10-Q 1 b40071ice10-q.txt INSTRON CORPORATION 1 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (MARK ONE) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2001 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ___________ TO ___________ COMMISSION FILE NUMBER 1-5641 INSTRON CORPORATION (Exact name of registrant as specified in its Charter) MASSACHUSETTS 04-2057203 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 100 ROYALL STREET 02021 CANTON, MASSACHUSETTS (Zip Code) (Address of Principal executive offices) (781) 828-2500 (Registrant's telephone number, including area 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 periods 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 [ ] As of June 30, 2001, the Registrant had 5,566,120 shares outstanding of common stock, all of which was held by affiliates of the Registrant. ================================================================================ 2 FORM 10-Q PART I ITEM I INSTRON CORPORATION Consolidated Balance Sheets (In thousands, except share and per share data)

See accompanying Notes to Consolidated Financial Statements 2 3 FORM 10-Q PART I ITEM I INSTRON CORPORATION Consolidated Statements of Operations (Unaudited) (In thousands, except share and per share data)

See accompanying Notes to Consolidated Financial Statements 3 4 FORM 10-Q PART I ITEM I INSTRON CORPORATION Consolidated Statements of Cash Flows (Unaudited) (In thousands)

See accompanying Notes to Consolidated Financial Statements 4 5 FORM 10-Q PART I ITEM I INSTRON CORPORATION Consolidated Statements of Comprehensive Loss (Unaudited) (In thousands)

