SCHMITT INDUSTRIES INC - Quarter Report: 2019 August (Form 10-Q)

SCHMITT INDUSTRIES INC - Quarter Report: 2019 August (Form 10-Q)

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10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

For the quarterly period ended: August 31, 2019

☐	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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☐

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):

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 ☒

The number of shares of each class of common stock outstanding as of September 30, 2019


Common stock, no par value		4,086,406

SCHMITT INDUSTRIES, INC.

INDEX TO FORM 10-Q


		Page
Part I - FINANCIAL INFORMATION

Item 1.	Consolidated Financial Statements (unaudited):

	Consolidated Balance Sheets		4

	Consolidated Statements of Operations and Comprehensive Income (Loss)		5

	Consolidated Statements of Cash Flows		6

	Consolidated Statement of Changes in Stockholders’ Equity		7

	Notes to Consolidated Interim Financial Statements		8

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		15

Item 3.	Quantitative and Qualitative Disclosures About Market Risk		18

Item 4.	Controls and Procedures		18

Part II - OTHER INFORMATION

Item 6.	Exhibits		19

Signatures

Certifications

Page 2

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

SCHMITT INDUSTRIES, INC.

CONSOLIDATED BALANCE SHEETS

(UNAUDITED)


	August 31, 2019			May 31, 2019
ASSETS
Current assets
Cash and cash equivalents	$	1,592,847		$	1,411,732
Restricted cash		54,895			55,703
Accounts receivable, net		2,004,159			1,996,240
Inventories		5,019,109			5,019,044
Prepaid expenses		155,405			150,975

Total current assets		8,826,415			8,633,694

Property and equipment, net		817,478			839,374

Other assets
Intangible assets, net		366,039			392,185
Operating lease right-of-use assets		102,767			0

TOTAL ASSETS	$	10,112,699		$	9,865,253

LIABILITIES & STOCKHOLDERS’ EQUITY
Current liabilities
Accounts payable	$	505,496		$	496,362
Accrued commissions		173,491			200,116
Accrued payroll liabilities		171,768			239,476
Customer deposits and prepayments		197,982			188,236
Other accrued liabilities		127,635			218,268
Income taxes payable		14,134			491
Current portion of long-term liabilities		21,258			20,828
Current portion of operating lease liabilities		32,721			0

Total current liabilities		1,244,485			1,363,777

Long-term liabilities		23,065			28,543
Long-term operating lease liabilities		70,046			0

Total liabilities		1,337,596			1,392,320

Stockholders’ equity
Common stock, no par value, 20,000,000 shares authorized, 4,032,878 shares issued and outstanding at August 31, 2019 and May 31, 2019		13,317,453			13,245,439
Accumulated other comprehensive loss		(467,479	)		(527,827	)
Accumulated deficit		(4,074,871	)		(4,244,679	)
Total stockholders’ equity		8,775,103			8,472,933

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	10,112,699		$	9,865,253

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

Page 3

SCHMITT INDUSTRIES, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

(UNAUDITED)

FOR THE THREE MONTHS ENDED AUGUST 31, 2019 AND 2018


	Three Months Ended August 31,
	2019			2018
Net revenue	$	3,341,885		$	3,440,453
Cost of revenue		1,781,547			2,100,655

Gross profit		1,560,338			1,339,798

Operating expenses:
General, administration and sales		1,279,007			1,405,363
Research and development		12,167			48,237

Total operating expenses		1,291,174			1,453,600

Operating income (loss)		269,164			(113,802	)
Other income (expense), net		(83,388	)		(91,651	)

Income (loss) before income taxes		185,776			(205,453	)
Provision for income taxes		15,968			6,366

Net income (loss)	$	169,808		$	(211,819	)

Net income (loss) per common share:
Basic	$	0.04		$	(0.05	)

Weighted average number of common shares, basic		4,032,878			3,994,545

Diluted	$	0.04		$	(0.05	)

