SCHMITT INDUSTRIES INC - Quarter Report: 2022 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, 2022

☐ 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.

 (Exact Name of Registrant as Specified in Its Charter)

(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.

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 outstanding common stock outstanding as of March 31, 2022: 

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.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

FOR THE THREE AND NINE MONTHS ENDED FEBRUARY 28, 2022 AND FEBRUARY 28, 2021

See accompanying notes to condensed consolidated financial statements.

SCHMITT INDUSTRIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED) 

FOR THE NINE MONTHS ENDED FEBRUARY 28, 2022, AND FEBRUARY 28, 2021

See accompanying notes to condensed consolidated financial statements.

SCHMITT INDUSTRIES, INC.

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY

(UNAUDITED)

FOR THE NINE MONTHS ENDED FEBRUARY 28, 2022 AND FEBRUARY 28, 2021

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, (collectively hereinafter the “consolidated financial statements”), have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) and contain all adjustments, consisting only of normal recurring adjustments, necessary to present fairly its financial position as of February 28, 2022 and its results of operations and its cash flows for the periods presented. The consolidated balance sheet at May 31, 2021 has been derived from the Annual Report on Form 10-K for the fiscal year ended May 31, 2021. The accompanying unaudited 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, 2021. 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, 2022.

Significant Accounting Policies

The Company’s significant accounting policies are described in “Note 2: Summary of Significant Accounting Policies” of our most recent Form 10-K for the fiscal year ended May 31, 2021.

Principles of Consolidation

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

Reclassifications

Certain amounts in the prior period consolidated statements of operations have been reclassified to conform to the presentation of the current period. These reclassifications had no effect on previously recorded net income (loss). 

Use of Estimates

The preparation of the consolidated financial statements in conformity with Generally Accepted Accounting Principles in the U.S. (“GAAP”) 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.

New Accounting Standards

The Company assesses the adoption impacts of recently issued accounting standards by the Financial Accounting Standards Board (“FASB”) on the Company's financial statements as well as material updates to previous assessments, if any, from the Company’s Annual Report on Form 10-K for the fiscal year ended May 31, 2021. There were no new material accounting standards issued in the nine months ended February 28, 2022 that impacted the Company.

Recently Adopted Accounting Standards

There were no new material accounting standards adopted in the nine months ended February 28, 2022.

Liquidity 

Our primary source of liquidity is our cash flows from operating activities resulting from net income and management of working capital. As of February 28, 2022, our available funds consisted of $1,999,241 in cash and cash equivalents. Management is seeking to sell additional assets held for sale as noted below, which would be a source of liquidity, in addition to sources related to the forgiveness of the Paycheck Protection Program (“PPP”) loans (see Note 13 – Long-Term Debt) and the commitment from Michael Zapata, our Chief Executive Officer (“CEO”), to provide additional capital if needed as noted below. We anticipate that the available funds and cash generated from operations and financing activities will be sufficient to meet cash and working capital requirements, including the anticipated level of capital expenditures to fund operations for at least one year after the date the consolidated financial statements are issued.

Investor 

On August 7, 2021, the Company received The Commitment Letter to Schmitt Industries (“Commitment”) from our CEO. The Commitment states that Sententia Capital Management LLC (“SCM”) or its affiliated entities will provide additional capital as required to Schmitt up to $1,300,000 for the Company’s operations as needed through February 28, 2023. The Company has not requested or used any of the funds available as of February 28, 2022.

On November 10, 2021, the Company closed on the sale of its building located at 2451 NW 28th Avenue, Portland, OR 97210 for $5,100,000 with net proceeds of $4,753,724. The Company recorded a gain on sale of property and equipment totaling $4,598,095 on its consolidated statement of operations. The property associated with the sale was previously classified as assets held for sale. See below for further details.

Business Combinations

The Company accounts for business combinations in accordance with Accounting Standard Codification (“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 the 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. See Note 2 – Acquisition of Ample Hills.

Assets Held 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 and are recorded within selling, general and administrative expenses on the consolidated statement of operations.

The Company owned a two story 35,050 sq. foot building in an industrial zone that was listed for sale in December 2020. On November 10, 2021, the Company sold the building located at 2451 NW 28th Avenue, Portland, OR 97210 for $5,100,000 with net proceeds of $4,753,724. The Company recorded a gain on sale of property and equipment totaling $4,598,095 on its consolidated statement of operations. Assets held for sale as of May 31, 2021 are associated with this property, and therefore, not included in assets held for sale as of February 28, 2022. The Company previously leased this property to two lessees, as described further in Note 5 – Leases. As such, this lease has been terminated as of February 28, 2022.

The Company owns two industrial office buildings totaling 11,667 sq. feet located at 2765 NW Nicolai Street, Portland, OR 97210 that were listed for sale in November 2021. Assets held for sale as of February 28, 2022 are associated with these properties. The Company currently occupies part of this property and leases a portion to a third party, as described further in Note 5 – Leases. A potential sale transaction would be structured as a sale-leaseback, as the Company occupies approximately 75% of the buildings.

As of February 28, 2022 and May 31, 2021, assets held for sale consisted of the following:

Summary of Significant Accounting Policies - Schedule of Assets Held for Sale

Concentration of Credit Risk 

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

Financial Instruments

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

NOTE 2 - AMPLE HILLS BUSINESS ACQUISITION

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 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 $1,000,000. The Asset Acquisition included 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 approximately $700,000 to certain landlords of Ample Hills in exchange for the right to assume leases with such landlords and $125,167 in transaction costs.

