UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

(Mark One)
ý	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the Fiscal year ended: May 31, 2003
or
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the transition period from                               to

 

Commission File Number:  0-23996

 

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class		Name of each exchange on which registered
None		None

 

Securities registered pursuant to Section 12(g) of the Act:

 

 

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

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ý

 

As of August 1, 2003, the aggregate market value of the registrant’s Common Stock held by nonaffiliates of the registrant was $2,451,975 based on the closing sales price of the registrant’s Common Stock on the Nasdaq SmallCap Market.  On that date, there were 2,478,924 shares of Common Stock outstanding.

 

Portions of the registrant’s definitive Proxy Statement for its 2003 Annual Meeting of Shareholders are incorporated by reference into Part III hereof.

 

 

PART I

 

Item 1.  Business

 

Introduction

 

The Company (an Oregon corporation) designs, assembles and markets computer-controlled balancing equipment primarily to the machine tool industry.  Through its wholly owned subsidiaries, Schmitt Measurement Systems, Inc. (“SMS”), an Oregon corporation and Acuity Research Incorporated (“ARI”), a California corporation, the Company designs, manufactures and markets precision laser measurement systems. The Company also sells and markets its products in Europe through its wholly owned subsidiaries, Schmitt Europe Ltd. (“SEL”), located in the United Kingdom and Schmitt Europa GmbH (“SEG”), located in Germany.  The Company’s executive offices are located at 2765 N.W. Nicolai Street, Portland, Oregon 97210, and its telephone number is (503) 227-7908.

 

Balancing Products

 

The Company’s principal product is the Schmitt Dynamic Balance System (the “SBS System”), consisting of a computer control unit, sensor, spindle-mounting adapter, and balance head.  It is designed to be an inexpensive, yet highly accurate, permanent installation on grinding machines. The Company acquired its original balancing equipment technology pursuant to a series of agreements from 1987 through 1991 and substantially enhanced and advanced the patented technology since that time.  Since inception the targeted customer base has been operators of grinding machines.

 

The SBS System is fully automated, eliminating the need to pre-balance such devices as grinding wheels.  This reduces machine setup time and ensures a smoother and more efficient operation.  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 sensor that feeds a signal to a controller that filters the signal by revolutions per minute.  The controller then 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.

 

Notable features of the SBS System include its ability to fit almost all 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 both English and metric systems, instrument grade calibration, short balance process, measurement of both displacement and/or velocity and minimal user maintenance.

 

Benefits to the system user include improved quality of finished parts, ease of product adaptation, 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 all major manufacturing areas including the automotive industry (camshafts, crankshafts, valves), bearings (roller and tapered types), ceramics (precision shaping), electric motors (shafts), pumps (shafts and turbines), aircraft (engine parts), and general manufacturing. Precision grinding has an established worldwide presence in all industrialized countries and is expanding as a method of material removal and processing.  Therefore, the Company believes there may be an increase in market growth and the need for automatic balancing. Within the industry there are three major market segments:

 

Machine Tool Builders - These companies design and manufacture a variety of cylindrical, surface and specialty application grinding machines.  SBS Systems are distributed to a variety of world markets through OEM (original equipment manufacturer) accounts, where a special pricing (20% discount) is offered to the machine builder incorporating the SBS System into its machine.

 

Examples of some well-known worldwide machine tool builders who have offered and/or installed the SBS System include ANCA (Australia), Blohm Incorporated (U.S.), Blohm GmbH (Germany),

 

2

 

Capco Machinery (U.S.), Cincinnati Milacron (U.S.), Ecotech/SMTW (China/U.S.), Gleason Works (U.S.), Litton IAS/Landis Grinding (U.S.), Micron Machinery Limited (Japan/U.S.), Normac Incorporated (U.S.), NTC Toyama America (U.S./Japan), Okomoto (Japan), Okuma Machine (Japan), Shigiya Machine (Japan), Sumitomo Heavy Industry (Japan), CETOS Hostivar (Czech Republic), TOS Holice (Czech Republic), Toyoda Machine (Japan) and Weldon Machine Tool (U.S.).  The Company currently sells its products directly to most of the major machine rebuilders in the U.S. and Western Europe.

 

Machine Tool Rebuilders – These customers, found in all industrial nations, develop their business by offering to completely update and refurbish older machine tools. 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 rebuilders in the U.S. and Western Europe.

