Forward-Looking Statements
This Annual Report on Form 10-K (the Report), including Managements Discussion and Analysis of Financial
Condition and Results of Operations in Item 7, contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 regarding future events and the future results of Schmitt Industries, Inc. and its
consolidated subsidiaries (the Company) that are based on managements current expectations, estimates, projections and assumptions about the Companys business. Words such as expects, anticipates,
intends, plans, believes, sees, estimates and variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees
of future performance and involve risks, uncertainties and assumptions that are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements due to
numerous factors, including, but not limited to, those discussed in the Risk Factors section in Item 1A, Managements Discussion and Analysis of Financial Condition and Results of Operations in Item 7 and elsewhere in
this Report as well as those discussed from time to time in the Companys other Securities and Exchange Commission filings and reports. In addition, such statements could be affected by general industry and market conditions. Such
forward-looking statements speak only as of the date of this Report or, in the case of any document incorporated by reference, the date of that document, and we do not undertake any obligation to update any forward-looking statement to reflect
events or circumstances after the date of this Report. If we update or correct one or more forward-looking statements, investors and others should not conclude that we will make additional updates or corrections with respect to other forward-looking
statements.
Introduction
Schmitt Industries, Inc. (the Company), an Oregon corporation, designs, manufactures and sells high precision test and measurement products for two main
business segments: the Balancer segment and the Measurement segment. For the Balancer segment, the Company designs, manufactures and sells computer-controlled vibration detection, balancing and process control systems for the worldwide machine
tool industry, particularly for grinding machines. Through its wholly owned subsidiary, Schmitt Measurement Systems, Inc., an Oregon corporation, the Company designs, manufactures and sells laser and white light sensors for distance,
dimensional and area measurement for a wide variety of commercial applications, laser-based microroughness measurement products for the semiconductor wafer and hard disk drive industries and for other industrial applications, laser-based surface
analysis and measurement products for a variety of scientific applications, and ultrasonic measurement products that accurately measure the fill levels of tanks holding propane, diesel and other tank-based liquids and transmit that data via
satellite to a secure web site for display (the Measurement segment). The Company also provides sales and service for Europe and Asia through its wholly owned subsidiary, Schmitt Europe Limited (SEL), located in Coventry, England and through
its sales representative office located in Shanghai, China. The Companys corporate office is located at 2765 N.W. Nicolai Street, Portland, Oregon.
SBS, SMS, Acuity, Xact, Lasercheck and AccuProfile are registered trademarks owned by the Company.
Balancer Segment
The
Companys principal product line for this segment is the Schmitt Dynamic Balance System (SBS), which consists of a vibration sensor, a computer control unit, and a balance head that is placed either externally on the grinding wheel spindle with
the use of a spindle mounted adaptor or internally inside the spindle bore. The
SB-5500
control panel contains up to four slots for additional circuit boards designed for specific functions, such as manual
balancing, balancing using hydro chambers and process monitoring, which involves the detection and
Page 2
analysis of high frequency noise, known as acoustic emission (AE), generated by the grinding process. SBS products are designed as economical yet highly precise measurement and control devices
for permanent or portable installation on grinding machines that can detect and correct imbalance caused by vibration as small as 0.02 microns. Customers can also detect and analyze the AE signal generated during grinding or wheel dressing to help
monitor and improve the grinding process. Customers include both end user operators as well as manufacturers of grinding machines worldwide for a wide variety of industries that utilize the grinding process, including the automotive, industrial,
aerospace, and medical industries where specifications and operating tolerances on machined parts are increasingly precise.
The SB-5500 is
fully automated, eliminating the need to
pre-balance
parts such as grinding wheels. This reduces machine setup time and ensures a smoother and more efficient grinding process. Operating on a
principle of mass compensation for wheel imbalance, the balance head contains two movable eccentric weights, each driven by electric motors through a precision gear train. These weights are repositioned to offset any imbalance in a grinding
wheel or other application. Imbalance or vibration is picked up by the vibration sensor that feeds the detected signal to the control unit, which filters the signal by revolutions per minute. The controller then automatically drives the
balance head weights in a direction that reduces the amplitude of the vibration signal. The balance cycle is complete when the weights are positioned to achieve the lowest vibration level, as low as 0.02 microns.
The SB-5500 also includes an optional Acoustic Emission Monitoring System (AEMS) control card, which uses proprietary acoustic sensor technology to
monitor the AE signal generated on the grinding machine during key events in the grinding process. The AEMS card allows rapid, automatic grinding wheel in-feed, right up to the point of initial contact of the grinding wheel with a new part loaded in
the machine. The system can automatically detect the initial contact and very quickly report this event to the machine control, stopping the wheel in-feed without operator intervention. Part crash occurs when a part or fixture is incorrectly loaded
into a grinding machine or some abnormal condition occurs. Rapid in-feed of the wheel may then result in a dangerous or expensive crash. The AEMS card allows the grinding machines operating system (known as a computer numeric control or CNC
system) on the machine to monitor the acoustic levels and detect any unexpected contact when it happens. The system then reports that abnormal contact and instructs the CNC program to stop the grinding process, usually within one millisecond.
The SB-5500 also offers two process control cards that fit inside the control panel to provide enhanced control of the grinding process: the
ExactControl card and the ExactDress card. The ExactControl process control card offers multi-functional grinding process control capability by detecting and analyzing either the AE signal pattern or the machine power fluctuations and
then using one of seven process control strategies to adjust and optimize the grinding process based on that signal data, resulting in improved part quality and reduced operating costs. Software control strategies include ExactDisplay (graphically
displays the measurement signal), ExactGap (displays and evaluates the measurement signal against a predetermined signal threshold to automatically determine when the grinding wheel touches the work piece and to shorten the time between grinding
work pieces), ExactTime (displays and evaluates the time interval of a measurement signal that is above a predetermined signal threshold to monitor the minimum or maximum processing time, ExactIntegral (displays and evaluates the area under a
measurement signal curve to optimize the grinding process for the particular work piece), and ExactDress (displays and evaluates the measurement signal and compares it to a standard threshold to optimize the grinding wheel dress process).