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 purchase price 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. 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, the Company recorded 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. The purchase price allocation has been finalized as of May 31, 2021, within the measurement period, and no further adjustments will be made.

In accordance with ASC 805, 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 consolidated statement of operations during the year ended May 31, 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 fair value of the assets acquired, and liabilities assumed, as of July 9, 2020, for the Company's acquisition of Ample Hills.

Ample Hills Business Acquisition - Schedule of Purchase Price Allocation

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 which resulted in a reduction in the bargain purchase gain, which reduced it to $1,138,808. The adjustments related to additional cure payments made during the prior year, the discovery of obsolete inventory, and the reduction of the deferred tax liability. The bargain purchase gain amount represents the excess of the estimated fair value of the net assets and intangibles, described above, acquired over the estimated fair value of the consideration transferred to the sellers and their landlords. In accordance with ASC 805, the Company estimated the fair value of the net assets acquired as of 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 engaged a third- party consultant to assist in evaluating alternative means by which to provide historic financial data in future periods.

For further information see Note 11 – Segment Information for further details regarding the operating results of the Ice Cream Segment, and Note 12 – Intangible Assets, net for further details regarding the intangible assets acquired in connection with the Transactions.

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 forfeitures as they occur. Compensation cost for all stock-based awards is recognized using the straight-line method.

Stock Options

As of February 28, 2022, 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 stock options outstanding as of February 28, 2022 were fully vested, the Company recorded no additional stock-based compensation expense related to stock options during the quarter ending February 28, 2022.

No stock options were granted, exercised, canceled or expired under the Company's stock-based compensation plans during the nine months ended February 28, 2022.

Restricted Stock Units

Service-based and market-based restricted stock units (“RSUs”) are granted to key employees, members of the Company's Board of Directors and others. Service-based RSUs generally fully vest on the first anniversary date of the award. Market-based RSUs 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 RSUs were granted in the nine months ended February 28, 2022.

During the nine months ended February 28, 2022, 12,332 service-based RSUs were granted.

RSU activity under the Company's stock-based compensation plans during the nine months ended February 28, 2022 is summarized as follows:

Stock Options and Stock-Based Compensation - Schedule of Restricted Stock Unit Activity

During the three and nine months ended February 28, 2022, total restricted stock-compensation expense recognized was $25,647 and $95,016, respectively, and has been recorded as selling, general and administrative expense in the consolidated statements of operations. Remaining stock-compensation expense to be recognized in future periods for non-vested RSUs with a time-vesting condition is $30,424.

NOTE 4 – WEIGHTED-AVERAGE SHARES AND RECONCILIATION

Basic net (loss) income per share is computed using the weighted-average number of shares of common stock outstanding. Diluted net (loss) income 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 RSUs 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, 2022, 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 for the three months ended February 28, 2022 and February 28, 2021, and for the nine months ended February 28, 2021, because the Company incurred a net loss during those periods. In periods when a net loss is incurred, no common stock equivalents are included in the calculation of diluted net income or loss for the Company since they are antidilutive. The Company recorded a net profit for the nine months ended February 28, 2022, and as such, all stock options outstanding are included in the computation of diluted net income for that period.

Basic weighted-average shares for the three and nine months ended February 28, 2022 and February 28, 2021 were as follows:

Weighted-Average Shares and Reconciliation - Schedule of Weighted-Average Number of Shares 

NOTE 5 – LEASES

Leases – as a Lessor

On November 22, 2019, the Company entered into a triple-net lease agreement with Tosei America, Inc. (“Tosei”), whereby Tosei leased the Company's building located at 2451 NW 28th Avenue, Portland, OR 97210 for a base monthly fee of $23,282 for a term of 120 months. This lease arrangement has been accounted for pursuant to Accounting Standards Update (“ASU”) No. 2016-02, "Leases (Topic 842) (“ASU Topic 842”)". The Company presents property revenues as other income. As previously noted, the Company sold this property on November 10, 2021. As such, this lease has been terminated as of February 28, 2022.

On October 1, 2020, the Company entered into a lease agreement (“Humboldt Lease”) whereby Humboldt Street Collective, LLC (“Humboldt”) will lease the Company's building located at 2765 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 Topic 842. The Company presents property revenues as other income. Minimum future lease payments receivable are as follows: 

On December 1, 2020, the Company entered into the Second Humboldt Lease, whereby Humboldt leased a portion of the Company’s building located at 2451 NW 28th Avenue, Portland, OR 97210 for a monthly fee of $4,596 for a term of 59 months. As noted above, the Company sold this property on November 10, 2021. As such, this lease has been terminated as of February 28, 2022.

Leases – as a Lessee

In connection with the acquisition of Ample Hills, the Company assumed multiple real estate leases for retail store locations as well as a manufacturing facility, all of which are classified as operating leases. On November 12, 2021, the Company signed an additional retail lease agreement in conjunction with its new retail store located in New York. The store is scheduled to open during the summer of 2022. Payments on this lease will commence on April 22, 2022.

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.