 

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 Company’s business is conducted worldwide with some better known customers including: Black & Decker, Briggs and Stratton, Caterpillar Inc., Daewoo International Corp., Eaton Corporation, Ford Motor Company, General Electric Corp., General Motors, Ingersoll Rand, Sumitomo Heavy Industries, Texas Instruments, The Timken Company, Torrington, TRW Automotive Components and Westinghouse Electric Corp.

 

The acquisition of SEG added the internal spindle, ring and water balancer designs to the Company’s product line.  These proven designs allow Schmitt to provide products to a broad range of machine applications.

 

In Fiscal 2003, 2002 and 2001, net sales of the Company’s balancing products totaled $5,481,010, $5,275,556 and $6,030,030 respectively.  Net sales of balancing products accounted for 74% of the Company’s revenue in Fiscal 2003, 77% in Fiscal 2002 and 80% in Fiscal 2001.  See Note 9 to Consolidated Financial Statements.

 

Competition:

 

Management believes the SBS System is one of few fully automatic balancing systems marketed in the world.  Most competitive products require special setup and training or calibration to the specific machine. The Company believes the SBS System is currently the only balancing product that fits all machines with wheel sizes from 6 to 48 inches in diameter and a spindle rpm of 500 through 7,500.

 

Competitive products come from European companies located in Switzerland, Germany, Spain and Italy.  These competitors produce electromechanical balancers similar to the SBS System and water balancers similar to the SEG system.  The Company considers these companies, with their established European base, to be the major competitors.  These balancers have electronic deficiencies, rendering them less effective in solving essential balancing requirements.  They cannot achieve the consistent low balance levels at 500-rpm (low speed) or at 7,500 rpm (high speed) as the SBS system can.  In addition, these balancers have inferior brush and cable assemblies that cause down time and high maintenance.  Finally, none of these companies can currently compete effectively with the Company in providing mounting adapters for all grinding machines.

 

Water balancers are the oldest on the market and are employed in the SEG-installed systems.  They require expensive plumbing and water chambers to be machined into the wheel hub while the SBS System does not.  They are currently priced about 1.25 times the level of the SBS System.  To install these systems, the grinding machines must be disassembled and parts remachined or replaced within the spindle assembly.  This can take two days, far longer than required to install the SBS system.  The water system is “tuned” or “calibrated” to the machine by a factory service technician while the SBS system can be installed by the operator.  Water systems work at mid- and high-speeds but cannot balance in low rpm environments while SBS products work in both environments.  Water systems require periodic monitoring while the SBS systems require little or no operator monitoring.

 

The SBS System list price is generally $7,995 worldwide.  Competitors’ electromechanical systems are priced at $8,000 to $10,000 worldwide while water balancers are priced at $9,000 to $11,000 worldwide.  Management market surveys indicate customers perceive the value of an automatic balancer to be approximately $8,000; therefore, Company pricing is geared to obtaining a dominant market position and

 

3

 

meeting competitive supplier prices.  The market strategy is to establish the SBS System as the foremost product with the best quality, reliability and performance and superior economic value.

 

Measurement Products

 

The Company manufactures and markets a line of laser-based, precision measurement systems and operates a precision laser light scatter measurement laboratory.  Light scatter technology involves using lasers, optics and detectors to throw a beam of light on a material sample and record its reflection/transmission.  Analysis of information can determine material characteristics such as surface roughness, defects and dimensional sizing without introducing contaminants and causing changes to the tested material.  The principal products are laser-based measurement products and technology applicable to both industrial and military markets.  The Company has used patents, patent applications, trademarks and other proprietary technology to focus marketing efforts on industrial markets, including electronics, computer disk and silicon wafer manufacturers.

 

There are four product lines: laser-based light-scatter measurement, dimensional sizing, research and other laser alignment products and a light-scatter measurement laboratory.

 

Laser-based light-scatter measurement:

 

These products use a patented laser light scatter technology to perform rapid, accurate, repeatable and non-destructive non-contact surface measurement tests that quantify surface micro-roughness.  Products are sold to manufacturers of disk drives and silicon wafers, both industries with fabrication processes that require precise and reliable measurements.

 

Computer hard disks require exact manufacturing control and a narrow tolerance band for acceptable roughness. The read/write head flies over the disk drive surface on a cushion of air generated when the rough surface of the rotating disk pulls air under the head.  The head may stick or bind to the disk when the surface is too smooth. If it is too rough, the head will fly too far from the disk surface, causing a reduction in data density or storage capacity.  The DUV and TMS product series meet the challenges of disk drive manufacturers.  Customers include IBM, Seagate Substrates, Western Digital and Komag, Inc.

