SCHMITT INDUSTRIES INC - Annual Report: 2019 (Form 10-K)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

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

For the fiscal year ended: May 31, 2019

or

 

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

For the transition period from                      to                     

Commission File Number: 000-23996

SCHMITT INDUSTRIES, INC.

(Exact name of registrant as specified in its charter)

 

Oregon		93-1151989
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification Number)

2765 N.W. Nicolai Street

Portland, Oregon 97210

(Address of principal executive offices) (Zip Code)

(503) 227-7908

(Registrant’s telephone number, including area code)

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

 

Title of each class		Trading Symbol(s)		Name of each exchange on which  registered
Common Stock - no par value Series A Junior Participating Preferred Stock Purchase Rights		SMIT		NASDAQ Capital Market

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

None

Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.     Yes  ☐    No  ☒

Indicate by check mark whether the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.    Yes  ☐    No  ☒

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

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (check one):

 

Large accelerated filer		☐		Accelerated filer		☐
Non-accelerated filer		☐		Smaller reporting company		☒
				Emerging growth company		☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.    ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes   ☐    No  ☒

As of the last day of the second fiscal quarter of 2019, the aggregate market value of registrant’s common stock held by non-affiliates of the registrant was approximately $6,820,200 based upon the closing price of $2.94 reported for such date on the NASDAQ Capital Market. As of July 31, 2019, the registrant had 4,032,878 outstanding shares of Common Stock.

Documents Incorporated by Reference

Portions of the registrant’s definitive Proxy Statement for its 2019 Annual Meeting of Shareholders are incorporated by reference into Part III hereof.

SCHMITT INDUSTRIES, INC.

INDEX TO FORM 10-K

 

				Page
Part I
Item 1.		Business			3
Item 1A.		Risk Factors			10
Item 1B.		Unresolved Staff Comments			13
Item 2.		Properties			13
Item 3.		Legal Proceedings			13
Item 4.		Mine Safety Disclosures			13
Part II
Item 5.		Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities			14
Item 6.		Selected Financial Data			15
Item 7.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			15
Item 7A.		Quantitative and Qualitative Disclosures about Market Risk			24
Item 8.		Financial Statements and Supplementary Data			25
Item 9.		Changes in and Disagreements with Accountants on Accounting and Financial Disclosure			49
Item 9A.		Controls and Procedures			49
Item 9B.		Other Information			49
Part III
Item 10.		Directors, Executive Officers and Corporate Governance			50
Item 11.		Executive Compensation.			50
Item 12.		Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters			50
Item 13.		Certain Relationships and Related Transactions and Director Independence			50
Item 14.		Principal Accounting Fees and Services			50
Part IV
Item 15.		Exhibits and Financial Statement Schedules			51
Signatures					53
Exhibits					52

 

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PART I

Cautionary Note Regarding Forward-Looking Statements

Certain statements contained in this report are forward-looking in nature. Words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “sees,” “estimates” and variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve risks, uncertainties and assumptions that are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements. Certain of such risks and uncertainty are discussed in the “Risk Factors” section in Item 1A.

 

ITEM 1.

BUSINESS

As a global leader in precision test, measurement and process control products, Schmitt helps customers save money, increase production efficiency and improve product quality across a variety of industries.

Schmitt was founded in 1987 to provide reliable solutions for in-process dynamic balancing of precision grinding machines. The Schmitt Dynamic Balance System (“SBS”) can detect and dynamically correct vibration as low as 0.02 microns to ensure product quality, and the SBS acoustic emission sensors help grinding machine operators maximize the efficiency of the grinding process, thereby increasing part throughput and lowering operating costs.

The Company’s family of products was expanded in June 2000 with the acquisition of the Acuity^™ line of dimensional and distance measurement lasers. These laser products utilize both triangulation and time-of-flight measurement principles and are known for their speed and accuracy. The Acuity products are used in a wide variety of industrial, commercial and research applications.

In 2007, the Company purchased Xact^™ ultrasonic measurement technology for the remote monitoring of the fill levels of propane and other liquid tanks. Together with the Xact gauge reader, the satellite-focused Xact systems can detect and communicate fill levels, along with other information such as tank size and configuration, to customers through the “Internet of Things” ecosystem using our satellite provider and a secure website. Typical users of Xact systems are bulk propane, diesel, jet fuel suppliers and ammonia users and distributors.

Today, Schmitt Industries is a world leader in providing highly precise test, measurement and process control products that help customers save money, increase production efficiency and improve product quality.

The Company was originally incorporated under the laws of British Columbia, Canada, in 1984 and was reincorporated under the laws of the State of Oregon in 1995. Schmitt is an ISO 9001 certified company.

Schmitt trades on the Nasdaq Composite Index (the “NASDAQ”) under the ticker “SMIT”.

We serve our customers and organize our business through the following reportable segments:

 

•

Balancer (“Balancer”) Segment. The principle product for the Balancer segment is the SBS product line, which designs, manufactures and sells computer-controlled vibration detection, balancing and process control systems for the worldwide machine tool industry, particularly for grinding machines.

 

•

Measurement (“Measurement”) Segment. Through its wholly owned subsidiary, Schmitt Measurement Systems, Inc., the Measurement segment manufacturers and sells products in two core product lines, Acuity and Xact:

 

–

Acuity sells products, solutions and services that includes laser and white light sensor distance, measurement and dimensional sizing products;

 

–

Xact includes satellite focused remote tank monitoring products and related monitoring services for markets in the Internet of Things (“IoT”) environment. The Xact products measure the fill

 

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levels of tanks holding propane, diesel and other tank-based liquids and the related monitoring services, which includes transmission of fill data from the tanks via satellite to a secure web site for display.

Our two reportable segments provide a wide range of products and services to various customers.

Balancer Segment

SCHMITT DYNAMIC BALANCE SYSTEMS (SBS)

The Company’s principal product line for the Balancer segment is the Schmitt Dynamic Balance System or SBS. SBS is an industry leader that designs, manufactures and sells computer-controlled vibration detection, balancing and process control systems for the worldwide machine tool industry, particularly for grinding machines. The Company provides sales and service through three primary channels: 1) United States, North America and a portion of the Asia markets through Schmitt Industries (SII), located in Portland, Oregon; 2) Europe and a portion of the Asia markets through the Company’s wholly owned subsidiary, Schmitt Europe Limited (SEL), located in Coventry, England and 3) China through the Company’s sales representative office, located in Shanghai, China.

Products and Services

SBS products are highly precise measurement and control devices for permanent or portable installation on grinding machines that can detect and correct imbalance caused by vibration as small as 0.02 microns. SBS products play a vital role for machine tool builders as they help to 1) improve product quality by reducing variability in the grinding process, 2) increase efficiency in the grinding process by eliminating grinding gap time in the grind cycle and 3) reduce machine downtime by helping to identify abnormalities in the grind cycle. SBS systems offer ease of product adaptation, quick installation and adaptability to all types of machines.

The following products are currently offered under the SBS brand:

SB-5500 Products – The SB-5500 product line is fully automated, eliminating the need to pre-balance parts, reducing machine setup time and ensuring a smoother and more efficient grinding process. The SB-5500 control panel contains up to four slots for additional functions, such as manual balancing and balancing using hydro chambers and process monitoring, which involves the detection and analysis of high frequency noise, known as acoustic emission (AE), generated by the grinding process.

The optional Acoustic Emission Monitoring System (AEMS) control card uses proprietary acoustic sensor technology to monitor the acoustic emissions signal generated on the grinding machine during key events in the grinding process. The AEMS card allows the grinding machine’s operating system to detect any unexpected contact allowing the system to stop the grinding process within one millisecond.

The SB-5500 also offers two process control cards to provide enhanced control of the grinding process: the ExactControl^™ card and the ExactDress^™ card. The ExactControl process control card offers multi-functional grinding process control capability by detecting and analyzing either the acoustic emissions pattern or the machine power fluctuations. Software control strategies include ExactDisplay, ExactGap, ExactTime, ExactIntegral, and ExactDress.

SB-2000 and AE-1000 Products – Additional SBS products include the SB-2000 and the AE-1000. The SB-2000 is an easy-to-use, compact manual balancing system offering both one and two plane manual balancing capabilities. The system comes in a dedicated machine installation version (SB-2000) and a portable version (SB-2000-P). The AE-1000 is a dedicated AE control platform that reduces air machine grinding time and alerts the operator to potential grinding wheel crash conditions by using proprietary AE detection technology to monitor the high frequency signals generated by the grinding process.

 

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Notable features of the SBS system include its ability to fit almost all grinding machines, ease of installation, compact and modular construction, ability to balance a wheel while on a machine, virtual elimination of wheel vibration, automatic monitoring of balancing, display in a variety of languages and units of measurement, instrument grade calibration, short balance process, measurement of both displacement and/or velocity and minimal operator maintenance. The SB-5500 also offers the capability of fully integrating its operation and output within any grinding machine’s CNC operating system by the use of its IVIS (Intelligent Visualization) software.

Customers and Markets

Precision grinding is necessary in major manufacturing areas including the automotive, industrial, aerospace and medical industries where specifications and operating tolerances on machined parts are increasingly precise.

Within the Company’s customer base for the SBS system, there are three major market segments:

Machine Tool Builders – Tool builder companies design and manufacture a variety of specialty application grinding machines. SBS systems are distributed to markets throughout the world through machine tool original equipment manufacturers (OEMs), who incorporate the SBS system into their products. SBS products are designed into world-class machine builder systems.

Examples of some well-known worldwide machine tool builders who have offered and/or installed the SBS System include Fritz Studer AG (Switzerland), Shanghai Machine Tool Works (China), ANCA (Australia), Capco Machinery (U.S.), Drake Manufacturing (U.S.), Ecotech/SMTW (China/U.S.), Matrix Machine Tool (UK), Schleifring Group (Germany, China), Shaanxi Qinchuan Machinery Development Co. (China), Fives Landis Grinding (U.S.), Koyo Machinery (U.S./Japan), Micron Machinery Limited (Japan/U.S.), Hardinge (U.S.), and Weldon Solutions (U.S.).

Machine Tool Rebuilders – Tool rebuilders develop their business by completely updating and refurbishing older grinding machines. These rebuilders typically tear the old machine apart and install new components, often including the SBS system. The Company currently sells its products directly to major machine tool rebuilders throughout the world.

Grinding Machine Users – These end users become aware of the SBS system through trade shows, trade magazine advertising, distributors, field representatives, referrals and new machine suppliers. The Company’s business is conducted worldwide with some better known customers including: Black & Decker, Briggs and Stratton, Schaeffler, Caterpillar, Eaton, Regal Beloit, Cummins Engine, Ford Motor Company, General Electric, General Motors, Ingersoll Rand, Komatsu, Sumitomo Heavy Industries, SKF Bearing Industries, Timken, TRW Automotive Components and Universal Bearing.

Schmitt works closely with our OEM customers to continually improve our systems. These relationships allow us to better serve our customers as we are better positioned to provide innovative solutions that assist them to be industry leaders in efficiency and effectiveness for their machines.