The Company’s operating leases contain varying terms and expire at various dates through 2032. For the three months ended February 28, 2022 and February 28, 2021, lease expenses under fixed term leases amounted to $478,890 and $400,609, respectively. For the nine months ended February 28, 2022 and February 28, 2021, lease expenses under fixed term leases amounted to $1,347,522 and $1,099,993, respectively.

Certain of the Company’s operating leases contain variable lease payments related to certain performance targets by the Company at the underlying store locations. These variable lease 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, 2022 were as follows:

Leases - Schedule of Future Minimum Lease Payments for Operating Leases

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.

The Company’s weighted-average remaining lease term and discount rates under operating leases that have commenced as of February 28, 2022 were as follows:

Leases - Schedule of Lease Terms and Discount Rates

NOTE 6 – PROPERTY AND EQUIPMENT, NET

The Company’s property and equipment, net consisted of the following:

Property and Equipment, Net - Schedule of Property, Plant and Equipment, Net

Depreciation expense for the three months ended February 28, 2022 and 2021 was $74,972 and $93,068, respectively. Depreciation expense for the nine months ended February 28, 2022 and 2021 was $305,811 and $217,834, respectively.

NOTE 7 - CUSTOMER CONCENTRATION

Accounts Receivable

Revenues 

The Company had one customer who accounted for 18% of net revenues for the three months ended February 28, 2022. The Company had one customer who accounted for 11% of net revenues for the nine months ended February 28, 2022. The Company had two customers who exceeded 10% of net revenues for the three months ended February 28, 2021, accounting for 21% and 11%, respectively. The Company had one customer who accounted for 18% of net revenues for the nine months ended February 28, 2021.

The Company had two customers who accounted for 23% and 12%, respectively, of accounts receivable, net as of February 28, 2022, and one customer who accounted for 21%, of accounts receivable, net as of February 28, 2021.

NOTE 8 – ACCOUNTS RECEIVABLE, NET

The Company’s accounts receivable, net consisted of the following: 

Accounts Receivable, Net - Schedule of Accounts Receivable, Net

NOTE 9 – INVENTORIES, NET

The Company’s inventories, net consisted of the following: 

Inventories, Net - Schedule of Inventories, Current

NOTE 10 - 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.

As of February 28, 2022 and of May 31, 2021, the Company had no other long-term liabilities related to income tax contingencies. Interest and penalties associated with uncertain tax positions are recognized as components of the "Provision for income taxes." The Company had no liability for payment of interest and penalties as of February 28, 2022 and May 31, 2021.

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

Effective Tax Rate

The effective tax rate was 0.9% and 5.5%, respectively, for the three and nine months ended February 28, 2022. The effective tax rate was (0.1%) and (8.0%), respectively, for the three and nine months ended February 28, 2021. The effective tax rate on consolidated net income (loss) for the three months ended February 28, 2022 and February 28, 2021 differs from the federal statutory tax rate primarily due to changes in the deferred tax asset valuation allowance. For the three months ended February 28, 2022, the tax benefit recorded related to the bargain purchase gain and changes in the deferred tax asset valuation allowance. 

NOTE 11 - SEGMENT INFORMATION

As described in Note 2 - Ample Hills Business Acquisition, the Company closed on the acquisition of Ample Hills on July 9, 2020. As a result of the acquisition of Ample Hills, the Company now has two reportable business segments: the Ice Cream Segment and the Measurement Segment. The Ice Cream Segment encompasses the activities of Ample Hills and focuses on the wholesale and retail sales of the Company’s ice cream products from 12 separate retail locations in New York, New Jersey and California. The Measurement Segment focuses on laser-based test and measurement systems and ultrasonic products. All of the Company’s operations are conducted within North America.

The foregoing information presents the balances and activities of the Measurement Segment for the three and nine months ended February 28, 2022 and February 28, 2021. For the Ice Cream Segment, the balances and activities for the three and nine months ended February 28, 2022 are included, however, due to the acquisition occurring on July 9, 2020, only a portion of balances and activities are presented for the three and nine months ended February 28, 2021.

The following table present the activity for the three months ended February 28, 2022 and 2021:

Segment Information - Schedule of Segment Reporting Information by Segment

The following table present the activity for the nine months ended February 28, 2022 and 2021: 

Segment Assets

NOTE 12 - INTANGIBLE ASSETS

Indefinite-Lived Intangible Assets

In connection with the acquisition of Ample Hills on July 9, 2020, the Company acquired tradenames and trademarks related to the Ample Hills business. The Company estimated the fair value of these assets utilizing the relief-from-royalty method. These assets were determined to be indefinite-lived and are not amortized, but instead are reviewed for impairment at least annually or whenever events or changes in circumstances indicate that such carrying values may not be recoverable as required by ASC 350, Intangibles — Goodwill and Other. The Company first performs a qualitative analysis to determine if it is “more likely than not” that an impairment event has occurred. If it is deemed to be more likely than not, then the Company will perform a qualitative analysis to estimate the fair value of the assets based on their discounted future cash flows. Should the carrying value of such assets exceed this fair value estimate, then an impairment charge for the difference will be recognized in earnings. The Company’s annual qualitative impairment analysis indicated that it was more likely than not that the indefinite-lived assets were impaired and, accordingly, a quantitative analysis was performed.

