FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 /X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended November 30, 2005. OR / / 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: 000-22893. AEHR TEST SYSTEMS (Exact name of Registrant as specified in its charter) CALIFORNIA 94-2424084 - -------------------------------------- ------------------------------------ (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 400 KATO TERRACE FREMONT, CA 94539 - -------------------------------------- ------------------------------------ (Address of principal (Zip Code) executive offices) (510) 623-9400 - ------------------------------------------------------------------------------ (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR, IF CHANGED SINCE LAST REPORT. N/A 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 as the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. (Item 1) YES X NO --- --- (Item 2) YES X NO --- --- Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). YES NO X --- --- Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES NO X --- --- 1
Number of shares of Common Stock, $0.01 par value, outstanding at December 31, 2005 was 7,507,134. 2
FORM 10-Q FOR THE QUARTER ENDED NOVEMBER 30, 2005 INDEX PART I. FINANCIAL INFORMATION ITEM 1. Condensed Consolidated Financial Statements (Unaudited) Condensed Consolidated Balance Sheets as of November 30, 2005 and May 31, 2005 . . . . . . . . . . . 4 Condensed Consolidated Statements of Operations for the three months and six months ended November 30, 2005 and 2004 . 5 Condensed Consolidated Statements of Cash Flows for the six months ended November 30, 2005 and 2004. . . . . . . 6 Notes to Condensed Consolidated 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 Risks. . 18 ITEM 4. Controls and Procedures. . . . . . . . . . . . . . . . . . . . 19 PART II. OTHER INFORMATION ITEM 1. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . 20 ITEM 1A. Risk Factors . . . . . . . . . . . . . . . . . . . . . . . . 20 ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds . . . . . . . . . . . . . . . . . . . . . . . . . . 23 ITEM 3. Defaults Upon Senior Securities . . . . . . . . . . . . . . . 23 ITEM 4. Submission of Matters to a Vote of Security Holders . . . . . 23 ITEM 5. Other Information . . . . . . . . . . . . . . . . . . . . . . 24 ITEM 6. Exhibits . . . . . . . . . . . . . . . . . . . . . . . . . . 24 SIGNATURE PAGE . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 Index to Exhibits . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 3
PART I. FINANCIAL STATEMENTS Item 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS AEHR TEST SYSTEMS CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands, except per share data) <TABLE> <CAPTION> November 30, May 31, 2005 2005 (Unaudited) ----------- ----------- <S> <C> <C> ASSETS Current assets: Cash and cash equivalents . . . . . . . . . . . $ 5,807 $ 4,952 Short-term investments. . . . . . . . . . . . . 1,003 3,813 Accounts receivable, net of allowances for doubtful accounts of $144 and $80 at November 30, 2005 and May 31, 2005, respectively . . . . . . . . . . . . . . . . 4,113 2,537 Inventories . . . . . . . . . . . . . . . . . . 8,609 7,140 Prepaid expenses and other. . . . . . . . . . . 388 585 ----------- ----------- Total current assets . . . . . . . . . . . . 19,920 19,027 Property and equipment, net . . . . . . . . . . . 1,328 1,232 Long-term investments . . . . . . . . . . . . . . -- 409 Goodwill. . . . . . . . . . . . . . . . . . . . . 274 274 Other assets, net . . . . . . . . . . . . . . . . 520 527 ----------- ----------- Total assets . . . . . . . . . . . . . . . . $22,042 $21,469 =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable. . . . . . . . . . . . . . . . $ 1,147 $ 1,050 Accrued expenses. . . . . . . . . . . . . . . . 1,931 1,943 Deferred revenue. . . . . . . . . . . . . . . . 1,255 692 ----------- ----------- Total current liabilities . . . . . . . . . . 4,333 3,685 Accrued lease commitment. . . . . . . . . . . . . 327 332 ----------- ----------- Total liabilities . . . . . . . . . . . . . . 4,660 4,017 ----------- ----------- Shareholders' equity: Common stock, $.01 par value: Issued and outstanding: 7,507 shares and 7,482 shares at November 30, 2005 and May 31, 2005, respectively. . . . . . . . . . 75 75 Additional paid-in capital. . . . . . . . . . . 37,636 37,568 Accumulated other comprehensive income. . . . . 1,190 1,250 Accumulated deficit . . . . . . . . . . . . . . (21,519) (21,441) ----------- ----------- Total shareholders' equity . . . . . . . . . 17,382 17,452 ----------- ----------- Total liabilities and shareholders' equity. . $22,042 $21,469 =========== =========== </TABLE> The accompanying notes are an integral part of these condensed consolidated financial statements. 4
AEHR TEST SYSTEMS CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share data) (Unaudited) <TABLE> <CAPTION> Three Months Ended Six Months Ended November 30 November 30 --------------------- -------------------- 2005 2004 2005 2004 --------- --------- --------- -------- <S> <C> <C> <C> <C> Net sales. . . . . . . . . . . . . . . . . . . $5,817 $4,790 $10,463 $10,726 Cost of sales. . . . . . . . . . . . . . . . . 3,112 3,302 5,570 8,171 --------- --------- -------- -------- Gross profit . . . . . . . . . . . . . . . . . 2,705 1,488 4,893 2,555 --------- --------- -------- -------- Operating expenses: Selling, general and administrative. . . . . 1,542 1,115 2,994 2,547 Research and development . . . . . . . . . . 1,006 992 2,040 2,017 --------- --------- -------- -------- Total operating expenses . . . . . . . . 2,548 2,107 5,034 4,564 --------- --------- -------- -------- Income (loss) from operations . . . . . . . . 157 ( 619) (141) (2,009) Interest income . . . . . . . . . . . . . . . 36 32 80 56 Other income, net . . . . . . . . . . . . . . 12 172 14 196 --------- --------- -------- -------- Income (loss) before income taxes . . . . . . 205 (415) (47) (1,757) Income tax expense . . . . . . . . . . . . . . 39 184 31 166 --------- --------- -------- -------- Net income (loss) . .. . . . . . . . . . . . . $ 166 $ (599) $ (78) $(1,923) ========= ========= ======== ======== Net income (loss) per share (basic) . . . . . $ 0.02 $ (0.08) $ (0.01) $ (0.26) Net income (loss) per share (diluted) . . . . $ 0.02 $ (0.08) $ (0.01) $ (0.26) Shares used in per share calculation: Basic. . . . . . . . . . . . . . . . . . . . 7,496 7,412 7,489 7,402 Diluted. . . . . . . . . . . . . . . . . . . 7,514 7,412 7,489 7,402 </TABLE> The accompanying notes are an integral part of these condensed consolidated financial statements. 5
AEHR TEST SYSTEMS CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) (Unaudited) <TABLE> <CAPTION> Six Months Ended November 30, ---------------------- 2005 2004 ---------- ---------- <S> <C> <C> Cash flows from operating activities: Net loss...................................... $ (78) $(1,923) Adjustments to reconcile net loss to net cash provided by operating activities: Provision for doubtful accounts............. 66 (14) Depreciation and amortization............... 210 161 Loss on disposal of property and equipment.. 45 -- Changes in operating assets and liabilities: Accounts receivable....................... (1,394) 1,390 Inventories............................... (1,726) 964 Accounts payable.......................... 180 (1,291) Accrued expenses and deferred revenue..... 610 ( 29) Accrued lease commitment ................. (5) 8 Other current assets...................... 190 59 ---------- ---------- Net cash used in operating activities.................. (1,902) (675) ---------- ---------- Cash flows from investing activities: Purchase of investments..................... (4,790) (9,386) Net proceeds from sales and maturity of investments................... 8,013 10,736 Purchase of property and equipment ......... (136) (142) ---------- ---------- Net cash provided by investing activities.................. 3,087 1,208 ---------- ---------- Cash flows from financing activities: Proceeds from issuance of common stock and exercise of stock options............. 68 85 ---------- ---------- Net cash provided by financing activities.................. 68 85 ---------- ---------- Effect of exchange rates on cash................ (398) 79 ---------- ---------- Net increase in cash and cash equivalents...................... 855 697 Cash and cash equivalents, beginning of period.. 4,952 4,041 ---------- ---------- Cash and cash equivalents, end of period........ $ 5,807 $ 4,738 ========== ========== Supplementary disclosure of non-cash item: Transfer of inventory to rental equipment....... $ 231 -- ========== ========= </TABLE> The accompanying notes are an integral part of these condensed consolidated financial statements. 6
