commenced during August 2000), inTEST Investments, Inc. (a Delaware holding company), inTEST IP Corp. (a Delaware holding company) and inTEST Licensing Corp. (a Delaware holding company).

The Company manufactures its products in the U.S.,U.K. and Singapore (where the Company commenced manufacturing during September 1999). Marketing and support activities are conducted worldwide from the Company's facilities in the U.S., U.K., Germany, Japan and Singapore.

On March 9, 2000, the Company completed a merger with Temptronic Corporation ("Temptronic") whereby Temptronic was merged into a wholly-owned subsidiary of the Company. The Company exchanged 2,046,793 shares of its common stock for all of the Temptronic common stock. Each share of Temptronic common stock was exchanged for 0.925 shares of the Company's common stock. In addition, outstanding Temptronic stock options were converted at the same exchange ratio into options to acquire 175,686 shares of the Company's common stock. The merger was accounted for under the pooling-of-interests method of accounting and, accordingly, the accompanying consolidated financial statements have been retroactively restated to give effect to the merger. Upon consummation of the merger, 55,557 shares of treasury stock held by Temptronic with a cost of $224 were retired. Temptronic also has a 100% owned foreign subsidiary which is consolidated with Temptronic for reporting purposes.

Basis of Presentation

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated upon consolidation. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Interim Financial Reporting

In the opinion of management, the accompanying unaudited consolidated financial statements include all adjustments (consisting only of normally recurring adjustments) necessary to present fairly the financial position, results of operations, and changes in cash flows for the interim periods presented.

Certain footnote information has been condensed or omitted from these financial statements. Therefore, these financial statements should be read in conjunction with the consolidated financial statements and accompanying footnotes included in the Company's Form 8-K/A filed on May 16, 2000.

Net Earnings Per Common Share

Basic earnings per common share is computed by dividing net earnings by the weighted average number of common shares outstanding during each period. Diluted earnings per common share is computed by dividing net earnings by the weighted average number of common shares and common share equivalents outstanding during each period. Common share equivalents represent stock options using the treasury stock method.

Weighted average common shares outstanding exclude unallocated shares of common stock held by the Company's Equity Participation Plan (414,685 shares as of September 30, 2000).

New Accounting Pronouncements

In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No. 133, Accounting for Derivative Instruments and Hedging Activities, which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities. SFAS 133, as amended by SFAS 137 and 138, is effective for all fiscal quarters of fiscal years beginning after June 15, 2000. The Company plans to adopt this Statement in the first quarter of 2001, as required. The adoption of this Statement is not expected to have a material effect on the results of operations, financial condition or long-term liquidity of the Company.

In December 1999, the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin ("SAB") No. 101, Revenue Recognition in Financial Statements, as amended by SAB 101A and 101B, which must be implemented in the quarter ending December 31, 2000. In anticipation of the adoption of SAB 101, the Company has analyzed its revenue recognition policies for its current products line in light of the SEC's guidance. As a result of this analysis, the Company believes that its current revenue recognition policies and practicies conform to both generally accepted accounting principles and the guidance provided in SAB 101.

Overview

We are a leading independent designer, manufacturer and marketer of interface solutions and temperature management products that semiconductor manufacturers use in conjunction with automatic test equipment, or ATE, in the testing of integrated circuits, or ICs. Our interface solutions products include manipulator, docking hardware and tester interface products. Our high performance products are designed to enable semiconductor manufacturers to improve the efficiency of their IC test processes and, consequently, their profitability. We supply our products worldwide to major semiconductor manufacturers directly and through leading ATE manufacturers.

Our revenues depend substantially upon the demand for ATE by semiconductor manufacturers and, therefore, fluctuate generally in response to the cyclicality in the semiconductor manufacturing industry. During the past several years, the demand for ATE by the semiconductor industry has exhibited a high degree of cyclicality. Our third quarter 2000 results reflect the continuation of a period of growth in the semiconductor industry which has been evidenced by our sequential quarterly growth in net revenues which grew from $15.2 million for the quarter ended September 30, 1999 to a record $24.5 million for the quarter ended September 30, 2000. Orders for our products ("bookings") were a record $26.4 million for the quarter ended September 30, 2000 compared with $18.3 million for the quarter ended September 30, 1999. As a result of our increased bookings, our backlog increased from $16.2 million at September 30, 1999 to $21.2 million at September 30, 2000. We believe that the increases in our net revenues, bookings, and backlog reflect the increased demand for ATE by semiconductor manufacturers. Although we calculate bookings and backlog on the basis of firm orders, we cannot give any assurance that customers will purchase the equipment subject to such orders. As a result, our bookings for any period and backlog at any particular date do not necessarily serve as an indicator of actual sales for any succeeding period.

