SCHMITT INDUSTRIES INC - Quarter Report: 2021 February (Form 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 February 28, 2021

☐ 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: 001-38964

  SCHMITT INDUSTRIES, INC.

(503) 227-7908  

(Registrant's Telephone Number, Including Area Code)

Securities registered under Section 12(b) of the Act:

Securities registered under Section 12(g) of the Act:

None

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):

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 March 31, 2021

  SCHMITT INDUSTRIES, INC.

  INDEX TO FORM 10-Q

 Part I - FINANCIAL INFORMATION

 Item 1: Financial Statements

     SCHMITT INDUSTRIES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS 

(UNAUDITED)  

See accompanying notes to condensed consolidated financial statements

   SCHMITT INDUSTRIES, INC.

 CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

(UNAUDITED)

FOR THE THREE AND NINE MONTHS ENDED FEBRUARY 28, 2021 AND FEBRUARY 29, 2020

See accompanying notes to condensed consolidated financial statements

     SCHMITT INDUSTRIES, INC.

 CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) 

FOR THE NINE MONTHS ENDED FEBRUARY 28, 2021 AND FEBRUARY 29, 2020

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

     SCHMITT INDUSTRIES, INC.

Condensed Consolidated Statement of Changes in Stockholders' Equity

(UNAUDITED)

For the Nine Months Ended February 28, 2021 and February 29, 2020

See accompanying notes to condensed consolidated financial statements

     SCHMITT INDUSTRIES, INC.

NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 1:

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

In the opinion of management of Schmitt Industries, Inc. (the "Company", "Schmitt", "we" or "our"), the accompanying unaudited interim condensed 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 February 28, 2021 and its results of operations and its cash flows for the periods presented. The condensed consolidated balance sheet at May 31, 2020 has been derived from the Annual Report on Form 10-K for the fiscal year ended May 31, 2020. The accompanying unaudited condensed consolidated financial statements and related notes should be read in conjunction with the audited consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ended May 31, 2020. 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, 2021.

Principles of Consolidation

These condensed consolidated financial statements include those of the Company and its wholly owned subsidiaries: Ample Hills Acquisition, LLC and Schmitt Measurement Systems, Inc.. All significant intercompany accounts and transactions have been eliminated in the preparation of the consolidated condensed financial statements.

Business Combination

On July 9, 2020, Ample Hills Acquisition LLC ("Buyer"), a New York limited liability company and wholly owned subsidiary of the Company, entered into an Asset Purchase Agreement (the "Agreement"), dated as of June 29, 2020, with Ample Hills Holdings, Inc., a Delaware corporation, Ample Hills Creamery, Inc., a New York corporation, and their subsidiaries (collectively, "Ample Hills"). The transactions contemplated by the Agreement (the "Transactions") closed on July 9, 2020, the day after a sale order approving the Transactions was entered by the Bankruptcy Court (defined below). The Ample Hills entities were debtors-in-possession under title 11 of the United States Code, 11 U.S.C. § 101 et seq. pursuant to voluntary petitions for relief filed under chapter 11 of the Bankruptcy Code on March 15, 2020 in the United States Bankruptcy Court for the Eastern District of New York (the "Bankruptcy Court"). The Transactions were conducted through a Bankruptcy Court-supervised process, subject to Bankruptcy Court-approved bidding procedures, approval of the Transactions by the Bankruptcy Court, and the satisfaction of certain closing conditions.

The Agreement provided that, upon the terms and subject to the conditions set forth therein, Ample Hills sold, transferred and assigned to Buyer, or one or more of its affiliates, the Acquired Assets (as defined in the Agreement) and Buyer, or one or more of its affiliates, assumed the Assumed Liabilities (as defined in the Agreement) for a purchase price of $1.0 million. The Asset Acquisition includes the following assets, among other things, Ample Hills' equipment, inventory, and all intellectual property, including the names and marks of "AMPLE HILLS" and "AMPLE HILLS CREAMERY" and all derivatives thereof. Pursuant to the Agreement, Buyer also paid an additional approximately $0.7 million to certain landlords of Ample Hills in exchange for the right to assume leases with such landlords. See Note 10 for acquisition accounting based on the estimated fair value of assets acquired and liabilities assumed.

The Company's strategy includes utilizing its capital for value opportunities. Accordingly, the primary purpose of the Ample Hills acquisition was to capitalize on this strategy by purchasing a business with a good brand name, which in light of the price we paid in bankruptcy, could have a significant upside. The Transactions were funded by the Company with cash on hand and has been accounted for in accordance with ASC 805 - Business Combinations. ASC-805 requires, among other things, an assignment of the acquisition consideration transferred to the sellers for the tangible and intangible assets acquired and liabilities assumed, using the bottom up approach, to estimate their value at acquisition date. Any excess of the fair value of the purchase consideration over these identified net assets is to be recorded as goodwill. Conversely, any excess of the fair value of the net assets acquired over the purchase consideration is recorded as a bargain purchase gain. Our estimates of fair value are based upon assumptions believed to be reasonable, yet are inherently uncertain and, as a result, may differ from actual performance. During the measurement period, not to exceed one year from the date of acquisition, we may record adjustments to the estimated fair values of the assets acquired and liabilities assumed with a corresponding adjustment to goodwill or bargain purchase gain, as appropriate, in the period in which such revised estimates are identified.

Revenue Recognition

The Company generates revenues from the following sources: (i) retail restaurant sales, (ii) factory sales, (iii) measurement product sales, and (iv) remote tank monitoring services.

Retail Restaurant Sales, net

The Company's generates revenues from retail restaurant sales to its end-user customers at the time of sale, net of discounts, coupons, employee meals, and complimentary meals and gift cards. Sales tax is collected from customers and remitted to governmental authorities and is presented on a net basis within revenue in our consolidated and combined statements of operations.

