UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

For the quarterly period ended: November 30, 2007February 29, 2008

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

For the transition period from: To:

Commission File Number: 000-23996

SCHMITT INDUSTRIES, INC.

(Exact name of registrant as specified in its charter)

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

~~2765 NW Nicolai Street, Portland, Oregon 97210-1818~~

~~(Address of principal executive offices) (Zip Code)~~

2765 NW Nicolai Street, Portland, Oregon 97210-1818

(Address of principal executive offices) (Zip Code)

(503) 227-7908

(Registrant’s telephone number, including area code)

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

~~Yes~~

Yes xNo o

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

Large accelerated filer o		Accelerated filer o

Non-accelerated filer x (Do not check if a smaller reporting company)	Smaller reporting company o

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

The number of shares of each class of common stock outstanding as of ~~January 15,~~March 31, 2008

Common stock, no par value2,870,160

~~2,670,183~~

SCHMITT INDUSTRIES, INC.

INDEX TO FORM 10-Q

		Page
Part I - FINANCIAL INFORMATION


Item 1.	Financial Statements:

	Consolidated Balance Sheets:	3
	– ~~November 30, 2007~~February 29, 2008 and May 31, 2007 (unaudited)

	Consolidated Statements of Operations:	4
	– For the Three and Nine Months Ended February 29, 2008 and February 28, 2007 (unaudited)

	Consolidated Statements of ~~Operations:~~ ~~– For the Three and Six Months Ended November 30, 2007 and 2006 (unaudited)~~Cash Flows:
		5
	~~Consolidated Statements of Cash Flows:~~ – For the ~~Six~~Nine Months Ended ~~November 30,~~February 29, 2008 and February 28, 2007 ~~and 2006~~ (unaudited)

	Consolidated Statement of Changes in Stockholders’ Equity and Comprehensive Income:	6
	– For the ~~Six~~Nine Months Ended ~~November 30, 2007~~February 29, 2008 (unaudited)

	Notes to Consolidated Interim Financial Statements	7

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

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	24

Item 4.	Controls and Procedures	24

Part II - OTHER INFORMATION

Item 6.	Exhibits	25

Signatures

Certifications

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

SCHMITT INDUSTRIES, INC.

CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

	November 30, 2007			May 31, 2007			February 29, 2008			May 31, 2007
ASSETS
Current assets
Cash and cash equivalents	$	2,263,306		$	1,513,061		$	4,238,369		$	1,513,061
Short-term investments	3,478,100			3,964,650			1,515,666			3,964,650
Accounts receivable, net of allowance of $25,865 and $20,818 at November 30, 2007 and May 31, 2007, respectively	1,533,061			1,461,511
Accounts receivable, net of allowance of $25,210 and $20,818 at February 29, 2008 and May 31, 2007, respectively							1,440,332			1,461,511
Inventories	3,664,311			3,690,363			3,627,228			3,690,363
Prepaid expenses	59,647			71,331			115,040			71,331
Income taxes receivable	51,380			—			47,486			—
Deferred tax asset	138,875			144,957			137,070			144,957
	11,188,680			10,845,873			11,121,191			10,845,873
Property and equipment
Land	299,000			299,000			299,000			299,000
Buildings and improvements	1,348,080			1,336,181			1,389,390			1,336,181
Furniture, fixtures and equipment	839,982			826,380			863,110			826,380
Vehicles	95,848			97,955			95,848			97,955
	2,582,910			2,559,516			2,647,348			2,559,516
Less accumulated depreciation and amortization	(1,328,284		)	(1,333,738		)	(1,367,500		)	(1,333,738		)
	1,254,626			1,225,778
							1,279,848			1,225,778
Other assets
Long-term deferred tax asset	566,180			32,780			552,740			32,780
Other assets	586,094			373,797			2,011,901			373,797
	1,152,274			406,577			2,564,641			406,577
TOTAL ASSETS	$	13,595,580		$	12,478,228		$	14,965,680		$	12,478,228

LIABILITIES & STOCKHOLDERS’ EQUITY
Current liabilities
Accounts payable	$	459,977		$	343,152		$	478,663		$	343,152
Accrued commissions	271,371			225,782			185,724			225,782
Accrued payroll liabilities	78,356			83,365			79,553			83,365
Other accrued liabilities	282,208			319,289			347,148			319,289
Income taxes payable	—			142,108			—			142,108
Total current liabilities	1,091,912			1,113,696			1,091,088			1,113,696
Other long term liabilities	602,217			—			564,384			—

Stockholders’ equity
Common stock, no par value, 20,000,000 shares authorized, 2,670,183 and 2,664,419 shares issued and outstanding at November 30, 2007 and May 31, 2007, respectively	8,152,835			8,114,251
Common stock, no par value, 20,000,000 shares authorized, 2,870,160 and 2,664,419 shares issued and outstanding at February 29, 2008 and May 31, 2007, respectively							9,340,352			8,114,251
Accumulated other comprehensive loss	(107,433		)	(122,050		)	(114,324		)	(122,050		)
Retained earnings	3,856,049			3,372,331			4,084,180			3,372,331
Total stockholders’ equity	11,901,451			11,364,532			13,310,208			11,364,532
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	13,595,580		$	12,478,228		$	14,965,680		$	12,478,228

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

SCHMITT INDUSTRIES, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE THREE AND ~~SIX~~NINE MONTHS ENDED ~~NOVEMBER 30,~~FEBRUARY 29, 2008 AND FEBRUARY 28, 2007 ~~AND 2006~~

(UNAUDITED)

	Three Months Ended November 30,				Six Months Ended November 30,				Three Months Ended February 29 and 28,					Nine Months Ended February 29 and 28,
	2007		2006		2007		2006		2008			2007		2008		2007

Net sales	$	3,110,921	$	2,961,176	$	5,449,926	$	6,070,690	$	2,811,111		$	3,003,110	$	8,261,037	$	9,073,800
Cost of sales	1,421,593		1,319,244		2,525,233		2,830,467		1,359,778			1,282,398		3,885,011		4,112,865
Gross profit	1,689,328		1,641,932		2,924,693		3,240,223		1,451,333			1,720,712		4,376,026		4,960,935

Operating expenses:
General, administration and sales	1,222,955		1,295,480		2,199,791		2,407,242		1,120,664			1,105,394		3,320,455		3,512,636
Research and development	189,802		18,240		235,194		39,449		180,916			15,041		416,110		54,490
Total operating expenses	1,412,757		1,313,720		2,434,985		2,446,691		1,301,580			1,120,435		3,736,565		3,567,126

Operating income	276,571		328,212		489,708		793,532		149,753			600,277		639,461		1,393,809

Other income	60,768		45,973		133,546		86,245		64,378			44,372		197,924		130,617

Income before income taxes	337,339		374,185		623,254		879,777		214,131			644,649		837,385		1,524,426
Provision for income taxes	72,500		103,000		174,000		338,000

Provision (benefit) for income taxes									(14,000		)	257,000		160,000		595,000

Net income	$	264,839	$	271,185	$	449,254	$	541,777	$	228,131		$	387,649	$	677,385	$	929,426

Net income per common share:

Basic	$	0.10	$	0.10	$	0.17	$	0.20	$	0.08		$	0.15	$	0.25	$	0.35

Diluted	$	0.10	$	0.10	$	0.16	$	0.20	$	0.08		$	0.14	$	0.24	$	0.34

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

SCHMITT INDUSTRIES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE ~~SIX~~NINE MONTHS ENDED ~~NOVEMBER 30,~~FEBRUARY 29, 2008 AND FEBRUARY 28, 2007 ~~AND 2006~~

(UNAUDITED)

	Six Months Ended November 30,						Nine Months Ended February 29 and 28,
	2007			2006			2008			2007
Cash flows relating to operating activities
Net income	$	449,254		$	541,777		$	677,385		$	929,426
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	92,421			104,463			141,870			157,147
Loss on disposal of property and equipment	703			8,813			703			7,558
Deferred taxes	(17,145		)	190,970			(1,900		)	553,260
Stock based compensation	15,305			26,918			22,957			40,377
Tax benefit related to stock options	10,175			8,739			10,175			8,739
Excess tax benefit from stock based compensation	(10,202		)				(10,202		)	—
Other, net	6,962			—			(30,871		)	—
(Increase) decrease in:
Accounts receivable	(59,304		)	409,557			22,432			15,036
Inventories	30,126			(68,979		)	63,544			(403,886		)
Prepaid expenses	12,042			24,962			(43,763		)	(50,927		)
Income taxes receivable	(51,380		)	—			(47,486		)	—
Increase (decrease) in:
Accounts payable	113,944			176,366			134,780			258,206
Accrued liabilities and customer deposits	692			(113,885		)	(17,188		)	(181,908		)
Income taxes payable	(22,562		)	(4,407		)	(22,562		)	(69,650		)
Net cash provided by operating activities	571,031			1,305,294			899,874			1,263,378