During the fourth quarter of the fiscal year ended May 31, 2021, the Company made an evaluation based on factors such as changes in the Ice Cream Segment’s growth rate and recent trends in the Ice Cream Segment’s forecasted financial information and concluded that a triggering event for an interim impairment analysis had occurred. As part of qualitative assessment, it was determined that the carrying value of the Ample Hills tradenames exceeded the estimated fair value. The tradename was valued using the relief-from-royalty method – a variation of the income approach – which was used for the initial valuation of the tradename in connection with the Company’s acquisition of Ample Hills. Due to a reduction in estimated total enterprise value as a result of the change in financial projections, there is no incremental fair value to allocate to the tradenames. Therefore, during the fiscal year ended May 31, 2021, the Company recognized an impairment loss in the amount of $903,422, which equals the total carrying value of the tradenames as of the testing date.

Finite-lived Intangible Assets

Amortizable intangible assets include purchased technology and patents for the Company’s Measurement Segment and proprietary recipes and the Company’s website for its Ice Cream Segment. These assets are amortized over their estimated useful lives ranging from three to fifteen years. In total, the weighted-average remaining amortization period of the Company’s intangible assets was 4.71 years as of February 28, 2022.

As of February 28, 2022 and May 31, 2021, for the Measurement Segment, the gross carrying value of amortizable intangible assets was $1,663,538, and accumulated amortization was $1,554,372 and $1,475,935, respectively, which includes fully amortized assets. Amortization expense for the Measurement Segment for the three months ended February 28, 2022 and February 28, 2021 was $26,145 and $21,562, respectively. Amortization expense for the Measurement Segment for the nine months ended February 28, 2022 and February 28, 2021 was $78,437 and $73,853, respectively. The weighted-average remaining amortization period for Measurement Segment intangible assets was 1.0 year as of February 28, 2022.

As of February 28, 2022 and May 31, 2021, for the Ice Cream Segment, the gross carrying value of amortizable intangible assets was $172,184, and accumulated amortization was $39,262 and $22,062, respectively. Amortization expense for the Ice Cream Segment for the three and nine months ended February 28, 2022 was $5,734 and $17,200, respectively. The weighted-average remaining amortization period for Ice Cream Segment intangible assets was 7.76 years as of February 28, 2022.

The following tables present the major components of finite-intangible assets which are subject to amortization as of February 28, 2022 and May 31, 2021:

Intangible Assets - Schedule of Finite-Lived Intangible Assets

Estimated amortization expense remaining for each of the following years is as follows:

Intangible Assets - Schedule of Finite-Lived Intangible Assets Future Amortization Expense

Finite-lived intangible assets are reviewed for impairment whenever events or changes in circumstances indicate the carrying amount of the asset may not be recoverable. Recoverability is determined by comparing the forecasted future net undiscounted cash flows from the operations to which the assets relate, based on management's best estimates using the appropriate assumptions and projections at the time, to the carrying amount of the assets. If the carrying value is determined to be in excess of such undiscounted cash flows, the asset is considered impaired and a loss is recognized equal to the amount by which the carrying amount exceeds the estimated fair value of the assets, which is determined by discounting future projected cash flows.

NOTE 13 – LONG-TERM DEBT

Paycheck Protection Program Loan

On March 21, 2020, the Coronavirus Aid Relief and Economic Security Ace (“CARES ACT”) was enacted. The CARES ACT established the 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, which include, but are not limited to, payroll, benefits, mortgage, lease and utility expenses.

The Company received three PPP loans during the fiscal year ended May 31, 2021, two of which were forgiven during the nine months ended February 28,2022. The remaining PPP loan is as follows:

The first two loans (both of which were forgiven during the nine months ended February 28, 2022 and therefore excluded from the table) were granted on July 30, 2020 (collectively the “First Draw PPP Loans”) under two notes payable. Both notes were issued July 30, 2020 and funds were disbursed on August 3, 2020. The third loan was granted and issued on April 6, 2021 (the “Second Draw PPP Loan”) to Ample Hills under a note payable which matures five years from the date of issuance and bears interest annually of 1.0%. Interest is accrued monthly, commencing on the date of issuance. Principal and interest is paid monthly through the maturity date, commencing on April 6, 2021 for the Second Draw PPP Loan, unless forgiven as described below. The note may be prepaid at any time prior to maturity with no prepayment penalties. As noted above, Loan proceeds may be used only for eligible expense. Ample Hills has used and intends to use the remaining funds for eligible purposes, including the re-hiring of its workforce. Ample Hills is currently seeking forgiveness of the balance of the Second Draw PPP Loan.

Forgiveness of the Second Draw PPP Loan is available for principal that is used for the limited purposes that qualify for forgiveness under the requirements of the Small Business Administration (“SBA”), in addition to accrued interest. To obtain forgiveness, the Company must request it, provide documentation in accordance with SBA requirements and certify that the amounts requested to be forgiven qualify under those requirements. There is no guarantee that the remaining Second Draw Loan will be forgiven by the SBA and therefore, the Company has recorded a $2,000,000 loan payable on the consolidated balance sheet as of the end of February 28, 2022. Of this amount, $472,431 has been recorded as a current liability to reflect the amount due within the twelve months through February 28, 2023.