See accompanying Notes to Consolidated Financial Statements 5 6 FORM 10-Q PART I ITEM 1 INSTRON CORPORATION Notes to Consolidated Financial Statements (Unaudited) 1. BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. For further information, refer to the consolidated financial statements and footnotes included in the Company's annual report on Form 10-K for the year ended December 31, 2000. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make certain estimates and assumptions that effect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported periods. Actual results could differ from those estimates. In the opinion of management, all adjustments (which include only normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the second quarter and first half of 2001 are not necessarily indicative of the results that may be expected for the year ended December 31, 2001. Prior year results have been restated to comply with Staff Accounting Bulletin No. 101 "Revenue Recognition in Financial Statements" ("SAB 101"). Also, certain prior year amounts have been reclassified to conform with the Emerging Issues Task Force's Issue No. 00-10 "Accounting for Shipping and Handling Fees and Cost" ("EITF 00-10") and with the fiscal 2001 presentation. 2. MERGER AGREEMENT AND RECAPITALIZATION On September 29, 1999, the Company completed a merger by and among the Company, ISN Acquisition Corporation ("MergerCo") and Kirtland Capital Partners III L.P. ("Kirtland") pursuant to which Kirtland and certain affiliates, together with members of Instron's management and certain members of Instron's Board of Directors who were also stockholders (collectively, the "Rollover Stockholders") acquired the Company. The merger and related transactions were treated as a recapitalization (the "Recapitalization") for accounting purposes. Accordingly, the historical basis of the Company's assets and liabilities were not affected by these transactions. In the merger, MergerCo merged with and into the Company with the Company continuing as the surviving corporation. Pursuant to the Merger, each outstanding share of the Company's common stock (except for shares held by the Company, its subsidiaries and MergerCo), were converted into the right to receive a cash payment of $22.00, without interest. Certain shares of the Company's common stock held by the Rollover Stockholders were converted into shares of stock of the surviving corporation. As a result of the Merger, the Company's common stock no longer is registered under the Securities Exchange Act of 1934. In 1999, the Company incurred compensation expenses of $13.0 million as a result of the Recapitalization. In addition, the Company incurred costs of $13.1 million directly related to the Recapitalization. Of these transaction costs, $9.0 million was capitalized and is being amortized over the life of the 13 1/4% Senior Subordinated Notes (the "Notes") and the Senior Credit Facility, and $4.1 million was charged to stockholders' equity. The Notes were originally issued as part of a unit offering. Each unit ("Unit") consisted of a $1,000 principal amount Note and one warrant to purchase 5.109 shares of Instron's recapitalized common stock (the "Warrants"). On February 14, 2000, the Notes were registered with the Securities and Exchange Commission (the "SEC"), at which time the Units separated into their component Notes and Warrants. The Notes and Warrants may now be traded separately and the Units have ceased to exist. 6 7 3. REVENUE RECOGNITION In the fourth quarter of 2000, effective as of January 1, 2000, the Company changed its revenue recognition policy for certain product sales to comply with SAB 101. SAB 101 provides guidelines on the timing of revenue recognition based upon factors such as passage of title, installation, payment terms and customer acceptance. Prior to the adoption of SAB 101, the Company recognized revenue on the sale of its systems when the system was shipped to the customer and the title had passed to the customer, although the Company often had a further obligation to install the system. Since the Company had a long record of success in installing its systems and obtaining customer acceptance of the system, revenue was recognized prior to the final customer acceptance but after the passage of title. Based upon the new guidelines of SAB 101, the Company has changed its revenue recognition method for systems where installation is deemed to be a critical element in the contractual obligation to the customer. The Company has termed these as "complex" systems. For complex systems, the Company now recognizes revenue upon the completion of installation or fulfilling the obligations to the customer under the terms of the contract. For non-complex or "standard" systems, the Company has determined that installation is inconsequential and perfunctory and thus recognizes revenue on these systems upon shipment and the passing of title to the customer. In certain instances, customer payment terms may provide that a minority of the equipment purchase price is paid only after installation has been completed. In those circumstances, the portion of the payment terms related to installation is deferred until the installation has been completed with the majority portion of revenue and the entire product