##### 



SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549   Form 10-Q
 (Mark One) þ Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934 For the quarterly period
ended December 31,
2004 OR o
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 Commission File Number 1-9965 KEITHLEY INSTRUMENTS, INC.  Ohio
    
    34-0794417(State or other jurisdiction of
    
    (I.R.S. Employerincorporation or organization)
    
    Identification No.)
 28775 Aurora Road, Solon, Ohio 44139
(Address of principal executive offices) (Zip Code) Registrants telephone number, including area code: (440) 248-0400 Indicate by check mark whether the Registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the Registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days. YESþ   NO
o Indicate by check whether the registrant is an accelerated filer (as defined in Rule 12b-2 of
the Exchange Act). YESþ   NO
o As of February 1, 2005 there were outstanding 14,199,260 Common Shares, without par
value and 2,150,502 Class B Common Shares, without par value.




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##### 



PART I. FINANCIAL INFORMATION ITEM 1. Financial Statements. KEITHLEY INSTRUMENTS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In Thousands of Dollars)
(Unaudited) DECEMBER 31,
    
    
    SEPTEMBER 30,2004
    
    
    2003
    
    
    2004AssetsCurrent assets:Cash and cash equivalents
    
    $
    17,856
    
    
    $
    15,868
    
    
    $
    16,451Short-term investments
    
    
    32,531
    
    
    
    21,090
    
    
    
    32,112Refundable income taxes
    
    
    56
    
    
    
    283
    
    
    
    181Accounts receivable and other, net
    
    
    18,299
    
    
    
    15,852
    
    
    
    21,435Inventories:Raw materials
    
    
    9,004
    
    
    
    8,435
    
    
    
    9,720Work in process
    
    
    1,243
    
    
    
    2,153
    
    
    
    840Finished products
    
    
    2,394
    
    
    
    1,601
    
    
    
    2,055Total inventories
    
    
    12,641
    
    
    
    12,189
    
    
    
    12,615Deferred income taxes
    
    
    6,648
    
    
    
    4,155
    
    
    
    7,438Other current assets
    
    
    2,251
    
    
    
    2,494
    
    
    
    1,927Total current assets
    
    
    90,282
    
    
    
    71,931
    
    
    
    92,159Property, plant and equipment, at cost
    
    
    48,430
    
    
    
    46,334
    
    
    
    47,271Less-Accumulated depreciation
    
    
    34,208
    
    
    
    32,197
    
    
    
    32,968Net property, plant and equipment
    
    
    14,222
    
    
    
    14,137
    
    
    
    14,303Deferred income taxes
    
    
    16,826
    
    
    
    20,092
    
    
    
    16,456Other assets
    
    
    14,635
    
    
    
    11,895
    
    
    
    13,748Total assets
    
    $
    135,965
    
    
    $
    118,055
    
    
    $
    136,666Liabilities and Shareholders EquityCurrent liabilities:Short-term debt
    
    $
    512
    
    
    $
    532
    
    
    $
    440Accounts payable
    
    
    5,975
    
    
    
    6,677
    
    
    
    7,422Accrued payroll and related expenses
    
    
    6,734
    
    
    
    5,330
    
    
    
    9,897Other accrued expenses
    
    
    5,468
    
    
    
    5,748
    
    
    
    5,047Income taxes payable
    
    
    3,981
    
    
    
    3,036
    
    
    
    4,935Total current liabilities
    
    
    22,670
    
    
    
    21,323
    
    
    
    27,741Long-term deferred compensation
    
    
    3,211
    
    
    
    3,168
    
    
    
    2,605Other long-term liabilities
    
    
    5,290
    
    
    
    4,594
    
    
    
    4,743Deferred income taxes
    
    
    
    
    
    
    2,353
    
    
    
    Shareholders equity:Common Shares, stated value $.0125:Authorized - 80,000,000; issued and outstanding -
14,092,907 at December 31, 2004, 13,438,202 at
December 31, 2003 and 14,067,107 at September 30, 2004
    
    
    176
    
    
    
    172
    
    
    
    176Class B Common Shares, stated value $.0125:Authorized - 9,000,000; issued and outstanding -
2,150,502 at December 31, 2004, December 31, 2003 and
September 30, 2004
    
    
    27
    
    
    
    27
    
    
    
    27Capital in excess of stated value
    
    
    27,910
    
    
    
    25,227
    
    
    
    27,449Retained earnings
    
    
    76,884
    
    
    
    66,161
    
    
    
    74,686Accumulated other comprehensive income
    
    
    1,089
    
    
    
    569
    
    
    
    501Unamortized portion of restricted stock plan
    
    
    (34
    )
    
    
    (58
    )
    
    
    (37
    )Common shares held in treasury, at cost
    
    
    (1,258
    )
    
    
    (5,481
    )
    
    
    (1,225
    )Total shareholders equity
    
    
    104,794
    
    
    
    86,617
    
    
    
    101,577Total liabilities and shareholders equity
    
    $
    135,965
    
    
    $
    118,055
    
    
    $
    136,666
 The accompanying notes are an integral part of these financial statements. 1




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##### 



KEITHLEY INSTRUMENTS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands of Dollars Except for Per Share Data)
(Unaudited) For the Three MonthsEnded December 31,2004
    
    
    2003Net sales
    
    $
    35,643
    
    
    $
    29,742Cost of goods sold
    
    
    14,200
    
    
    
    12,143Selling, general and administrative expenses
    
    
    13,586
    
    
    
    12,810Product development expenses
    
    
    4,090
    
    
    
    3,345Operating income
    
    
    3,767
    
    
    
    1,444Investment income
    
    
    291
    
    
    
    151Interest expense
    
    
    (13
    )
    
    
    (17
    )Income before income taxes
    
    
    4,045
    
    
    
    1,578Income tax provision
    
    
    1,254
    
    
    