Weighted average number of common shares, diluted		4,059,279			3,994,545

Comprehensive income (loss)
Net income (loss)	$	169,808		$	(211,819	)
Foreign currency translation adjustment		60,348			79,644

Total comprehensive income (loss)	$	230,156		$	(132,175	)

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

Page 4

SCHMITT INDUSTRIES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

FOR THE THREE MONTHS ENDED AUGUST 31, 2019 AND 2018


	Three Months Ended August 31,
	2019			2018
Cash flows relating to operating activities
Net income (loss)	$	169,808		$	(211,819	)
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Depreciation and amortization		47,974			47,217
Gain on disposal of property and equipment		(12,000	)		0
Stock based compensation		72,014			5,597
(Increase) decrease in:
Accounts receivable		(22,782	)		164,312
Inventories		(11,863	)		(434,075	)
Prepaid expenses		(5,106	)		28,447
Increase (decrease) in:
Accounts payable		11,575			(14,346	)
Accrued liabilities and customer deposits		(171,702	)		11,722
Income taxes payable		13,643			479

Net cash provided by (used in) operating activities		91,561			(402,466	)

Cash flows relating to investing activities
Purchases of property and equipment		0			(5,250	)
Proceeds from the sale of property and equipment		12,000			0

Net cash provided by (used in) investing activities		12,000			(5,250	)

Cash flows relating to financing activities
Payments on long-term liabilities		(5,048	)		0

Net cash used in investing activities		(5,048	)		0

Effect of foreign exchange translation on cash		81,794			97,009

Increase (decrease) in cash, cash equivalents and restricted cash		180,307			(310,707	)
Cash, cash equivalents and restricted cash, beginning of period		1,467,435			2,111,533

Cash, cash equivalents and restricted cash, end of period	$	1,647,742		$	1,800,826

Supplemental disclosure of cash flow information
Cash paid during the period for income taxes	$	2,325		$	5,887

Cash paid during the period for interest	$	2,073		$	263

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

Page 5

SCHMITT INDUSTRIES, INC.

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY (UNAUDITED)

FOR THE THREE MONTHS ENDED AUGUST 31, 2019 AND 2018


	Shares		Amount		Accumulated other comprehensive loss			Accumulated deficit			Total
Balance, May 31, 2019		4,032,878	$	13,245,439	$	(527,827	)	$	(4,244,679	)	$	8,472,933
Stock-based compensation		0		72,014		0			0			72,014
Net income		0		0		0			169,808			169,808
Other comprehensive income		0		0		60,348			0			60,348

Balance, August 31, 2019		4,032,878	$	13,317,453	$	(467,479	)	$	(4,074,871	)	$	8,775,103

Balance, May 31, 2018		3,994,545	$	13,085,652	$	(536,307	)	$	(3,033,689	)	$	9,515,656
Stock-based compensation		0		5,597		0			0			5,597
Net loss		0		0		0			(211,819	)		(211,819	)
Other comprehensive income		0		0		79,644			0			79,644

Balance, August 31, 2018		3,994,545	$	13,091,249	$	(456,663	)	$	(3,245,508	)	$	9,389,078

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

Page 6

SCHMITT INDUSTRIES, INC.

NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS

NOTE 1:

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

In the opinion of management, the accompanying unaudited Consolidated Financial Statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission and contain all adjustments, consisting only of normal recurring adjustments, necessary to present fairly its financial position as of August 31, 2019 and its results of operations and its cash flows for the periods presented. The consolidated balance sheet at May 31, 2019 has been derived from the Annual Report on Form 10-K for the fiscal year ended May 31, 2019. The accompanying unaudited financial statements and related notes should be read in conjunction with the audited financial statements included in our Annual Report on Form 10-K for the fiscal year ended May 31, 2019. Operating results for the interim periods presented are not necessarily indicative of the results that may be experienced for the fiscal year ending May 31, 2020.

