SCHMITT INDUSTRIES INC - Quarter Report: 2001 November (Form 10-Q)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended: November 30, 2001

Or

For the transition period from                to               

Commission File Number: 0-23996

SCHMITT INDUSTRIES, INC.
(Exact name of registrant as specified in its charter)

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

    The number of shares of each class of common stock outstanding as of November 30, 2001

    Common stock, no par value            7,467,474

SCHMITT INDUSTRIES, INC.

INDEX TO FORM 10-Q

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PART I—FINANCIAL INFORMATION

Item 1. Financial Statements

SCHMITT INDUSTRIES, INC.
CONSOLIDATED BALANCE SHEETS

The accompanying notes are an integral part of these financial statements

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SCHMITT INDUSTRIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE AND SIX MONTHS ENDED NOVEMBER 30, 2001 AND 2000
(UNAUDITED)

The accompanying notes are an integral part of these financial statements

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SCHMITT INDUSTRIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED NOVEMBER 30, 2001 AND 2000
(UNAUDITED)

The accompanying notes are an integral part of these financial statements

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SCHMITT INDUSTRIES, INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
SIX MONTHS ENDED NOVEMBER 30, 2001 AND 2000
(UNAUDITED)

Note 1:

    These financial statements are those of the Company and its wholly owned subsidiaries. In the opinion of management, the accompanying Consolidated Financial Statements of Schmitt Industries, Inc. contain all adjustments, consisting only of normal recurring adjustments, necessary to present fairly its financial position as of November 30, 2001 and 2000 and its results of operations and its cash flows for the three-month and six-month periods ended November 30, 2001 and 2000. Operating results for the six-month period ended November 30, 2001 are not necessarily indicative of the results that may be experienced for the fiscal year ending May 31, 2002.

Note 2: Revenue Recognition

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

Note 3: New Accounting Pronouncements

    On July 20, 2001, the FASB issued SFAS No. 141, Business Combinations. SFAS No. 141 establishes new standards for accounting and reporting requirements for business combinations and requires the purchase method of accounting be used for all business combinations initiated after June 30, 2001. Use of the pooling-of-interest method is now prohibited. The Company adopted this statement during the first quarter of fiscal 2002. Management does not believe that SFAS No. 141 will have a material impact on the Company's consolidated financial statements.

    On July 20, 2001, the FASB issued FASB Statement No. 142 (FAS 142) Goodwill and Other Intangible Assets. FAS 142 changes the accounting for goodwill and certain other intangible assets from an amortization method to an impairment-only approach. Upon adoption of FAS 142, goodwill and certain other intangible assets will be tested at the reporting unit annually and whenever events or circumstances occur indicating that goodwill and certain other intangible assets might be impaired. Amortization of goodwill and certain other intangible assets, including goodwill recorded in past business combinations, will cease. The adoption date for the Company will be June 1, 2002. The Company has not yet determined what the impact of FAS 142 will be on the Company's results of operations and financial position.

Note 4: EPS Reconciliation

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Note 5: Comprehensive (Loss) Income

    The long-term investment is classified as an "Available-for-sale security". As required under Statement of Financial Accounting Standards No. 115, all unrealized gains and losses, net of tax benefits, are included in Accumulated Other Comprehensive Income (Loss) and reported as a separate component of Other Comprehensive Income (Loss) in Stockholders' Equity until realized. The cumulative translation adjustment consists of unrealized gains/losses from translation adjustments on intercompany foreign currency transactions that are of a long-term nature.

Note 6: Segments of Business

Segment Information

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Geographic Information

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Long-term Assets

    Note—Europe is defined as the two European subsidiaries, Schmitt Europe, Ltd. and Schmitt Europa, GmbH

Note 7: Line of credit

    The Company has a $1.0 million short-term line of credit agreement, secured by U.S. accounts receivable and inventories, with a commercial bank. The line is guaranteed by the Company's wholly owned subsidiary, Schmitt Measurement Systems, Inc. Interest is payable at the bank's prime rate plus 1.50% and expires on June 1, 2002. As of November 30, 2001 and May 31, 2001, $600,000 and $200,000 was outstanding respectively. There are certain covenants related to the earnings of the company and the current ratio. As of November 30, 2001 the Company was in compliance with these covenants.