Cash flows relating to investing activities
Purchase of short-term investments	(6,013,450		)	(4,491,807		)	(7,551,016		)	(7,488,747		)
Maturities of short-term investments	6,500,000			3,000,000			10,000,000			5,500,000
Purchase of property and equipment	(104,591		)	(47,379		)	(170,718		)	(132,884		)
Proceeds from sale of property and equipment	100			—			100			—
Advances and payments on business being acquired	(229,576		)	—
Advances and payments on asset acquisition							(484,158		)	(125,000		)
Net cash provided (used) in investing activities	152,483			(1,539,186		)	1,794,208			(2,246,631		)

Cash flows relating to financing activities
Repayments on long-term obligations	—			(9,648		)	—			(12,046		)
Common stock issued on exercise of stock options	13,104			61,041			13,104			61,041
Excess tax benefit from stock based compensation	10,202			—			10,202			—
Net cash provided by financing activities	23,306			51,393			23,306			48,995

Effect of foreign exchange translation on cash	3,425			70,757			7,920			94,942

Increase (decrease) in cash and cash equivalents	750,245			(111,742		)	2,725,308			(839,316		)

Cash and cash equivalents, beginning of period	1,513,061			1,552,072			1,513,061			1,552,072

Cash and cash equivalents, end of period	$	2,263,306		$	1,440,330		$	4,238,369		$	712,756

Supplemental Disclosure of Cash Flow Information
Cash paid during the period for interest	$	—		$	206		$	—		$	303
Cash paid during the period for income taxes	$	248,200		$	143,028		$	252,894		$	143,734

Non cash common stock issued in connection with asset acquisition							$	1,179,865		$	—

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

SCHMITT INDUSTRIES, INC.

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

AND COMPREHENSIVE INCOME

FOR THE ~~SIX~~NINE MONTHS ENDED ~~NOVEMBER 30, 2007~~FEBRUARY 29, 2008

(UNAUDITED)

				Accumulated
				other							Total
				comprehensive			Retained				comprehensive		Shares	Amount		Accumulated other comprehensive loss			Retained earnings		Total		Total comprehensive income
	Shares	Amount		loss			earnings		Total		income
Balance, May 31, 2007	2,664,419	$	8,114,251	$	(122,050	)	$	3,372,331	$	11,364,532			2,664,419	$	8,114,251	$	(122,050	)	$	3,372,331	$	11,364,532
Adoption of FIN 48							34,464		34,464										34,464		34,464
Stock options exercised and related tax benefit of $10,175	5,764	23,279		—			—		23,279				5,764	23,279		—			—		23,279
Stock based compensation		15,305		—					15,305					22,957		—			—		22,957
Common stock issued in connection with asset acquisition													199,977	1,179,865							1,179,865
Net income	—	—		—			449,254		449,254		$	449,254	—	—		—			677,385		677,385		$	677,385
Other comprehensive income	—	—		14,617			—		14,617		14,617		—	—		7,726			—		7,726		7,726
Balance, November 30, 2007	2,670,183	$	8,152,835	$	(107,433	)	$	3,856,049	$	11,901,451
Balance, February 29, 2008													2,870,160	$	9,340,352	$	(114,324	)	$	4,084,180	$	13,310,208

Comprehensive income, six months ended November 30, 2007											$	463,871
Comprehensive income, nine months ended February 29, 2008																							$	685,111

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

SCHMITT INDUSTRIES, INC.

NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS

Note 1:

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The consolidated financial information included herein has been prepared by Schmitt Industries, Inc. (the Company or Schmitt) and its wholly owned subsidiaries. In the opinion of management, the accompanying unaudited Consolidated Financial Statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission and contain all adjustments, consisting only of normal recurring adjustments, necessary to present fairly its financial position as of ~~November 30, 2007~~February 29, 2008 and its results of operations for the three and nine months ended February 29, 2008 and February 28, 2007 and its cash flows for the ~~three and six~~nine months ended ~~November 30, 2007~~February 29, 2008 and ~~2006.~~February 28, 2007. The consolidated balance sheet at May 31, 2007 has been derived from the Annual Report on Form 10-K for the fiscal year ended May 31, 2007. The accompanying unaudited financial statements and related notes should be read in conjunction with the audited financial statements included in our Annual Report on Form 10-K for the fiscal year ended May 31, 2007. 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, 2008. Certain amounts in prior periods’ financial statements have been reclassified to conform to the current periods’ presentation. These reclassifications did not affect consolidated net income.

Revenue Recognition and Accounts Receivable

The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable and collectability is reasonably assured. For sales to all customers, including manufacturer representatives, distributors or their third-party customers, these criteria are met at the time product is shipped. When other significant obligations remain after products are delivered, revenue is recognized only after such obligations are fulfilled. Substantially all product sales are sold FCA (free carrier) shipping point and any related shipping and handling costs are expensed as incurred and included in cost of sales.

Recent Issued Accounting Pronouncements

The Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (FIN 48) in June 2006. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in our financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes” (SFAS 109). Additionally, in May 2007, the FASB published FASB Staff Position No. FIN 48-1, “Definition of Settlement in FASB Interpretation No. 48” (FSP FIN 48-1). FSP FIN 48-1 is an amendment to FIN 48. It clarifies how an enterprise should determine whether a tax position is effectively settled for the purpose of recognizing previously unrecognized tax benefits. FSP FIN 48-1 is effective upon the initial adoption of FIN 48. The provisions of FIN 48 are effective for our fiscal year beginning June 1, 2007. The adoption of FIN 48 did not have a material impact on the Company’s results of operations and cash flows. Refer to Note 5 of the Notes to Consolidated Interim Financial Statements for discussion of the impact of adoption of FIN 48.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (SFAS 157). SFAS 157 defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and expands disclosures about fair value measurements. The provisions of SFAS 157 are effective for the fiscal year beginning June 1, 2008. The Company is currently evaluating the impact of the provisions of SFAS 157.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities including an Amendment of FASB Statement No. 115” (SFAS 159). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value. The provisions of SFAS 159 are effective for the fiscal year beginning June 1, 2008. The Company is currently evaluating the impact of the provisions of SFAS 159.

In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations, which replaces SFAS No 141. The statement retains the purchase method of accounting for acquisitions, but requires a number of changes, including changes in the way assets and liabilities are recognized in the purchase accounting. It also changes the recognition of assets acquired and liabilities assumed arising from contingencies, requires the capitalization of in-process research and development at fair value, and requires the expensing of acquisition-related costs as incurred. SFAS No. 141R is effective beginning June 1, 2009 and will apply prospectively to business combinations completed on or after that date.

In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB 51, which changes the accounting and reporting for minority interests. Minority interests will be recharacterized as noncontrolling interests and will be reported as a component of equity separate from the parent’s equity, and purchases or sales of equity interests that do not result in a change in control will be accounted for as equity transactions. In addition, net income attributable to the noncontrolling interest will be included in consolidated net income on the face of the income statement and, upon a loss of control, the interest sold, as well as any interest retained, will be recorded at fair value with any gain or loss recognized in earnings. SFAS No. 160 is effective beginning June 1, 2009 and will apply prospectively, except for the presentation and disclosure requirements, which will apply retrospectively. The Company is currently evaluating the impact of the provisions of SFAS 160.

Note 2:

LINE OF CREDIT

The Company has a $1.0 million bank line of credit secured by U.S. accounts receivable, inventories and general intangibles which expires on March 1, 2009. Interest is payable at the bank’s prime rate, ~~7.5%~~6% as of ~~November 30, 2007.~~February 29, 2008. There were no outstanding balances on the line of credit at ~~November 30, 2007.~~February 29, 2008.

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 value of the portion of the stock-based award that will vest during the period, adjusted for expected forfeitures. Compensation cost for all stock-based awards is recognized using the straight-line method. Stock-based compensation recognized in the Company’s Consolidated Financial Statements for the three and ~~six~~nine months ended ~~November 30, 2007~~February 29, 2008 includes compensation cost for stock-based awards granted prior to, but not fully vested as of, May 31, 2006. There were no stock-based awards granted subsequent to May 31, 2006. The Company uses the Black-Scholes option pricing model as its method of valuation for stock-based awards. The Black-Scholes option pricing model requires the input of highly subjective assumptions, and other reasonable assumptions could provide differing results. These variables include, but are not limited to:

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

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

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

•· Expected Dividend Yield.The Company has never paid any cash dividends on its common stock and does not anticipate paying any cash dividends in the foreseeable future. Consequently, the Company uses an expected dividend yield of zero.

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

The Company has computed, to determine stock-based compensation expense recognized for the three and ~~six~~nine months ended ~~November 30,~~February 29, 2008 and February 28, 2007, ~~and 2006,~~ the value of all stock options granted using the Black-Scholes option pricing model using the following assumptions:

Risk-free interest rate		3.8-4.45%
Expected life		4.0-4.7 years
Expected volatility		95-102%

At ~~November 30, 2007~~February 29, 2008 the Company had a total of 170,109 outstanding stock options (163,859 vested and exercisable and 6,250 non-vested) with a weighted average exercise price of $2.58. The Company estimates that a total of approximately ~~$15,000~~$7,650 will be recorded as additional stock-based compensation expense ~~over~~during the ~~period beginning with the~~fourth quarter ~~ending February 29, 2008 through the fiscal year~~ ending May 31, 2008, for all options which are outstanding as of ~~November 30, 2007,~~February 29, 2008, but which were not yet vested.

