Note 3:
STOCK
OPTIONS AND STOCK-BASED COMPENSATION
Stock-based compensation
includes expense charges for all stock-based awards to employees and directors
granted under the Companys stock option plan. Stock-based compensation
recognized during the period is based on the value of the portion of the
stock-based award that will vest during the period, adjusted for expected
forfeitures. Compensation cost for all stock-based awards is recognized using
the straight-line method. Stock-based compensation recognized in the Companys
Consolidated Financial Statements for the three and six months ended November 30,
2007 includes compensation cost for stock-based awards granted prior to, but
not fully vested as of, May 31, 2006. There were no stock-based awards
granted subsequent to May 31, 2006. The Company uses the Black-Scholes
option pricing model as its method of valuation for stock-based awards. The
Black-Scholes option pricing model requires the input of highly subjective
assumptions, and other reasonable assumptions could provide differing results. These
variables include, but are not limited to:
Risk-Free Interest Rate.
The
Company bases the risk-free interest rate on the implied yield currently
available on U.S. Treasury issues with an equivalent remaining term approximately
equal to the expected life of the award.
Expected Life.
The
expected life of awards granted represents the period of time that they are
expected to be outstanding. The Company determines the expected life based on
historical experience with similar awards, giving consideration to the
contractual terms, vesting schedules and pre-vesting and post-vesting
forfeitures.
Expected Volatility.
The
Company estimates the volatility of its common stock at the date of grant based
on the historical volatility of its common stock. The volatility factor the
Company uses is based on its historical stock prices over the most recent
period commensurate with the estimated expected life of the award. These
historical periods may exclude portions of time when unusual transactions
occurred.
Expected Dividend Yield.
The
Company has never paid any cash dividends on its common stock and does not
anticipate paying any cash dividends in the foreseeable future. Consequently,
the Company uses an expected dividend yield of zero.
Expected Forfeitures.
The
Company uses relevant historical data to estimate pre-vesting option
forfeitures. The Company records stock-based compensation only for those awards
that are expected to vest.
The Company has computed,
to determine stock-based compensation expense recognized for the three and six
months ended November 30, 2007 and 2006, the value of all stock options
granted using the Black-Scholes option pricing model using the following
assumptions:
Risk-free interest rate
|
|
3.8-4.45%
|
|
Expected life
|
|
4.0-4.7 years
|
|
Expected volatility
|
|
95-102%
|
|
At November 30, 2007
the Company had a total of 170,109 outstanding stock options (163,859 vested
and exercisable and 6,250 non-vested) with a weighted average exercise price of
$2.58. The Company estimates that a total of approximately $15,000 will be
recorded as additional stock-based compensation expense over the period
beginning with the quarter ending February 29, 2008 through the fiscal
year ending May 31, 2008, for all options which are outstanding as of November 30,
2007, but which were not yet vested.
8
Adoption
of FIN 48
Each
year the company files income tax returns in the various national, state and
local income taxing jurisdictions in which it operates. These tax returns are
subject to examination and possible challenge by the taxing authorities. Positions
challenged by the taxing authorities may be settled or appealed by the
Company. As a result, there is an uncertainty in income taxes recognized in the
Companys financial statements in accordance with SFAS No. 109. In 2006,
the FASB issued FIN 48, which clarifies the application of SFAS 109 by defining
criteria that an individual income tax position must meet for any part of
the benefit of that position to be recognized in an enterprises financial
statements and provides guidance on measurement, derecognition, classification,
accounting for interest and penalties, accounting in interim periods,
disclosure, and transition.
On June 1, 2007, the
Company adopted the provisions of FIN 48. The adoption of FIN 48 resulted in a
$34,464 decrease in the Companys liability for unrecognized tax benefits,
which was accounted for as an increase to the June 1, 2007 retained
earnings balance. At June 1, 2007 the gross amount of unrecognized tax
benefits was approximately $586,000, which includes approximately $150,000 of
net unrecognized tax benefits that, if recognized, would reduce the Companys
effective income tax rate. Unrecognized tax benefits did not change significantly
during the three or six month periods ended November 30, 2007.
Interest
and penalties associated with uncertain tax positions are recognized as
components of the Provision for income taxes.
The Companys accrual for interest and penalties was $96,500 upon
adoption of FIN 48. The liability for payment of interest and penalties did not
significantly change during the three or six months ended November 30,
2007.
Several
tax years are subject to examination by major tax jurisdictions. In the United
States, federal tax years for Fiscal 2004 and after are subject to examination.
In the United Kingdom, tax years for Fiscal 2006 and after are subject to
examination. In the United States, returns related to an acquired subsidiary
for the year ending October 31, 1994 and final return for the period
ending May 19, 1995 are also subject to examination.