On August 2, 2021, the Company requested forgiveness of the First Draw PPP Loan and provided documentation in accordance with SBA requirements and certified the amounts requested to be forgiven qualified under the requirements. On August 28, 2021, the Company received correspondence from Bank of America, which included a Notice of Paycheck Protection Program Forgiveness Payment from SBA for a portion of the First Draw PPP Loan in the amount of $588,534. The Company must retain all records for the PPP loan for six years from the date the loan is forgiven. Additionally, subsequent to receiving the First Draw PPP Loan in fiscal 2021, the Company repaid $264,476. During the nine months ended February 28, 2022, Bank of America returned this payment to the Company as a result of a portion of the First Draw PPP loan being forgiven.

Schmitt Industries

On December 15, 2021 and December 22, 2021, respectively, for the remaining portion of the First Draw PPP Loan and the Second Draw PPP Loan, the Company provided documentation in accordance with SBA requirements and certified the amounts requested to be forgiven qualified under the requirements. During the three months ended February 28, 2022, the Company received notification that the remaining First Draw PPP Loan had been forgiven by the SBA and subsequently recognized a $1,471,022 gain on the forgiveness of this loan.

As of February 28, 2022 and May 31, 2021, the Company has the following current and long-term liabilities recorded for the PPP loans:

Long-Term Debt - Schedule of Debt

NOTE 14 – COMMITMENTS AND CONTINGENCIES

In a transaction related to the acquisition of Schmitt Measurement Systems, Inc., formerly TMA Technologies, Inc. ("TMA"), the Company established a royalty pool and vested in each shareholder and debt holder of the acquired company an interest in the royalty pool equal to the amount invested or loaned including interest payable through March 1995. The royalty pool is funded at 5% of net revenues (defined as gross sales less returns, allowances and sales commissions) of the Company's surface measurement products and future derivative products developed by Schmitt Industries, Inc., which utilize these technologies. As part of the royalty pool agreement, each former shareholder and debt holder released TMA from any claims with regards to the acquisition except their rights to future royalties. Royalty expense for the nine months ended February 28, 2022 and February 28, 2021 amounted to $19,429 and $18,992, respectively.

During the Company’s fiscal year ended May 31, 2020 (“Fiscal 2020”), the Company determined that it was more likely than not that the Company had a pre-existing tax liability related to prior periods. The Company has analyzed the liability and estimated it to be $265,349 and accordingly, the Company recognized estimated liability in operating expenses in Fiscal 2020 and recorded an accrual for the liability. Management has evaluated the exposure related to this matter and believes that the remaining liability is its best estimate as of February 28, 2022. 

NOTE 15 - SUBSEQUENT EVENTS

On March 4, 2022, March 15, 2022, and April 13, 2022, the Company signed three new retail lease agreements in conjunction with its plans to expand its Ample Hills store footprint.

On April 13, 2022, the Company formalized drawdown terms on its existing $1,300,000 Commitment Letter with its CEO, which states that SCM or its affiliates will provide the Company with additional capital of up to $1,300,000 for the Company’s operations, as needed, through February 28, 2023. Drawdown terms include: 1.0% origination fee, 18-month term after drawdown, 8.0% payment-in-kind interest rate.

Subsequent Event 

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 year ended May 31, 2021, 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 Industries, Inc. (the "Company", "Schmitt", "we" or "our") operates a diversified business. The Company reports in two business segments, the Ice Cream Segment and the Measurement Segment.

The accompanying unaudited financial information should be read in conjunction with our Annual Report on Form 10-K filed on August 31, 2021.

Highlights of the Three Months Ended February 28, 2022 and February 28, 2021

Highlights of the Nine Months Ended February 28, 2022 and February 28, 2021

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, 2021 filed on August 31, 2021 with the Securities and Exchange Committee (“SEC”). There have been no changes subsequent to May 31, 2021.

Discussion of Operating Results

The Company has previously reported segment information between their two identified reportable segments: the Balancer Segment and the Measurement Segment. As described in the Company’s Annual Report on Form 10-K for the year ended May 31, 2021, 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 acquisition of Ample Hills closed during the first quarter of fiscal 2021 ended August 31, 2020. Subsequent to the acquisition of Ample Hills, the Company has two identifiable reportable segments: the Measurement Segment and the Ice Cream Segment. The foregoing information presents the balances and activities of the Measurement Segment and the Ice Cream Segment as of and for the three and nine months ended February 28, 2022.

Consolidated Revenue- Consolidated revenues increased $180,469, or 10.8%, to $1,848,913 for the three months ended February 28, 2022, as compared to $1,668,444 for the three months ended February 28, 2021. Consolidated revenues increased $3,364,412, or 64.6%, to $8,570,053 for the nine months ended February 28, 2022, as compared to $5,205,641 for the nine months ended February 28, 2021. The increase was driven by the Ice Cream Segment, which generated revenues of $972,920 and $5,908,291 for the three and nine months ended February 28, 2022, respectively, accounting for 52.6% and 68.9% of total revenue for the three and nine month periods.

Ice Cream Segment - The Ice Cream Segment encompasses the operations of Ample Hills Acquisition, LLC and focuses on the retail and wholesale sales of ice cream and related products through a network of 11 individual retail locations located in New York, New Jersey and California. 

Ice Cream Segment revenue increased $351,190, or 56.5%, to $972,920 for the three months ended February 28, 2022, as compared to $621,730, for the three months ended February 28, 2021. Ice Cream Segment revenue increased $3,626,152, or 158.9%, to $5,908,291 for the nine months ended February 28, 2022, as compared to $2,282,139 for the nine months ended February 28, 2021. The increase was primarily due to the inclusion of Ice Cream Segment revenue for the entire nine months ended February 28, 2022, versus partial inclusion for the nine months ended February 28, 2021, as the acquisition occurred on July 9, 2020. In addition, the Company opened an additional retail location on May 28, 2021.

