UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.   20549

 

FORM 10-Q

 

 

 

For the transition period from:                        To:                 

 

Commission File Number:  0-23996

 

SCHMITT INDUSTRIES, INC.

(Exact Name of Registrant as Specified in its Charter)

 

 

2765 NW Nicolai Street, Portland, Oregon 97210

(Address of Registrant’s Principal Executive Office)

 

(503) 227-7908

(Registrant’s Telephone Number)

 

Indicate by check mark whether the registrant has (1) filed all reports required to be filed by Section 13 of 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes ý  No o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No ý

 

Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2).  Yes o  No ý

 

The number of shares of each class of common stock outstanding as of December 31, 2005

 

Common stock, no par value

2,613,419

 

 

 

SCHMITT INDUSTRIES, INC.

 

INDEX TO FORM 10-Q

 

				Page
Part I - FINANCIAL INFORMATION
Item 1.		Financial Statements:
		Consolidated Balance Sheets: —November 30, 2005 and May 31, 2005 (unaudited)		3
		Consolidated Statements of Operations: —For the Three and Six Months Ended November 30, 2005 and 2004 (unaudited)		4
		Consolidated Statement of Changes in Stockholders’ Equity: —For the Six Months Ended November 30, 2005 (unaudited)		5
		Consolidated Statements of Cash Flows: —For the Six Months Ended November 30, 2005 and 2004 (unaudited)		6
		Notes to Consolidated Interim Financial Statements:		7
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations		12
Item 3.		Quantitative and Qualitative Disclosures About Market Risk		20
Item 4.		Controls and Procedures		20
Part II - OTHER INFORMATION
Item 4.		Submission of Matters to a Vote of Security Holders		21
Item 6.		Exhibits and Reports on Form 8-K		21
Signatures				21
Certifications				22

 

 

2

 

PART I - FINANCIAL INFORMATION

 

Item 1.    Financial Statements

 

SCHMITT INDUSTRIES, INC.

CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

 

		November 30, 2005			May 31, 2005
ASSETS
Current assets
Cash and cash equivalents		$	2,141,547		$	1,176,959
Accounts receivable, net of allowance of $44,643 and $41,366 at November 30, 2005 and May 31, 2005, respectively		1,656,886			2,109,143
Inventories		3,506,681			3,533,313
Prepaid expenses		44,245			104,292
Deferred tax asset		96,160			92,319
		7,445,519			7,016,026
Property and equipment
Land		299,000			299,000
Buildings and improvements		1,273,450			1,214,348
Furniture, fixtures and equipment		1,157,466			1,120,946
Vehicles		96,849			96,849
		2,826,765			2,731,143
Less accumulated depreciation and amortization		(1,550,200		)	(1,462,637		)
		1,276,565			1,268,506
Other assets
Long-term deferred tax asset		760,740			547,681
Other assets		225,708			243,009
		986,448			790,690
Total assets		$	9,708,532		$	9,075,222
LIABILITIES & STOCKHOLDERS’ EQUITY
Current liabilities
Accounts payable		$	410,609		$	497,206
Accrued commissions		233,380			275,745
Accrued payroll liabilities		94,519			102,883
Other accrued liabilities		126,335			141,550
Income taxes payable		40,299			26,147
Current portion of long-term obligations		19,242			32,114
Total current liabilities		924,384			1,075,645
Long-term obligations		11,304			20,756
Stockholders’ equity
Common stock, no par value, 20,000,000 shares authorized, 2,612,169 and 2,559,687 shares issued and outstanding at November 30, 2005 and May 31, 2005, respectively		7,656,681			7,496,098
Accumulated other comprehensive loss		(258,656		)	(254,654		)
Retained earnings		1,374,819			737,377
Total stockholders’ equity		8,772,844			7,978,821
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY		$	9,708,532		$	9,075,222

 

 

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

 

 

3

 

SCHMITT INDUSTRIES, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE THREE AND SIX MONTHS ENDED NOVEMBER 30, 2005 AND 2004

(UNAUDITED)

 

