SCHMITT INDUSTRIES INC - Quarter Report: 2002 November (Form 10-Q)

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

FORM 10-Q

Commission File Number: 0-23996

SCHMITT INDUSTRIES, INC.
(Exact name of registrant's principal executive office)

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

        The number of shares of each class of common stock outstanding as of November 30, 2002

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, 2002 AND 2001
(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, 2002 AND 2001
(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, 2002 AND 2001

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, 2002 and 2001 and its results of operations and its cash flows for the three and six-months ended November 30, 2002 and 2001. Operating results for the six-month period ended November 30, 2002 are not necessarily indicative of the results that may be experienced for the fiscal year ending May 31, 2003.

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

        During Fiscal 2002, the FASB issued SFAS No. 143, Accounting for Asset Retirement Obligations, which requires the recognition, as an Asset Retirement Obligation (ARO), of a liability for dismantlement and restoration costs associated with the retirement of tangible long-lived assets in the period in which the liability is incurred. SFAS No. 143 must be applied for fiscal years beginning after June 15, 2002. The Company is currently evaluating the impact of SFAS 143 and expects there to be no material financial statement effect relating to the adoption of this pronouncement.

        During 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS No. 144 supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. SFAS No. 144 retains the fundamental provisions of SFAS No. 121 for the measurement and recognition of the impairment of long-lived assets to be held and used, as well as the measurement of long-lived assets to be disposed of by sale. SFAS No. 144 resolves significant implementation issues related to SFAS No. 121, broadens the component of an entity to be included in the presentation for discontinued operations, and measures long-lived assets held for sale at the lower of their carrying amount or fair value (less cost to sell), while ceasing depreciation. The Company adopted this statement effective June 1, 2002 and has determined the impact of FAS 144 will not have a material impact on the Company's results of operations and financial position as of the adoption date.

Note 4: EPS Reconciliation

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Note 5: Long-term investments

        The Company owns 1,375,716 shares or approximately 11% of the outstanding shares of Air Packaging Technologies, Inc. That company is engaged in the design, manufacture, marketing and sales of "Air Box" patented packaging systems used in the retail, industrial protective and promotional packaging markets worldwide. This 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. At November 30, 2002, the adjusted acquisition cost exceeded the market value by $509,000, resulting in a reported asset value of $110,000.

Note 6: Line of credit

        The Company has a $500,000 short-term line of credit agreement with a commercial bank, secured by U.S. accounts receivable and inventories. 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 February 1, 2003. At November 30, 2002 there was no balance outstanding on this line of credit while, as of May 31, 2002, $200,000 was outstanding. There are certain covenants related to the earnings of the Company and the current ratio. As of November 30, 2002 the Company was in compliance with those covenants.

Note 7: 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 8: 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 taxes, 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 9: Subsequent Event

        Subsequent to November 30, 2002, the Board of Directors of the Company approved a reverse split of the Company's Common Stock. The Board was acting under the authority of the Company's shareholders who approved the reverse split at their annual meeting held on October 4, 2001. Stockholders of record on December 31, 2002, the effective date of the reverse stock split, will be entitled to receive one share of Common Stock for every three shares of Common Stock held as of the effective date. No fractional shares of common stock will be issued as a result of the reverse stock split and each holder of the resulting fractional shares will be entitled to receive a cash distribution for those fractional shares. All share amounts have been adjusted, where applicable, to reflect this reverse split.

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SCHMITT INDUSTRIES, INC.
FORM 10-Q
SECOND QUARTER FISCAL YEAR 2003

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, 2002 and 2001 and its results of operations and its cash flows for the three and six-month periods ended November 30, 2002 and 2001. Operating results for the six-month period ended November 30, 2002 are not necessarily indicative of the results that may be experienced for the fiscal year ending May 31, 2003.

RESULTS OF OPERATIONS

Three months ended November 30, 2002 and 2001:

        Sales in the second quarter of fiscal 2003 decreased to $1,794,452 versus $1,879,212 in the same period last year, with sales in the Balancer segment decreasing while those in the Measurement segment were increasing. Worldwide sales of Balancer products were $1,201,306 in the second quarter of fiscal 2003 compared to $1,480,514 for the same period last year with sales in the North American, Asian and European markets decreasing by 21%, 28% and 8% respectively from year ago levels for the same period. Measurement product sales totaled $593,146 in the second quarter of fiscal 2003 compared to $398,698 in the second quarter of fiscal 2002.