The ExactDress control strategy is also available in a separate process control card as part of the AEMS system to automatically monitor and
control the grinding wheel dressing process. The AE signal pattern of a wheel dress is displayed and compared to a stored master AE signal pattern and indicates when the dressing process has been successfully completed. Monitoring for AE
levels during wheel dressing permits the operator or CNC control to determine if the wheel is being dressed fully across its width, control the aggressiveness of the process and maintain the quality of the dressed wheel to conserve wheel material.
Page 3
Additional SBS products include the SB-2000 and the AE-1000. The SB-2000 is an easy-to-use, compact
manual balancing system offering both one and two plane manual balancing capabilities. The system comes in a dedicated machine installation version (SB-2000) and a portable version (SB-2000-P). Each version of the system displays up to
four digits of resolution for vibration and six digits for RPM readings and supports a spindle speed range of 30 to 100,000 RPM. The portable SB-2000-P version attaches magnetically to any location on the machine for easy setup and
use. The AE-1000 is a dedicated AE control platform that reduces air machine grinding time and alerts the operator to potential grinding wheel crash conditions by using proprietary AE detection technology to monitor the high frequency signals
generated by the grinding process.
Notable features of the SBS system include its ability to fit almost all grinding machines, ease of
installation, compact and modular construction, ability to balance a wheel while on a machine, virtual elimination of wheel vibration, automatic monitoring of balancing, display in a variety of languages and in metric units of measurement,
instrument grade calibration, short balance process, measurement of both displacement and/or velocity and minimal operator maintenance. The SB-5500 also offers the capability of fully integrating its operation and output within any grinding
machines CNC operating system by the use of its IVIS (Intelligent Visualization) software.
Benefits of using the SBS system include
improved quality of finished parts, elimination of grinding gap time in the grind cycle resulting in increased efficiency and part throughput, ease of product adaptation, monitoring and correction of part crash, minimal downtime, complete and ready
installation, elimination of static balancing, longer life of the grinding wheel, diamond dressings and spindle bearings, the ability to balance within 0.02 microns and its adaptability to all types of machines.
Precision grinding is necessary in major manufacturing areas including the automotive industry (gear trains, camshafts, crankshafts, valves), bearings
(roller and tapered types), ceramics (precision shaping), electric motors (shafts), pumps (shafts and turbines), aircraft (engine parts such as turbine blades), and general manufacturing. Precision grinding has an established worldwide presence in
all industrialized countries and is expanding as a method of material removal and part processing. Within the Companys customer base for the SBS system, there are three major market segments:
Machine Tool Builders
These companies design and manufacture a variety of specialty application grinding
machines. SBS systems are distributed to markets throughout the world through machine tool original equipment manufacturers (OEMs), who incorporate the SBS system into their products.
Examples of some
well-known
worldwide machine tool builders who have offered and/or installed the
SBS System include Shanghai Machine Tool Works (China), ANCA (Australia), Capco Machinery (U.S.), Drake Manufacturing (U.S.), Ecotech/SMTW (China/U.S.), Erwin Junker (U.S.), Matrix Machine Tool (UK), Schleifring Group (Germany, China), Shaanxi
Qinchuan Machinery Development Co. (China), Cinetic Landis Grinding (U.S.), Koyo Machinery (U.S./Japan), Micron Machinery Limited (Japan/U.S.), USACH Technologies (U.S.), Tschudin (U.S.) and Weldon Solutions (U.S.). The Company currently sells
its products directly to major machine builders throughout the world.
Machine Tool Rebuilders
These
customers, found in most, if not all, industrialized nations, develop their business by offering to completely update and refurbish older grinding machines. These rebuilders typically tear the old machine apart and install new components, such
as the SBS system. The Company currently sells its products directly to major machine tool rebuilders throughout the world.
Grinding Machine Users
These end users become aware of the SBS system through trade shows, trade magazine
advertising, distributors, field representatives, referrals and new machine suppliers. The Companys business is conducted worldwide with some better known customers including: Black & Decker, Briggs and Stratton, Schaeffler,
Caterpillar, Eaton, Emerson Power Transmission, Cummins Engine, Ford Motor Company, General Electric, General Motors, Ingersoll Rand, Komatsu, Sumitomo Heavy Industries, SKF Bearing Industries, Timken, TRW Automotive Components and Universal
Bearing.
Page 4
For the years ended May 31, 2016, May 31, 2015 and May 31, 2014 (Fiscal 2016, 2015 and 2014), net sales of
the Companys balancing products totaled $6,962,746, $7,850,236 and $7,721,211, respectively. Net sales of balancing products accounted for 60%, 60% and 64% of the Companys total sales in Fiscal 2016, 2015 and 2014, respectively. See Note
5 to Consolidated Financial Statements.
Competition
Competitors in the Balancer segment primarily come from Germany and Italy. These competitors produce electromechanical and water balancers and process control products similar to SBS. The Companys
primary competitors are Marposs S.p.A., MPM Micro Prazision Marx GmbH and Balance Systems S.r.l.
Measurement Segment
Within the Measurement segment, the Company designs, manufactures and sells laser and white light sensors for distance,
dimensional and area measurement for a wide variety of commercial applications, laser-based microroughness measurement products for the semiconductor wafer and hard disk drive industries and for other industrial applications, laser-based surface
analysis and measurement products for a variety of scientific applications, and ultrasonic measurement products that accurately measure the fill levels of tanks holding propane, diesel and other tank-based liquids and transmit that data via
satellite to a secure web site for display.