Our
effective tax rate on consolidated net income was 27.9% for the six months
ended November 30, 2007. Our effective tax rate on consolidated net income
differs from the federal statutory tax rate primarily due to certain expenses
not deductible for income tax reporting offset by lower effective tax rates on
net income reported by the Companys wholly owned subsidiary, Schmitt Europe
Ltd. (SEL), located in the United Kingdom. Management believes the effective
tax rate on consolidated net income in future periods will reflect a normal
combined state and federal rate, net of the effect from expenses not deductible
for income tax reporting and net income or losses reported by SEL.
Note 6:
SEGMENTS OF BUSINESS
The Company has two
reportable business segments: the design and assembly of dynamic balancing
systems for the machine tool industry (Balancer), and the design and assembly
of laser measurement systems (Measurement). The Company operates in three
principal geographic markets: North America, Europe and Asia.
10
Segment
and Geographic Assets
|
|
November 30, 2007
|
|
May 31, 2007
|
|
Segment assets to total assets
|
|
|
|
|
|
Balancer
|
|
$
|
4,733,548
|
|
$
|
5,030,049
|
|
Measurement
|
|
1,999,979
|
|
1,792,731
|
|
Corporate assets
|
|
6,863,037
|
|
5,655,448
|
|
Total assets
|
|
$
|
13,596,564
|
|
$
|
12,478,228
|
|
|
|
|
|
|
|
Geographic assets to total assets
|
|
|
|
|
|
United States
|
|
$
|
13,058,739
|
|
$
|
11,819,905
|
|
Europe
|
|
537,825
|
|
658,323
|
|
Total assets
|
|
$
|
13,596,564
|
|
$
|
12,478,228
|
|
Note 7:
RELATED PARTY TRANSACTIONS
Effective June 1,
2004, the Company entered into a contract to provide consulting services to
PulverDryer USA, Inc. (PulverDryer), pursuant to which PulverDryer paid
the Company $8,000 a month from June 2004 through October 2004. PulverDryer
also buys certain products from the Company at normal prevailing rates. The
Company and PulverDryer extended the contract from November 1, 2004
forward at that same monthly fee of $8,000. Product sales to PulverDryer during
the three months ended November 30, 2007 and 2006 totaled $150 and $7,945,
respectively. Product sales to PulverDryer during the six months ended November 30,
2007 and 2006 totaled $3,828 and $19,523, respectively.
In connection with the
contract, the Board authorized Wayne Case, the Companys Chief Executive Officer,
to provide advisory services to PulverDryer, and permitted Mr. Case to
receive as compensation the total consulting fees paid by PulverDryer from June 2004
through October 2004. Effective November 1, 2004, Mr. Case
receives 40% of the ongoing consulting fee from PulverDryer, which percentage
was determined by the Compensation Committee. Mr. Case also serves on the
board of directors of PulverDryer.
Note 8:
SUBSEQUENT EVENT
The Company entered into
a convertible promissory note agreement with Xtero Datacom, Inc. (Xtero)
of Vancouver, British Columbia in February 2007 pursuant to which the
Company agreed to loan up to $250,000 USD to Xtero to fund product development
and testing of Xtero satellite measurement technologies. On October 5,
2007 Xtero and the Company announced the completion of an Interim Acquisition
Agreement (Interim Agreement) to acquire Xtero pursuant to which the Company
agreed to advance an additional $250,000 to Xtero, pay royalties of 15% to 25%
to Xtero for product sales until closing and issue 200,000 shares of Schmitt
common stock in exchange for 100% of Xtero at closing. Pursuant to the Interim
Acquisition Agreement, Xtero has granted the Company an exclusive license for
the Xtero technology, so that the Company can begin necessary production and
marketing prior to closing of the Transaction described below. As of November 30,
2007, the Company had advanced $500,000 to Xtero, which funds have been used
for patent work and other corporate product development and testing activities,
and legal fees incurred by Xtero in connection with the structuring and
negotiation of the Transaction. The Company has also reimbursed $89,055 of
expenses incurred by or on behalf of Xtero since October 1, 2007,
including operational expenses and consulting fees.
On December 14,
2007, the Company entered into an Arrangement Agreement with Xtero pursuant to
which the Company, through its newly formed wholly owned subsidiary, Schmitt
Industries (Canada) Limited, a British Columbia corporation (SCL), will acquire
all of the issued and outstanding common shares of Xtero (the Transaction). The
Arrangement Agreement was entered into in furtherance of the purposes of the
Interim Agreement among Schmitt, Xtero and certain of Xteros shareholders. Upon
closing of the Transaction, Xtero will become a wholly owned subsidiary of the
Company and Schmitt will own and operate Xteros business, including its
patented technologies. In addition, Xtero shareholders will be eligible to
receive shares of SCL stock which are exchangeable for shares of Schmitt common
stock on a one-for-one basis based on the after-tax earnings derived from Xtero
products during a five-year earn-out program ending on May 31, 2013. The
Transaction is subject to various conditions, including approval by Xtero
shareholders, approval by a British Columbia court and other customary closing
conditions, and is expected to close by the end of January 2008.