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 $170,721 or 16.3%, to $875,993 for the three months ended February 28, 2022, as compared to $1,046,714 for the three months ended February 28, 2021. Measurement Segment revenue decreased $261,741, or 9.0%, to $2,661,762 for the nine months ended February 28, 2022, as compared to $2,923,502 for the nine months ended February 28, 2021. For the three months ended February 28, 2022, the decrease is driven by a decrease in Acuity revenue of $106,420 and decreases in Xact product revenue and Xact monitoring revenue of $29,720 and $33,976, respectively. For the nine months ended February 28, 2022, the decrease is primarily driven by a decrease in Xact product revenue and Xact monitoring revenue of $127,156 and $50,349, respectively, as well as a decrease in Acuity revenue of $97,435.

Revenue by product line for the Measurement Segment for the three months ended February 28, 2022 and February 28, 2021, respectively, were as follows: 

Revenue by product line for the Measurement Segment for the nine months ended February 28, 2022 and February 28, 2021, respectively, were as follows: 

Gross Margin – Ice Cream Segment gross margin for the three months ended February 28, 2022 decreased to 40.1%, as compared to 42.4% for the three months ended February 28, 2021. Ice Cream Segment gross margin for the nine months ended February 28, 2022 increased to 59.7%, as compared to 41.4% for the nine months ended February 28, 2021. The Ice Cream Segment’s performance was driven by improved factory utilization and yield.

Measurement Segment gross margin for the three months ended February 28, 2022 increased to 62.5%, as compared to 54.2% for the three months ended February 28, 2021. Measurement Segment gross margin for the nine months ended February 28, 2022 increased to 53.5% as compared to 49.8% for the nine months ended February 28, 2021. Measurement Segment’s improved margin was driven by a higher percentage of Xact Monitoring revenue.

Operating Expenses – Ice Cream Segment operating expenses decreased $236,056 or 9.6%, to $2,227,303 for the three months ended February 28, 2022, as compared to $2,463,359 for the three months ended February 28, 2021. Ice Cream Segment operating expenses increased $2,656,813 or 45.4%, to $8,503,239 for the nine months ended February 28, 2022, as compared to $5,846,426 for the nine months ended February 28, 2021. The increase was primarily due to the inclusion of the Ample Hills business, acquired in July 2020.

Measurement Segment operating expenses increased $223,564, or 25.6%, to $1,095,856 for the three months ended February 28, 2022, as compared to $872,292 for the three months ended February 28, 2021. Measurement Segment operating expenses increased $299,387, or 10.6%, to $3,127,341 for the nine months ended February 28, 2022, as compared to $2,827,953 for the nine months ended February 28, 2021. The operating expense increase was driven by higher corporate administrative costs supporting the Measurement businesses, as well as higher professional fees.

Gain on Sale of Property and Equipment – During the nine months ended February 28, 2022, the Company recorded a gain on the sale of property and equipment totaling $4,598,095. The gain is primarily the result of the sale of a two story 35,050 sq. foot building located at 2451 NW 28th Avenue, Portland, OR. On November 10, 2021, the Company closed on the sale of this building for $5,100,000 gross proceeds.

Bargain Purchase Gain - In connection with the acquisition of Ample Hills on July 9, 2020, the Company recognized an initial bargain purchase gain of $1,271,615 that was recorded as a component of other income on the consolidated statement of operations. The bargain purchase gain amount represents the excess of the estimated fair value of net assets acquired over the estimated fair value of the consideration transferred to the sellers and their landlords. In accordance with ASC 805 - Business Combinations (“ASC 805"), we have estimated the fair value of the net assets acquired as of the acquisition date. 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 of $132,807 during the year ended May 31, 2021, which decreased the total bargain purchase gain recognized to $1,138,808. The adjustments were primarily related to additional cure payments subsequent to the acquisition which related to circumstances that existed prior to the acquisition date, and the identification of acquired inventory deemed obsolete as of the acquisition date. See Note 2 – Ample Hills Business Acquisition for further discussion. The purchase price allocation has been finalized as of May 31, 2021, within the measurement period, and no further adjustments will be made.

Interest Expense – Interest expense was $8,232 for the three months ended February 28, 2022, as compared to $5,400 for the three months ended February 28, 2021. Interest expense was $37,811 for the nine months ended February 28, 2022, as compared to $12,854 for the nine months ended February 28, 2021.

Other Income, Net - Other income, net, primarily consists of rental income, interest income and other income. Other income, net was $38,286 for the three months ended February 28, 2022, as compared to other income of $90,703 for the three months ended February 28, 2021. Other income, net, was $323,590 for the nine months ended February 28, 2022, as compared to $58,777 for the nine months ended February 28, 2021.

Income Taxes - The effective tax rate was 0.9% and 5.5%, respectively, for the three and nine months ended February 28, 2022. The effective tax rate was (0.1%) and (8.0%), respectively, for the three and nine months ended February 28, 2021. The effective tax rate on consolidated net loss for the three months ended February 28, 2022 and February 28, 2021 differs from the federal statutory tax rate primarily due to changes in the deferred tax asset valuation allowance. For the three months ended February 28, 2021, the tax benefit recorded related to the bargain purchase gain and changes in the deferred tax asset valuation allowance. 