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.

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

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 $37,228 and $49,240 for the three months ended August 31, 2019 and August 31, 2018, 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 expected to be completed in the second 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 August 31, 2019 and May 31, 2019 to the sum of the same such amounts as shown in the Consolidated Statement of Cash Flows for the three months ended August 31, 2019:

Page 7


	August 31, 2019		May 31, 2019
Cash and cash equivalents	$	1,592,847	$	1,411,732
Restricted cash		54,895		55,703

Total cash, cash equivalents, and restricted cash shown in the Consolidated Statement of Cash Flows	$	1,647,742	$	1,467,435

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 $48,960 and $43,388 as of August 31, 2019 and May 31, 2019, 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 August 31, 2019 and May 31, 2019 inventories consisted of:


	August 31, 2019		May 31, 2019
Raw materials	$	2,259,759	$	2,222,245
Work-in-process		1,193,955		1,020,683
Finished goods		1,565,395		1,776,116

	$	5,019,109	$	5,019,044

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 August 31, 2019 and May 31, 2019, property and equipment consisted of:


	August 31, 2019			May 31, 2019
Land	$	299,000		$	299,000
Buildings and improvements		1,814,524			1,814,524
Furniture, fixtures and equipment		1,398,613			1,403,755
Vehicles		0			44,704

		3,512,137			3,561,983
Less accumulated depreciation		(2,694,659	)		(2,722,609	)

	$	817,478		$	839,374

Leases

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. In July 2018, the FASB issued ASU No. 2018-11, Leases: Targeted Improvements, which provides an option to apply the guidance prospectively, instead of retrospectively, and allows for other classification provisions.

Page 8

On June 1, 2019, the Company adopted the new standard on June 1, 2019 using the modified retrospective approach and electing the option to not apply the guidance to comparative periods, which continue to be presented under the accounting methods in effect for those periods.

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	$	18,079
2021		24,105
2022		6,009

Total future minimum payments		48,193
Less: amount representing interest		(3,870	)

Present value of minimum payments of long-term liabilities	$	44,323

Current portion of long-term liabilities		21,258
Long-term liabilities		23,065

	$	44,323

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.

NOTE 2:

STOCK OPTIONS AND 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. Stock-based compensation recognized during the period is based on the portion of the grant date fair value 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. The Company uses the Black-Scholes option pricing model as its method of valuation for stock-based awards. The Black-Scholes option pricing model requires the input of highly subjective assumptions, and other reasonable assumptions could provide differing results. These variables include, but are not limited to:

•

Risk-Free Interest Rate. The Company bases the risk-free interest rate on the implied yield currently available on U.S. Treasury issues with an equivalent remaining term approximately equal to the expected life of the award.

•

Expected Life. The expected life of awards granted represents the period of time that they are expected to be outstanding. The Company determines the expected life based on historical experience with similar awards, giving consideration to the contractual terms, vesting schedules and pre-vesting and post-vesting forfeitures.

•

Expected Volatility. The Company estimates the volatility of its common stock at the date of grant based on the historical volatility of its common stock. The volatility factor the Company uses is based on its historical stock prices over the most recent period commensurate with the estimated expected life of the award. These historical periods may exclude portions of time when unusual transactions occurred.

•

Expected Dividend Yield. The Company does not anticipate paying any cash dividends in the foreseeable future. Consequently, the Company uses an expected dividend yield of 0.

Page 9

•

Expected Forfeitures. The Company uses relevant historical data to estimate pre-vesting option forfeitures. The Company records stock-based compensation only for those awards that are expected to vest.

There were no options granted during the three months ended August 31, 2019.

At August 31, 2019, the Company had a total of 236,666 outstanding stock options (236,666 vested and exercisable and 0 non-vested) with a weighted average exercise price of $2.35. As all options outstanding as of August 31, 2019 were fully vested, the Company estimates that $0 will be recorded as additional stock-based compensation expense during the year ending May 31, 2020.