        The slowdown in the global economy has impacted the Balancer segment sales over the past few fiscal quarters through reduced demand. Beyond that, there are no other specific or quantifiable reasons for the decline in sales. The Balancer segment sales focus on end-users, rebuilders and original equipment manufacturers throughout the world. Sales people, representatives and distributors throughout these geographic areas spend a large amount of time with targeted customers. Over the past several 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. Customers are seeing lack of demand for their products and as a result their demand for Schmitt Dynamic Balancing Systems has declined in recent fiscal periods.

        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 products by the targeted industries. Over the past several months, 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. Therefore, sales to customers in these industries can be very cyclical.

        Second quarter cost-of-sales decreased to 40% of sales versus 41% in the same period last year. Cost-of-sales of Balancer products was 47% and 45% for the three months ended November 30, 2002 and 2001 respectively while the cost of sales percentage of Measurement products was 26% for the second quarter of fiscal 2003 versus 24% in the same period last year. The increase in the Balancer segment was due to the higher proportion of sales in Europe, where competitive market conditions generally result in lower sales prices and therefore higher cost of sales. The increase in the cost of sales in the Measurement segment was due to the sales mix as the sales of surface roughness measurement products (which have

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higher 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 $1,060,650 versus $1,032,403 for the same period last year. As a percentage of revenues, operating expenses (including R&D) during the second quarter of fiscal 2003 were 59% compared to 55% for the same period last year. The reason for the increase both in dollars and as a percentage of sales was due to an increase in payroll costs at the Acuity Research subsidiary. Those costs were increased to hire engineering staff to develop additional products that would expand upon the Acuity patented technology. Initial sales from those efforts are expected to be realized in the last six months of the current fiscal year. When those additional costs are excluded, the overall operating expenses were below year ago levels in terms of dollars and equal in terms of percentage of sales.

        Sales by the foreign subsidiaries totaled $409,334 for the most recent quarter versus $448,321 for the same quarter last year.

        In the three-month period ended November 30, 2002, net income was $32,449 compared to net income of $71,096 for the same period last year. Three-month net income per share, basic and diluted, was $.01 and $.03 for the three months ended November 30, 2002 and 2001 respectively.

Six months ended November 30, 2002 and 2001:

        Sales in the six months ended November 30, 2002 increased to $3,795,643 versus $3,464,456 in the same period last year, with a decrease of 5% in the Balancer segment and an increase of 72% in the Measurement segment. Worldwide sales of Balancer products were $2,684,636 and $2,818,240 for the six months ended November 30, 2002 and 2001 respectively, with sales lower in the North American and Asian markets by 12% and 9% respectively but higher in the European market by 13%. 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 $1,111,007 and $646,216 for the six months ended November 30, 2002 and 2001 respectively.

        Although there has been some improvement in revenues in comparison to the same period in the prior fiscal year, business activity continues to be affected by the slowdown in the global economy. 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, this information has discussed at length declining demand for and sales of the products of those two industries and has 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. Therefore, sales to customers in these industries can be very cyclical.

        For the six months ended November 30, 2002, cost-of-sales decreased to 41% of sales versus 43% in the same period last year. Cost-of-sales of Balancer products was 48% and 46% for the six months ended November 30, 2002 and 2001 respectively while the cost of sales percentage of Measurement products was 24% for the six months ended November 30, 2001 versus 30% for the six months ended November 30, 2001. The increase in the Balancer segment was due to the higher proportion of sales in Europe, where competitive market conditions generally result in lower sales prices and therefore higher cost of sales. The decrease in the cost of sales in the Measurement segment was due to the sales mix as the sales were

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comprised of products that had lower materials cost than those sold for the same period in the prior fiscal year.

        General, administrative and R&D expenses totaled $2,227,135 for the six months ended November 30, 2002 versus $2,154,447 for the same period last year. As a percentage of revenues, operating expenses (including R&D) during the second quarter of fiscal 2003 were 59% compared to 62% for the same period last year. The reason for the increase in dollars was due to an increase in payroll costs at the Acuity Research subsidiary. Those costs were increased to hire engineering staff to develop additional products that would expand upon the Acuity patented technology. Initial sales from those efforts are expected to be realized in the last six months of the current fiscal year. When those additional costs are excluded, the overall operating expenses were below year ago levels in terms of both dollars and as a percentage of sales.

        Sales by the foreign subsidiaries totaled $951,566 for the most recent six month period versus $830,233 for the same period last year. 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.