Factory Sales, net

The Company generates revenues from sales from its Brooklyn, New York factory, including wholesale, e-commerce, direct-to-consumer, and manufacturing production sales for third parties. These revenues are recognized when control of the goods is transferred to the customer, in accordance with the terms of the applicable agreement. Payment terms are typically 30 days from the date control over the product is transferred to the customer.

Measurement Product Sales

The Company determines the amount of revenue it recognizes associated with the transfer of each product. For sales of products 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 meets all of the above criteria, revenue is recognized for the sales of product at the time of shipment.

The Company incurs commissions associated with the sales of certain products, which are accrued and expensed at the time the product is shipped. These amounts are recorded within general, administrative 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 $5,380 and $21,066 for the nine months ended February 28, 2021 and February 29, 2020, respectively.

Remote Tank Monitoring Services

The Company's Xact product line includes satellite focused remote tank monitoring products and related monitoring services for markets in the Internet of Things ("IoT") environment.

The Company determines the amount of revenue it recognizes associated with the transfer of such services. For 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 provide monitoring services meets all of the above criteria, revenue is recognized at the completion of the month in which monitoring services are provided.

Customer deposits and prepayments

The Company defers revenue recognition of revenues in instances where consideration is received from customers in advance of the Company completing its obligations in exchange for such consideration. As of February 28, 2021 and May 31, 2020, significant contract balances were as follows:

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 held in escrow related to the sale of the balancer business segment and Ample Hills Retail Operations respectively, as described in the notes to the condensed consolidated financial statements. Once certain events are complete, the restrictions on this 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 February 28, 2021 and May 31, 2020 to the sum of the same such amounts as shown in the Consolidated Statement of Cash Flows for the three months ended February 28, 2021:

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 aging reports, 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 $94,007 and $103,029 as of February 28, 2021 and May 31, 2020, 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 February 28, 2021 and May 31, 2020 inventories consisted of:

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; the lesser of the useful life or the remaining lease term for leasehold improvements; and twenty-five years for buildings. Expenditures for maintenance and repairs are charged to expense as incurred. As of February 28, 2021 and May 31, 2020, property and equipment consisted of:

Assets Held for Sale

The Company owns a two story 35,050 sq. foot building in industrial zoning that has been listed for sale. Assets held for sale are stated at the lower of cost less depreciation or expected net realizable value. Depreciation is computed using the straight-line method over estimated useful lives of 25 years for building improvements. Expenditures for maintenance and repairs are charged to expense as incurred. As of February 28, 2021 and May 31, 2020, assets held for sale consisted of:

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.

On June 1, 2019, the Company adopted the new standard 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.

On November 22, 2019, the Company entered into a commercial lease agreement in which it is the lessor. This agreement contains a 10-year term with a renewal option to extend.

On July 9, 2020, the Company executed a business combination through its acquisition of Ample Hills. In connection with this business combination, the Company became the lessee for multiple leased stores and a manufacturing facility. Upon acquisition, the Company renegotiated the terms of these leases. Upon acquisition, the lease liabilities were measured based upon the present value of future lease payments.

On October 1, 2020 the Company entered into a triple-net lease agreement (the "Humboldt Lease") with Humboldt Street Collective, LLC ("Humboldt"), whereby Humboldt will lease the Company's building located at 2765-2755 NW Nicolai Street, Portland, OR 97210 for a monthly fee of $3,185 for a term of 62 months.

Bargain Purchase Gain

In connection with the acquisition of Ample Hills during the quarter ended August 31, 2020 the Company recorded a bargain purchase gain of $1,271,615 that was recorded as a component of net income. As a result of additional information obtained during the measurement period about the facts and circumstances that existed as of the acquisition date, the Company recorded measurement period adjustments during the nine months ended February 28, 2021 in the amount of $2,277, which resulted in a reduction in the bargain purchase gain for the nine months ended February 28, 2021 to $1,187,235. The adjustment related to additional cure payments made during the quarter and obsolete inventory acquired as part of the acquisition. The bargain purchase gain amount represents the excess of the estimated fair value of the net assets and intangibles, described below, acquired over the estimated fair value of the consideration transferred to the sellers and their landlords. In accordance with ASC 805 - Business Combinations, we have estimated the fair value of the net assets acquired as of the acquisition date.

Intangible Assets

In connection with the acquisition of Ample Hills during the quarter ended August 31, 2020 the Company acquired multiple intangible assets including the names and marks, proprietary recipes, and company website related to the Ample Hills business. The Company has determined that the aggregate fair value of such intangibles upon the closing of the acquisition was $1,117,470. The Company estimated the fair value of these assets utilizing the relief-from-royalty method, for the Proprietary Recipes and Tradename, which requires assumptions related to projected sales from its annual long-range plan; assumed royalty rates that could be payable if the Company did not own the trademarks; and a discount rate. For the website, the Reproduction Cost Approach was used which estimates the cost to replace the website. These assets have been determined to be indefinite-lived and are not amortized, but instead are reviewed for impairment at least annually or more frequently if indicators of impairment exist. As of February 28, 2021 and May 31, 2020, net amortizable intangible assets were $1,315,174 and $287,602, respectively.

Use of Estimates

The preparation of the condensed 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 condensed consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

NOTE 2:

RECENT ACCOUNTING PRONOUNCEMENTS

In December 2019, the FASB issued ASU No. 2019-12: Simplifying the Accounting for Income Taxes (Topic 740). The objective of the standard is to improve areas of GAAP by removing certain exceptions permitted by ASC 740 and clarifying existing guidance to facilitate consistent application. The standard will become effective for the Company beginning on June 1, 2021. The Company is currently evaluating the new standard to determine the potential impact on its financial condition, results of operations, cash flows, and financial statement disclosures.