Outstanding Options					Exercisable Options
Number of Shares	Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (yrs)		Number of Shares		Weighted Average Exercise Price
124,166	$	1.70		6.4		124,166	$	1.70
15,000		2.53		2.8		15,000		2.53
62,500		2.85		3.4		62,500		2.85
35,000		3.65		0.7		35,000		3.65

236,666	$	2.35		4.6		236,666	$	2.35

Options granted, exercised, canceled and expired under the Company’s stock-based compensation plans during the three months ended August 31, 2019 are summarized as follows:


	Three Months Ended August 31, 2019
	Number of Shares			Weighted Average Exercise Price
Options outstanding - beginning of period		254,166		$	2.41
Options granted		0			0.00
Options exercised		0			0.00
Options forfeited/canceled		(17,500	)		3.29

Options outstanding - end of period		236,666		$	2.35

Restricted Stock Units

Service-based and market-based restricted stock units are granted to key employees and members of the Company’s Board of Directors. Service-based restricted stock units generally fully vest on the first anniversary date of the award. Market-based restricted stock units are contingent on continued service and vest based on 15-day average closing price of the Company’s common stock equal or exceeding certain targets established by the Compensation Committee of the Board of Directors.

During the three months ended August 31, 2019, 30,528 service-based restricted stock units were granted and were immediately vested on the date of the grants.

Restricted stock unit activity under the Company’s stock-based compensation plans during the three months ended August 31, 2019 is summarized as follows:

Page 10


	Number of Units			Weighted Average Price at Time of Grant			Aggregate Intrinsic Value
Non-vested restricted stock units - May 31, 2019		98,000		$	2.94
Restricted stock units granted		30,528			2.14
Restricted stock units vested		(30,528	)		(2.14	)

Non-vested restricted stock units - August 31, 2019		98,000		$	2.94		$	105,840

During the three months ending August 31, 2019, total restricted stock unit compensation expense recognized was $72,014 and has been recorded as general, administration and sales expense in the Consolidated Statements of Operations and Comprehensive Loss.

NOTE 3:

WEIGHTED AVERAGE SHARES AND RECONCILIATION

The following table is a reconciliation of the numerators and denominators of the basic and diluted per share computations for income (loss) from continuing operations for the three months ended August 31:


	Three Months Ended August 31,
	2019		2018
Weighted average shares (basic)		4,032,878		3,994,545
Effect of dilutive stock options		26,401		0

Weighted average shares (diluted)		4,059,279		3,994,545

NOTE 4:

INCOME TAXES

The Company accounts for income taxes using the asset and liability method. This approach requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax basis of assets and liabilities. Deferred tax assets are reduced by a valuation allowance if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax assets 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 to allow for the deferred tax asset to be fully utilized. The Company currently maintains a full valuation allowance against net deferred tax assets.

Each year the Company files income tax returns in the various national, 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, de-recognition, classification, accounting for interest and penalties, accounting in interim periods, disclosure, and transition.

Other long-term liabilities related to tax contingencies were $0 as of both August 31, 2019 and May 31, 2019. 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 August 31, 2019 and May 31, 2019.

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

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Effective Tax Rate

The effective tax rate for the three months ended August 31, 2019 was 8.6%. The effective tax rate on consolidated net income for the three months ended August 31, 2019 and 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. Management believes the effective tax rate for Fiscal 2020 will be approximately 9.2% due to the items noted above.

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.

