##### Table of Contents



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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



---



Form 10-Q

(Mark One)


ý
    
    Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934


For the quarterly period ended December 31, 2003

OR

 ̈
    
    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
incorporation or organization)
    
    (I.R.S. Employer
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.

YES
 ý     
NO   ̈

Indicate by check whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).

YES
 ý     
NO   ̈

As of February 6, 2004 there were outstanding 13,803,512 Common Shares,
without par value and 2,150,502 Class B Common Shares, without par value.

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TABLE OF CONTENTS



|                              |                                                                                                |                                       |  |  |  |  |  | 
|----------------------------- | ---------------------------------------------------------------------------------------------- | ------------------------------------- |  |  |  |  |  | 
|PART I. FINANCIAL INFORMATION
|                              | ITEM 1. Financial Statements.                                                                 
|                              |                                                                                                | CONSOLIDATED BALANCE SHEETS          
|                              |                                                                                                | CONSOLIDATED STATEMENTS OF OPERATIONS
|                              |                                                                                                | CONSOLIDATED STATEMENTS OF CASH FLOWS
|                              | ITEM 2. Managements Discussion and Analysis of Financial Condition and Results of Operations.
|                              | ITEM 3. Quantitative and Qualitative Disclosure About Market Risk.                            
|                              | ITEM 4. Controls and Procedures.                                                              
|PART II. OTHER INFORMATION   
|                              | Item 6. Exhibits and Reports on Form 8-K.                                                     
|SIGNATURES                   
|EX-31(A)  302 Cert for CEO   
|EX-31(B)  302 Cert for CFO   
|EX-32(A)  906 Cert for CEO   
|EX-32(B)  906 Cert for CFO   



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##### Table of Contents






PART I. FINANCIAL INFORMATION




ITEM 1. Financial Statements.




KEITHLEY INSTRUMENTS, INC.
CONSOLIDATED BALANCE SHEETS
(In Thousands of Dollars)
(Unaudited)

DECEMBER 31,
    
    SEPTEMBER 30,2003
    
    2002
    
    2003AssetsCurrent assets:Cash and cash equivalents
    
    $
    15,868
    
    
    $
    19,482
    
    
    $
    15,739Short-term investments
    
    
    21,090
    
    
    
    27,832
    
    
    
    20,070Refundable income taxes
    
    
    283
    
    
    
    680
    
    
    
    519Accounts receivable and other, net
    
    
    15,852
    
    
    
    13,031
    
    
    
    15,607Inventories:Raw materials
    
    
    8,435
    
    
    
    6,592
    
    
    
    7,842Work in process
    
    
    2,153
    
    
    
    871
    
    
    
    1,513Finished products
    
    
    1,601
    
    
    
    1,558
    
    
    
    1,859Total inventories
    
    
    12,189
    
    
    
    9,021
    
    
    
    11,214Deferred income taxes
    
    
    4,155
    
    
    
    4,391
    
    
    
    4,023Other current assets
    
    
    2,494
    
    
    
    1,729
    
    
    
    1,088Total current assets
    
    
    71,931
    
    
    
    76,166
    
    
    
    68,260Property, plant and equipment, at cost
    
    
    46,334
    
    
    
    44,155
    
    
    
    45,383Less-Accumulated depreciation
    
    
    32,197
    
    
    
    30,211
    
    
    
    31,082Net property, plant and equipment
    
    
    14,137
    
    
    
    13,944
    
    
    
    14,301Deferred income taxes
    
    
    20,092
    
    
    
    17,027
    
    
    
    20,002Other assets
    
    
    11,895
    
    
    
    9,782
    
    
    
    11,623Total assets
    
    $
    118,055
    
    
    $
    116,919
    
    
    $
    114,186Liabilities and Shareholders EquityCurrent liabilities:Short-term debt
    
    $
    532
    
    
    $
    573
    
    
    $
    409Accounts payable
    
    
    6,677
    
    
    
    6,166
    
    
    
    7,071Accrued payroll and related expenses
    
    
    5,330
    
    
    
    4,124
    
    
    
    4,661Other accrued expenses
    
    
    5,748
    
    
    
    4,950
    
    
    
    4,855Income taxes payable
    
    
    3,036
    
    
    