cost recognized upon shipment and passage of title. Systems installation is typically provided by the Company, is generally not billed separately to the customer and the costs to complete the installation are accrued for at the time of shipment. If it is billed separately to the customer then the installation revenue will be recognized in the period that installation is performed. Revenue from services are recognized as services are performed and ratably over the contract period for service maintenance contracts. The SAB 101 restatement has been applied retroactively to transactions that occurred prior to 2000. The cumulative effect adjustment of the change in accounting on prior years through December 31, 1999 was a reduction to income of $4.3 million (after credit for income taxes of $3.5 million), or $0.77 cents per diluted share, recorded in the first quarter of 2000. The effect of adopting SAB 101 increased second quarter of 2000 revenues by $4.8 million and increased the net loss by $0.2 million or $0.03 per diluted share. The effect of adopting SAB101 increased first half of 2000 revenues by $8.7 million and decreased the net loss by $0.3 million or $0.05 per diluted share. In September 2000, the Emerging Issues Task Force ("EITF") of the Financial Accounting Standards Board ("FASB") reached a consensus on EITF 00-10. This consensus requires that all shipping and handling amounts billed to a customer in a sale transaction represent revenues earned for the goods provided and should be classified as revenue. Adoption of the consensus reached on EITF 00-10 was required no later than the required implementation date for SAB 101. The Company adopted EITF 00-10 in the year ended December 31, 2000 and a retroactive reclassification was recorded on the historical statement of operations for all quarters in 2000, 1999 and 1998. The second quarter of 2000 reclassification resulted in an increase in revenues and cost of sales of $331,000. The first half of 2000 reclassification resulted in an increase in revenues and cost of sales of $662,000. In accordance with American Institute of Certified Public Accountants ("AICPA") Statement of Position No. 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts ("SOP No. 81-1"), prior to 2001, the Company accounted for long-term contracts using the completed contract method as it was unable to make reasonable dependable estimates on a consistent basis regarding contract costs. During 2000, the Company completed a restructuring of its business, which included headcount reductions, realignment and re-allocation of resources specifically with regards to contracts that are complex and long-term in nature, and a conscious management focus of accepting long-term contracts with less technological risk. Additionally, the Company has refined its internal process management controls in order to develop more dependable cost and completion estimates. These changes have had a significant impact on the Company's ability to estimate and control costs, as supported by the results reported during the second half of fiscal year 2000, where the Company consistently met its forecasts for long-term contracts. Accordingly, commencing January 1, 2001, for certain long-term contracts revenue is recognized using the percentage-of-completion method based upon an efforts-expanded approach, whereby revenue and profit are recognized throughout the performance and production period of the contract. In all cases, changes to total estimated costs and anticipated losses, if any, are recognized in the period in which determined. Long-term contracts that are not eligible for percentage-of-completion accounting 7 8 continue to be recognized using the completed contract method. In the second quarter of 2001, revenue and gross profit recognized under percentage-of- completion accounting method were approximately $2.9 million and $1.0 million, respectively. In the first half of 2001, revenue and gross profit recognized under percentage of completion accounting method were approximately $4.9 million and $1.5 million, respectively. Unbilled revenue on contracts represents revenue earned under the percentage-of-completion method but not yet billable under the terms of the contract. These amounts are billable based on the terms of the contract which include shipment of the product, achievement of milestones or completion of the contract. Contracts in progress include costs on uncompleted contracts in excess of cost of sales recognized to date, accounted for using the percentage-of-completion method. Excess of advance payments over accrued revenue represents advanced payments received from customers in excess of billing on contracts recognized under the percentage-of-completion method. Revenue recognized to date in excess of costs and estimated earnings on uncompleted contracts is recorded in accrued liabilities on the balance sheet. Contracts in progress consisted of the following at June 30, 2001: Costs incurred on uncompleted contracts $ 4,392 Estimated earnings to date 1,509 ------- 5,901 Less: revenue recognized to date (4,873) ------- 1,028 ======= Contracts in progress (presented on the balance sheet) 1,184 Revenue recognized to date in excess of costs and estimated earnings on uncompleted contracts (156) ------- $ 1,028 =======