Segment Information


	Three Months Ended August 31,
	2019				2018
	Balancer		Measurement		Balancer			Measurement
Net revenue	$	2,247,107	$	1,094,778	$	2,194,332		$	1,246,121

Operating income (loss)	$	74,158	$	195,006	$	(262,501	)	$	148,699

Depreciation expense	$	12,894	$	8,934	$	12,072		$	8,999

Amortization expense	$	0	$	26,146	$	0		$	26,146

Capital expenditures	$	0	$	0	$	5,250		$	0

Geographic Information


	Three Months Ended August 31,
	2019		2018
North America	$	2,325,220	$	2,200,201
Europe		428,551		373,463
Asia		548,151		824,776
Other markets		39,963		42,013

Total net revenue	$	3,341,885	$	3,440,453


	Three Months Ended August 31,
	2019				2018
	United States		Europe		United States			Europe
Operating income (loss)	$	162,895	$	106,269	$	(131,190	)	$	17,388

Depreciation expense	$	21,572	$	256	$	21,071		$	0

Amortization expense	$	26,146	$	0	$	26,146		$	0

Capital expenditures	$	0	$	0	$	5,250		$	0

(1) “Europe” is defined in the above chart to include results from the European subsidiary, Schmitt Europe Ltd.

(2) “United States” is defined to include remainder of the results not included in the results from the European subsidiary

Page 12

Segment and Geographic Assets


	August 31, 2019		May 31, 2019
Segment assets to total assets
Balancer	$	6,003,195	$	5,805,796
Measurement		2,461,762		2,592,022
Corporate assets		1,647,742		1,467,435

Total assets	$	10,112,699	$	9,865,253

Geographic assets to long-lived assets
United States	$	815,656	$	837,228
Europe		1,822		2,146

Total long-lived assets	$	817,478	$	839,374

Geographic assets to total assets
United States	$	9,133,435	$	8,578,770
Europe		979,264		1,286,483

Total assets	$	10,112,699	$	9,865,253

(1) “Europe” is defined in the above chart to include assets held by the European subsidiary, Schmitt Europe Ltd.

(2) “United States” is defined to include the remainder of the assets not held by the European subsidiary.

NOTE 6:

LEASES

The Company leases certain of its facilities and equipment under operating leases, which are recorded as right-of-use assets and lease liabilities. The Company’s leases generally are month-to-month leases or have terms of 2 to 5 years. The Company currently does not have leases that include options to purchase or provisions that would automatically transfer ownership of the leased property to the Company.

Operating lease expense is recognized on a straight-line basis over the lease term. The Company had no variable lease costs for the three months ended August 31, 2019. For the three months ended August 31, 2019, operating lease expense for the operating lease right-of-use assets was $9,984 and lease expense associated with short-term leases was $10,116.

The Company determines whether a contract is or contains a lease at the inception of the contract. A contract will be deemed to be or contain a lease if the contract conveys the right to control and direct the use of identified property, plant, or equipment for a period of time in exchange for consideration. The Company generally must also have the right to obtain substantially all of the economic benefits from the use of the property or equipment.

Operating lease assets and liabilities are recognized at the lease commencement date based on the present value of lease payments over the lease term. To determine the present value of lease payments, the Company uses the rate implicit in the agreement. If the rate implicit in the agreement is not determinable, the Company’s incremental borrowing rate is used. At August 31, 2019, the weighted average remaining lease term for the operating leases was 3.0 years and the weighted average discount rate was 8.2%.

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The following table summarizes the maturity of the operating lease liabilities on an undiscounted cash flow basis and provides a reconciliation to the operating lease liabilities recognized on our consolidated balance sheet as of August 31, 2019:


	Years ending May 31,
2020 (excludes the three months ended August 31, 2019)	$	29,953
2021		35,591
2022		19,080
2023		19,080
2024		15,900
Thereafter		0

Total future minimum payments		119,604
Less: amount representing interest		16,837

Present value of minimum payments of operating lease liabilities	$	102,767


Current portion of operating lease liabilities		32,721
Long term operating lease liabilities		70,046