    489Net income
    
    $
    2,791
    
    
    $
    1,089Basic earnings per share
    
    $
    0.17
    
    
    $
    0.07Diluted earnings per share
    
    $
    0.17
    
    
    $
    0.07Cash dividends per Common Share
    
    $
    .0375
    
    
    $
    .0375Cash dividends per Class B
Common Share
    
    $
    .030
    
    
    $
    .030
 The accompanying notes are an integral part of these financial statements. 2




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##### 



KEITHLEY INSTRUMENTS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands of Dollars) (Unaudited) For the Three MonthsEnded December 31,2004
    
    
    2003Cash flows from operating activities:Net income
    
    $
    2,791
    
    
    $
    1,089Depreciation
    
    
    1,091
    
    
    
    977Changes in working capital
    
    
    (1,572
    )
    
    
    (657
    )Other operating activities
    
    
    304
    
    
    
    346Net cash provided by
operating activities
    
    
    2,614
    
    
    
    1,755Cash flows from investing activities:Payments for property, plant and equipment
    
    
    (945
    )
    
    
    (786
    )Purchase of short-term investments
    
    
    (4,046
    )
    
    
    (5,264
    )Sale of short-term investments
    
    
    3,559
    
    
    
    4,205Net cash used in investing activities
    
    
    (1,432
    )
    
    
    (1,845
    )Cash flows from financing activities:Net increase in short term debt
    
    
    45
    
    
    
    123Cash dividends
    
    
    (593
    )
    
    
    (568
    )Proceeds from the sale of Common Shares
    
    
    147
    
    
    
    261Net cash used in financing activities
    
    
    (401
    )
    
    
    (184
    )Effect of exchange rate changes on cash
    
    
    624
    
    
    
    403Increase in cash and cash equivalents
    
    
    1,405
    
    
    
    129Cash and cash equivalents at beginning of period
    
    
    16,451
    
    
    
    15,739Cash and cash equivalents at end of period
    
    $
    17,856
    
    
    $
    15,868
 The accompanying notes are an integral part of these financial statements. 3




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##### 



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(In thousands of dollars, except for share data)  A.
    Nature of OperationsKeithley Instruments, Inc. offers a broad line of test and measurement products for
engineers and scientists throughout the world in dozens of disciplines. The Company markets
highly accurate instruments and data acquisition products that measure low levels of
voltage, resistance, current, capacitance, and charge, along with complete system solutions
for high volume production and assembly testing. Our products are manufactured in Ohio and
sold throughout the world in over 70 countries. Our principal markets are the United
States, Europe and the Pacific Basin, where we have subsidiaries or sales offices in 15
countries. References herein to the Company, Keithley, we or our are to Keithley
Instruments, Inc., and its subsidiaries unless the context indicates otherwise.B.
    Summary of Significant Accounting PoliciesBasis of PresentationThe consolidated financial statements at December 31, 2004 and 2003, and for the three
month periods then ended have not been audited by an independent registered public
accounting firm, but in the opinion of our management, all adjustments necessary to fairly
present the consolidated balance sheets, consolidated statements of operations and
consolidated statements of cash flows for those periods have been included. All adjustments
included are of a normal recurring nature.The Companys consolidated financial statements for the three month periods ended December
31, 2004 and 2003 included in this Form 10-Q report have been prepared in accordance with
the accounting policies described in the Notes to Consolidated Financial Statements for the
year ended September 30, 2004, which were included in the Form 10-K filed on December 13,
2004. Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles have been
condensed or omitted pursuant to the rules and regulations of the Securities and Exchange
Commission. These financial statements should be read in conjunction with the financial
statements and the notes thereto included in the Form 10-K referred to above.The preparation of financial statements in conformity with accounting principles generally
accepted in the United States of America requires management to make estimates and
assumptions. These estimates and assumptions affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of the reported
financial statements and the reported amounts of revenues and expenses during the reporting
periods. Examples include the allowance for doubtful accounts, estimates of contingent
liabilities, inventory valuation, depreciation, amortization and recoverability of long
-lived assets, pension plan assumptions, and the assessment of the valuation of deferred
income taxes and income tax reserves. Actual results could differ from those estimates.ReclassificationsCertain reclassifications have been made to prior year financial statements and the notes
to conform to the current year presentation.C.
    Recent Accounting PronouncementsIn November 2004, the FASB issued SFAS No. 151, Inventory Costs, an amendment of ARB No. 43,
Chapter 4. SFAS No. 151 amends the guidance in ARB No. 43, Chapter 4, Inventory Pricing, to
clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and
wasted material (spoilage). Paragraph 5 of ARB 43, Chapter 4, previously stated that . . . under
some circumstances, items such as idle facility expense, excessive spoilage, double freight, and
rehandling costs may be so abnormal as to require treatment as current period charges  SFAS No.
151 requires that those items be recognized as current-period charges regardless of whether they
meet the criterion of so abnormal. In addition, SFAS No. 151 requires that allocation of fixed
production overheads to the costs of conversion be based on the normal capacity of the production
facilities.The provisions of SFAS No. 151 will apply to inventory costs beginning in 4