Significant Events

On March 9, 2000, we acquired Temptronic Corporation. The acquisition was in the form of a merger of Temptronic into a subsidiary of ours, and was accounted for as a pooling of interests. The following discussion describes our results of operations and financial condition on a pooled basis.

Results of Operations

Three Months Ended September 30, 2000 Compared to Three Months Ended September 30, 1999:

Net Revenues. Net revenues were a record $24.5 million for the quarter ended September 30, 2000 compared to $15.2 million for the same period in 1999, an increase of $9.3 million or 61%. We believe that the increase in net revenues over the comparable prior period is principally the result of continued growth in the demand for ATE in 2000 compared to 1999.

Gross Margin. Gross margin decreased to 46% for the quarter ended September 30, 2000 from 50% for the same period in 1999. The decline in gross margin primarily resulted from increased material costs coupled with higher levels of fixed manufacturing costs. The increase in material costs was the result of several factors including higher costs to purchase certain component materials, such as aluminum, combined with increases in fabrication costs as well as additions to our obsolescence reserve during the quarter. We believe the increase in fabrication costs is the result of increased demand for fabrication in most of the markets where we operate. The additions to our obsolescence reserve are primarily the result of new product introductions at our Temptronic subsidiary which have caused certain parts in its inventory to become obsolete. The increase in fixed manufacturing costs is primarily the result of increased levels of salary expense due to salary increases for existing staff as well as additional operations staff hired in late 1999 and 2000, combined with higher rent and depreciation costs primarily resulting from the relocation and expansion of our Cherry Hill, NJ and Sunnyvale, CA manufacturing facilities which significantly increased our manufacturing capacity. We believe this increased capacity will enable us to meet the continued demand for our products in the future.

Selling Expense. Selling expense was $3.3 million for the quarter ended September 30, 2000 compared to $2.3 million for the same period in 1999, an increase of $1.0 million or 44%. We attribute the increase primarily to increased commission expense resulting from the higher sales levels in 2000, as well as higher levels of salary and benefits for new and existing staff combined with increased travel to support the higher sales levels.

Engineering and Product Development Expense. Engineering and product development expense was $1.6 million for the quarter ended September 30, 2000 compared to $1.2 million for the same period in 1999, an increase of $348,000 or 28%. We attribute the increase primarily to the salary expense of additional engineering and technical staff, and to a lesser extent, increased spending on technical consultants associated with new product development.

General and Administrative Expense. General and administrative expense was $2.0 million for the quarter ended September 30, 2000 compared to $1.5 million for the same period in 1999, an increase of $485,000 or 32%. We attribute the increase primarily to increases in incentive compensation for existing staff and higher administrative salary expense resulting from staffing additions and salary increases for existing staff.

Write-off of Deferred Offering Costs. During September 2000, we withdrew our registration statement for the offering of 2.0 million shares of our common stock, 1.0 million of which were to be offered by us and 1.0 million by certain of our shareholders. Approximately $415,000 of costs related to the withdrawn offering, which consisted primarily of professional fees, printing costs and roadshow costs, were expensed during the third quarter.

Income Tax Expense. Income tax expense increased to $1.6 million for the quarter ended September 30, 2000 from $901,000 for the comparable period in 1999, an increase of $651,000. Our effective tax rate for the third quarter of 2000 was 37% compared to 34% for the comparable prior period. The increase in the effective tax rate was primarily due to the fact that no taxes were accrued in the third quarter of 1999 on Temptronic's operating income for that period because no benefit had been recorded for Temptronic's previous operating losses. Also contributing to the increase was a higher percentage contribution to pre-tax earnings by our Japanese subsidiary in 2000 compared to 1999.

Nine Months Ended September 30, 2000 Compared to the Nine Months Ended September 30, 1999

Net Revenues. Net revenues were $66.1 million for the nine months ended September 30, 2000 compared to $34.3 million for the same period in 1999, an increase of $31.8 million or 93%. We believe that the increase in net revenues over the comparable prior period is principally the result of continued growth in the demand for ATE in 2000 compared to 1999.