 

The original TMS-2000 (Texture Measurement System) product, the world’s fastest and most accurate non-contact texture measurement system, revolutionized disk-manufacturing technology.  The product (used on aluminum substrates) is currently used worldwide by most major disk drive manufacturers and provides fast, accurate and repeatable microroughness measurements and quadruples production throughput when compared to other testing devices.  Surface roughness can now be measured to levels below 0.5 Angstroms (the point of a needle is one million Angstroms in diameter).

 

The TMS-2000-DUV product measures the surface microroughness of glass rather than aluminum substrates.  Manufacturers require the technology and products to measure surface roughness of these substrates to the same exact levels as those that measure aluminum. The Deep Ultra-violet light (DUV) technology and product uses the patented light scatter technology to measure the surface roughness of glass substrates to levels less than one Angstrom.

 

Both products simultaneously measure 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.  This measurement method is not possible through any other cost effective measurement means.

 

The TMS-2000W and TMS-3000W provide fast, accurate, repeatable measurements for manufacturers of silicon wafers, computer chips 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 chemical deposition, grinding, polishing, etching, or any number of other production techniques, some method of measuring these surface characteristics is required.  The wafer measurement products provide a way for SMS customers in this industry to quantify and control their manufacturing process. The system provides measurements to a few hundredths of an Angstrom, a level unachievable by other testing devices.

 

4

 

Dimensional Sizing Products:

 

ARI develops and assembles laser distance sensors for industrial and OEM use. Applications include steel casting, paper production, medical imaging, crane control and micron-level part and surface inspection.  Presently, there are four product lines: the AR4000 distance measurement sensor, the AR4000 Line Scanner and the AR600 and AR200 series of triangulating laser displacement sensors.

 

The AccuRange 4000 is an optical distance measurement sensor for most diffuse reflective surfaces.  It operates by emitting a collimated laser beam that is reflected from the target surface and collected by a sensor.  The sensor is suitable for a wide variety of distance measurement applications that demand high accuracy and fast response times.  Notable features include the operating range for most surfaces (zero to fifty feet), fast response time (50 kHz maximum sample rate), compact and lightweight power design and has a tightly collimated output beam for small spot size.  The product has three output beam configurations available: visible infrared, eye safe infrared and reflective tape targets.  It is ideally suited to level and position measurement, machine vision, autonomous vehicle navigation and 3D imaging applications.

 

The AR4000 Line Scanner is used with the AccuRange 4000 to scan and collect distance data over a full circle.  The scanner consists of a balanced, rotating mirror and motor with position encoder and mounting hardware for use with the AccuRange 4000.  The scanner deflects the beam 90 degrees, sweeping it through a full circle as it rotates.  The product can scan at rates of up to 2600 lines per minute, sweeps the laser beam through a full 360 degrees and is both compact and lightweight.

 

The AR600 series is a family of triangulating laser displacement sensors with excellent accuracy and sensitivity.  The sensor projects 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 target’s distance is computed from the image pixel data. The line includes 11 models measuring displacements from 1/8” to 50” and accuracy’s down to .00015” (4 microns). They can operate on all types of surfaces at speeds up to 1250 samples/second.  The product is extremely sensitive and can detect glass and liquid surfaces and also detect multiple surfaces of transparent materials, allowing great flexibility in specialized applications.

 

The AR200 line is Acuity Research’s most compact series of triangulating laser displacement sensors. Four models cover metric measurement ranges from six to fifty millimeters.  All models boast a 1/500 accuracy rating for measurements within twelve microns.  The AR200 sensor is the only sensor of its kind to feature pushbutton selection of output signals.  All models are standard with Analog, Limit Switch and Serial outputs.  The AR200 sensors, much like the longer-range AR600 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 target’s distance is computed from the image pixel data.  The AR200-6M, -12M, -25M and -50M have ranges in millimeters that match their model number.  The AR200 displacement sensor can not be overloaded and measures accurately even when a mirror reflects the entire light beam back to the detector.

 

Research and Other Measurement Products:

 

CASI Scatterometers are sold to companies and institutions involved in research efforts. A Scatterometer uses 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 measurement instruments providing customers with precise roughness measurements 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. Customers include Pratt & Whitney, Boeing, The U.S. Navy and Rockwell Collins North America.