---



##### 



fiscal year
2006. The adoption of SFAS No. 151 is not expected to have a significant effect on the
consolidated financial statements of the Company.In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets, an
Amendment of APB Opinion No. 29. The guidance in Accounting Principles Board (APB)
Opinion No. 29, Accounting for Nonmonetary Transactions, is based on the principle that
exchanges of nonmonetary assets should be measured based on the fair value of the assets
exchanged. The guidance in APB Opinion No. 29, however, included certain exceptions to that
principle. SFAS No. 153 amends APB Opinion No. 29 to eliminate the exception for
nonmonetary exchanges of similar productive assets and replaces it with a general exception
for exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary
exchange has commercial substance if the future cash flows of the entity are expected to
change significantly as a result of the exchange. Currently the Company does not enter into
nonmonetary exchange transactions; however, the provisions of SFAS No. 153 will be applied
prospectively to any of these transactions entered into beginning in our fourth quarter of
fiscal year 2005.In December 2004, the FASB issued SFAS No. 123 (Revised 2004), Share -Based Payment
(SFAS No . 123R). This new pronouncement requires compensation cost relating to share
-based payment transactions be recognized in financial statements. That cost will be
measured based on the fair value of the equity or liability instruments issued. SFAS No.
123R covers a wide range of share -based compensation arrangements including stock options,
restricted stock plans, performance -based awards, stock appreciation rights, and employee
stock purchase plans. SFAS No. 123R replaces SFAS No. 123, Accounting for Stock-Based
Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to
Employees . SFAS No. 123, as originally issued in 1995, established as preferable a fair
-value -based method of accounting for share -based payment transactions with employees.
However, SFAS No. 123 permitted entities the option of continuing to apply the guidance in
APB Opinion No. 25, as long as the footnotes to financial statements disclosed what net
income would have been had the fair-value -based method been used. Public entities (other
than those filing as small business issuers) will be required to apply SFAS No. 123R as of
the first interim or annual reporting period that begins after June 15, 2005. Accordingly,
the Company will be required to adopt the provisions of SFAS No. 123R in our fourth quarter
of fiscal year 2005. Management is currently evaluating the requirements of SFAS No. 123R.
The adoption of SFAS No. 123R is expected to have a significant effect on the consolidated
financial statements of the Company. See Note D for the pro forma impact on net earnings
(loss) and earnings (loss) per share from calculating stock-related compensation costs
under the fair value alternative of SFAS No. 123. However, the calculation of compensation
cost for share -based payment transactions issued after the effective date of SFAS No. 123R
may be different from the calculation of compensation cost under SFAS No. 123, but such
differences have not yet been quantified. Management is currently evaluating the
requirements of SFAS No. 123R and the impact on the Company including stock-based
compensation valuation models and transition methods allowed under the pronouncement.In December 2004, the FASB issued two FASB staff positions (FSP): FSP FAS 109-1,
Application of FASB Statement No. 109, Accounting for Income Taxes, for the Tax Deduction
Provided to U.S. -Based Manufacturers by the American Jobs Creation Act of 2004; and FSP
FAS 109-2, Accounting and Disclosure Guidance for the Foreign Earnings Repatriation
Provision within the American Jobs Creation Act of 2004.  FSP FAS 109-1 clarifies that the
tax deduction for domestic manufacturers under the American Jobs Creation Act of 2004 (the
Act) should be accounted for as a special deduction in accordance with SFAS No. 109,
Accounting for Income Taxes. FSP FAS 109-1 will begin to
impact the Company in our
2006 fiscal year. Management is currently evaluating the provisions of the pronouncement to
identify the impact on the Company. FSP FAS 109-2 provides enterprises more time (beyond
the financial reporting period during which the Act took effect) to evaluate the Acts
impact on the enterprises plan for reinvestment or repatriation of certain foreign
earnings for purposes of applying SFAS No. 109. The Company has historically repatriated
dividends from our foreign subsidiaries; therefore, this provision of the American Jobs
Creation Act provides no benefit to the Company. As such, FSP FAS 109-2 will not impact our
consolidated financial statements for fiscal 2005.D.
    Earnings Per Share, Including Pro Forma Effects of Stock-Based CompensationBoth Common Shares and Class B Common Shares are included in calculating earnings per
share. The weighted average number of shares outstanding used in the calculation is set
forth below: 5




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##### 



For the Three MonthsEnded December 31,2004
    
    
    2003Net income
    
    $
    2,791
    
    
    $
    1,089Weighted average shares outstanding
    
    
    16,225,559
    
    
    
    15,544,377Assumed exercise of stock options
    
    
    352,529
    
    
    
    565,567Assumed purchase of stock under
stock purchase plan
    
    
    15,102
    
    
    
    49,795Weighted average shares used for
dilutive earnings per share
    
    
    16,593,190
    
    
    
    16,159,739Basic earnings per share
    
    $
    0.17
    
    
    $
    0.07Diluted earnings per share
    
    $
    0.17
    
    
    $
    0.07
 The Company has elected to continue to account for stock issued to employees according to APB
Opinion 25, Accounting for Stock Issued to Employees and its related interpretations. Under APB
No. 25, no compensation expense is recognized in the Companys consolidated financial statements
for employee stock options except in certain cases when stock options are granted below the market
price of the underlying stock on the date of grant. Alternatively, under the fair value method of
accounting provided for under SFAS No. 123, Accounting for Stock-Based Compensation and SFAS No.
148, Accounting for Stock-Based Compensation  Transition and Disclosure  an amendment of FASB
Statement No. 123, the measurement of compensation expense is based on the fair value of employee
stock options or purchase rights at the grant or right date and requires the use of option pricing
models to value the options. During the first quarter of fiscal 2005, the Company amended the 1993 Employee Stock Purchase Plan
to change the subscription period from the calendar year to a six month period ending June 30. The
change was made to maintain the current benefits of the Plan for all eligible employees through
June 30, 2005 while assessing the future value of the Plan relative to the expense that would be
required to be recorded by SFAS No. 123R for subscription periods beginning after June 30, 2005. The pro forma impact to both net income and earnings per share from calculating stock-related
compensation expense consistent with the fair value alternative of SFAS 123 is indicated below: For the Three MonthsEnded December 31,2004
    
    
    2003Net income
    
    $
    2,791
    
    
    $
    1,089Add: Stock-based employee compensation
expense included in reported income,
net of related tax effects
    
    
    22
    
    
    
    5Deduct: Stock-based employee
compensation expense determined
under fair value based methods for
all awards, net of related tax effects
    
    
    (823
    )
    