Laser and White Light Sensors
These products include lasers utilizing both triangulation and time-of-flight methods of measurement, and confocal chromatic white light sensors that
are used in a wide range of industrial applications including manufacturing, lumber production, steel casting, glass and paper production, medical imaging, crane control and micron-level part and surface inspection and are sold under the Acuity
brand. Presently, there are 12 products offered under the Acuity brand: The AccuRange (AR)1000, AR2000, AR2500 and AR3000 distance measurement sensors, the AR700, AR500 and AR200 series of triangulating laser displacement sensors, the AR
CCS Prima and the AR CCS Initial chromatic confocal sensors, the AccuProfile (AP) 400 and AP820 and the Aquity (AQ) 6 2D laser line scanners. The Company designs, manufactures and sells the AR200 and AR700 and distributes the AR500, AR1000,
AR2000, AR2500, AR3000, AR CCS Prima, AR CCS Initial, AP400, AP820 and the AQ6, primarily into North America.
The AR1000, AR2000, AR2500 and
AR3000 distance measurement lasers utilize pulsed time of flight measurement principles to accurately measure distances of up to 30 meters (up to 300 meters with retro-reflective tape) with the AR1000, up to 100 meters (500 meters with
retro-reflective tape) with the AR2000, up to 50 meters (500 meters with retro-reflective tape) with the AR2500 and up to 300 meters (3000 meters with retro-reflective tape) with the AR3000. These products are highly versatile, being able to
measure distances both indoors and outdoors. Applications include, but are not limited to, load confirmation, alignment, lumber positioning, crane monitoring, fill level measurement, velocity measurement and laser altimeter.
The AR700 is a triangulation laser displacement sensor that provides superior performance in terms of accuracy, repeatability, and sample speed. The
AR700 boasts output speeds up to 9400 Hz and resolutions as a micron. The laser will output 9400 distance readings in a single second. The unit is also very compact, measuring approximately 80% smaller than its predecessor, the
AR600. Model variations permit applications up to 50 inches in range. Applications include high speed road profiling, product dimensional or thickness measurement, rubber thickness measurement, lumber or plywood thickness measurement,
carton dimensioning and product positioning.
The AR500 is a compact triangulation laser displacement sensor that provides accurate
measurements (+/- 0.15% linearity) at high speeds (standard to 9400 Hz, high speed option up to 56K Hz). The same compact enclosure houses models with ranges from 5 to 1000 millimeters. Sensor options include blue laser diodes, faster
speeds and cooling jackets. Applications include radiating surfaces and high speed applications such as road texture, ballistics and high speed event monitoring.
Page 5
The AR200 line is the Companys most compact series of triangulating laser displacement sensors. Four
models cover metric measurement ranges from 6 to 100 millimeters. All models boast a 1/500 accuracy rating for measurements within twelve microns. All models are standard with analog, limit switch and serial outputs. The AR200 sensors, much like the
longer-range AR700 sensors, project a beam of visible laser light that creates a spot on the target surface. Reflected light from the surface is viewed from an angle by a line scan camera and the targets distance is computed from the image
pixel data. The AR200-6M, -12M, -25M, -50M, and -100M have ranges in millimeters that match their model number. The AR200 displacement sensor cannot be overloaded and measures accurately even when a mirror reflects the entire light beam back to the
detector.
The AR CCS Prima white light confocal-chromatic displacement sensor is the most precise measurement system from Acuity. Using a
novel optical principle of measuring the reflected lights component wavelengths, these confocal sensors measure distance and position to within nanometers. These compact probes can measure to opaque, shiny or even transparent surfaces. Unlike
the other Acuity distance sensors, the Prima Confocal systems are comprised of an optical measurement pen and a separate controller. This controller houses all of the electronics, light source, etc. Only emitted white light and reflected
signals are passed between the pen and the controller via a thin fiber-optic transmission cable. The Confocal-Chromatic Sensors (CCS) are offered in a variety of measurement ranges and standoff distances, each with a corresponding resolution. The
shortest-range models resolve to 5 nanometers of height change.
The AR CCS Initial confocal sensor is an extremely precise point sensor for
measuring displacement and thickness. Each system includes a controller unit, a fiber optic cable, a measuring probe and all necessary cables and software. The CCS Initial measures distance and topography of varied targets, including
silicon, polished metals, glass, contoured lenses, polymers, semiconductor masks and natural materials. The technology in the CCS Initial supports nanometer-scale resolutions and the system comes in five different measurement models that range
from 0.4 to 12.0 mm.
The AP400 series line sensors are entry-level two-dimensional CMOS digital sensors for industrial surface dimensioning
and measurement applications. The scanner quickly and accurately generates low noise 2D profile scans of objects, surface or scenes. The sensor has an onboard processor and memory and comes with AcuityView image analysis
software. Typical applications include weld gap tracking and weld bead profiling, positional control of objects and surfaces, tire profiling, wheel profiling, surface profiling, 3D profile generation and dimensional measurement.
The AP820 is a two-dimensional laser line scanner that measures surface height profiles by projecting a beam of visible laser light that creates a line
on a targeted surface. The AP820 is a highly accurate sensor for industrial surface dimensional and measurement applications. The scanner quickly and accurately generates low-noise 2D or 3D profile scans of objects, surfaces or
scenes. The sensor automatically adjusts laser power and detector exposure to compensate for varying surface conditions. Typical scanner applications include weld gap tracking and weld bead profiling, positional control of objects and
surfaces, tire profiling, wheel profiling, surface profiling, 3D profile generation and dimensional measurement.
The new AQ6 laser line
sensor offers higher speed and higher resolution, with models from 0.3 megapixels to over 12 megapixels. The AQ6 uses the latest in new high density CMOS camera design with new Gigabit Ethernet communications and the newly released GeniCam high
speed vision protocols. This allows the customer to increase the resolution on the target and reduce the amount of sensors needed for larger parts. The new outputs also will allow for a faster and less expensive integration of the sensor into the
customers application. Applications include pipe and tube manufacturers, large laser line applications for flaw detection, and high accuracy scans of difficult targets. The AQ6 also lends itself to custom OEM applications with laser lines of
over 80 inches in length. Currently there are 9 models available.
Page 6
Surface Roughness Measurement Products
These products use a patented technology using laser light scatterometry to perform rapid, accurate, repeatable, non-destructive and non-contact surface
measurement tests that quantify surface micro-roughness. The technology is extremely precise, measuring surface roughness at the molecular (sub-Angstrom) level. Products are sold to manufacturers of hard disk drives, semiconductors,
silicon wafers and optical products and industries involved in fabrication processes that require precise and reliable measurements.