		Three Months Ended November 30,						Six Months Ended November 30,
		2005			2004			2005			2004
Net sales		$	2,640,671		$	2,480,771		$	5,309,574		$	4,912,524
Cost of sales		1,135,065			999,325			2,375,859			2,072,742
Gross profit		1,505,606			1,481,446			2,933,715			2,839,782
Operating expenses:
General, administration and sales		1,271,466			1,160,695			2,293,140			2,232,730
Research and development		19,131			26,649			33,639			32,716
Total operating expenses		1,290,597			1,187,344			2,326,779			2,265,446
Operating income		215,009			294,102			606,936			574,336
Other income (expense)		(2,421		)	1,065			(451		)	6,886
Income before income taxes		212,588			295,167			606,485			581,222
Provision (benefit) for income taxes		(181,957		)	6,000			(30,957		)	12,000
Net income		$	394,545		$	289,167		$	637,442		$	569,222
Net income per common share:
Basic		$	0.15		$	0.11		$	0.25		$	0.23
Diluted		$	0.14		$	0.11		$	0.23		$	0.21

 

 

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

 

 

4

 

SCHMITT INDUSTRIES, INC.

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

FOR THE SIX MONTHS ENDED NOVEMBER 30, 2005

(UNAUDITED)

 

 

 

		Shares		Amount			Accumulated other comprehensive income (loss)				Retained earnings				Total				Total comprehensive income (loss)
Balance, May 31, 2005		2,559,687		$	7,496,098		$		(254,654	)	$		737,377		$	7,978,821
Stock options exercised and related tax benefit of $76,141		52,482		160,583			—				—				160,583
Net income		—		—			—				637,442				637,442				$	637,442
Other comprehensive (loss)		—		—			(4,002			)	—				(4,002			)	(4,002		)
Balance, November 30, 2005		2,612,169		$	7,656,681		$	(258,656		)	$	1,374,819			$		8,772,844
Comprehensive income, six months ended November 30, 2005																			$	633,440

 

 

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

 

 

5

 

SCHMITT INDUSTRIES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE SIX MONTHS ENDED NOVEMBER 30,  2005 AND 2004

(UNAUDITED)

 

		Six Months Ended November 30,
		2005				2004
Cash flows relating to operating activities
Net income		$	637,442			$	569,222
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		106,333				102,981
Deferred taxes		(216,900			)	—
Tax benefit related to stock options		76,141				—
(Increase) decrease in:
Accounts receivable		452,257				(92,244		)
Inventories		26,632				(782,156		)
Prepaid expenses		60,047				(73,342		)
Income taxes receivable		—				29,950
Increase (decrease) in:
Accounts payable		(86,597			)	219,818
Accrued liabilities and customer deposits		(65,944			)	72,613
Income taxes payable		14,152				—
Net cash provided by operating activities		1,003,563				46,842
Cash flows relating to investing activities
Purchase of property and equipment		(97,091			)	(66,781		)
Disposals of property and equipment		—				3,275
Net cash used in investing activities		(97,091			)	(63,506		)
Cash flows relating to financing activities
Repayments on long-term obligations		(22,324			)	(25,046		)
Common stock issued on exercise of stock options		84,442				94,782
Net cash provided by financing activities		62,118				69,736
Effect of foreign exchange translation on cash		(4,002			)	(16,326		)
Increase in cash and cash equivalents		964,588				36,746
Cash and cash equivalents, beginning of period		1,176,959				604,194
Cash and cash equivalents, end of period		$		2,141,547		$	640,940
Supplemental Disclosure of Cash Flow Information
Cash paid during the period for interest		$		333		$	—
Cash paid during the period for income taxes		$		95,650		$	800

 

 

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

 

 

6

 

SCHMITT INDUSTRIES, INC.

NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS

 

Note 1:                   Basis of Presentation

The consolidated financial information included herein has been prepared by Schmitt Industries, Inc. (the Company) and its wholly owned subsidiaries.  In the opinion of management, the accompanying unaudited Consolidated Financial Statements have been prepared pursuant to the rules and regulations of the Securities Exchange Commission and contain all adjustments, consisting only of normal recurring adjustments, necessary to present fairly its financial position as of November 30, 2005 and its results of operations and its cash flows for the six-months ended November 30, 2005 and 2004.  The consolidated balance sheet at May 31, 2005 has been derived from the Annual Report on Form 10-K for the fiscal year ended May 31, 2005.  The accompanying unaudited financial statements and related notes should be read in conjunction with the audited financial statements included in our Annual Report on Form 10-K for the fiscal year ended May 31, 2005.  Operating results for the interim periods presented are not necessarily indicative of the results that may be experienced for the fiscal year ending May 31, 2006.  Certain amounts in prior periods’ financial statements have been reclassified to conform to the current periods’ presentation. These reclassifications did not affect consolidated net income.