    
    (1,054
    )Pro forma net income
    
    $
    1,990
    
    
    $
    40Pro forma basic earnings per share
    
    $
    0.12
    
    
    $
    0.00Pro forma diluted earnings per share
    
    $
    0.12
    
    
    $
    0.00
  E.
    Repurchase of Common Shares 6




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##### 



On December 10, 2003, the Company announced its Board of Directors had approved an open market
stock repurchase program (the 2003 program). Under the terms of the 2003 program, the Company may
purchase up to 2,000,000 Common Shares, or approximately 13 percent of shares outstanding, over a
three-year period. The purpose of the 2003 program is to offset the dilutive effect of stock option
and stock purchase plans. Common Shares held in treasury may be reissued in settlement of stock
purchases under these plans. The 2003 program replaces the prior program, which expired in December
2003.The following table summarizes the Companys stock repurchase activity: For the Three MonthsEnded December 31,2004
    
    
    2003Total number of shares purchased
    
    
    
    
    
    
    Average price paid per share
(including commissions)
    
    
    
    
    
    $
    Identity of broker-dealer used
to effect the purchases
    
    
    N/A
    
    
    
    N/ANumber of shares purchased as part of
publicly announced repurchase programs
    
    
    
    
    
    
    Maximum number of shares that remain
to be purchased under the program
    
    
    2,000,000
    
    
    
    2,000,000
  There were no Common Shares remaining in treasury under the Companys share repurchase
programs at December 31, 2004, as these shares were reissued under stock option or stock
purchase plans. There were no shares issued from treasury under these plans during the
first quarter of fiscal 2005 while 76,481 shares were issued from treasury during the same
period in fiscal 2004.Also, included in the Common shares held in treasury, at cost caption of the consolidated
balance sheets are shares repurchased to settle non -employee Directors fees deferred
pursuant to the Keithley Instruments, Inc. 1996 Outside Directors Deferred Stock Plan.
Shares held in treasury related to this plan at December 31, 2004 totaled 145,968.F.
    Financing ArrangementsOn March 30, 2004, the Company amended its credit agreement to extend the term to March 31,
2005 from March 30, 2004. The agreement is a $10,000 debt facility ($472 outstanding at
December 31, 2004) that provides unsecured, multi-currency revolving credit at various
interest rates based on Prime or LIBOR and for standby letters of credit ($672 outstanding
at December 31, 2004) . The Company intends to extend the terms of the credit agreement
with the bank or seek to enter into a new credit agreement to provide access to capital
should the need arise beyond March 31, 2005. Additionally, the Company has a number of
other credit facilities in various currencies aggregating $5,000 ($40 outstanding at
December 31, 2004). The principal on these facilities is due monthly with a 30-day rollover
provision. The Company has $13,816 available under the short -term lines of credit with
domestic and foreign banks at December 31, 2004.Under certain provisions of the debt agreements, the Company is required to comply with
various financial ratios and covenants. The Company is in compliance with these
requirements as of December 31, 2004.G.
    Accounting for Derivatives and Hedging ActivitiesIn accordance with the provisions of Statement of Financial Accounting Standards No. 133,
Accounting for Derivative Instruments and Hedging Activities (as amended),all of the Companys
derivative instruments are 7




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##### 



recognized on the balance sheet at their fair value. To hedge sales, the
Company currently utilizes foreign exchange forward contracts or option contracts to sell foreign
currencies to fix the exchange rates related to near-term sales and effectively fix the Companys
margins. Underlying hedged transactions are recorded at hedged rates, therefore realized and
unrealized gains and losses are recorded when the hedged transactions occur. The Company also has
an interest rate swap instrument, which expires September 19, 2005. The estimated fair value of the
swap instrument is determined through quotes from the related financial institutions.On the date the derivative contract is entered into, the Company designates its derivative as
either a hedge of the fair value of a recognized asset or liability (fair value hedge), as a
hedge of the variability of cash flows to be received (cash flow hedge), or as a foreign-currency
cash flow hedge (foreign currency hedge). Changes in the fair value of a derivative that is
highly effective as, and that is designated and qualifies as, a fair value hedge, along with the
gain or loss on the hedged asset or liability that is attributable to the hedged risk are recorded
in current period earnings. Changes in the fair value of a derivative that is highly effective and
that is designated and qualifies as a cash flow hedge are recorded in other comprehensive income
until earnings are affected by the transaction in the underlying asset. Changes in the fair value
of derivatives that are highly effective and that qualify as foreign currency hedges are recorded
in either current period income or other comprehensive income, depending on whether the hedge
transaction is a fair value hedge or a cash flow hedge. At December 31, 2004, the foreign exchange
forward contracts were designated as foreign currency cash flow hedges. The interest rate swap
instrument was determined to be an ineffective hedge and accordingly, changes in its fair market
value are recorded in the Companys records as income or expense in the interest expense line item
in the consolidated statements of operations. The Company recorded income of $41 and $45 for the
three month periods ended December 31, 2004 and 2003, respectively, for the interest rate swap.At December 31, 2004, the Company had obligations under foreign exchange forward contracts to sell
2,100,000 Euros, 300,000 British pounds and 225,000,000 Yen at various dates through March 2005. In
accordance with the provisions of SFAS 133, the derivative instruments are recorded on the
Companys Consolidated Balance Sheets. At December 31, 2004, the fair market value of the foreign
exchange forward contracts and interest rate swap represented liabilities to the Company of $232
and $80, respectively. At December 31, 2003, the fair market value of the foreign exchange forward
contracts and interest rate swap represented liabilities to the Company of and $286 and $238,
respectively.The Company documents all relationships between hedging instruments and hedged items, as well as
its risk-management objective and strategy for undertaking various hedge transactions. The Company
also assesses whether the derivatives that are used in hedging transactions are highly effective in
offsetting changes in cash flows of hedged items. When it is determined that a derivative is not
highly effective as a hedge, the Company discontinues hedge accounting prospectively. Cash flows
resulting from hedging transactions are classified in the consolidated statements of cash flows in
the same category as the cash flows from the item being hedged. 8