In November 2019, the FASB issued ASU 2019-08, Compensation - Stock Compensation (Topic 718) and Revenue from Contracts with Customers (Topic 606): Codification Improvements - Share-based Consideration Payable to a Customer.  The objective of the standard is to clarify that an entity must measure and classify share-based payment awards granted to a customer by applying the guidance in Topic 718. ASU 2019-08 is effective for fiscal years beginning after December 15, 2019, including interim reporting periods within those fiscal years. The Company adopted ASU 2019-08 effective June 1, 2020 and the adoption did not have an impact on the Company's financial condition or its results of operations.

NOTE 3:

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.

Stock Options

At February 28, 2021, the Company had outstanding stock options to purchase 22,500 shares of Common Stock all of which are vested and exercisable with a weighted average exercise price of $1.70. As all options outstanding as of February 28, 2021 were fully vested; the Company estimates that $0 will be recorded as additional stock-based compensation expense related to stock options during the year ending May 31, 2021.

No stock options were granted, exercised, canceled or expired under the Company's stock-based compensation plans during the nine months ended February 28, 2021.

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 the 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. No market-based restricted stock units were granted in the nine months ended February 28, 2021.

During the nine months ended February 28, 2021, two tranches of the market-based restricted stock units granted in Fiscal 2020 and Fiscal 2019 vested.

During the nine months ended February 28, 2021, 62,881 service-based restricted stock units were granted.

Restricted stock unit activity under the Company's stock-based compensation plans during the nine months ended February 28, 2021 is summarized as follows:

During the nine months ended February 28, 2021, total restricted stock unit compensation expense recognized was $163,493 and has been recorded as general, administration and sales expense in the Consolidated Statements of Operations and Comprehensive Loss. Stock compensation expense related to non-vested restricted stock units with a time vesting condition was $50,048.

NOTE 4:

WEIGHTED AVERAGE SHARES AND RECONCILIATION

Basic net income (loss) per share is computed using the weighted average number of shares of Common Stock outstanding. Diluted net income (loss) per share is computed using the weighted average number of shares of Common Stock outstanding, adjusted for dilutive incremental shares attributed to outstanding options to purchase Common Stock and restricted stock units vested but not issued. 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.

For the three and nine months ended February 28, 2021, potentially dilutive securities consisted of options to purchase 22,500 shares of Common Stock at $1.70 per share. Of these potentially dilutive securities, all of the shares of Common Stock underlying the options are excluded from the computation of diluted earnings per share because the Company incurred a net loss from continuing operations. In periods when a net loss is incurred in continuing operations, no Common Stock equivalents are included in the calculation of diluted net income or loss from discontinued operations or overall Company net income or loss since they are antidilutive. As such, all stock options outstanding are excluded from the computation of diluted net income in those periods.

Basic weighted average shares for the three and nine months ended February 28, 2021 and February 29, 2020 were as follows:

On December 3, 2019, the Company announced that its Board of Directors authorized a share repurchase plan to buy up to $2 million of its Common Stock. The plan was authorized through December 16, 2020.

On December 17, 2019, the Company acquired 365,490 shares of Common Stock at $3.25 per share from Walter Brown Pistor.

On January 31, 2020, the Company entered into an agreement with former director David Hudson to initiate a cashless exercise for 64,166 of his options, whereby the Company purchased 36,000 shares for $3.25 per share from Mr. Hudson to fund the exercise of his remaining 28,166 shares.

Through February 28, 2021, the Company repurchased 418,051 shares, at an average price of $3.23 per share, under its previously announced $2 million share repurchase plan, which was done in accordance with a 10b5-1 plan.

In addition, on July 20, 2020, the Company concluded its previously announced cash tender offer to purchase up to $2.5 million of the Company's common stock at a price per share not less than $3.00 and not greater than $3.25 per share. The Company accepted for purchase 72,101 shares at a price of $3.25 per share.

NOTE 5:

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 consolidated 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 income tax contingencies were $0 as of February 28, 2021 and $0 as of May 31, 2020. 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 February 28, 2021 and May 31, 2020.

Several tax years are subject to examination by major tax jurisdictions. In the United States, federal tax years ended May 31, 2017 and after are subject to examination.

Effective Tax Rate

The effective tax rate was (0.1%)  and (15.4%) for the three and nine months ended February 28, 2021 respectively. The effective tax rate on consolidated net income for the three and nine months ended February 28, 2021 and February 29, 2020 differs from the federal statutory tax rate primarily due to changes in the deferred tax valuation allowance, tax benefit recorded related to the bargain purchase gain and the impact of certain expenses not being deductible for income tax reporting purposes.

NOTE 6:

LEASES

On November 22, 2019, the Company entered in a commercial lease agreement as part of the sale of the Schmitt Dynamic Balance Systems business line to Tosei Engineering Corp. and Tosei America Inc., which has been accounted for pursuant to (ASU) No. 2016-02, "Leases (Topic 842)". The Company elected the practical expedient to not separate lease and non-lease components and will present property revenues as Other Income, combined based upon the lease being determined to be the predominant component.

The lessor commercial agreement contains a 10-year term with a renewal option to extend, which will be considered a new, separate contract and will be recognized at the time the option is exercised on a straight-line basis over the renewal period, and early termination options based on established terms specific to the individual agreement. Minimum future lease payments receivable are as follows: 

On October 1, 2020, the Company entered into a triple-net lease agreement with Humboldt Street Collective ("Humboldt Lease"), whereby Humboldt will lease the Company's building located at 2755 NW Nicolai Street, Portland, OR 97210 for a monthly fee of $3,185 for a term of 62 months. This lease arrangement been accounted for pursuant to (ASU) No. 2016-02, "Leases (Topic 842)". The Company presents property revenues as other income. Minimum future lease payments receivable are as follows:

In connection with the July 9, 2020 acquisition of Ample Hills, the Company has multiple real estate leases for its leased stores as well as a manufacturing facility that are recorded as operating leases under various non-cancellable operating leases.

