UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended: August 31, 2005

Or

o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from: To:

Commission File Number: 0-23996

SCHMITT INDUSTRIES, INC.

(Exact Name of Registrant as Specified in its Charter)

Oregon		93-1151989
(State of Incorporation)		(IRS Employer ID Number)

2765 NW Nicolai Street, Portland, Oregon 97210

(Address of Registrant’s Principal Executive Office)

(503) 227-7908

(Registrant’s Telephone Number)

Indicate by check mark whether the registrant has (1) filed all reports required to be filed by Section 13 of 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes

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

Common stock, no par value

2,593,796

SCHMITT INDUSTRIES, INC.

INDEX TO FORM 10-Q

Part I -	FINANCIAL INFORMATION

Item 1 -	Financial Statements:

	Consolidated Balance Sheets:
	– August 31, 2005 (unaudited) and May 31, 2005

	Consolidated Statements of Income:
	– For the Three Months Ended August 31, 2005 and 2004 (unaudited)

	Consolidated Statement of Changes in Stockholders’ Equity:
	– For the Three Months Ended August 31, 2005 (unaudited)

	Consolidated Statements of Cash Flows:
	– For the Three Months Ended August 31, 2005 and 2004 (unaudited)

	Notes to Consolidated Interim Financial Statements: – Three Months Ended August 31, 2005 and 2004

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

Item 6 -	Exhibits and Reports on Form 8-K

Signatures -

Certifications

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

SCHMITT INDUSTRIES, INC.

CONSOLIDATED BALANCE SHEETS

	August 31, 2005			May 31, 2005
	Unaudited
ASSETS
Current assets
Cash	$	2,168,115		$	1,176,959
Accounts receivable, net of allowance of $18,466 and $41,366 at August 31, 2005 and May 31, 2005, respectively	1,654,718			2,109,143
Inventories	3,361,478			3,533,313
Prepaid expenses	89,771			104,292
Deferred tax asset	92,319			92,319
	7,366,401			7,016,026

Property and equipment
Land	299,000			299,000
Buildings and improvements	1,228,725			1,214,348
Furniture, fixtures and equipment	1,156,657			1,120,946
Vehicles	96,849			96,849
	2,781,231			2,731,143
Less accumulated depreciation and amortization	(1,509,153		)	(1,462,637		)
	1,272,078			1,268,506

Other assets
Long-term deferred tax asset	427,681			547,681
Other assets	234,358			243,009
	662,039			790,690

TOTAL ASSETS	$	9,300,518		$	9,075,222

LIABILITIES & STOCKHOLDERS’ EQUITY

Current liabilities
Accounts payable	$	417,820		$	497,206
Accrued commissions	246,265			275,745
Accrued payroll liabilities	86,005			102,883
Other accrued liabilities	141,641			141,550
Income taxes payable	57,147			26,147
Current portion of long-term obligations	25,041			32,114
Total current liabilities	973,919			1,075,645

Long-term obligations	15,944			20,756

Stockholders’ equity
Common stock, no par value, 20,000,000 shares authorized, 2,593,796 and 2,559,687 shares issued and outstanding at August 31, 2005 and May 31, 2005, respectively	7,554,668			7,496,098
Accumulated other comprehensive loss	(224,287		)	(254,654		)
Retained earnings	980,274			737,377
Total stockholders’ equity	8,310,655			7,978,821

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	9,300,518		$	9,075,222

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

SCHMITT INDUSTRIES, INC.

CONSOLIDATED STATEMENTS OF INCOME

FOR THE THREE MONTHS ENDED AUGUST 31, 2005 AND 2004

(UNAUDITED)

	Three Months Ended
	August 31, 2005		August 31, 2004

Net sales	$	2,656,434	$	2,428,729
Cost of sales	1,244,325		1,070,393
Gross profit	1,412,109		1,358,336

Operating expenses:
General, administration and sales	1,013,644		1,074,392
Research and development	14,508		6,067
Total operating expenses	1,028,152		1,080,459

Operating income	383,957		277,877

Other income	9,940		8,178

Income before provision for income taxes	393,897		286,055

Provision for income taxes	151,000		6,000

Net income	$	242,897	$	280,055

Net income per common share:

Basic	$	.09	$	.11

Diluted	$	.09	$	.10

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

SCHMITT INDUSTRIES, INC.