    4,418
    
    
    
    2,796Total current liabilities
    
    
    21,323
    
    
    
    20,231
    
    
    
    19,792Other long-term liabilities
    
    
    7,762
    
    
    
    6,964
    
    
    
    7,292Deferred income taxes
    
    
    2,353
    
    
    
    552
    
    
    
    2,339Shareholders equity:Paid-in-capital
    
    
    25,426
    
    
    
    26,685
    
    
    
    25,569Retained earnings
    
    
    66,161
    
    
    
    71,018
    
    
    
    65,640Accumulated other comprehensive income (loss)
    
    
    569
    
    
    
    (345
    )
    
    
    98Unamortized portion of restricted stock
    
    
    (58
    )
    
    
    (98
    )
    
    
    (65
    )Common shares held in treasury, at cost
    
    
    (5,481
    )
    
    
    (8,088
    )
    
    
    (6,479
    )Total shareholders equity
    
    
    86,617
    
    
    
    89,172
    
    
    
    84,763Total liabilities and shareholders equity
    
    $
    118,055
    
    
    $
    116,919
    
    
    $
    114,186


The accompanying notes are an integral part of the financial statements.

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KEITHLEY INSTRUMENTS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands of Dollars Except for Per Share Data)
(Unaudited)

FOR THE THREE MONTHSENDED DECEMBER 31,2003
    
    2002Net sales
    
    $
    29,742
    
    
    $
    26,199Cost of goods sold
    
    
    12,143
    
    
    
    11,557Selling, general and administrative expenses
    
    
    12,810
    
    
    
    12,434Product development expenses
    
    
    3,345
    
    
    
    3,210Operating income (loss)
    
    
    1,444
    
    
    
    (1,002
    )Investment income
    
    
    151
    
    
    
    279Interest expense
    
    
    (17
    )
    
    
    (58
    )Income (loss) before income taxes
    
    
    1,578
    
    
    
    (781
    )Income taxes (benefit)
    
    
    489
    
    
    
    (274
    )Net income (loss)
    
    $
    1,089
    
    
    $
    (507
    )Basic earnings (loss) per share
    
    $
    0.07
    
    
    $
    (0.03
    )Diluted earnings (loss) per share
    
    $
    0.07
    
    
    $
    (0.03
    )Cash dividends per Common Share
    
    $
    0.0375
    
    
    $
    0.0375Cash dividends per Class B
Common Share
    
    $
    0.0300
    
    
    $
    0.0300


The accompanying notes are an integral part of the financial statements.

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KEITHLEY INSTRUMENTS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands of Dollars)
(Unaudited)

FOR THE THREE MONTHSENDED DECEMBER 31,2003
    
    2002Cash flows from operating activities:Net income (loss)
    
    $
    1,089
    
    
    $
    (507
    )Expenses not requiring outlay of cash
    
    
    1,156
    
    
    
    1,112Changes in working capital
    
    
    (657
    )
    
    
    969Other operating activities
    
    
    167
    
    
    
    (299
    )Net cash provided by operating activities
    
    
    1,755
    
    
    
    1,275Cash flows from investing activities:Payments for property, plant, and equipment
    
    
    (786
    )
    
    
    (1,098
    )Purchase of investments
    
    
    (5,264
    )
    
    
    (5,073
    )Sale of investments
    
    
    4,205
    
    
    
    5,240Net cash used in investing activities
    
    
    (1,845
    )
    
    
    (931
    )Cash flows from financing activities:Increase in short-term debt
    
    
    123
    
    
    
    26Cash dividends
    
    
    (568
    )
    
    
    (561
    )Purchase of treasury stock
    
    
    
    
    
    
    (2,355
    )Proceeds from employee stock purchase plans
    
    
    261
    
    
    
    65Net cash used in financing activities
    
    
    (184
    )
    
    
    (2,825
    )Effect of changes in foreign currency exchange rates
on cash and cash equivalents
    
    
    403
    
    
    
    256Change in cash and cash equivalents
    
    
    129
    
    
    
    (2,225
    )Cash and cash equivalents at beginning of period
    
    
    15,739
    
    
    