13
Item
2.
Managements
Discussion and Analysis of Financial Condition and Results of Operations
Schmitt Industries, Inc.
designs, assembles and markets computer controlled balancing equipment (the
Balancer Segment) primarily to the machine tool industry. Through its wholly
owned subsidiary, Schmitt Measurement Systems, Inc. (SMS), the Company
designs, manufactures and markets precision laser measurement systems (the
Measurement Segment). The Company also sells and markets its products in Europe
through its wholly owned subsidiary, Schmitt Europe Ltd. (SEL), located in the
United Kingdom. The accompanying unaudited financial information should be read
in conjunction with our Annual Report on Form 10-K for the fiscal year
ended May 31, 2007. Certain amounts in prior periods financial
information have been reclassified to conform to the current periods
presentation. These reclassifications did not affect consolidated net income.
RESULTS OF OPERATIONS
Overview
Balancer segment sales
focus throughout the world on end-users, rebuilders and original equipment
manufacturers of grinding machines with the target geographic markets in North
America, Asia and Europe. Combined Balancer sales increased 3.5% for the six
months ended November 30, 2007 compared to the six months ended November 30,
2006. Balancer sales for the three months ended November 30, 2007
increased 22.6% compared to the three months ended November 30, 2006. North
American sales increased 11.8% in the six months ended November 30, 2007
and increased 38.8% in the three months ended November 30, 2007 when
compared to the same periods ending November 30, 2006. Market demand in
Asia for the Balancer segment products remains solid as that region showed a
9.4% increase for the six months ended November 30, 2007 and increased
33.7% in the three months ended November 30, 2007 when compared to the
same periods ending November 30, 2006. The North American and Asian sales
increase is predominately the result of a recovery from softer Balancer sales
during the last fiscal year from recent weakness in the worldwide automotive,
bearing and aircraft industries and its impact on the machine tool industry. Recent
weakness in industrial production toward the end of 2006 especially in the
motor vehicle sector, has caused production in other manufacturing industries to
soften. These economic conditions in the worldwide automotive, bearing and
aircraft industries and its impact on the machine tool industry were the reason
for softer Balancer sales during the prior fiscal year. European market sales
slowed as total Balancer sales into that geographic market decreased (12%)
during the six months ended November 30, 2007 compared to the six months
ended November 30, 2006 and have decreased (14.2%) during the most recent
three month period ended November 30, 2007 when compared to the same
periods ending November 30, 2006. Sales in all Other markets decreased
(26.1%) in the six months ended November 30, 2007 and increased 9.2% for
the three months ended November 30, 2007 when compared to the same periods
ending November 30, 2006. As with the North American market, the business
conditions in Asia and the European market cannot be forecasted with any
certainty.
The Measurement segment
product line consists of both laser light-scatter and dimensional sizing
products. Combined Measurement sales decreased (37.1%) for the six months ended
November 30, 2007 compared to the six months ended November 30, 2006.
Measurement sales for the three months ended November 30, 2007 decreased
(26.3%) compared to the three months ended November 30, 2006. The
decreased sales volume is primarily due to lack of complete system shipments of
laser light-scatter products to disk drive manufacturers and reduced
dimensional sizing product sales as well as reduced CASI Scatterometer sales. As
noted below sales can be very cyclical in the Measurement segment. The business
operations and prospects for these two product lines are summarized as follows:
Laser light-scatter
products for disk drive and silicon wafer manufacturers The primary target
markets for Measurement products have been disk drive and silicon wafer
manufacturers and companies and organizations involved in research efforts. Sales
to these customers totaled $374,222 for the six months ended November 30,
2007 compared to the $783,046 for the six months ended November 30, 2006. Due
to the significant challenges posed by the need to continually innovate and
improve manufacturing efficiency and because of the increasing amounts of
capital and research and development expenditure required, the disc drive
industry has undergone significant consolidation as disc drive manufacturers
and component suppliers merged or exited the industry. Through such
combinations, disc drive manufacturers have also become increasingly vertically
integrated. Sales to customers in these industries can be very cyclical and
therefore the impact of the current weak demand in the disk drive industry on
sales to the Companys laser light-scatter products is unknown at this time and
cannot be forecasted with any certainty.