Note 8: Restructuring reserve

    In the fourth quarter of the prior fiscal year, the Company established a liability of $106,764 for certain costs expected to be incurred in association with the restructuring of German operations. During the six months ended November 30, 2001 this liability changed as follows:

    All employees (five in total) were terminated effective May 31, 2001 and all payments to those employees since that date were under contractual agreements between those employees and the Company. Payments of the operating expenses included items related to the closure of the existing facility plus various legal and professional fees related to the restructure. This restructure is expected to be completed in the third quarter of fiscal 2002.

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SCHMITT INDUSTRIES, INC.
FORM 10-Q
SECOND QUARTER YEAR 2002

Item 2—Management's Discussion and Analysis of Financial Condition and Results of Operations:

    These financial statements are those of the Company and its wholly owned subsidiaries. In the opinion of management, the accompanying Consolidated Financial Statements of Schmitt Industries, Inc. contain all adjustments, consisting only of normal recurring adjustments, necessary to fairly state its financial position as of November 30, 2001 and 2000 and its results of operations and its cash flows for the three and six-month periods ended November 30, 2001 and 2000. Operating results for the six-month period ended November 30, 2001 are not necessarily indicative of the results that may be experienced for the fiscal year ending May 31, 2002.

Results of Operations:

Three months ended November 30, 2001 and 2000:

    Sales in the second quarter of fiscal 2002 increased to $1,879,212 versus $1,785,195 in the same period last year, with substantially all of the increase in the Measurement segment. Worldwide sales of Balancer products were $1,480,514 in the second quarter of fiscal 2002 compared to $1,485,625 for the same period last year with sales in both domestic and European markets virtually equal to year ago levels. Measurement product sales totaled $398,698 in the second quarter of fiscal 2002 compared to $299,570 in the second quarter of fiscal 2001.

    Revenues in both the Balancer and Measurement product lines have been effected in the past several months by the slowdown in the global economy. That has in turn resulted in a reduced demand for both balancer and measurement products. During the second quarter of fiscal 2002, demand for balancer products improved slightly over the prior fiscal quarters but are still not near historic quarterly highs. There are no specific or quantifiable reasons for the improvement in sales nor reasons to point toward continued improvement in sales trends. The Balancer segment sales focus on end-users, rebuilders and original equipment manufacturers throughout the world. Sales staff, representatives and distributors throughout these geographic areas spend a large amount of time with the targeted customers. Over the past twelve months they have found many of the customers in the automotive, bearing and aircraft industries have referred to the state of the economy and its impact on the machine tool industry as reasons for their reduced ordering activity. While the second quarter showed an increase in demand for the Company's products, there are no guarantees this trend will continue.

    The primary target markets for Measurement products have historically been disk drive and silicon wafer manufacturers. Management and the sales staff monitor industry publications and public financial information in order to judge the potential demand for Measurement products by these targeted industries. Over the past several months, all of this information has discussed at length declining demand for and sales of the products of those two industries and have generally defined industries that are in a severe recession. Also, frequent discussions with customers have confirmed the information presented in the public information and their inability to purchase Measurement products due to their lack of a capital budget.

    Second quarter cost-of-sales decreased to 41% of sales versus 61% in the same period last year. Most of the decrease occurred as the prior years percentage included an inventory write-down of $286,267 in the Measurement segment. When this write-down is excluded, cost of sales as a percentage of sales was 45%. Cost-of-sales of Balancer products was 45% and 46% for the three months ended November 30, 2001 and 2000 respectively while the cost of sales percentage of Measurement products was 24% for the second quarter of fiscal 2002 versus 41% (when the inventory write-down is excluded) in the same period last year. The decrease in the cost of sales in the Measurement segment was due to

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the sales mix as the sales of Acuity Research products (which have lower materials costs than other measurement products) were a higher proportion of total sales in the most current quarter than was the case in the same quarter in the prior year.