	$	102,767

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

This Quarterly Report filed with the SEC on Form 10-Q (the “Report”), including “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Item 2, contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 regarding future events and the future results of Schmitt Industries, Inc. and its consolidated subsidiaries (the “Company”) that are based on management’s current expectations, estimates, projections and assumptions about the Company’s business. 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 due to numerous factors, including, but not limited to, those discussed in the “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this Report as well as those discussed from time to time in the Company’s other Securities and Exchange Commission filings and reports. In addition, such statements could be affected by general industry and market conditions. Such forward-looking statements speak only as of the date of this Report or, in the case of any document incorporated by reference, the date of that document, and we do not undertake any obligation to update any forward-looking statement to reflect events or circumstances after the date of this Report. If we update or correct one or more forward-looking statements, investors and others should not conclude that we will make additional updates or corrections with respect to other forward-looking statements.

RESULTS OF OPERATIONS

Schmitt Industries, Inc. (“Schmitt” or the “Company”) designs, manufactures and sells high precision test and measurement products, solutions and services. We provide the products and services through our SBS^®, Acuity^® and Xact^® Product lines, which are reported in two business segments, Balancer and Measurement:

•

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^® product line includes ultrasonic-based remote tank monitoring products and related monitoring revenues 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.

The accompanying unaudited financial information should be read in conjunction with our Annual Report on Form 10-K for the fiscal year ended May 31, 2019.

Highlights of the Quarter Ended August 31, 2019

•

Consolidated revenue decreased $98,568, or 2.9%, to $3,341,885 for the three months ended August 31, 2019 from $3,440,453 for three months ended August 31, 2018, attributed to a decrease in Measurement segment revenue.

•

Balancer segment revenue increased $52,775, or 2.4%, to $2,247,107 for the three months ended August 31, 2019 as compared to $2,194,332 for the three months ended August 31, 2018, attributed to growth in the North American market.

•

Measurement segment revenue decreased $151,343, or 12.1%, to $1,094,778 for the three months ended August 31, 2019 as compared to $1,246,121 for the three months ended August 31, 2018, attributed to a decrease in Xact product revenue. Xact’s services in the “Internet of Things” environment continued to grow with monitoring revenue increasing 16.3% to $367,841 for the three months ended August 31, 2019 as compared to $316,173 for the three months ended August 31, 2018.

•

Operating expenses decreased $162,426, or 11.2%, to $1,291,174 for the three months ended August 31, 2019 from $1,453,600 for the three months ended August 31, 2018.

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•

Net income (loss) was $169,808, or $0.04 per fully diluted share, for the three months ended August 31, 2019 as compared to net income (loss) of $(211,819), or $(0.05) per fully diluted share, for the three months ended August 31, 2018.

Critical Accounting Policies

There were no material changes in our critical accounting policies as disclosed in our Annual Report on Form 10-K for the year ended May 31, 2019, other than the adoption of Accounting Standards Update (ASU) No. 2016-02, “Leases (Topic 842)” which the Company adopted on June 1, 2019. See Note 1 “Leases” for further discussion and disclosures related to the adoption of ASU No. 2016-02.

Discussion of Operating Results


	Three Months Ended
	August 31, 2019					August 31, 2018
Balancer revenue	$	2,247,107		67.2	%	$	2,194,332		63.8	%
Measurement revenue		1,094,778		32.8	%		1,246,121		36.2	%

Total net revenue		3,341,885		100.0	%		3,440,453		100.0	%
Cost of revenue		1,781,547		53.3	%		2,100,655		61.1	%

Gross profit		1,560,338		46.7	%		1,339,798		38.9	%

Operating expenses:
General, administration and sales		1,279,007		38.3	%		1,405,363		40.8	%
Research and development		12,167		0.4	%		48,237		1.4	%

Total operating expenses		1,291,174		38.6	%		1,453,600		42.3	%

Operating income (loss)		269,164		8.1	%		(113,802	)	-3.3	%
Other income (expense), net		(83,388	)	-2.5	%		(91,651	)	-2.7	%

Income (loss) before income taxes		185,776		5.6	%		(205,453	)	-6.0	%
Provision for income taxes		15,968		0.5	%		6,366		0.2	%

Net income (loss)	$	169,808		5.1	%	$	(211,819	)	-6.2	%

Consolidated Revenue – Consolidated revenue decreased $98,568, or 2.9%, to $3,341,885 for the three months ended August 31, 2019 from $3,440,453 for the three months ended August 31, 2018. Growth in the Balancer segment was offset by declines in the Measurement segment.