For the years ended May 31, 2019, May 31, 2018 and May 31, 2017 (Fiscal 2019, 2018 and 2016), net revenues of the Company’s Balancer segment products totaled $9,080,719, $9,026,830 and $7,082,474, respectively. Net revenues of Balancer segment products accounted for 66%, 65% and 57% of the Company’s total revenues in Fiscal 2019, 2018 and 2017, respectively. See Note 5 to Consolidated Financial Statements.

Competition

The Company’s primary competitors in the Balancer segment are Marposs S.p.A., Balance Systems S.r.l. and MPM Micro Prazision Marx GmbH.

 

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Measurement Segment

In the Measurement Segment, our measurement solutions support a wide range of industries through its laser solutions product and applications and our tank monitoring products. These products and services include the Acuity and Xact product lines.

ACUITY LASERS

Acuity sells products, solutions and services including laser and white light sensor distance, measurement and dimensional sizing products.

Products and Services

Products sold under the Acuity brand include lasers utilizing both triangulation and time-of-flight methods of measurement, and confocal chromatic white light sensors. These lasers are used in a wide range of industrial applications including manufacturing, lumber production, steel casting, glass and paper production, medical imaging, crane control and micron-level part and surface inspection.

Customers and Markets

Acuity laser measurement sensors are used for fast and accurate dimensional measurement in a wide range of applications, including factory automation, surface profile scanning, crane positioning, road profiling, tire production, semiconductor manufacturing and many other industrial and commercial applications.

The market for Acuity lasers is growing as the industry moves from a products market to a solutions-based market as customers seek tailored solutions to solve complex problems in a range of industrial and manufacturing businesses.

Competition

The Company believes the principal elements of competition include quality of ongoing technical support and maintenance coupled with responsiveness to customer needs, as well as price, product quality, reliability and performance. The Acuity products market is extremely competitive, characterized by rapidly changing technology, and includes multinational competitors. Company pricing is intended to obtain market share and meet competitive supplier prices. The market strategy is to establish products with the best quality, reliability and performance and superior economic value.

XACT REMOTE TANK MONITORING SYSTEMS

Xact product line includes satellite focused remote tank monitoring products and related monitoring services for markets in the Internet of Things (“IoT”) environment. The products measure the fill levels of tanks holding propane, diesel and other tank-based liquids and the related monitoring services includes transmission of fill data from the tanks via satellite to a secure web site for display.

Products and Services

Xact Satellite Remote Tank Monitors include both ultrasonic and gauge reader sensors that provide remote fill level monitoring of propane, diesel and other tank-based liquids for tanks anywhere in the world. The Xact systems can be used to monitor tanks as small as 125 gallons (473 liters) and as large as 90,000 gallons (340,686 liters). With Xact, users access timely and accurate remote tank data on a consistent schedule or by customized critical fill alarms to optimize inventory management processes.

 

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There are three main components to the Xact Tank Monitoring System:

Tank Sensors – Xact offers two sensors, the Xact Ultrasonic sensor and the Xact Gauge Reader.

The Xact Ultrasonic sensor incorporates patented technology and is externally mounted to the bottom of the tank with no reliance on existing mechanical gauges. The system employs a small electrical pulse, which is able to calculate the precise fill level inside using patented sonar technology (measurement accuracy to within ±2% for large tanks and ±1% for small tanks). Ultrasonic sensors work with any tank-based liquids including propane, diesel and natural gas.

The Xact gauge reader connects to the face of a float gauge and detects the fill level that is reported by the gauge. The system then transmits that data by satellite in the same manner as the Ultrasonic sensor. Float gauges have a typical accuracy range of ±4% to ±8%. Gauge readers are primarily used in the propane industry to monitor propane tanks and support refill optimization for distributors and customers.

Satellite Radio Transmitter – The Xact radio transmitter is placed on the top of the tank and is connected by cable to the tank sensor or gauge reader. The transmitter transmits the tank data using the GlobalStar^® satellite network to the secure Xact website. Xact satellite telemetry provides global coverage with no dependence on land lines, cellular networks or Wi-Fi signals, making it a reliable monitoring solution for tanks located anywhere in the world.

Xact Website – The Xact website is a secured location providing controlled access to the tank data for each customer’s various tank locations. Customers can access the website to check fill levels and additional information such as temperature, battery status, GPS coordinates and map location. In addition, the data can also be integrated into customer back-office software via API. This integration can be automatically directed to a customer’s inventory or delivery management system for full automation of the delivery process.

The Xact Tank Monitoring Systems are highly dependable, providing the ability to operate in a wide range of environments with temperatures ranging from -40ºC to 60ºC.

Customers and Markets

Accessing accurate fill level information is essential to effectively manage inventory, improve delivery efficiency, reduce operating costs and increase profitability, and justify capital expenditures for fuel providers. Xact focuses on niche satellite solutions, which separates it from intense competition in the cellular monitoring industry. To reach our customers and fill gaps in cellular monitor customers, Xact partners with select cell providers in providing our Xact solution. Given our niche market, Xact is well positioned to partner with various providers to offer a full range solution.

Customers of the Xact Tank Monitoring System include large, regional and local propane distributors, such as Superior Propane (Canada), Suburban Propane (U.S.), AmeriGas (U.S.), Dassel Petroleum (U.S.) and TermoGas (Mexico). The Company is currently focusing its business development efforts on the propane industry in the United States and Canada.

Competition

Competitors offer telemetry options based on cellular or closed-loop communication networks, whereas Xact telemetry is satellite based. General tank monitoring competitors include: Anova (Wesroc), NasCorp (SkyTracker), WACnGO, Silicon Controls, TankScan, SkyBitz, Otodata, Angus Energy (Gremlin), and Tank Utility. Competitors that offer satellite telemetry include Anova (WESROC), NasCorp (SkyTracker), and Micro-Design, Inc. (LevelCon).

 

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Other Measurement Segment Products

Also included in the Measurement segment are the following products, however, these products are either being phased out, have been sold or are no longer actively being produced:

TMS – TMS (Texture Measurement System) 2000-RC is an accurate non-contact texture measurement system. The product (used on aluminum substrates) provides fast, accurate and repeatable microroughness measurements while quadrupling production throughput when compared to other testing devices. Surface roughness can be measured to levels below 0.5 Angstroms. An Angstrom (Å) is a unit of measure equal to 1 hundred-millionth of a centimeter (the point of a needle is one million Å in diameter).

In Fiscal 2019, 2018 and 2017, net revenues of Measurement products totaled $4,729,442, $4,861,233 and $5,315,169, respectively, and accounted for 34%, 35% and 43% of the Company’s total revenues in Fiscal 2019, 2018 and 2017, respectively. See Note 5 to Consolidated Financial Statements.

Revenues by Geographic Area

In Fiscal 2019, 2018 and 2017, the Company recorded net revenues of its products in the United States, its country of domicile, of $6,819,118, $6,932,943 and $6,797,469, respectively. Net revenues in the last three fiscal years by geographic areas were:

 

		North America				Europe				Asia				Others
Fiscal 2019		$	8,217,025			$	2,094,627			$	3,327,352			$	171,157
Fiscal 2018		$	8,371,376			$	2,258,495			$	3,122,484			$	135,708
Fiscal 2017		$	8,162,340			$	1,451,293			$	2,500,191			$	283,819

Business and Marketing Strategy

The Company designs, manufactures and markets all of its products with operations divided into a number of different channels and geographies.

Balancer Segment Products

The Company markets and sells its SBS products in a variety of ways. First, selling channels are provided by approximately 65 individuals organizations (including approximately 15 in the United States and four in China) that are independent manufacturers’ representatives and distributors.

Second, OEMs integrate the SBS products on the machine tools they produce. Users purchase the SBS products concurrently with the machine tools. End users of grinding machines that have purchased the SBS system directly from the Company, after enjoying the benefits of our products, often request that SBS products be included with the new equipment they order from OEMs. The SBS systems are often installed by machine tool builders prior to displaying their own machine tools at various trade shows, becoming endorsements that prove beneficial to the Company’s sales efforts.

Third, worldwide trade shows have proven to be an excellent source of business. Representatives from all facets of the Company’s target markets attend these trade shows where Company representatives are able to interact with these attendees and highlight SBS products.

Measurement Segment Products

Similar to the Balancer segment, the Measurement segment uses a variety of methods to market and sell its products. Primarily, our sales and marketing managers direct the overall worldwide sales and marketing efforts

 

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for the Acuity and Xact products, including the employment and management of representatives and distributors in various markets. In addition, trade shows have recently proven to be an excellent source of business. Representatives from all facets of the Company’s target markets attend these trade shows.

Backlog

The Company does not generally track backlog. Normally, orders are shipped within one to three weeks after receipt unless the customer requests otherwise.

Manufacturing

The Company uses a variety of sources for the supply of raw materials for the product lines. Essential electronic components, available in large quantities from various suppliers, are assembled into the Balancing and Measurement electronic control units under the Company’s quality and assembly standards. Company-owned software and firmware are coupled with the electronic components to provide the basis of the Company’s various electronic control units. Management believes several supply sources exist for all electronic components and assembly work incorporated into its electronic control systems. Mechanical parts for the Company’s products are produced by high quality machine shops. The Company is not dependent on any one supplier of mechanical components. In the event of supply problems, the Company believes that two or three alternatives could be developed within 30 days. The Company is subject to availability and pricing on the various components parts purchased, which has had, and may continue to have, a material impact on operations.

The Company uses in-house skilled assemblers to construct and test vendor-supplied components. Component inventory of finished vendor-supplied parts is held on Company property to assure adequate flow of parts to meet customer order requirements. Inventory is monitored by a computer control system designed to assure timely re-ordering of components. In-house personnel assemble various products and test all finished components before placing them in the finished goods inventory. Finished goods inventory is maintained via computer to assure timely shipment and service to customers. All customer shipments are from the finished goods inventory.

The Company’s Quality Control Program first received full ISO 9001 certification in 1996. In 2005, the Company received its certification to the newer ISO 9001:2000 requirements and received subsequent recertification in 2011, 2014 and 2017.

Proprietary Technology

The Company’s success depends in part on its proprietary technology, which the Company protects through patents, copyrights, trademarks, trade secrets and other measures. Ten patents and several trademarks and copyrights currently offer protection of this proprietary technology. The Company has a policy of seeking patents, where appropriate, on inventions concerning new products and improvements developed as part of its ongoing research, development and manufacturing activities. While patents provide certain legal rights of enforceability, there can be no assurance the historic legal standards surrounding questions of validity and enforceability will continue to be applied or that current defenses with respect to issued patents will, in fact, be considered substantial in the future. There can be no assurance as to the degree and range of protection any patent will afford and whether patents will be issued or the extent to which the Company may inadvertently infringe upon patents granted to others.

The Company also relies upon trade secret protection for its confidential and proprietary information. There can be no assurance that others will not independently develop substantially equivalent proprietary information and techniques or otherwise gain access to the Company’s trade secrets or disclose such technology or that the Company can meaningfully protect its trade secrets.

While the Company pursues patent, trademark, trade secret and copyright protection for products and various trademarks, it also relies on know-how and continuing technology advancement, manufacturing capabilities,

 

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affordable high-quality products, new product introduction and direct marketing efforts to develop and maintain its competitive position.

Product Development

The Company maintains an ongoing research and development program to expand the product lines and capabilities of its business segments. During Fiscal 2019, 2018 and 2017, the Company’s research and development expense totaled $129,040, $327,317 and $256,164, respectively.