Outstanding Options	Outstanding Options				Exercisable Options			Outstanding Options				Exercisable Options
Number of Shares		Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (yrs)	Number of Shares	Weighted Average Exercise Price			Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (yrs)	Number of Shares	Weighted Average Exercise Price
76,110		$	1.20	4.3	76,110	$	1.20		$	1.20	4.0	76,110	$	1.20
62,499		2.30		6.5	62,499	2.30			2.30		6.3	62,499	2.30
5,000		5.80		7.9	5,000	5.80			5.80		7.7	5,000	5.80
26,500		6.58		7.8	20,250	6.58			6.58		7.6	20,250	6.58
170,109		$	2.58	5.8	163,859	$	2.42		$	2.58	5.5	163,859	$	2.42

Options granted, exercised, canceled and expired under the Company’s stock option plan during the three and ~~six~~nine months ended ~~November 30, 2007~~February 29, 2008 are summarized as follows:

	Three Months Ended November 30, 2007				Six Months Ended November 30, 2007				Three Months Ended February 29, 2008			Nine Months Ended February 29, 2008
	Number of Shares		Weighted Average Exercise Price		Number of Shares		Weighted Average Exercise Price		Number of Shares	Weighted Average Exercise Price		Number of Shares		Weighted Average Exercise Price
Options outstanding - beginning of period	171,359		$	2.58	175,873		$	2.57	170,109	$	2.58	175,873		$	2.57

Options granted	—				—				—			—
Options exercised	(1,250	)	2.30		(5,764	)	2.27		—			(5,764	)	2.27
Options forfeited/cancelled	—				—				—			—
Options outstanding - November 30, 2007	170,109		$	2.58	170,109		$	2.58
Options outstanding - February 29, 2008									170,109	$	2.58	170,109		$	2.58

Note 4:

EPS RECONCILIATION

	Three Months Ended November 30,		Six Months Ended November 30,		Three Months Ended February 29 and 28,		Nine Months Ended February 29 and 28,
	2007	2006	2007	2006	2008	2007	2008	2007
Weighted average shares (basic)	2,669,180	2,647,245	2,668,528	2,642,468	2,692,158	2,642,919	2,676,375	2,645,655

Effect of dilutive stock options	107,636	193,045	114,419	198,020	98,468	188,162	109,954	194,768

Weighted average shares (diluted)	2,776,816	2,840,290	2,782,947	2,840,488	2,790,626	2,831,081	2,786,329	2,840,423

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

Note 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.

Adoption of FIN 48

Each year the ~~company~~Company files income tax returns in the various national, state and local income taxing jurisdictions in which it operates. These tax returns are subject to examination and possible challenge by the taxing authorities. Positions challenged by the taxing authorities may be settled or appealed by the Company. As a result, there is an uncertainty in income taxes recognized in the Company’s financial statements in accordance with SFAS No. 109. In 2006, the FASB issued FIN 48, which clarifies the application of SFAS 109 by defining criteria that an individual income tax position must meet for any part of the benefit of that position to be recognized in an enterprise’s financial statements and provides guidance on measurement, derecognition, classification, accounting for interest and penalties, accounting in interim periods, disclosure, and transition.

On June 1, 2007, the Company adopted the provisions of FIN 48. The adoption of FIN 48 resulted in a $34,464 decrease in the Company’s liability for unrecognized tax benefits, which was accounted for as an increase to the June 1, 2007 retained earnings balance. At June 1, 2007 the gross amount of unrecognized tax benefits was approximately $586,000, which includes approximately $150,000 of net unrecognized tax benefits that, if recognized, would reduce the Company’s effective income tax rate. ~~Unrecognized tax benefits did not change significantly~~The Company settled liabilities of approximately $40,000 during the ~~three or six month periods~~third quarter and nine months ended ~~November 30, 2007.~~February 29, 2008, respectively, which resulted in a benefit and reduction of the Company’s effective income tax rate in the third quarter of Fiscal 2008. Other long-term liabilities related to tax contingencies were $564,384 as of February 29, 2008.

Interest and penalties associated with uncertain tax positions are recognized as components of the “Provision for income taxes.” The Company’s accrual for interest and penalties was $96,500 upon adoption of FIN 48. The liability for payment of interest and penalties did not significantly change during the three or ~~six~~nine months ended ~~November 30, 2007.~~February 29, 2008.

Several tax years are subject to examination by major tax jurisdictions. In the United States, federal tax years for Fiscal 2004 and after are subject to examination. In the United Kingdom, tax years for Fiscal 2006 and after are subject to examination. In the United States, returns related to an acquired subsidiary for the year ~~ending~~ended October 31, 1994 and final return for the period ~~ending~~ended May 19, 1995 are also subject to examination.

Effective Tax Rate

Our effective tax rate on consolidated net income was ~~27.9%~~19.1% for the ~~six~~nine months ended ~~November 30, 2007.~~February 29, 2008. Our effective tax rate on consolidated net income differs from the federal statutory tax rate primarily due to the settlement of unrecognized tax benefits, the difference between prior years reported income tax provision and the actual filed income tax returns, certain expenses not deductible for income tax reporting offset by lower effective tax rates on net income reported by the Company’s wholly owned subsidiary, Schmitt Europe Ltd. (SEL), located in the United Kingdom. Management believes the effective tax rate on consolidated net income in future periods will reflect a normal combined state and federal rate, net of the effect from settlement of unrecognized tax benefits, expenses not deductible for income tax reporting and net income or losses reported by SEL.

Note 6:

SEGMENTS OF BUSINESS

The Company has two reportable business segments: the design and assembly of dynamic balancing systems for the machine tool industry (Balancer), and the design and assembly of laser measurement systems (Measurement). The Company operates in three principal geographic markets: North America, Europe and Asia.

Segment Information

	Three Months Ended November 30,												Three Months Ended February 29 and 28,
	2007						2006						2008						2007
	Balancer			Measurement			Balancer			Measurement			Balancer			Measurement			Balancer			Measurement
Gross sales	$	2,482,498		$	799,193		$	2,054,749		$	1,149,530		$	2,308,342		$	841,921		$	2,097,645		$	1,085,874
Intercompany sales	(155,333		)	(15,437		)	(156,545		)	(86,558		)	(333,446		)	(5,706		)	(168,646		)	(11,763		)
Net sales	$	2,327,165		$	783,756		$	1,898,204		$	1,062,972		$	1,974,896		$	836,215		$	1,928,999		$	1,074,111

Operating income	$	325,306		$	(48,735	)	$	6,579		$	321,633		$	149,893		$	(140	)	$	179,038		$	421,239

Intercompany rent expense (income)	$	—		$	—		$	(7,500	)	$	7,500		$	—		$	—		$	(7,500	)	$	7,500

Depreciation expense	$	31,259		$	7,276		$	35,798		$	7,349		$	32,861		$	7,949		$	37,560		$	6,473

Amortization expense	$	—		$	8,640		$	—		$	8,652		$	—		$	8,639		$	—		$	8,652
Advances and payments on business being acquired	$	229,576		$	—		$	—		$	—

Advances and payments on asset acquisition													$	—		$	1,434,447		$	—		$	125,000

Capital expenditures	$	73,001		$	20,626		$	20,815		$	18,610		$	20,017		$	46,110		$	86,701		$	—

	Six Months Ended November 30,												Nine Months Ended February 29 and 28,
	2007						2006						2008						2007
	Balancer			Measurement			Balancer			Measurement			Balancer			Measurement			Balancer			Measurement
Gross sales	$	4,457,128		$	1,311,523		$	4,301,345		$	2,150,510		$	6,765,470		$	2,153,444		$	6,398,990		$	3,236,384
Intercompany sales	(299,770		)	(18,955		)	(286,084		)	(95,081		)	(633,216		)	(24,661		)	(454,730		)	(106,844		)
Net sales	$	4,157,358		$	1,292,568		$	4,015,261		$	2,055,429		$	6,132,254		$	2,128,783		$	5,944,260		$	3,129,540

Operating income	$	603,365		$	(113,657	)	$	111,991		$	681,541		$	753,258		$	(113,797	)	$	291,029		$	1,102,780

Intercompany rent expense (income)	$	—		$	—		$	(15,000	)	$	15,000		$	—		$	—		$	(22,500	)	$	22,500

Depreciation expense	$	61,086		$	14,056		$	72,434		$	14,725		$	93,947		$	22,005		$	109,993		$	21,198

Amortization expense	$	—		$	17,279		$	—		$	17,304		$	—		$	25,918		$	—		$	25,956
Advances and payments on business being acquired	$	229,576		$	—		$	—		$	—

Advances and payments on asset acquisition													$	—		$	1,664,023		$	—		$	125,000

Capital expenditures	$	76,467		$	28,024		$	28,769		$	18,610		$	96,584		$	74,134		$	114,274		$	18,610

Geographic Information-Net Sales by Geographic Area

	Three Months Ended November 30,						Six Months Ended November 30,						Three Months Ended February 29 and 28,						Nine Months Ended February 29 and 28,
Geographic Sales	2007			2006			2007			2006			2008			2007			2008			2007
North American
United States	$	1,564,418		$	1,445,953		$	2,767,059		$	3,018,284		$	1,413,500		$	1,252,968		$	4,180,559		$	4,271,252
Canada and Mexico	118,350			14,712			203,180			121,191			33,827			33,480			237,007			154,671
Total North American	1,682,768			1,460,665			2,970,239			3,139,475			1,447,327			1,286,448			4,417,566			4,425,923