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

FOR THE THREE MONTHS ENDED AUGUST 31, 2005

(UNAUDITED)

	Shares	Amount		Accumulated other comprehensive income (loss)			Retained earnings		Total		Total comprehensive income
Balance, May 31, 2005	2,559,687	$	7,496,098	$	(254,654	)	$	737,377	$	7,978,821
Stock options exercised	34,109	58,570		—			—		58,570
Net income	—	—		—			242,897		242,897		$	242,897
Other comprehensive income	—	—		30,367			—		30,367		30,367
Balance, August 31, 2005	2,593,796	$	7,554,668	$	(224,287	)	$	980,274	$	8,310,655
Comprehensive income, Three months ended August 31, 2005											$	273,264

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

SCHMITT INDUSTRIES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE THREE MONTHS ENDED AUGUST 31, 2005 AND 2004

(UNAUDITED)

	Three Months Ended
	August 31, 2005			August 31, 2004
Cash Flows Relating to Operating Activities
Net income	$	242,897		$	280,055
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	55,167			50,530
Deferred taxes	120,000			—
(Increase) decrease in:
Accounts receivable	454,425			2,713
Inventories	171,835			(361,776		)
Prepaid expenses	14,521			(6,300		)
Income taxes receivable	—			14,976
Increase (decrease) in:
Accounts payable	(79,386		)	170,894
Accrued liabilities and customer deposits	(46,267		)	98,914
Income taxes payable	31,000			—
Net cash provided by operating activities	964,192			250,006

Cash Flows Relating to Investing Activities
Purchase of property and equipment	(50,088		)	(49,990		)
Net cash used in investing activities	(50,088		)	(49,990		)

Cash Flows Relating to Financing Activities
Repayments on long-term debt	(11,885		)	(12,813		)
Common stock issued on exercise of stock options	58,570			58,414
Net cash provided by financing activities	46,685			45,601

Effect of foreign exchange translation on cash	30,367			(24,202		)

Increase in cash	991,156			221,415

Cash, beginning of period	1,176,959			604,194

Cash, end of period	$	2,168,115		$	825,609

Supplemental Disclosure of Cash Flow Information

Cash paid during the period for interest	$	175		$	—
Cash paid during the period for income taxes	$	300		$	—

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

SCHMITT INDUSTRIES, INC.

NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS

THREE MONTHS ENDED AUGUST 31, 2005

Note 1: Basis of Presentation

These financial statements are those of the Company and its wholly owned subsidiaries. In the opinion of Management, the accompanying unaudited Consolidated Financial Statements of Schmitt Industries, Inc. have been prepared pursuant to the rules and regulations of the Securities Exchange Commission and contain all adjustments, consisting only of normal recurring adjustments, necessary to present fairly its financial position as of August 31, 2005 and its results of operations and its cash flows for the three-months ended August 31, 2005 and August 31, 2004. Operating results for the three-month period ended August 31, 2005 are not necessarily indicative of the results that may be experienced for the fiscal year ending May 31, 2006. The consolidated balance sheet at May 31, 2005 has been derived from the audited financial statements at that date. The accompanying unaudited financial statements and related notes should be read in conjunction with the audited financial statements and Form 10-K of the Company for the fiscal year ended May 31, 2005.

Note 2: Revenue Recognition

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

Note 3: Recent Accounting Pronouncements

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

The Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 153, “Exchanges of Nonmonetary Assets—an amendment of APB Opinion No. 29” in December 2004. The guidance in APB Opinion No. 29, “Accounting for Nonmonetary Transactions”, is based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. The guidance in that Opinion, however, included certain exceptions to that principle. This Statement amends Opinion 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. A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. The Company does not expect this pronouncement to have a material impact on the financial statements.