AEHR TEST SYSTEMS NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS THREE MONTHS ENDED NOVEMBER 30, 2005 (UNAUDITED) 1. BASIS OF PRESENTATION The accompanying condensed consolidated financial information has been prepared by Aehr Test Systems, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC") and therefore does not include all information and footnotes necessary for a fair presentation of financial position, results of operations and cash flows in accordance with generally accepted accounting principles. In the opinion of management, the unaudited condensed consolidated financial statements for the interim periods presented reflect all adjustments, consisting of only normal recurring adjustments, necessary for a fair presentation of the condensed consolidated financial position and results of operations as of and for such periods indicated. These condensed consolidated financial statements and notes thereto should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the fiscal year ended May 31, 2005. Results for the interim periods presented herein are not necessarily indicative of results which may be reported for any other interim period or for the entire fiscal year. PRINCIPLES OF CONSOLIDATION. The consolidated financial statements include the accounts of Aehr Test Systems and its subsidiaries (collectively, the "Company," "we," "us," and "our"). All significant intercompany balances have been eliminated in consolidation. ACCOUNTING ESTIMATES. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from those estimates. REVISION IN CLASSIFICATION OF CERTAIN SECURITIES. During the third quarter of fiscal 2005, the Company concluded that it was appropriate to classify auction rate securities as short-term investments. Previously, such investments had been classified as cash and cash equivalents. The Company has made corresponding revisions to the accompanying statements of cash flows to reflect the purchases and proceeds from sales of the auction rate securities as investing activities. These revisions resulted in a net increase in cash provided by investing activities of $4.2 million in the six months ended November 30, 2004. These revisions had no impact on previously reported results of operations, operating cash flows or working capital of the Company. 2. STOCK-BASED COMPENSATION The Company accounts for stock-based employee compensation arrangements in accordance with provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," ("APB 25") and related interpretations and complies with the disclosure provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), as amended by Statement of Financial Accounting Standards No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure" ("SFAS 148"). Under APB 25, compensation expense is based on the difference, if any, on the date of the grant, between the fair value of the Company's shares and the exercise price of the option. Stock-based compensation for consultants or other third parties are accounted for in accordance with SFAS 123 and Emerging Issues Task Force No. 96-18, "Accounting 7
for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services." For purposes of pro forma disclosures, the estimated fair value of the stock options and grants under the Company's Employee Stock Purchase Plan are amortized to expense over the vesting period. The Company's pro forma information follows (in thousands, except per share amounts): <TABLE> <CAPTION> Three Months Ended Six Months Ended November 30, November 30, --------- --------- --------- --------- 2005 2004 2005 2004 --------- --------- --------- --------- (unaudited) <S> <C> <C> <C> <C> Net income (loss), as reported:............. $ 166 $ (599) $ (78) $(1,923) Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects......................... (189) (197) (382) (398) --------- --------- --------- --------- Pro forma net loss.......................... $ (23) $ (796) $ (460) $(2,321) ========= ========= ========= ========= Net income (loss) per share: Basic, as reported.......................... $ 0.02 $ (0.08) $ (0.01) $ (0.26) ========= ========= ========= ========= Basic, pro forma............................ $ 0.00 $ (0.11) $ (0.06) $ (0.31) ========= ========= ========= ========= Diluted, as reported........................ $ 0.02 $ (0.08) $ (0.01) $ (0.26) ========= ========= ========= ========= Diluted, pro forma.......................... $ 0.00 $ (0.11) $ (0.06) $ (0.31) ========= ========= ========= ========= </TABLE> The above pro forma effects on net income (loss) may not be representative of the effects on net income (loss) for future years as option grants typically vest over several years and additional options are generally granted each year. The fair value of each option and stock purchase plan grant has been estimated on the date of grant using the Black-Scholes option pricing model and the following weighted average assumptions: <TABLE> <CAPTION> Three Months Ended Six Months Ended November 30, November 30, --------- --------- --------- --------- 2005 2004 2005 2004 --------- --------- --------- --------- <S> <C> <C> <C> <C> Risk-free Interest Rate .............. 4.26% 3.41% 4.11% 3.56% Expected Life......................... 5 years 5 years 5 years 5 years Volatility............................ 79% 83% 79% 83% Dividend Yield........................ -- -- -- -- </TABLE> Statement of Financial Accounting Standards ("SFAS") No. 123R is now effective for public companies for annual reporting periods beginning after June 15, 2005 (the first quarter of fiscal 2007 for the Company). The impact of SFAS 123R on the Company in fiscal 2007 and beyond will depend upon various factors, among them being the Company's future compensation strategy. The pro forma compensation costs presented in the table above and in prior filings for the Company have been calculated using the Black-Scholes option pricing model and may not be indicative of amounts which should be expected in future years. As of the date of this filing, no decisions have been made as to the selection of an option pricing model and a transition method for adoption. The Company expects that the adoption of SFAS 123R will have an adverse impact on the Company's consolidated statements of operations. 8
3. EARNINGS PER SHARE EARNINGS PER SHARE. Earnings per share is computed based on the weighted average number of common and common equivalent shares (common stock options) outstanding, when dilutive, during each period using the treasury stock method. <TABLE> <CAPTION> Three Months Ended Six Months Ended November 30, November 30, --------- --------- --------- --------- 2005 2004 2005 2004 --------- --------- --------- --------- (in thousands, except per share amounts) (unaudited) <S> <C> <C> <C> <C> Net income (loss) available to common shareholders: Numerator: Net income (loss)................ $ 166 $ (599) $ (78) $(1,923) --------- --------- --------- --------- Denominator for basic net income (loss) per share: Weighted-average shares outstanding ...... 7,496 7,412 7,489 7,402 --------- --------- --------- --------- Shares used in basic per share calculation.. 7,496 7,412 7,489 7,402 Effect of dilutive securities: Employee stock options.................. 18 -- -- -- --------- --------- --------- --------- Denominator for diluted net income (loss) per share............................... 7,514 7,412 7,489 7,402 --------- --------- --------- --------- Basic net income (loss) per share........... $ 0.02 $ (0.08) $ (0.01) $ (0.26) ========= ========= ========= ========= Diluted net income (loss) per share......... $ 0.02 $ (0.08) $ (0.01) $ (0.26) ========= ========= ========= ========= </TABLE> Stock options to purchase 1,392,888 and 1,286,985 shares of common stock were outstanding on November 30, 2005 and 2004, respectively, but were not included in the computation of diluted loss per share because the inclusion of such shares would be anti-dilutive. 4. INVENTORIES Inventories are comprised of the following (in thousands): <TABLE> <CAPTION> November 30, May 31, 2005 2005 ----------- ----------- (unaudited) <S> <C> <C> Raw materials and sub-assemblies $2,789 $2,939 Work in process 3,153 3,694 Finished goods 2,667 507 ----------- ----------- $8,609 $7,140 =========== =========== </TABLE> 5. SEGMENT INFORMATION The Company operates in one reportable segment; the design, manufacture and marketing of advanced test and burn-in products to the semiconductor manufacturing industry. The following presents information about the Company's operations in different geographic areas (in thousands): 9