        For the six-month period ended November 30, 2002, net income was $87,764 with net income per share of $.03, basic and diluted. This compares to a net loss of $(180,544) with the net loss per share of $(.07), basic and diluted for the same period last year

        On December 19, 2002 the Company issued a press release titled "Schmitt Industries Announces Continued Profits" disclosing earnings per share and other financial data. Subsequently, on December 31, 2002, the Board of Directors, acting under approval of the Company's shareholders, completed a 1 for 3 reverse stock split. This Form 10-Q contains common stock and earnings per share data that has been adjusted to reflect the reverse stock split. However, the earnings per share information in the press release was based upon the amount of outstanding shares prior to the reverse stock split. If the financial information included in the press release had been adjusted to reflect the reverse split, earnings per share would have been $.01 (basic and diluted) per share for the three-months ended November 30, 2002 compared to $.03 (basic and diluted) per share for the three months ended November 30, 2001. Additionally, earnings (loss) per share for the six-months ended November 30, 2002 should have been $.04 (basic and diluted) compared to ($.07) (basic) for the same period in the previous year.

LIQUIDITY AND CAPITAL RESOURCES

        The Company's ratio of current assets to current liabilities increased to 9.5 to 1 at November 30, 2002 compared to 5.7 to 1 at May 31, 2002. As of November 30, 2002 the Company had $405,662 in cash compared to $447,679 at May 31, 2002.

        During the six-months ended November 30, 2002, cash provided from operating activities amounted to $435,036 with the changes described as follows:

•

Net income for the six-months ended November 30, 2002 of $87,764 plus two non cash items: depreciation and amortization of $119,148 and recognition of a deferred tax provision of $24,000.



•

Accounts receivable provided cash as the balance decreased by $81,729 to a November 30, 2002 balance of $1,053,307 compared to $1,135,036 at May 31, 2002. At November 30, 2002, no significant accounts receivable were considered a doubtful collection. The Company generally experiences a payment cycle of 30-90 days on invoices. Management believes its credit and collection policies are effective and appropriate for the marketplace. There can be no assurance that the Company's collection procedures will continue to be successful, particularly with current economic conditions.

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•

Inventories decreased $20,135 to a November 30, 2002 balance of $3,187,987 compared to $3,208,122 at May 31, 2002. The Company maintains levels of inventory sufficient to satisfy normal customer demands plus an increasing short-term delivery requirement for a majority of its Balancer products. Management believes its ability to provide prompt delivery gives it a competitive advantage for certain sales.



•

Prepaid expenses increased by $38,028 due to the addition of prepaid trade show costs less the amortization of several items including prepaid trade show costs, professional fees and various business and life insurance costs.



•

Income taxes receivable declined by $99,777 with $125,887 received from Federal and local tax refunds less $26,110 in State and local estimated tax payments made during the six-months ended November 30, 2002.



•

Trade accounts payable increased by $75,423 with the increase due to increased purchasing activities of the Balancer segment, particularly for items related to two new product lines. The purchasing activities of that segment were higher in the weeks preceeding November 30, 2002 than in the weeks preceeding May 31, 2002.



•

Other accrued liabilities (including commission, payroll items and other accrued expenses) decreased by $34,912.

        During the six months ended November 30, 2002, net cash used in investing activities was $55,605, consisting of net additions to property and equipment. Net cash used in financing activities amounted to $424,998, which consists of repayments of long-term debt of $224,998 and the credit line of $200,000.

        The following summarizes contractual obligations at November 30, 2002 and the effect on future liquidity and cash flows:

        Specific business challenges faced by the Company over the past few years have had a negative impact on operations and liquidity. Management has responded to these challenges by reducing operating expenses, developing new products and penetrating new markets for the Company's products. As a result of these efforts, Management believes its cash flows from operations, available credit resources and its cash position will provide adequate funds on both a short-term and long-term basis to cover currently foreseeable debt payments, lease commitments and payments under existing and anticipated supplier agreements. Management believes that such cash flow (without the raising of external funds) is sufficient to finance current operations, projected capital expenditures, anticipated long-term sales agreements and other expansion-related contingencies during Fiscal 2003. However, in the event the Company fails to achieve its operating and financial goals for fiscal 2003, management may be required to take certain actions to finance operations in that time period. These actions could include, but are not limited to, implementation of additional cost cutting measures, increased borrowings from existing credit facilities or entering into additional borrowing arrangements collateralized by assets.

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Business Risks

        This report includes "forward-looking statements" as that term is defined in Section 21E of the Securities Exchange Act of 1934. Forward-looking statements can be identified by the use of forward-looking terminology such as "believes," "expects," "may," "will," "should," "seeks," "approximately," "intends," "plans," "estimates," "anticipates," or "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:

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Demand for company products may change.



•

New products may not be developed to satisfy changes in consumer demands.