    21,707Cash and cash equivalents at end of period
    
    $
    15,868
    
    
    $
    19,482


The accompanying notes are an integral part of the financial statements.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(In thousands of dollars, except for share data)



|A. |  | Nature of Operations
|-- |  | --------------------



| |  | Keithley Instruments, Inc. provides a greater measure of confidence to
customers around the world by designing solutions for their emerging test
and measurement needs. By building from our strength in electrical
measurement solutions for research, Keithley has become a production test
technology leader through working partnerships with leaders in fields where
the pace of innovation and change is fast, such as global communications,
semiconductors, and components manufacturing. Keithley 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. |  | Financial Statement Presentation
|-- |  | --------------------------------



| |  | The consolidated financial statements at December 31, 2003 and 2002, and for
the three month periods then ended have not been audited by independent
auditors, but in the opinion of the management of Keithley Instruments,
Inc., all adjustments necessary to fairly present the consolidated balance
sheet, consolidated statement of operations and consolidated statement 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, 2003 and 2002 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, 2003,
which were included in the Form 10-K filed on December 24, 2003. 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, pension
plan assumptions, and the assessment of the valuation of deferred income
taxes and income tax reserves. Actual results could differ from those
estimates.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  | Certain amounts in the prior year have been reclassified to be consistent
with the current years presentation.
| |  | ---------------------------------------------------------------------------------------------------------------



|C. |  | Earnings Per Share, Including Pro Forma Effects of Stock-based Compensation
|-- |  | ---------------------------------------------------------------------------



| |  | Both 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:
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

December 31,2003
    
    2002Net income (loss)
    
    $
    1,089
    
    
    $
    (507
    )Weighted average shares outstanding
    
    
    15,544,377
    
    
    
    15,488,886Assumed exercise of stock options
    
    
    565,567
    
    
    
    Assumed purchase of stock under stock purchase plan
    
    
    49,795
    
    
    
    Weighted average shares used for dilutive
earnings per share
    
    
    16,159,739
    
    
    
    15,488,886Basic earnings (loss) per share
    
    $
    0.07
    
    
    $
    (0.03
    )Diluted earnings (loss) per share
    
    $
    0.07
    
    
    $
    (0.03
    )




| |  | In 2002, 425,326 shares are excluded from the dilutive calculation due to
the net loss. 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.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 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:
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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December 31,2003
    
    2002Net income (loss)
    
    $
    1,089
    
    
    $
    (507
    )Add: Stock-based employee compensation
expense included in reported loss/
income, net of related tax effects
    
    
    5
    
    
    
    6Deduct: Stock-based employee
compensation expense determined
under fair value based methods for
all awards, net of related tax effects
    
    
    (1,054
    )
    
    
    (1,053
    )Pro forma net income (loss)
    
    $
    40
    
    
    $
    (1,554
    )Pro forma basic earnings (loss) per share
    
    $
    0.00
    
    
    $
    (0.10
    )Pro forma diluted earnings (loss) per share
    
    $
    0.00
    
    
    $
    (0.10
    )




|D. |  | Repurchase of Common Shares
|-- |  | ---------------------------



| |  | 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 shares purchased in the prior fiscal year, were acquired under the old
repurchase program, which had substantially the same terms as the 2003
program.
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The following table summarizes the Companys stock repurchase activity:
| |  | -----------------------------------------------------------------------

Three Months Ended December 31,2003
    
    2002Total number of shares purchased
    
    
    
    
    
    
    210,711Average price paid per share
(including commissions)
    
    
    
    
    
    $
    11.18Identity of broker-dealer used to effect the purchases
    
    not applicable
    
    Bear StearnsSecurities Corp.Number of shares purchased as part of
publicly announced repurchase programs
    
    
    
    
    
    
    210,711Maximum number of shares that remain
to be purchased under the program (1)
    
    
    2,000,000
    
    
    