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##### 



H.
    Comprehensive IncomeComprehensive income for the three month periods ended December 31, 2004 and 2003 is as
follows: For the Three MonthsEnded December 31,2004
    
    
    2003Net income
    
    $
    2,791
    
    
    $
    1,089Unrealized losses on value
of derivative securities
    
    
    (44
    )
    
    
    (35
    )Net unrealized investment
(losses) gains
    
    
    (45
    )
    
    
    114Foreign currency translation
adjustments
    
    
    677
    
    
    
    392Comprehensive income
    
    $
    3,379
    
    
    $
    1,560
  I.
    Geographic Segment InformationThe Companys business is to develop test and measurement solutions to verify customers
product performance or aid in their product development process. The Companys customers
are engineers, technicians and scientists in manufacturing, product development and
research functions within a range of industries. Although the Companys products vary in
capability, sophistication, use, size and price, they basically test, measure and analyze
electrical and physical properties . The Companys gross margins, customers, production
processes and distribution methods are similar for all its products. Accordingly, the
Company reports a single Test and Measurement segment. The Companys net sales and long
-lived assets by geographic area are presented below.
The basis for attributing revenues from external customers to a geographic area is the
location of the customer. For the Three MonthsEnded December 31,2004
    
    
    2003Net sales:Americas
    
    $
    11,759
    
    
    $
    8,810Europe
    
    
    11,413
    
    
    
    11,014Asia
    
    
    12,471
    
    
    
    9,918$
    35,643
    
    
    $
    29,742
 At December 31,
    
    
    At September 30,2004
    
    
    2003
    
    
    2004Long-lived assets:Americas
    
    $
    22,703
    
    
    $
    20,960
    
    
    $
    22,750Germany
    
    
    4,993
    
    
    
    4,341
    
    
    
    4,545Other
    
    
    1,161
    
    
    
    731
    
    
    
    756$
    28,857
    
    
    $
    26,032
    
    
    $
    28,051
 9




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##### 



J.
    Guarantors Disclosure RequirementsGuarantee of original leaseThe Company has assigned the lease of its former office space in Reading, Great Britain to
a third party. In the event the third party defaults on the monthly lease payments, the
Company would be responsible for the payments until the lease expires on July 14, 2009. If
the third party were to default, the maximum amount of future payments (undiscounted) the
Company would be required to make under the guarantee would be approximately $1,002 through
July 14, 2009. The Company has not recorded any liability for this item, as it does not
believe that it is probable that the third party will default on the lease payments.Product WarrantiesGenerally, the Companys products are covered under a one -year warranty; however, certain
products are covered under a two or three -year warranty. It is the Companys policy to
accrue for all product warranties based upon historical in -warranty repair data. In
addition, the Company accrues for specifically identified product performance issues. The
Company also offers extended warranties for certain of its products for which revenue is
recognized over the life of the contract period. The costs associated with servicing the
extended warranties are expensed as incurred. The revenue, as well as the costs related to
the extended warranties is immaterial for the three month periods ending December 31, 2004
and 2003.A reconciliation of the estimated changes in the aggregated product warranty liability for
the three month periods ending December 31, 2004 and 2003 is as follows: For the Three MonthsEnded December 31,2004
    
    
    2003Balance, beginning of period
    
    $
    1,459
    
    
    $
    1,498Accruals for warranties issued during the period
    
    
    586
    
    
    
    347Accruals related to pre-existing warranties
(including changes in estimates and
expiring warranties)
    
    
    (202
    )
    
    
    (96
    )Settlements made (in cash or in kind)
during the period
    
    
    (425
    )
    
    
    (201
    )Balance, end of period
    
    $
    1,418
    
    
    $
    1,548
  K.
    Pension BenefitsThe Company has noncontributory defined benefit pension plans covering all of its eligible
employees in the United States and certain non -U.S. employees. Pension benefits are based
upon the employees length of service and a percentage of compensation above certain base
levels. The Company also has an unfunded supplemental retirement plan (SERP) for former key
employees, which includes retirement, death and disability benefits. Net periodic benefit
cost for this plan is $ 2 for the three month periods ended December 31, 2004 and 2003, and
is included in the table below. A summary of the components of net periodic pension cost
for the three month periods ending December 31, 2004 and 2003 is shown below: 10




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##### 



For the Three MonthsEnded December 31,2004
    
    
    2003Service cost-benefits earned during the period
    
    $
    365
    
    
    $
    353Interest cost on projected benefit obligation
    
    
    538
    
    
    
    512Expected return on plan assets
    
    
    (690
    )
    
    
    (655
    )Amortization of transition asset
    
    
    (5
    )
    
    
    (6
    )Amortization of prior service cost
    
    
    46
    
    
    
    46Net periodic pension cost
    
    $
    254
    
    
    $
    250
  I.
    Accrued Severance LiabilityDuring the last half of fiscal 2003, the Company recorded pretax charges of $ 845 for
severance relating to a reduction in force. The remaining liabilities under these severance
agreements were paid in the first quarter of fiscal 2005. A reconciliation of the changes
in the aggregated accrued severance liability for the three month periods ended December
31, 2004 and 2003 is as follows: For the Three MonthsEnded December 31,2004
    
    
    2003Balance, beginning of period
    
    $
    107
    
    
    $
    503Payments made
    
    
    (94
    )
    
    
    (80
    )Adjustments and write-offs
    
    
    (21
    )
    
    
    Foreign exchange revaluation
    
    
    8
    
    
    
    31Balance, end of period
    
    $
    
    
    