•

Failure to protect intellectual property rights could adversely affect future performance and growth.



•

Production time and the overall cost of products could increase if any of the primary suppliers are lost or if any primary supplier increased the prices of raw materials.



•

Fluctuations in quarterly and annual operating results make it difficult to predict future performance.



•

The Company may not be able to reduce operating costs quickly enough if sales decline further.



•

The Company maintains a significant investment in inventories in anticipation of future sales.



•

The limited duration of the bank credit agreement could impact future liquidity.



•

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



•

The Company faces risks from international sales and currency fluctuations.



•

The Company maintains a significant investment in another publicly held company where the fair market value of the stock is below acquisition cost:



•

Future operations may not generate sufficient earnings to fully realize the US Federal tax net operating loss carryforwards.

        Such risks and uncertainties could cause actual results to be materially different from those in the forward-looking statements. Readers are cautioned not to place undue reliance on the forward-looking statements in this report. We assume no obligation to update such information.

Demand for Company products may change:

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

        Management has responded to these soft market conditions in several ways. First, it appears there is a significant portion of the marketplace that is not using the automatic balancing products of the Company or any of its competitors. The Company will therefore devote a significant part of its R&D efforts in Fiscal 2003 and 2004 toward developing products that will both broaden the scope of products offered to the current customer base plus offer products for new markets thereby reducing the reliance on historic markets. Second, management initiated a restructuring plan in Europe in the fourth fiscal quarter of 2001 that was intended to increase worldwide operating efficiency. All engineering design and manufacturing

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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 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 Fiscal 2001, personal computer manufacturers warned of lower sales expectations and many initiated actions to significantly reduce costs. These soft market conditions have continued into Fiscal Years 2002 and 2003. Consequently, demand for drives has fallen and operations of those companies have suffered with one result being reduced capital spending. This has resulted in minimal demand for and sporadic sales of the Company's TMS products. Industry forecasts are for these conditions to continue in the foreseeable future.

        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 and these conditions continued into Fiscal 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. Forecasts for that industry are for improvements in market conditions to begin sometime in calendar 2003.

        Management will continue to market these products to these historic markets as it appears no other technology has been introduced that would make the TMS products technologically obsolete. There is the belief that once market conditions improve in the disk drive and silicon wafer markets, demand for the Company's products and technology will increase. 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 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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Fluctuations in quarterly and annual operating results make it difficult to predict future performance:

        Quarterly and annual operating results are likely to fluctuate in the future due to a variety of factors, some of which are beyond management's control. As a result of quarterly operating fluctuations, it is important to realize quarter-to-quarter comparisons of operating results are not necessarily meaningful and should not be relied upon as indicators of future performance.

The Company may not be able to reduce operating costs quickly enough if sales decline:

        Operating expenses are generally fixed in nature and largely based on anticipated sales. During the second quarter of Fiscal 2002, Management responded to declining sales by instituting an expense reduction program that significantly reduced the break-even sales point. However, should sales decline, there is no guarantee management could take actions that would further reduce operating expenses in either a timely manner or without seriously impacting the operations of the Company.

The Company maintains a significant investment in inventories in anticipation of future sales:

        The Company has always sought to maintain a competitive advantage by shipping product to its customers more rapidly than its competitors. Therefore, the Company has a significant investment in finished goods and raw materials inventories. These inventories are recorded using the lower-of-cost or market method, which requires Management to make certain estimates. Management evaluates the recorded inventory values based on customer demand, market trends and expected future sales and changes these estimates accordingly. A significant shortfall of sales may result in carrying higher levels of inventories of finished goods and raw materials thereby increasing the risk of inventory obsolescence and corresponding inventory write-downs. As a result, the Company may not carry adequate reserves to offset such write-downs.

The limited duration of the bank credit agreement could impact future liquidity:

        The short-term credit line expires on February 1, 2003 and there is no guarantee the arrangement will be renewed beyond that date. Should the credit line not be renewed, Management would seek such an arrangement from other sources. While management believes it could secure credit from another source, there is no guarantee this can be accomplished or, if it is accomplished, the terms will be as favorable as those under the current line of credit.

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

        Future success depends on the efforts and services of key management, technical and sales personnel. Significant competition exists for such personnel and there is no assurance key technical and sales personnel can be retained nor assurances there will be the ability to attract, assimilate and retain other highly qualified technical and sales personnel as required. There is also no guarantee key employees will not leave and subsequently compete against the Company. The inability to retain key personnel could adversely impact the business, financial condition and results of operations.