Computer
hard disk drives require exact manufacturing control and a narrow tolerance band for acceptable roughness, with surface roughness outside that narrow band resulting in a reduction in data density or storage capacity. The Companys technology
simultaneously measures disk surface roughness in two directions, radially, when the read/write head is moving to another disk sector, and circumferentially, when the read/write head is processing information on the disk. The two separate roughness
levels are required for proper head operation. The Company believes the precise measurement methods provided by its products are not possible through any other cost-effective measurement means.
The Companys product for the disk industry is the TMS (Texture Measurement System) 2000-RC, an accurate non-contact texture measurement
system. The product (used on aluminum substrates) is currently used worldwide by most major disk drive manufacturers, providing fast, accurate and repeatable microroughness measurements while quadrupling production throughput when compared to
other testing devices. Surface roughness can be measured to levels below 0.5 Angstroms. An Angstrom (Å) is a unit of measure equal to 1 hundred-millionth of a centimeter (the point of a needle is one million Å in diameter).
The Company offers two products devoted to the semiconductor wafer industry: the TMS2000W-RC and TMS3000W-RC. Both products provide fast,
accurate, repeatable measurements for manufacturers of silicon wafers, device quality semiconductors and memory devices. This industry demands manufacturing precision to increase performance and capacity and these products help achieve those goals.
Silicon wafers are carefully cut and polished to provide the base upon which a computer or memory chip is produced. Therefore, chip manufacturing is extremely dependent on the beginning surface roughness of the wafer. Since all silicon wafers
exhibit a microscopic level of surface roughness stemming from production techniques such as chemical deposition, grinding, polishing and etching, some method of measuring surface roughness is required. The Companys wafer measurement products
provide a way for customers to quantify and control their manufacturing process. The system provides measurements to less than 0.5 Å.
The Company also offers the Lasercheck line of surface roughness measurement gauges. Lasercheck is a unique laser-based non-contact roughness gauge
incorporating patented laser light-scatter technology that can make precise and repeatable surface roughness measurements in the 0.025 to 2 micron (<1.0 to 80 micro inches) range. Lasercheck provides high-speed in-process measurements in a
fraction of a second and is optimized for surface measurements of ground, sanded, polished, hone, super-finished and shot-blasted surfaces.
Laser Light-Scatter Surface Measurement Products
The Companys CASI (Complete Angle Scatter Instrument) Scatterometers are sold to companies and institutions involved in scientific research and development. The CASI Scatterometer uses visible,
ultraviolet or infrared laser light as a nondestructive probe to measure surface quality, optical performance, smoothness, appearance, defects and contamination on a wide variety of materials. These products are scientific measurement instruments
providing customers with molecular-level precision in roughness measurement of optical surfaces, diffuse materials, semiconductor wafers, magnetic storage media and
precision-machined
surfaces, as well as
surfaces affecting the cosmetic appearance of consumer products.
The MicroScan system is a portable device consisting of a
hand-held
control unit, an interchangeable measurement head and a separate charging unit. To perform a measurement, the operator places the measurement
Page 7
head on the objective area and presses a button. Each measurement takes less than five seconds with results displayed and stored in system memory. The MicroScan can store 700
measurements in 255 files and provides the capability to program pass/fail criteria. Software is available for control, analysis and file conversion. From a single measurement, a user can determine RMS surface roughness, reflectance and
scatter light levels (BRDF) on either flat or curved surfaces and under any lighting conditions.
Competition
Management believes the TMS and Lasercheck surface measurement products are two of only a few systems that provide fast, accurate, repeatable non-contact
microroughness measurement for a wide variety of commercial customers. The Company believes its surface measurement products are currently the only systems that can provide measurements as low as a few hundredths of an Å, with reproducibility
+/- 0.2Å or 1% and repeatability of +/-0.1Å. There are differences between our surface measurement products and other optical techniques (which include profilometers, scanning tunneling microscopes, atomic force microscopes or
interferometers). These other technologies require the intervention of a skilled operator to perform measurements relatively slowly, whereas our surface measurement products are much simpler and, consequently, can make measurements more rapidly
while still maintaining excellent repeatability and accuracy. Stylus profilometers are simpler devices that require less skilled operators. However, measurements must be conducted under vibration isolation conditions, and large areas require
numerous scans; thus, stylus profilometers are generally destructive to soft materials such as most coated optics.
The market for distance
measurement and dimensional sizing products is extremely competitive, characterized by rapidly changing technology. The Company believes the principal elements of competition include quality of ongoing technical support and maintenance coupled with
responsiveness to customer needs, as well as price, product quality, reliability and performance. The differences between the Companys sensors and competitive products include pushbutton selection of output signals in certain models and
sensors that can be programmed using serial commands through a PC computer.
Competing surface measurement products and dimensional sizing
products come from established multinational competitors, most of which are significantly larger and have greater financial, engineering, manufacturing and marketing resources. Company pricing is intended to obtain market share and meet
competitive supplier prices. The market strategy is to establish measurement products with the best quality, reliability and performance and superior economic value.
Remote Tank Monitoring Products
The Companys Xact Tank
Monitoring System provides remote fill level monitoring of propane, diesel and other tank-based liquids for tanks, large or small, anywhere in the world.