To determine whether a contract is or contains a lease, the Company determines at contract inception whether it contains the right to control the use of an identified asset for a period of time in exchange for consideration to the counterparty in the transaction. If the Company determines that the contract provides the right to obtain substantially all of the economic benefit from the use of the leased asset, as well as the right for the Company to direct the asset's use, the Company recognizes a right-of-use asset and liability upon contract inception. The initial carrying value of the operating lease liability is determined by calculating the present value of future lease payments under the contract. The Company considers the future lease payments under the original terms of the contract and also includes explicitly enumerated renewal periods where management is reasonably certain that such renewal options will be exercised. Our operating leases contain varying terms and expire at various dates through 2030. For the three months ended February 28, 2021 and February 29, 2020 lease expenses under fixed term leases amounted to $400,609 and $0, respectively. For the nine months ended February 28, 2021 and February 29, 2020, lease expenses under fixed term leases amounted to $1,099,993 and $0, respectively.

Certain of our operating leases contain variable lease payments, either in part or in total, related to certain performance targets by the Company at the underlying store locations. These variable leases costs are recognized as incurred in accordance with ASC 842 - Leases.

The Company's future minimum lease payments required under operating leases that have commenced as of February 28, 2021 were as follows:

In order to calculate the operating lease asset and liability for a lease, ASC 842 - Leases requires that a lessee apply a discount rate equal to the rate implicit in a lease whenever such a rate is readily determinable. The Company's lease agreements do not provide a readily determinable implicit rate, nor is this rate available from our leasing counterparties. Consequently, the Company estimates an incremental borrowing rate to determine the present value of the lease payments. This incremental borrowing rate represents the Company's estimate of an interest rate that the Company would be able to obtain from a lender to borrow, on a collateralized basis, over a similar term to obtain an asset of similar value.

Lease term and discount rates were as follows:

NOTE 7:

CUSTOMER CONCENTRATION

The Company had two customers who exceeded 10% of net revenues for the three months ended February 28, 2021, accounting for 21.1% and 10.9%, respectively. The Company had one customer who accounted for 17.6% of net revenues for the nine months ended February 28, 2021.

NOTE 8:

DISCONTINUED OPERATIONS

On October 10, 2019, the Company entered into an agreement ("Purchase Agreement") to sell the Schmitt Dynamic Balance Systems ("SBS") business line to Tosei Engineering Corp. and Tosei America, Inc. (collectively "Tosei") for a purchase price of $10,500,000 in cash. The transaction closed on November 22, 2019 and included certain assets held by the U.S. parent company and all the outstanding stock of the UK subsidiary, Schmitt Europe Limited. As a result, the financial position, results of operations, and cash flows relating to our SBS business line are reported as discontinued operations in the accompanying condensed consolidated financial statements.

The consideration included $9,940,000 in unrestricted cash from the Buyer at closing, plus $420,000 to be placed into an escrow account, net of $140,000 in minimum cash settled via the funds flow at closing. Remaining escrow funds become unrestricted after certain events are completed and after one year from closing. The Purchase Agreement requires an adjustment to purchase price after closing based on the difference between (a) the calculated amount of working capital at closing and (b) the target working capital of $4,200,000. The closing working capital calculation resulted in $107,000 in net proceeds paid from Buyer to Seller in February 2020.

The following is a composition of the line items constituting income from discontinued operations:

NOTE 9:

SEGMENT INFORMATION

As described in Note 1 and Note 10, the Company closed on the acquisition of Ample Hills during the three months ended August 31, 2020. With the acquisition of Ample Hills, the Company has two reportable business segments, Ice Cream and Measurement. The Ice Cream Segment encompasses the activities of Ample Hills and focuses on the wholesale and retail sale of the Company's ice cream products from 10 separate retail locations in New York, New Jersey and California. The Measurement Segment focuses on laser-based test and measurement systems and ultrasonic products. Substantially all of the Company's operations are conducted within North America.

The Company has previously reported segment information between their two identified legacy reportable segments: Balancer and Measurement. As described in Note 8, the Company sold the Dynamic Balance Systems ("SBS") business line on November 22, 2019. This entity composed substantially all of the business activities of the Company's legacy Balancer segment. Subsequent to this sale, management determined that the Company had a single reportable segment (until the aforementioned acquisition of Ample Hills closed during the quarter ended August 31, 2020). The foregoing information presents the balances and activities of only the Measurement segment as of and for the three and nine months ended February 28, 2021 and February 29, 2020.

Segment Information

* Ice Cream Segment activity includes activities from the date of acquisition (July 9, 2020) through February 28, 2021.

Segment Assets

NOTE 10:

AMPLE HILLS BUSINESS ACQUISITION

As described in Note 1, the Company closed on the Ample Hills acquisition on July 9, 2020. The Company paid the sellers $1.0 million dollars for assets of Ample Hills. Additionally, the Company paid approximately $0.7 million dollars to certain landlords and vendors of the sellers in exchange for the right to assume the associated leases with such landlords and $125,167 in transaction costs.

In accordance with ASC 805 - Business Combinations, the Company has recognized the assets and liabilities of Ample Hills at fair value with the excess of such values over the fair value of consideration transferred to the seller presented as a bargain purchase gain recognized on the accompanying condensed consolidated statement of operations during the nine months ended February 28, 2021. The foregoing amounts reflect our current estimates of fair value as of the July 9, 2020 acquisition date.

The following table summarizes the Company's preliminary fair value of the assets acquired, and liabilities assumed, as of July 9, 2020, for the Company's acquisition of Ample Hills.

As a result of additional information obtained during the measurement period about the facts and circumstances that existed as of the acquisition date, the Company recorded a measurement period adjustment during the three months ended November 30, 2020 in the amount of $2,277, which resulted in a reduction in the bargain purchase gain for the nine months ended February 28, 2021 to $1,187,235. The purchase price allocation will be finalized as soon as practicable within the measurement period, but no later than one year following the acquisition date.