14
Laser light-scatter
products for research organizations The Company continues to receive
inquiries for these products and provide quotes to interested parties. The
Company completed the delivery of CASI Scatterometer software and other
upgrades in the current fiscal quarter and expects to deliver a new CASI
Scatterometer system in the third fiscal quarter of 2008. Measurement sales
during the six months and three months ended November 30, 2006 included
the delivery of a new CASI Scatterometer system.
Dimensional sizing
products These products are marketed and sold into a wide array of industries
and used in applications from steel casting, paper production, crane control
and medical imaging to micron level part and surface inspection. Sales
decreased (16.9%) for the six months ended November 30, 2007 and decreased
(19.5%) for the three months ended November 30, 2007 when compared to the
same periods ending November 30, 2006. Sales of these products can be cyclical
and therefore the duration of the continued demand cannot be forecasted with
any certainty.
The Company entered into
certain agreements (Transaction) with Xtero Datacom, Inc. (Xtero) of
Vancouver, British Columbia beginning in February 2007 pursuant to which
the Company will acquire all of the issued and outstanding common shares of
Xtero. Upon closing of the Transaction, Xtero will become a wholly owned
subsidiary of Schmitt and Schmitt will own and operate Xteros business,
including its patented technologies for remote satellite sensing of large
chemical storage tanks. The Transaction is subject to various conditions,
including approval by Xtero shareholders, approval by a British Columbia court
and other customary closing conditions, and is expected to close by the end of January 2008.
Refer to Note 8 of the Notes to Consolidated Interim Financial Statements for
further discussion of the Transaction.
Critical
Accounting
Policies
With
the adoption of FIN 48 as of
June 1, 2007, the Company has added Uncertain Tax Positions as a
critical accounting policy. There are no other material changes in our critical
accounting policies as disclosed in our Annual Report on Form 10-K for the
year ended May 31, 2007.
Uncertain
Tax Positions
The Company accounts for uncertain tax positions in
accordance with FIN 48. The application of income tax law is inherently complex.
Laws and regulations in this area are voluminous and are often ambiguous. As
such, the Company is required to make many subjective assumptions and judgments
regarding income tax exposures. Interpretations of and guidance surrounding
income tax laws and regulations change over time, accordingly, changes in the
Companys subjective assumptions and judgments can materially affect amounts
recognized in the consolidated balance sheets and consolidated statements of
operations. Refer to Note 5 of the Notes to Consolidated Interim Financial
Statements for discussion of the impact of adoption of FIN 48.
Recently
issued accounting pronouncements:
Refer to Note 1 of the Notes to Consolidated Interim
Financial Statements for discussion of recently issued accounting
pronouncements.
Discussion
of Operating Results
Three
months ended November 30, 2007 and 2006
|
|
Three Months Ended November 30, 2007
|
|
|
|
Consolidated
|
|
Balancer
|
|
Measurement
|
|
|
|
Dollars
|
|
%
|
|
Dollars
|
|
%
|
|
Dollars
|
|
%
|
|
Sales
|
|
$
|
3,110,921
|
|
100.0
|
|
$
|
2,327,165
|
|
100.0
|
|
$
|
783,756
|
|
100.0
|
|
Cost of sales
|
|
1,421,593
|
|
45.7
|
|
1,116,262
|
|
48.0
|
|
305,331
|
|
39.0
|
|
Gross profit
|
|
1,689,328
|
|
54.3
|
|
$
|
1,210,903
|
|
52.0
|
|
$
|
478,425
|
|
61.0
|
|
Operating expenses
|
|
1,412,757
|
|
45.4
|
|
|
|
|
|
|
|
|
|
Operating income
|
|
$
|
276,571
|
|
8.9
|
|
|
|
|
|
|
|
|
|
15
|
|
Three Months Ended November 30, 2006
|
|
|
|
Consolidated
|
|
Balancer
|
|
Measurement
|
|
|
|
Dollars
|
|
%
|
|
Dollars
|
|
%
|
|
Dollars
|
|
%
|
|
Sales
|
|
$
|
2,961,176
|
|
100.0
|
|
$
|
1,898,204
|
|
100.0
|
|
$
|
1,062,972
|
|
100.0
|
|
Cost of sales
|
|
1,319,244
|
|
44.6
|
|
899,290
|
|
47.4
|
|
419,954
|
|
39.5
|
|
Gross profit
|
|
1,641,932
|
|
55.4
|
|
$
|
998,914
|
|
52.6
|
|
$
|
643,018
|
|
60.5
|
|
Operating expenses
|
|
1,313,720
|
|
44.4
|
|
|
|
|
|
|
|
|
|
Operating income
|
|
$
|
328,212
|
|
11.0
|
|
|
|
|
|
|
|
|
|
Worldwide sales of
Balancer products increased 22.6% in the three month period ended November 30,
2007 when compared to the same period in the prior fiscal year as sales to the
North American and Asian markets increased by 38.8% and 33.7%, respectively. These
increases were offset by a decrease in the European markets which decreased
(14.2%) in the most current fiscal quarter when compared to the same period in
the prior fiscal year. Sales in Other markets of $143,684 in the three month
period ended November 30, 2007 also increased 9.2% when compared to the
same period in the prior fiscal year. Unit sales prices of Balancer products
are relatively stable in each of the major markets and therefore any increases
or decreases in the dollar amount of sales between fiscal periods can generally
be attributed to an increase or decrease in the number of units sold. The North
American and Asian sales increase is predominately the result of a recovery
from softer Balancer sales during the last fiscal year from recent weakness in
the worldwide automotive, bearing and aircraft industries and its impact on the
machine tool industry. The Balancer product sales increase in Asia is also
attributed to the continued expansion of the sales efforts in China. The
European market remains soft when compared to longer term historical results
due to strong competition and weaker economic conditions in certain European Balancer
markets.