Accessing accurate fill level information is essential to effectively manage
inventory, improve delivery efficiency, reduce operating costs and increase profitability, and justify capital expenditures. The Xact system utilizes an ultrasonic sensor that is applied externally to the tank to calculate the fill level inside the
tank with great accuracy (+/- 2% for large tanks, +/-1% for small tanks). The Xact system can also be installed to measure the fill levels of bobtail and transport trucks. For smaller tanks that are difficult to access or where the precise accuracy
provided by the ultrasonic sensor is not as important, Xact also offers a sensor that is affixed to the dial of a preinstalled float gauge (known as a gauge reader) which detects the fill level that is reported by the gauge. Float gauges
have a typical accuracy of +/- 8% to 12%. Tank fill data is then transmitted via the Globalstar
®
satellite
network to a secure website for display. There is no reliance on phone land lines or cellular networks and therefore no dropped data. The use of satellite telemetry permits monitoring of any tank anywhere in the world. With the Xact system, minimum
or maximum alarm or fill levels can be set to automatically notify operators by email anytime a particular tank reading exceeds thresholds or needs refilling. The Xact system can be used to monitor tanks as small as 125 gallons (473 liters) and as
large as 90,000 gallons (340,686 liters). With Xact, operators can obtain timely and accurate readings of inventory levels and tank refill requirements on a predetermined timely basis.
Page 8
There are three main components to the Xact Tank Monitoring System:
Tank Sensor
The Xact ultrasonic sensor incorporates patented technology and is externally mounted to the bottom of the tank. The sensor produces a small electrical pulse, or a ping, that travels through
the tanks steel shell, which is reflected off the bottom surface of the liquid stored in the tank in the form of an echo that is detected by the sensor. The time of flight between the ping and the echo, which is measured in
milliseconds, is then calculated to determine, based upon additional data regarding tank size and shape, the volume of liquid the tank contains. This information is then remotely transmitted via a satellite radio transmitter. For smaller tanks that
are difficult to access or where the precise accuracy provided by the ultrasonic sensor is not as important, Xact also offers a sensor that is affixed to the dial of a preinstalled float gauge (known as a gauge reader).The gauge reader
detects the fill level that is reported by the gauge and transmits that data by satellite in the same manner as the ultrasonic sensor. Float gauges have a typical accuracy range of +/- 8% to 12%.
Satellite Radio Transmitter
The Xact radio transmitter is placed on the top of the tank and is connected by cable to the tank sensor or gauge reader. The satellite transmitter transmits the tank data using the GlobalStar
®
satellite network to a GlobalStar
®
ground station and then to the Xact secure website where the tank data is displayed or is automatically directed to a customers automated inventory or delivery
management system.
Xact Website
The Xact website is a secured location providing controlled access to the tank data for each customers various tank locations. The tank fill level data and geometry of the tank are used to calculate
and display the precise fill level at predetermined measurement times along with additional information such as temperature, battery status, GPS coordinates and map location, fill levels that trigger email notification and the list of email
recipients. In addition to the data being displayed on the website, the data can also be automatically directed to a customers automated inventory or delivery management system for full automation of the delivery process. Operators can now
obtain highly accurate readings and tank information from even the most remote tanks conveniently and cost-effectively using their desktop computer, laptop, tablet or smart phone.
Benefits
Benefits of using the Xact Tank Monitoring System include external
mounting with no reliance on existing mechanical gauges when using the ultrasonic sensors, tank fill data is sent directly and instantly from the tank to the user via satellite, no reliance on telephone lines or cellular networks and no dropped
data, temperature adjusted readings for accuracy within +/- 2% for large tanks and +/- 1% for smaller tanks when using the ultrasonic sensor, user-set alarm levels and automatic low tank-level messaging via email or cell phone, the ability to
operate in a wide range of operating environments from -40ºC to 60ºC, long battery life, quick and easy installation, secure data transmission via satellite, the ability to integrate directly into delivery scheduling management systems and
the ability to monitor any tank anywhere in the world.
Customers
Customers of the Xact Tank Monitoring System include large, regional and local propane distributors, such as Superior Propane (Canada), Suburban Propane (U.S.), AmeriGas (U.S.), Pacific Propane (U.S.) and
TermoGas (Mexico). The Company is focusing its business development efforts on the propane industry in the United States, Canada, Mexico, Central and South America.
Page 9
Competition
Management believes that the Xact Tank Monitoring System offers the only ultrasonic sensor specifically designed to provide independent precise tank level calculation while most other competitors utilize
gauge-reading technology, which reads the tank fill level from a pre-installed float gauge and is less accurate. Competitors offer telemetry options based on cellular or closed loop communication networks whereas Xact telemetry is satellite
based. Competitors include, but are not limited to, Independent Technologies, Inc. (Wesroc), NasCorp (SkyTracker), WacnGo, Silicon Controls, TankLink, Centeron, TankScan and Enertrack.
In Fiscal 2016, 2015 and 2014, net sales of Measurement products totaled $4,722,607, $5,218,855 and $4,413,295, respectively, and accounted for 40%, 40% and 36% of the Companys total sales in Fiscal
2016, 2015 and 2014, respectively. See Note 5 to Consolidated Financial Statements.
Sales by Geographic Area
In Fiscal 2016, 2015 and 2014, the Company recorded net sales of its products in the United States, its country of domicile, of
$6,931,278, $7,174,257 and $6,704,239, respectively. Net sales in the last three fiscal years by geographic areas were:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North
America
|
|
|
Europe
|
|
|
Asia
|
|
|
Others
|
|
Fiscal 2016
|
|
$
|
7,749,753
|
|
|
$
|
1,435,280
|
|
|
$
|
2,288,550
|
|
|
$
|
211,770
|
|
Fiscal 2015
|
|
$
|
8,165,269
|
|
|
$
|
1,194,186
|
|
|
$
|
3,388,757
|
|
|
$
|
320,879
|
|
Fiscal 2014
|
|
$
|
7,474,067
|
|
|
$
|
1,773,928
|
|
|
$
|
2,693,767
|
|
|
$
|
192,744
|
|
Business and Marketing Strategy
The Company designs, manufactures and markets all of its products with operations divided into a number of different channels and geographies.
Balancer Segment Products
The Company markets and sells its SBS products in a
variety of ways. First, selling channels are provided by independent manufacturers representatives and distributors. There are currently approximately 65 individuals and/or organizations throughout the world acting in one of these capacities,
including approximately 15 in the United States and 15 in China.