 

 

Note 2:                   Revenue Recognition

The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable and collectibility is probable.  For sales to all customers, including manufacturer representatives, distributors or their third-party customers, these criteria are met at the time product is shipped.  When other significant obligations remain after products are delivered, revenue is recognized only after such obligations are fulfilled.

 

 

Note 3:                   Recent Accounting Pronouncements

The Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 151, “Inventory Costs - an Amendment to ARB No. 43, Chapter 4” in November 2004.  This Statement requires that abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage) costs be recognized as current-period charges.  In addition, this Statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities.  The Company does not expect this pronouncement to have a material impact on the financial statements.

 

The Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 154, “Accounting Changes and Error Corrections—a replacement of APB Opinion No. 20 and FASB Statement No. 3”.  This Statement replaces APB Opinion No. 20, “Accounting Changes”, and FASB Statement No. 3, “Reporting Accounting Changes in Interim Financial Statements”, and changes the requirements for the accounting for and reporting of a change in accounting principle. This Statement applies to all voluntary changes in accounting principle. It also applies to changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. When a pronouncement includes specific transition provisions, those provisions should be followed.  The Company does not expect this pronouncement to have a material impact on the financial statements.

 

The Financial Accounting Standards Board revised Statement of Financial Accounting Standards No. 123R, “Share-Based Payment” in December 2004.  Under the revised standard, the Company will be required to recognize compensation cost, related to its stock options, beginning in the first fiscal quarter of the year beginning June 1, 2006.  The cost of services received from employees in exchange for awards of share-based compensation generally shall be measured based on the grant-date fair value of the equity instruments issued.  The Company expects the effect of this pronouncement to approximate the proforma amounts disclosed in Note 4.

 

 

Note 4:                   Stock — Based Compensation

The Company has elected to follow the accounting provisions of Accounting Principles Board Opinion No. 25 (“APB 25”), “Accounting for Stock Issued to Employees”, for stock-based compensation and to furnish the pro forma disclosures required under SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure.”  No stock-based employee compensation cost is reflected in net income because all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of the grant.

 

 

7

 

The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS 123 to stock-based compensation:

 

		Three Months Ended November 30,						Six Months Ended November 30,
		2005			2004			2005			2004
Net income, as reported		$	394,545		$	289,167		$	637,442		$	569,222
Add: Stock-based employee compensation expense included in reported net income, net of tax		—			—			—			—
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of tax		(4,188		)	(64,820		)	(9,624		)	(129,320		)
Pro forma net income		$	390,357		$	224,347		$	627,818		$	439,902
Earnings per share — basic
As reported		$	.15		$	.11		$	.25		$	.23
Pro forma		$	.15		$	.09		$	.24		$	.17
Earnings per share — diluted
As reported		$	.14		$	.11		$	.23		$	.21
Pro forma		$	.14		$	.08		$	.23		$	.16

 

The effects of applying SFAS No. 123 in this pro forma disclosure are not necessarily indicative of future amounts.

 

The Company continues to measure compensation cost for the Plan using the method of accounting prescribed by APB 25.  In electing to continue to follow APB 25 for expense recognition purposes, the Company is required to provide the expanded disclosures required under SFAS No. 148 for stock-based compensation granted, including disclosure of pro forma net income and earnings per share, as if the fair value based method of accounting defined in the SFAS No. 123, had been adopted.

 

The Company has computed, for pro forma disclosure purposes, the value of each option granted using the Black-Scholes option pricing model as prescribed by SFAS No. 123 using the following assumptions:

 

 

 

Note 5:                   EPS Reconciliation

		Three Months Ended November 30,				Six Months Ended November 30,
		2005		2004		2005		2004
Weighted average shares (basic)		2,607,948		2,524,316		2,595,500		2,520,034
Effect of dilutive stock options		145,153		208,477		155,228		197,513
Weighted average shares (diluted)		2,753,101		2,732,793		2,750,728		2,717,547

 

Basic earnings per share are computed using the weighted average number of shares outstanding.  Diluted earnings per share are computed using the weighted average number of shares outstanding, adjusted for dilutive incremental shares attributed to outstanding options to purchase common stock.