Employees

As of July 31, 2019, the Company employed 50 individuals, none of which were covered by a collective bargaining agreement.

 

ITEM 1A.

RISK FACTORS

The following are important factors that could cause actual results or events to differ materially from those contained in any forward-looking statements made by or on behalf of the Company (see the forward-looking statements disclaimer at the beginning of Part 1, Item 1 in this Report). In addition, the risks and uncertainties described below are not the only ones that the Company faces. Unforeseen risks could arise and problems or issues that the Company now views as minor could become more significant. If the Company were unable to adequately respond to any risks, the Company’s business, financial condition or results of operations could be materially adversely affected. In addition, the Company cannot be certain that any actions taken to reduce known or unknown risks and uncertainties will be effective.

General economic conditions and uncertainties may adversely affect the Company’s business, operating results and financial condition

The Company’s operations and performance depend significantly on worldwide economic conditions, particularly in the industrial, manufacturing and automotive sectors in the U.S., Asia and Europe, and their impact on levels of capital spending. Economic factors that could adversely influence demand for the Company’s products include uncertainty about global economic conditions leading to reduced levels of investment, reduction in demand for our customers’ products, customers’ and suppliers’ access to credit and the stability of the global financial system, the overall health of our markets, unemployment and other macroeconomic factors generally affecting commercial and industrial spending behavior.

Past distress in the global financial markets and global economy resulted in reduced liquidity and a tightening of credit markets. If these conditions were to reoccur, the Company could experience several potential adverse effects, including the inability of customers to obtain credit to finance purchases of the Company’s products, the insolvency of customers resulting in reduced revenues and bad debts, and the insolvency of key suppliers resulting in product development and production delays.

The Company’s primary markets are volatile and unpredictable

The Company’s business depends on the demand for our various products in a variety of commercial and industrial markets. In the past, demand for our products in these markets has fluctuated due to a variety of factors, some of which are beyond our control, including: general economic conditions, both domestically and internationally, the timing, number and size of orders from, and shipments to, our customers as well as the relative mix of those orders and variations in the volume of orders for a particular product line in a particular quarter. Further, as a result of efforts to reduce carbon dioxide emissions, the automotive industry is expected to move towards electric propulsion vehicles, with a lower count of parts requiring grinding per drive system. This shift may negatively affect Balancer sales in the future as fewer grinding machines are used.

 

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Technology advance and potential competition

The failure to develop new products or enhance existing products or react to changes in existing technologies could result in decreased revenues and a loss of market share to competitors.

Competition is intense and the Company’s failure to compete effectively would adversely affect its business

Competition in the markets for the Company’s products is intense. The speed with which the Company can identify new applications for the Company’s various technologies, develop products to meet those needs and supply commercial quantities at low prices to those new markets are important competitive factors. The principal competitive factors in the Company’s markets are product features, performance, reliability and price. Many of the Company’s competitors have greater financial, technical, engineering, production and marketing resources than we do. Those competitors with greater resources may, in addition to other things, be able to better withstand periodic downturns, compete more effectively on the basis of price and technology, or more quickly develop enhancements to products that compete with the products we manufacture and market. New companies may enter the markets in which we compete, further increasing competition in those markets. No assurance can be given that the Company will be able to compete effectively in the future, and the failure to do so would have a material adverse effect on the Company’s business, financial condition and results of operations.

The Company may experience increased pricing pressure

We have experienced and continue to experience pricing pressure in the sale of our products, from both competitors and customers. Our business, financial condition, margins or results of operations may be materially and adversely affected by competitive pressure and intense price-based competition.

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 could be adversely affected if adequate supplies of raw materials cannot be obtained in a timely manner or if raw material costs increase significantly.

The Company may not be able to ramp up manufacturing to satisfy increasing orders, which may lead to the loss of significant revenue opportunities

The Company manufactures several different product lines, all of which involve complicated technology and individual attention for each product made. The production time for each product can vary, depending on a variety of circumstances, including component availability, timing of delivery of components from suppliers and employee availability. Should the Company receive a large increase in orders, an increase in the size of orders or a shortening of the required delivery time on existing orders, the Company may not be able to ramp up manufacturing to satisfy customer expectations, which may lead to the loss of significant revenue opportunities.

The Company maintains a significant investment in inventories in anticipation of future revenues

The Company believes it maintains a competitive advantage by shipping product to its customers more rapidly than its competitors and therefore maintains a significant investment in inventories. These inventories are recorded using the lower of cost or net realizable method, which requires management to make certain estimates. Management evaluates the recorded inventory values based on customer demand, market trends and expected future revenues, and changes valuation estimates accordingly. A significant shortfall of revenues may result in carrying higher levels 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.

 

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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. Specifically, currency fluctuations will impact revenues, costs and earnings. No assurances can be given that 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.

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

Operating expenses are generally fixed in nature and largely based on anticipated revenues. However, should future revenues 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.

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 or that other highly qualified technical and sales personnel as required can be attracted, assimilated and retained. There is also no guarantee that key employees will not leave and subsequently compete against the Company. The inability to attract and retain key personnel could adversely impact the business, financial condition and results of operations.

Changes in the effective tax rate may have an adverse effect on the Company’s results of operations

The Company’s future effective tax rate may be adversely affected by a number of factors including: the jurisdictions in which profits are determined to be earned and taxed; the resolution of issues arising from future, potential tax audits with various tax authorities; changes in the valuation of our deferred tax assets and liabilities; adjustments to estimated taxes upon finalization of various tax returns; increases in expenses not deductible for tax purposes; changes in available tax credits; changes in stock-based compensation expense; changes in tax laws or the interpretations of such tax laws and changes in generally accepted accounting principles.

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.

Failure to protect our technology systems from cybersecurity occurrences may have an adverse effect on the Company’s operations

Our information technology systems, or those of certain key vendors or other third parties on which we rely, are subject to an increasing threat of continually evolving cybersecurity risks. A breach in the security of our systems or our key business partners’ systems could result in business disruptions, which could have a material adverse effect on our financial condition, results of operations or cash flows. The Company does not retain any customer credit card or financial information on our technology systems.

 

Page 12

Our reorganization activities and cost saving initiatives may not achieve the results we anticipate.

Beginning in the second half of Fiscal 2019, The Company has undergone management changes and initiated a Company reorganization and cost reduction to improve profitability and optimize operational efficiencies. For example, we initiated an in-depth review of inventory carried, our sales support staff, and our pricing and cost structures. We cannot be certain that we will be able to complete these initiatives as planned or without business interruption, that these initiatives will not generate additional costs, such as severance or other charges, or that the estimated operating efficiencies or cost savings from such activities will be fully realized or maintained over time.

Changes in securities laws and regulations have increased and could continue to increase Company expenses

Changes in the laws and regulations affecting public companies, including the provisions of the Sarbanes-Oxley Act of 2002 and rules promulgated by the Securities and Exchange Commission, have increased and may continue to increase Company expenses as the Company devotes resources to ensure compliance with all applicable laws and regulations. In addition, the NASDAQ Capital Market, on which the Company’s common stock is listed, has also adopted comprehensive rules and regulations relating to corporate governance. These laws, rules and regulations have increased the scope, complexity and cost of corporate governance, reporting and disclosure practices. The Company may be required to hire additional personnel and use outside legal, accounting and advisory services to address these laws, rules and regulations. The Company also expects these developments to make it more difficult and more expensive for the Company to obtain director and officer liability insurance in the future, and the Company may be required to accept reduced coverage or incur substantially higher costs to obtain coverage. Further, the Company’s board members, Chief Executive Officer and Chief Financial Officer could face an increased risk of personal liability in connection with the performance of their duties. As a result, we may have difficulty attracting and retaining qualified board members and executive officers, which would adversely affect the Company.

 

ITEM 1B.

UNRESOLVED STAFF COMMENTS

None.

 

ITEM 2.

PROPERTIES

The Company’s design and assembly facilities and executive offices are located in Portland, Oregon in three Company-owned buildings totaling approximately 40,500 square feet. SEL occupies a 1,080-square foot facility in Coventry, England pursuant to a monthly lease. The current basic monthly rent amount is £1,167 ($1,472 as of May 31, 2019).

 

ITEM 3.

LEGAL PROCEEDINGS

On January 8, 2019, Schmitt was served with a complaint filed by North American Satellite Corp., Insite Platform Partners, and Rick Humphreys (collectively, the “Plaintiffs”) in the Circuit Court of the State of Oregon against the Company. The complaint made various allegations specific to patent infringement, tortious interference, unfair competition, conspiracy, conspiracy to induce breach of contract, and conversion, with the total amount of $10,000,000 being sought by the Plaintiffs. The Company believed the complaint was without merit and intended to defend the claim vigorously. On April 1, 2019, Schmitt and Plaintiffs settled the complaint. Though the terms of the settlement agreement are confidential, the settlement amount was immaterial to the Company.

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

 

ITEM 4.

MINE SAFETY DISCLOSURES

Not applicable.

 

Page 13

PART II

 

ITEM 5.

MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

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

The following tables set forth the high and low closing prices of the Company’s Common Stock as reported on the NASDAQ Capital Market for the periods indicated.

 

Year Ended May 31, 2018		High				Low
First Quarter		$	1.90			$	1.57
Second Quarter		$	2.48			$	1.65
Third Quarter		$	3.06			$	2.25
Fourth Quarter		$	2.78			$	1.96
Year Ended May 31, 2019		High				Low
First Quarter		$	3.11			$	2.29
Second Quarter		$	3.01			$	2.59
Third Quarter		$	2.99			$	2.55
Fourth Quarter		$	2.57			$	2.16

As of July 31, 2019, there were 4,032,878 shares of Common Stock outstanding held by approximately 60 holders of record.

The Company has not paid any dividends on its Common Stock since 1994. The Company’s current policy is to retain earnings to finance the Company’s business. Future dividends will be dependent upon the Company’s financial condition, results of operations, current and anticipated cash requirements, acquisition plans and plans for expansion and any other factors that the Company’s Board of Directors deems relevant. The Company has no present intention of paying dividends on its Common Stock in the foreseeable future.

This table shows information about equity awards under the Company’s equity compensation plans at May 31, 2019:

 

Plan Category		Number of Securities to be issued upon exercise of outstanding options				Weighted-average exercise price of outstanding options				Number of Securities remaining available for future issuance under equity compensation plans (excluding securities in column a)
		(a)				(b)				(c)
Equity compensation plans approved by security holders			380,166			$	2.68				144,000
Equity compensation plans not approved by security holders			0				0				0
			380,166			$	2.68				144,000

Recent Sales of Unregistered Securities

None.

Issuer Purchases of Equity Securities

None.

 

Page 14

ITEM 6.