Second, OEMs integrate the Balancer segment products on the machine tools
they produce. Users thus purchase the SBS products concurrently with the machine tools. Conversely, end users of grinding machines that have purchased the SBS system directly from the Company, and after enjoying the benefits of the products, often
request that SBS products be included with the new equipment they order from OEMs. The SBS Systems are often installed by machine tool builders prior to displaying their own machine tools at various trade shows, becoming endorsements that prove
beneficial to the Companys sales efforts.
Third, worldwide trade shows have proven to be an excellent source of business. Company
representatives, usually one or more of the marketing managers and the CEO, attend these events along with local Company representatives. These individuals operate a display booth featuring an SBS System demonstration stand and product and technical
literature. Representatives from all facets of the Companys target markets attend these trade shows.
In North America and Asia,
products are shipped directly to customers from the Companys factory in Portland, Oregon. Where the Company has distributors, the product is shipped to the distributor, who in turn pays the Company directly and then delivers and installs the
product for the end user. European distribution to customers is handled by shipping the product directly from the Companys Portland headquarters to its European subsidiary in the United Kingdom, which in turn sells and distributes the
products.
Page 10
Measurement Segment Products
Similar to the Balancer segment, the Measurement segment uses a variety of methods to market and sell its products. First, sales and marketing managers direct the overall worldwide marketing efforts
for surface measurement, laser and white light sensor and remote tank monitoring products. Second, both a marketing manager and a sales manager direct the overall worldwide marketing and sales efforts for distance measurement and dimensional
sizing products. Third, the Company uses distributors for international markets for the promotion and sale of surface measurement products in China, Taiwan, Japan and Korea. The Xact product line utilizes two business development
personnel, in addition to distributors for selected markets. All Measurement segment products are assembled in the Portland, Oregon facility and shipped worldwide directly to customers.
Backlog
The Company does not generally track backlog. Normally, orders
are shipped within one to two weeks after receipt unless the customer requests otherwise.
Manufacturing
There are no unique sources of supply or raw materials in any product lines. Essential electronic components, available in large quantities from various
suppliers, are assembled into the Balancing and Measurement electronic control units under the Companys quality and assembly standards. Company-owned software and firmware are coupled with the electronic components to provide the basis of the
Companys various electronic control units. Management believes several supply sources exist for all electronic components and assembly work incorporated into its electronic control systems. Mechanical parts for the Companys products are
produced by high quality machine shops. The Company is not dependent on any one supplier of mechanical components. In the event of supply problems, the Company believes that two or three alternatives could be developed within 30 days. The Company is
subject to availability and pricing on the various components parts purchased, which has had, and may continue to have, a material impact on operations.
The Company uses
in-house
skilled assemblers to construct and test vendor-supplied components. Component inventory of finished vendor-supplied parts is held on
Company property to assure adequate flow of parts to meet customer order requirements. Inventory is monitored by a computer control system designed to assure timely re-ordering of components. In-house personnel assemble various products and test all
finished components before placing them in the finished goods inventory. Finished goods inventory is maintained via computer to assure timely shipment and service to customers. All customer shipments are from the finished goods inventory.
The Companys Quality Control Program first received full ISO 9001 certification in 1996. In 2005, the Company received its
certification to the newer ISO 9001:2000 requirements and in 2011 and 2014 received its recertification.
Proprietary Technology
The Companys success depends in part on its proprietary technology, which the Company protects through patents, copyrights,
trademarks, trade secrets and other measures. The Company has U.S. patents covering both Balancer and Measurement products, processes and methods that the Company believes provide it with a competitive advantage. The Company has a policy
of seeking patents where appropriate on inventions concerning new products and improvements developed as part of its ongoing research, development and manufacturing activities. While patents provide certain legal rights of enforceability, there
can be no assurance the historic legal standards surrounding questions of validity and enforceability will continue to be applied or that current defenses with respect to issued patents will, in fact, be considered substantial in the
future. There can be no assurance as to the degree and range of protection any patent will afford and whether patents will be issued or the extent to which the Company may inadvertently infringe upon patents granted to others.
Page 11
The Company manufactures its Balancer segment products under copyright protection in the U.S. for electronic
board designs. Encapsulation of the finished product further protects the Companys technologies including software.
The Company
also relies upon trade secret protection for its confidential and proprietary information. There can be no assurance that others will not independently develop substantially equivalent proprietary information and techniques or otherwise gain
access to the Companys trade secrets or disclose such technology or that the Company can meaningfully protect its trade secrets.
While
the Company pursues patent, trademark, trade secret and copyright protection for products and various trademarks, it also relies on know-how and continuing technology advancement, manufacturing capabilities, affordable high-quality products, new
product introduction and direct marketing efforts to develop and maintain its competitive position.
Product Development
The Company maintains an ongoing research and development program to expand the product lines and capabilities of its business
segments. The goal of this program is to expand the product base in historic markets and to enter new market areas so as to reduce reliance on historic market segments. During Fiscal 2016, 2015 and 2014, the Companys research and
development expense totaled $287,672, $378,305 and $475,430, respectively.
Employees
As of July 31, 2016, the Company employed 54 individuals worldwide on a full-time basis. There were no part-time or temporary employees. None of the
Companys employees are covered by a collective bargaining agreement.
The following are important
factors that could cause actual results or events to differ materially from those contained in any forward-looking statements made by or on behalf of the Company (see the forward-looking statements disclaimer at the beginning of Part 1, Item 1 in
this Report). In addition, the risks and uncertainties described below are not the only ones that the Company faces. Unforeseen risks could arise and problems or issues that the Company now views as minor could become more significant. If the
Company were unable to adequately respond to any risks, the Companys business, financial condition or results of operations could be materially adversely affected. In addition, the Company cannot be certain that any actions taken to reduce
known or unknown risks and uncertainties will be effective.