 

 

8

 

Note 6:                   Deferred Tax Assets

The Company applies the asset and liability method in recording income taxes, under which deferred income tax assets and liabilities are determined, based on the differences between the financial reporting and tax bases of assets and liabilities and are measured using currently enacted tax rates and laws.  Deferred tax assets are evaluated and a valuation allowance is established if it is more likely than not that all or a portion of the deferred tax asset will not be realized. The Company has recorded a substantial deferred tax asset related to the expected realization of net operating loss carryforwards for federal income tax purposes and other temporary differences between book and tax bases of assets and liabilities.  Certain of these assets arose when the Company acquired the stock and therefore the net operating loss carryforwards of its wholly owned subsidiary, Schmitt Measurement Systems in 1996.  Due to the uncertainty of utilization of the Company’s NOLs and in consideration of other factors, management recorded a valuation allowance on the deferred tax asset at May 31, 2003.

 

In Fiscal 2005 management concluded future operations would produce sufficient earnings so that a portion of this asset could be used in future periods to reduce federal and state tax liabilities.  As a result, the valuation reserve for this asset was reduced as of May 31, 2005 to reflect the amount of the asset management expected to utilize in future fiscal periods.  As of November 30, 2005 management concluded future operations would produce sufficient earnings so that additional portions of this asset could be used in future periods to reduce federal and state tax liabilities.  Therefore, the allowance was reduced by $281,000 to approximately $807,000 to reflect the amount of the deferred tax asset management believes can be utilized in Fiscal 2006 and beyond.  This resulted in a net tax benefit of $181, 957 and $30,957 for the three and six month periods ended November 30, 2005, respectively.  Management believes the effective tax rate in future periods will reflect a normal combined state and federal rate.

 

Note 7:                   Segments of Business

Segment Information

 

		Three Months Ended November 30,
		2005						2004
		Balancer			Measurement			Balancer			Measurement
Gross sales		$	1,974,700		$	847,085		$	1,900,367		$	794,638
Intercompany sales		(140,722		)	(40,392		)	(209,361		)	(4,873		)
Net sales		$	1,833,978		$	806,693		$	1,691,006		$	789,765
Operating income		$	35,953		$	179,056		$	18,365		$	275,737
Intercompany rent expense (income)		$	(7,500	)	$	7,500		$	(7,500	)	$	7,500
Depreciation expense		$	33,337		$	9,179		$	34,280		$	9,521
Amortization expense		$	—		$	8,650		$	—		$	8,650
Capital expenditures		$	1,062		$	45,941		$	16,791		$	—
		Six Months Ended November 30,
		2005						2004
		Balancer			Measurement			Balancer			Measurement
Gross sales		$	4,022,828		$	1,604,419		$	3,845,619		$	1,477,379
Intercompany sales		(273,070		)	(44,603		)	(398,902		)	(11,572		)
Net sales		$	3,749,758		$	1,559,816		$	3,446,717		$	1,465,807
Operating income		$	334,628		$	272,308		$	103,553		$	470,783
Intercompany rent expense (income)		$	(15,000	)	$	15,000		$	(15,000	)	$	15,000
Depreciation expense		$	70,478		$	18,554		$	67,721		$	17,959
Amortization expense		$	—		$	17,301		$	—		$	17,301
Capital expenditures		$	36,394		$	60,697		$	58,456		$	8,325

 

 

9

 

Geographic Information

		Three Months Ended November 30,							Six Months Ended November 30,
Geographic Sales		2005			2004				2005				2004
North American Sales
United States		$	1,314,069		$		1,380,460		$	2,813,637			$	2,788,486
Canada and Mexico		17,198			25,344				54,264				86,387
North American total		1,331,267			1,405,804				2,867,901				2,874,873
European Sales
Germany		80,412			182,031				161,193				259,478
United Kingdom		255,180			321,633				483,394				640,584
Intercompany		(181,114		)	(214,234			)	(313,967			)	(410,474			)
United Kingdom total		74,066			107,399				169,427				230,110
Other European Sales		247,010			247,240				414,638				522,302
Total Europe		401,488			536,670				745,258				1,011,890
Asia		610,973			433,016				1,158,366				869,475
Other markets		296,943			105,281				538,049				156,286
		$	2,640,671		$	2,480,771			$		5,309,574		$		4,912,524

 

 

 

Note —  Europe is defined as the European subsidiary, Schmitt Europe, Ltd.

 

Long-term Assets

 

 

 

10

 

Note 8:                   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 totaled $72,568 during the fiscal quarter ended November 30, 2005.

 

In connection with the contract, the Board authorized Wayne Case, the Company’s 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.