Ample Hills was a privately held company that was acquired out of bankruptcy. Management has performed a thorough evaluation of the pre-bankruptcy books and found the records to not be auditable. Therefore, management has engaged a third party consultant to assist in evaluating alternative means by which to provide historic financial data in future periods.

Further, please reference Note 9 for further details regarding the results of the Ice Cream segment.

NOTE 11:  

INTANGIBLE ASSETS

Tradenames, Trademarks, Recipes and the Company website

In connection with the acquisition of Ample Hills during the nine months ended February 28, 2021 the Company acquired multiple intangible assets including the names and marks, proprietary recipes, and company website related to the Ample Hills business. The Company has determined that the aggregate fair value of such tradenames upon the closing of the acquisition was $1,117,470. The Company estimated the fair value of these assets utilizing the relief-from-royalty method, for the Proprietary Recipes and Tradename, which requires assumptions related to projected sales from its annual long-range plan; assumed royalty rates that could be payable if the Company did not own the trademarks; and a discount rate. For the website, the Reproduction Cost Approach was used which estimates the cost to replace the website. These assets have been determined to be indefinite-lived and are not amortized, but instead are reviewed for impairment at least annually or more frequently if indicators of impairment exist.

NOTE 12:

DEBT

Paycheck Protection Program Loan

On March 21, 2020, the Coronavirus Aid Relief and Economic Security Act ("CARES ACT") was enacted. The CARES ACT established the Paycheck Protection Program ("PPP") which funds eligible businesses through federally guaranteed loans. Under the PPP, companies are eligible for forgiveness of principal and accrued interest if the proceeds are used for eligible costs.

On August 3, 2020, Schmitt received loan proceeds in the amount of $584,534 (and subsequently returned $264,476 of the funds received) and, on August 3, 2020, Ample Hills received $1,471,022 under the PPP (the "Loans").

The Loans were granted on July 30, 2020, under two notes payable (the "Notes"). The note payable issued by Schmitt was dated July 30, 2020 and the note payable issued by Ample Hills was dated July 30, 2020. The Notes mature five years from the date of issuance and bear interest annually at 1.0%. Principal and accrued interest are payable monthly through the maturity date, commencing on July 30, 2020 and July 30, 2020 for the Notes issued by Schmitt and Ample Hills, respectively, unless forgiven as described below. The Notes may be prepaid at any time prior to maturity with no prepayment penalties. Loan proceeds may be used only to retain workers and maintain payroll or make mortgage payments, lease payments, and utility payments. The Company intends to use the funds for eligible purposes, including the re-hiring of Ample Hills's work force, and seek forgiveness of the balance of the loans.

Forgiveness of the Loans is only available for principal that is used for the limited purposes that qualify for forgiveness under the requirements of the United States Small Business Administration ("SBA"). To obtain forgiveness, the Company must request it, provide documentation in accordance with the SBA requirements, and certify that the amounts requested to be forgiven qualify under those requirements. There is no guarantee that the Loan will be forgiven by the SBA and therefore the Company has recorded $1.8 million as a loan payable on the February 28, 2021 condensed consolidated balance sheet. Of this amount, $0.3 million has been recorded as a current liability to reflect the amount due within twelve months from the balance sheet.

NOTE 13:

OUT-OF-PERIOD ADJUSTMENT

During the current quarter, the Company recorded an out-of-period adjustment that affected the condensed consolidated balance sheet as of February 28, 2021 and the consolidated statement of operations and comprehensive income (loss) and the condensed consolidated statement of changes in stockholders’ equity for the periods then ended.  The adjustment related to the manner in which the Company was accounting for market-based stock-based compensation.  The impact of this adjustment resulted in a decrease of stock-based compensation of approximately $243,187 for the three months ended February 28, 2021 and $243,187 for the nine months ended February 28, 2021.  The Company also recorded a decrease in additional paid-in-capital of $243,187 as of February 28, 2021.  Management has evaluated the impact of this out-of-period adjustment and has concluded that it is not material to any current or previously reported quarterly or annual consolidated financial statements.

NOTE 14:

SUBSEQUENT EVENTS

On April 6, 2021, Ample Hills Acquisition received loan proceeds in the amount of $2,000,000 from the Second Draw PPP Loan. The Loan constitutes a Second Draw PPP Loan made pursuant to Section 7(a)(37) of the Small Business Act (15 U.S.C. 636(a)(37)), as amended from time to time (the “Second Draw PPP Legislation”) and applicable provisions of the Paycheck Protection Program under the Coronavirus Aid, Relief, and Economic Security Act ((a) as amended by each of (i) the Paycheck Protection Program and Health Care Enhancement Act, (ii) the Paycheck Protection Program Flexibility Act of 2020, (iii) the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act, (iv) Title V of the American Rescue Plan Act of 2021, and (v) the PPP Extension Act of 2021, and (b) as otherwise amended from time to time, the “CARES Act PPP Provisions” and, together with the Second Draw PPP Legislation, collectively, “PPP Legislation” the PPP Legislation, together with all rules, regulations and guidance issued by the SBA with respect thereto from time to time, is referred to herein as the “PPP Guidance”).

The Loan was granted on April 6, 2021, under a note payable (the "Note"). The Note matures five years from the date of issuance and bear interest annually at 1.0%. Interest is accruing monthly, commencing on April 6, 2021. The Notes may be prepaid at any time prior to maturity with no prepayment penalties. Loan proceeds may be used only to retain workers and maintain payroll or make mortgage payments, lease payments, and utility payments. The Company intends to use the funds for eligible purposes, including the re-hiring of Ample Hills's work force, and seek forgiveness of the balance of the loans.