Measurement product
sales decreased by a combined (26.3%) in the most current fiscal quarter when
compared to the same period in the prior fiscal year due to sales of
dimensional sizing products decreasing (19.5%), surface measurement products
increasing 4% and the sale of a CASI Scatterometer in last years second fiscal
quarter with no comparable sale this year. The Measurement segments largest
market, North America, decreased (17.3%) in the three months ended November 30,
2007 compared to the three months ended November 30, 2006. Market demand
in Asia, historically the second largest geographic market for Measurement
products, showed a 2.8% increase for the three months ended November 30,
2007 compared to the three months ended November 30, 2006. The European
market reported a sales decrease to $55,970 in the most current fiscal quarter
when compared to the $310,986 sold in the same period in the prior fiscal year.
The sales decrease in Europe is attributed to the decline of CASI Scatterometer
sales noted above.
Cost of sales for the
Balancer segment increased (as a percentage of sales) in the most current
fiscal quarter when compared to the same period in the prior fiscal year
primarily due to the product sales mix as production labor and overhead costs
were relatively stable. Cost of sales for the Measurement segment decreased
slightly (as a percentage of sales) in the most current fiscal quarter when
compared to the same period in the prior fiscal year primarily due to the
product sales mix.
Sales by SEL totaled
$519,703 for the most recent quarter versus $787,250 for the same quarter last
year. Approximately 38.5% of the decrease is due to lower unit sales volumes
offset by a 4.5% increase due to the changes in foreign exchange rates between
the two fiscal periods. The lower sales volumes were realized primarily due to
the sale of a CASI Scatterometer in last years second fiscal quarter with no
comparable sale this year.
In the three month period
ended November 30, 2007, net income was $264,839 ($.10 per fully diluted
share) compared to net income of $271,185 ($.10 per fully diluted share) for
the same period last year. Net income was negatively impacted primarily by
higher research and development expenditures involving technologies related to
the Xtero Transaction offset by a lower income tax provision for the three
month period ended November 30, 2007 compared to the same period last
year.
16
Six
months ended November 30, 2007 and 2006
|
|
Six Months Ended November 30, 2007
|
|
|
|
Consolidated
|
|
Balancer
|
|
Measurement
|
|
|
|
Dollars
|
|
%
|
|
Dollars
|
|
%
|
|
Dollars
|
|
%
|
|
Sales
|
|
$
|
5,449,926
|
|
100.0
|
|
$
|
4,157,358
|
|
100.0
|
|
$
|
1,292,568
|
|
100.0
|
|
Cost of sales
|
|
2,525,233
|
|
46.3
|
|
1,962,440
|
|
47.2
|
|
562,793
|
|
43.5
|
|
Gross profit
|
|
2,924,693
|
|
53.7
|
|
$
|
2,194,918
|
|
52.8
|
|
$
|
729,775
|
|
56.5
|
|
Operating expenses
|
|
2,434,985
|
|
44.7
|
|
|
|
|
|
|
|
|
|
Operating income
|
|
$
|
489,708
|
|
9.0
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended November 30, 2006
|
|
|
|
Consolidated
|
|
Balancer
|
|
Measurement
|
|
|
|
Dollars
|
|
%
|
|
Dollars
|
|
%
|
|
Dollars
|
|
%
|
|
Sales
|
|
$
|
6,070,690
|
|
100.0
|
|
$
|
4,015,261
|
|
100.0
|
|
$
|
2,055,429
|
|
100.0
|
|
Cost of sales
|
|
2,830,467
|
|
46.6
|
|
2,074,960
|
|
51.7
|
|
755,507
|
|
36.8
|
|
Gross profit
|
|
3,240,223
|
|
53.4
|
|
$
|
1,940,301
|
|
48.3
|
|
$
|
1,299,922
|
|
63.2
|
|
Operating expenses
|
|
2,446,691
|
|
40.3
|
|
|
|
|
|
|
|
|
|
Operating income
|
|
$
|
793,532
|
|
13.1
|
|
|
|
|
|
|
|
|
|
Worldwide sales of
Balancer products increased 3.5% in the six months ended November 30, 2007
compared to the six months ended November 30, 2006 as sales to the North
American and Asian markets increased by 11.8% and 9.4%, respectively. These
increases were offset by a decline in the European market of (12%) and by
decreases in all Other markets of (26.1%). Unit sales prices of Balancer products
are relatively stable in each of the major markets and therefore any increases
or decreases in the dollar amount of sales between fiscal periods can generally
be attributed to an increase or decrease in the number of units sold. The North
American and Asian sales increase is predominately the result of a recovery
from softer Balancer sales during the last fiscal year from recent weakness in
the worldwide automotive, bearing and aircraft industries and its impact on the
machine tool industry. The large percentage decrease in all Other markets was
predominately a result of decreases in the Japanese and South American markets.