    Second quarter general, administrative and R&D expenses totaled $1,032,403 versus $1,132,202 for the same period last year. As a percentage of revenues, operating expenses (including R&D) during the second quarter of fiscal 2002 were 55% compared to 63% for the same period last year. The reason for the decline both in dollars and as a percentage of sales was due to management actions in the second fiscal quarter to reduce operating expenses. During this quarter, management initiated a program to significantly reduce operating expenses with the goal to reduce expenses to a level that could produce break-even operations on sales levels that approximate those realized in the first quarter of the current fiscal year.

    Sales by the foreign subsidiaries totaled $448,321 for the most recent quarter versus $463,463 for the same quarter last year.

    In the three-month period ended November 30, 2001, the net income was $71,096 compared to a net loss of $(268,957) for the same period last year. Three-month income (loss) per share, basic and diluted, were $.01 and $(.03) for the three months ended November 30, 2001 and 2000, respectively.

Six months ended November 30, 2001 and 2000:

    Sales in the six months ended November 30, 2001 decreased to $3,464,456 versus $3,728,185 in the same period last year, with decreases in both business segments. Worldwide sales of Balancer products were $2,818,240 and $3,032,569 for the six months ended November 30, 2001 and 2000 respectively, with sales lower in both the domestic and European markets. While sales appear to have stabilized in the past few months, there is no certainty this trend will continue in all geographic markets. Measurement product sales totaled $646,216 and $695,616 for the six months ended November 30, 2001 and 2000 respectively.

    Revenues in the past several months have been effected by the slowdown in the global economy, resulting in reduced demand for both Balancer and Measurement devices. The Balancer segment sales focus on end-users, rebuilders and original equipment manufacturers throughout the world. Sales staff, representatives and distributors throughout these geographic areas spend a large amount of time with the targeted customers. Over the past twelve months they have found many of the customers in the automotive, bearing and aircraft industries have referred to the state of the economy and its impact on the machine tool industry as reasons for their reduced ordering activity. The primary target markets for Measurement products have historically been disk drive and silicon wafer manufacturers. Management and the sales staff monitor industry publications and public financial information in order to judge the potential demand for measurement products by these targeted industries. Over the past several months, all of this information has discussed at length declining demand for and sales of the products of those two industries and have generally defined industries that are in a severe recession. Also, frequent discussions with customers have confirmed the information presented in the public information and their inability to purchase measurement products due to their lack of a capital budget.

    For the six months ended November 30, 2001, cost-of-sales decreased to 43% of sales versus 50% in the same period last year. Most of the decrease occurred as the prior years percentage included an inventory write-down of $286,267 in the Measurement segment. When this write-down is excluded, cost of sales as a percentage of sales was 42%. Cost-of-sales of Balancer products was 46% and 44% for the six months ended November 30, 2001 and 2000 respectively while the cost of sales percentage of Measurement products was 30% for the six months ended November 30, 2001 versus 35% (when the inventory write-down is excluded) in the same period last year. The decrease in the cost of sales in the Measurement segment was due to the sales mix as the sales of Acuity Research products (which have

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lower materials costs than other Measurement products) were a higher proportion of total sales in the most current quarter than was the case in the same quarter in the prior year.

    General, administrative and R&D expenses totaled $2,154,447 for the six months ended November 30, 2001 versus $2,271,666 for the same period last year. As a percentage of revenues, operating expenses (including R&D) during the second quarter of fiscal 2002 were 62% compared to 61% for the same period last year. These expenses are expected to decline in future periods, both in dollars and as a percentage of sales, due to management actions initiated in the second quarter of the current fiscal year. During this quarter, management initiated a program to significantly reduce operating expenses with the goal to reduce expenses to a level that could produce break-even operations on sales levels that approximate those realized in the first quarter of the current fiscal year.