Net Income (Loss) - Net loss was ($893,244), or ($0.24), per fully diluted share, for the three months ended February 28, 2022, as compared to net loss of (2,419,797), or ($0.64), per fully diluted share, for the three months ended February 28, 2021. Net income was $249,629, or $0.07, per fully diluted share, for the nine months ended February 28, 2022, as compared to net loss of ($4,635,607), or ($1.23), per fully diluted share, for the nine months ended February 28, 2021.

COVID-19 Update

As of February 28, 2022, all of the Company’s manufacturing facilities and retail shops were operational. Throughout the COVID-19 pandemic, the Company has been adhering to mandates and other guidance from local governments and health authorities, including the World Health Organization and the Centers for Disease Control and Prevention. The Company has taken extraordinary measures and invested significantly in practices to protect employees and reduce the risk of spreading the virus, while continuing to operate where permitted and to the extent possible. These actions include additional cleaning of our facilities, staggering crews, incorporating visual cues to reinforce social distancing, providing face coverings and gloves, as well as implementing daily health validation at our manufacturing and office facilities. We expect to continue to incur costs to maintain these precautionary measures for the foreseeable future. The health and safety of our employees and our communities is our highest priority.

LIQUIDITY AND CAPITAL RESOURCES

The Company's net working capital decreased $1,648,791 to $1,299,162 as of February 28, 2022, as compared to $2,947,953 as of May 31, 2021. 

Net cash used in operating activities was $6,907,162 during the nine months ended February 28, 2022, as compared to net cash used in operating activities of $5,657,905 during the nine months ended February 28, 2021. The net cash used in operating activities was primarily driven by a gain on disposal of property and equipment of $4,598,095 and forgiveness of part of the First Draw PPP Loan received through the Paycheck Protection Program (“PPP”) totaling $2,059,826. These uses of cash were offset by net income of $249,629, depreciation and amortization of $401,448, non-cash lease costs of $92,042, stock-based compensation of $95,016, an increase in inventories of $638,534, an increase in rent, utility deposits and ERP deposits of $397,193, a decrease in accounts receivable, net of $217,836, a decrease in accrued liabilities and customer deposits of $409,187, a decrease in accounts payable of $27,776, and a decrease in prepaid expenses of $167,478.

Net cash provided by investing activities was $4,609,237 for the nine months ended February 28, 2022, as compared to net cash used in investing activities of $2,188,225 for the nine months ended February 28, 2021. The net cash provided by investing activities for the nine months ended February 28, 2022 is driven by proceeds from the sale of property and equipment of $4,797,924, offset partially by purchases of property and equipment of $188,687. The net cash used in investing activities for the nine months ended February 28, 2021 was primarily the result of the acquisition of Ample Hills and associated cure costs totaling $1,713,404 and purchases of property and equipment totaling $510,321, partially offset by proceeds from the sale of property and equipment of $35,500.

Net cash provided by financing activities was $264,476 during the nine months ended February 28, 2022, as compared to net cash provided by financing activities of $1,445,963 for the nine months ended February 28, 2021. The net cash provided by financing activities for the nine months ended February 28, 2022 was due to the forgiveness of part of the First Draw PPP Loan received through the PPP, which resulted in a repayment to the Company of $264,476 for a loan payment previously made by the Company on this loan. The net cash provided by financing activities for the nine months ended February 28, 2021 was primarily the result of proceeds received by the Company for the First Draw PPP Loan totaling $2,059,556, offset by a repayment of the PPP loan totaling $264,476, the repurchases of common stock totaling $300,492 and payments on short-term borrowing of $48,625.

Management is seeking to sell the assets held for sale, which would be a source of liquidity for the Company, though there can be no assurance as to whether the Company will consummate a sale or as to the proceeds the Company would receive in any such sale.

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. The Company may seek to generate additional cash, whether the remaining 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.

On August 7, 2021, the Company received The Commitment Letter to Schmitt Industries (“Commitment”) from Michael Zapata, our Chief Executive Officer (“CEO”). The Commitment states that Sententia Capital Management LLC (“SCM”) or its affiliated entities will provide additional capital as required to Schmitt up to $1,300,000 for the Company’s operations as needed through February 28, 2023. The Company has not requested or used any of the $1,300,000 as of February 28, 2022.

On August 2, 2021, the Company requested forgiveness of the First Draw PPP Loan and provided documentation in accordance with SBA requirements and certified the amounts requested to be forgiven qualified under the requirements. On August 28, 2021, the Company received correspondence from Bank of America, which included a Notice of Paycheck Protection Program Forgiveness Payment from SBA for a portion of the First Draw PPP Loan in the amount of $588,534. In February 2022, the Company received notification that the remaining First Draw PPP Loan had been forgiven by the SBA in the amount of $1,471,022. The Company must retain all records for the PPP loan for six years from the date the loan is forgiven. Additionally, subsequent to receiving the First Draw PPP Loan in fiscal 2021, the Company repaid $264,476. During the nine months ended February 28, 2022, Bank of America returned this payment to the Company as a result of a portion of the First Draw PPP loan being forgiven.