 

 

11

 

Item 2 - Management’s 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. Effective May 30, 2005 the Company has liquidated and dissolved the German Subsidiary, Schmitt Europa, GmbH.  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, 2005.  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 8.8% for the six months ended November 30, 2005 compared to the six months ended November 30, 2004.  Balancer sales for the three months ended November 30, 2005 increased 8.5% compared to the same fiscal quarter ended November 30, 2004.  Beginning in March 2004, improving economic conditions in North America resulted in increased sales in that geographic market.  Sales people, representatives and distributors throughout these geographic areas spend a large amount of time with targeted customers.  Many customers in the automotive, bearing and aircraft industries refer to improved economic conditions and its impact on the machine tool industry in North America as the reason for their increased orders, although the growth rate has slowed in the last two quarters.  While those customers are optimistic regarding short term demand for Balancer products, they remain uncertain as to the strength and duration of current business conditions in North America for their products which incorporate the Balancer segment product line.  North American sales increased only 1.6% in the six months ended November 30, 2005 compared to the six months ended November 30, 2004.  Market demand in Asia for the Balancer segment products remains strong with that region showing a 58.1% increase for the six months ended November 30, 2005 compared to the six months ended November 30, 2004.  The European market remains soft as total Balancer sales into that geographic market declined 37.9% during the six months ended November 30, 2005 compared to the six months ended November 30, 2004.  Sales in all Other markets increased to $483,399 in the six months ended November 30, 2005 compared to the $156,286 for the six months ended November 30, 2004, a 314% increase.  The large percentage increase was predominately a result of increases in the Japan and South American markets.  As with the North American market, the duration of the strong demand in Asia, Japan and South American markets cannot be forecasted with any certainty.

 

The Measurement segment product line consists of both laser light-scatter and dimensional sizing products. Combined Measurement sales increased 6.4% for the six months ended November 30, 2005 compared to the six months ended November 30, 2004.  Measurement sales for the three months ended November 30, 2005 increased 2.1% when compared to the same fiscal quarter ended November 30, 2004.  Sales in all other markets increased 37.9% in the six months ended November 30, 2005 compared to the six months ended November 30, 2004.  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. Certain segments of these targeted industries have seen consolidation into very large international manufacturers.  Sales totaled $555,903 for the six months ended November 30, 2005 compared to the $598,877 for the six months ended November 30, 2004.  Management and the sales staff monitor industry publications and public financial information in order to judge the potential demand for products by the targeted industries.  Over the past year, this information has indicated improving demand for and sales of the products of those industries.  Sales to customers in these industries can be very cyclical and therefore the impact of this recovery on sales to the Company’s laser light-scatter products is unknown at this time.

 

Laser light-scatter products for research organizations — The Company continues to receive inquiries for these products and provide quotes to interested parties.  However, in the current fiscal quarter, no sales of these products were realized.

 

 

12

 

Dimensional sizing products — These products are marketed and sold into a wide array of industries.  Sales totaled $1,003,913 for the six months ended November 30, 2005 compared to the $866,930 for the six months ended November 30, 2004.  In Fiscal 2004 Management built a sales distribution network covering all fifty states.  As a result of this action, the Company experienced increasing interest and sales in these products.  During the quarter ended August 31, 2003, Management consolidated the operations related to these products (which had been located in Menlo Park, California) into the Measurement segment operations in Portland, Oregon.  The relocation was completed as of August 31, 2003.   Since relocation to Portland, sales of these products were $1,763,307 and $1,023,278 in Fiscal 2005 and 2004, respectively.

 

Critical Accounting Policies

 

Revenue Recognition — The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable and collectibility is probable.  For sales to all customers, including manufacturer representatives, distributors or their third-party customers, these criteria are met at the time product is shipped.  When other significant obligations remain after products are delivered, revenue is recognized only after such obligations are fulfilled.

 

Accounts Receivable — The Company maintains credit limits for all customers that are developed based upon several factors, including but not limited to payment history, published credit reports and use of credit references.  On a monthly basis, management performs various analyses to evaluate accounts receivable balances to ensure recorded amounts reflect estimated net realizable value.  This review includes accounts receivable agings, other operating trends and relevant business conditions, including general economic factors, as they relate to the Company’s domestic and international customers. If these analyses lead management to the conclusion that potential significant accounts are uncollectible, a reserve is provided.

 

Inventories — These assets are stated at the lower of cost or market on an average cost basis. Each fiscal quarter, management utilizes various analyses based on sales forecasts, historical sales and inventory levels to ensure the current carrying value of inventory accurately reflects current and expected requirements within a reasonable timeframe.