Balancer segment – The Balancer segment focuses its sales efforts on end-user, rebuilders and original equipment manufacturers of grinding machines within the worldwide machine tool industry, with our primary target geographic markets being North America, Asia and Europe.

Balancer segment revenue increased $52,775, or 2.4%, to $2,247,107 for the three months ended August 31, 2019 compared to $2,194,332 for the three months ended August 31, 2018. Growth in the North American market was offset by declines in the Asian markets.

Revenue by geographic markets for the Balancer segment for the three months ended August 31, 2019 and 2018 were as follows:

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	Three Months Ended August 31,
	2019		2018
North America	$	1,320,138	$	990,881
Asia		518,211		789,586
Europe		372,275		371,852
Other		36,483		42,013

Total Balancer segment revenue	$	2,247,107	$	2,194,332

Measurement segment – The Measurement segment includes two main product lines: the Acuity product line, which includes laser-based distance measurement and dimensional sizing laser sensors; and the Xact product line, which includes ultrasonic-based remote tank monitoring products and related monitoring revenues for markets in the IoT environment.

Measurement segment revenue decreased $151,343, or 12.1%, to $1,094,778 for the three months ended August 31, 2019 as compared to $1,246,121 in August 31, 2018, primarily attributed to a 58.5% decrease in Xact product revenue. Xact customers intermittently purchase Xact products based on their respective business needs and capital expenditure budgets, causing irregular product revenue over quarterly periods.

Revenue by product line for the Measurement segment for three months ended August 31, 2019 and 2018 were as follows:


	Three Months Ended August 31,
	2019		2018		Variance
Acuity revenue	$	445,893	$	420,372	$	25,521		6.1	%
Xact - product revenue		211,044		508,826		(297,782	)	(58.5	%)
Xact - monitoring revenue		367,841		316,173		51,668		16.3	%

Total Measurement segment revenue - current product lines	$	1,024,778	$	1,245,371		(220,593	)	(17.7	%)
Total Measurement segment revenue - discontinued product lines		70,000		750		69,250

Total Measurement segment revenue	$	1,094,778	$	1,246,121	$	(151,343	)	(12.1	%)

Gross Margin – Gross margin for the three months ended August 31, 2019 increased to 46.7% as compared to 38.9% for the three months ended August 31, 2018. The variances in gross margin between the periods presented were primarily influenced by improvements in procurement, favorable product mix shifts and the $70,000 sale of discontinued product line items with no offsetting cost of sales.

Operating Expenses – Operating expenses decreased $162,426, or 11.2%, to $1,291,174 for the three months ended August 31, 2019 from $1,453,600 for the three months ended August 31, 2018. The decrease in operating expenses for the three months ended August 31, 2019 is primarily due to decreases in professional, legal and accounting expenses, sales commissions and research and development expenses. These results also include non-recurring reorganization and legal expenses of $41,984 incurred during the three-month period ended August 31, 2019, that are not expected to be incurred in future periods.

Other Income (Expense) – Other income (expense) consists of interest income, interest expense, foreign currency exchange gain (loss) and other income (expense). Interest income was $4,285 for the three months ended August 31, 2019 as compared to $7,470 for the three months ended August 31, 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 $2,073 for the three months ended August 31, 2019 as compared to $263 for the three months ended August 31, 2018.

Foreign currency exchange loss was $85,611 for the three months ended August 31, 2019 as compared to foreign currency exchange loss of $98,872 for the three months ended August 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.