<TABLE> <CAPTION> United Adjust- States Asia Europe ments Total --------- --------- --------- --------- --------- <S> <C> <C> <C> <C> <C> Three months ended November 30, 2005: Net sales...................... $ 5,766 $ 557 $ 384 $ (890) $ 5,817 Portion of U.S. net sales from export sales............ 4,662 -- -- -- 4,662 Income (loss) from operations.. 185 (82) 86 (32) 157 Identifiable assets............ 30,301 1,907 903 (11,069) 22,042 Property and equipment, net.... 1,137 157 34 -- 1,328 Six months ended November 30, 2005: Net sales...................... $ 9,727 $1,140 $ 579 $ (983) $10,463 Portion of U.S. net sales from export sales............ 7,940 -- -- -- 7,940 Income(loss) from operations... (102) (85) 43 3 (141) Identifiable assets............ 30,301 1,907 903 (11,069) 22,042 Property and equipment, net.... 1,137 157 34 -- 1,328 Three months ended November 30, 2004: Net sales...................... $ 3,586 $ 236 $1,213 $ (245) $ 4,790 Portion of U.S. net sales from export sales............ 3,001 -- -- -- 3,001 Income (loss) from operations.. (949) (105) 380 55 ( 619) Identifiable assets............ 31,632 1,337 1,272 (10,419) 23,822 Long-lived assets.............. 975 301 12 -- 1,288 Six months ended November 30, 2004: Net sales...................... $ 9,497 $ 474 $1,400 $ (645) $10,726 Portion of U.S. net sales from export sales............ 8,404 -- -- -- 8,404 Income (loss) from operations.. (2,129) (238) 334 24 (2,009) Identifiable assets............ 31,632 1,337 1,272 (10,419) 23,822 Long-lived assets.............. 975 301 12 -- 1,288 </TABLE> The Company's foreign operations are primarily those of its Japanese and German subsidiaries. Substantially all of the sales of the subsidiaries are made to unaffiliated Japanese or European customers. Net sales and income (loss) from operations from outside the United States include the operating results of Aehr Test Systems Japan K.K. and Aehr Test Systems GmbH. Adjustments consist of intercompany eliminations. Identifiable assets are all assets identified with operations in each geographic area. 6. PRODUCT WARRANTIES The Company provides for the estimated cost of product warranties at the time the products are shipped. While the Company engages in extensive product quality programs and processes, including actively monitoring and evaluating the quality of its component suppliers, the Company's warranty obligation is affected by product failure rates, material usage and service delivery costs incurred in correcting a product failure. Should actual product failure rates, material usage or service delivery costs differ from the Company's estimates, revisions to the estimated warranty liability would be required. Following is a summary of changes in the Company's liability for product warranties during the three months and six months ended November 30, 2005 and 2004: <TABLE> <CAPTION> Three Months Ended Six Months Ended November 30, November 30, --------- --------- --------- --------- 2005 2004 2005 2004 --------- --------- --------- --------- (in thousands, unaudited) <S> <C> <C> <C> <C> Balance at the beginning of the period . . . $142 $138 $213 $146 Accruals for warranties issued during the period . . . . . . . . . . . . 13 21 54 86 Reversals of warranties issued during the period . . . . . . . . . . . . -- -- (52) -- Settlement made during the period (in cash or in kind) . . . . . . . . . . . (36) (56) (96) (129) --------- --------- --------- --------- Balance at the end of the period . . . . . . $119 $103 $119 $103 ======= ======= ======= ======= </TABLE> 10
7. OTHER COMPREHENSIVE INCOME (LOSS) Other comprehensive income (loss), net of tax are comprised of the following : <TABLE> <CAPTION> Three Months Ended Six Months Ended November 30 November 30 --------------------- -------------------- 2005 2004 2005 2004 --------- --------- --------- -------- (in thousands, unaudited) <S> <C> <C> <C> <C> Net income (loss) . . . . . .. . . . . . . . . $ 166 $(599) $ (78) $(1,923) Foreign currency translation adjustments expense. . . . . . . . . . . . . (65) (41) (64) (60) Unrealized holding gains (losses) arising during period. . . . . . . . . . . . . . . . -- (12) 4 (6) --------- --------- -------- -------- Comprehensive income (loss) .. . . . . . . . . $ 101 $(652) $ (138) $(1,989) ========= ========= ======== ======== </TABLE> 8. RECENT ACCOUNTING PRONOUNCEMENTS In November 2004, the Financial Accounting Standards Board ("FASB")issued Statement of Financial Accounting Standards ("SFAS") No. 151, "Inventory Costs - - an Amendment of ARB No. 43, Chapter 4". This statement clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted materials (spoilage) to require them to be recognized as current-period charges and to require the allocation of fixed production overhead to inventory based on the normal capacity of a production facility. This statement is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. Earlier application is permitted. The adoption of this statement is not expected to have a material impact on the Company's financial position, results of operations or cash flows. In December 2004, the FASB issued SFAS No. 123 (revised 2004), "Share- Based Payment" ("SFAS 123R"), which is a revision SFAS 123 and supersedes APB 25. Generally, the approach in SFAS 123R is similar to the approach described in SFAS 123. SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their grant-date fair values. Pro forma disclosure is no longer an alternative. In April 2005, the Securities and Exchange Commission delayed the effective date of SFAS 123R, which is now effective for the annual reporting period that begins after June 15, 2005. The Company will adopt SFAS 123R beginning in the Company's first quarter of fiscal 2007. We are currently evaluating the impact of adopting this statement on our financial position and results of operations. The impact on our financial statements will be dependent on the transition method, the option pricing model used to compute fair value and the inputs to that model such as volatility and expected life. The pro forma disclosures of the impact of SFAS 123 provided earlier in Note 2 may not be representative of the impact of adopting this statement. The Company expects that the adoption of SFAS 123R will have an adverse impact on the Company's consolidated statements of operations. On March 29, 2005, the SEC staff issued Staff Accounting Bulletin ("SAB") No. 107, "Share-Based Payment" to express the views of the staff regarding the interaction between SFAS no. 123R and certain SEC rules and regulations and to provide the staff's views regarding the valuation of share-based payment arrangements for public companies. The Company is currently in the process of implementing SFAS No. 123R, effective as of June 1, 2007, and will take into consideration the additional guidance provided by SAB No. 107 in connection with the implementation of SFAS 123R. In December 2004, the FASB issued SFAS 153, "Exchanges of Nonmonetary Assets - an amendment of APB Opinion No. 29." This statement amends APB Opinion No. 29 to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. This statement is effective for nonmonetary asset exchanges occurring in fiscal periods 11
beginning after June 15, 2005. Earlier application is permitted. The adoption of this standard is not expected to have a material impact on the Company's financial position, results of operations or cash flows. In December 2004, the FASB issued FASB Staff Position No. FAS 109-2, "Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004" ("FSP FAS 109-2"). The American Jobs Creation Act ("Act") introduces a special one-time dividends received deduction on the repatriation of certain foreign earnings to a U.S. taxpayer (repatriation provision), provided certain criteria are met. FSP FAS 109-2 provides accounting and disclosure guidance for the repatriation provision. The deduction is subject to a number of limitations and, as of today, uncertainty remains as to how to interpret numerous provisions in the Act. As such, we are not yet in a position to decide on whether, and to what extent, we might repatriate foreign earnings that have not yet been remitted to the U.S. and cannot reasonably estimate the income tax effect of the Foreign Earnings Repatriation Provision. The Company has yet to complete its evaluation of the Foreign Earnings Repatriation Provision within the Act. The Company plans to complete its evaluation in the second half of fiscal 2006. In June 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections (SFAS No. 154), a replacement of APB Opinion No. 20, Accounting Changes (APB 20), and FASB SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements (SFAS No. 3). SFAS No. 154 applies to all voluntary changes in accounting principle, and changes the requirements for accounting for and reporting of a change in accounting principle. SFAS No. 154 requires retrospective application to prior periods financial statements of a voluntary change in accounting principle unless it is impracticable. SFAS No. 154 also requires that a change in method of depreciation, amortization, or depletion for long-lived, non-financial assets be accounted for as a change in accounting estimate that is affected by a change in accounting principle. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Earlier application is permitted for accounting changes and corrections or errors made occurring in fiscal years beginning after June 1, 2005. SFAS No. 154 does not change the transition provisions of any existing accounting pronouncements, including those that are in a transition phase as of the effective date of this Statement. The Company does not believe the adoption of SFAS No. 154 will have a material impact on its financial statements. Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion of the financial condition and results of operations of the Company should be read in conjunction with the condensed consolidated financial statements and the related notes that appear elsewhere in this document and with our Annual Report on Form 10-K for the fiscal year ended May 31, 2005 and the consolidated financial statements and notes thereto. In addition to historical information, this report contains forward- looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Act of 1934. These statements typically may be identified by the use of forward-looking words or phrases such as "believe," "expect," "intend," "anticipate," "should," "planned," "estimated," and "potential," among others and include, but are not limited to, statements concerning our expectations regarding our operations, business, strategies, prospects, revenues, expenses, costs and resources. These forward-looking statements are subject to certain risks and uncertainties that could cause our actual results to differ materially from those the anticipated results or other expectations reflected in the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in this report and other factors beyond our control, and in particular, the risks discussed below and under the heading "Factors that May Affect Future Results of Operations" and those discussed in 12
other documents we file with the Securities and Exchange Commission. All forward-looking statements included in this document are based on our current expectations, and we undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements. CRITICAL ACCOUNTING POLICIES The Company's discussion and analysis of its financial condition and results of operations are based upon the Company's condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, the Company evaluates its estimates, including those related to customer programs and incentives, product returns, bad debts, inventories, investments, intangible assets, income taxes, financing operations, warranty obligations, long-term service contracts, and contingencies and litigation. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. For a discussion of the critical accounting policies, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies" in the Company's Annual Report on Form 10-K for the fiscal year ended May 31, 2005. RESULTS OF OPERATIONS The following table sets forth items in the Company's condensed consolidated statements of operations as a percentage of net sales for the periods indicated. <TABLE> <CAPTION> Three Months Ended Six Months Ended November 30, November 30, ---------------------- -------------------- 2005 2004 2005 2004 ---------- ---------- --------- ---------- <S> <C> <C> <C> <C> Net sales. . . . . . . . . . . . . . . . . . . 100.0 % 100.0 % 100.0 % 100.0 % Cost of sales. . . . . . . . . . . . . . . . . 53.5 68.9 53.2 76.2 ---------- ---------- --------- -------- Gross profit . . . . . . . . . . . . . . . . . 46.5 31.1 46.8 23.8 ---------- ---------- --------- -------- Operating expenses: Selling, general and administrative. . . . . 26.5 23.3 28.6 23.7 Research and development . . . . . . . . . . 17.3 20.7 19.5 18.8 ---------- ---------- --------- -------- Total operating expenses . . . . . . . . 43.8 44.0 48.1 42.5 ---------- ---------- --------- -------- Income (loss) from operations . .. . . . . . . 2.7 (12.9) (1.3) (18.7) Interest income . . . . . . . . . . . . . . . 0.7 0.6 0.8 0.5 Other income, net . . . . . . . . . . . . . . 0.2 3.6 0.1 1.8 ---------- ---------- --------- -------- Income (loss) before income taxes . .. . . . . 3.6 (8.7) (0.4) (16.4) Income tax expense . . . . . . . . . . . . . . 0.7 3.8 0.3 1.5 ---------- ---------- --------- -------- Net income (loss) . . . . . . . . . . . . . 2.9 % (12.5)% (0.7)% (17.9)% ========== ========== ========= ======== </TABLE> THREE MONTHS ENDED NOVEMBER 30, 2005 COMPARED TO THREE MONTHS ENDED NOVEMBER 30, 2004 NET SALES. Net sales increased to $5.8 million in the three months ended November 30, 2005 from $4.8 million in the three months ended November 30, 13
2004, an increase of 21.4%. The increase in net sales in the three months ended November 30, 2005 resulted primarily from an increase in net sales of the Company's dynamic burn-in products, partially offset by a decrease in sales of the Company's MTX products. Net sales of the Company's dynamic burn- in products for the three months ended November 30, 2005 were $5.4 million, and increased approximately $2.4 million from the three months ended November 30, 2004. Net sales of the Company's MTX products for the three months ended November 30, 2005 were $140,000, and decreased approximately $1.6 million from the three months ended November 30, 2004. The Company anticipates that net sales in the third quarter of fiscal 2006 will increase when compared with those of the second quarter of fiscal 2006. GROSS PROFIT. Gross profit consists of net sales less cost of sales. Cost of sales consists primarily of the cost of materials, assembly and test costs, and overhead from operations. Gross profit increased to $2.7 million in the three months ended November 30, 2005 from $1.5 million in the three months ended November 30, 2004, an increase of 81.8%. Gross profit margin increased to 46.5% in the three months ended November 30, 2005 from 31.1% in the three months ended November 30, 2004. The increase in gross profit margin from last year was related to manufacturing efficiencies resulting from increased production levels. Beginning in January 2004, the Company received turnkey MTX system orders from a single customer, which included certain very low margin products not typically sold directly by the Company which are used in conjunction with the Company's systems. At the customer's request, these products were included as part of the order. These products were priced at or near the Company's cost and are referred to here as "MTX pass-through" products. There was a reduction in net sales of MTX pass-through products of $576,000 from the second quarter of fiscal 2005 to the second quarter of fiscal 2006. Since the Company does not typically accept orders for pass- through products, it has requested that, going forward, the customer purchases these pass-through products directly through the vendors that currently manufacture such products. The customer has already ordered some of these products directly from the vendors. The customer has not advised the Company of its intent to purchase any additional pass-through products from the Company. SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative ("SG&A") expenses consist primarily of salaries and related costs of employees, commission expenses to independent sales representatives, product promotion and other professional services. SG&A expenses increased to $1.5 million in the three months ended November 30, 2005 from $1.1 million in the three months ended November 30, 2004, an increase of 38.3%. The increase in SG&A expenses was primarily due to an increase in commission expenses of approximately $222,000 and an increase in the provision for bad debt of approximately $78,000. As a percentage of net sales, SG&A expenses increased to 26.5% in the three months ended November 30, 2005 from 23.3% in the three months ended November 30, 2004, reflecting the increased expense levels, partially offset by higher net sales. RESEARCH AND DEVELOPMENT. Research and development ("R&D") expenses consist primarily of salaries and related costs of employees engaged in ongoing research, design and development activities, costs of engineering materials and supplies, and professional consulting expenses. R&D expenses increased to $1.0 million in the three months ended November 30, 2005 from $992,000 in the three months ended November 30, 2004, an increase of 1.4%. As a percentage of net sales, R&D expenses decreased to 17.3% in the three months ended November 30, 2005 from 20.7% in the three months ended November 30, 2004, reflecting higher net sales. INTEREST INCOME. Interest income increased to $36,000 in the three months ended November 30, 2005 from $32,000 in the three months ended November 30, 2004. OTHER INCOME (EXPENSE), NET. Other income, net decreased to $12,000 in the three months ended November 30, 2005 from $172,000 in the three months ended November 30, 2004. The decrease in other income, net was primarily due 14