European
Germany	58,716			82,461			152,774			144,527			91,916			54,043			244,690			198,570
United Kingdom	315,336			357,932			582,142			602,085			457,947			214,845			1,040,089			816,930
Intercompany	(170,770		)	(243,103		)	(318,725		)	(381,165		)	(339,152		)	(180,409		)	(657,877		)	(561,574		)
Total United Kingdom	144,566			114,829			263,417			220,920			118,795			34,436			382,212			255,356
Other European	248,558			575,252			401,820			786,432			427,326			340,264			829,146			1,126,696
Total European	451,840			772,542			818,011			1,151,879			638,037			428,743			1,456,048			1,580,622

Asia	744,097			585,466			1,336,653			1,336,470			479,431			811,167			1,816,084			2,147,637
Other markets	232,216			142,503			325,023			442,866			246,316			476,752			571,339			919,618
Total Net Sales	$	3,110,921		$	2,961,176		$	5,449,926		$	6,070,690		$	2,811,111		$	3,003,110		$	8,261,037		$	9,073,800

	Three Months Ended November 30,								Three Months Ended February 29 and 28,
	2007				2006				2008				2007
	United States		Europe		United States		Europe		United States		Europe		United States		Europe
Operating income (loss)	$	158,316	$	118,255	$	289,921	$	38,291

Operating income									$	97,429	$	52,324	$	538,748	$	61,529

Depreciation expense	$	36,560	$	1,975	$	40,306	$	2,841	$	39,008	$	1,802	$	41,218	$	2,815

Amortization expense	$	8,640	$	—	$	8,652	$	—	$	8,639	$	—	$	8,652	$	—
Advances and payments on business being acquired	$	229,576	$	—	$	—	$	—

Advances and payments on asset acquisition									$	1,434,447	$	—	$	125,000	$	—

Capital expenditures	$	93,627	$	—	$	39,110	$	315	$	66,127	$	—	$	86,701	$	—

	Six Months Ended November 30,									Nine Months Ended February 29 and 28,
	2007				2006					2008				2007
	United States		Europe		United States		Europe			United States		Europe		United States		Europe
Operating income (loss)	$	316,175	$	173,533	$	863,557	$	(70,025	)

Operating income										$	413,604	$	225,857	$	1,159,303	$	234,506

Depreciation expense	$	71,221	$	3,921	$	81,437	$	5,722		$	110,229	$	5,723	$	122,653	$	8,538

Amortization expense	$	17,279	$	—	$	17,304	$	—		$	25,918	$	—	$	25,956	$	—
Advances and payments on business being acquired	$	229,576	$	—	$	—	$	—

Advances and payments on asset acquisition										$	1,664,023	$	—	$	125,000	$	—

Capital expenditures	$	104,491	$	—	$	46,510	$	869		$	170,718	$	—	$	132,317	$	567

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

Segment and Geographic Assets

	February 29, 2008		May 31, 2007
Segment assets to total assets
Balancer	$	4,607,820	$	5,030,049
Measurement	3,866,529		1,792,731
Corporate assets	6,491,331		5,655,448
Total assets	$	14,965,680	$	12,478,228

Geographic assets to total assets
United States	$	14,232,744	$	11,819,905
Europe	732,936		658,323
Total assets	$	14,965,680	$	12,478,228

November 30, 2007

May 31, 2007

Segment assets to total assets

Balancer

$
4,733,548

$
5,030,049

Measurement

1,999,979

1,792,731

Corporate assets

6,863,037

5,655,448

Total assets

$
13,596,564

$
12,478,228

Geographic assets to total assets

United States

$
13,058,739

$
11,819,905

Europe

537,825

658,323

Total assets

$
13,596,564

$
12,478,228

Long-lived assets totaled $1,279,848 of which $1,279,010 were located in the United States.

Note 7:

RELATED PARTY TRANSACTIONS

Effective June 1, 2004, the Company entered into a contract to provide consulting services to PulverDryer USA, Inc. (PulverDryer), pursuant to which PulverDryer paid the Company $8,000 a month from June 2004 through October 2004. PulverDryer also buys certain products from the Company at normal prevailing rates. The Company and PulverDryer extended the contract from November 1, 2004 forward at that same monthly fee of $8,000. Product sales to PulverDryer during the three months ended ~~November 30,~~February 29, 2008 and February 28, 2007 totaled $11,959 and ~~2006 totaled $150 and $7,945,~~$11,710, respectively. Product sales to PulverDryer during the ~~six~~nine months ended ~~November 30,~~February 29, 2008 and February 28, 2007 totaled $15,787 and ~~2006 totaled $3,828 and $19,523,~~$31,233, respectively.

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

Note 8:

~~SUBSEQUENT EVENT~~ACQUISITION

~~The Company entered into a convertible promissory note agreement with Xtero Datacom, Inc. (Xtero) of Vancouver, British Columbia in~~On February 2007 pursuant to which the Company agreed to loan up to $250,000 USD to Xtero to fund product development and testing of Xtero satellite measurement technologies. On October 5, 2007 Xtero and the Company announced the completion of an Interim Acquisition Agreement (Interim Agreement) to acquire Xtero pursuant to which the Company agreed to advance an additional $250,000 to Xtero, pay royalties of 15% to 25% to Xtero for product sales until closing and issue 200,000 shares of Schmitt common stock in exchange for 100% of Xtero at closing. Pursuant to the Interim Acquisition Agreement, Xtero has granted the Company an exclusive license for the Xtero technology, so that the Company can begin necessary production and marketing prior to closing of the Transaction described below. As of November 30, 2007, the Company had advanced $500,000 to Xtero, which funds have been used for patent work and other corporate product development and testing activities, and legal fees incurred by Xtero in connection with the structuring and negotiation of the Transaction. The Company has also reimbursed $89,055 of expenses incurred by or on behalf of Xtero since October 1, 2007, including operational expenses and consulting fees.

~~On December 14, 2007, the Company entered into an Arrangement Agreement with Xtero pursuant to which~~20, 2008 the Company, through its newly formed wholly owned subsidiary, Schmitt Industries (Canada) Limited, a British Columbia corporation (SCL), ~~will acquire~~acquired all of the issued and outstanding common shares of Xtero ~~(the Transaction)~~Datacom Inc., a British Columbia corporation (Xtero). ~~The Arrangement Agreement was entered into in furtherance of~~As consideration for the ~~purposes of the Interim Agreement among Schmitt,~~ Xtero ~~and certain of Xtero’s shareholders. Upon closing of the Transaction, Xtero will become a wholly owned subsidiary of~~shares, the Company ~~and Schmitt will own and operate Xtero’s business, including its patented technologies.~~issued 199,977 shares of Company common stock to the Xtero shareholders. In addition, Xtero shareholders will be eligible to receive shares of SCL stock which are exchangeable for shares of Schmitt common stock on a one-for-one basis based on 50% of the after-tax earnings derived from Xtero products during a five-year earn-out program ending on May 31, 2013. The ~~Transaction is subject~~issuance of the 199,977 shares was not registered, and was made in reliance upon Section 3(a)(10) of the Securities Act of 1933 (the Act), which exempts judicially approved share exchanges from the Act’s registration requirements. Based upon the closing price of the Company’s common stock of $5.90 on February 20, 2008 as reported on the NASDAQ Capital Market, the aggregate value of the Company’s 199,977 shares issued to ~~various conditions, including approval by~~the Xtero shareholders ~~approval by~~was approximately $1,179,865. The aggregate purchase price for the acquisition was $1,864,024 which includes the value of shares issued, advances to Xtero prior to February 20, 2008 on a ~~British Columbia court~~convertible promissory note, Xtero net liabilities assumed and other ~~customary closing conditions, and is expected to close by the end of January 2008.~~transaction costs.

The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition:

Tangible assets and liabilities assumed:
Receivables	$	182,000
Accounts and liabilities payable	(248,657		)
Intangible assets
Purchased technology	1,930,681
Total	$	1,864,024

The allocation process requires an analysis and valuation of acquired assets, including deferred tax assets, technologies, customer contracts and relationships, trade names and liabilities assumed, including contractual commitments and legal contingencies. The values assigned to certain acquired assets and liabilities are preliminary, are based on information available as of February 20, 2008, and may be adjusted as further information becomes available. Additional information that may become available subsequently and may result in changes in the values allocated to various assets and liabilities includes, but is not limited to, unidentified claims from suppliers or other contingent obligations, the amounts required to settle them, and the value of deferred tax assets and liabilities. Any changes in the values allocated to tangible and specifically identified intangible assets acquired and liabilities assumed during the allocation period may result in adjustments to intangible assets.

Purchased technology relates to Xtero’s remote satellite sensing of large chemical storage tanks that have reached technological feasibility. The fair value of the purchased technology is being amortized over the expected remaining useful life of 15 years.