    1,256,300


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| |  | (1)  The shares remaining at December 31, 2002, expired in December 2003.
| |  | -------------------------------------------------------------------------



| |  | Common Shares purchased under the Companys share repurchase programs
remaining in treasury at December 31, 2003, totaled 322,356, at an average
cost of $13.55 per share, including commissions.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 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. The total number of shares
held in treasury at December 31, 2003 was 461,961.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|E. |  | Accounting for Derivatives and Hedging Activities
|-- |  | -------------------------------------------------



| |  | In 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
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 designed 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, 2003, the forward 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. The
Company recorded income of $45 and $5 in the three months ended December 31,
2003 and 2002, respectively for the interest rate swap.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | 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
| |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  | is determined
that a derivative is not highly effective as a hedge, the Company
discontinues hedge accounting prospectively.
| |  | ----------------------------------------------------------------------------------------------------------------------------



|F. |  | Comprehensive Income
|-- |  | --------------------



| |  | Comprehensive income for the three months ended December 31, 2003 and 2002
is as follows:
| |  | -----------------------------------------------------------------------------------------

December 31,2003
    
    2002Net income (loss)
    
    $
    1,089
    
    
    $
    (507
    )Unrealized losses on value
of derivative securities
    
    
    (35
    )
    
    
    (177
    )Net unrealized investment gains
(losses)
    
    
    114
    
    
    
    (113
    )Foreign currency translation
adjustments
    
    
    392
    
    
    
    293Comprehensive income (loss)
    
    $
    1,560
    
    
    $
    (504
    )




|G. |  | Geographic Segment Information
|-- |  | ------------------------------



| |  | The Companys business is to develop test and measurement-based 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 product vary in capability,
sophistication, use size and price, they basically test, measure and analyze
electrical and physical properties, and in some cases RF or light. 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 revenues 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 Months EndedDecember 31,2003
    
    2002Net sales:United States
    
    $
    8,092
    
    
    $
    8,925Europe
    
    
    10,809
    
    
    
    8,600Pacific Basin
    
    
    8,462
    
    
    
    7,587Other
    
    
    2,379
    
    
    
    1,087$
    29,742
    
    
    $
    26,199


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At December 31,2003
    
    2002Long-lived assets:United States
    
    $
    20,960
    
    
    $
    19,458Germany
    
    
    4,341
    
    
    
    3,491Other
    
    
    731
    
    
    
    777$
    26,032
    
    
    $
    23,726




|H. |  | Guarantors Disclosure Requirements
|-- |  | -----------------------------------



| |  | Guarantee of original lease:
The 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 $1,138
through July 14, 2009. The Company has not recorded any liability for this
item, as it is does not believe that it is probable that the third party
will default on the lease payments.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Product warranties:
| |  | -------------------



| |  | Generally, 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 revenue, as well as the
costs related to the extended warranties is immaterial for the three months
ended December 31, 2003 and 2002.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | A reconciliation of the estimated changes in the aggregated product warranty
liability for the first quarter of fiscal 2004 and 2003 is as follows:
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------

2003
    
    2002Balance at October 1
    
    $
    1,498
    
    
    $
    1,415Accruals for warranties issued during the period
    
    
    347
    
    
    
    365Accruals related to pre-existing warranties
(including changes in estimates and expiring warranties)
    
    
    (96
    )
    
    
    (208
    )Settlements made (in cash or in kind) during the period
    
    
    (201
    )
    
    
    (229
    )Balance at December 31
    
    $
    1,548
    
    
    $
    1,343




|I. |  | Accrued Severance Liability
|-- |  | ---------------------------



| |  | During the third and fourth quarters of fiscal 2003, the Company recorded
pretax charges of $535 and $310, respectively, for severance relating to a
reduction in force of approximately 23 individuals, or less than 5 percent
of the worldwide work force. The majority of the individuals were in sales
or sales support functions.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  | A reconciliation of the changes in the aggregated accrued severance
liability for the first quarter of fiscal 2004 is as follows:
| |  | ---------------------------------------------------------------------------------------------------------------------------------

Balance at October 1, 2003
    
    $
    503Payments made
    
    
    (80
    )Foreign exchange revaluation
    
    
    31Balance at December 31, 2003
    
    $
    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 lean manufacturing, ERP and CRM system implementations, investments
to develop RF products, cost reduction efforts, conditions of the electronics
industry, general economic conditions, 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 DC, RF or
optical signals. Our customers are engineers, technicians and scientists in
manufacturing, product development and research functions. During the first
quarter of fiscal 2004, orders from our semiconductor customers comprised
approximately 25 percent of the total, wireless communications orders were
approximately 15 percent, precision electronic components and subassembly
manufacturers orders were approximately 30 percent, research and education made
up about 20 percent, optoelectronics orders made up 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, RF, optical or physical
properties. As such, we consider our business to be in a single test and
measurement industry segment.