to a decrease in foreign currency exchange gains recorded by the Company and its subsidiaries in the three months ended November 30, 2005, when compared with such gains in the three months ended November 30, 2004. INCOME TAX EXPENSE. Income tax expense decreased to $39,000 in the three months ended November 30, 2005, from $184,000 in the three months ended November 30, 2004. The income tax expense in the three months ended November 30, 2005 and in the three months ended November 30, 2004 related primarily to the tax expense recorded as a result of income earned in the Company's German subsidiary. The Company's U.S. operations and its Japanese subsidiary have experienced significant cumulative losses and thus generated certain net operating losses available to offset future taxes payable in the U.S. and Japan. As a result of the cumulative operating losses in the Company's U.S. operations and its Japanese subsidiary, a valuation allowance was established for the full amount of its net deferred tax assets for both its U.S. operations and its Japanese subsidiary. SIX MONTHS ENDED NOVEMBER 30, 2005 COMPARED TO SIX MONTHS ENDED NOVEMBER 30, 2004 NET SALES. Net sales decreased to $10.5 million in the six months ended November 30, 2005 from $10.7 million in the six months ended November 30, 2004, a decrease of 2.5%. The decrease in net sales in the six months ended November 30, 2005 resulted primarily from decreases in net sales of the Company's MTX products, partially offset by an increase in net sales of the Company's dynamic burn-in products. Net sales of the Company's MTX products for the six months ended November 30, 2005 were $2.3 million, and decreased approximately $3.5 million from the six months ended November 30, 2004. Net sales of the Company's dynamic burn-in products for the six months ended November 30, 2005 were $7.9 million, and increased approximately $3.2 million from the six months ended November 30, 2004. GROSS PROFIT. Gross profit increased to $4.9 million in the six months ended November 30, 2005 from $2.6 million in the six months ended November 30, 2004, an increase of 91.5%. Gross profit margin increased to 46.8% in the six months ended November 30, 2005 from 23.8% in the six months ended November 30, 2004. The increase in gross profit margin was related to manufacturing efficiencies resulting from increased production levels. Additionally, the six months ended November 30, 2004 included nearly $2.8 million in MTX pass- through products that had little or no margin. SELLING, GENERAL AND ADMINISTRATIVE. SG&A expenses increased to $3.0 million in the six months ended November 30, 2005 from $2.5 million in the six months ended November 30, 2004, an increase of 17.6%. The increase in SG&A expenses was primarily due to an increase in commission expenses of approximately $248,000 and an increase in the provision for bad debt of approximately $90,000. As a percentage of net sales, SG&A expenses increased to 28.6% in the six months ended November 30, 2005 from 23.7% in the six months ended November 30, 2004, reflecting higher commission and bad debt expenses. RESEARCH AND DEVELOPMENT. R&D expenses were unchanged at $2.0 million in both the six months ended November 30, 2005 and the six months ended November 30, 2004. As a percentage of net sales, R&D expenses increased to 19.5% in the six months ended November 30, 2005 from 18.8% in the six months ended November 30, 2004, reflecting somewhat lower net sales. INTEREST INCOME. Interest income increased to $80,000 in the six months ended November 30, 2005 from $56,000 in the six months ended November 30, 2004, a increase of 46.4%. The increase was primarily the result of higher interest rates earned on invested amounts. OTHER INCOME (EXPENSE), NET. Other income, net decreased to $14,000 in the six months ended November 30, 2005 from $196,000 in the six months ended November 30, 2004. The decrease in other income, net was primarily due to a decrease in foreign currency exchange gains recorded by the Company and its 15
subsidiaries in the three months ended November 30, 2005, when compared with such gains in the three months ended November 30, 2004. INCOME TAX EXPENSE. Income tax expense decreased to $31,000 in the six months ended November 30, 2005, from $166,000 in the six months ended November 30, 2004. The income tax expense in the six months ended November 30, 2005 and in the six months ended November 30, 2004 related primarily to the tax expense recorded as a result of income earned in the Company's German subsidiary. The Company's U.S. operations and its Japanese subsidiary have experienced significant cumulative losses and thus generated certain net operating losses available to offset future taxes payable in the U.S. and Japan. As a result of the cumulative operating losses in the Company's U.S. operations and its Japanese subsidiary, a valuation allowance was established for the full amount of its net deferred tax assets for both its U.S. operations and its Japanese subsidiary. LIQUIDITY AND CAPITAL RESOURCES Net cash used in operating activities was $1.9 million for the six months ended November 30, 2005 and approximately $675,000 for the six months ended November 30, 2004. For the six months ended November 30, 2005, net cash used in operating activities was due primarily to increased inventory balances ($1.7 million) and accounts receivable balances ($1.4 million), offset partially by increased accrued expenses and deferred revenue balances ($610,000) and accounts payable balances ($180,000). The balance increases in the six months ended November 30, 2005 were primarily related to higher production and shipment levels. Net cash provided by investing activities was approximately $3.1 million for the six months ended November 30, 2005 and approximately $1.2 million for the six months ended November 30, 2004. The net cash provided by investing activities during the six months ended November 30, 2005 and November 30, 2004 was primarily due to the net proceeds from sales and maturities of investments partially offset by the purchase of investments. Financing activities provided cash of approximately $68,000 in the six months ended November 30, 2005 and $85,000 in the six months ended November 30, 2004. Net cash provided by financing activities during the six months ended November 30, 2005 and 2004 was due to proceeds from issuance of common stock and exercise of stock options. As of November 30, 2005, the Company had working capital of $15.6 million. Working capital consists of cash and cash equivalents, short-term investments, accounts receivable, inventory and other current assets, less current liabilities. The Company announced in August 1998 that its board of directors had authorized the repurchase of up to 1,000,000 shares of its outstanding common shares. The Company may repurchase the shares in the open market or in privately negotiated transactions, from time to time, subject to market conditions. The number of shares of common stock actually acquired by the Company will depend on subsequent developments and corporate needs, and the repurchase program may be interrupted or discontinued at any time. Any such repurchase of shares, if consummated, may use a portion of the Company's working capital. The Company leases most of its manufacturing and office space under operating leases. The Company entered into a non-cancelable operating lease agreement for its United States manufacturing and office facilities, which commenced in December 1999 and expires in December 2009. Under the lease agreement, the Company is responsible for payments of utilities, taxes and insurance. From time to time, the Company evaluates potential acquisitions of businesses, products or technologies that complement the Company's business. 16
Any such transactions, if consummated, may use a portion of the Company's working capital or require the issuance of equity. The Company has no present understandings, commitments or agreements with respect to any material acquisitions. The Company anticipates that the existing cash balance together with cash provided by operations, if any, are adequate to meet its working capital and capital equipment requirements through calendar year 2006. After calendar year 2006, depending on its rate of growth and profitability, the Company may require additional equity or debt financing to meet its working capital requirements or capital equipment needs. There can be no assurance that additional financing will be available when required, or, if available, that such financing can be obtained on terms satisfactory to the Company. OFF-BALANCE SHEET ARRANGEMENTS The Company has not entered into any off-balance sheet financing arrangements and has not established any special purpose entities. OVERVIEW OF CONTRACTUAL OBLIGATIONS There have been no material changes in the composition, magnitude or other key characteristics of the Company's contractual obligations or other commitments as disclosed in the Company's Form 10-K for the year ended May 31, 2005. RECENT ACCOUNTING PRONOUNCEMENTS In November 2004, the Financial Accounting Standards Board ("FASB")issued Statement of Financial Accounting Standards ("SFAS") No. 151, "Inventory Costs - - an Amendment of ARB No. 43, Chapter 4". This statement clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted materials (spoilage) to require them to be recognized as current-period charges and to require the allocation of fixed production overhead to inventory based on the normal capacity of a production facility. This statement