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

Schmitt Industries, Inc. designs, assembles and markets computer controlled balancing equipment (the Balancer Segment) primarily to the machine tool industry. Through its wholly owned subsidiary, Schmitt Measurement Systems, Inc. (SMS), the Company designs, manufactures and markets precision laser measurement systems (the Measurement Segment). The Company also sells and markets its products in Europe through its wholly owned subsidiary, Schmitt Europe Ltd. (SEL), located in the United Kingdom. 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, 2007. Certain amounts in prior periods’ financial information have been reclassified to conform to the current periods’ presentation. These reclassifications did not affect consolidated net income.

RESULTS OF OPERATIONS

Overview

Balancer segment sales focus throughout the world on end-users, rebuilders and original equipment manufacturers of grinding machines with the target geographic markets in North America, Asia and Europe. Combined Balancer sales increased ~~3.5%~~3.2% for the ~~six~~nine months ended ~~November 30, 2007~~February 29, 2008 compared to the ~~six~~nine months ended ~~November 30, 2006.~~February 28, 2007. Balancer sales for the three months ended ~~November 30, 2007~~February 29, 2008 increased ~~22.6%~~2.4% compared to the three months ended ~~November 30, 2006.~~February 28, 2007. North American sales increased ~~11.8%~~6.6% in the ~~six~~nine months ended ~~November 30, 2007~~February 29, 2008 and ~~increased 38.8%~~decreased (3.8%) in the three months ended ~~November 30, 2007~~February 29, 2008 when compared to the same periods ending ~~November 30, 2006.~~February 28, 2007. Market demand in Asia for the Balancer segment products ~~remains solid as that region~~ showed a ~~9.4%~~5.3% increase for the ~~six~~nine months ended ~~November 30, 2007 and increased 33.7%~~February 29, 2008 but did decrease (4.2%) in the three months ended ~~November 30, 2007~~February 29, 2008 when compared to the same periods ending ~~November 30, 2006.~~February 28, 2007. The North American and Asian sales increase for the nine months ended February 29, 2008 is predominately the result of a recovery from softer Balancer sales during the last fiscal year from recent weakness in the worldwide automotive, bearing and aircraft industries and its impact on the machine tool industry. Recent weakness in industrial production ~~toward~~beginning near the end of 2006 and continuing into 2007 especially in the motor vehicle sector, has caused production in other manufacturing industries to soften. These economic conditions in the worldwide automotive, bearing and aircraft industries and its impact on the machine tool industry were the reason for softer Balancer sales during the prior fiscal year. European market sales ~~slowed~~rebounded in the recent fiscal quarter as total Balancer sales into that geographic market ~~decreased (12%)~~increased 31.4% during the ~~six~~three months ended ~~November 30, 2007~~February 29, 2008 compared to the ~~six~~three months ended ~~November 30, 2006~~February 28, 2007 and have ~~decreased (14.2%)~~now increased 1.7% during the ~~most recent three~~nine month period ended ~~November 30, 2007~~February 29, 2008 when compared to the nine months ending February 28, 2007. Sales in all Other markets decreased (20.2%) in the nine months ended February 29, 2008 and decreased (10.9%) for the three months ended February 29, 2008 when compared to the same periods ~~ending November 30, 2006. Sales in all Other markets decreased (26.1%) in the six months~~ ended ~~November 30, 2007 and increased 9.2% for the three months ended November 30, 2007 when compared to the same periods ending November 30, 2006.~~February 28, 2007. As with the North American market, the business conditions in Asia and the European market cannot be forecasted with any certainty.

The Measurement segment product line consists of both laser light-scatter and dimensional sizing products. Combined Measurement sales decreased ~~(37.1%~~(32%) for the ~~six~~nine months ended ~~November 30, 2007~~February 29, 2008 compared to the ~~six~~nine months ended ~~November 30, 2006.~~February 28, 2007. Measurement sales for the three months ended ~~November 30, 2007~~February 29, 2008 decreased ~~(26.3%~~(22.1%) compared to the three months ended ~~November 30, 2006.~~February 28, 2007. The decreased sales volume is primarily due to lack of complete system shipments of laser light-scatter products to disk drive manufacturers and reduced dimensional sizing product sales ~~as well as reduced~~offset by increased CASI Scatterometer sales. As noted below, sales can be very cyclical in the Measurement segment. The business operations and prospects for these two product lines are summarized as follows:

Laser light-scatter products for disk drive and silicon wafer manufacturers –— The primary target markets for Measurement products have been disk drive and silicon wafer manufacturers and companies and organizations involved in research efforts. Sales to these customers totaled ~~$374,222~~$481,672 for the ~~six~~nine months ended ~~November 30, 2007~~February 29, 2008 compared to the ~~$783,046~~$1,401,648 for the ~~six~~nine months ended ~~November 30, 2006.~~February 28, 2007. Due to the significant challenges posed by the need to continually innovate and improve manufacturing efficiency and because of the increasing amounts of capital and research and development expenditure required, the disc drive industry has undergone significant consolidation as disc drive manufacturers and component suppliers merged or exited the industry. Through such combinations, disc drive manufacturers have also become increasingly vertically integrated. Sales to customers in these industries can be very cyclical and therefore the impact of the current weak demand in the disk drive industry on sales to the Company’s laser light-scatter products is unknown at this time and cannot be forecasted with any certainty.

1415

Laser light-scatter products for research organizations – The Company continues to receive inquiries for these products and provide quotes to interested parties. The Company completed the delivery of a CASI Scatterometer system, software and other upgrades in the current fiscal quarter and expects to deliver a new CASI Scatterometer system in the third fiscal quarter of 2008. Measurement sales during the six months and three months ended November 30, 2006 included the delivery of a new CASI Scatterometer system.quarter.

Dimensional sizing products – These products are marketed and sold into a wide array of industries and used in applications from steel casting, paper production, crane control and medical imaging to micron level part and surface inspection. Sales decreased ~~(16.9%~~(16%) for the ~~six~~nine months ended ~~November 30, 2007~~February 29, 2008 and decreased ~~(19.5%~~(14.1%) for the three months ended ~~November 30, 2007~~February 29, 2008 when compared to the same periods ending ~~November 30, 2006.~~February 28, 2007. Sales of these products can be cyclical and therefore the duration of the continued demand cannot be forecasted with any certainty.

Other income increased to $197,924 in the nine months ended February 29, 2008 compared to the $130,617 reported in the same period ended February 28, 2007 and increased to $64,378 in the three months ended February 29, 2008 compared to the $44,372 reported in the same fiscal quarter in the prior fiscal year. The increases are primarily due to improved interest income in Fiscal 2008 compared to 2007 due to increasing interest rates over the past two years. In addition, our average cash, cash equivalents and short-term investment balance was $5.7 million for the nine months ended February 29, 2008 compared to $4.7 million in the same period ended February 28, 2007.

The Company entered into certain agreements (Transaction) with Xtero Datacom, Inc. (Xtero) of Vancouver, British Columbia beginning in February 2007 pursuant to which the Company ~~will acquire~~acquired all of the issued and outstanding common shares of Xtero. Upon closing of the Transaction ~~Xtero will become a wholly owned subsidiary of~~on February 20, 2008, Schmitt ~~and Schmitt will own and operate~~acquired Xtero’s business, including its patented technologies for remote satellite sensing of large chemical storage tanks. The Transaction is subject to various conditions, including approval by Xtero shareholders, approval by a British Columbia court and other customary closing conditions, and is expected to close by the end of January 2008. Refer to Note 8 of the Notes to Consolidated Interim Financial Statements for further discussion of the Transaction.

Critical Accounting Policies

With the adoption of FIN 48 as of June 1, 2007, the Company has added “Uncertain Tax Positions” as a critical accounting policy. There are no other material changes in our critical accounting policies as disclosed in our Annual Report on Form 10-K for the year ended May 31, 2007.

Uncertain Tax Positions – The Company accounts for uncertain tax positions in accordance with FIN 48. The application of income tax law is inherently complex. Laws and regulations in this area are voluminous and are often ambiguous. As such, the Company is required to make many subjective assumptions and judgments regarding income tax exposures. Interpretations of and guidance surrounding income tax laws and regulations change over time, accordingly, changes in the Company’s subjective assumptions and judgments can materially affect amounts recognized in the consolidated balance sheets and consolidated statements of operations. Refer to Note 5 of the Notes to Consolidated Interim Financial Statements for discussion of the impact of adoption of FIN 48.

Recently issued accounting pronouncements:

Refer to Note 1 of the Notes to Consolidated Interim Financial Statements for discussion of recently issued accounting pronouncements.