    $
    454
 ITEM 2. Managements Discussion and Analysis of Financial Condition and Results of Operations. Forward-Looking Statements Certain of the matters and subject areas discussed in this Quarterly Report on Form 10-Q contain
forward-looking statements within the meaning of the Private Securities Litigation Reform Act of
1995. All statements other than statements of historical information provided herein are
forward-looking statements. Forward-looking statements generally include words such as
anticipates, expects, believes, intends, estimates, and similar expressions, and include
those statements regarding our expectations, intentions and beliefs with regard to the future,
including our efforts involving ERP and CRM system implementations, investments to develop RF
products, conditions of the electronics industry, technology or other trends and known
uncertainties. These forward-looking statements involve certain risks and uncertainties that could
cause actual results to differ materially from those anticipated in the forward-looking statements
as a result of many factors, including those more fully described under the caption Factors That
May Affect Future Results and elsewhere in this Quarterly Report. These forward-looking statements
reflect managements analysis, judgment, belief or expectation only as of the date hereof. We
assume no obligation to update any forward-looking statements. Overview Our business is to design, develop, manufacture and market complex electronic instruments and
systems geared to the specialized needs of electronics manufacturers for high-performance
production testing, process monitoring, product development and research. Our primary products are
integrated systems used to source, measure, connect, control or communicate electrical direct
current (DC), radio frequency (RF) or optical signals. Our customers are engineers, technicians and
scientists in manufacturing, product development and research functions. During the first quarter
of fiscal 2005, orders from our semiconductor customers comprised approximately 35 percent of the
total, wireless communications orders were approximately 10 percent, precision electronic
components and subassembly 11




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manufacturers orders were approximately 25 percent, research and education made up about 20
percent, optoelectronics orders were less than 5 percent, with the remainder coming from customers
in a variety of other industries. Although our products vary in capability, sophistication, use,
size and price, they generally test, measure and analyze electrical, optical or physical
properties. As such, we consider our business to be in a single test and measurement industry
segment. Many of the industries we serve, including but not limited to the semiconductor industry, the
wireless communications industry, the optoelectronics industry, and precision electronic components
and subassemblies manufacturers, have historically been very cyclical and have experienced periodic
downturns. The downturns have had, and may have in the future, a material adverse impact on our
customers demand for equipment, including test and measurement equipment. The severity and length
of a downturn also may affect overall access to capital, which could adversely affect the Companys
customers. In addition, the factors leading to and the severity and length of a downturn are
difficult to predict and there can be no assurance that we will appropriately anticipate changes in
the underlying end markets we serve or that any recent increased levels of business activity will
continue as a trend into the future. In addition, our orders are cancelable by customers, and
consequently, orders outstanding at the end of a reporting period may not result in realized sales
in the future. Beginning near the end of fiscal 2002, we began to incur costs in preparation for the transition to
new ERP (Enterprise Resource Planning) and CRM (Customer Relationship Management) software systems.
We went live with ERP in the United States and Europe in the third quarter of fiscal 2003 and the
first quarter of fiscal 2004, respectively.


 Additionally, we went live with CRM in the United States during the first quarter of fiscal 2004.
We are continuing to roll out additional ERP and CRM modules and locations throughout 2005. Critical Accounting Policies and Estimates Management has identified the Companys critical accounting policies. These policies have the
potential to have a more significant impact on our financial statements, either because of the
significance of the financial statement item to which they relate, or because they require judgment
and estimation due to the uncertainty involved in measuring, at a specific point in time, events
which will be settled in the future. Our critical accounting policies and estimates are described in Managements Discussion and
Analysis included in the 2004 annual report on Form 10-K filed on December 13, 2004, and include
use of estimates, revenue recognition, inventories, income, income taxes, pension plan and stock
compensation plans. Results of Operations First Quarter Fiscal 2005 Compared with First Quarter Fiscal 2004 Net sales of $35,643 for the first quarter of fiscal 2005 increased 20 percent from sales of
$29,742 in the prior years first quarter. Approximately three percentage points of the increase
was due to the weaker U.S. dollar with the remaining increase due to higher volume. Sales were
higher in all major geographies with the Americas sales up 33 percent, Asia up 26 percent and
European sales up 4 percent from the prior years quarter. Sequentially, sales decreased 10 percent
from the fourth quarter of fiscal 2004. Orders of $34,943 for the first quarter of fiscal 2005 increased 13 percent from last years orders
of $30,919.


 Geographically, orders were up 29 percent in the Americas, up 23 percent in Asia, and were down
nine percent in Europe. Compared to the prior years first quarter, orders from semiconductor
customers increased approximately 44 percent, orders from wireless customers decreased
approximately 40 percent, orders from precision electronic components and subassembly manufacturers
were down about 5 percent, research and education customer orders increased approximately 25
percent, and optoelectronics customer orders were up approximately 80 percent. Order backlog
decreased $51 during the quarter to $15,922 at December 31, 2004. The Company does not track net
sales in the same manner as it tracks orders by major customer group. However, sales trends
generally correlate to Company order trends although they may vary between quarters depending upon
the orders which remain in backlog. Cost of goods sold as a percentage of net sales decreased to 39.8 percent from 40.8 percent in the
prior years first quarter, a 1.0 percentage point improvement.The improvement was due to lower
material and manufacturing costs, partially offset by unfavorable geographic and customer mix.
Nearly all products the Company sells are manufactured in the United States; therefore, cost of
goods sold expressed in dollars is generally not affected by changes in foreign currencies. However, as a percentage of net sales, it is affected as net sales dollars
fluctuate due to currency exchange rates changes. As such, gross margins benefited due to the
weaker dollar in the first quarter of 12