SELECTED FINANCIAL DATA

In thousands, except per share information

 

Year Ended		5/31/2019				5/31/2018				5/31/2017				5/31/2016				5/31/2015
Net sales		$	13,810			$	13,888			$	12,398			$	11,685			$	13,069
Net income (loss)		$	(1,211	)		$	211			$	(1,073	)		$	(1,515	)		$	(94	)
Net income (loss) per common share, basic		$	(0.30	)		$	0.06			$	(0.36	)		$	(0.51	)		$	(0.03	)
Weighted average number of common shares, basic			4,006				3,423				2,996				2,996				2,996
Net income (loss) per common share, diluted		$	(0.30	)		$	0.06			$	(0.36	)		$	(0.51	)		$	(0.03	)
Weighted average number of common shares, diluted			4,006				3,460				2,996				2,996				2,996
Stockholders’ equity		$	8,473			$	9,516			$	6,977			$	8,004			$	9,489
Total assets		$	9,865			$	11,286			$	9,006			$	9,635			$	11,104
Long-term debt (including current portion)		$	29			$	0			$	0			$	0			$	0

 

ITEM 7.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

OVERVIEW

We are a global leader in precision test, measurement and process control products, Schmitt’s family of products help customers save money, increase production efficiency and improve product quality across a variety of industries. The Company’s family of products included SBS, Acuity and Xact and serves a variety of industries. Schmitt trades on the NASDAQ under the ticker “SMIT”.

We serve our customers and organize our business through two reportable business segments, Balancer and Measurement, as described below under “Segment Results”.

RECENT DEVELOPMENTS

Strategic Reorganization

Following the election of new Board members in October 2018, we announced a strategic reorganization on November 30, 2018. The announced strategic reorganization was to better position the Company to capitalize on the growing SBS Balancer business, while streamlining the Company and maximizing shareholder value through the disposition of non-core assets.

On July 2, 2019, we announced that the Board of Directors adopted a stockholder rights plan in an effort to protect its net operating loss carryforwards (“NOLs”) under Section 382 of the Internal Revenue Code. As of May 31, 2019, Schmitt had federal and state NOLs of approximately $5.6 million and $6.1 million, respectively, which could be used in certain circumstances to offset Schmitt’s future taxable income or otherwise payable taxes and therefore reduce its federal and state income tax liabilities. Our ability to use the NOLs would be limited in the event of an “ownership change” under Section 382 of the Internal Revenue Code and related U.S. Treasury regulations. The stockholder rights plan is intended to reduce the likelihood of an unintended ownership change occurring through the buying of Schmitt common stock and is not meant to be an anti-takeover measure.

Key Leadership Changes

On November 30, 2018, we announced, effective December 1, 2018, the transition of David Case from CEO and President to Special Advisor to the Board of Directors. Mr. Case helped to steward the reorganization through April 2019. We also announced the appointment of Michael R. Zapata as President and Executive Chairman, effective December 1, 2018. Last, we announced the retirement of Michael Ellsworth, as Chairman and director. Mr. Ellsworth was a director since 2006 and served as Chairman from 2017.

 

Page 15

On June 26, 2019, we announced the appointment of Steven Strom as the fifth member of the Company’s Board, effective June 21, 2019. Steven Strom is an “independent director” according to the rules of the Securities and Exchange Commission and the NASDAQ and his appointment created a majority of independent directors on the Board in compliance with NASDAQ requirements. Mr. Strom is the founder of Odinbrook Global Advisors and has more than thirty years of experience advising companies in the US, Canada, Latin America, Europe and Asia.

On August 1, 2019, we announced the appointment of Michael R. Zapata as President and Chief Executive Officer, effective July 30, 2019.

Highlights of the Fiscal Year Ended May 31, 2019

 

•

Consolidated revenue decreased $77,902, or 0.6%, to $13,810,161 in the fiscal year ended May 31, 2019 (Fiscal 2019) from $13,888,063 in the fiscal year ended May 31, 2018 (Fiscal 2018);

 

•

Balancer segment revenue increased $53,889, or 0.6%, to $9,080,719 in Fiscal 2019 compared to $9,026,830 in Fiscal 2018. Measurement segment revenue decreased $131,791, or (2.7%), to $4,729,442 in Fiscal 2019 compared to $4,861,233 in Fiscal 2018.

 

•

Within the Measurement segment, Xact’s products and services in the “Internet of Things” industry continue to grow with monitoring revenue increasing 16.2% to $1,367,329 in Fiscal 2019 compared to $1,176,323 in Fiscal 2018.

 

•

Gross margin decreased to 36.0% for Fiscal 2019 from 43.7% in Fiscal 2018. This decrease is due, in part, to the inventory adjustments of $(407,558) and $(189,990) recorded during the third and fourth quarters of Fiscal 2019. These inventory adjustments were the outcome of new management’s requirement to complete an in-depth review of the inventory, with standards of the review focused on more current turnover. This review was driven by the organizational changes to the business models for the Company’s three product lines as a result of the overall reorganization efforts. These adjustments are direct charges to cost of sales and resulted in a reduction of gross margin from 40.3%, before adjustment, to 36.0% for Fiscal 2019.

 

•

Operating expenses increased $170,863, or 2.9%, to $6,080,805 in Fiscal 2019 compared to $5,909,942 in Fiscal 2018. These results include non-recurring reorganization, legal and other professional expenses of $752,481 incurred during Fiscal 2019 that were not incurred during the prior year.

 

•

Net loss was $(1,210,990), or $(0.30) per fully diluted share, for Fiscal 2019 as compared to net income of $210,639, or $0.06 per fully diluted share, for Fiscal 2018.

 

•

Non-GAAP EPS for Fiscal 2019 was $0.03 per fully diluted share compared to $0.06 per fully diluted share for Fiscal 2018.

 

Page 16

RESULTS OF OPERATIONS

 

		Year Ended May 31,
		2019								2018								2017
Balancer segment revenue		$	9,080,719				65.8	%		$	9,026,830				65.0	%		$	7,082,474				57.1	%
Measurement segment revenue			4,729,442				34.2	%			4,861,233				35.0	%			5,315,169				42.9	%
Total revenue, net			13,810,161				100.0	%			13,888,063				100.0	%			12,397,643				100.0	%
Cost of sales			8,836,856				64.0	%			7,822,749				56.3	%			7,511,836				60.6	%
Gross profit			4,973,305				36.0	%			6,065,314				43.7	%			4,885,807				39.4	%
Operating expenses:
General, administration and sales			5,951,765				43.1	%			5,582,625				40.2	%			5,618,327				45.3	%
Research and development			129,040				0.9	%			327,317				2.4	%			256,164				2.1	%
Total operating expenses			6,080,805				44.0	%			5,909,942				42.6	%			5,874,491				47.4	%
Operating income (loss)			(1,107,500	)			(8.0	%)			155,372				1.1	%			(988,684	)			(8.0	%)
Other income (expense), net			(77,051	)			(0.6	%)			81,182				0.6	%			(56,671	)			(0.5	%)
Income (loss) before income taxes			(1,184,551	)			(8.6	%)			236,554				1.7	%			(1,045,355	)			(8.4	%)
Provision for income taxes			26,439				0.2	%			25,915				0.2	%			28,009				0.2	%
Net income (loss)		$	(1,210,990	)			(8.8	%)		$	210,639				1.5	%		$	(1,073,364	)			(8.7	%)

Fiscal Year Ended May 31, 2019 Compared to Fiscal Year Ended May 31, 2018

Consolidated Revenue – Consolidated revenue decreased $77,902, or 0.6%, to $13,810,161 in Fiscal 2019 from $13,888,063 in Fiscal 2018.

Balancer segment revenue increased $53,889, or 0.6%, to $9,080,719 in Fiscal 2019 compared to $9,026,830 in Fiscal 2018. Revenue by geographic markets for the Balancer segment for the years ended May 31, 2019 and 2018 were as follows:

 

		Year Ended May 31,
		2019				2018				Variance
North America		$	3,868,166			$	3,835,913			$	32,253				0.8	%
Asia			3,094,888				2,854,504				240,384				8.4	%
Europe			1,981,228				2,222,747				(241,519	)			(10.9	%)
Other			136,437				113,666				22,771				20.0	%
Total Balancer segment revenue		$	9,080,719			$	9,026,830			$	53,889				0.6	%

The continued growth in Fiscal 2019 is due to growth in Asian markets, which was offset by a reduction of revenues into the Europe market driven primarily by an OEM customer’s adjustment to their project schedule and timing. While there is concern tariffs could impact our sales into the Asia market, only marginal impact has been experienced to date.

 

Page 17

Measurement segment revenue decreased $131,791, or 2.7%, to $4,729,442 in Fiscal 2019 as compared to $4,861,233 in Fiscal 2018. Revenue by product line for the Measurement segment for Fiscal 2019 compared to Fiscal 2018 were as follows:

 

		Year Ended May 31,
		2019				2018				Variance
Acuity		$	2,128,136			$	2,363,083			$	(234,947	)			(9.9	%)
Xact - product			1,203,893				1,196,071				7,822				0.7	%
Xact - monitoring			1,367,329				1,176,323				191,006				16.2	%
Lasercheck			7,500				95,046				(87,546	)			(92.1	%)
SMS			22,584				30,710				(8,126	)			(26.5	%)
Total Measurement segment revenue		$	4,729,442			$	4,861,233			$	(131,791	)			(2.7	%)

The decrease in Measurement segment revenue is a reflection of two discontinued product lines, Lasercheck and SMS and a reduction in Acuity revenue due to the loss of key sales staff at the end of Fiscal 2018. The Company is taking steps to address the sales staffing levels to continue to move Acuity from a products-based business to a solutions-based business. These decreases were partially offset by the increases in Xact monitoring revenue.

Gross margin – In Fiscal 2019, gross margin decreased to 36.0% in Fiscal 2019 from 43.7% in Fiscal 2018. This decrease was due, in part, to inventory adjustments of $(407,558) and $(189,990) recorded in the third and fourth quarters of Fiscal 2019, respectively. These adjustments were the outcome of new management’s requirement to complete an in-depth review of the inventory, with standards of the review focused on more current turnover. This review was driven by the organizational changes to the business models for the Company’s three product lines as a result of the overall reorganization efforts. These adjustments are direct charges to cost of sales and resulted in a reduction of gross margin from 40.3%, before adjustment, to 36.0% for Fiscal 2019. The remainder of the variance in gross margin between the periods presented was primarily influenced by focused efforts to reduce product costs and targeted efforts to increase prices where possible, as well as shifts in the product sales mix from lower to higher margin product line sales.

Operating expenses – Operating expenses increased $170,863, or 2.9%, to $6,080,805 in Fiscal 2019 compared to $5,909,942 in Fiscal 2018. These results include non-recurring reorganization and legal expenses of $752,481 incurred during Fiscal 2019 that are not expected to be incurred in future periods.

Items included in the non-recurring reorganization and legal expenses were as follows:

 

•

Employee severance and termination benefits of $248,522;

 

•

Cancellation of agreements with certain contractors and service providers amounting to $42,525 in non-recurring expense;

 

•

Legal and other professional expenses incurred totaling $403,751 related to the Company’s 2018 proxy and certain legal proceedings associated with a complaint filed against the Company, which occurred primarily during the third quarter of Fiscal 2019, and;

 

•

Curtailment of work provided by certain consultants, which amounted to $57,683 in Fiscal 2019 expense.