General economic conditions and uncertainties may adversely affect the
Companys business, operating results and financial condition
The Companys operations and performance depend significantly on
worldwide economic conditions, particularly in the industrial, manufacturing and automotive sectors in the U.S., Asia and Europe, and their impact on levels of capital spending, which have deteriorated significantly in the past and may become
depressed, or be subject to further deterioration. Economic factors that could adversely influence demand for the Companys products include uncertainty about global economic conditions leading to reduced levels of investment, reduction in
demand for our customers products, customers and suppliers access to credit and the stability of the global financial system, the overall health of our markets, unemployment and other macroeconomic factors generally affecting
commercial and industrial spending behavior.
Past distress in the global financial markets and global economy resulted in reduced liquidity
and a tightening of credit markets. If these conditions were to reoccur, the Company could experience several potential adverse
Page 12
effects, including the inability of customers to obtain credit to finance purchases of the Companys products, the insolvency of customers resulting in reduced sales and bad debts, and the
insolvency of key suppliers resulting in product development and production delays.
The Companys primary markets are volatile and
unpredictable
The Companys business depends on the demand for our various products in a variety of commercial and industrial
markets. In the past, demand for our products in these markets has fluctuated due to a variety of factors, some of which are beyond our control, including: general economic conditions, both domestically and internationally, the timing, number and
size of orders from, and shipments to, our customers as well as the relative mix of those orders and variations in the volume of orders for a particular product line in a particular quarter.
The Companys efforts to continue to accelerate growth of the Xact Tank Monitoring System may not be successful
The Xact Tank Monitoring System measures the fill levels of tanks holding propane, diesel and other tank-based liquids and communicates that data via satellite to a secure web site. The Companys
efforts to continue to accelerate the growth of Xact in its two primary markets of North America and Latin America may not be successful, anticipated market demand for the products may not materialize, and additional products or market opportunities
may not be identified, developed and brought to market in a timely and cost-effective manner. All of this could continue to negatively impact future operating results and result in large and immediate write-offs of recorded intangible asset
balances.
New products may not be developed to satisfy changes in consumer demands
The failure to develop new products or enhance existing products or react to changes in existing technologies could result in decreased revenues and a
loss of market share to competitors. Financial performance depends on the ability to design, develop, manufacture, assemble, test, market and support new products and enhancements on a timely and cost-effective basis. New product opportunities may
not be identified and developed and brought to market in a timely and cost-effective manner. Products or technologies developed by other companies may render products or technologies obsolete or noncompetitive, or a fundamental shift in technologies
in the product markets could have a material adverse effect on the Companys competitive position within historic industries.
Competition is intense and the Companys failure to compete effectively would adversely affect its business
Competition in the markets for the Companys products is intense. The speed with which the Company can identify new applications for the
Companys various technologies, develop products to meet those needs and supply commercial quantities at low prices to those new markets are important competitive factors. The principal competitive factors in the Companys markets are
product features, performance, reliability and price. Many of the Companys competitors have greater financial, technical, engineering, production and marketing resources than we do. Those competitors with greater resources may, in addition to
other things, be able to better withstand periodic downturns, compete more effectively on the basis of price and technology, or more quickly develop enhancements to products that compete with the products we manufacture and market. New companies may
enter the markets in which we compete, further increasing competition in those markets. No assurance can be given that the Company will be able to compete effectively in the future, and the failure to do so would have a material adverse effect on
the Companys business, financial condition and results of operations.
The Company may experience increased pricing pressure
We have experienced and continue to experience pricing pressure in the sale of our products, from both competitors and
customers. Pricing pressures typically have become more intense during cyclical downturns
Page 13
when competitors seek to maintain or increase market share, reduce inventory or introduce more technologically advanced products or lower cost products. In addition, we may agree to pricing
concessions or extended payment terms with our customers in connection with volume orders or to reduce cost of ownership in highly competitive applications. Our business, financial condition, margins or results of operations may be materially
and adversely affected by competitive pressure and intense price-based competition.
Production time and the overall cost of products could
increase if any of the primary suppliers are lost or if a primary supplier increased the prices of raw materials
Manufacturing operations
depend upon obtaining adequate supplies of raw materials on a timely basis. The results of operations could be adversely affected if adequate supplies of raw materials cannot be obtained in a timely manner or if the costs of raw materials
increased significantly.
The Company may not be able to ramp up manufacturing to satisfy increasing orders, which may lead to the loss of
significant revenue opportunities
The Company manufactures several different product lines, all of which involve complicated technology
and individual attention for each product made. The production time for each product can vary, depending on a variety of circumstances, including component availability, timing of delivery of components from suppliers and employee
availability. Should the Company receive a large increase in orders, an increase in the size of orders or a shortening of the required delivery time on existing orders, the Company may not be able to ramp up manufacturing to satisfy customer
expectations, which may lead to the loss of significant revenue opportunities.
The Company maintains a significant investment in
inventories in anticipation of future sales
The Company believes it maintains a competitive advantage by shipping product to its customers
more rapidly than its competitors. As a result, the Company has a significant investment in inventories. These inventories are recorded using the lower of cost or market method, which requires management to make certain
estimates. Management evaluates the recorded inventory values based on customer demand, market trends and expected future sales, and changes these estimates accordingly. A significant shortfall of sales may result in carrying higher levels
of inventories of finished goods and raw materials thereby increasing the risk of inventory obsolescence and corresponding inventory write-downs. As a result, the Company may not carry adequate reserves to offset such write-downs.
The Companys existing cash may not be sufficient and the Company may not be able to obtain financing to fund operations or future growth
The Company had a cash balance of $988,686 as of May 31, 2016, compared to $1,795,654 as of May 31, 2015, and has no bank line of credit
facility. The Company believes that its existing cash and investments combined with the cash from operating activities will be sufficient to meet its cash requirements for the near term. However, if sales weaken and the Company is unable
to reduce its operating costs in a timely manner or access additional financing, the Company may have to continue to reduce its cash balance, which could significantly impact the liquidity or operations of the Company, and may have to explore other
financing alternatives to raise cash.
Fluctuations in quarterly and annual operating results make it difficult to predict future
performance
Quarterly and annual operating results are likely to fluctuate in the future due to a variety of factors, some of which are
beyond managements control. As a result of quarterly operating fluctuations, it is important to realize quarter-to-quarter comparisons of operating results are not necessarily meaningful and should not be relied upon as indicators of future
performance.