Discussion of Operating Results

Three months ended ~~November 30,~~February 29, 2008 and 2007 ~~and 2006~~

	Three Months Ended November 30, 2007									Three Months Ended February 29, 2008
	Consolidated			Balancer			Measurement			Consolidated			Balancer			Measurement
	Dollars		%	Dollars		%	Dollars		%	Dollars		%	Dollars		%	Dollars		%
Sales	$	3,110,921	100.0	$	2,327,165	100.0	$	783,756	100.0	$	2,811,111	100.0	$	1,974,896	100.0	$	836,215	100.0
Cost of sales	1,421,593		45.7	1,116,262		48.0	305,331		39.0	1,359,778		48.4	956,704		48.4	403,074		48.2
Gross profit	1,689,328		54.3	$	1,210,903	52.0	$	478,425	61.0	1,451,333		51.6	$	1,018,192	51.6	$	433,141	51.8
Operating expenses	1,412,757		45.4							1,301,580		46.3
Operating income	$	276,571	8.9							$	149,753	5.3

1516

	Three Months Ended November 30, 2006									Three Months Ended February 28, 2007
	Consolidated			Balancer			Measurement			Consolidated			Balancer			Measurement
	Dollars		%	Dollars		%	Dollars		%	Dollars		%	Dollars		%	Dollars		%
Sales	$	2,961,176	100.0	$	1,898,204	100.0	$	1,062,972	100.0	$	3,003,110	100.0	$	1,928,999	100.0	$	1,074,111	100.0
Cost of sales	1,319,244		44.6	899,290		47.4	419,954		39.5	1,282,398		42.7	922,684		47.8	359,714		33.5
Gross profit	1,641,932		55.4	$	998,914	52.6	$	643,018	60.5	1,720,712		57.3	$	1,006,315	52.2	$	714,397	66.5
Operating expenses	1,313,720		44.4							1,120,435		37.3
Operating income	$	328,212	11.0							$	600,277	20.0

Worldwide sales of Balancer products increased ~~22.6%~~2.4% in the three month period ended ~~November 30, 2007~~February 29, 2008 when compared to the same period in the prior fiscal year as sales to the ~~North American and Asian~~European markets increased by ~~38.8% and 33.7%, respectively.~~31.4%. These European market increases were offset by a decrease in the ~~European~~North American and Asian markets which decreased ~~(14.2%~~(3.8%) and (4.2%), respectively, in the most current fiscal quarter when compared to the same period in the prior fiscal year. Sales in Other markets of ~~$143,684~~$161,485 in the three month period ended ~~November 30, 2007~~February 29, 2008 also ~~increased 9.2%~~decreased (10.9%) when compared to the same period in the prior fiscal year. Unit sales prices of Balancer products are relatively stable in each of the major markets and therefore any increases or decreases in the dollar amount of sales between fiscal periods can generally be attributed to an increase or decrease in the number of units sold. The ~~North American and Asian~~European sales increase is predominately the result of a recovery from softer Balancer sales during the last few fiscal ~~year from recent weakness in~~years, however, the worldwide automotive, bearing and aircraft industries and its impact on the machine tool industry. The Balancer product sales increase in Asia is also attributed to the continued expansion of the sales efforts in China. The European market remains soft when compared to longer term historical results due to strong competition and weaker economic conditions in certain European Balancer markets.

Measurement product sales decreased by a combined ~~(26.3%~~(22.1%) in the most current fiscal quarter when compared to the same period in the prior fiscal year due to sales of dimensional sizing products decreasing ~~(19.5%~~(14.1%), surface measurement products ~~increasing 4% and~~decreasing (82.6%) offset by the sale of a CASI Scatterometer equipment and software of $326,446 in ~~last year’s second~~current fiscal quarter with no comparable ~~sale this~~sales during the same fiscal quarter last year. The Measurement segment’s largest market, North America, ~~decreased (17.3%)~~increased 49.2% in the three months ended ~~November 30, 2007~~February 29, 2008 compared to the three months ended ~~November 30, 2006.~~February 28, 2007. Market demand in Asia, historically the second largest geographic market for Measurement products, showed a ~~2.8% increase~~(93.1%) decrease for the three months ended ~~November 30, 2007~~February 29, 2008 compared to the three months ended ~~November 30, 2006.~~February 28, 2007. The European market reported a sales ~~decrease~~increase to ~~$55,970~~$137,476 in the most current fiscal quarter when compared to the ~~$310,986~~$47,829 sold in the same period in the prior fiscal year. The sales ~~decrease~~increase in Europe is attributed to ~~the decline of~~ CASI Scatterometer sales noted above.

Cost of sales for the Balancer segment increased (as a percentage of sales) in the most current fiscal quarter when compared to the same period in the prior fiscal year primarily due to the product sales mix as production labor and overhead costs were relatively stable. Cost of sales for the Measurement segment ~~decreased slightly~~increased significantly (as a percentage of sales) in the most current fiscal quarter when compared to the same period in the prior fiscal year primarily due to the product sales mix. Dimensional sizing products and surface measurement services, which both have lower margins than CASI and surface measurement equipment products, represented a higher percentage of Measurement segment sales.

Operating expenses increased 16% in the three month period ended February 29, 2008 when compared to the same period in the prior fiscal year predominately due to increased research and development expenditures involving technologies related to the Xtero Transaction. General and administrative costs included approximately $75,000 of Section 404 Sarbanes-Oxley Act related implementation expenses offset by lower salaries and other general administrative expense.

Other income increased to $64,378 in the three months ended February 29, 2008 compared to the $44,372 reported in the same fiscal quarter in the prior fiscal year. The increases are primarily due to improved interest income in Fiscal 2008 compared to 2007 due to increasing interest rates over the past two years. In addition, our average cash, cash equivalents and short-term investment balance was $5.7 million in the three months ended February 29, 2008 compared to $4.9 million in the same period ended February 28, 2007.

Sales by SEL totaled ~~$519,703~~$598,297 for the most recent quarter versus ~~$787,250~~$463,772 for the same quarter last year. Approximately ~~38.5%~~27.9% of the ~~decrease~~increase is due to ~~lower~~higher unit sales volumes ~~offset by a 4.5%~~and 1.1% of the increase is due to the changes in foreign exchange

rates between the two fiscal periods. The ~~lower~~higher sales volumes were realized ~~primarily~~ due to ~~the sale of~~ a ~~CASI Scatterometer~~40.9% increase in ~~last year’s second fiscal quarter with no comparable sale this year.~~Balancer product sales.

In the three month period ended ~~November 30, 2007,~~February 29, 2008, net income was ~~$264,839~~$228,131 ($~~.10~~.08 per fully diluted share) compared to net income of ~~$271,185~~$387,649 ($~~.10~~.14 per fully diluted share) for the same period last year. Net income was negatively impacted primarily by reduced net sales, lower margin Measurement product sales, higher research and development expenditures involving technologies related to the Xtero Transaction offset by a lower income tax provision for the three month period ended ~~November 30, 2007~~February 29, 2008 compared to the same period last year.

~~Six~~Nine months ended ~~November 30,~~February 29, 2008 and 2007 ~~and 2006~~

	Six Months Ended November 30, 2007									Nine Months Ended February 29, 2008
	Consolidated			Balancer			Measurement			Consolidated			Balancer			Measurement
	Dollars		%	Dollars		%	Dollars		%	Dollars		%	Dollars		%	Dollars		%
Sales	$	5,449,926	100.0	$	4,157,358	100.0	$	1,292,568	100.0	$	8,261,037	100.0	$	6,132,254	100.0	$	2,128,783	100.0
Cost of sales	2,525,233		46.3	1,962,440		47.2	562,793		43.5	3,885,011		47.0	2,919,144		47.6	965,867		45.4
Gross profit	2,924,693		53.7	$	2,194,918	52.8	$	729,775	56.5	4,376,026		53.0	$	3,213,110	52.4	$	1,162,916	54.6
Operating expenses	2,434,985		44.7							3,736,565		45.2
Operating income	$	489,708	9.0							$	639,461	7.8

	Six Months Ended November 30, 2006									Nine Months Ended February 28, 2007
	Consolidated			Balancer			Measurement			Consolidated			Balancer			Measurement
	Dollars		%	Dollars		%	Dollars		%	Dollars		%	Dollars		%	Dollars		%
Sales	$	6,070,690	100.0	$	4,015,261	100.0	$	2,055,429	100.0	$	9,073,800	100.0	$	5,944,260	100.0	$	3,129,540	100.0
Cost of sales	2,830,467		46.6	2,074,960		51.7	755,507		36.8	4,112,865		45.3	2,997,645		50.4	1,115,220		35.6
Gross profit	3,240,223		53.4	$	1,940,301	48.3	$	1,299,922	63.2	4,960,935		54.7	$	2,946,615	49.6	$	2,014,320	64.4
Operating expenses	2,446,691		40.3							3,567,126		39.3
Operating income	$	793,532	13.1							$	1,393,809	15.4

Worldwide sales of Balancer products increased ~~3.5%~~3.2% in the ~~six months~~nine month period ended ~~November 30, 2007~~February 29, 2008 when compared to the ~~six months ended November 30, 2006~~same period in the prior fiscal year as sales to the North American, Asian and ~~Asian~~European markets increased by ~~11.8%~~6.6%, 5.3% and ~~9.4%~~1.7%, respectively. These market increases were offset by a ~~decline~~decrease in the ~~European market of (12%) and by decreases~~Sales in ~~all~~ Other markets ~~of (26.1%~~which decreased (20.2%)., in the nine month period ended February 29, 2008 when compared to the same period in the prior fiscal year. Unit sales prices of Balancer products are relatively stable in each of the major markets and therefore any increases or decreases in the dollar amount of sales between fiscal periods can generally be attributed to an increase or decrease in the number of units sold. The North American, Asian and ~~Asian~~European sales increase is predominately the result of a recovery from softer Balancer sales during the last fiscal ~~year from recent weakness in~~year; however, the worldwide automotive, bearing and aircraft industries and its impact on the machine tool industry. The large percentage decrease in all Other markets was predominately a result of decreases in the Japanese and South American markets. The European market remains soft when compared to longer term historical results due to strong competition and weaker economic conditions in certain European Balancer markets.