Gross Margin. Gross margin decreased to 48% for the nine months ended September 30, 2000 from 49% for the comparable period in 1999. The decline in gross margin primarily resulted from increased material costs coupled with higher levels of fixed manufacturing costs. The increase in material costs was the result of several factors including higher costs to purchase certain component materials, such as aluminum, combined with increases in fabrication costs and additions to our obsolescence reserve during the third quarter. We believe the increase in fabrication costs is the result of higher demand for fabrication in most of the markets where we operate. The additions to our obsolescence reserve are primarily the result of new product introductions at our Temptronic subsidiary which have caused certain parts in its inventory to become obsolete. The increase in fixed manufacturing costs is primarily the result of increased levels of salary expense due to increases for existing staff as well as additional operations staff hired in late 1999 and 2000, combined with higher rent and depreciation costs. These costs primarily result from the relocation and expansion of our Cherry Hill, NJ (lease commenced in September 2000) and Sunnyvale, CA (lease commenced in February 2000) manufacturing facilities which significantly increased our manufacturing capacity. We believe this increased capacity will enable us to meet the continued demand for our products in the future. The effect of these additional costs was partially offset by significantly higher net revenue levels in 2000 compared to 1999.

Selling Expense. Selling expense was $8.3 million for the nine months ended September 30, 2000 compared to $5.7 million for the same period in 1999, an increase of $2.6 million or 46%. We attribute the increase primarily to increased commission expense resulting from the higher sales levels in 2000, as well as increases in salary expense resulting from new sales and marketing staff hired in 1999. To a lesser extent higher levels of travel costs, advertising expenditures, warranty costs and freight expenses also contributed to the increase in selling expense.

Engineering and Product Development Expense. Engineering and product development expense was $4.7 million for the nine months ended September 30, 2000 compared to $3.5 million for the same period in 1999, an increase of $1.2 million or 33%. We attribute the increase primarily to the salary expense of additional engineering and technical staff, as well as increased expenditures for product development materials, technical consultants and travel expenses associated with new product development.

General and Administrative Expense. General and administrative expense was $5.3 million for the nine months ended September 30, 2000 compared to $3.9 million for the same period in 1999, an increase of $1.5 million or 37%. We attribute the increase primarily to increases in incentive compensation for existing staff and higher administrative salary expense resulting from staffing additions and salary increases for existing staff. To a lesser extent, increases in professional fees and investor relations expense contributed to the increase in general and administrative expenses. This was partially offset by $200,000 received during the first quarter from the settlement of patent infringement litigation.

Merger-related Costs. Merger-related costs resulting from the Company's merger with Temptronic Corporation were $2.7 million, which consisted primarily of fees paid to investment bankers, professional fees, printing, escrow and other miscellaneous costs.

Write-off of Deferred Offering Costs. During September 2000, we withdrew our registration statement for the offering of 2.0 million shares of our common stock, 1.0 million of which were to be offered by us and 1.0 million by certain of our stockholders. Approximately $415,000 of costs related to the withdrawn offering, which consisted primarily of professional fees, printing costs and roadshow costs, were expensed during the third quarter.

Income Tax Expense. Income tax expense increased to $4.9 million for the nine months ended September 30, 2000 from $1.4 million for the comparable prior period in 1999, an increase of $3.5 million. Our effective tax rate for the first nine months of 2000 was 45% compared with 37% for the comparable prior period. The increase in the effective tax rate is primarily due to $2.3 million of non-tax deductible merger-related costs. In addition, we recognized a $237,000 taxable gain on the liquidation of life insurance policies held on certain former Temptronic officers and directors.