Forgiveness of the Loans is only available for principal that is used for the limited purposes that qualify for forgiveness under the requirements of the United States Small Business Administration ("SBA"). To obtain forgiveness, Ample Hills must request it, provide documentation in accordance with the SBA requirements, and certify that the amounts requested to be forgiven qualify under those requirements. There is no guarantee that the Loan will be forgiven by the SBA and therefore the Company has recorded $2.0 million as a loan payable in the fourth quarter of fiscal year 2021.

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 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 disclosed in our Annual Report on Form 10-K for the fiscal year ended May 31, 2020, as well as in "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 operates a diversified business. The Company reports in two business segments, Ice Cream and Measurement.

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, 2020.

Highlights of the Three and Nine Months Ended February 28, 2021 and February 29, 2020

Critical Accounting Policies

The Company's critical accounting policies are disclosed in its Annual Report on Form 10-K for the year ended May 31, 2020. Subsequent to May 31, 2020, the Company completed its acquisition of Ample Hills. In connection with this acquisition, the Company reports certain financial statement captions that it had not previously and, as such, has included the critical accounting policies associated with such items herein.

Bargain Purchase Gain

In accordance with ASC 805 - Business Combinations, we have estimated the fair value of the net assets acquired as part of our purchase of the Ample Hills business. We have determined that the aggregate fair value of these assets is in excess of the fair value of the consideration transferred to the seller and their landlords. As such, we have recorded a bargain purchase gain for the three and nine months ended February 28, 2021. ASC 805 allows for a measurement period, not to exceed 12 months from the date of acquisition, for filers to compile sufficient information to complete their estimate of the fair value of the net assets acquired. As of February 28, 2021, the Company is still in this measurement period. Any significant adjustments to our estimates of fair value of acquired net assets in future periods could have significant impacts on reported results from such periods.

Tradenames, Trademarks, Recipes and the Company website

The trade names and marks obtained as part of our acquisition of Ample Hills are considered to be indefinite-lived. The Proprietary recipes and website have lives of five and three years, respectively. For the indefinite lived intangibles, the assets are not subject to amortization but are tested annually. We will conduct our annual impairment test on May 31, or earlier if impairment indicators are present. As of February 28, 2021, the Company has not identified any events or circumstances indicating than an acceleration of this impairment test would be necessary.

A quantitative impairment test would utilize a discounted relief-from-royalty model. The discounted cash flow analysis is subject to multiple variables requiring significant judgment including the selection of an appropriate discount rate that reasonably reflects the assumed rate of return that third party buyer would expect to receive if they were purchasing the tradename, the selection of a reasonable royalty rate that represents what the Company would pay a third party to access a similar tradename, as well as an estimate of future cash flows, which are based on our best estimates of future store openings and closings, the future performance of existing stores, the growth rate of sales as our ability to effectively manager future costs. Such inputs are highly subjective and actual results could differ substantially from our estimates. Revisions of such estimates, whether due to macroeconomic conditions or our inability to successfully execute on our revenue and profitability growth goals for the Ice Cream Segment could have a significant impact on future reported results.

Lease Accounting - Lessees

We evaluate our leases to determine if we have the right to control the use of an asset, or group of assets, for a period of time in exchange for consideration. If we determine that we have the right to obtain substantially all of the economic benefits arising from the use of such assets, we recognize a right-of-use asset and lease liability. We evaluate each lease to estimate its expected term which includes renewal options that we are reasonably assured that we will exercise and also evaluate the classification of the lease as either an operating lease or a finance lease. As our leases do not provide an implicit rate, we must estimate an incremental borrowing rate based on the information available at the time the lease is commenced or amended. This estimated rate is directly utilized in determining the present value of lease payments. As the Company does not have any outstanding debt, other than the PPP Loan referred to in Note 12 to the extent not forgiven, or committed credit facilities, we must estimate the incremental borrowing rate based on prevailing financial market conditions, peer company credit analyses, and management judgment. We assess our right-of-use assets for impairment whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable.

Changes in assumptions regarding lease renewals and estimated incremental borrowing rates may produce materially different amounts in the initial recognition of right-of-use assets and lease liabilities. Additionally, an inability to perform on our strategic revenue and cash flow growth plans could result in the recognition of impairment losses in future periods, which could be material.

Discussion of Operating Results from Continuing Operations

The Company has previously reported segment information between their two identified reportable segments: Balancer and Measurement. As described in the accompanying condensed consolidated financial statements, the Company sold the Dynamic Balance Systems ("SBS") business line on November 22, 2020. This entity composed substantially all of the business activities of the Company's legacy Balancer segment. Subsequent to this sale, Management determined that the Company had a single reportable segment (until the acquisition of Ample Hills closed during the quarter ended August 31, 2020). The foregoing information presents the balances and activities of the Measurement segment as of and for the three and nine months ended February 28, 2021 as balances and activities of the newly identified Ice Cream Segment.

Consolidated Revenue- Consolidated revenue increased $573,477 or 52.4%, to $1,668,644 for the three months ended February 28, 2021 from $1,094,967 for the three months ended February 29, 2020. Consolidated revenue increased $1,982,795 or 61.5%, to $5,205,641 for the nine months ended February 28, 2021 from $3,222,846 for the nine months ended February 29, 2020. The decrease in the Measurement Segment was offset by revenues in the newly identified Ice Cream Segment for the period from the acquisition of Ample Hills (July 9, 2020) through February 28, 2021.  

Ice Cream Segment - The Ice Cream Segment encompasses the operations of Ample Hills Acquisition, LLC and focuses on the wholesale and retail sales of ice cream and related products through a network of 10 individual retail locations located in New York, New Jersey and California. 

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. Substantially all activity of our Measurement Segment is conducted in North America. 