4. ACCOUNTING FOR DERIVATIVE INSTRUMENTS In June 1998, the FASB issued Statement of Financial Accounting Standards No. 133, " Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"). SFAS 133 is effective for fiscal year 2001. SFAS 133 requires that all derivative instruments be recorded on the balance sheet at their fair value. Changes in the fair value of derivatives are recorded each period in either current earnings or accumulated other comprehensive loss, depending on whether a derivative is designated as part of a hedge transaction and, if it is, the type of hedge transaction. Instron uses derivatives to hedge foreign currency cash flows. Since the Company is using foreign exchange derivative instruments to hedge foreign exchange exposures, the changes in the value of the derivatives are highly effective in offsetting changes in the fair value or cash flows of the hedged item. Any ineffective portion of the derivatives is recognized in current earnings, which represented an immaterial amount for the periods presented. The ineffective portion of the derivatives is primarily related to discounts or premiums on forward contracts. The Company uses foreign currency forward contracts to hedge the variability of cash flows related to a foreign currency denominated forecasted transaction. These derivatives are designated as cash flow hedges, and changes in their fair value are carried in accumulated other comprehensive loss until the underlying forecasted transaction occurs. Once the underlying forecasted transaction is realized, the appropriate gain or loss from the derivative designated as the hedge of the transaction is reclassified from accumulated other comprehensive loss to the income statement, in revenue and expense, as appropriate. In the event that the underlying forecasted transaction does not occur, the amount recorded in accumulated other comprehensive loss will 8 9 be reclassified to the other (income)/expense section of the income statement in the then-current period. Instron's cash flow hedges generally mature within 18 months or less. The Company adopted SFAS 133 during the first quarter of 2001. As a result of this adoption, effective January 1, 2001, all derivatives designated as cash flow hedges are recognized on the balance sheet at fair value with the offsetting adjustment recorded in accumulated other comprehensive loss. Accordingly, the Company recorded an adjustment as of January 1, 2001 to the Statement of Comprehensive Loss to account for the cumulative effect of the accounting change. This adjustment resulted in a gain, net of tax of $0.5 million, totaling $0.7 million. The amount of the adjustment reclassified into earnings during the second quarter and first half of 2001 totaled $14,000, net of tax and $0.2 million, net of tax, respectively. The amount that will be classified from accumulated other comprehensive loss to earnings in the next twelve months is a gain of approximately $0.7 million, net of tax. 5. EARNINGS PER SHARE Basic earnings per share is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted earnings per share is computed by dividing net income by the weighted average number of common shares, plus the dilutive effect of common share equivalents outstanding using the "treasury stock method." For the three months and six months ended June 30, 2001, outstanding options and warrants totaling 752,000 and 306,540 shares, respectively, have been excluded from the diluted earnings per share computation as their inclusion would be antidilutive. For the three months and six months ended July 1, 2000, outstanding options and warrants totaling 459,050 and 306,540 shares, respectively, have been excluded from the diluted earnings per share computation as their inclusion would be antidilutive. The following is a reconciliation of the basic and diluted EPS calculations:

6. INVENTORIES (IN THOUSANDS) JUNE 30, DECEMBER 31, 2001 2000 -------- ------------ Raw materials $11,817 $13,219 Work-in-process 14,024 13,326 Finished goods 19,558 27,069 ------- ------- $45,399 $53,614 ======= ======= Inventories are valued at the lower of cost or market (net realizable value). The last-in, first-out (LIFO) method of determining cost is used for certain inventories in the United States and certain Asian branches. The Company uses the first-in, first-out (FIFO) method for all other inventories. Inventories valued at LIFO amounted to $8,416,000 and $6,599,000 at June 30, 2001 and December 31, 2000, respectively. The excess of current cost over stated LIFO value was $5,638,000 at June 30, 2001 and $5,460,000 at December 31, 2000. 9 10 7. BORROWING ARRANGEMENTS Total debt for the periods:

As part of the Recapitalization, the Company entered into a Senior Credit Facility providing for a Revolving Credit Facility of up to $50.0 million (subject to an available borrowing base) and a Term Loan Facility of $30.0 million, maturing in five and one-half years, unless terminated sooner upon certain events of default. If terminated upon an event of default, all outstanding advances under the credit facility may be required to be immediately repaid. The revolving portion of the Senior Credit Facility can be used to complete permitted acquisitions or for working capital and other general corporate purposes. Borrowings under the Senior Credit Facility will bear interest, at our option, at either the higher of the federal funds rate plus 1.0% or the prime rate plus 1.75%, or a LIBOR rate plus 3.25%. Ability to borrow under the Senior Credit Facility will be subject to the Company's compliance with the covenants described below. In addition, the Company incurred $60 million of debt through the sale of its 13 -1/4% Senior Subordinated Notes and Warrants (the "Senior Subordinated Notes"). The Warrants, when and if exercised, will entitle the holder thereof to receive 5.109 of a fully paid non-assessable share of common stock, par value $0.001 per share at an exercise price of $0.001 per share, subject to adjustment. The Warrants will be exercisable on or prior to September 15, 2009. The value of the Warrants on the date of the Recapitalization was $2.3 million and this value is being amortized over 10 years. Under the mandatory repayment schedule of the Term Loan Facility, the Company is required to make scheduled repayments in twenty-two quarterly installments of principal with interest thereon on the first day of each January, April, July and October commencing January 1, 2000. The Senior Subordinated Notes, which mature in 2009, require interest to be paid semi-annually in arrears each March 15 and September 15. The Company is also required, under the Terms of the Senior Credit Facility, to pay a commitment fee based on the unused amount of the Revolving Credit Facility at an annual rate of 0.50%, paid quarterly in arrears. All of our obligations under the Senior Credit Facility are and will be secured by a first priority lien on substantially all of the properties and assets of Instron and our existing and future domestic subsidiaries. In addition, our obligations under the Senior Credit Facility are and will be secured by a first priority pledge of and security interest in all of the outstanding capital stock of our existing domestic subsidiaries and future domestic subsidiaries and a pledge of 65% of the outstanding capital stock of some foreign subsidiaries. Certain of our foreign subsidiaries have also granted a lien on substantially all of their properties and assets. The Senior Credit Facility requires that the Company meet and maintain certain financial ratios and tests, including a minimum consolidated net worth, consolidated adjusted EBITDA, consolidated capital expenditure, consolidated interest coverage ratio, consolidated fixed charge coverage ratio, maximum consolidated leverage ratio and senior leverage ratio. As of June 30, 2001, the Company was in compliance with the amended Senior Credit Facility covenants. The Company anticipates that the covenants will be amended during the third quarter of 2001 to reflect the adoption of recently issued accounting pronouncements. The Senior Subordinated Notes are governed by negative covenants that are less restrictive than those of the Senior Credit Facility. In addition, the Senior Subordinated Notes contain a provision whereby the Notes are in default if there is an acceleration of payment under the terms of the Senior Credit Facility. The Senior Credit Facility also contains covenants that limit the ability of the Company and its operating subsidiaries to take various actions, without the consent of the Senior lenders, including incurring additional indebtedness and liens and entering into some leases, fundamentally changing corporate structure, including mergers, consolidations and liquidations, acquiring and disposing of property, making principal payments on indebtedness prior to maturity, dividends and capital stock purchases, 10 11 investments, capital expenditures, some modifications to organizational documents, changing fiscal periods, entering into sale and leaseback transactions, entering into affiliate transactions, entering into agreements restricting distributions, amending the acquisition documents, granting negative pledges and making a material change in the nature of the Company's business. 8. GUARANTOR AND NON-GUARANTOR SUBSIDIARY INFORMATION As part of the Recapitalization in 1999, Instron Corporation issued public debt securities which are fully and unconditionally guaranteed by certain of the Corporation's subsidiaries. Below is the condensed consolidating financial information for the guarantor subsidiaries, which includes Instron Corporation (parent company and issuer of the debt), and the non-guarantor subsidiaries as of June 30, 2001 and December 31, 2000 and for the three-months and six-months periods ended June 30, 2001 and July 1, 2000. 11 12 INSTRON CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS

12 13 INSTRON CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS

13 14 INSTRON CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

INSTRON CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

14 15 INSTRON CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

INSTRON CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

15 16 INSTRON CORPORATION CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS

16 17 INSTRON CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

17 18 9. NEW ACCOUNTING PRONOUNCEMENTS In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 141 ("SFAS No. 141"), "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets" ("SFAS No. 142"). SFAS No. 141 requires that all business combinations be accounted for under the purchase method only, eliminating the pooling-of-interests method and that certain acquired intangible assets in a business combination be recognized as assets apart from goodwill. SFAS No. 142 requires, among other things, the discontinuance of goodwill amortization, which is replaced with periodic tests of the goodwill's impairment and that intangible assets other than goodwill be amortized over their useful lives. In addition, the standard includes provisions for the reclassification of certain existing recognized intangibles as goodwill, reassessment of the useful lives of existing recognized intangibles, reclassification of certain intangibles out of previously reported goodwill and the identification of reporting units for purposes of assessing potential future impairments of goodwill. SFAS No. 142 also requires the Company to complete a transitional goodwill impairment test six months from the date of adoption. SFAS No. 141 is effective for all business combinations initiated after June 30, 2001 and for all business combinations accounted for by the purchase method for which the date of acquisition is after June 30, 2001. The provisions of SFAS No. 142 will be effective for fiscal years beginning after December 15, 2001, and will thus be adopted by the Company, as required on January 1, 2002. The Company is currently assessing but has not yet determined the impact of SFAS No. 142 on its financial position and results of operations. 18 19 FORM 10-Q PART I ITEM 2 INSTRON CORPORATION Management's Discussion and Analysis of Financial Condition and Results of Operations RESULTS OF OPERATIONS QUARTER ENDED JUNE 30, 2001 VS. QUARTER ENDED JULY 1, 2000 The Company has two operating units: Instron Materials Testing Business ("IMT") and Instron Structural Testing Business ("Structures") ("IST"). IMT manufactures and markets material testing instruments, software and accessories. Material testing instruments include static (electromechanical), dynamic (servohydraulic), hardness and impact testing systems. IST manufactures and markets systems for simulating real-life testing of components and products. Revenues for the second quarter of 2001 were $50.8 million, $3.5 million lower than the same period last year. The decrease in revenues was primarily due to a decline in sales volume in IST and North America IMT sales, partially offset by an increase in European and Japanese IMT sales. Foreign sales accounted for approximately 61.9% of consolidated second quarter revenues compared with 56.6% for the second quarter of 2000. The consolidated gross margin, as a percentage of revenue, improved to 36.3% for the second quarter of 2001 compared to 33.4% for the second quarter of 2000. The increase was due to improved margins in the Structures business, partially offset by the decline in gross margin in the IMT business. Selling and administrative expenses for the second quarter of 2001 were $13.2 million, or 26.1% of revenues, compared to $13.3 million, or 24.5% of revenues, in the second quarter of last year, an increase of 1.6% on a percentage of sales basis. The increase of 1.6% is primarily due to the decrease in revenues in the second quarter of 2001, compared to the same period last year. Research and development expenses were $2.1 million, or 4.2% of revenues in the second quarter of 2001, compared to $2.5 million, or 4.7% of revenues in the second quarter of last year. This decrease is primarily due to capitalizing $0.4 million of software development costs during the second quarter of 2001, compared with $0.1 million in the second quarter of last year. During the second quarter of 2001, the Company had a workforce reduction of 22 people, of which 13 were in the U.S. and 9 were in the U.K. Severance costs associated with the workforce reductions were $0.6 million. The personnel reductions were primarily in engineering, manufacturing and sales and the Company anticipates cost savings from the reduction of approximately $1.7 million annually. As of June 30, 2001, the liability remaining related to the workforce reductions was approximately $0.3 million. Remaining severance costs are expected to be paid in the third quarter of 2001. During the first and second quarters of 2000, the Company completed a workforce reduction of 84 people, of which 24 were in the U.S. and 60 were in Germany and the U.K. The personnel reductions were primarily in engineering, manufacturing and administration. Severance costs associated with the workforce reductions were $0.3 million and $1.5 million during the first and second quarter of 2000, respectively. Net interest expense decreased to $3.4 million compared to $3.7 million in the second quarter of 2000. This decrease in 2001 is due to reduced borrowings and lower interest rates. Loss before taxes for the second quarter of 2001 was $1.0 million, compared to loss before taxes of $2.9 million for the same period last year. This improvement in profitability is due to increased margins on the Structures business and lower operating expenses. The tax expense of $0.9 million or (88.1%) of the pre-tax loss, for the second quarter 2001 reflects a valuation allowance placed on tax losses in certain jurisdictions and foreign tax credits generated in the United States, as the realization of these tax losses and credits cannot be assured. Net loss for the second quarter of 2001 was $2.0 million, or $0.35 per diluted share, compared to net loss of $2.4 million, or $0.44 per diluted share for the second quarter of last year. 19 20 SIX MONTHS ENDED JUNE 30, 2001 VS. SIX MONTHS ENDED JULY 1, 2000 Revenues for the first half of 2001 were $95.9 million, compared to $99.3 million for the first half of 2000, a decrease of 3.5%. Foreign sales were 59.2% of total revenues for the first half of 2001 compared to 57.2% for the first half of 2000. Gross margin as a percentage of revenues was 37.9% for the first half of 2001 compared to 34.0% for the first half of 2000 due to the improved margins