    Sales by the foreign subsidiaries totaled $830,233 for the most recent quarter versus $924,002 for the same quarter last year. The decline was primarily the result of the restructure of the German subsidiary that started late in the prior fiscal year. During that process, sales were delayed for approximately thirty to forty days early in fiscal 2002. The production and operations changes were completed in the first fiscal quarter and should no longer have a negative impact on sales. Market demand in Europe has been soft, and also has contributed to the lower sales. Marketing initiatives begun in the prior fiscal year in Europe are expected to produce sales comparable to the prior fiscal year, although this impact could be dampened until the soft market conditions in the European market improve.

    In the six-month period ended November 30, 2001, the net loss was $(180,544) compared to a net loss of $(239,819) for the same period last year. Six-month income (loss) per share, basic and diluted, were $(.02) and $(.03) for the six months ended November 30, 2001 and 2000 respectively.

Liquidity and Capital Resources:

    The Company's working capital position decreased slightly to $4,073,979 at November 30, 2001 compared to $4,189,525 at May 31, 2001. Cash stood at $672,213 at November 30, 2001 compared to $291,083 at May 31, 2001.

    During the six months ended November 30, 2001, cash provided from operations amounted to $44,027 with the changes described as follows:

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The net loss for the six months ended November 30, 2001 of $(180,544) plus one noncash item, depreciation and amortization of $127,895.



•

Accounts receivable provided cash as the balance decreased $124,629 to a balance at November 30, 2001 of $1,102,528 compared to $1,227,157 at May 31, 2001. At November 30, 2001, no significant accounts receivable were considered a doubtful collection. The Company generally experiences a payment cycle of 30-80 days on invoices. Management believes its credit and collection policies are effective and appropriate for the marketplace and the Company has had no significant bad debt write-offs since its inception in 1986. There can be no assurance that the Company's collection procedures will continue to be successful, particularly with an economy that in many respects appears to be in a recession.



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Inventories decreased $159,535 from the balances at May 31, 2001 with virtually all of the decrease in the Balancer segment. The Company maintains levels of inventory sufficient to satisfy normal customer demands plus an increasing short-term delivery requirement for a majority of its Balancer products. Management believes its ability to provide prompt delivery gives it a competitive advantage for certain sales.



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Prepaid expenses decreased by $51,658 due to amortization of several items including prepaid trade show costs, professional fees and various business and life insurance costs.

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Trade accounts payable decreased by $137,266 with the reduction due to the continued decline in purchasing activities in the US companies. The purchasing activities of those companies, particularly for inventory items, were lower in the weeks preceding November 30, 2001 than in the weeks preceding May 31, 2001.



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Other accrued liabilities (including commission, payroll items and other accrued expenses) decreased by $101,770. The largest decrease was for the liability related to the restructure of operations in Germany ($81,450).

    During the six-month period ended November 30, 2001, net cash used in investing activities was $30,640, consisting of net additions to property and equipment. Net cash provided by financing activities amounted to $312,775, which consists of a $400,000 increase in the line of credit, less $50,000 in repayments of long-term debt and the purchase of shares of the Company's common stock for $37,225.

    Management believes that cash from operations, available credit resources and its working capital position could provide adequate funds on a short-term basis to cover currently foreseeable payments, commitments and payments under existing and anticipated supplier agreements. Management believes that such cash flow could be sufficient to finance current short-term operations, projected capital expenditures, anticipated short-term sales agreements and other contingencies during at least the next twelve months.

    Management is currently reviewing long-range capital requirements as they relate to funding of current operations. This analysis may or may not result in future decisions to seek additional funding for the Company via debt or equity to service the Company's future requirements.

Item 3—Quantitative and Qualitative Disclosures About Market Risk:

Interest Rate Risk

    The Company does not have any derivative financial instruments as of November 30, 2001. However, the Company is exposed to interest rate risk. The Company employs established policies and procedures to manage its exposure to changes in the market risk of its marketable securities.

