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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)

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.

(Exact name of registrant as specified in its charter)

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 ü    NO     

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

YES          NO ü

     As of February 12, 2003 there were outstanding 13,320,856 Common Shares, without par value (net of shares held in treasury), and 2,150,502 Class B Common Shares, without par value.

Table of Contents

PART I. FINANCIAL INFORMATION

ITEM 1. Financial Statements.

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

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

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

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A.		Management Representation
		The consolidated financial statements at December 31, 2002 and 2001, and for the three month periods then ended have not been examined by independent accountants, but in the opinion of the management of Keithley Instruments, Inc., (the “Company” or “Keithley”) all adjustments necessary to a fair statement of the consolidated balance sheet, consolidated statement of income and consolidated statement of cash flows for those periods have been included. All adjustments included are of a normal recurring nature.
B.		Earnings Per Share Denominator
		The weighted average number of shares and share equivalents used in determining earnings per share was 15,488,886 for the quarter ended December 31, 2002, and 15,624,502 for the quarter ended December 31, 2001. Both Common Shares and Class B Common Shares are included in calculating the weighted average number of shares outstanding.
C.		Stock Repurchase Programs
		On December 11, 2000, the Company announced its Board of Directors had approved an open market stock repurchase program. Under the terms of the 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 repurchase 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 following table summarizes the Company’s stock repurchase activity for the three months ended December 31, 2002:

At December 31, 2002, 523,649 Common Shares purchased under the Company’s share repurchase programs remained in treasury at an average cost of $13.60 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, 2002 was 655,142.

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D.		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”, 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 cost of goods sold. 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. 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, 2002, the forward exchange forward contracts were designed as 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 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.

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E.		Comprehensive Income
		Comprehensive income for the three months ended December 31, 2002 and 2001 is as follows:

F.		Segment and Geographic 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 products vary in capability, sophistication, use and price, they basically test, measure and analyze electrical and physical properties, and in some cases RF or light. As such, the Company’s management has determined that the Company operates in a single industry segment. The operations by geographic area are presented below. The basis for attributing revenues from external customers to a geographic area is the location of the customer.

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G.		Guarantor’s Disclosure Requirements
		In November 2002, the Financial Accounting Standards Board issued FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (“FIN 45”). FIN 45 elaborates on the disclosures to be made by a guarantor in its financial statements about its obligations under certain guarantees it has issued. It also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The initial recognition and initial measurement provisions of FIN 45 are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. The disclosure requirements are effective for financial statements of interim or annual periods ending after December 15, 2002.
		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 $1,239 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 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.
		A reconciliation of the estimated changes in the aggregated product warranty liability for the first quarter of fiscal 2003 is as follows:

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ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Critical Accounting Policies and Estimates

Management has identified the Company’s “critical accounting policies”. These policies have the potential to have a significant impact on the Company’s 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.

Use of estimates:

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 that 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 period. Actual results could differ materially from those estimates.

Inventories:

Inventories are stated at the lower of cost or market. Cost is determined based on a currently-adjusted standard, which approximates actual cost on a first-in, first-out basis. The Company periodically reviews its recorded inventory and estimates a reserve for obsolete or slow-moving items. Such estimates are difficult to make under current economic conditions. If actual demand and market conditions are less favorable than those projected by management, additional reserves may be required. If actual market conditions are more favorable than anticipated, the Company’s cost of sales will be lower than expected in that period.

Income taxes:

The Company’s provision for income taxes and the determination of the resulting deferred tax assets and liabilities involves a significant amount of judgment by management. The quarterly provision for income taxes or benefits is based upon an estimate of pretax financial accounting income or loss for the full year in each of the jurisdictions in which the Company operates, and is impacted by various differences between financial accounting income or loss and taxable income or loss. Judgment is also applied in determining whether the deferred tax assets will be realized in full or in part.

Stock compensation plans:

The Company has two active stock option plans and one inactive plan. The two active stock option plans are the 2002 Stock Incentive Plan and the 1997 Directors’ Stock Option Plan. The Company also has an employee stock purchase plan. The Company has chosen the disclosure provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-based Compensation” (SFAS 123), and as such, no compensation cost for the stock option and stock purchase plans has been recognized in the Company’s consolidated financial statements. For disclosure purposes, the valuation of stock issued to employees requires management to determine estimates for the expected life of the options, the expected risk-free interest rate during the expected life of the option, the expected volatility of the stock price over the expected life of

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the option, and the expected dividend yield. These estimations are significant factors in the valuation model and actual results could differ materially from these estimates. Currently, management expects to continue to follow the disclosure provisions of SFAS 123 and not record compensation expense related to these stock compensation plans.

Results of Operations — In Thousands of Dollars Except for Per Share Data

First Quarter Fiscal 2003 Compared with First Quarter Fiscal 2002

The Company reported a net loss for the first quarter of fiscal 2003 of $507, or $0.03 per share, compared to a net loss of $1,634, or $0.10 per share, in last year’s first quarter.

Net sales of $26,199 for the first quarter of fiscal 2003 increased 28 percent from sales of $20,424 in the prior year’s first quarter. Sales were higher in all major geographies with sales in the United States up 19 percent, Europe up 4 percent and the Pacific Basin region up 111 percent from the prior year’s quarter. Sequentially, sales decreased 8 percent from the fourth quarter of fiscal 2002.

Orders of $23,049 for the first quarter increased 15 percent from last year’s orders of $20,080. Geographically, orders were up 14 percent in the United States, up 88 percent in the Pacific Basin, and down 17 percent in Europe when compared to the prior year. Compared to the prior year’s first quarter, orders from semiconductor customers increased 57 percent, wireless communications customers increased 41 percent, electronic components and subassembly manufacturers increased 4 percent, and research and education increased 7 percent. For the first quarter, semiconductor orders comprised approximately 20 percent of the total, wireless communications orders were approximately 15 percent, electronic components and subassembly manufacturers orders were approximately 20 percent, research and education made up about 25 percent, while optoelectronics orders made up less than 5 percent. Sequentially, orders decreased 12 percent from the fourth quarter of fiscal 2002. Order backlog decreased $2,467 during the quarter to $12,310 at December 31, 2002.

Cost of goods sold as a percentage of net sales decreased to 44.1 percent from 44.9 percent in the prior year’s first quarter. The improvement was due to better gross margins in Japan resulting from the opening of a direct sales office in April 2002, an approximately 12 percent weaker U.S. dollar versus European currencies, and fixed costs being spread over higher sales volumes. This was partially offset by higher start-up costs related to t