Other items that impacted operating expenses in Fiscal 2019 include:

 

•

Decrease in commission expense in the amount of $179,876, or 19.6%, as a result of the restructuring of the Company’s sales commissions programs that occurred during Fiscal 2018;

 

Page 18

•

Decrease in trade show expenses in the amount of $39,949, or 17.2%, and decrease in sales travel in the amount of $51,326, or 29.7%, due to timing of certain trade shows for our three product lines; and

 

•

Decrease in research and development expense in the amount of $198,277, or 60.6%, as a result of the shift of engineering resources towards support of existing product initiatives rather than research and development.

Other income (expense) – Other income (expense) consists of interest income, interest expense, foreign currency exchange gain (loss) and other income (expense). Interest income was $24,221 in Fiscal 2019 compared to $10,955 in Fiscal 2018. Fluctuations in interest income are impacted by the levels of our average cash and investment balances and changes in interest rates. Interest expense was $12,160 in Fiscal 2019 compared to $1,401 in Fiscal 2018. Foreign currency exchange loss was $89,162 for the year ended May 31, 2019 compared to foreign currency exchange gain of $72,216 for the year ended May 31, 2018. The foreign currency exchange gain and loss fluctuates with the strength of foreign currencies against the U.S. dollar during the respective periods.

Adjusted EBITDA – Adjusted EBITDA, which excludes the non-recurring reorganization, legal and other professional expense and the inventory adjustments, was $365,986 for Fiscal 2019 as compared to Adjusted EBITDA of $443,194 for Fiscal 2018.

Reconciliation of EBITDA to Adjusted EBITDA – Adjusted EBITDA for Fiscal 2019 and 2018 is calculated as follows:

 

		Fiscal Year Ended May 31, 2019				Fiscal Year Ended May 31, 2018
Net loss			$(1,210,990	)		$	210,639
Provision for income taxes			26,439				25,915
Depreciation and amortization			188,348				205,239
Interest expense			12,160				1,401
EBITDA			(984,043	)			443,194
Inventory adjustments			597,548				-
Non-recurring reorganization, legal and other professional expenses			752,481				-
Adjusted EBITDA (non-GAAP)		$	365,986			$	443,194

Provision for income taxes – The effective tax rate in Fiscal 2019 was (2.2)%. The effective tax rate in Fiscal 2018 was 11.0%. The effective tax rate on consolidated net income in Fiscal 2019 and Fiscal 2018 differs from the federal statutory tax rate primarily due to changes in the deferred tax valuation allowance and the impact of certain expenses not being deductible for income tax reporting purposes.

Net income (loss) – Net loss was $(1,210,990), or $(0.30) per fully diluted share, for the year ended May 31, 2019 compared to net income of $210,639, or $0.06 per fully diluted share, for the year ended May 31, 2018.

 

Page 19

Reconciliation of Adjusted Net Income and Non-GAAP EPS — Adjusted net income excludes the inventory adjustments and non-recurring reorganization, legal and other professional expenses. See reconciliation of net loss to adjusted net income and the resulting impact on earnings per fully diluted share as follows:

 

		Fiscal Year Ended May 31, 2019
Net loss		$	(1,210,990	)
Inventory adjustments			597,548
Non-recurring reorganization, legal and other professional expenses			752,481
Adjusted net income (non-GAAP)		$	139,039
Non-GAAP earnings per fully diluted share		$	0.03

Adjusted EBITDA and adjusted net income are not financial measures defined by Generally Accepted Accounting Principles (GAAP). Generally a non-GAAP financial measure is a numerical measure that either excludes or includes amounts that are not normally excluded or included in the most direct comparable measure calculated and presented in accounting with GAAP. Adjusted EBITDA and adjusted net income should not be construed as a substitute for net income (loss) as Adjusted EBITDA and adjusted net income are not defined by GAAP.

Fiscal Year Ended May 31, 2018 Compared to Fiscal Year Ended May 31, 2017

Consolidated Revenue – Consolidated revenue increased $1,490,420, or 12.0%, to $13,888,063 for the fiscal year ended May 31, 2018 (Fiscal 2018) from $12,397,643 in the fiscal year ended May 31, 2017 (Fiscal 2017).

Balancer segment revenue increased $1,944,356, or 27.5%, to $9,026,830 in Fiscal 2018 compared to $7,082,474 in Fiscal 2017. This increase was attributed to stronger sales in each of our target markets. Revenue by geographic markets for the Balancer segment for the years ended May 31, 2018 and 2017 were as follows:

 

		Year Ended May 31,
		2018				2017				Variance
North America		$	3,835,913			$	3,337,215			$	498,698				14.9	%
Asia			2,854,504				2,300,682				553,822				24.1	%
Europe			2,222,747				1,261,387				961,360				76.2	%
Other			113,666				183,190				(69,524	)			(38.0	%)
Total Balancer segment revenue		$	9,026,830			$	7,082,474			$	1,944,356				27.5	%

Measurement segment revenue decreased $453,936, or 8.5%, to $4,861,233 in Fiscal 2018 as compared to $5,315,169 in Fiscal 2017. During Fiscal 2017, the Company made the decision to no longer focus on and eventually phase out the SMS and Lasercheck product lines, which have historically been included in the Measurement segment. Revenue by product line for the Measurement segment for Fiscal 2018 compared to Fiscal 2017 were as follows:

 

		Year Ended May 31,
		2018				2017				Variance
Acuity		$	2,363,083			$	2,471,684			$	(108,601	)			(4.4	%)
Xact - product			1,196,071				1,414,586				(218,515	)			(15.4	%)
Xact - monitoring			1,176,323				1,022,209				154,114				15.1	%
Lasercheck			95,046				90,911				4,135				4.5	%
SMS			30,710				315,779				(285,069	)			(90.3	%)
Total Measurement segment revenue		$	4,861,233			$	5,315,169			$	(453,936	)			(8.5	%)

 

Page 20

Gross margin – In Fiscal 2018, gross margin increased to 43.7% compared to 39.4% in Fiscal 2017. The variances in gross margin between the periods presented were primarily influenced by focused efforts to reduce product costs and targeted efforts to increase prices where possible, as well as shifts in the product sales mix from lower to higher margin product line sales.

Operating expenses – Operating expenses increased $35,451, or 0.6%, to $5,909,942 in Fiscal 2018 to $5,874,491 in Fiscal 2017. The increase in operating expenses was in part due to the following:

 

•

Increases in research and development expenses;

 

•

Increases in professional expenses; and

 

•

Increases in other administrative expenses;

These increases were partially offset by:

 

•

Decreases in sales and commissions expense due to restructuring of some of the commissions programs; and

 

•

Decreases in sales related travel and entertainment expenses.

Other income (expense) – Other income (expense) consists of interest income, interest expense, foreign currency exchange gain (loss) and other income (expense). Interest income was $10,955 in Fiscal 2018 compared to $2,309 in Fiscal 2017. Fluctuations in interest income are impacted by the levels of our average cash and investment balances and changes in interest rates. Interest expense, which is primarily related to the capital lease of a piece of manufacturing equipment, was $1,401 in Fiscal 2018 compared to $2,982 in Fiscal 2017. Foreign currency exchange gain was $72,216 for the year ended May 31, 2018 compared to foreign currency exchange loss of $63,744 for the year ended May 31, 2017. The foreign currency exchange gain and loss fluctuates with the strength of foreign currencies against the U.S. dollar during the respective periods.

Provision for income taxes – The effective tax rate in Fiscal 2018 was 11.0%. The effective tax rate on consolidated net income in Fiscal 2018 differs from the federal statutory tax rate primarily due to changes in the deferred tax valuation allowance and the impact of certain expenses not being deductible for income tax reporting purposes. The effective tax rate in Fiscal 2017 was 2.7%. The effective tax rate on consolidated net loss in Fiscal 2017 differed from the federal statutory tax rate primarily due to changes in the deferred tax valuation allowance.

Net income (loss) – Net income was $210,639, or $0.06 per fully diluted share, for the year ended May 31, 2018 as compared to net loss of $1,073,364, or $(0.36) per fully diluted share, for the year ended May 31, 2017. Net income for Fiscal 2018 was the result of the combination of increased revenues in the Balancing segment and increases in the overall gross margin.

LIQUIDITY AND CAPITAL RESOURCES

While cash, cash equivalents and restricted cash decreased $644,098 from $2,111,533 as of May 31, 2018 to $1,467,435 as of May 31, 2019, the Company finished Fiscal 2019 by increasing its cash, cash equivalents and restricted cash balance by $241,670 from $1,225,765 at February 28, 2019.

The Company’s working capital decreased $978,056 to $7,269,917 as of May 31, 2019 compared to $8,247,973 as of May 31, 2018. The reduction in working capital in Fiscal 2019 was primarily impacted by the reduction in inventories and the use of cash for accounts payable.

Accounts payable decreased $527,894 from $1,024,256 at May 31, 2018 to $496,362 at May 31, 2019, which was driven by the reorganization efforts and the re-evaluation of the Company’s policies and procedures, including reductions in the timelines for accounts payable. The reduction in accounts payable is a reflection of a healthier balance sheet and bringing accounts payable current.

 

Page 21

Inventories decreased $691,844 to $5,019,044 as of May 31, 2019 compared to $5,710,888 as of May 31, 2018. This decrease was due, in part, to inventory adjustments of $(407,558) and $(189,990) recorded in the third and fourth quarters of Fiscal 2019, respectively. These inventory adjustments were the outcome of new management’s requirement to complete an in-depth review of the inventory, with standards of the review focused on more current turnover. This review was driven by the organizational changes to the business models for the Company’s three product lines as a result of the overall reorganization efforts. Additional reduction in inventory is a reflection of the Company’s efforts to streamline inventory purchases as they focus on increased turns and lean purchasing.

Other items that impacted working capital included the changes in accounts receivable, customer deposits and prepayments and other accrued liabilities. At May 31, 2019, accounts receivable decreased $50,792 to $1,996,240 compared to $2,047,032 as of May 31, 2018. The decrease in accounts receivable was due to the timing of collections. Customer deposits and prepayments, which fluctuate from period to period depending on the nature of the customer orders and their credit profile, decreased from $249,579 at May 31, 2018 to $188,236 at May 31, 2019. Other accrued liabilities increased $109,057 to $218,268 at May 31, 2019 compared to $109,211 at May 31, 2018. This increase was driven by the short-term financing of the purchased enterprise resource planning software, with the remainder of the increase due to amounts owing for services rendered in Fiscal 2019 for which invoices had not yet been received.

Cash used in operating activities was $716,613 in Fiscal 2019 as compared to cash used in operating activities of $1,002,849 and $148,288 in Fiscal 2018 and Fiscal 2017, respectively. The net loss and decrease in the accounts payable balance were the primary drivers of the overall operating cash usage for Fiscal 2019. The most significant component of the cash used in operating activities for Fiscal 2018 was the cash used for the investment in inventory, which occurred after the successful completion of the Rights Offering in December 2017. The amount of cash used in operating activities for Fiscal 2017 was primarily impacted by the amount of net loss and the increase in accounts receivable, offset by decreases in inventories and increases in accounts payable.

Net cash used in investing activities of $6,473, $6,967 and $98 for Fiscal 2019, 2018 and 2017, respectively, includes purchases of computers and other office-related equipment. Fiscal 2017 also includes the results of the purchase of one vehicle and the proceeds from the disposition of two vehicles.