---



##### 



fiscal 2005 versus the prior years quarter. The effect of
foreign exchange hedging on cost of goods sold was immaterial in both periods. Selling, general and administrative expenses of $13,586 increased $776, or 6.1 percent, from last
years first quarter, although such expenses decreased as a percentage of net sales to 38.1 percent
from 43.1 percent last year. The increase in costs was primarily due to higher incentive and
internal commission costs that are tied to financial performance offset by lower external commissions costs. Product development expenses for the quarter were $4,090, or 11.5 percent of net sales, up $745, or
22.3 percent, from last years $3,345, or 11.2 percent of sales.The increase is primarily a result
of our increased investment in the development of RF products that began in the first quarter of
fiscal 2004. Additionally, product development expenses increased due to higher incentive costs
that are tied to financial performance. The Company reported operating income for the first quarter of fiscal 2005 of $3,767 versus $1,444
for the prior years quarter. Higher sales and better gross margins, partially offset by higher
operating costs, accounted for the increase. Investment income was $291 for the quarter compared to $151 in last years first quarter. Higher
average cash and short-term investment balances as well as higher interest rates accounted for the
increase. The Company recorded interest expense for the quarter of $13 compared to $17 in the prior
year. The Company recorded income taxes at a 31.0 percent rate for the first quarter of both fiscal 2005
and 2004. The rate in 2005 was lower than the statutory rate due to extraterritorial income
exclusion benefits and research and development credits. The rate in 2004 was lower than the
statutory rate due to an estimated return provision adjustment partially offset by an additional
valuation allowance for foreign tax credits generated during fiscal 2004. The Company reported net income of $2,791, or $0.17 per diluted share, compared to $1,089, or $0.07
per diluted share, in last years first quarter. The increase from the prior year was largely due
to higher sales and improved gross margins, offset somewhat by higher operating expenses described
above. Financial Condition, Liquidity and Capital Resources Cash and cash equivalents and short-term investments totaled $50,387 at December 31, 2004, an
increase of $1,824 during the quarter and $13,429 from December 31, 2003. We consider our
short-term investments to be available for working capital needs as the investments consist of
highly liquid corporate bonds and notes, mutual funds, and U.S. government and agency securities.
Short-term debt was $512 at December 31, 2004, an increase of $72 during the quarter and a decrease
of $20 from December 31, 2003. We have no long-term debt. Net cash provided by operating activities
was $2,614 during the first quarter of fiscal 2005. We also received $147 through our employee
stock option and purchase plans during the first three months of fiscal 2005. Cash was used for
capital expenditures of $945 and to pay dividends to our shareholders of $593 for the three month
period ending December 31, 2004. During the first quarter of fiscal 2004, our Board of Directors
authorized an open market stock repurchase program to replace the program which expired in December
2003. See Notes to Condensed Consolidated Financial Statements Note E. We did not repurchase any of
our stock during the first three months of fiscal 2005. We expect to finance capital spending, working capital requirements and the stock repurchase
program with cash and short-term investments on hand and cash provided by operations. At December
31, 2004, we had available unused lines of credit with domestic and foreign banks aggregating
$13,816, all of which was short-term. Our credit agreement was amended during the second quarter of
fiscal 2004 to extend the terms of the agreement to March 31, 2005. See Notes to Condensed
Consolidated Financial Statements Note F. Outlook We continue to believe that our ability to achieve a higher level of orders in the future will
be driven by our customers spending patterns as they invest in new capacity or upgrade their lines
for their new product offerings, as well as our ability to gain market share. 13




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##### 



Based upon current expectations, the company is estimating sales for the second quarter of fiscal
2005, which will end March 31, 2005, to range between $36,000 and $41,000 based upon current order
projections. Pretax earnings are expected to be between the upper single digits and the mid-teens
as a percentage of net sales. Factors That May Affect Future Results Many of the industries we serve, including but not limited to the semiconductor industry, the
wireless communications industry, the optoelectronics industry, and precision electronic components
and subassemblies manufacturers, have historically been very cyclical and have experienced periodic
downturns. The downturns have had, and may have in the future, a material adverse impact on our
customers demand for equipment, including test and measurement equipment. The severity and length
of a downturn also may affect overall access to capital, which could adversely affect the Companys
customers. In addition, the factors leading to and the severity and length of a downturn are
difficult to predict and there can be no assurance that we will appropriately anticipate changes in
the underlying end markets we serve. In addition, there can be no assurance that any recent
increased levels of business activity will continue as a trend into the future or that any expected
business activity, including large anticipated orders, will materialize. In addition, our orders
are cancelable by customers, and consequently, orders outstanding at the end of a reporting period
may not result in realized sales in the future. Our business relies on the development of new high technology products and services to provide
solutions to our customers complex measurement needs. This requires anticipation of customers
changing needs and emerging technology trends. We must make long-term investments and commit
significant resources before knowing whether our expectations will eventually result in products
that achieve market acceptance. We incur significant expenses developing new products, including
RF, that may or may not result in significant sources of revenue and earnings in the future. If
these expenses do not result in future earnings, our operating results will be adversely affected. In many cases our products compete directly with those offered by other manufacturers. If any of
our competitors were to develop products or services that are more cost-effective or technically
superior, demand for our product offerings could slow. Our products contain large quantities of electronic components and subassemblies that in some cases
are supplied through sole or limited source third-party suppliers. As a result, there can be no
assurance that parts and supplies will be available in a timely manner and at reasonable prices.
Additionally, our inventory is subject to risks of changes in market demand for particular
products. Our inability to obtain critical parts and supplies or any resulting excess and/or
obsolete inventory could have an adverse impact on our results of operations. We currently have subsidiaries or sales offices located in 15 countries including the United
States, and non-U.S. sales accounted for approximately two-thirds of our revenue during the first
quarter of fiscal 2005. Our future results could be adversely affected by several factors relating
to our international sales operations, including changes in foreign currency exchange rates,
political unrest, wars and acts of terrorism, changes in other economic or political conditions,
trade protection measures, import or export licensing requirements, unexpected changes in
regulatory requirements and natural disasters. Any of these factors could have a negative impact on
our revenue and operating results. Our gross margin improvements are due in part to the benefits from our lean manufacturing
initiative in our manufacturing facilities, which are located in Solon, Ohio. We may not experience
future benefits if we are unable to continue to effectively manage this initiative, and we could
incur additional costs in the future, having a negative impact on gross margin, if new initiatives
are needed to further improve manufacturing and execution efficiencies. We pay taxes in several jurisdictions throughout the world. We utilize available tax credits and
other tax planning strategies in an effort to minimize our overall tax liability. Our estimated tax
rate for fiscal 2005 could change from what is currently anticipated due to changes in tax laws of
various countries, changes in our overall tax planning strategy, or countries where earnings or
losses are incurred. At December 31, 2004, we had a valuation allowance against certain deferred
tax assets and had not established valuation allowances against other deferred tax assets based on
tax strategies planned to mitigate the risk of impairment to these assets. Accordingly, if facts or
financial results were to change thereby impacting the likelihood of realizing the deferred tax assets, our tax rate
and therefore our earnings could be adversely affected. Throughout fiscal 2004 and into fiscal 2005, we have continued our implementation of ERP and CRM
systems. Our results could be adversely affected if we are unable to implement the systems without
significant interruptions in accounting systems, order entry, billing, manufacturing and other
customer support functions. 14