in the Structures business. Selling and administrative expenses were $26.3 million, or 27.4% of revenues, for the first half of 2001, compared to $26.6 million, or 26.8% of revenues, for the first half of 2000, a decrease of 1.3%. The lower expenses are primarily the result of lower expenses in the Structures business as a result of last year's restructuring. Research and development expenses were $4.2 million, or 4.4% of revenues, for the first half of 2001, compared to $5.0 million, or 5.0% of revenues, for the first half of 2000. Software development costs of $0.8 million were capitalized during the first half of 2001, compared to $0.3 million during the first half of 2000. If software development costs were reported as period expense, research and development expenses would have declined $0.3 million, or 5.6%, from 2000. The higher 2000 expense levels reflect the investment made in certain key product development programs. During the second quarter of 2001, the Company had a workforce reduction of 22 people, of which 13 were in the U.S. and 9 were in the U.K. Severance costs associated with the workforce reductions were $0.6 million. The personnel reductions were primarily in engineering, manufacturing and sales and the Company anticipates cost savings from the reduction of approximately $1.7 million annually. As of June 30, 2001, the liability remaining related to the workforce reduction was approximately $0.3 million. Remaining severance costs are expected to be paid in the third quarter of 2001. During the first half of 2000, the Company completed a workforce reduction of 84 people, of which 24 were in the U.S. and 60 were overseas. The personnel reductions were primarily in engineering, manufacturing and administration. Total severance costs in the first half of 2000 related to these workforce reductions were $1.8 million. Net interest expense of $6.7 million for the first half of 2001, compared to $7.2 million for the first half of 2000. This decrease in the first half of 2001, compared to the same period last year is due to reduced borrowings and lower interest rates. The tax expense of $0.7 million, or (37.7%) of the pre-tax losses, for the first half of 2001, reflects a valuation allowance placed on tax losses in certain jurisdictions and foreign tax credits generated in the United States, as the realization of these tax losses and credits can not be assured. Each quarter, the Company estimates its annual effective tax rate and adjusts the provision or benefit. Net loss before cumulative effect of accounting change was $2.4 million or $0.43 per diluted share of common stock for the first half of 2001 compared to $4.7 million, or $0.85 per diluted share of common stock for the first half of 2000. Net loss after cumulative effect of accounting change for SAB 101 was $2.4 million, or $0.43 per diluted share for the first half of 2001, compared to $9.0 million, or $1.62 per diluted share for the same period last year. FINANCIAL CONDITION During the first half of 2001, the Company used $1.4 million of cash from operating activities compared to generating $4.0 million of cash for the same period in the prior year. The cash used by operating activities of $1.4 million during the first half of 2001, was mostly due to paying down accrued liabilities of $2.3 million. The large decrease in the June 30, 2001 inventory and deferred revenue balance compared to the December 31, 2000 inventory and deferred revenue balances was primarily the result of the SAB 101 adjustment at December 31, 2000. This adjustment had no impact on cash. The decline in accounts receivable by $12.0 million was primarily due to lower revenues in the second quarter of 2001, as compared to the preceding three months ended December 31, 2000 and the timing of cash collections. The Company used $1.9 million of cash for investing activities during the first half of 2001, compared to $1.9 million of cash used during the same period in the prior year, primarily to fund capital expenditures and software development costs. The Company increased net borrowings by $3.3 million compared to paying down debt by $9.3 million during the same period last year. 20 21 Capital expenditures during the first half of 2001 were $1.2 million, compared to $1.7 million in the first half of 2000. The lower level of capital expenditures reflects the timing of the 2001 capital requirements. The Company plans to make capital expenditures of approximately $2.8 million during the current fiscal year. In addition, the Company plans to continue to develop and enhance its software products and pursue its strategy of acquisitions. At June 30, 2001, the Company had borrowings of $27.2 million, and additional borrowing availability of $14.5 million, under its $50.0 million multi-currency revolving credit facility, compared to $23.0 million in borrowings at December 31, 2000. The Company had $24.6 million outstanding under its term loan at June 30, 2001, compared to $26.6 million outstanding at December 31, 2000. At June 30, 2001, the Company also had $60.0 million of 13 1/4% Senior Subordinated Notes Due 2009 outstanding. The Senior Credit Facility requires that the Company meet and maintain certain financial ratios and tests, including a minimum consolidated net worth, consolidated adjusted EBITDA, consolidated capital expenditure, consolidated interest coverage ratio, consolidated fixed charge coverage ratio, maximum consolidated leverage ratio and senior leverage ratio. During the third quarter of 2000, the Company renegotiated and obtained more lenient debt covenants for the Senior Credit Facility. The Company has been in compliance with the amended Senior Credit Facility since the third quarter of 2000. The Company anticipates that the covenants will be amended during the third quarter of 2001 to reflect the impact of the recently issued accounting pronouncements. The Company is confident that it will be able to meet these covenants for the remainder of 2001. At April 1 and July 1, 2000, the Company was not in compliance with three of the original Senior Credit Facility covenants. The Company requested and was granted waivers of covenants. The Company believes its present capital resources and anticipated operating cash flows are sufficient to finance its planned operations and investing activities for the next eighteen months. If the Company were to consider a significant acquisition, it would have to seek alternative sources of equity funds and or additional debt. Bookings for the second quarter of 2001 were $44.0 million, a decrease of 15.7% over the same period last year. The decrease in bookings was primarily in North America and Europe for the material testing business. Bookings for the first half of 