Net cash provided by financing activities of $52,122 for the year ended May 31, 2019 was primarily due to the proceeds associated with the exercise of options for the issuance of common stock. On December 20, 2017, the Company completed its Subscription Rights Offering (the “Rights Offering”) in which 998,635 common shares were issued, resulting in proceeds to the Company, net of expenses, of $2,386,029 which is reflected in net cash provided by financing activities for the year ended May 31, 2018. Pursuant to the Rights Offering, the Company issued one right for each common share to shareholders of record as of November 27, 2017. Holders of the rights were entitled to purchase common shares by submitting three rights and $2.50 for each share to be purchased. The new shares were issued on December 27, 2017.

We believe that our existing cash balances combined with the cash we anticipate to generate from operating activities and financing available from other sources will be sufficient to meet our cash requirements for the foreseeable future. We do not have any significant commitments nor are we aware of any significant events or conditions that are likely to have a material impact on our liquidity or capital resources.

 

Page 22

QUARTERLY FINANCIAL DATA

In thousands, except per share information (unaudited)

 

2019 Quarter Ended		August 31				November 30				February 28				May 31
Consolidate revenue		$	3,440			$	3,503			$	3,082			$	3,785
Gross profit		$	1,340			$	1,363			$	1,012			$	1,274
Net loss		$	(212	)		$	(255	)		$	(475	)		$	(269	)
Net loss per share, basic		$	(0.05	)		$	(0.06	)		$	(0.12	)		$	(0.07	)
Net loss per share, diluted		$	(0.05	)		$	(0.06	)		$	(0.12	)		$	(0.07	)
2018 Quarter Ended		August 31				November 30				February 28				May 31
Consolidate revenue		$	3,084			$	3,771			$	3,239			$	3,794
Gross profit		$	1,400			$	1,726			$	1,322			$	1,617
Net income (loss)		$	(134	)		$	103			$	16			$	226
Net income (loss) per share, basic		$	(0.04	)		$	0.03			$	0.00			$	0.07
Net income (loss) per share, diluted		$	(0.04	)		$	0.03			$	0.00			$	0.07

Critical Accounting Policies

Revenue Recognition – The Company determines the amount of revenue it recognizes associated with the transfer of each product or service. For sales of products or delivery of monitoring services to all customers, each transaction is evaluated to determine whether there is approval and commitment from both the Company and the customer for the transaction; whether the rights of each party are specifically identified; whether the transaction has commercial substance; whether collectability from the customer is probable at the inception of the contract and whether the transaction amount is defined. If a transaction to sell products or provide monitoring services meets all of the above criteria, revenue is recognized for the sales of product at the time of shipment or for monitoring services at the completion of the month in which monitoring services are provided.

The Company incurs commissions associated with the sales of products, which are accrued and expensed at the time the product is shipped. These amounts are recorded within general, administration and sales expense. The Company also incurs costs related to shipping and handling of its products, the costs of which are expensed as incurred as a component of cost of sales. Shipping and handling fees billed to customers are recognized at the time of shipment as a component of net revenues.

Allowance for Doubtful Accounts – The Company maintains credit limits for all customers based upon several factors, including but not limited to financial condition and stability, payment history, published credit reports and use of credit references. 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. In the event there is doubt about whether a customer’s account is collectible, a reserve is provided. If these analyses lead management to the conclusion that the customer’s account is uncollectible, the balance will be directly charged to bad debt expense.

Inventories – Inventories are valued at the lower of cost or net realizable value with cost determined on the average cost basis. Costs included in inventories consist of materials, labor and manufacturing overhead, which are related to the purchase or production of inventories. Write-downs, when required, are made to reduce excess inventories to their net realizable values. Such estimates are based on assumptions regarding future demand and market conditions. If actual conditions become less favorable than the assumptions used, an additional inventory write-down may be required.

 

Page 23

Deferred Taxes – 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. 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 assets can be fully utilized.

Intangible Assets – Intangible and other long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate the carrying amount of the asset may not be recoverable. Recoverability is determined by comparing the forecasted future undiscounted 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.

Recent Accounting Pronouncements

Refer to Note 2 of the Notes to Consolidated Financial Statements for a discussion of recent accounting pronouncements.

 

ITEM 7A.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest Rate Risk

The Company did not have any derivative financial instruments as of May 31, 2019. 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 cash equivalents.

The Company’s interest income and expense are most sensitive to changes in the general level of U.S. interest rates. In this regard, changes in the U.S. interest rates affect the interest earned on the Company’s interest bearing cash equivalents and short term investments.    The Company has no credit line or other long-term obligations 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 on outstanding interest bearing obligations 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. Results of operations included foreign exchange gains/(losses) of $(89,162), $72,216 and $(63,744) for Fiscal 2019, 2018 and 2017, respectively. The foreign exchange gains or losses are primarily attributable to Company’s United Kingdom subsidiary, Schmitt Europe, Ltd.

 

Page 24

Item 8.

Financial Statements and Supplementary Data

SCHMITT INDUSTRIES, INC.

CONSOLIDATED BALANCE SHEETS

 

		May 31, 2019				May 31, 2018
ASSETS
Current assets
Cash and cash equivalents		$	1,411,732			$	2,053,181
Restricted cash			55,703				58,352
Accounts receivable, net			1,996,240				2,047,032
Inventories			5,019,044				5,710,888
Prepaid expenses			150,975				148,924
			8,633,694				10,018,377
Property and equipment, net			839,374				770,915
Other assets
Intangible assets, net			392,185				496,768
TOTAL ASSETS		$	9,865,253			$	11,286,060
LIABILITIES & STOCKHOLDERS’ EQUITY
Current liabilities
Accounts payable		$	496,362			$	1,024,256
Accrued commissions			200,116				194,797
Accrued payroll liabilities			239,476				188,568
Customer deposits and prepayments			188,236				249,579
Other accrued liabilities			218,268				109,211
Income taxes payable			491				3,993
Current portion of long-term liabilities			20,828				0
Total current liabilities			1,363,777				1,770,404
Long-term liabilities			28,543				0
Commitments and contingencies (Note 4)
Stockholders’ equity
Common stock, no par value, 20,000,000 shares authorized, 4,032,878 shares issued and outstanding at May 31, 2019 and 3,994,545 shares issued and outstanding at May 31, 2018			13,245,439				13,085,652
Accumulated other comprehensive loss			(527,827	)			(536,307	)
Accumulated deficit			(4,244,679	)			(3,033,689	)
Total stockholders’ equity			8,472,933				9,515,656
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY		$	9,865,253			$	11,286,060

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

 

Page 25

SCHMITT INDUSTRIES, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

 

		Year Ended May 31,
		2019				2018				2017
Net sales		$	13,810,161			$	13,888,063			$	12,397,643
Cost of sales			8,836,856				7,822,749				7,511,836
Gross profit			4,973,305				6,065,314				4,885,807
Operating expenses:
General, administration and sales			5,951,765				5,582,625				5,618,327
Research and development			129,040				327,317				256,164
Total operating expenses			6,080,805				5,909,942				5,874,491
Operating income (loss)			(1,107,500	)			155,372				(988,684	)
Other income (expense), net			(77,051	)			81,182				(56,671	)
Income (loss) before income taxes			(1,184,551	)			236,554				(1,045,355	)
Provision for income taxes			26,439				25,915				28,009
Net income (loss)		$	(1,210,990	)		$	210,639			$	(1,073,364	)
Net income (loss) per common share, basic		$	(0.30	)		$	0.06			$	(0.36	)
Weighted average number of common shares, basic			4,005,795				3,422,724				2,995,910
Net income (loss) per common share, diluted		$	(0.30	)		$	0.06			$	(0.36	)
Weighted average number of common shares, diluted			4,005,795				3,460,339				2,995,910
Comprehensive income (loss)
Net income (loss)		$	(1,210,990	)		$	210,639			$	(1,073,364	)
Foreign currency translation adjustment			8,480				(108,735	)			(33,054	)
Total comprehensive income (loss)		$	(1,202,510	)		$	101,904			$	(1,106,418	)

 

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

 

Page 26

SCHMITT INDUSTRIES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

		Year Ended May 31,
		2019				2018				2017
Cash flows relating to operating activities
Net income (loss)		$	(1,210,990	)		$	210,639			$	(1,073,364	)
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Depreciation and amortization			188,348				205,239				219,082
(Gain) loss on disposal of property and equipment			0				619				(7,223	)
Stock based compensation			94,621				50,336				79,765
Inventory adjustment			597,548				0				0
(Increase) decrease in:
Accounts receivable			24,538				311,433				(272,506	)
Inventories			96,610				(1,494,009	)			478,532
Prepaid expenses			(3,119	)			(32,463	)			14,267
Income taxes receivable			0				7,310				1,122
Increase (decrease) in:
Accounts payable			(523,410	)			(78,049	)			230,242
Accrued liabilities and customer deposits and prepayments			22,743				(187,897	)			181,795
Income taxes payable			(3,502	)			3,993				0
Net cash used in operating activities			(716,613	)			(1,002,849	)			(148,288	)
Cash flows relating to investing activities
Purchase of property and equipment			(6,473	)			(8,467	)			(52,633	)
Proceeds from sale of property and equipment			0				1,500				52,535
Net cash used in investing activities			(6,473	)			(6,967	)			(98	)
Cash flows relating to financing activities
Common stock issued through rights offering, net of expenses			0				2,386,029				0
Payments on long-term liabilities			(13,044	)			0				0
Common stock issued through exercise of options			65,166				0				0
Net cash provided by financing activities			52,122				2,386,029				0
Effect of foreign exchange translation on cash			26,866				(132,287	)			27,307
Increase (decrease) in cash and cash equivalents			(644,098	)			1,243,926				(121,079	)
Cash, cash equivalents and restricted cash, beginning of period			2,111,533				867,607				988,686
Cash, cash equivalents and restricted cash, end of period		$	1,467,435			$	2,111,533			$	867,607
Supplemental disclosure of non-cash investing and financing activities
Acquisition of property and equipment through financed payables		$	145,784			$	0			$	0
Supplemental disclosure of cash flow information
Cash paid during the year for income taxes		$	29,940			$	14,661			$	27,772
Cash paid during the year for interest		$	12,160			$	1,401			$	2,982

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

 

Page 27

SCHMITT INDUSTRIES, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

 

		Shares				Amount				Accumulated other comprehensive loss				Retained earnings				Total
Balance, May 31, 2016			2,995,910			$	10,569,522			$	(394,518	)		$	(2,170,964	)		$	8,004,040
Stock based compensation			0				79,765				0				0				79,765
Net loss			0				0				0				(1,073,364	)			(1,073,364	)
Other comprehensive loss			0				0				(33,054	)			0				(33,054	)
Balance, May 31, 2017			2,995,910				10,649,287				(427,572	)			(3,244,328	)			6,977,387
Stock based compensation			0				50,336				0				0				50,336
Common stock issued in connection with rights offering, net of expenses			998,635				2,386,029				0				0				2,386,029
Net income			0				0				0				210,639				210,639
Other comprehensive loss			0				0				(108,735	)			0				(108,735	)
Balance, May 31, 2018			3,994,545				13,085,652				(536,307	)			(3,033,689	)			9,515,656
Stock options exercised net of related tax benefit of $0			38,333				65,166				0				0				65,166
Stock-based compensation			0				94,621				0				0				94,621
Net loss			0				0				0				(1,210,990	)			(1,210,990	)
Other comprehensive income			0				0				8,480				0				8,480
Balance, May 31, 2019			4,032,878			$	13,245,439			$	(527,827	)		$	(4,244,679	)		$	8,472,933

 

 

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

 

Page 28

Schmitt Industries, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED MAY 31, 2019, 2018 AND 2017

NOTE 1:

THE COMPANY

Schmitt was founded in 1987 to provide reliable solutions for in-process dynamic balancing of precision grinding machines. The Schmitt Dynamic Balance System (“SBS”) was created to serve this precision grinding industry. The SBS systems can detect and dynamically correct vibration as low as 0.02 microns to ensure product quality, and the SBS acoustic emission sensors help grinding machine operators maximize the efficiency of the grinding process, thereby increasing part throughput and lowering operating costs.