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Many of the industries we serve, including but not limited to the semiconductor
industry, the wireless communications industry, the optoelectronics industry,
and electronic components and subassemblies manufacturers have historically
been very cyclical. Beginning in the second half of fiscal year 2001, an
economic downturn affecting the worldwide electronics industry had a negative,
material impact on our customers businesses, as well as our business.
Conditions throughout the electronics industry appear to have stabilized, and
we noted an improved environment in the electronics industry during the fourth
quarter of fiscal year 2003, continuing into the first quarter of fiscal 2004.
However, there can be no assurance that the underlying end markets we serve
will continue to improve or that the recent increased levels of business
activity will continue as a trend into the future.

Effective January 1, 2003, we began to sell our products in the United States
through a direct sales force. Prior to January 1, 2003, we sold through sales
representatives to which we paid a commission. The change in our sales channel
allowed us to build a sales network of focused, highly trained sales engineers
who specialized in measurement expertise and problem-solving for customers, and
enhanced our ability to sell not only in the United States, but to U.S.
companies with foreign manufacturing operations. During the first quarter of
fiscal 2003, we incurred approximately $600 in one-time costs as we paid both
commissions to sales representatives and salaries to our own sales employees.
We expect that selling through our own sales force in the United States will be
favorable to earnings during times of strong U.S. sales and unfavorable during
times of depressed U.S. sales as a greater portion of U.S. selling costs are
now fixed.

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 will continue to roll out
additional ERP and CRM modules and locations throughout 2004.

Over the last 15 to 21 months, we have made major changes to the way we
purchase materials and manufacture our products as we have adopted lean
manufacturing principles. During the initial start-up phase, our overall
manufacturing costs increased. During the fourth quarter of fiscal 2003, we
began our next phase of the lean implementation, which involves fine-tuning our
processes and improving our execution. We began to see improvements during the
fourth quarter of fiscal 2003 and into the first quarter of fiscal 2004 in
lowering our manufacturing costs and improving our manufacturing effectiveness.

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.

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Our critical accounting policies and estimates are described in Managements
Discussion and Analysis included in the 2003 annual report on Form 10-K filed
on December 24, 2003, and include use of estimates, revenue recognition,
inventories, income taxes, pension plan, and stock compensation plans. In
addition, foreign currency translation has been added to our critical
accounting policies and estimates for the first quarter of fiscal 2004.

Foreign currency translation:

Our revenues, costs and expenses, and assets and liabilities are exposed to
changes in foreign currency exchange rates as a result of our global
operations. For those subsidiaries that operate in a local currency functional
environment, all assets and liabilities are translated into U.S. dollars using
current exchange rates, and revenues and expenses are translated using average
exchange rates in effect during the period. Resulting translation adjustments
are reported as a separate component of accumulated comprehensive income (loss)
in shareholders equity. For those entities that operate in a U.S. dollar
functional currency environment, foreign currency assets and liabilities are
remeasured into U.S. dollars at current exchange rates. Gains or losses from
foreign currency remeasurement are generally immaterial and are included in the
Selling, general and administrative expenses caption of the consolidated
statements of operations.

Results of Operations

First Quarter Fiscal 2004 Compared with First Quarter Fiscal 2003

Net sales of $29,742 for the first quarter of fiscal 2004 increased 14 percent
from sales of $26,199 in the prior years first quarter. Approximately six
percent of the increase was due to the weaker U.S. dollar. Sales were higher in
all major geographies except the United States with U.S. sales down 9 percent,
Europe up 26 percent and the Pacific Basin region up 12 percent from the prior
years quarter. Sequentially, sales increased one percent from the fourth
quarter of fiscal 2003, due primarily to the weaker dollar.