The European market remains soft when compared to longer term historical
results due to strong competition and weaker economic conditions in certain
European Balancer markets.
Measurement product
sales decreased (37.1%) in the six months ended November 30, 2007 compared
to the six months ended November 30, 2006 due to sales of dimensional
sizing products decreasing (16.9%), surface measurement products declining
(52.2%) and the sale of a CASI Scatterometer in last years second fiscal
quarter with no comparable sale this year.
Cost of sales for the
Balancer segment decreased (as a percentage of sales) in the six months ended November 30,
2007 compared to the six months ended November 30, 2006 primarily due to
the product sales mix as production labor and overhead costs were relatively
stable. Margins were also positively impacted as a result of the higher sales
increase in North American markets as a smaller portion of those sales are made
through distributors who receive pricing net of commissions and other sales
costs.
Cost of sales for the
Measurement segment increased (as a percentage of sales) in the six months
ended November 30, 2007 compared to the six months ended November 30,
2006 primarily due to the product sales mix as surface measurement products
generate higher gross profit margins than dimensional sizing products.
Sales by SEL totaled
$889,349 for the six months ended November 30, 2007 compared to sales of
$1,200,467 in the six months ended November 30, 2006. Approximately 31.2%
of the decrease is due to lower unit sales volumes offset by a 5.4% increase
due to the changes in foreign exchange rates between the two fiscal periods. The
lower sales volumes were realized primarily due to the sale of a CASI
Scatterometer in last years second fiscal quarter with no comparable sale this
year.
17
In the six month period
ended November 30, 2007, net income was $449,254 ($0.16 per fully diluted
share) compared to net income of $541,777 ($0.20 per fully diluted share) for
the same period last year. Net income was negatively impacted primarily by
lower net sales which declined by 10.2% offset by a lower provision for income
taxes, which decreased to $174,000 for the six month period ended November 30,
2007 compared to the $338,000 in the same period last year.
LIQUIDITY AND CAPITAL
RESOURCES
The Companys ratio of
current assets to current liabilities increased to 10.2 to 1 at November 30,
2007 compared to 9.7 to 1 at May 31, 2007. Cash, cash equivalents and
available for sale short term investments totaled $5,741,406 as of November 30,
2007 compared to $5,477,711 at May 31, 2007. As of November 30, 2007
the Company had $2,263,306 in cash and cash equivalents compared to $1,513,061
at May 31, 2007. As of November 30, 2007 the Company had $3,478,100
in short term investments compared to $3,964,650 at May 31, 2007. Short
term investments consisted of highly liquid A1-P1 rated commercial paper
securities maturing through February 2008.
During the six months
ended November 30, 2007, cash provided by operating activities amounted to
$571,031 with the changes described as follows:
·
Net income
for the six months ended November 30, 2007 of $449,254 plus non-cash
items: depreciation and amortization of $92,421, stock-based compensation
related items of $15,278, the $703 loss on disposal of property and equipment,
the $6,962 increase in other long-term obligations offset by the $17,145 change
in deferred taxes.
·
Accounts
receivable balance increased by $59,304 to a November 30, 2007 balance of
$1,533,061. The Company generally experiences a payment cycle of 30-90 days on
invoices, depending on the geographic market. Management believes its credit
and collection policies are effective and appropriate for the marketplace. There
can be no assurance that the Companys collection procedures will continue to
be successful.