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

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

Note 4: Stock – Based Compensation

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

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

	Three Months Ended August 31,
	2005			2004
Net income, as reported	$	242,897		$	280,055
Add: Stock-based employee compensation expense included in reported net income, net of tax	—			—
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of tax	(5,436		)	(64,500		)
Pro forma net income (loss)	$	237,461		$	215,555

Earnings (loss) per share – basic
As reported	$	.09		$	.11
Pro forma	$	.09		$	.09
Earnings (loss) per share – diluted
As reported	$	.09		$	.10
Pro forma	$	.09		$	.08

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

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

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

	Three Months Ended August 31,
	2005		2004
Risk-free interest rate	6.00	%	4.00	%
Expected dividend yield	0	%	0	%
Expected life	5.4 years		8.0 years
Expected volatility	48	%	122	%

Note 5: EPS Reconciliation

	Three Months Ended August 31,
	2005	2004
Weighted average shares (basic)	2,583,183	2,490,498
Effect of dilutive stock options	169,310	184,770
Weighted average shares (diluted)	2,752,493	2,675,268

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

Note 6: Long-term deferred tax asset

The Company applies the asset and liability method in recording income taxes, under which deferred income tax assets and liabilities are determined, based on the differences between the financial reporting and tax bases of assets and liabilities and are measured using currently enacted tax rates and laws. Additionally, deferred tax assets are evaluated and a valuation allowance is established if it is more likely than not that all or a portion of the deferred tax asset will not be realized. In Fiscal 2005 Management concluded future operations would produce sufficient earnings so that a portion of this asset could be used in future periods to reduce Federal and State tax liabilities. As a result, the valuation reserve for this asset was reduced as of May 31, 2005 to reflect the amount of the asset management expects to utilize in future fiscal periods. Management continues to review the level of the valuation allowance on a quarterly basis.

Note 7: Segments of Business

Segment Information

	Three Months Ended August 31,
	2005						2004
	Balancer			Measurement			Balancer			Measurement
Gross sales	$	2,035,688		$	753,773		$	1,942,228		$	682,741
Intercompany sales	(128,816		)	(4,211		)	(189,541		)	(6,699		)
Net sales	$	1,906,872		$	749,562		$	1,752,687		$	676,042

Income from operations	$	288,094		$	95,863		$	82,831		$	195,046

Intercompany rent	$	—		$	7,500		$	—		$	7,500

Depreciation expense	$	37,141		$	9,375		$	33,441		$	8,438

Amortization expense	$	—		$	8,651		$	—		$	8,651

Capital expenditures	$	35,332		$	14,756		$	41,665		$	8,325

Geographic Information

	Three Months Ended August 31,
	2005			2004
Geographic Sales

North American Sales
United States	$	1,487,099		$	1,405,002
Canada and Mexico	37,066			61,043
North American total	1,524,165			1,466,045

European Sales
Germany	80,781			77,447

United Kingdom	228,214			318,951
Intercompany	(132,853		)	(196,240		)
United Kingdom total	95,361			122,711

Other European Sales	167,628			275,062

Total Europe	343,770			475,220

Asia	547,393			436,459
Others	241,106			51,005
	$	2,656,434		$	2,428,729

	Three Months Ended August 31,
	2005				2004
	United States		Europe		United States		Europe
Income (Loss) from operations	$	366,668	$	17,289	$	339,782	$	(61,905	)

Depreciation expense	$	42,322	$	4,194	$	40,977	$	902

Amortization expense	$	8,651	$	—	$	8,651	$	—

Capital expenditures	$	46,500	$	3,588	$	54,169	$	(4,179	)

Long-term Assets

	August 31, 2005		May 31, 2005
Segment:
Balancer	$	1,441,659	$	1,563,468
Measurement	$	492,458	$	495,728

Geographic:
United States	$	1,907,114	$	2,031,587
Europe	$	27,003	$	27,609

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

Note 8: Related Party Transactions

Effective June 1, 2004, the Company entered into a contract to provide consulting services to PulverDryer USA, Inc., (“PulverDryer”) pursuant to which PulverDryer paid the Company $8,000 a month from June 2004 through October 2004. PulverDryer also buys certain products from the Company at normal prevailing rates. The Company and PulverDryer extended the contract from November 1, 2004 forward at that same monthly fee of $8,000. Product sales to PulverDryer totaled $63,106 during the fiscal quarter ended August 31, 2005.