 

Deferred Tax Assets — The Company applies the asset and liability method in recording income taxes, under which deferred income tax assets and liabilities are determined, based on the differences between the financial reporting and tax bases of assets and liabilities and are measured using currently enacted tax rates and laws. Additionally, deferred tax assets are evaluated and a valuation allowance is established if it is more likely than not that all or a portion of the deferred tax asset will not be realized.  In Fiscal 2005 and at November 30, 2005, management concluded future operations would produce sufficient earnings so that a portion of this asset could be used in future periods to reduce federal and state tax liabilities.  Management continues to review the level of the valuation allowance on a quarterly basis. There can be no assurance that the Company’s future operations will produce sufficient earnings so that the deferred tax asset can be fully utilized.

 

Intangible Assets — There is a periodic review of intangible and other long-lived assets for impairment.  This review consists of the analysis of events or changes in circumstances that would indicate the carrying amount of the asset may not be recoverable. Recoverability is determined by comparing the forecasted future net cash flows from the operations to which the assets relate, based on management’s best estimates using the appropriate assumptions and projections at the time, to the carrying amount of the assets.  If the carrying value is determined to be in excess of  future operating cash flows, the asset is considered impaired and a loss is recognized equal to the amount by which the carrying amount exceeds the estimated fair value of the assets.   As of November 30, 2005, management does not believe impairment, as defined above, exists.

 

Recently issued accounting pronouncements:

 

The Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 151, “Inventory Costs - an Amendment to ARB No. 43, Chapter 4” in November 2004.  This Statement requires that abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage) costs be recognized as current-period charges.  In addition, this Statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities.  The Company does not expect this pronouncement to have a material impact on the financial statements.

 

 

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The Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 154, “Accounting Changes and Error Corrections—a replacement of APB Opinion No. 20 and FASB Statement No. 3”.  This Statement replaces APB Opinion No. 20, “Accounting Changes”, and FASB Statement No. 3, “Reporting Accounting Changes in Interim Financial Statements”, and changes the requirements for the accounting for and reporting of a change in accounting principle. This Statement applies to all voluntary changes in accounting principle. It also applies to changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. When a pronouncement includes specific transition provisions, those provisions should be followed.  The Company does not expect this pronouncement to have a material impact on the financial statements.

 

The Financial Accounting Standards Board revised Statement of Financial Accounting Standards No. 123, “Share-Based Payment” in December 2004.  Under the revised standard, the Company will be required to recognize compensation cost, related to its stock options, beginning in the first fiscal quarter of the year beginning June 1, 2006.  The cost of services received from employees in exchange for awards of share-based compensation generally shall be measured based on the grant-date fair value of the equity instruments issued.  The Company expects the effect of this pronouncement to approximate the proforma amounts disclosed in Note 4 of the Notes to Consolidated Interim Financial Statements.

 

 

Discussion of operating results:

 

Three months ended November 30, 2005 and 2004:

		Three months ended November 30, 2005
		Consolidated					Balancer					Measurement
		Dollars			%		Dollars			%		Dollars					%
Sales		$	2,640,671		100.0		$	1,833,978		100.0		$	806,693				100.0
Cost of sales		1,135,065			43.0		861,923			47.0		273,142					33.9
Gross profit		1,505,606			57.0		$	972,055		53.0		$	533,551				66.1
Operating expenses		1,290,597			48.9
Operating income		$	215,009		8.1
		Three months ended November 30, 2004
		Consolidated					Balancer					Measurement
		Dollars			%		Dollars			%		Dollars				%
Sales		$	2,480,771		100.0		$	1,691,006		100.0		$	789,765			100.0
Cost of sales		999,325			40.3		770,200			45.5		229,125				29.0
Gross profit		1,481,446			59.7		$	920,806		54.5		$	560,640			71.0
Operating expenses		1,187,344			47.9
Operating income		$	294,102		11.9

 

 

Worldwide sales of Balancer products increased 8.5% in the three month period ended November 30, 2005 when compared to the same period in the prior fiscal year as sales to the Asian and Other markets (including Japan and South America) increased by 114.7% and 211.1%, respectively.  These increases were offset by a slight decrease in the North American market of 3.7% and continued decline in the European market, which decreased 43.8% in the most current fiscal period when compared to the same period in the prior fiscal year.  Unit sales prices of Balancer products are relatively stable 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 Balancer product sales increase in Asia and Other markets is attributed to expansion of the sales efforts in China and other market regions.  The decreased units sold in Europe are attributed to strong European competition and weaker economic conditions in certain European markets.

 

 

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