·
Inventories
decreased $30,126 to a November 30, 2007 balance of $3,664,311. The
Company maintains levels of inventory sufficient to satisfy normal customer
demands plus an increasing short-term delivery requirement for a majority of
its Balancer products. Management believes its ability to provide prompt
delivery gives it a competitive advantage for certain sales.
·
Prepaid
expenses decreased by $12,042 to $59,647 with the decrease due to prepaid
insurance, fees, trade show costs and various business costs.
·
Trade
accounts payable increased by $113,944 to $459,977 primarily due to normal
fluctuations in timing of payment of outstanding payable balances.
·
Other
accrued liabilities (including customer deposits, commissions, payroll items,
sales returns, expected warranty costs
and other accrued expenses) increased by $692 to a balance of $631,935.
·
Net current
income taxes payable and receivable decreased cash by $73,942.
During the six months
ended November 30, 2007, net cash provided by investing activities was
$152,483, consisting of net maturities of short term investments of $486,550
less net additions to property and equipment of $104,491 and advances and
payments on business being acquired of $229,576. Net cash provided by financing
activities amounted to $23,306 which consisted of items related to common stock
issued on exercised stock options.
The following summarizes
contractual obligations at November 30, 2007 and the effect on future
liquidity and cash flows:
Years ending
November 30,
|
|
Total contractual
obligations
|
|
2008
|
|
$
|
54,734
|
|
2009
|
|
33,680
|
|
2010
|
|
12,159
|
|
Thereafter
|
|
|
|
Total
|
|
$
|
100,573
|
|
Management has
historically responded to business challenges that had a negative impact on
operations and liquidity by reducing operating expenses, developing new
products and attempting to penetrate new markets for the Companys products. Management
believes its cash flows from operations, its available credit resources and its
cash position will provide adequate funds on both a short-term and long-term
basis to cover currently foreseeable debt payments, lease commitments and
payments under existing and anticipated supplier agreements. The Companys bank
line of credit expires
18
March 1, 2009. Management
believes that such cash flow (without the raising of external funds) is
sufficient to finance current operations, projected capital expenditures,
anticipated long-term sales agreements and other expansion-related
contingencies during Fiscal 2008 and 2009. However, in the event the Company
fails to achieve its operating and financial goals for Fiscal 2008, management may be
required to take certain actions to finance operations in that time period. These
actions could include, but are not limited to, implementation of cost cutting
measures and/or entering into additional borrowing arrangements collateralized
by assets.
Business
Risks
This
report includes forward-looking statements as that term is defined in Section 21E
of the Securities Exchange Act of 1934. Forward-looking statements can be
identified by the use of forward-looking terminology such as believes, expects,
may, will, should, seeks, approximately, intends, plans, estimates,
anticipates, or hopes, or the negative of those terms or other comparable
terminology, or by discussions of strategy, plans or intentions. For example,
this section contains numerous forward-looking statements. All
forward-looking statements in this report are made based on managements
current expectations and estimates, which involve risks and uncertainties,
including those described in the following paragraphs. Among these factors are
the following:
·
Demand for Company products may change.
·
New products may not be developed to satisfy
changes in consumer demands.
·
Failure to protect intellectual property rights
could adversely affect future performance and growth.
·
Production time and the overall cost of products
could increase if any of the primary suppliers are lost or if any primary
supplier increased the prices of raw materials.
·
Fluctuations in quarterly and annual operating
results make it difficult to predict future performance.
·
The Company may not be able to reduce
operating costs quickly enough if sales decline.
·
The Company maintains a significant investment in
inventories in anticipation of future sales.
·
Future success depends in part on attracting
and retaining key management and qualified technical and sales personnel.
·
Changes in securities laws and regulations have
increased and will continue to increase Company expenses
·
The Company faces risks from international sales
and currency fluctuations
.
Such
risks and uncertainties could cause actual results to be materially different
from those in the forward-looking statements. Readers are cautioned not to
place undue reliance on the forward-looking statements in this report. We
assume no obligation to update such information.
Demand
for Company products may change:
During
Fiscal 2007 Balancer sales in North America declined (8.3%) when compared to
Fiscal 2006 and declined (11.7%) during the three months ended August 31,
2007 compared to the three months ended August 31, 2006. Combined Balancer
sales increased 3.5% for the six months ended November 30, 2007 compared
to the six months ended November 30, 2006. The conditions and
circumstances could change in future periods and as a result demand for the
Companys products could continue to decline. Management is responding to these
risks in two ways. First, it appears there is still a significant portion of
the marketplace that is not using the automatic balancing products of the
Company or any of its competitors. The Company will therefore continue to
devote part of its future R&D efforts toward developing products that
will both broaden the scope of Balancing products offered to the current
customer base. Second, there are uses for the Companys Balancer products in
industries other than those in the Companys historic customer base. Management
is devoting time to identify these markets and educate those markets on the
value of those products within their operations.