In connection with the contract, the Board authorized Wayne Case, the Company’s Chief Executive Officer, to provide advisory services to PulverDryer, and permitted Mr. Case to receive as compensation the total consulting fees paid by PulverDryer from June 2004 through October 2004. Effective November 1, 2004, Mr. Case receives 40% of the ongoing consulting fee from PulverDryer, which percentage was determined by the Compensation Committee. Mr. Case also serves on the board of directors of PulverDryer.

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 unaudited Consolidated Financial Statements of Schmitt Industries, Inc. have been prepared pursuant to the rules and regulations of the Securities Exchange Commission and contain all adjustments, consisting only of normal recurring adjustments, necessary to present fairly its financial position as of August 31, 2005 and its results of operations and its cash flows for the three months ended August 31, 2005 and August 31, 2004. Operating results for the three month period ended August 31, 2005 are not necessarily indicative of the results that may be experienced for the fiscal year ending May 31, 2006. The accompanying unaudited financial statements and related notes should be read in conjunction with the audited financial statements and Form 10-K of the Company for the fiscal year ended May 31, 2005.

RESULTS OF OPERATIONS

Overview

Balancer segment sales focus throughout the world on end-users, rebuilders and original equipment manufacturers of grinding machines with the target geographic markets in North America, Asia and Europe. Beginning in March 2004, improving economic conditions in North America resulted in increased sales in that geographic market. Sales people, representatives and distributors throughout these geographic areas spend a large amount of time with targeted customers. They are finding that many of the customers in the automotive, bearing and aircraft industries refer to improved economic conditions and its impact on the machine tool industry in North America as the reason for their increased orders. While those customers are optimistic regarding short term demand for Balancer products, they remain uncertain as to the strength and duration of current business conditions in North America for their products which incorporate the Balancer segment product line. North American sales increased 7.7% in the fiscal quarter ended August 31, 2005 compared to the fourth quarter ended May 31, 2005. Market demand in Asia for the Balancer segment products remains strong with that region showing a 19.6% increase for the three months ended August 31, 2005 compared to the fourth quarter ended May 31, 2005. As with the North American market, the duration of the strong demand in Asia cannot be forecasted with any certainty. The European market remains soft as total balancer sales into that geographic market were off 26.8% during the fiscal quarter August 31, 2005 compared to the fourth quarter ended May 31, 2005.

The Measurement segment product line consists of both laser light-scatter and dimensional sizing products. Combined Measurement sales decreased 31.9% for the three months ended August 31, 2005 compared to the fourth quarter ended May 31, 2005. Measurement sales for the three months ended August 31, 2005 increased 10.9% when compared to the same fiscal quarter ended August 31, 2004. As noted below sales can be very cyclical in the Measurement segment. The business operations and prospects for these two product lines are summarized as follows:

Laser light-scatter products for disk drive and silicon wafer manufacturers – The primary target markets for Measurement products have been disk drive and silicon wafer manufacturers and companies and organizations involved in research efforts. Management and the sales staff monitor industry publications and public financial information in order to judge the potential demand for products by the targeted industries. Over the past year, this information has indicated improving demand for and sales of the products of those industries. Also, frequent discussions with customers have confirmed the information presented in the public information. Sales to customers in these industries can be very cyclical and therefore the impact of this recovery on sales to the Company’s laser light-scatter products is unknown at this time, although sales personnel have seen increasing interest and inquiries regarding the Company’s products.

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

Dimensional sizing products – These products are marketed and sold into a wide array of industries. In Fiscal 2004 Management built a sales distribution network covering all fifty states. As a result of this action, the Company experienced increasing interest and sales in these products in the most recent fiscal period when compared to the same period in the prior fiscal year. During the quarter ended August 31, 2003, Management consolidated the operations related to these products (which had been located in Menlo Park, California) into the Measurement segment operations in Portland, Oregon. The relocation was completed as of August 31, 2003. Since relocation to Portland, sales of these products were $1,763,307 and $1,023,278 in Fiscal 2005 and 2004, respectively.

Critical Accounting Policies

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

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

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

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

Intangible Assets – There is a periodic review of intangible and other long-lived assets for impairment. This review consists of the analysis of events or changes in circumstances that would indicate the carrying amount of the asset may not be recoverable. Recoverability is determined by comparing the forecasted future net cash flows from the operations to which the assets relate, based on Management’s best estimates using the appropriate assumptions and projections at the time, to the carrying amount of the assets. If the carrying value is determined to be in excess of future operating cash flows, the asset is considered impaired and a loss is recognized equal to the amount by which the carrying amount exceeds the estimated fair value of the assets. As of August 31, 2005, Management does not believe impairment, as defined above, exists.