 

The μScan 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 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 μScan 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 flat or curved surfaces under any lighting conditions.

 

5

 

Testing Laboratory:

 

The Company provides a highly advanced measurement services laboratory to a wide variety of industrial and commercial businesses that require precise measurements only advanced laser light scatter technology can provide.  The laboratory uses CASI Scatterometers for measuring surface roughness. The true value of the laboratory is not only its extremely precise measurement capability but also the test item is not altered, touched or destroyed.  Thus, the laboratory is widely used by manufacturers of critical optical components in aerospace and defense systems, including such companies as Aerojet, AT&T Bell Labs, Eastman Kodak, General Electric, IBM, NASA and dozens of other industrial companies, universities and government agencies.

 

In Fiscal 2003, 2002 and 2001, net sales of Measurement products totaled $1,938,511, $1,599,103 and $1,550,124 respectively and accounted for 26%, 23% and 20% of the Company’s total sales in Fiscal 2003, 2002 and 2001 respectively.

 

Business and Marketing Strategy

 

The Company designs, assembles and markets all of its products with operations divided into a number of different areas.  The Vice President of Operations directs SBS System production, and is responsible for all assembly, purchasing and production engineering as well as the technical services division that provides technical support to customers.  The President/CEO directs the production, assembly, purchasing, engineering and technical services functions for the SMS and ARI product lines.  The Product Marketing Division, managed by the President/CEO, is responsible for the sale of SBS System products.  Two Marketing Managers are responsible for domestic sales while a third is responsible for sales in Mainland China, Taiwan and Korea.  The Company also has one person who performs field service/sales.  The President/CEO is responsible for European sales and oversees the efforts of the European Marketing Manager who is headquartered in the United Kingdom.  Finally, there is a research and development group supervised directly by the President/CEO and the Vice President of Operations.

 

The Company markets and sells the SBS System in a variety of ways.  First, are the channels provided by independent manufacturer’s representatives and distributors.  There are currently approximately 25 individuals and/or organizations in the United States acting in one of these capacities. Independent sales agents are paid a 10% commission; distributors are sold products at a 15% discount.

 

Second, worldwide trade shows have proven to be an excellent source of business.  Company representatives, usually one or more of the Marketing Managers and/or the President/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 Company’s target markets attend these trade shows.

 

Third, original equipment manufacturers (OEMs) include the SBS System on the machine tools they produce. Users thus purchase the SBS System 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 builders prior to displaying their own machine tools at various trade shows, becoming endorsements that prove beneficial to the Company’s sales efforts.

 

In the United States, most products are shipped directly to customers from the Company’s distribution center 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 Company’s Portland headquarters to the European subsidiaries, who in turn sell and distribute the products.

 

Similar to the parent company, SMS uses a variety of methods to market and sell its measurement products.  First, a Marketing Manager, under the direction of the President/CEO, directs the overall worldwide marketing efforts.  Second, the Company uses an independent manufacturer’s representative group to market and sell products to various customers in the Western United States. That group is paid a 20% commission on units they are responsible for selling.  Third, the Company has a nonexclusive distribution agreement with a

 

6

 

company in Japan for the promotion and sale of SMS products in Japan, Korea, Malaysia, Singapore, the Philippines and Taiwan. Fourth, trade shows represent a significant amount of marketing/sales effort.  The President/CEO attends these events along with various Company representatives.  These individuals operate a display booth featuring SMS product demonstrations and product and technical literature.  Representatives from all facets of the market to which the Company directs its sales efforts attend these trade shows.  Finally, one of the best marketing channels is the testing laboratory.  Once customers see the capabilities of the technology, it can lead to orders for the Company’s laser based light scatter measurement products.

 

All SMS products are assembled in the Portland, Oregon facility and shipped worldwide directly to customers.

 

Acuity exclusively markets and sells its measurement products through a worldwide network of manufacturer’s representatives and distributors.  The Marketing Manager of ARI, under the direction of the Company’s President/CEO, directs the overall marketing efforts.  There are seven representatives in North America and seven located in countries throughout the world.  The United States representatives receive a 15% commission while the foreign representatives receive a 25% commission on all units they sell. Management of both the Company and ARI will also attend trade shows where the products are displayed and demonstrated.  All ARI products are assembled in the Menlo Park, California facility and shipped worldwide directly to customers.

 

The SBS, SMS and ARI customer bases consist of over 250, 200 and 300 companies respectively.