The
laser light-scatter products of the Measurement segment have relied heavily
upon sales to disk drive and silicon wafer manufacturers. The Company had
experienced increasing sales in Fiscal 2006; however, sales during Fiscal 2007
have decreased (13.6%) and have declined (58.1%) during the six months ended November 30,
2007 compared to the six months ended November 30, 2006. Previous
information had indicated continued improving demand for and sales of disk
drive products. Recently, however, certain disk drive manufacturers have scaled
back their outlook for disk drive sales, blaming a price war over high-capacity
desktop computer drives, which now store as much as about one trillion bytes of
data. With respect to handheld applications, disk drive manufacturers believe
disc drive products smaller than 1.8-inch form factors have to a large
extent been replaced by competing storage technologies, such as solid state or
flash memory. The long-term impact on demand for the Companys surface
Measurement products cannot be predicted with any certainty.
19
Management
will continue to market these products to these historic markets as it appears
no other technology has been introduced that would make the laser light-scatter
products technologically obsolete. There is the belief that once market
conditions improve in the disk drive and silicon wafer markets, demand for the
Companys products and technology will increase although most likely not to
historic levels. Also, management believes there are other uses for the Companys
laser light scatter technology and continues to evaluate R&D efforts to
develop new products and introduce them to the marketplace.
New
products may not be developed to satisfy changes in consumer demands:
The
failure to develop new technologies, or react to changes in existing
technologies, could materially delay development of new products, which 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.
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.
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.
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.
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.
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.
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 nor assurances there will be the ability to attract, assimilate and
retain other highly qualified technical and sales personnel as required. There
is also no guarantee key employees will not leave and subsequently compete
against the Company. The inability to retain key personnel could adversely
impact the business, financial condition and results of operations.
20
Changes in securities laws and regulations have
increased and will 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 will continue to
increase Company expenses as the Company devotes resources to respond to their
requirements. In particular, the Company will incur significant additional
administrative expense and a diversion of managements time in Fiscal 2008 to
implement Section 404 of the Sarbanes-Oxley Act which requires management
to report on, and the Companys independent registered public accounting firm
to attest to, our internal control over financial reporting. The Company may also
incur additional fees starting in Fiscal 2009 from its independent registered
public accounting firm as they perform the additional services necessary
for them to provide their attestation. 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, Company 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 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. No assurances can
be given 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.
21
Item
3
.
Quantitative
and Qualitative Disclosures about Market Risk
Interest
Rate Risk
The Company did not have
any derivative financial instruments as of November 30, 2007. However, the
Company could be exposed to interest rate risk at any time in the future and therefore,
employs established policies and procedures to manage its exposure to changes
in the market risk of its marketable securities.
The Companys interest
income and expense are most sensitive to changes in the general level of U.S.
and European interest rates. In this regard, changes in U.S. and European
interest rates affect the interest earned on the Companys interest bearing
cash equivalents and short term investments. The Company has a variable rate
line of credit facility with a bank but there is no outstanding balance as of November 30,
2007. Also, there is no other long-term obligation whose interest rates are
based on variable rates that may fluctuate over time based on economic
changes in the environment. Therefore, at this time, the Company is not subject
to interest rate risk on outstanding interest bearing obligations if market
interest rates fluctuate and does not expect any change in the interest rates
to have a material effect on the Companys results from operations.
Foreign
Currency Risk
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.
The Company operates a subsidiary in the United Kingdom and acquires certain
materials and services from vendors transacted in foreign currencies. Therefore,
the Companys business and financial condition is sensitive to currency
exchange rates or any other restrictions imposed on their currencies. For the
six months ended November 30, 2007 and 2006 results of operations included
gains on foreign currency denominated transactions of $430 and $4,649
respectively. For the three months ended November 30, 2007 and 2006
results of operations included gains (losses) on foreign currency denominated
transactions of ($6,751) and $5,218, respectively.
Item 4.
Controls and Procedures
(a)
Under
the supervision and with the participation of our management, including our
principal executive officer and principal financial officer, we conducted an
evaluation of our disclosure controls and procedures, as such term is defined
under Rules 13a-15(e) and 15d-15(e) promulgated under the
Securities Exchange Act of 1934, as amended, as of the end of the period
covered by this report. Based on their evaluation, our principal executive
officer and principal financial officer concluded that our disclosure controls
and procedures are effective as of the end of the period covered by this
report.
(b)
There
have been no changes in our internal controls that occurred during the period
covered by this report that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.
22