2001 were $81.5 million, a decrease of 16.6% over the same period last year. The Company's order backlog was $91.5 million at the end of the first half of 2001, compared to $100.6 million at the end of the first half of 2000 and $111.4 million at December 31, 2000. NEW ACCOUNTING PRONOUNCEMENTS The Company adopted Statement of Financial Accounting Standards No. 133 during the first quarter of 2001. As a result of this adoption, effective January 1, 2001, all derivatives designated as cash flow hedges are recognized on the balance sheet at fair value with the offsetting adjustment recorded in accumulated other comprehensive loss. Accordingly, the Company recorded an adjustment as of January 1, 2001 to the Statement of Comprehensive Loss to account for the cumulative effect of the accounting change. This adjustment resulted in a gain, net of tax of $0.5 million, totaling $0.7 million. The amount of the adjustment reclassified into earnings during the second quarter and first half of 2001 totaled $14,000, net of tax and $0.2 million, net of tax, respectively. The amount that will be classified from accumulated other comprehensive loss to earnings in the next twelve months is a gain of approximately $0.7 million, net of tax. 21 22 In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 141 ("SFAS No. 141"), "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets" ("SFAS No. 142"). SFAS No. 141 requires that all business combinations be accounted for under the purchase method only, eliminating the pooling-of-interests method and that certain acquired intangible assets in a business combination be recognized as assets apart from goodwill. SFAS No. 142 requires, among other things, the discontinuance of goodwill amortization, which is replaced with periodic tests of the goodwill's impairment and that intangible assets other than goodwill be amortized over their useful lives. In addition, the standard includes provisions for the reclassification of certain existing recognized intangibles as goodwill, reassessment of the useful lives of existing recognized intangibles, reclassification of certain intangibles out of previously reported goodwill and the identification of reporting units for purposes of assessing potential future impairments of goodwill. SFAS No. 142 also requires the Company to complete a transitional goodwill impairment test six months from the date of adoption. SFAS No. 141 is effective for all business combinations initiated after June 30, 2001 and for all business combinations accounted for by the purchase method for which the date of acquisition is after June 30, 2001. The provisions of SFAS No. 142 will be effective for fiscal years beginning after December 15, 2001, and will thus be adopted by the Company, as required on January 1, 2002. The Company is currently assessing but has not yet determined the impact of SFAS No. 142 on its financial position and results of operations. ITEM 3. QUANTITATIVE AND QUALITATIVE INFORMATION ABOUT MARKET RISK The Company is exposed to market risk related to changes in foreign currency exchange rates. The Company enters into foreign exchange contracts to manage and reduce the impact of changes in foreign currency exchange rates. The Company does not enter into derivatives or other financial instruments for trading or speculative purposes. The exposures are associated with certain accounts receivable and accounts payable denominated in local currencies and certain foreign revenue and expense transactions. There has been no material changes related to the quantitative or qualitative aspects of market risk since December 31, 2000. FORWARD LOOKING STATEMENTS Certain statements contained in this Form 10Q are "forward-looking" statements within the meaning of the federal securities laws and are made in reliance upon the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements reflect our current views about future events and financial performance. Words such as "will," "should," "believe," "expect," "anticipate," "confident" and other similar expressions that predict or indicate future events or trends, 22 23 or that are not statements of historical matters, identify forward-looking statements. Investors should not rely on forward-looking statements because they are subject to a variety of risks, uncertainties, and other factors that could cause actual results to differ materially from our expectations, and we expressly do not undertake any duty to update forward-looking statements, which speak only as of the date of this release. These risks, uncertainties, and factors include, but are not limited to: (1) fluctuations in interest rates; (2) the stability of financial markets; (3) the level of bookings worldwide for Instron and IST; (4) our ability to timely ship backlog (in this regard, our expectations are based on historical as well as anticipated production levels); (5) the success of the automobile industry which is the major purchaser of IST products; (6) the impact of fluctuations in exchange rates and the uncertainties of operating in a global economy, including fluctuations in the economic conditions of the foreign and domestic markets served by the Company which can effect demand for its products and services; (7) our ability to identify and successfully consummate strategic acquisitions and our anticipated funding requirements in connection therewith; (8) our ability to meet the covenants and repayment schedules of the new loan and debt facilities undertaken as a result of the Merger and Recapitalization and the amendments to certain covenants contained in such facilities effected in the third quarter of 2000; (9) the effect of changes in accounting and/or tax policies and practices; and (10) other factors detailed from time to time in our filings with the Securities and Exchange Commission. 23 24 FORM 10-Q PART II INSTRON CORPORATION PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS Neither the Registrant nor any of its subsidiaries is a party to, nor is any of their property the subject of, any material pending legal proceedings. ITEM 2. CHANGES IN THE RIGHTS OF THE COMPANY'S SECURITY HOLDERS None. ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not applicable. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. ITEM 5. OTHER INFORMATION None. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K None 24 25 SIGNATURES Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. INSTRON CORPORATION Date: August 14, 2001 By /s/ James M. McConnell ----------------------------------- James M. McConnell President and Chief Executive Officer Date: August 14, 2001 By /s/ Linton A. Moulding ----------------------------------- Linton A. Moulding Chief Financial Officer 25

INSTRON CORP 10-Q