Recently issued accounting pronouncements:

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

pronouncement includes specific transition provisions, those provisions should be followed. The Company does not expect this pronouncement to have a material impact on the financial statements.

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

Discussion of operating results:

	Three months ended August 31, 2005
	Consolidated				Balancer				Measurement
	Dollars		%		Dollars		%		Dollars		%
Sales	$	2,656,434	100.0	%	$	1,906,872	100.0	%	$	749,562	100.0	%
Cost of sales	1,244,325		46.8	%	936,860		49.1	%	307,465		41.0	%
Gross profit	1,412,109		53.2	%	$	970,012	50.9	%	$	442,097	59.0	%
Operating expenses	1,028,152		38.7	%
Income from operations	$	383,957	14.5	%

	Three months ended August 31, 2004
	Consolidated				Balancer				Measurement
	Dollars		%		Dollars		%		Dollars		%
Sales	$	2,428,729	100.0	%	$	1,752,687	100.0	%	$	676,042	100.0	%
Cost of sales	1,070,393		44.1	%	851,249		48.6	%	219,144		32.4	%
Gross profit	1,358,336		55.9	%	$	901,438	51.4	%	$	456,898	67.6	%
Operating expenses	1,080,459		44.5	%
Income from operations	$	277,877	11.4	%

Worldwide sales of Balancer products increased 8.8% in the most current fiscal period when compared to the same period in the prior fiscal year as sales to the North American and Asian markets increased by 7.7% and 23.4% respectively. These increases were offset by decreases in the European market of 30.6%. Unit sales prices of balancer products are relatively stable and therefore any increases or decreases in the dollar amount of sales between fiscal periods can generally be attributed to an increase or decrease in the number of units sold. The increase in units sold in North America is attributed to growing demand and stronger economic conditions. The increase in Asia is attributed to expansion of the sales efforts in China. The decreased units sold in Europe are attributed to strong European competition and weaker economic conditions in certain European markets.

Measurement product sales increased 10.9% in the most current fiscal period when compared to the same period in the prior fiscal year as sales of the Company’s dimensional sizing products increased by 39.7% offset by decreases in surface measurement products of 21.4%. The sales of dimensional sizing products in the most recent fiscal period increased as they included more unit sales than in the same fiscal period in the prior year. The decreases in surface measurement products are due to a decrease in sales of large value laser light-scatter products.

Cost of sales for the both the Balancer and Measurement segments increased (as a percentage of sales) in the most current fiscal period when compared to the same period in the prior fiscal year primarily due to the product sales mix as production labor and overhead costs were stable.

Sales by the foreign subsidiary totaled $428,094 for the most recent quarter versus $456,508 for the same quarter last year. Approximately 4% of the decrease is due to lower unit sales volumes with the remainder due to the changes in foreign exchange rates between the two fiscal periods. The lower sales volumes were realized as a result of the soft sales in European markets, which were partially offset by increases in other markets primarily located in South America.

In the three month period ended August 31, 2005, net income was $242,897 ($.09 per fully diluted share) compared to net income of $280,055 ($.10 per fully diluted share) for the same period last year. Net income was negatively impacted by the provision for income taxes, which increased to $151,000 for the three month period ended August 31, 2005 from the $6,000 reported in the same period last year.

LIQUIDITY AND CAPITAL RESOURCES

The Company’s ratio of current assets to current liabilities increased to 7.6 to 1 at August 31, 2005 compared to 6.5 to 1 at May 31, 2005. As of August 31, 2005, the Company had $2,168,115 in cash compared to $1,176,959 at May 31, 2005.

During the three-months ended August 31, 2005, cash provided by operating activities amounted to $964,192 with the changes described as follows:

• Net income for the three-months ended August 31, 2005 of $242,897 plus two non-cash items: depreciation and amortization of $55,167 and deferred taxes of $120,000.