Orders of $30,919 for the first quarter of fiscal 2004 increased 34 percent
from last years orders of $23,049. Geographically, orders were flat in the
United States, up 42 percent in the Pacific Basin, and up 63 percent in Europe.
Orders increased across all major customer groups with semiconductor customer
orders up approximately 65 percent, wireless communications customers
increasing approximately 40 percent, precision electronic components and
subassembly manufacturers up about 35 percent, and research and education up
about five percent. See the Overview section of Managements Discussion and
Analysis of Financial Condition and Results of Operations for a breakout of
first quarter fiscal 2004 orders by major industry group. Order backlog
increased $2,340 during the quarter to $16,846 at December 31, 2003. The
Company does not track net sales in the same manor as it tracks orders by major
customer group. However, sales trends will 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 40.8 percent from
44.1 percent in the prior years first quarter. The improvement was due to
lower manufacturing costs as a result of the progress we made in fine-tuning
our lean manufacturing process, as well as spreading fixed manufacturing costs
over higher sales volume. Nearly all products the Company sells are
manufactured in the United States; therefore, cost of goods sold expressed in
dollars is generally

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not affected by changes in foreign currencies. However, as
a percentage of net sales, it is affected as net sales dollars are affected by
currency exchange rate changes. The gross margin benefit of the weaker dollar
was almost entirely offset by unfavorable customer and product mix in the first
quarter of fiscal 2004 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 $12,810 increased $376, or
three percent, from last years first quarter, although such expenses decreased
as a percentage of net sales to 43.1 percent from 47.5 percent last year. The
increase in costs was primarily due to higher costs outside the United States
due to the weaker dollar (approximately $430), the accrual of fiscal year
incentive costs that are tied to financial performance (approximately $330),
and higher salaries and inside commissions for the direct sales force
(approximately $105), which were partially offset by lower commissions as a
result of going direct in the United States of (approximately $575).

Product development expenses for the quarter were $3,345, or 11.2 percent of
net sales, up $135, or four percent, from last years $3,210, or 12.3 percent
of sales. To take further advantage of growing opportunities in wireless test
beyond our current product offering, we have increased our product development
budget and resources for RF products by adding a team of experienced RF
engineers for our newly established West Coast product development center. This
expansion will allow us to accelerate our RF product development plans over
time. We expect the additional costs in product development will be offset by
decreases in costs in other areas. All product development activities are done
in the United States, therefore, changes in foreign exchange rates have no
impact on these expenses.

The Company reported operating income for the first quarter of fiscal 2004 of
$1,444 versus a loss from operations of $1,002 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 $151 for the quarter compared to $279 in last years
first quarter. Lower average cash and short-term investment balances and lower
interest rates accounted for the decrease.

The Company recorded income taxes at a 31.0 percent rate for the quarter. The
rate was lower than the statutory rate due to an estimated return provision
adjustment offset somewhat by an additional valuation allowance for foreign tax
credits generated during the current fiscal year. Last years first quarter tax
benefit was recorded at a 35.0 percent rate.

The Company reported net income of $1,089, or $0.07 per share, compared to a
net loss of $507, or $0.03 per share, in last years first quarter. The
increase from the prior year was largely due to higher sales and lower
manufacturing costs, offset somewhat by higher operating expenses described
above.

Financial Condition, Liquidity and Capital Resources

Cash and cash equivalents and short-term investments totaled $36,958 at
December 31, 2003, an increase of $1,149 from September 30, 2003. We consider
our short-term investments to be

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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 $532 at December
31, 2003, an increase of $123 during the quarter. We have no long-term debt.
The primary source of cash for the Company is through its product sales. During
the first quarter, net cash provided by operating activities was $1,755. We
also received $261 through our employee stock option plans. The principle use
of cash was for capital expenditures of $786 and to pay dividends to our
shareholders of $568. During the quarter, our Board of Directors authorized an
open market stock repurchase program to replace the program which expired in
December 2003. See Note D. We did not repurchase any of our stock during the
first quarter of fiscal 2004.

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, 2003, we had available unused lines of
credit with domestic and foreign banks aggregating $14,468, all of which was
short-term. Our credit agreement will expire on March 30, 2004. We are in
discussions with our lead bank to either extend the current credit agreement or
negotiate a new credit agreement. We expect to have an agreement in place
before our current agreement expires.