is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. Earlier application is permitted. The adoption of this statement is not expected to have a material impact on the Company's financial position, results of operations or cash flows. In December 2004, the FASB issued SFAS No. 123 (revised 2004), "Share- Based Payment" ("SFAS 123R"), which is a revision SFAS 123 and supersedes APB 25. Generally, the approach in SFAS 123R is similar to the approach described in SFAS 123. SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their grant-date fair values. Pro forma disclosure is no longer an alternative. In April 2005, the Securities and Exchange Commission delayed the effective date of SFAS 123R, which is now effective for the annual reporting period that begins after June 15, 2005. The Company will adopt SFAS 123R beginning in the Company's first quarter of fiscal 2007. We are currently evaluating the impact of adopting this statement on our financial position and results of operations. The impact on our financial statements will be dependent on the transition method, the option pricing model used to compute fair value and the inputs to that model such as volatility and expected life. The pro forma disclosures of the impact of SFAS 123 provided earlier in Note 2 may not be representative of the impact of adopting this statement. The Company expects that the adoption of SFAS 123R will have an adverse impact on the Company's consolidated statements of operations. On March 29, 2005, the SEC staff issued Staff Accounting Bulletin ("SAB") No. 107, "Share-Based Payment" to express the views of the staff regarding the interaction between SFAS no. 123R and certain SEC rules and regulations and to provide the staff's views regarding the valuation of share-based payment 17
arrangements for public companies. The Company is currently in the process of implementing SFAS No. 123R, effective as of June 1, 2007, and will take into consideration the additional guidance provided by SAB No. 107 in connection with the implementation of SFAS 123R. In December 2004, the FASB issued SFAS 153, "Exchanges of Nonmonetary Assets - an amendment of APB Opinion No. 29." This statement amends APB Opinion No. 29 to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. This statement is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. Earlier application is permitted. The adoption of this standard is not expected to have a material impact on the Company's financial position, results of operations or cash flows. In December 2004, the FASB issued FASB Staff Position No. FAS 109-2, "Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004" ("FSP FAS 109-2"). The American Jobs Creation Act ("Act") introduces a special one-time dividends received deduction on the repatriation of certain foreign earnings to a U.S. taxpayer (repatriation provision), provided certain criteria are met. FSP FAS 109-2 provides accounting and disclosure guidance for the repatriation provision. The deduction is subject to a number of limitations and, as of today, uncertainty remains as to how to interpret numerous provisions in the Act. As such, we are not yet in a position to decide on whether, and to what extent, we might repatriate foreign earnings that have not yet been remitted to the U.S. and cannot reasonably estimate the income tax effect of the Foreign Earnings Repatriation Provision. The Company has yet to complete its evaluation of the Foreign Earnings Repatriation Provision within the Act. The Company plans to complete its evaluation in the second half of fiscal 2006. In June 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections (SFAS No. 154), a replacement of APB Opinion No. 20, Accounting Changes (APB 20), and FASB SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements (SFAS No. 3). SFAS No. 154 applies to all voluntary changes in accounting principle, and changes the requirements for accounting for and reporting of a change in accounting principle. SFAS No. 154 requires retrospective application to prior periods financial statements of a voluntary change in accounting principle unless it is impracticable. SFAS No. 154 also requires that a change in method of depreciation, amortization, or depletion for long-lived, non-financial assets be accounted for as a change in accounting estimate that is affected by a change in accounting principle. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Earlier application is permitted for accounting changes and corrections or errors made occurring in fiscal years beginning after June 1, 2005. SFAS No. 154 does not change the transition provisions of any existing accounting pronouncements, including those that are in a transition phase as of the effective date of this Statement. The Company does not believe the adoption of SFAS No. 154 will have a material impact on its financial statements Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS The Company considered the provisions of Financial Reporting Release No. 48, "Disclosures of Accounting Policies for Derivative Financial Instruments and Derivative Commodity Instruments, and Disclosures of Quantitative and Qualitative Information about Market Risk Inherent in Derivative Commodity Instruments." The Company had no holdings of derivative financial or commodity instruments at November 30, 2005. The Company is exposed to financial market risks, including changes in interest rates and foreign currency exchange rates. The Company invests excess cash in a managed portfolio of corporate and government bond instruments with maturities of 18 months or less. The Company does not use 18
any financial instruments for speculative or trading purposes. Fluctuations in interest rates would not have a material effect on the Company's financial position, results of operations and cash flows. A majority of the Company's revenue and capital spending is transacted in U.S. dollars. The Company, however, enters into transactions in other currencies, primarily Japanese Yen. Substantially all sales to Japanese customers are denominated in Yen. Since the price is determined at the time a purchase order is accepted, the Company is exposed to the risks of fluctuations in the Yen-U.S. dollar exchange rate during the lengthy period from purchase order to ultimate payment. This exchange rate risk is partially offset to the extent that the Company's Japanese subsidiary incurs expenses payable in Yen. To date, the Company has not invested in instruments designed to hedge currency risks. In addition, the Company's Japanese subsidiary typically carries debt or other obligations due to the Company that may be denominated in either Yen or U.S. dollars. Since the Japanese subsidiary's financial statements are based in Yen and the Company's financial statements are based in U.S. dollars, the Japanese subsidiary and the Company recognize foreign exchange gain or loss in any period in which the value of the Yen rises or falls in relation to the U.S. dollar. A 10% decrease in the value of the Yen as compared with the U.S. dollar would not be expected to result in a significant change in the net income or loss. Item 4. CONTROLS AND PROCEDURES Evaluation of disclosure controls and procedures. Our management evaluated, with the participation of our Chief Executive Officer and our Chief Financial Officer, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that our disclosure controls and procedures are effective to ensure that information we are required to disclose in reports that we file or submit under the Securities and Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms. Changes in internal controls over financial reporting. There was no change in our internal control over financial reporting that occurred during the period covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. 19