• Accounts receivable generated cash as the balance decreased by $454,425 to an August 31, 2005 balance of $1,654,718 compared to $2,109,143 at May 31, 2005, a 21.5% decrease. The Company generally experiences a payment cycle of 30-90 days on invoices, depending on the geographic market. 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.

• Inventories decreased $171,835 to an August 31, 2005 balance of $3,361,478 compared to $3,533,313 at May 31, 2005, a 4.9% decrease. 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 decreased by $14,521 to $89,771 from a balance of $104,292 at May 31, 2005 with the decrease due to prepaid fees, trade show costs and various business and insurance costs.

• Trade accounts payable decreased by $79,386 to $417,820 from a balance of $497,206 at May 31, 2005 primarily due to lower operating expenses during the current quarter when compared to the fourth quarter ended May 31, 2005 and normal fluctuations in timing of payment of outstanding payable balances.

• Other accrued liabilities (including customer deposits, commissions, payroll items and other accrued expenses) decreased by $46,267 to a balance of $473,911 from $520,178 at May 31, 2005.

During the three-months ended August 31, 2005, net cash used in investing activities was $50,088, consisting of additions to property and equipment. Net cash provided by financing activities amounted to $46,685 which consisted of $58,570 in common stock issued to employees who exercised stock options less payment on long-term obligations of $11,885.

The following summarizes contractual obligations at August 31, 2005 and the effect on future liquidity and cash flows:

Years Ending August 31,	Long term obligations		Operating Leases		Total Contractual Obligations
2006	$	25,041	$	40,533	$	65,574
2007	12,785		40,533		53,318
2008	3,159		30,400		33,559
2009	—		—		—
Total	$	40,985	$	111,466	$	152,451

Management has historically responded to business challenges that had a negative impact on operations and liquidity by reducing operating expenses, developing new products and attempting to penetrate new markets for the Company’s products. As a result of these efforts, results of operations and cash flow from operations have improved. Management believes its cash flows from operations, its 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 2006 and 2007. However, in the event the Company fails to achieve its operating and financial goals for Fiscal 2006, 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 cost cutting measures and/or entering into additional borrowing arrangements collateralized by assets.

Business Risks

This report includes “forward-looking statements” as that term is defined in Section 21E of the Securities Exchange Act of 1934. Forward-looking statements can be identified by the use of forward-looking terminology such as “believes,” “expects,” “may,” “will,” “should,” “seeks,” “approximately,” “intends,” “plans,” “estimates,” “anticipates,” or “hopes,” or the negative of those terms or other comparable terminology, or by discussions of strategy, plans or intentions. For example, this section contains numerous forward-looking statements. All forward-looking statements in this report are made based on management’s current expectations and estimates, which involve risks and uncertainties, including those described in the following paragraphs. Among these factors are the following:

• Demand for Company products may change.

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

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

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

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

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

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

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

• The Company faces risks from international sales and currency fluctuations.

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

Demand for Company products may change:

Over the past six fiscal quarters, the Company has experienced increasing demand for its Balancer products in North America. These increases are attributed primarily to an improving economy in North America.. The conditions and circumstances could change in future periods and as a result demand for the Company’s products could decline. Management is responding to these risks in two ways. First, it appears there is a significant portion of the marketplace that is not using the automatic balancing products of the Company or any of its competitors. The Company will therefore continue to devote part of its future R&D efforts toward developing products that will both broaden the scope of Balancing products offered to the current customer base. Second, there are uses for the Company’s Balancer products in industries other than those in the Company’s historic customer base. Management is devoting a significant portion of its time to identify these markets and educate those markets on the value of those products within their operations.

The laser light-scatter products of the Measurement segment have 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 2004 and consequently, demand for drives fell over these periods. As the operations of those companies suffered, they in turn reduced capital spending resulting in minimal demand for and sporadic sales of the Company’s laser light-scatter products. Industry forecasts are for improving conditions and the Company has experienced increasing sales in Fiscal 2005 and 2006 to those industries. However, the long-term impact on demand for the Company’s surface Measurement products cannot be predicted with any certainty.

The semiconductor industry has also faced a down cycle over the past few fiscal years. Beginning in Fiscal 2002 the semiconductor industry experienced backlog cancellations, resulting in slower revenue growth and these conditions continued into Fiscal 2004. 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. Some improvement in market conditions is forecasted to occur sometime in the next several months, although there is no certainty if and when those improvements will occur.