Page 14
The Company may experience a downturn due to the risks of operating a global business
Sales to customers outside the U.S. accounted for 40.7% of total sales in Fiscal 2016. We expect that sales to customers outside the U.S. will
continue to represent a significant percentage of sales in the future. We currently have a sales and service office in Coventry, England and a sales office in Shanghai, China. We may need to increase our foreign operations in the
future. Our international sales, purchases and operations are subject to risks inherent in conducting business abroad, many of which are outside of our control, including periodic local or geographical economic downturns, fluctuations in the
relative values of currencies, difficulties in protecting intellectual property, shipping delays and disruptions, local labor disputes, unexpected changes in trading policies, regulatory requirements, tariffs and duties and difficulties in managing
a global presence, including staffing, collecting accounts receivable, and managing distributors and sales representatives.
The Company
faces risks from international sales and currency fluctuations
The Company markets and sells its products worldwide and international
sales have accounted for and are expected to continue to account for a significant portion of future revenue. International sales are subject to a number of risks, including: the imposition of governmental controls; trade restrictions; difficulty in
collecting receivables; changes in tariffs and taxes; difficulties in staffing and managing international operations; political and economic instability; general economic conditions; and fluctuations in foreign currencies. In a referendum held in
the United Kingdom (UK) on June 23, 2016, a majority of those voting voted for the UK to leave the European Union (EU) (commonly referred to as Brexit). The terms of the UKs future relationship with the EU
will be negotiated over time. In the meantime, there are immediate uncertainties that face U.S. companies with operations in the UK and the EU, of which Schmitt is one of those companies. Specifically, currency fluctuations will impact sales, costs
and earnings. At one point shortly after the Brexit vote, the British pound fell more than 10% to the lowest level since 1985. Currencies could remain volatile for the foreseeable future. No assurances can be given that these factors will not have a
material adverse effect on future international sales and operations and, consequently, on business, financial condition and results of operations.
The Company may not be able to reduce operating costs quickly enough if sales decline
Operating expenses are generally fixed in nature and largely based on anticipated sales. However, should future sales decline significantly and
rapidly, there is no guarantee management could take actions that would further reduce operating expenses in either a timely manner or without seriously impacting the operations of the Company.
Future success depends in part on attracting and retaining key management and qualified technical and sales personnel
Future success depends on the efforts and continued services of key management, technical and sales personnel. Significant competition exists for
such personnel and there is no assurance key technical and sales personnel can be retained or that other highly qualified technical and sales personnel as required can be attracted, assimilated and retained. There is also no guarantee that key
employees will not leave and subsequently compete against the Company. The inability to attract and retain key personnel could adversely impact the business, financial condition and results of operations.
Changes in the effective tax rate may have an adverse effect on the Companys results of operations
The Companys future effective tax rate may be adversely affected by a number of factors including: the jurisdictions in which profits are determined
to be earned and taxed; the resolution of issues arising from future, potential tax audits with various tax authorities; changes in the valuation of our deferred tax assets and liabilities; adjustments to estimated taxes upon finalization of various
tax returns; increases in expenses not deductible for tax purposes; changes in available tax credits; changes in stock-based compensation expense; changes in tax laws or the interpretations of such tax laws and changes in generally accepted
accounting principles.
Page 15
Failure to protect intellectual property rights could adversely affect future performance and growth
Failure to protect existing intellectual property rights may result in the loss of valuable technologies or paying other companies for
infringing on their intellectual property rights. The Company relies on patent, trade secret, trademark and copyright law to protect such technologies. There is no assurance any of the Companys U.S. patents will not be invalidated,
circumvented, challenged or licensed to other companies.
Changes in securities laws and regulations have increased and could continue to
increase Company expenses
Changes in the laws and regulations affecting public companies, including the provisions of the Sarbanes-Oxley
Act of 2002 and rules promulgated by the Securities and Exchange Commission, have increased and may continue to increase Company expenses as the Company devotes resources to ensure compliance with all applicable laws and regulations. In addition,
the NASDAQ Capital Market, on which the Companys common stock is listed, has also adopted comprehensive rules and regulations relating to corporate governance. These laws, rules and regulations have increased the scope, complexity and cost of
corporate governance, reporting and disclosure practices. The Company may be required to hire additional personnel and use outside legal, accounting and advisory services to address these laws, rules and regulations. The Company also expects these
developments to make it more difficult and more expensive for the Company to obtain director and officer liability insurance in the future, and the Company may be required to accept reduced coverage or incur substantially higher costs to obtain
coverage. Further, the Companys board members, Chief Executive Officer and Chief Financial Officer could face an increased risk of personal liability in connection with the performance of their duties. As a result, we may have difficulty
attracting and retaining qualified board members and executive officers, which would adversely affect the Company.
The Company may
experience uncertainties resulting from conflict minerals regulation
On August 22, 2012, the SEC adopted a new rule requiring disclosures
of specified minerals, known as conflict minerals, that are necessary to the functionality or production of products manufactured or contracted to be manufactured by companies filing public reports. The new rule requires a disclosure report to
be filed annually with the SEC and this report will require companies to perform due diligence, disclose and report whether such minerals originate from the Democratic Republic of Congo or an adjoining country. The new rule could affect
sourcing at competitive prices and availability in sufficient quantities of certain minerals used in the manufacture of our products. The number of suppliers who provide conflict-free minerals may be limited. In addition, there may be
material costs associated with complying with the disclosure requirements, such as costs related to determining the source of certain minerals used in our products as well as costs of possible changes to products, processes, or sources of supply as
a consequence of such verification activities. Since our supply chain is complex, we may not be able to sufficiently verify the origins of the relevant minerals used in our products through the due diligence procedures that we implement, which
may harm our reputation. In addition, we may encounter challenges to satisfy those customers who require that all of the components of our products be certified as conflict-free, which could place us at a competitive disadvantage if we are
unable to do so.