PART II - OTHER INFORMATION Item 1. LEGAL PROCEEDINGS None. Item 1A. RISK FACTORS Set forth below and elsewhere in this Quarterly Report on Form 10-Q and in other documents we file with the Securities and Exchange Commission, including without limitation our most recently filed Form 10-K as amended, are risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward-looking statements in this Quarterly Report on Form 10-Q. We believe that these risks and uncertainties are the principal material risks facing the Company as of the date of this Form 10-Q. In the future, we may become subject to additional risks that are not currently known to us. If any of these risks actually occur, our business, financial condition and operating results could be seriously harmed. As a result, the trading price of our common stock could decline, and you could lose all or part of the value of your investment. CUSTOMER CONCENTRATION. The semiconductor manufacturing industry is highly concentrated, with a relatively small number of large semiconductor manufacturers and contract assemblers accounting for a substantial portion of the purchases of semiconductor equipment. Sales to the Company's five largest customers accounted for approximately 73.1%, 70.5% and 73.0% of its net sales in fiscal 2005, 2004 and 2003, respectively. Sales to the Company's five largest customers accounted for approximately 84.3% of its net sales in the six months ended November 30, 2005. During fiscal 2005, Spansion Inc. (formerly FASL LLC.) and Texas Instruments Incorporated accounted for 43.1% and 16.9% of the Company's net sales, respectively. During fiscal 2004, Texas Instruments Incorporated and FASL LLC. accounted for 33.8% and 17.8% of the Company's net sales, respectively. During fiscal 2003, Texas Instruments Incorporated and First International Computer, Inc. accounted for 45.3% and 10.7% of the Company's net sales, respectively. No other customers represented more than 10% of the Company's net sales for any of such periods. The Company expects that sales of its products to a limited number of customers will continue to account for a high percentage of net sales for the foreseeable future. In addition, sales to particular customers may fluctuate significantly from quarter to quarter. The loss of or reduction or delay in an order or orders from a significant customer, or a delay in collecting or failure to collect accounts receivable from a significant customer could adversely affect the Company's business, financial condition and operating results. DEPENDENCE ON INTERNATIONAL SALES AND OPERATIONS. Approximately 81.2%, 84.5% and 73.0% of the Company's net sales for fiscal 2005, 2004 and 2003, respectively, were attributable to sales to customers for delivery outside of the United States. Approximately 88.2% of the Company's net sales in the six months ended November 30, 2005 were attributable to sales for customers for delivery outside the United States. The Company operates sales, service and limited manufacturing organizations in Japan and Germany and a sales and support organization in Taiwan. The Company expects that sales of products for delivery outside of the United States will continue to represent a substantial portion of its future revenues. The future performance of the Company will depend, in significant part, upon its ability to continue to compete in foreign markets which in turn will depend, in part, upon a continuation of current trade relations between the United States and foreign countries in which semiconductor manufacturers or assemblers have operations. A change toward more protectionist trade legislation in either the United States or such foreign countries, such as a change in the current tariff structures, export compliance or other trade policies, could adversely affect the Company's ability to sell its products in foreign markets. In addition, the Company is subject to other risks associated with doing business internationally, including longer receivable collection periods and greater 20
difficulty in accounts receivable collection, the burden of complying with a variety of foreign laws, difficulty in staffing and managing global operations, risks of civil disturbance or other events which may limit or disrupt markets, international exchange restrictions, changing political conditions and monetary policies of foreign governments. A substantial portion of the Company's sales has been in Asia. Turmoil in the Asian financial markets has resulted, and may result in the future, in dramatic currency devaluations, stock market declines, restriction of available credit and general financial weakness. In addition, DRAM, flash and other memory device prices in Asia have on occasion declined dramatically, and will likely do so again in the future. These developments may affect the Company in several ways. The Company believes that many international semiconductor manufacturers limited their capital spending (including the purchase of MTXs) in fiscal years 2003 and 2002, and that the uncertainty of the memory market may cause some manufacturers in the future to again delay capital spending plans. The economic conditions in Asia may also affect the ability of the Company's customers to meet their payment obligations, resulting in cancellations or deferrals of existing orders and the limitation of additional orders. In addition, Asian governments have subsidized some portion of fabrication construction. Financial turmoil may reduce these governments' willingness to continue such subsidies. Such developments could have a material and adverse effect on the Company's business, financial condition and results of operations. Because a substantial portion of the Company's net sales is from sales of products for delivery outside the United States, an increase in the value of the U.S. Dollar relative to foreign currencies would increase the cost of the Company's products compared to products sold by local companies in such markets. Approximately 87.2%, 4.4% and 8.4% of the Company's net sales for fiscal 2005 were denominated in U.S. Dollars, Japanese Yen and Euros. Although a large percentage of sales to European customers is denominated in U.S. Dollars, substantially all sales to Japanese customers are denominated in Yen. Since the price is determined at the time a purchase order is accepted, the Company is exposed to the risks of fluctuations in the Yen-U.S. Dollar exchange rate during the lengthy period from the date a purchase order is received until payment is made. This exchange rate risk is partially offset to the extent the Company's Japanese subsidiary incurs expenses payable in Yen. To date, the Company has not invested in instruments designed to hedge currency risks. In addition, the Company's Japanese subsidiary typically carries debt or other obligations due to the Company that may be denominated in either Yen or U.S. Dollars. A substantial portion of the world's manufacturers of memory devices are in Korea, Japan, Taiwan and China and growth in the Company's net sales depends in large part upon its ability to penetrate these markets. Both the Korean and Japanese markets are difficult for foreign companies to penetrate. The Company has served the Japanese market through its Japanese subsidiary, which has experienced limited success and has incurred operating losses in recent years. Sales into Korea have not been significant in recent years. Taiwan and China represent an increasingly important portion of the memory manufacturer market. The Company established a support organization in Taiwan in fiscal 2001 and subsequently added a sales function. The lack of local manufacturing may impede the Company's efforts to develop the Japanese, Korean, Taiwanese and Chinese markets. There can be no assurance that the Company's efforts in Japan, Korea, Taiwan or China will be successful or that the Company will be able to achieve and sustain significant sales to, or be able to successfully compete in, these markets. INTENSE COMPETITION. In each of the markets it serves, the Company faces competition from established competitors and potential new entrants, many of which have greater financial, engineering, manufacturing and marketing resources than the Company. The Company expects its competitors will continue to improve the performance of their current products and to introduce new products with improved price and performance characteristics. In addition, continuing consolidation in the semiconductor equipment industry, and 21
potential future consolidation, could adversely affect the ability of smaller companies, such as the Company, to compete with larger, integrated competitors. New product introductions by the Company's competitors or by new market entrants could cause a decline in sales or loss of market acceptance of the Company's existing products. Increased competitive pressure could also lead to intensified price-based competition, resulting in lower prices which could adversely affect the Company's business, financial condition and operating results. The Company believes that to remain competitive it must invest significant financial resources in new product development and expand its customer service and support worldwide. There can be no assurance that the Company will be able to compete successfully in the future. The semiconductor equipment industry is intensely competitive. Significant competitive factors in the semiconductor equipment market include price, technical capabilities, quality, delivery lead-time, flexibility, automation, cost of ownership, reliability, throughput and customer service. In each of the markets it serves, the Company faces competition from established competitors and potential new entrants, many of which have greater financial, engineering, manufacturing and marketing resources than the Company. Because the Company's MTX system performs burn-in and many of the functional tests performed by traditional memory testers, the MTX system faces intense competition from burn-in system suppliers and traditional memory tester suppliers. The market for burn-in systems is highly fragmented, with many domestic and international suppliers. Some users, such as independent test labs, build their