Liquidity and Capital Resources

Net cash used in operations for the nine months ended September 30, 2000 was $994,000. Accounts receivable increased $8.2 million from December 31, 1999 to September 30, 2000 primarily due to the significant increase in sales activity during the first nine months of 2000. Inventories increased $3.0 million, also as a result of the increased sales activity as we made purchases for future product shipments. Other current assets decreased $208,000, primarily as a result of the expensing of previously capitalized merger-related costs. This was partially offset by an increase in prepaid consumption taxes paid by our Japanese subsidiary. Accounts payable

increased $234,000 due to the higher production levels during the first nine months of 2000. Accrued expenses increased $820,000 primarily as a result of additional accruals for sales commissions and salary and incentive compensation as well as merger-related costs. This was partially offset by the payment of previously accrued professional fees, primarily related to the merger with Temptronic. Domestic and foreign income taxes payable increased $1.6 million as a result of the accrual of income taxes on the earnings for the first nine months of 2000.
Purchases of machinery and equipment were $3.4 million for the nine months ended September 30, 2000, which consisted primarily of improvements to the Company's facilities in the United States. During this period we spent approximately $518,000 on equipment, $254,000 on leasehold improvements and $250,000 on furnishings at our new facility for our inTEST Sunnyvale operation. During the third quarter of 2000, we also relocated our headquarters and primary manufacturing facility and spent approximately $1.0 million on leasehold improvements, $386,000 on furnishings and $240,000 on machinery and equipment for our new facility. We plan to relocate our Temptronic subsidiary during the first quarter of 2001 and we estimate that the total cost of leasehold improvements and other costs associated with the move will range between $700,000 and $1.0 million. In addition, we spent approximately $506,000 on manufacturing and computer equipment at various other domestic operations during the nine months, including approximately $123,000 for demonstration equipment related to a recently redesigned product of our Temptronic subsidiary and $30,000 as a deposit on an additional coordinate measuring machine for our Cherry Hill location. We expect delivery and final payment for this equipment of approximately $190,000 in the first quarter of 2001.

Other long-term assets decreased $933,000 primarily as a result of the liquidation of life insurance policies held on certain former Temptronic officers and directors.

Net cash used in financing activities for the nine months ended September 30, 2000 was $1.2 million. During that period we repaid approximately $1.2 million under revolving lines of credit as well as $256,000 of long-term debt acquired as a result of the merger with Temptronic. During the same period we received $227,000 from the exercise of stock options held by employees.

We believe that our existing cash balances and lines of credit plus the anticipated net cash provided from operations will be sufficient to satisfy our cash requirements for the foreseeable future. However, future acquisitions or new product development may require additional equity or debt financing to meet working capital requirements or capital expenditure needs. We do not anticipate paying dividends in the foreseeable future.

International Operations

Net revenues generated by our foreign subsidiaries were 16% and 17% of consolidated net revenues for the nine months ended September 30, 2000 and 1999, respectively. We anticipate that net revenues generated by our foreign subsidiaries will continue to account for a significant portion of consolidated net revenues in the foreseeable future. The net revenues generated by our foreign subsidiaries will continue to be subject to certain risks, including political and economic instability of foreign countries, the imposition of financial and operational controls or regulatory restrictions by foreign governments, the need to comply with a variety of U. S. and foreign export and import laws, trade restrictions, changes in tariffs and taxes, longer payment cycles, fluctuations in foreign currency exchange rates, and the greater difficulty of administering business abroad. We cannot predict whether quotas, duties, taxes or other charges or restrictions will be implemented by the United States or any other country upon the importation or exportation of our products in the future. Any of these factors or the adoption of restrictive policies could have a material adverse effect on our business, financial condition or results of operations.

Net revenues denominated in foreign currencies were 11% and 12% of consolidated net revenues for the nine months ended September 30, 2000 and 1999, respectively. Although we seek to operate our business such that a significant portion of our product costs are denominated in the same currency that the associated sales are made in, we may be adversely affected in the future due to our exposure to foreign operations. Moreover, net revenues denominated in currencies other than U.S. dollars expose us to currency fluctuations, which can adversely affect results of operations.

The portion of our consolidated net revenues that were derived from sales to the Asia-Pacific region were 9% and 12% for the nine months ended September 30, 2000 and 1999, respectively. Countries in the Asia-Pacific region, including Japan, have experienced economic instability resulting in weaknesses in their currency, banking and equity markets. Although the past economic instability in the Asia-Pacific region has not materially adversely affected our order backlog, financial position, or results of operations to date, continued economic instability could have a material adverse effect on demand for our products and our consolidated results of operations.