---



##### 



Other risk factors include but are not limited to changes in our customer and product mix, which
affects our gross margins, credit risk of customers, potential litigation, claims, regulatory and
administrative proceedings arising in the normal course of business, as well as terrorist
activities and armed conflicts. ITEM 3. Quantitative and Qualitative Disclosure About Market Risk. The Company is exposed to a variety of risks, including foreign currency fluctuations, interest
rate fluctuations and changes in the market value of its short-term investments. In the normal
course of business, we employ established policies and procedures to manage our exposure to
fluctuations in foreign currency values and interest rates. The Company is exposed to foreign currency exchange rate risk primarily through transactions
denominated in foreign currencies. We currently utilize foreign exchange forward contracts or
option contracts to sell foreign currencies to fix the exchange rates related to near-term sales
and effectively fix our margins. Generally, these contracts have maturities of three months or
less. Our policy is to only enter into derivative transactions when we have an identifiable
exposure to risk, thus not creating additional foreign currency exchange rate risk. In our opinion,
a 10 percent adverse change in foreign currency exchange rates would not have a material effect on
these instruments and therefore our results of operations, financial position or cash flows. The Company also has an interest rate swap instrument originally entered into to mitigate the risk
of interest rate changes related to long-term debt. The agreement effectively fixes the interest
rate on a notional $3,000 of variable rate debt; however, the interest rate swap instrument was
determined to be an ineffective hedge and accordingly, changes in the fair market value of the
interest rate swap are recorded in the Companys records as income or expense. The instrument
expires September 19, 2005. In managements opinion, a 10 percent adverse change in interest rates
would not have a material effect on this instrument and therefore on our results of operations,
financial position or cash flows. The Company maintains a short-term investment portfolio consisting of United States government
backed notes and bonds, corporate notes and bonds, and mutual funds consisting primarily of
government notes and bonds. An increase in interest rates would decrease the value of certain of
these investments. However, in managements opinion, a 10 percent increase in interest rates would
not have a material impact on our results of operations, financial position or cash flows. ITEM 4. Controls and Procedures. The Company carried out an evaluation, under the supervision and with participation of the
Companys management, including the Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of the Companys disclosure controls and procedures as of
the end of the period covered by this report pursuant to Rule 13a-15(b) under the Securities
Exchange Act of 1934. Based upon that evaluation, the Chief Executive Officer and Chief Financial
Officer have concluded that the Companys disclosure controls and procedures are effective in
timely alerting them to material information required to be included in the periodic SEC filings
for the Company. There was no change in the internal control over financial reporting that occurred during the first
quarter of fiscal 2005 that has materially affected or is reasonably likely to materially affect
the Companys internal controls over financial reporting.  15




---



##### 



PART II. OTHER INFORMATION Item 2. Unregistered Sales of Equity Securities and Use of Proceeds. On December 10, 2003, the Company announced its Board of Directors had approved an open market
stock repurchase program (the 2003 program). Under the terms of the 2003 program, the Company may
purchase up to 2,000,000 Common Shares, or approximately 13 percent of shares outstanding, over a
three-year period. The Company made no share repurchases during the first quarter of fiscal 2005 or
2004. See Notes to Condensed Consolidated Financial Statements Note E. Item 6. Exhibits. (a)Exhibits. The following exhibits are filed herewith: ExhibitNumber
    
    Exhibit31 (a)
    
    Certification of Joseph P. Keithley pursuant to Rule 13a -14(a)-15d -14(a).31 (b)
    
    Certification of Mark J. Plush pursuant to Rule 13a -14(a)-15d -14(a).32 (a)+
    
    Certification of Joseph P. Keithley pursuant to Rule 13a -14(b) and 18 U.S.C. Section
1350.32 (b)+
    
    Certification of Mark J. Plush pursuant to Rule 13a -14(b) and 18 U.S.C. Section 1350.
 + The certifications furnished pursuant to this item will not be deemed filed for purposes of
Section 18 of the Exchange Act (15 U.S.C. 78r), or otherwise subject to the liability of that
section. Such certification will not be deemed to be incorporated by reference into any filing
under the Securities Act or the Exchange Act, except to the extent that the registrant
specifically incorporates it by reference. 16




---



##### 



SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto duly authorized. KEITHLEY INSTRUMENTS,
INC. (Registrant)Date: February 9, 2005
    
    /s/ Joseph P. KeithleyJoseph P. Keithley Chairman, President and Chief Executive Officer(Principal Executive Officer)Date: February 9, 2005
    
    /s/ Mark J. PlushMark J. Plush Vice President and Chief Financial Officer
   (Principal Financial and Accounting Officer)
 17