 

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 Company’s quality and assembly standards.  Company-owned software and firmware are coupled with the electronic components to provide the basis of the Company’s various electronic control units.  Management believes several supply sources exist for all electronic components and assembly work incorporated into its electronic control systems.  The primary outside supplier of electronic assemblies is Vanguard EMS of Beaverton, Oregon, a custom supplier of assembled electronic products for several Pacific Northwest companies.  In the event of supply problems, the Company believes that two or three alternatives could be developed within 30 days to supplement or replace Vanguard.

 

Mechanical parts for the Company’s products are produced by high quality CNC machine shops.  The Company is not dependent on any one supplier of mechanical components.  Principal suppliers of components for the Company’s products include MacKay Manufacturing of Spokane, Washington; OEM Manufacturing of Corvallis, Oregon; Eagle Industries of Newberg, Oregon; and Forest City Gear of Roscoe, Illinois.

 

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.

 

In November 1996, the Company’s Quality Control Program received full ISO-9001 certification.  This certification was renewed in November 2002.

 

Proprietary Technology

 

The Company’s success depends in part on its proprietary technology, which the Company attempts to protect through patents, copyrights, trademarks, trade secrets and other measures.

 

The Company has U.S. patents covering its SBS, SMS and ARI products, processes and methods which 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

 

7

 

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 as 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.

 

“SBS” and “SMS” are registered trademarks and are affixed to all products and literature created in the Company’s balancer and measurement product lines, respectively.

 

The Company manufactures its SBS products under copyright protection in the U.S. for electronic board designs.  Encapsulation of the finished product further protects the Company’s 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 Company’s 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 marks, 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

 

In Fiscal 1997, the Company began a research and development program to expand the product lines and capabilities of SBS and SMS products.  That policy has been incorporated into the operations of ARI as well.  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.  Since that Fiscal year, the Company has continued to develop the following new balancing and laser measurement products.

 

The SB-4500 unit is now a multi-function unit providing the versatility to control several activities including all of Schmitt’s balancer products.  It controls balancing in applications with speeds ranging from 300 to 30,000 rpm compared to a range of 500 to 10,000 rpm with the prior Schmitt product.  Vibrations are measured to 0.02 microns or 0.75 millionths of an inch, a ten-fold performance improvement over the prior control unit.  It also allows customers to balance their grinding machines faster, reducing costly down time and increasing factory throughput. This generation of computer control allows the future addition of new Schmitt products.

 

The AEMS (Acoustical Emissions Monitoring System) is controlled by the SB-4500 unit and monitors the customers’ dressing and grinding processes by direct measurement of machine-generated acoustic signals.  By monitoring the high frequency sound signal generated by contact between the wheel and work piece, the system automatically determines when wheel contact is made.  Users can eliminate the “gap” time from their grinding process and also automatically detect the beginning of a wheel “crash” and immediately signal the grinder to stop before real damage occurs.  The benefits of the AEMS product to the customer include time savings from quick and easy setups, improved dressing and grinding processes, and elimination of expensive part and machine damage.

 

The disk drive industry presented the Company with the challenge of developing the technology and products to measure the surface roughness of glass substrates. Existing SMS technology was modified to produce the required light scatter information to provide the necessary measurements.  The engineering staff developed the DUV (Deep Ultra-violet light) technology to measure surface microroughness of glass substrates to the same precise levels as existing products and at levels required by the industry. This technology compliments existing products and provides the Company the ability to supply solutions for all media used by the disk drive industry.

 

During Fiscal 2003, 2002 and 2001, the Company’s research and development expense totaled $192,686, $217,444 and $327,474 respectively.

 

8

 

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 management’s 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.

•                  The lack of a line of credit agreement could impact future liquidity.

•                  Future success depends in part on attracting and retaining key management and qualified technical and sales personnel.

•                  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:

 

For several months, the Company has experienced soft market demand for its Balancer products.  While specific reasons are difficult to pinpoint, the low demand can generally be attributed to worldwide economic conditions, specifically those in the grinding machine industry, the primary market for the Company’s Balancer products.  Based upon analysis by management and the sales staff, the decline in sales does not appear to arise from the customer base shifting to competitor products.