Cautionary Statement Regarding Forward-Looking Statements

This Report contains statements of a forward-looking nature relating to future events, such as statements regarding the anticipated market for our products throughout the balance of 2000; projected expenditures for leasehold improvements and moving costs for our Temptronic subsidiary; anticipated net revenues generated by foreign operations; sufficiency of cash balances, lines of credit and net cash from operations; and use of forward exchange rate contracts. Forward-looking statements typically can be identified by the use of terminology such as "believes," expects," "may," "will," "should" or "anticipates" or the negative thereof or other variations thereon or comparable terminology, or by discussions of strategy that involve risks and uncertainties. Investors and prospective investors are cautioned that such statements are only projections and that actual events or results may differ materially from those expressed in any such forward-looking statements. In addition to the factors described in this Report, our actual consolidated quarterly or annual operating results have been affected in the past, or could be affected in the future, by additional factors, including, without limitation: changes in business conditions and the economy, generally; a decline in the demand for integrated circuits; our ability to obtain patent protection, and enforce our patent rights, for existing and developing proprietary technologies; our ability to integrate successfully businesses, technologies or products which we may acquire; the effect of the loss of, or reduction in orders from, a major customer; cancellation, or delays in shipment, of orders in our backlog; competition from other manufacturers of docking hardware, manipulators, tester interfaces and related ATE interface products and temperature management products; progress of product development programs; cost overruns relating to leasehold improvements and moving costs for our Temptronic subsidiary; unanticipated exchange rate fluctuations; and capital requirements relating to future acquisitions.

We are exposed to currency exchange rate risk in the normal course of our business, primarily in our Japanese operations. Our exposure results from the fact that the sales of our Japanese subsidiary are in Japanese yen and inventory purchases are in U.S. dollars. We will have the same exposure in our German operations (which commenced in August 2000) as a portion of total sales will be in German deutsche marks while inventory purchases will be in U.S. dollars. We will also have a similar exposure in our Singapore operations as our manufacturing operations, which commenced in September 1999, expand, because our sales will be in U.S. dollars but our manufacturing costs will be primarily in Singapore dollars. We employ risk management strategies, including the use of forward exchange rate contracts, to manage our exposure to exchange rate risks involving the yen, and may, in the future, use forward exchange rate contracts to manage our exposure to exchange rate risks involving the Singapore dollar and German deutsche mark.

Our objective in managing currency exchange risk is to minimize the impact of significant currency exchange rate fluctuations. We use forward exchange rate contracts to establish a fixed conversion rate between the Japanese yen and the U.S. dollar so that the level of our gross margin from sales in Japan is not negatively affected by significant movements in the Japanese yen to U.S. dollar exchange rate. We purchase forward exchange rate contracts on a monthly basis in the amounts management deems appropriate in light of the amount of the U.S. dollar denominated obligations of our Japanese subsidiary that are due within the month. We do not purchase forward contracts with settlement dates beyond 30 days. As of September 30, 2000, there were no forward exchange rate contracts outstanding.

It is our policy to enter into forward exchange rate contracts only to the extent necessary to achieve the desired objectives of management in limiting our exposure to significant fluctuations in currency exchange rates. We do not expect that the results of our operations or our liquidity will be materially affected by these risk management activities. We do not hedge all of our currency exchange rate risk exposures in a manner that would completely eliminate the impact of changes in currency exchange rates on our net earnings.

Not applicable

Not applicable

None

On October 18, 2000, the Company issued a press release regarding its earnings performance for the quarter ended September 30, 2000 and management's expectations regarding future performance. This press release is filed as an exhibit hereto and incorporated into this Report by reference.

(a)  Exhibits:

3.1*  Articles of Incorporation: Previously filed by the Company as an Exhibit
         to the Company's Registration Statement on Form S-1, File No. 333-26457,
         and incorporated herein by reference.

3.2*  By-Laws: Previously filed by the Company as an Exhibit to the Company's
         Registration Statement on Form S-1, File No. 333-26457, and incorporated
         herein by reference.

10.1  Amendment to Employment Agreement dated March 9, 2000 between William M. Stone and Temptronic
         Corporation (filed as Exhibit 10.4 to the Company's Form 10Q/A filed June 21, 2000).

10.2* Amended and Restated 1997 Stock Plan (filed as an appendix to the Company's proxy statement filed
          June 30, 2000, and incorporated herein by reference).

27     Financial Data Schedule

99     Press Release dated October 18, 2000



* Indicates document previously filed

(b)  Reports on Form 8-K