Management will continue to market these products to these historic markets as it appears no other technology has been introduced that would make the laser light-scatter products technologically obsolete. There is the belief that once market conditions improve in the disk drive and silicon wafer markets, demand for the Company’s products and technology will increase although most likely not to historic levels. Also, Management believes there are other uses for the Company’s laser light scatter technology and continues to evaluate R&D efforts to develop new products and introduce them to the marketplace.

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

The failure to develop new technologies, or react to changes in existing technologies, could materially delay development of new products, which could result in decreased revenues and a loss of market share to competitors. Financial performance depends on the ability to design, develop, manufacture, assemble, test, market and support new products and enhancements on a timely and cost-effective basis. New product opportunities may not be identified and developed and brought to market in a timely and cost-effective manner. Products or technologies developed by other companies may render products or technologies obsolete or noncompetitive or a fundamental shift in technologies in the product markets could have a material adverse effect on the Company’s competitive position within historic industries.

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

Failure to protect existing intellectual property rights may result in the loss of valuable technologies or paying other companies for infringing on their intellectual property rights. The Company relies on patent, trade secret, trademark and copyright law to protect such technologies. There is no assurance any of the Company’s U.S. patents will not be invalidated, circumvented, challenged or licensed to other companies.

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

Manufacturing operations depend upon obtaining adequate supplies of raw materials on a timely basis. The results of operations could be adversely affected if adequate supplies of raw materials cannot be obtained in a timely manner or if the costs of raw materials increased significantly.

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

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

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

Operating expenses are generally fixed in nature and largely based on anticipated sales. However, should future sales decline significantly and rapidly, there is no guarantee management could take actions that would further reduce operating expenses in either a timely manner or without seriously impacting the operations of the Company.

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

The Company believes it maintains a competitive advantage by shipping product to its customers more rapidly than its competitors. As a result, the Company has a significant investment in inventories. These 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.

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

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

The Company faces risks from international sales and currency fluctuations:

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

Item 3 – Quantitative and Qualitative Disclosures About Market Risk:

Interest Rate Risk

The Company did not have any derivative financial instruments as of August 31, 2005. However, the Company could be exposed to interest rate risk at any time in the future and therefore, 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 does have a line of credit but does not have an outstanding balance as of August 31, 2005. Also, there is no other debt whose interest rates are based on variable rates that may fluctuate over time based on economic changes in the environment. Therefore, at this time, the Company is not subject to interest rate risk if market interest rates fluctuate and does not expect any change in the interest rates to have a material effect on the Company’s results from operations.

Foreign Currency Risk

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. The Company operates a subsidiary in the United Kingdom and acquires certain materials and services from vendors transacted in foreign currencies. Therefore, the Company’s business and financial condition is sensitive to currency exchange rates or any other restrictions imposed on their currencies. For the three-months ended August 31, 2005 and 2004, results of operations included losses on foreign currency translation of $2,867 and $2,943 respectively.

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 Rules 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended, as of the end of the period covered by this report. Based on their evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective as of the end of the period covered by this report.

(b) There have been no changes in our internal controls that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Part II - OTHER INFORMATION

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits

31.1		Certification of Principal Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2		Certification of Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1		Certification of Principal Executive Officer and Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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.

	SCHMITT INDUSTRIES, INC.
	(Registrant)

Date:	10/17/2005	/s/ Wayne A. Case
			Wayne A. Case, President/CEO/Director

Date:	10/17/2005	/s/ Michael S. McAfee
			Michael S. McAfee, Chief Financial Officer/Treasurer

SCHMITT INDUSTRIES INC - Quarter Report: 2005 August (Form 10-Q)

WASHINGTON, D.C. 20549

For the quarterly period ended: August 31, 2005

PART I - FINANCIAL INFORMATION

CONSOLIDATED STATEMENTS OF INCOME

SCHMITT INDUSTRIES, INC.

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

CONSOLIDATED STATEMENTS OF CASH FLOWS

Segment Information

Geographic Information

Long-term Assets

RESULTS OF OPERATIONS

LIQUIDITY AND CAPITAL RESOURCES

Interest Rate Risk

Foreign Currency Risk