Measurement product sales decreased ~~(37.1%~~by a combined (32%) in the ~~six months~~nine month period ended ~~November 30, 2007~~February 29, 2008 when compared to the ~~six months ended November 30, 2006~~same period in the prior fiscal year due to sales of dimensional sizing products decreasing ~~(16.9%~~(16%), surface measurement products ~~declining (52.2%~~decreasing (65.6%) ~~and~~offset by the sale of a CASI Scatterometer equipment and software of $373,984 in current fiscal year compared to $211,542 during the same period last ~~year’s~~year. The Measurement segment’s largest market, North America, decreased (11%) in the nine months ended February 29, 2008 compared to the nine months ended February 28, 2007. Market demand in Asia, historically the second largest geographic market for Measurement products, showed a (70.4%) decrease for the nine months ended February 29, 2008 compared to the nine months ended February 28, 2007. The European market reported a sales decrease of (38.6%) in the nine months ended February 28, 2007 when compared to the same period in the prior fiscal ~~quarter with no comparable sale this~~ year.

Cost of sales for the Balancer segment decreased (as a percentage of sales) in the ~~six months~~nine month period ended ~~November 30, 2007~~February 29, 2008 when compared to the ~~six months ended November 30, 2006~~same period in the prior fiscal year primarily due to the product sales mix as production labor and overhead costs were relatively stable. Margins were also positively impacted as a result of the higher sales increase in North American markets as a smaller portion of those sales are made through distributors who receive pricing net of commissions and other sales costs.

Cost of sales for the Measurement segment increased significantly (as a

percentage of sales) in the ~~six months~~nine month period ended ~~November 30, 2007~~February 29, 2008 when compared to the ~~six months ended November 30, 2006~~same period in the prior fiscal year primarily due to the product sales ~~mix as~~mix. Dimensional sizing products and surface measurement ~~products generate higher gross profit~~services, which both have lower margins than ~~dimensional sizing products.~~CASI and surface measurement equipment products, represented a higher percentage of Measurement segment sales.

Operating expenses increased 4.8% in the nine month period ended February 29, 2008 when compared to the same period in the prior fiscal year predominately due to increased research and development expenditures involving technologies related to the Xtero Transaction offset by lower sales and marketing expenses in the first half of Fiscal 2008. General and administrative costs included approximately $85,000 of Section 404 Sarbanes-Oxley Act related implementation expenses.

Other income increased to $197,924 in the nine months ended February 29, 2008 compared to the $130,617 reported in the same period ended February 28, 2007. The increases are primarily due to improved interest income in Fiscal 2008 compared to 2007 due to increasing interest rates over the past two years. In addition, our average cash, cash equivalents and short-term investment balance was $5.7 million for the nine months ended February 29, 2008 compared to $4.7 million in the same period ended February 28, 2007.

Sales by SEL totaled ~~$889,349~~$1,487,646 for the ~~six~~nine months ended ~~November 30, 2007~~February 29, 2008 compared to ~~sales of $1,200,467~~$1,664,239 in the ~~six~~nine months ended ~~November 30, 2006.~~February 28, 2007. Approximately ~~31.2%~~15.2% of the decrease is due to lower unit sales volumes offset by a ~~5.4%~~4.2% increase due to the changes in foreign exchange rates between the two fiscal periods. The lower sales volumes were realized ~~primarily~~ due to ~~the sale~~a 77% decrease in Measurement segment sales offset by increased Balancer product sales of ~~a CASI Scatterometer in last year’s second fiscal quarter with no comparable sale this year.~~11.2%.

In the ~~six~~nine month period ended ~~November 30, 2007,~~February 29, 2008, net income was ~~$449,254~~$677,385 ($~~0.16~~.24 per fully diluted share) compared to net income of ~~$541,777~~$929,426 ($~~0.20~~.34 per fully diluted share) for the same period last year. Net income was negatively impacted primarily by ~~lower~~reduced net sales, ~~which declined by 10.2%~~lower margin Measurement product sales, higher research and development expenditures involving technologies related to the Xtero Transaction offset by a lower income tax provision for ~~income taxes, which decreased to $174,000 for~~ the ~~six~~nine month period ended ~~November 30, 2007~~February 29, 2008 compared to ~~the $338,000 in~~ the same period last year.

LIQUIDITY AND CAPITAL RESOURCES

The Company’s ratio of current assets to current liabilities increased to 10.2 to 1 at ~~November 30, 2007~~February 29, 2008 compared to 9.7 to 1 at May 31, 2007. Cash, cash equivalents and available for sale short term investments totaled ~~$5,741,406~~$5,754,035 as of ~~November 30, 2007~~February 29, 2008 compared to $5,477,711 at May 31, 2007. As of ~~November 30, 2007~~February 29, 2008, the Company had ~~$2,263,306~~$4,238,369 in cash and cash equivalents compared to $1,513,061 at May 31, 2007. As of ~~November 30, 2007~~February 29, 2008, the Company had ~~$3,478,100~~$1,515,666 in short term investments compared to $3,964,650 at May 31, 2007. Short term investments at February 29, 2008 consisted of highly liquid ~~A1-P1 rated commercial paper securities~~certificates of deposit maturing through ~~February 2008.~~April 2008

During the ~~six~~nine months ended ~~November 30, 2007,~~February 29, 2008, cash provided by operating activities amounted to ~~$571,031~~$899,874 with the changes described as follows:

· Net income for the ~~six~~nine months ended ~~November 30, 2007~~February 29, 2008 of ~~$449,254~~$677,385 plus non-cash items: depreciation and amortization of ~~$92,421,~~$141,870, stock-based compensation related items of ~~$15,278,~~$22,930, the $703 loss on disposal of property and equipment offset by the ~~$6,962 increase~~$30,871 decrease in other long-term obligations ~~offset by~~and the ~~$17,145~~$1,900 change in deferred taxes.

· Accounts receivable balance ~~increased~~decreased by ~~$59,304~~$22,432 to a ~~November 30, 2007~~February 29, 2008 balance of ~~$1,533,061.~~$1,440,332. The Company generally experiences a payment cycle of 30-90 days on invoices, depending on the geographic market. Management believes its credit and collection policies are effective and appropriate for the marketplace. There can be no assurance that the Company’s collection procedures will continue to be successful.

· Inventories decreased ~~$30,126~~$63,544 to a ~~November 30, 2007~~February 29, 2008 balance of ~~$3,664,311.~~$3,627,228. The Company maintains levels of inventory sufficient to satisfy normal customer demands plus an increasing short-term delivery requirement for a majority of its Balancer products. Management believes its ability to provide prompt delivery gives it a competitive advantage for certain sales.

· Prepaid expenses ~~decreased~~increased by ~~$12,042~~$43,763 to ~~$59,647~~$115,040 with the ~~decrease~~increase due to prepaid insurance, fees, trade show costs and various business costs.

· Trade accounts payable increased by ~~$113,944~~$134,780 to ~~$459,977~~$478,663 primarily due to normal fluctuations in timing of payment of outstanding payable balances.

· Other accrued liabilities (including customer deposits, commissions, payroll items, sales returns, expected warranty costs and other accrued expenses) ~~increased~~decreased by ~~$692~~$17,188 to a balance of ~~$631,935.~~$612,425.

· Net current income taxes payable and receivable decreased cash by ~~$73,942.~~$70,048.

During the ~~six~~nine months ended ~~November 30, 2007,~~February 29, 2008, net cash provided by investing activities was ~~$152,483,~~$1,794,208, consisting of net maturities of short term investments of ~~$486,550~~$2,448,984 less net additions to property and equipment of ~~$104,491~~$170,618 and advances and payments on business being acquired of ~~$229,576.~~$484,158. Net cash provided by financing activities amounted to $23,306 which consisted of items related to common stock issued on exercised stock options.

The following summarizes contractual obligations at ~~November 30, 2007~~February 29, 2008 and the effect on future liquidity and cash flows:

Years ending November 30,	Total contractual obligations
2008	$	54,734
Years ending February 28,			Total contractual obligations
2009	33,680		$	52,783
2010	12,159		24,520
2011			7,690
Thereafter	—		—
Total	$	100,573	$	84,993

Management has historically responded to business challenges that had a negative impact on operations and liquidity by reducing operating expenses, developing new products and attempting to penetrate new markets for the Company’s products. Management believes its cash flows from operations, its available credit resources and its cash position will provide adequate funds on both a short-term and long-term basis to cover currently foreseeable debt payments, lease commitments and payments under existing and anticipated supplier agreements. The Company’s philosophy regarding the maintenance of a balance sheet with a large component of cash and short-term investments reflects our views on potential future capital requirements relating to research and development, creation and expansion of sales distribution channels and investments and acquisitions. We regularly assess our investment management approach in view of our current and potential future needs. The Company’s bank line of credit expires

March 1, 2009. Management believes that such cash flow (without the raising of external funds) is sufficient to finance current operations, projected capital expenditures, anticipated long-term sales agreements and other expansion-related contingencies during Fiscal 2008 and 2009. However, in the event the Company fails to achieve its operating and financial goals for Fiscal 2008, management may be required to take certain actions to finance operations in that time period. These actions could include, but are not limited to, implementation of cost cutting measures and/or entering into additional borrowing arrangements collateralized by assets.