Going Concern

In connection with preparing the consolidated financial statements for the three and nine months ended February 28, 2022, management evaluated whether there were conditions and events, considered in the aggregate, that raised substantial doubt about the Company’s ability to continue as a going concern within one year from the date the financial statements are issued. In making this assessment we performed a comprehensive analysis of our current circumstances including our financial position and cash usage forecasts. The analysis used to determine the Company’s ability as a going concern does not include cash sources outside the Company’s direct control that management expects to be available within the next 12 months. The Company has incurred significant losses and has not demonstrated sufficient revenues to achieve profitable operations on a consolidated basis. In addition, the Company will continue to generate losses from operations for at least one year and will require additional financing until the operations achieve profitability. These factors could create substantial doubt as to the Company’s ability to continue as a going concern for at least one year after the date our unaudited condensed consolidated financial statements are issued. However, management expects that our existing cash and cash equivalents, planned sale of real estate assets, our access to the Sententia Capital Management Commitment Letter, and any potential additional equity financing, will be sufficient to fund our anticipated level of operations through at least April 2023 and alleviates substantial doubt about the Company’s ability to continue as a going concern.

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 year ended May 31, 2021.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Securities Exchange Act of 1934, as amended (Exchange Act), is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms. Our disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in our reports filed under the Exchange Act is accumulated and communicated to management as appropriate to allow timely decisions regarding required disclosures. 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.

An evaluation was carried out under the supervision and with the participation of the Company’s management, including the CEO and Chief Financial Officer (“CFO”), of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report as defined in Exchange Act Rule 13a-15(e) and Rule 15d-15(e). Based on that evaluation, the CEO and CFO have concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were not effective in ensuring that information required to be disclosed in our Exchange Act reports is (1) recorded, processed, summarized and reported in a timely manner, and (2) accumulated and communicated to our management, including our CEO and CFO, as appropriate, to allow timely decisions regarding required disclosure.

As previously disclosed in Item 9A of our Annual Report on Form 10-K for the year ended May 31, 2021, 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 stock-based compensation, accounts receivable, accounts payable, inventory, accrued liabilities, sales taxes, expense classification, depreciation of property and equipment, net and earnings per share. 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.

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. As a result of the material weakness, our CEO and CFO have concluded that, as of February 28, 2022, the end of the period covered by this report, our disclosure controls and procedures were not effective at a reasonable assurance level.

Remediation of Material Weaknesses

Management developed a remediation plan in response to the material weakness identified. Management has leveraged 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. Additional accounting resources include the Company’s announcement of the appointment of Philip Bosco as CFO on November 6, 2020, effective December 1, 2020. In addition, a consulting firm has been engaged to assist with the development and implementation of our internal controls remediation plan.

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 weakness and enhance our overall control environment. 

This quarterly report does not include an attestation report of the Company's registered public accounting firm regarding internal control over financial reporting. Management's report was not subject to attestation by the Company's registered public accounting firm pursuant to SEC rules adopted in conformity with the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.

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 fiscal year ending May 31, 2021, the Company acquired the Ample Hills business. As of February 28, 2022, 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 fiscal year ending May 31, 2022.

During the fiscal year ended May 31, 2021, the Company identified an error in its recording of market-based stock compensation, and recorded an adjustment to the consolidated balance sheet as of May 31, 2021, the consolidated statement of operations and the 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 quarter ended February 28, 2022 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

There have been no material changes from the risk factors set forth in Part I, Item 1A, “Risk Factors” of the year ended May 31, 2021 except as set forth below. The risk factors set forth below supplement, and should be read together with the risk factors disclosed in Part I, Item 1A of our Annual Report on Form 10-K for the year ended May 31, 2021, and 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 and nine months ended February 28, 2022.

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

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

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

Further, the current Russia-Ukraine conflict has created extreme volatility in the global financial markets and is expected to have further global economic consequences, including disruptions of the global supply chain and energy markets. Any such volatility and disruptions may have adverse consequences on us or the third parties on whom we rely. If the equity and credit markets deteriorate, including as a result of political unrest or war, it may make any necessary debt or equity financing more difficult to obtain in a timely manner or on favorable terms, more costly or more dilutive. Our business, financial condition and results of operations may be materially and adversely affected by any negative impact on the global economy and capital markets resulting from the conflict in Ukraine or any other geopolitical tensions.

Our profitability is vulnerable to inflation and cost increases.

Current and future increases in costs such as the cost of raw materials, components, merchandise, shipping rates, freight costs, fuel costs and store occupancy costs may reduce our profitability. These cost increases may be the result of inflationary pressures that could further reduce our sales or profitability. Increases in other operating costs, including changes in energy prices, wage rates and lease and utility costs, may increase our cost of goods sold or operating expenses. Competitive pressures in our industry may have the effect of inhibiting our ability to reflect these increased costs in the prices of our products and therefore reduce our profitability.

Item 5. Other Information

On March 4, 2022, March 15, 2022, and April 13, 2022, the Company signed three new retail lease agreements in conjunction with its plans to expand its Ample Hills store footprint.

On April 13, 2022, the Company formalized drawdown terms on its existing $1,300,000 Commitment Letter with its CEO, which states that SCM or its affiliates will provide the Company with additional capital of up to $1,300,000 for the Company’s operations, as needed, through February 28, 2023. Drawdown terms include: 1.0% origination fee, 18-month term after drawdown, 8.0% payment-in-kind interest rate.

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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