The Company faces risks from international sales and currency fluctuations:

        The Company markets and sells its products worldwide and international sales have accounted for and are expected to continue to account for a significant portion of future revenue. International sales are subject to a number of risks, including: the imposition of governmental controls; trade restrictions; difficulty in collecting receivables; changes in tariffs and taxes; difficulties in staffing and managing international operations; political and economic instability; general economic conditions; and fluctuations in foreign currencies. No assurances can be given these factors will not have a material adverse effect on

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future international sales and operations and, consequently, on business, financial condition and results of operations.

The Company maintains a significant investment in another publicly held company where the fair market value of the stock is below acquisition cost:

        The Company maintains an investment in Air Packaging Technologies, Inc. (AIRP). As required under Statement of Financial Accounting Standards No. 115, this investment is classified as "Available-for-sale securities" with all unrealized gains and losses (net of taxes) included in Accumulated Other Comprehensive Loss and reported as a separate component in Other Comprehensive Loss in Stockholders' Equity until realized. Management reviews the investment each quarter in order to evaluate if the unrealized loss is temporary or a permanent impairment in value. If conditions lead to the conclusion the difference appears to be "other than temporary", the investment is required to be written down to the estimated fair market value with the loss included in earnings. As of November 30, 2002 Management did not believe the unrealized loss was permanent in nature. However, there can be no guarantees that in future periods Management's analysis of this investment will lead to the same conclusion.

Future operations may not generate sufficient earnings to fully realized the US Federal Tax net operating loss carryforwards:

        As of November 30, 2002, the Company had a net deferred tax asset of $612,006 that relates to net operating loss carryforwards from prior periods. These net operating loss carryforwards will provide a benefit in future periods by reducing the liability for Federal taxes on income. However, to the extent there is no income through the expiration of the NOLs, (currently through 2009) the deferred tax asset could be worthless. The prospects for future earnings are therefore evaluated by Management each quarter so as to properly assess the likelihood there will be sufficient operating income (for US Federal income tax purposes) to fully utilize this asset. As of November 30, 2002, the assessment by Management concluded there appeared to be sufficient earnings potential through the year ending May 31, 2009 so that these NOLs and therefore the deferred tax asset could be utilized. However, there can be no guarantees that future analysis by Management will lead to the same conclusion.

Item 3—Quantitative and Qualitative Disclosures About Market Risk:

Interest Rate Risk

        The Company did not have any derivative financial instruments as of November 30, 2002. 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. Therefore, the Company's business and financial condition is sensitive to currency exchange rates or any other restrictions imposed

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on their currencies. To date, the foreign currency exchange rates have not significantly impacted the Company's profitability.

Item 4. Controls and Procedures

(a)

Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rule 13a-14(c) promulgated under the Securities Exchange Act of 1934, as amended, within 90 days of the filing date of this amended report. Based on their evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective.

(b)

There have been no significant changes (including corrective actions with regard to significant deficiencies or material weaknesses) in our internal controls or in other factors that could significantly affect these controls subsequent to the date of the evaluation referenced in paragraph (a) above.

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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 (please note the vote on these items was prior to the reverse stock split that was effective December 31, 2002 and therefore the number of shares below are pre-split amounts):

        The Company conducted an Annual Meeting of the Shareholders on October 4, 2002. At the meeting, the following person was elected to fill the vacancy on the Board of Directors created by the expiration of the Class 1 director's' terms, to serve until the year 2005 Annual Meeting of the Shareholders and until his successor shall be duly elected:

        Also at the meeting, the stockholders' approved an amendment to the Company's 1998 Amended and Restated Stock Option Plan to increase the number of shares of Common Stock of the Company issuable under the Option Plan from 800,000 to 1,200,000 shares.

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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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CERTIFICATION PURSUANT TO
18 U.S. C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

        I, Wayne A. Case, certify that:

        1.    I have reviewed this quarterly report on Form 10-Q of Schmitt Industries, Inc.;

        2.    Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

        3.    Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

        4.    The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

        a)    designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

        b)    evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and

        c)    presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

        5.    The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):

        a)    all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and

        b)    any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and

        6.    The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

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CERTIFICATION PURSUANT TO
18 U.S. C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

        I, Robert C. Thompson, certify that:

        1.    I have reviewed this quarterly report on Form 10-Q of Schmitt Industries, Inc.;

        2.    Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

        3.    Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

        4.    The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

        a)    designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

        b)    evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and

        c)    presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

        5.    The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):

        a)    all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and

        b)    any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and

        6.    The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

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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
Item 4. Controls and Procedures

Part II—OTHER INFORMATION