 

Management has responded to these soft market conditions in several ways.  First, it appears there is 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 a significant part of its R&D efforts in Fiscal 2004 and 2005 toward developing products that will both broaden the scope of products offered to the current customer base plus offer products for new markets thereby reducing the reliance on historic markets.  Second, management initiated a restructuring plan in Europe in the fourth Fiscal quarter of 2001 that was intended to increase worldwide operating efficiency.  All engineering design and manufacturing operations are now consolidated in the United States, a step that has reduced operating costs.  In addition, all European operations are now focused totally on marketing and sales.  Finally, management will continue to evaluate all operating costs and seek to reduce costs where necessary.

 

The Measurement segment has relied heavily upon sales to disk drive and silicon wafer manufacturers.  Conditions in those markets adversely affected sales beginning in Fiscal 1999 and those poor conditions continued into Fiscal 2003. Disk drive demand is largely tied to and dependent upon demand for personal computers.  In Fiscal 2001, personal computer manufacturers warned of lower sales expectations and many initiated actions to significantly reduce costs.  These soft market conditions have continued into Fiscal Years 2002 and 2003.  Consequently, demand for drives has fallen and operations of those companies have suffered with one result being reduced capital spending.  This has resulted in minimal demand for and sporadic sales of the Company’s TMS products.  Industry forecasts are for these conditions to continue in the foreseeable future.

 

9

 

The semiconductor industry is also currently facing a down cycle. Beginning in Fiscal 2002 the semiconductor industry experienced backlog cancellations, resulting in slower revenue growth and these conditions continued into Fiscal 2003.  The result is similar to disk drive manufacturers in that capital spending has declined significantly and consequently so has demand for and sales of the Company’s wafer products.  Forecasts for that industry are for improvements in market conditions to begin sometime in calendar 2003, although there is no certainty those improvements will occur during that time period.

 

Management will continue to market these products to these historic markets as it appears no other technology has been introduced that would make the TMS products technologically obsolete.  There is the belief that once market conditions improve in the disk drive and silicon wafer markets, demand for the Company’s products and technology will increase although most likely not to historic levels.  Also, management believes there are other uses for the Company’s 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 Company’s 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 Company’s 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 management’s 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.  During the second quarter of Fiscal 2002, Management responded to declining sales by instituting an expense reduction program that significantly reduced the break-even sales point.  However, should sales decline, 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

 

10

 

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 lack of a line of credit agreement could impact future liquidity:

 

The short-term credit line expired on April 30, 2003 and the commercial bank chose not to renew the arrangement.  While management believes it could secure credit from another source, there is no guarantee this can be accomplished or, if it is accomplished, the terms may not be as favorable as those under the expired line of credit.

 

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.

 

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.

 

International Sales

The Company’s sales in the last three Fiscal years by geographic areas are:

 

 

Backlog

 

The Company does not generally track backlog.  Normally, orders are shipped within a few days after receipt unless the customer requests otherwise.

 

Employees

 

As of July 7, 2003, the Company employed 43 individuals worldwide on a full-time basis.  There were no regular part-time employees.  None of the Company’s employees is covered by a collective bargaining agreement.

 

Item 2.    Properties

 

The Company’s design and assembly facilities and executive offices are located in a 7,500-square foot Company-owned building in Portland, Oregon and SMS operations are in a 33,000-square foot Company-owned facility located across the street from the executive offices.  SEL occupies a 1,893-square foot facility

 

11

 

in Coventry, England pursuant to a three-year lease beginning June 1, 2002 with a basic monthly rent of £1,875 (approximately $2,750 as of July 7, 2003).  SEG occupies a 620 square foot facility in Pfungstadt, Germany pursuant to a five-year lease beginning December 1, 2001 with a basic monthly rent of 658 Euros (approximately $775 as of July 7, 2003).  ARI occupies a 3,670 square foot facility in Menlo Park, California pursuant to a one-year lease beginning November 1, 2002 with a current monthly rent of $7,487 as of July 5, 2003.  Management believes its facilities are adequate to meet its currently foreseeable needs.

 

Item 3.    Legal Proceedings

 

There are no material legal proceedings currently pending against the Company.

 

Item 4.    Submission of Matters to a Vote of Security Holders

 

No matters were submitted to a vote of the security holders of the Company during the fourth quarter ended May 31, 2003.

 

PART II

 

Item 5.    Market for Registrant’s Common Equity and Related Stockholder Matters

 

The Company’s Common Stock is traded on the Nasdaq SmallCap Market under the symbol “SMIT.”

 

The following tables set forth the high and low sales prices of the Company’s Common Stock as reported on the Nasdaq National Market and The Nasdaq Smallcap Market (after May 23, 2002) for the periods indicated.