The Company’s family of products was expanded in June 2000 with the acquisition of the Acuity^™ line of dimensional and distance measurement lasers. These laser products utilize both triangulation and time-of-flight measurement principles and are known for their speed and accuracy. The Acuity products are used in a wide variety of industrial, commercial and research applications.

In 2007, the Company purchased Xact^™ ultrasonic measurement technology for the remote monitoring of the fill levels of propane and other liquid tanks. Together with the Xact gauge reader, the satellite-focused Xact systems can detect and communicate fill levels, along with other information such as tank size and configuration, to customers through the “Internet of Things” ecosystem using our satellite provider and a secure website. Typical users of Xact systems are bulk propane, diesel, jet fuel suppliers and ammonia users and distributors.

The Company was originally incorporated under the laws of British Columbia, Canada, in 1984 and was reincorporated under the laws of the State of Oregon in 1995. Schmitt is an ISO 9001 certified company.

We serve our customers and organize our business through the following reportable segments:

 

•

Balancer (“Balancer”) Segment. The principle product for the Balancer segment is the SBS product line, which designs, manufactures and sells computer-controlled vibration detection, balancing and process control systems for the worldwide machine tool industry, particularly for grinding machines.

 

•

Measurement (“Measurement”) Segment. Through its wholly owned subsidiary, Schmitt Measurement Systems, Inc., the Measurement segment manufacturers and sells products in two core product lines, Acuity and Xact:

 

–

Acuity sells products, solutions and services that includes laser and white light sensor distance, measurement and dimensional sizing products;

 

–

Xact includes satellite focused remote tank monitoring products and related monitoring services for markets in the Internet of Things (“IoT”) environment. The Xact products measure the fill levels of tanks holding propane, diesel and other tank-based liquids and the related monitoring services, which includes transmission of fill data from the tanks via satellite to a secure web site for display.

NOTE 2:

SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

These consolidated financial statements include those of the Company and its wholly owned subsidiaries: Schmitt Measurement Systems, Inc., Schmitt Europe, Ltd. and Schmitt Industries (Canada) Limited. All significant intercompany accounts and transactions have been eliminated in the preparation of the consolidated financial statements.

 

Page 29

Schmitt Industries, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED MAY 31, 2019, 2018 AND 2017

 

Reclassification

Certain amounts in the prior period consolidated balance sheet have been reclassified to conform to the presentation of the current period. These reclassifications had no effect on the statement of operations, comprehensive income (loss) or cash flows.

Revenue Recognition

On June 1, 2018, the Company adopted Accounting Standards Update (ASU) No. 2014-09, “Revenue from Contracts with Customers (Topic 606)” using the modified retrospective approach. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements or related disclosures.

The Company determines the amount of revenue it recognizes associated with the transfer of each product or service. For sales of products or delivery of monitoring services to all customers, each transaction is evaluated to determine whether there is approval and commitment from both the Company and the customer for the transaction; whether the rights of each party are specifically identified; whether the transaction has commercial substance; whether collectability from the customer is probable at the inception of the contract and whether the transaction amount is defined. If a transaction to sell products or provide monitoring services meets all of the above criteria, revenue is recognized for the sales of product at the time of shipment or for monitoring services at the completion of the month in which monitoring services are provided.

The Company incurs commissions associated with the sales of products, which are accrued and expensed at the time the product is shipped. These amounts are recorded within general, administration and sales expense. The Company also incurs costs related to shipping and handling of its products, the costs of which are expensed as incurred as a component of cost of sales. Shipping and handling fees billed to customers, which are recognized at the time of shipment as a component of net revenues, were $202,615, $207,501 and $155,077 for the years ended May 31, 2019, 2018 and 2017, respectively.

Cash, Cash Equivalents and Restricted Cash

The Company generally invests its excess cash in money market funds. The Company’s investment policy also allows for cash to be invested in investment grade highly liquid securities, and the Company considers securities that are highly liquid, readily convertible into cash and have original maturities of less than three months when purchased to be cash equivalents. The Company’s cash consists of demand deposits in large financial institutions. At times, balances may exceed federally insured limits.

Restricted cash consists of an amount received from a customer in December 2017 as part of an on-going contract. The services being provided under this contract are on-going and expected to be completed in the first half of Fiscal 2020. Once the services under this contract are complete and acceptance has been provided by the customer, the restrictions on this advance cash payment will be released.

The following table provides a reconciliation of cash and cash equivalents and restricted cash as reported within the Consolidated Balance Sheets as of May 31, 2019 and 2018 to the sum of the same such amounts as shown in the Consolidated Statement of Cash Flows for the respective years then ended:

 

		2019				2018
Cash and cash equivalents		$	1,411,732			$	2,053,181
Restricted cash			55,703				58,352
Total cash, cash equivalents, and restricted cash shown in the Consolidated Statement of Cash Flows		$	1,467,435			$	2,111,533

 

Page 30

Schmitt Industries, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED MAY 31, 2019, 2018 AND 2017

 

Accounts Receivable

The Company maintains credit limits for all customers based upon several factors, including but not limited to financial condition and stability, payment history, published credit reports and use of credit references. Management performs various analyses to evaluate accounts receivable balances to ensure recorded amounts reflect estimated net realizable value. This review includes using accounts receivable agings, other operating trends and relevant business conditions, including general economic factors, as they relate to each of the Company’s domestic and international customers. In the event there is doubt about whether a customer account is collectible, a reserve is provided. If these analyses lead management to the conclusion that a customer account is uncollectible, the balance will be directly charged to bad debt expense. The allowance for doubtful accounts was $43,388 and $95,207 as of May 31, 2019 and 2018, respectively.

Inventories

Inventories are valued at the lower of cost or net realizable value with cost determined on the average cost basis. Costs included in inventories consist of materials, labor and manufacturing overhead, which are related to the purchase or production of inventories. Write-downs, when required, are made to reduce excess inventories to their net realizable values. Such estimates are based on assumptions regarding future demand and market conditions. If actual conditions become less favorable than the assumptions used, an additional inventory write-down may be required. As of May 31 inventories consisted of:

 

		2019				2018
Raw materials		$	2,222,245			$	2,796,691
Work-in-process			1,020,683				1,009,424
Finished goods			1,776,116				1,904,773
		$	5,019,044			$	5,710,888

Property and Equipment

Property and equipment are stated at cost, less depreciation and amortization. Depreciation is computed using the straight-line method over estimated useful lives of three to seven years for furniture, fixtures, and equipment; three years for vehicles; and twenty-five years for buildings and improvements. Expenditures for maintenance and repairs are charged to expense as incurred. As of May 31 property and equipment consisted of:

 

		2019				2018
Land		$	299,000			$	299,000
Buildings and improvements			1,814,524				1,814,524
Furniture, fixtures and equipment			1,403,755				1,252,598
Vehicles			44,704				44,704
			3,561,983				3,410,826
Less accumulated depreciation			(2,722,609	)			(2,639,911	)
		$	839,374			$	770,915

Intangible Assets

Amortizable intangible assets, which include purchased technology and patents, are amortized over their estimated useful lives ranging from five to seventeen years. As of May 31, 2019 and 2018, amortizable intangible

 

Page 31

Schmitt Industries, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED MAY 31, 2019, 2018 AND 2017

 

assets were $2,200,883, and accumulated amortization was $1,808,698 and $1,704,115, respectively. Amortization expense for each of the following years ending May 31 is expected to be as follows:

 

Year ending May 31,
2020		$	104,583
2021			104,583
2022			104,583
2023			78,436
2024			0
Thereafter			0
		$	392,185

Intangible and other long-lived assets are reviewed for impairment whenever events or changes in circumstances 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 May 31, 2019, no impairment existed.

Customer deposits and prepayments

Customer deposits and prepayments consists of amounts received from customers as prepayments for orders that have been received and have been produced but have not yet shipped, credit balances for items returned by customers for which refunds have not yet been provided and deposits made by customers in advance of production. For the years ended May 31, 2019 and 2018, the balance also includes an amount received from a customer in December 2017 as part of an on-going contract. The services being provided under this contract are expected to be completed in the first half of Fiscal 2020, at which time the amount will be considered to be earned.

Other accrued liabilities

Other accrued liabilities include an accrual for warranty reserve and sales return reserve, amount financed on a short-term arrangement for the purchase of the Company’s new enterprise resource planning software and amounts owing under various professional fee contracts for which invoices have not yet been received.

 

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Schmitt Industries, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED MAY 31, 2019, 2018 AND 2017

 

Long-term liabilities and current portion of long-term liabilities

Long-term liabilities consist of a financing arrangement executed for the purchase of certain property and equipment over a term of 36 months. Future minimum commitments under this agreement for the each of the years ending May 31 are as follows:

 

		Years ending May 31,
2020		$	24,105
2021			24,105
2022			6,009
2023			0
2024			0
Total future minimum payments			54,219
Less: amount representing interest			(4,848	)
Present value of minimum payments of long-term liabilities		$	49,371
Current portion of long-term liabilities			20,828
Long-term liabilities			28,543
		$	49,371

Foreign Currency

Financial statements for the Company’s subsidiaries outside the United States are translated into U.S. dollars at year-end exchange rates for assets and liabilities and weighted average exchange rates for income and expenses. The resulting translation adjustments are included as a separate component of stockholders’ equity titled “Accumulated Other Comprehensive Loss.” Transaction gains and losses are included in net income (loss).

Advertising

Advertising costs included in general, administration and sales, are expensed when the advertising first takes place. Advertising expense was $28,187, $71,280 and $30,500 for the years ended May 31, 2019, 2018 and 2017, respectively.

Research and Development Costs

Research and development costs, predominately internal labor costs and costs of materials, are charged to expense when incurred.

Warranty Reserve

Warranty costs are estimated and charged to operations to cover a defined warranty period. The estimated warranty cost is based on the history of warranty claims for each particular product type. For new product types without a warranty history, preliminary estimates are based on historical information for similar product types. The warranty reserve accruals, included in other accrued liabilities, are reviewed periodically and updated based on warranty trends.

 

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Schmitt Industries, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED MAY 31, 2019, 2018 AND 2017

 

Stock-Based Compensation

Stock-based compensation includes expense charges for all stock-based awards to employees and directors granted under the Company’s stock option plan. The Company requires the measurement and recognition of compensation for all stock-based awards made to employees and directors including stock options based on estimated fair values.