Measurement Segment revenue decreased $48,253, or 4.4%, to $1,046,714 for the three months ended February 28, 2021 as compared to $1,094,967 for the three months ended February 29, 2020. The decrease is primarily driven by a decrease in Acuity and Xact product revenue of $48,029 and $36,910, respectively. The decline was offset by an increase in Xact monitoring revenue of $36,893, or 9.4%. Measurement Segment revenue decreased $299,344, or 9.3%, to $2,923,502 for the nine months ended February 28, 2021 as compared to $3,222,846 for the nine months ended February 29, 2020. The decrease is driven by a decrease in Acuity and Xact product revenue of $161,465 and $157,880, respectively. The decline was offset by an increase in Xact monitoring revenue of $96,648, or 8.5%, for the nine months ended February 28, 2021 as the Company's installed base of monitoring devices continues to grow. 

Revenue by product line for the Measurement Segment for the three months and nine months ended February 28, 2021 and February 29, 2020 respectively, were as follows: 

Gross Margin - Ice Cream Segment gross margin was 42.4% and 41.4% for the three and nine month period ended February 28, 2021. As the Company continues to manage the day-to-day operations of the business and as capital improvements are placed into service, we expect to be able to identify opportunities to drive additional revenue and volume through our factory, which will improve gross margin. Measurement Segment gross margin for the nine months ended February 28, 2021 increased 4.2% to 49.8% as compared to 45.6% for the nine months ended February 29, 2020.

Operating Expenses – For the three and nine month period ended February 28, 2021, operating expenses increased $2,300,328 and $5,856,192 as compared to the comparative periods in fiscal year 2020. This is primarily driven by the new Ice Cream Segment, which had operating expenses of $2,463,358 and $5,846,426 for the three and nine month periods ended February 28, 2021, respectively, and accounted for 73.8% and 67.4% total operating expenses for the three and nine month periods. Results from this segment are entirely attributable to our Ample Hills business, which was acquired on July 9, 2020.

Measurement Segment operating expenses decreased $163,030, or (15.7%), to $872,292 for the three months ended February 28, 2021 from $1,035,322 for the three months ended February 29, 2020. Measurement Segment operating expenses increased $9,766, or 0.3%, to $2,827,953 for the nine months ended February 28, 2021 from $2,818,187 for the nine months ended February 29, 2020. The increase in operating expenses for the nine months ended February 28, 2021 is primarily due to increased stock-based compensation, professional fees, and investments to develop our new ERP system and to invest in our Xact tank monitoring business. Additionally, corporate payroll expenses increased due to the hiring of a new CFO and the CEO transitioning to payroll in the nine months ended February 28, 2021.  

Bargain Purchase Gain - In connection with the acquisition of Ample Hills during the quarter ended August 31, 2020 the Company recorded a bargain purchase gain of $1,271,615 that was recorded as a component of net income. Adjustments of $82,103 and $2,277 were recorded to the bargain purchase gain for quarters ended November 30, 2020 and February 28, 2021, respectively, reducing the bargain gain for the nine months ended February 28, 2021 to $1,187,235. This amount represents the excess of the estimated fair value of the net assets acquired over the estimated fair value of the consideration transferred to the sellers and their landlords.

Other Income (Expense) - Other income (expense) consists of rental income, interest income, interest expense, foreign currency exchange gain (loss) and other income (expense). Rental income was $81,203 and $254,642 for the three and nine month period ended February 28, 2021 as compared to $0 and $0 for the three and nine month period ended February 29, 2020, respectively.

Interest income was $2,114 and $8,857 respectively for the three and nine months ended February 28, 2021 as compared to $37,614 and $47,928 for the three and nine months ended February 29, 2020. Fluctuations in interest income are impacted by the levels of our average cash and investment balances and changes in interest rates. Interest expense was ($5,400) and ($12,854) for the three and nine months ended February 28, 2021 as compared to $0 and $2,435 for the three and nine months ended February 29, 2020, respectively.

During the nine months ended February 28, 2021, management maintained a reserve against escrow cash related to the sale of the SBS business in fiscal year 2020, in the amount of $220,000 to other expenses.

Foreign currency exchange loss was $0 for the three months ended February 28, 2021 as compared to foreign currency exchange loss of $2,041 for the three months ended February 29, 2020. 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 February 28, 2021 was (0.1)%, as compared to 1.7% for the three months ended February 29, 2020. The effective tax rate on consolidated net income for the three months ended August 31, 2020 and 2019 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 Loss - Net loss from continuing operations was ($2,419,797), or ($0.64) per fully diluted share, for the three months ended February 28, 2021 compared to net loss from continuing operations of ($240,277) or ($0.06) per fully diluted share, for the three months ended February 29, 2020. Net loss from continuing operations was ($4,635,607), or ($1.23) per fully diluted share, for the nine months ended February 28, 2021 compared to net loss from continuing operations of ($1,138,481) or ($0.29) per fully diluted share, for the nine months ended February 29, 2020. 

LIQUIDITY AND CAPITAL RESOURCES

The Company's working capital decreased $7,136,942 to $3,816,522 as of February 28, 2021 as compared to $10,953,464 as of May 31, 2020. 

Cash, cash equivalents and restricted cash decreased $6,400,167 to $4,166,364 as of February 28, 2021 from $10,566,531 as of May 31, 2020. Cash used in operating activities totaled $5,657,905 the nine months ended February 28, 2021 as compared to cash provided in operating activities of $401,477 for the nine months ended February 29, 2020. Net loss from continuing operations of $4,635,607 along with the offsetting bargain purchase gain of $1,187,235 primarily impacted the total cash from operating activities for the nine months ended February 28, 2021. 

At February 28, 2021, the Company had accounts receivable of $956,871 as compared to $574,926 at May 31, 2020, an increase of $381,945. Inventories increase $945,112 to $2,004,469 as of February 28, 2021 as compared to $1,059,357 at May 31, 2020. At February 28, 2021, total current liabilities increased $2,134,587 to $3,442,611 as compared to $1,308,024 at May 31, 2020. The increase in current liabilities is primarily due to liabilities associated with the acquisition of Ample Hills. 