own burn-in systems, and some other users, particularly large Japanese IC manufacturers, acquire burn-in systems from captive or affiliated suppliers. Competing suppliers of burn-in and functional test systems include Advantest Corporation, Reliability Incorporated and Dong-Il Corporation. The Company's MAX monitored and dynamic burn-in systems have faced and are expected to continue to face, increasingly severe competition, especially from several regional, low cost manufacturers and from systems manufacturers that offer higher power dissipation per device under test. The Company's FOX full wafer contact system is expected to face competition from larger systems manufacturers that have sufficient technological know-how and manufacturing capability. Competing suppliers of full wafer contact systems include Matsushita Electric Industrial Co., Ltd. and Delta V Instruments, Incorporated. The Company expects that its DiePak products will face significant competition. The Company believes that several companies have developed or are developing products which are intended to enable burn-in and test of bare die. As the bare die market develops, the Company expects that other competitors will emerge. The DiePak products also face severe competition from other alternative test solutions. The Company expects that the primary competitive factors in this market will be cost, performance, reliability and assured supply. Competing suppliers of DiePak products include Yamaichi Electronics Co., Ltd. The Company's test fixture products face numerous competitors. There are limited barriers to entry into the burn-in board ("BIB") market, and as a result, many small companies design and manufacture BIBs, including BIBs for use with the Company's MAX system. The Company's strategy is to provide only certain high performance BIBs, and the Company generally does not compete to supply low cost, low performance BIBs. The Company has a partnership with Pycon, Inc. whereby Pycon, Inc. designs, manufactures and sells the BIBs and the Company provides Pycon, Inc. with system know-how. Both companies jointly market and sell the BIBs and performance test boards ("PTBs"). There can be no assurance that the partnership will be successful. The Company has granted royalty-bearing licenses to several companies to make PTBs for use with the Company's MTX systems, in order to assure customers a second source of supply, and the Company may grant additional licenses as well. Sales of PTBs by 22
licensees result in royalties to the Company but reduce the Company's own sales of PTBs. The Company expects its competitors to continue to improve the performance of their current products and to introduce new products with improved price and performance characteristics. New product introductions by the Company's competitors or by new market entrants could cause a decline in sales or loss of market acceptance of the Company's products. Increased competitive pressure could also lead to intensified price-based competition, resulting in lower prices which could adversely affect the Company's business, financial condition and operating results. The Company believes that to remain competitive it must invest significant financial resources in new product development and expand its customer service and support worldwide. There can be no assurance that the Company will be able to compete successfully in the future. DEPENDENCE ON SUBCONTRACTORS; SOLE OR LIMITED SOURCES OF SUPPLY. The Company relies on subcontractors to manufacture many of the components or subassemblies used in its products. The Company's MTX, MAX, and FOX systems and DiePak carriers contain several components, including environmental chambers, power supplies, wafer and die contactors, signal distribution substrates and certain ICs, which are currently supplied by only one or a limited number of suppliers. The Company's reliance on subcontractors and single source suppliers involves a number of significant risks, including the loss of control over the manufacturing process, the potential absence of adequate capacity and reduced control over delivery schedules, manufacturing yields, quality and costs. In the event that any significant subcontractor or single source supplier was to become unable or unwilling to continue to manufacture subassemblies, components or parts in required volumes, the Company would have to identify and qualify acceptable replacements. The process of qualifying subcontractors and suppliers could be lengthy, and no assurance can be given that any additional sources would be available to the Company on a timely basis. Any delay, interruption or termination of a supplier relationship could have a material and adverse effect on the Company's business, financial condition and operating results. Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS None. Item 3. DEFAULTS UPON SENIOR SECURITIES None. Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The Company held an Annual Meeting of Shareholders on October 27, 2005 (the "Annual Meeting"). There were issued and outstanding on September 13, 2005, the record date, 7,481,429 shares of Common Stock. There were present at the Annual Meeting in person and by proxy Shareholders of the Company who were holders of 7,237,555 shares of Common Stock entitled to vote thereat, constituting a quorum. At the Annual Meeting, the following votes were cast for the proposals indicated: Proposal One: Election of Directors of the Company. NOMINEE VOTES FOR VOTES WITHHELD BROKER NON-VOTES - ------------------ --------- -------------- ---------------- Rhea J. Posedel 5,344,281 1,893,274 -- Robert R. Anderson 7,234,103 3,452 -- William W.R. Elder 6,536,938 702,617 -- Mukesh Patel 6,552,338 685,217 -- Mario M. Rosati 6,534,038 703,517 -- 23
Proposal Two: Ratify the selection of PricewaterhouseCoopers LLP as the Company's independent registered public accounting firm for the fiscal year ending May 31, 2006. VOTES --------- FOR 7,233,261 AGAINST 1,092 ABSTAIN 3,202 BROKER NON-VOTES -- We note that on December 6, 2005, the Audit Committee of the Board of Directors of Aehr Test Systems (the "Company") dismissed PricewaterhouseCoopers LLP ("PwC") as its independent registered public accounting firm, effective immediately. PwC's reports on the Company's financial statements for the fiscal year ended May 31, 2005 and 2004 did not contain an adverse opinion or disclaimer of opinion and were not qualified or modified as to uncertainty, audit scope, or accounting principle. During the fiscal years ended May 31, 2005 and 2004, and through December 6, 2005, there were no disagreements with PwC on any matter of accounting principles or practices, financial statements disclosure, or auditing scope or procedure, which disagreements, if not resolved to PwC's satisfaction, would have caused PwC to make reference thereto in its reports on the financial statements for such years. During the period described in the preceding sentence, there were no "reportable events" (as defined in the Securities and Exchange Commission Regulation S-K, Item 304 (a)(1)(v)). We further note that on December 6, 2005, the Audit Committee of the Board of Directors of the Company engaged Burr, Pilger & Mayer LLP ("BPM") as the Company's independent registered public accounting firm for the fiscal year ending May 31, 2006. During the Company's two most recent fiscal years ended May 31, 2004, neither the Company nor anyone acting on its behalf consulted with BPM regarding either: (i) the application of accounting principles to a specific transaction, either completed or proposed, or the type of audit opinion that might be rendered on the Company's financial statements; or (ii) any matter that was the subject of a disagreement or event identified in response to Item 304(a)(1)(iv) of Regulation S-K and the related instructions to that Item. We expect at our next annual meeting of shareholders to request that the shareholders ratify the selection of BPM for the fiscal year ending in 2007. Item 5. OTHER INFORMATION None. Item 6. EXHIBITS The Exhibits listed on the accompanying "Index to Exhibits" are filed as part hereof, or incorporated by reference into, the report. 24
SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Aehr Test Systems (Registrant) Date: January 13, 2006 /s/ RHEA J. POSEDEL --------------- Rhea J. Posedel Chief Executive Officer and Chairman of the Board of Directors Date: January 13, 2006 /s/ GARY L. LARSON -------------- Gary L. Larson Vice President of Finance and Chief Financial Officer 25
AEHR TEST SYSTEMS INDEX TO EXHIBITS Exhibit No. Description - ---------- ------------ 31.1 Certification of Chief Executive Officer pursuant to Rules 13a-14(a) and 15d-14(a) promulgated under the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002. 31.2 Certification of Chief Financial Officer pursuant to Rules 13a-14(a) and 15d-14(a) promulgated under the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002. 32 Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 26