Business Risks

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

· Demand for Company products may change.

· The acquisition of Xtero Datacom Inc. technology may not become commercially viable and satisfy expected demand.

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

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

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

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

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

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

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

· Changes in securities laws and regulations have increased and will continue to increase Company ~~expenses~~expenses.

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

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

Demand for Company products may change:

During Fiscal 2007 Balancer sales in North America declined (8.3%) when compared to Fiscal 2006 and declined ~~(11.7%~~(3.8%) during the three months ended ~~August 31, 2007~~February 29, 2008 compared to the three months ended ~~August 31, 2006.~~February 28, 2007. Combined Balancer sales increased ~~3.5%~~6.6% for the ~~six~~nine months ended ~~November 30, 2007~~February 29, 2008 compared to the ~~six~~nine months ended ~~November 30, 2006.~~February 28, 2007. The conditions and circumstances could change in future periods and as a result demand for the Company’s products could continue to decline. Management is responding to these risks in two ways. First, it appears there is still a significant portion of the marketplace that is not using the automatic balancing products of the Company or any of its competitors. The Company will therefore continue to devote part of its future R&D efforts toward developing products that will both broaden the scope of Balancing products offered to the current customer base. Second, there are uses for the Company’s Balancer products in industries other than those in the Company’s historic customer base. Management is devoting time to identify these markets and educate those markets on the value of those products within their operations.

The laser light-scatter products of the Measurement segment have relied heavily upon sales to disk drive and silicon wafer manufacturers. The Company had experienced increasing sales in Fiscal 2006; however, sales during Fiscal 2007 have decreased (13.6%) and have declined ~~(58.1%~~(47%) during the ~~six~~nine months ended ~~November 30, 2007~~February 29, 2008 compared to the ~~six~~nine months ended ~~November 30, 2006.~~February 28, 2007. Previous information had indicated continued improving demand for and sales of disk drive products. Recently, however, certain disk drive manufacturers have scaled back their outlook for disk drive sales, blaming a price war over high-capacity desktop computer drives, which now store as much as about one trillion bytes of data. With respect to handheld applications, disk drive manufacturers believe disc drive products smaller than 1.8-inch form factors have to a large extent been replaced by competing storage technologies, such as solid state or flash memory. The long-term impact on demand for the Company’s surface Measurement products cannot be predicted with any certainty.

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

The acquisition of Xtero Datacom Inc. technology may not become commercially viable and satisfy expected demand:

On February 20, 2008 the Company completed the acquisition of Xtero Datacom Inc., (Xtero) and Xtero’s patented and patent pending technology for remote satellite sensing of large chemical storage tanks. Management believes Xtero products have reached technological feasibility. Although our acquisition of Xtero with related research and development costs has negatively impacted current operating results, the transaction should allow us to enter new measurement markets and is expected to add sales and profits to the Company in future years. However, Xtero product opportunities may not be identified and developed and brought to market in a timely and cost-effective manner which could continue to negatively impact future operating results and result in large and immediate write-offs of recorded intangible asset balances.

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

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

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

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

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

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

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

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

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

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

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

The Company believes it maintains a competitive advantage by shipping product to its customers more rapidly than its competitors. As a result, the Company has a significant investment in inventories. These inventories are recorded using the lower-of-cost or market method, which requires management to make certain estimates. Management evaluates the recorded inventory values based on customer demand, market trends and expected future sales and changes these estimates accordingly. A significant shortfall of sales may result in carrying higher levels of inventories of finished goods and raw materials thereby increasing the risk of inventory obsolescence and corresponding inventory write-downs. As a result, the Company may not carry adequate reserves to offset such write-downs.

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

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

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

Changes in the laws and regulations affecting public companies, including the provisions of the Sarbanes-Oxley Act of 2002 and rules promulgated by the Securities and Exchange Commission, have increased and will continue to increase Company expenses as the Company devotes resources to respond to their requirements. In particular, the Company will incur significant additional administrative expense and a diversion of management’s time in Fiscal 2008 to implement Section 404 of the Sarbanes-Oxley Act which requires management to report on, and the Company’s independent registered public accounting firm to attest to, our internal control over financial reporting. The Company may also incur additional fees starting in Fiscal 2009 from its independent registered public accounting firm as they perform the additional services necessary for them to provide their attestation. In addition, the NASDAQ Capital Market, on which the Company’s common stock is listed, has also adopted comprehensive rules and regulations relating to corporate governance. These laws, rules and regulations have increased the scope, complexity and cost of corporate governance, reporting and disclosure practices. The Company may be required to hire additional personnel and use outside legal, accounting and advisory services to address these laws, rules and regulations. The Company also expects these developments to make it more difficult and more expensive for the Company to obtain director and officer liability insurance in the future, and the

Company may be required to accept reduced coverage or incur substantially higher costs to obtain coverage. Further, Company board members, Chief Executive Officer and Chief Financial Officer could face an increased risk of personal liability in connection with the performance of their duties. As a result, we may have difficulty attracting and retaining qualified board members and executive officers, which would adversely affect the Company.

The Company faces risks from international sales and currency fluctuations:

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

2123

Item 3.Quantitative and Qualitative Disclosures about Market Risk

Interest Rate Risk

The Company did not have any derivative financial instruments as of ~~November 30, 2007.~~February 29, 2008. However, the Company could be exposed to interest rate risk at any time in the future and therefore, employs established policies and procedures to manage its exposure to changes in the market risk of its marketable securities.

The Company’s interest income and expense are most sensitive to changes in the general level of U.S. and European interest rates. In this regard, changes in U.S. and European interest rates affect the interest earned on the Company’s interest bearing cash equivalents and short term investments. The Company has a variable rate line of credit facility with a bank but there is no outstanding balance as of ~~November 30, 2007.~~February 29, 2008. Also, there is no other long-term obligation whose interest rates are based on variable rates that may fluctuate over time based on economic changes in the environment. Therefore, at this time, the Company is not subject to interest rate risk on outstanding interest bearing obligations if market interest rates fluctuate and does not expect any change in the interest rates to have a material effect on the Company’s results from operations.

Foreign Currency Risk

The Company markets and sells its products worldwide and international sales have accounted for and are expected to continue to account for a significant portion of future revenue. The Company operates a subsidiary in the United Kingdom and acquires certain materials and services from vendors transacted in foreign currencies. Therefore, the Company’s business and financial condition is sensitive to currency exchange rates or any other restrictions imposed on their currencies. For the ~~six~~nine months ended ~~November 30,~~February 29, 2008 and February 28, 2007, ~~and 2006 results of operations included gains on foreign currency denominated transactions of $430 and $4,649 respectively. For the three months ended November 30, 2007 and 2006~~ results of operations included gains (losses) on foreign currency denominated transactions of ~~($6,751)~~$8,464 and ~~$5,218,~~($13,642) respectively. For the three months ended February 29, 2008 and February 28, 2007, results of operations included gains (losses) on foreign currency denominated transactions of $8,034 and ($18,291), respectively.

Item 4. Controls and Procedures

(a) Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rules 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended, as of the end of the period covered by this report. Based on their evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective as of the end of the period covered by this report.

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

2224

PART II - - OTHER INFORMATION

Item 6. Exhibits ~~Exhibits~~

Exhibit		Description
2.1		~~Interim Acquisition~~Arrangement Agreement by and among Schmitt Industries, Inc., Schmitt Industries (Canada) Limited, and Xtero Datacom Inc. dated ~~October 4,~~December 14, 2007.

2.2		Amending Agreement to Arrangement Agreement by and among Schmitt Industries, Inc., Schmitt Industries (Canada) Limited, and Xtero Datacom Inc. dated February 7, 2008.

3.1		Second Restated Articles of Incorporation of Schmitt Industries, Inc. (the “Company”). Incorporated by reference to Exhibit 3(i) to the Company’s Annual Report on Form 10-K for the fiscal year ended May 31, 1998.

3.2		Second Restated Bylaws of the Company. Incorporated by reference to Exhibit 3(ii) to the Company’s Annual Report on Form 10-K for the fiscal year ended May 31, 1998.

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

~~10.1~~		~~Xtero Datacom, Inc. Convertible Promissory Note dated February 9, 2007.~~

~~10.2~~		~~Xtero Datacom, Inc. Amendment No.1 to Convertible Promissory Note.~~

~~10.3~~		~~Technology License Agreement dated October 4, 2007.~~

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

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

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

SIGNATURES

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

SCHMITT INDUSTRIES, INC.

~~SCHMITT INDUSTRIES, INC.~~

(Registrant)

Date:	~~January 22,~~April 8, 2008	/s/ Wayne A. Case

			Wayne A. Case, President/CEO/Director

Date:	~~January 22,~~April 8, 2008	/s/ Michael S. McAfee
			Michael S. McAfee, Chief Financial Officer/Treasurer

2326