Outlook

Worldwide economies continued to improve during the first quarter, and our
customers are more optimistic than they have been in quite some time. And while
our customers are optimistic, they remain cautious about their
capital commitments.
Our future growth will be driven by a change in their spending patterns when
they invest in new capacity or to upgrade their lines for their new product
offerings.

Based upon current expectations, the Company is estimating sales for the second
quarter of fiscal 2004, which will end March 31, 2004, to range between $30,000
and $33,000. Pretax earnings are expected to be in the single digits as a
percentage of sales.

Factors That May Affect Future Results

Our business depends primarily on capital expenditures of manufacturers in the
electronics industry. These industries have historically been very cyclical and
have experienced downturns, which have had a material impact on our business.
The economic downturn of the past two to three years resulted in reduced
purchasing and capital spending in many of the markets that we serve worldwide.
In particular, the communications, semiconductor and electronics industries had
been in a downward cycle characterized by diminished product demand and excess
manufacturing capacity. Although these industries have shown recent signs of
stabilization or improvement, there can be no assurance that these industries
will continue to improve or that the recent increased levels of business
activity will continue into the future. The cyclicality and volatility in our
markets have in the past, and could continue, to adversely affect our results
depending upon future business conditions in these industries. The Company has
been experiencing some pricing pressures from our customers, which could reduce
gross margins. 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.

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We are managing our cost structure to reallocate resources to areas that we
feel will provide the best long-term benefit to our customers and shareholders.
For instance, we are working to reduce our manufacturing costs, while
increasing our product development investments for RF technologies. If we fail
to cut costs in some areas as we increase them in others, our operating results
will be adversely affected.

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 that may or may not result in significant sources of revenue and
earnings in the future.

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 volumes of electronic components and subassemblies
that in some cases are supplied through sole or limited source third-party
suppliers. Although we do not anticipate any problems procuring supplies in the
near-term, there can never be any 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. The 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 almost
three-quarters of our revenue during the first quarter of fiscal 2004. Our
future results could be adversely affected by several factors, including
changes in foreign currency exchange rates, political unrest, wars and other
acts of terrorism, changes in other economic or political conditions, trade
protection measures, import or export licensing requirements, unexpected
changes in regulatory requirements, natural disasters, and the potential for a
reoccurrence of the SARS virus.

We began to implement a lean manufacturing initiative in our manufacturing
facilities, which are located in Solon, Ohio. We incurred start-up costs during
fiscal 2002 and fiscal 2003, which adversely affected gross margins. The next
phase of the lean implementation involves fine-tuning processes and improving
execution. Our results, as well as the benefits we expect to derive from lean
manufacturing, could be adversely affected if we are unable to continue to
effectively implement the next phase of the lean manufacturing initiative.

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 2004
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, 2003, 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

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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.

On January 1, 2003, we began to use our own employees, rather than sales
representatives, to sell our products in the United States. We believe we have
regained any momentum lost during the transition period. However, this action
raised our fixed costs and our results could be adversely affected during times
of depressed sales.

Throughout fiscal 2004, we will continue 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.

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

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of certain of these investments.
However, 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.

Management of the Company has evaluated, with the participation of the
Companys Chief Executive Officer and Chief Financial Officer, the
effectiveness 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 on that evaluation, the Chief Executive
Officer and Chief Financial Officer have concluded that the Companys
disclosure controls and procedures are effective to ensure the timely
collection, evaluation and disclosure of information relating to the Company
that would potentially be subject to disclosure under the Securities Exchange
Action of 1934, as amended, and the rules and regulations promulgated
thereunder.




PART II. OTHER INFORMATION




Item 6. Exhibits and Reports on Form 8-K.



|(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.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(b) |  | Reports on Form 8-K. On November 3, 2003, and December 8,
2003, the Company furnished Current Reports on Form 8-K reporting
the results of operations for its fourth fiscal quarter and year
ended September 30, 2003, under Item 12  Results of Operations and
Financial Condition.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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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 13, 2004
    
    /s/  Joseph P. Keithley
Joseph P. Keithley
Chairman, President and
Chief Executive Officer
(Principal Executive Officer)Date: February 13, 2004
    
    /s/  Mark J. Plush
Mark J. Plush
Vice President and Chief
Financial Officer
(Principal Financial and
Accounting Officer)


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