Capital expenditures increased significantly, consistent with the fiscal year 2021 plan, during the nine months ended February 28, 2021. During the nine months ended February 28, 2021 the Company incurred $510,321 in capital expenditure as compared to $28,256 comparative period in fiscal year 2020. The increase in in capital expenditures is primarily due to the equipment upgrade at the Ice Cream segment's factory and retail locations as well as the build-out of the segment's new Long Beach, California and Brooklyn, New York locations. 

We believe that our existing cash and cash equivalents combined with the cash we anticipate generating from operating and financing 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. As the Company had a significant reduction in its cash and cash equivalents due to planned capital expenditures, the Company may also seek to generate additional cash, whether the Second Draw PPP Loan is forgiven or otherwise. Such efforts could include the sale of previously disclosed real estate efforts or additional financing. Any subsequent equity financing sought may have dilutive effects on our current shareholders. The Company has no agreements or understandings with respect to the foregoing.

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, 2020.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

The Company’s management evaluated, with the participation of the Company’s principal executive and principal financial officers, the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), as of February 28, 2021. Based on their evaluation, the Company’s principal executive and principal financial officers concluded that the Company’s disclosure controls and procedures were not effective as of February 28, 2021 due to the material weaknesses in our internal control over financial reporting described below.

As previously disclosed in Item 9A of our Annual Report on Form 10-K for the year ended May 31, 2020, management had concluded that there was a material weakness in internal control over financial reporting due to deficiencies in the design and operation of internal controls over segregation of duties; and ineffective management review over accounting reconciliations for inventory, accrued liabilities, and taxes. We are in the process of remediating the material weakness as of the end of the period covered by this Quarterly Report on Form 10-Q.

During the quarter ended February 28, 2021, management identified additional material weaknesses due to deficiencies in the design of internal controls as follows:

A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements would not be prevented or detected on a timely basis.

Remediation of Material Weaknesses

Management intends to leverage additional accounting resources, both internal and external, to strengthen the financial close and reporting process so as to more effectively detect such misstatements in a more timely fashion.  The remediation plan includes both management’s assessment and recommendations from independent accounting advisors used in the review process.  This remediation plan is intended to address the identified material weaknesses and enhance our overall control environment. 

Notwithstanding the identified material weaknesses, management believes that the condensed consolidated financial statements included in this Quarterly Report on Form 10-Q present fairly, in all material respects, our financial position, results of operations, and cash flows as of and for the periods presented in accordance with U.S. GAAP. 

Changes in Internal Control Over Financial Reporting

In the current fiscal year ending May 31, 2021, the Company acquired the Ample Hills business. As of quarter ended February 28, 2021, management has expanded the head count in the accounting and finance department and is in the process of integrating this new business line into the Company's overall internal control environment. Further, management has performed a thorough review of processes and procedures to ensure appropriate segregation of duties are in place to improve the internal control environment. Management anticipates completing these integration efforts by the end of the current fiscal year ending May 31, 2021.

In the quarter ended February 28, 2021, the Company identified an error in its recording of market based stock compensation, and recorded an adjustment to the condensed consolidated balance sheet as of February 28, 2021, the consolidated statement of operations and comprehensive income (loss) and the condensed consolidated statement of changes in stockholders equity for the periods then ended.

Other than the above referenced matter, including those described in the Remediation of Material Weakness section above, there has been no change in the Company's internal control over financial reporting that occurred during the Company's fiscal quarter ended February 28, 2021 that has materially affected, or is reasonably likely to materially affect, such internal control over financial reporting.

 Part II - OTHER INFORMATION

 Item 1A. 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, 2020, and to the disclosure relating to material weaknesses due to deficiencies in the design of internal controls under  Item 4 - Controls and Procedures  of this Form 10-Q for the three months ended February 28, 2021, 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 5. Other Information

On April 6, 2021, Ample Hills Acquisition received loan proceeds in the amount of $2,000,000 from the Second Draw PPP Loan. The Loan constitutes a Second Draw PPP Loan made pursuant to Section 7(a)(37) of the Small Business Act (15 U.S.C. 636(a)(37)), as amended from time to time (the “Second Draw PPP Legislation”) and applicable provisions of the Paycheck Protection Program under the Coronavirus Aid, Relief, and Economic Security Act ((a) as amended by each of (i) the Paycheck Protection Program and Health Care Enhancement Act, (ii) the Paycheck Protection Program Flexibility Act of 2020, (iii) the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act, (iv) Title V of the American Rescue Plan Act of 2021, and (v) the PPP Extension Act of 2021, and (b) as otherwise amended from time to time, the “CARES Act PPP Provisions” and, together with the Second Draw PPP Legislation, collectively, “PPP Legislation” the PPP Legislation, together with all rules, regulations and guidance issued by the SBA with respect thereto from time to time, is referred to herein as the “PPP Guidance”).

The Loan was granted on April 6, 2021, under a note payable (the "Note"). The Note matures five years from the date of issuance and bear interest annually at 1.0%. Interest is accrued monthly, commencing on April 6, 2021, unless forgiven as described below. The Notes may be prepaid at any time prior to maturity with no prepayment penalties. Loan proceeds may be used only to retain workers and maintain payroll or make mortgage payments, lease payments, and utility payments. The Company intends to use the funds for eligible purposes, including the re-hiring of Ample Hills's work force, and seek forgiveness of the balance of the loans.

Forgiveness of the Loans is only available for principal that is used for the limited purposes that qualify for forgiveness under the requirements of the United States Small Business Administration ("SBA"). To obtain forgiveness, the Company or Ample Hills, as the case may be, must request it, provide documentation in accordance with the SBA requirements, and certify that the amounts requested to be forgiven qualify under those requirements. There is no guarantee that the Loan will be forgiven by the SBA and therefore the Company has recorded $2.0 million as a loan payable in the fourth quarter of fiscal year 2021.

Item 6. Exhibits

  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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