Income Taxes – The effective tax rate for the three months ended August 31, 2019 was 8.6%. The effective tax rate for the three months ended August 31, 2018 was (3.1)%. The effective tax rate on consolidated net income for the three months ended August 31, 2019 and 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.

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Net Income (Loss) – Net income (loss) was $169,808, or $0.04 per fully diluted share, for the three months ended August 31, 2019 compared to net income (loss) of $(211,819), or $(0.05) per fully diluted share, for the three months ended August 31, 2018.

LIQUIDITY AND CAPITAL RESOURCES

The Company’s working capital increased $312,013 to $7,581,930 as of August 31, 2019 as compared to $7,269,917 as of May 31, 2019.

Cash, cash equivalents and restricted cash increased $180,307 to $1,647,742 as of August 31, 2019 from $1,467,435 as of May 31, 2019. Cash generated by operating activities totaled $91,561 for the three months ended August 31, 2019 as compared to cash used in operating activities of $402,466 for the three months ended August 31, 2018. Net income of $169,808, along with decreases in accrued liabilities and customer deposits, primarily impacted the total cash generated from operating activities for the three months ended August 31, 2019.

At August 31, 2019, the Company had accounts receivable of $2,004,159 as compared to $1,996,240 at May 31, 2019, an increase of $7,919. Inventories increased $65 to $5,019,109 as of August 31, 2019 as compared to $5,019,044 at May 31, 2019. At August 31, 2019, total current liabilities decreased $119,282 to $1,244,485, as compared to $1,363,777 at May 31, 2019. The decrease in current liabilities is primarily due to decreases in accrued payroll liabilities and other accrued liabilities.

We believe that our existing cash and cash equivalents combined with the cash we anticipate generating from operating activities 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.

Risk Factors

Please refer to the risk factors disclosed in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended May 31, 2019 for a listing of 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.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

There have been no material changes from the information previously reported under Item 7A of our Annual Report on Form 10-K for the fiscal year ended May 31, 2019.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

As of August 31, 2019, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and the Company’s Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures, as such term is defined in Rule 13a-15(e) of the Securities Exchange Act of 1934 (the “Exchange Act”). Based on the evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of the period covered by this Report, the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed in the Company’s Exchange Act reports is (1) recorded, processed, summarized and reported in a timely manner, and (2) accumulated and communicated to the Company’s management, including the Company’s Chief Executive Officer and the Company’s Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives, and management necessarily is required to use its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

Page 18

Changes in Internal Control Over Financial Reporting

There has been no change in the Company’s internal control over financial reporting that occurred during the Company’s fiscal quarter ended August 31, 2019 that has materially affected, or is reasonably likely to materially affect, such internal control over financial reporting.

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PART II - OTHER INFORMATION

Item 6. Exhibits


Exhibit		Description

3.1		Second Restated Articles of Incorporation of Schmitt Industries, Inc. [Form 10-K for the fiscal year ended May 31, 1998, Exhibit 3(i)].

3.2		Second Restated Bylaws of Schmitt Industries, Inc. [Form 10-K for the fiscal year ended May 31, 1998, Exhibit 3(ii)].

4.1		See Exhibits 3.1 and 3.2 for provisions of the Articles of Incorporation and Bylaws defining the rights of security holders.

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

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

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

101.INS		XBRL Instance Document.

101.SCH		XBRL Taxonomy Extension Schema Document.

101.CAL		XBRL Taxonomy Extension Calculation Linkbase Document.

101.LAB		XBRL Taxonomy Extension Label Linkbase Document.

101.PRE		XBRL Taxonomy Extension Presentation Linkbase Document.

101.DEF		XBRL Taxonomy Extension Definition Linkbase Document.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

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Large accelerated filer

Accelerated filer

Non-accelerated filer

Smaller reporting company

Emerging growth company