Stock-based compensation recognized during the period is based on the value of the portion of the stock-based award that will vest during the period, adjusted for expected forfeitures. Compensation cost for all stock-based awards is recognized using the straight-line method.

Income Taxes

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. 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. The Company currently maintains a full valuation allowance against net deferred tax assets.

Earnings (Loss) Per Share

Basic earnings (loss) per share is computed using the weighted average number of common shares outstanding. Diluted earnings (loss) per share is computed using the weighted average number of common shares outstanding, adjusted for dilutive incremental shares attributed to outstanding options to purchase common stock. Common stock equivalents for stock options are computed using the treasury stock method. In periods in which a net loss is incurred, no common stock equivalents are included since they are antidilutive and as such all stock options outstanding are excluded from the computation of diluted net loss in those periods. 43,751, 0 and 0 potentially dilutive common shares from outstanding stock options have been excluded from diluted earnings (loss) per share for the years ended May 31, 2019, 2018 and 2017, respectively.

Concentration of Credit Risk

Financial instruments that potentially expose the Company to concentration of credit risk are trade accounts receivable. Credit terms generally require an invoice to be paid within 30 to 60 days or include a discount of up to 1.5% if the invoice is paid within ten days, with the net amount payable in 30 days. Terms are set for each account depending on the customer’s credit standing with the Company.

Financial Instruments

The carrying value of all other financial instruments potentially subject to valuation risk (principally consisting of cash and cash equivalents, accounts receivable, accounts payable and the current portion of long-term liability) approximates fair value because of their short-term maturities.

Shipping and Handling Charges

The Company incurs costs related to shipping and handling of its manufactured products. These costs are expensed as incurred as a component of cost of sales. Shipping and handling charges related to the receipt of raw materials are also incurred, which are recorded as a cost of the related inventory.

 

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Schmitt Industries, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED MAY 31, 2019, 2018 AND 2017

 

Use of Estimates

The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

Recent Accounting Pronouncements

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), in order to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet for most leases previously classified as operating leases. Subsequent amendments have been issued by the FASB to clarify the codification and to correct unintended application of the new guidance. The ASU is required to be applied using a retrospective approach with two disclosure methods permissible. The full retrospective approach requires that the guidance be applied to each lease that existed at the beginning of the earliest comparative period presented. The modified retrospective approach requires that the guidance be applied to each lease that existed as of the beginning of the reporting period in which the entity first applied the standard. The Company will adopt the new standard on June 1, 2019 using the modified retrospective approach. The Company is substantially complete with its lease contract and business process review to support recognition and disclosures under this new guidance. Based on these efforts, the Company expects the adoption will not result in a material increase in the assets and liabilities on its Consolidated Balance Sheets and is not expected to have a material effect on the results of operations or cash flows.

NOTE 3:

INCOME TAXES

On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”). The Tax Act made broad and complex changes to the U.S. tax code by reducing the U.S. federal corporate tax rate from 34 percent to 21 percent, requiring companies to pay a one-time transition tax on certain unrepatriated earnings of foreign subsidiaries, generally eliminating U.S. federal income taxes on dividends from foreign subsidiaries, creating a new limitation on deductible interest expense and changing rules related to uses and limitations of net operating loss carryforwards created in tax years beginning after December 31, 2017.

The SEC staff subsequently issued Staff Accounting Bulletin 118 (“SAB 118”), which provides a one-year measurement for companies to complete the accounting for the effects of the Tax Act. In accordance with SAB 118, where accounting is complete, a company must reflect the income tax effects of those aspects, but to the extent that a company’s accounting is incomplete but a reasonable estimate may be made, a provisional estimate should be recorded in the financial statements. Where a company is unable to determine a provisional estimate, SAB 118 permits application of the tax laws that were in effect immediately before the enactment.

Due to the reduction of the corporate tax rate as part of the Tax Act, the Company recorded during the third quarter of Fiscal 2018 a provisional decrease to deferred tax assets of $780,195 and corresponding decrease to the valuation allowance. The change in tax rate did not impact tax expense due to the valuation allowance recorded against the net deferred tax asset.

The Act also provided for a tax on the deemed repatriation of previously untaxed accumulated earnings and profits of foreign subsidiaries. The Company was not subject to this tax due to an accumulated loss in the Company’s foreign subsidiary.

 

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Schmitt Industries, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED MAY 31, 2019, 2018 AND 2017

 

The provision for income taxes is as follows:

 

		Year ended May 31,
		2019				2018				2017
Current		$	26,439			$	25,915			$	28,009
Deferred			329,035				(808,548	)			356,169
Change in valuation allowance			(329,035	)			808,548				(356,169	)
Total provision for income taxes		$	26,439			$	25,915			$	28,009

Deferred tax assets are comprised of the following components:

 

		2019				2018
Basis difference of assets		$	182,654			$	202,763
Inventory related items			169,585				189,893
Other reserves and liabilities			74,694				87,519
Net operating loss carryforward			1,507,141				1,136,358
General business and other credit carryforward			489,327				456,343
Other deferred items, net			7,692				29,182
Gross deferred tax assets			2,431,093				2,102,058
Deferred tax asset valuation allowance			(2,431,093	)			(2,102,058	)
Net deferred tax asset		$	0			$	0

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. The Company has recorded a substantial deferred tax asset related to temporary differences between book and tax bases of assets and liabilities. During the year ended May 31, 2019, the Company increased its valuation allowance $329,035 as a result of the increase in the Company’s deferred tax assets most of which was due to the increase in net operating losses carryforwards generated by the Fiscal 2019 results. During the year ended May 31, 2018, the Company decreased its valuation allowance $808,548 as a result of the decrease in the Company’s deferred tax assets due to the impact of the reduction of the corporate rate as part of the Tax Act and income generated in Fiscal 2018. During year ended May 31, 2017, the Company increased its valuation allowance $356,169 as a result of the increase in the Company’s deferred tax assets. The Company has provided a full valuation allowance against all of its deferred tax assets as the recent losses have been given more weight than projected future income when determining the need for a valuation allowance.

The Company has federal net operating loss carryforwards of approximately $5.6 million which begin to expire in 2030 along with the federal general business and other credit carryforwards. The Company has state net operating loss carryforwards of approximately $6.1 million which begin to expire in 2024.

 

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Schmitt Industries, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED MAY 31, 2019, 2018 AND 2017

 

The provision for income taxes differs from the amount of income taxes determined by applying the U.S. statutory federal tax rate to pre-tax loss due to the following:

 

		Year ended May 31,
		2019				2018				2017
Statutory federal tax rate			21.0	%			28.6	%			34.0	%
State taxes, net of federal benefit			5.3				2.6				4.4
Change in deferred tax valuation allowance			(25.7	)			(350.8	)			(34.1	)
Impact of Tax Act			0.0				329.8				0.0
Stock-based compensation			(1.8	)			6.6				(2.2	)
R&E tax credits			1.8				1.6				(1.6	)
Effect of foreign income tax rates			(3.4	)			1.3				0.3
Deferred tax true-up			4.1				(12.6	)			(1.8	)
State minimum taxes			(1.0	)			5.1				(1.1	)
Permanent and other differences			(2.5	)			(1.2	)			(0.6	)
Effective tax rate			(2.2	)%			11.0	%			(2.7	)%

Each year the Company files income tax returns in the various federal, state and local income taxing jurisdictions in which it operates. These tax returns are subject to examination and possible challenge by the taxing authorities. Positions challenged by the taxing authorities may be settled or appealed by the Company. As a result, there is an uncertainty in income taxes recognized in the Company’s financial statements in accordance with ASC Topic 740. The Company applies this guidance by defining criteria that an individual income tax position must meet for any part of the benefit of that position to be recognized in an enterprise’s financial statements and provides guidance on measurement, derecognition, classification, accounting for interest and penalties, accounting in interim periods, disclosure, and transition. The liability for unrecognized tax benefits was $0 as of May 31, 2019 and 2018.

Interest and penalties associated with uncertain tax positions are recognized as components of the “Provision for income taxes.” The liability for payment of interest and penalties was $0 as of May 31, 2019 and 2018.

Several tax years are subject to examination by major tax jurisdictions. In the United States, federal tax years for the years ended May 31, 2016 and after are subject to examination. In the United Kingdom, tax year for the year ended May 31, 2018 is subject to examination.

NOTE 4:

COMMITMENTS AND CONTINGENCIES

The Company entered into a 5-year lease of manufacturing equipment in May 2014. The lease is classified as a capital lease and the asset, valued at $38,890, is included in the furniture, fixtures and equipment amount in Note 2 – Property and Equipment as of May 31, 2019 and 2018. The lease ended in May 2019 and the ownership for the asset was transferred to the Company in June 2019 when the Company executed the buy-out option for the lease.

The Company leases certain vehicles and equipment to support operations under non-cancelable operating leases and other contractual obligations. Total lease expense under operating leases for the years ended May 31, 2019, 2018 and 2017 amounted to $49,349, $47,829 and $47,695, respectively. The Company also has certain office leases that are currently month-to-month.

 

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Schmitt Industries, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED MAY 31, 2019, 2018 AND 2017

 

The future minimum commitments under operating leases for each of the years ending May 31 are as follows:

 

Year ending May 31,
2020		$	43,039
2021			19,080
2022			19,080
2023			15,900
2024			0
Thereafter			0

In a transaction related to the acquisition of Schmitt Measurement Systems, Inc., formerly TMA Technologies, Inc. (“TMA”), the Company established a royalty pool and vested in each shareholder and debt holder of the acquired company an interest in the royalty pool equal to the amount invested or loaned including interest payable through March 1995. The royalty pool is funded at 5% of net sales (defined as gross sales less returns, allowances and sales commissions) of the Company’s surface measurement products and future derivative products developed by Schmitt Industries, Inc., which utilize these technologies. As part of the royalty pool agreement, each former shareholder and debt holder released TMA from any claims with regard to the acquisition except their rights to future royalties. Royalty expense applicable to the years ended May 31, 2019, 2018 and 2017 amounted to $1,126, $1,527 and $15,407, respectively.

NOTE 5:

SEGMENT INFORMATION

The Company has two reportable business segments, Balancer and Measurement. Balancer focuses on dynamic balancing and process control systems for the machine tool industry and Measurement focuses on laser-based test and measurement systems and ultrasonic measurement products. The Company operates in three principal geographic markets: North America, Europe and Asia.

 

		Year Ended May 31,
		2019								2018								2017
		Balancer				Measurement				Balancer				Measurement				Balancer				Measurement
Net revenues		$	9,080,719			$	4,729,442			$	9,026,830			$	4,861,233			$	7,082,474			$	5,315,169
Operating income (loss)		$	(1,508,058	)		$	400,558			$	(50,686	)		$	206,058			$	(931,770	)		$	(56,914	)
Depreciation expense		$	47,768			$	35,997			$	63,390			$	37,266			$	70,018			$	37,534
Amortization expense		$	0			$	104,583			$	0			$	104,583			$	0			$	111,530
Capital expenditures		$	152,257			$	0			$	4,353			$	4,114			$	46,495			$	6,138

Inventory adjustments of $(384,295) for the Balancer segment and $(213,253) for the Measurement segment are included in operating income (loss) for Fiscal 2019.

 

Page 38