    The Company's interest income and expense are most sensitive to changes in the general level of U.S. and European interest rates. In this regard, changes in U.S. and European interest rates affect the interest earned on the Company's cash equivalents as well as interest paid on debt.

    The Company has a line of credit whose interest rate is based on various published prime rates that may fluctuate over time based on economic changes in the environment. The Company is subject to interest rate risk and could be subject to increased interest payments if market interest rates fluctuate. The Company does not expect any change in the interest rates to have a material adverse effect on the Company's results from operations.

Foreign Currency Risk

    The Company operates subsidiaries in the United Kingdom and Germany. The Company's business and financial condition is, therefore, sensitive to currency exchange rates or any other restrictions imposed on their currencies. To date, the foreign currency exchange rates have not significantly impacted the Company's profitability.

Business Risks

    This annual 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,"

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"approximately," "intends," "plans," "estimates," "anticipates," or "hopeful," 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: changes in demand for company products; 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: and 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. 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.

Changes in demand for Company products:

    Over the past several months, the Company experienced soft market demand for its Balancer products. While the specific reasons are difficult to pinpoint, these can generally be attributed to economic conditions in the United States, specifically those in the grinding machine industry, the primary market for the Company's Balancer products. Based upon management's analysis, the decline in sales does not appear to arise from a shift in the customer base 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. To capitalize on this opportunity, two new sales people have been hired, one late in fiscal 2001 and the second in January 2002. Second, the Company will devote a significant part of its R&D efforts in fiscal 2002 and 2003 toward developing products that will both broaden the scope of products offered to the current customer base and offer products for new markets so as to reduce the reliance on historic markets. Third, management initiated a restructuring plan in Europe in the fourth fiscal quarter of 2001 that is intended to increase worldwide operating efficiency. All engineering design and manufacturing operations are now consolidated in the United States, a step that is expected to reduce 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 have adversely affected sales beginning in fiscal 1999 and those poor conditions continued into fiscal 2002. Disk drive demand is largely tied to and dependent upon demand for personal computers. In the prior fiscal year, personal computer manufacturers warned of lower sales expectations and many have initiated actions to significantly reduce costs. Consequently, demand for drives have fallen and operations of those companies have suffered with one result being reduced capital spending. This has resulted in minimal demand for and sales of the Company's TMS products. Industry forecasts are for these conditions to continue in the foreseeable future.

    The semiconductor industry is also currently facing a down cycle. Beginning in fiscal 2001 the semiconductor industry experienced backlog cancellations, resulting in slower revenue growth. Industry forecasts are for these conditions to continue into calendar 2002. 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.

    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,

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demand for the Company's products and technology will increase. Also, there are other uses for the Company's laser light scatter technology and efforts will be directed toward the 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 having to pay 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 can be no assurance that 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 an adequate supplies of raw materials cannot be obtained in a timely manner or if the costs of raw materials increased significantly.

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Part II — OTHER INFORMATION

Item 1. Legal Proceedings—None

Item 2. Changes in Securities—None

Item 3. Default Upon Senior Securities—None

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

The Company conducted an Annual Meeting of the Shareholders on October 5, 2001. At the meeting, the following persons were elected to fill the vacancies on the Board of Directors created by the expiration of the Class 1 directors' terms, to serve until the year 2004 Annual Meeting of the Shareholders and until their successors shall be duly elected:

Also at the meeting, the stockholders' approved an amendment to the Company's Second Restated Articles of Incorporation to effect a reverse stock split of the Company's Common Stock and grant the Company's Board of Directors the authority to set the ratio for the reverse stock split at one-for-two, one-for-three or one-for-four, or not to complete any reverse stock split.

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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.

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QuickLinks

PART I—FINANCIAL INFORMATION
Item 1. Financial Statements

Item 2—Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 3—Quantitative and Qualitative Disclosures About Market Risk

Part II — OTHER INFORMATION
Item 1. Legal Proceedings— None
Item 2. Changes in Securities— None
Item 3. Default Upon Senior Securities— None
Item 4. Submission of Matters to a Vote of Security Holders