UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM10-Q

For the quarterly period ended: February 28,August 31, 2019

Or

For the transition period from:                    To:                    

Commission File Number:000-23996

SCHMITT INDUSTRIES, INC.

(Exact name of registrant as specified in its charter)

2765 NWN.W. Nicolai Street

Portland, Oregon 97210-181897210

(Address of principal executive offices) (Zip Code)

(503)227-7908

(Registrant’s telephone number, including area code)

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

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

None

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

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

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

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of RegulationS-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form10-K or any amendment to this Form10-K.  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule12b-2 of the Exchange Act. (check one):

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule12b-2 of the Exchange Act).    Yes  ☐    No  ☒

The number of shares of each class of common stock outstanding as of March 31,September 30, 2019

SCHMITT INDUSTRIES, INC.

INDEX TO FORM10-Q

Page 2

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

SCHMITT INDUSTRIES, INC.

CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

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

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SCHMITT INDUSTRIES, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

(UNAUDITED)

FOR THE THREE AND NINE MONTHS ENDED FEBRUARY 28,AUGUST 31, 2019 AND 2018

(UNAUDITED)

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

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SCHMITT INDUSTRIES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

FOR THE NINETHREE MONTHS ENDED FEBRUARY 28,AUGUST 31, 2019 AND 2018

(UNAUDITED)

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

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SCHMITT INDUSTRIES, INC.

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY (UNAUDITED)

FOR THE NINETHREE MONTHS ENDED FEBRUARY 28,AUGUST 31, 2019

(UNAUDITED) AND 2018

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

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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 February 28,August 31, 2019 and its results of operations and its cash flows for the periods presented. The consolidated balance sheet at May 31, 20182019 has been derived from the Annual Report on Form10-K for the fiscal year ended May 31, 2018.2019. The accompanying unaudited financial statements and related notes should be read in conjunction with the audited financial statements included in our Annual Report on Form10-K for the fiscal year ended May 31, 2018.2019. Operating results for the interim periods presented are not necessarily indicative of the results that may be experienced for the fiscal year ending May 31, 2019.2020.

Revenue RecognitionPrinciples of Consolidation

On June 1, 2018, the Company adopted Accounting Standards Update (ASU)No. 2014-09, “Revenue from Contracts with Customers (Topic 606)” using the modified retrospective approach. The adoption of this standard did not have a material impact on the Company’sThese consolidated financial statements include those of the Company and its wholly owned subsidiaries: Schmitt Measurement Systems, Inc., Schmitt Europe, Ltd. and Schmitt Industries (Canada) Limited. All significant intercompany accounts and transactions have been eliminated in the preparation of the consolidated financial statements.

Reclassification

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

Revenue Recognition

The Company determines the amount of revenue it recognizes associated with the transfer of each product or service using the five-step model provided by Topic 606.service. For sales of products or delivery of monitoring services to all customers, including manufacturing representatives, distributors or their third-party customers, each transaction is evaluated to determine whether there is approval and commitment from both the Company and the customer for the transaction; whether the rights of each party are specifically identified; whether the transaction has commercial substance; whether collectability from the customer is probable at the inception of the contract and whether the transaction amount is defined. If a transaction to sell products or provide monitoring services meets all of the above criteria, revenue is recognized for the sales of product at the time of shipment or for monitoring services at the completion of the month in which monitoring services are provided.

The Company incurs commissions associated with the sales of products, which are accrued and expensed at the time the product is shipped. These amounts are recorded within general, administration and sales expense.

The Company also incurs costs related to shipping and handling of its products, the costs of which are expensed as incurred as a component of cost of sales. Shipping and handling fees billed to customers, which are recognized at the time of shipment as a component of net sales.revenues, were $37,228 and $49,240 for the three months ended August 31, 2019 and August 31, 2018, respectively.

Financial InstrumentsCash, Cash Equivalents and Restricted Cash

The carrying value of all other financial instruments potentially subjectCompany generally invests its excess cash in money market funds. The Company’s investment policy also allows for cash to valuation risk (principally consisting ofbe invested in investment grade highly liquid securities, and the Company considers securities that are highly liquid, readily convertible into cash and have original maturities of less than three months when purchased to be cash equivalents, accounts receivable and accounts payable) also approximates fair value becauseequivalents. The Company’s cash consists of their short-term maturities.

Restricted Cashdemand deposits in large financial institutions. At times, balances may exceed federally insured limits.

Restricted cash consists of an amount received from a customer in December 2017 as part of anon-going contract. The timeline for services being provided under this contract has been extended and isare expected to be completed duringin the second half of Fiscal 2019, at which time2020. Once the services under this contract are complete and acceptance has been provided by the customer, the restrictions on this advance cash payment will lapse.be released.

The following table provides a reconciliation of cash and cash equivalents and restricted cash as reported within the Consolidated Balance Sheets as of February 28,August 31, 2019 and May 31, 20182019 to the sum of the same such amounts as shown in the Consolidated Statement of Cash Flows for the ninethree months ended February 28,August 31, 2019:

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

Long-Term Liabilities and Current Portion of long-term liabilitiesLong-Term Liabilities

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

Recent Accounting PronouncementsUse of Estimates

In February 2016, the FASB issued ASUNo. 2016-02, Leases (Topic 842), in order to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet for most leases previously classified as operating leases. The ASU is required to be applied using a modified retrospective approach at the beginningpreparation of the earliest period presented,consolidated financial statements in conformity with optional practical expedients. The FASB recently proposed an optional transition alternative, which would allow for applicationaccounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the guidance atamounts reported in the beginning of the period in which it is adopted, rather than at the beginning of the earliest comparative period presented. The Company will adopt the new standard on June 1, 2019.

The Company is currently evaluating the impact of this guidance, including reviewing the standard’s provisionsconsolidated financial statements and gathering and analyzing data to support further evaluation of all real estate andnon-real estate leases. The Company is also evaluating the impact of the accounting standard on the Company’s financial statement disclosures, systems, processes and controls.accompanying notes. Actual results could differ from those estimates.

NOTE 2:

STOCK OPTIONS AND STOCK-BASED COMPENSATION

Stock-based compensation includes expense charges for all stock-based awards to employees and directors granted under the Company’s stock option plan. Stock-based compensation recognized during the period is based on the portion of the grant date fair value of the stock-based award that will vest during the period, adjusted for expected forfeitures. Compensation cost for all stock-based awards is recognized using the straight-line method. The Company uses the Black-Scholes option pricing model as its method of valuation for stock-based awards. The Black-Scholes option pricing model requires the input of highly subjective assumptions, and other reasonable assumptions could provide differing results. These variables include, but are not limited to:

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To determine stock-based compensation expense recognized for thoseThere were no options granted during the ninethree months ended February 28, 2019, the Company has computed the value of all stock options granted using the Black-Scholes option pricing model as prescribed by ASC Topic 718 using the following assumptions:August 31, 2019.

At February 28,August 31, 2019, the Company had a total of 266,166236,666 outstanding stock options (243,665(236,666 vested and exercisable and 22,5010non-vested) with a weighted average exercise price of $2.42. The$2.35. As all options outstanding as of August 31, 2019 were fully vested, the Company estimates that $897$0 will be recorded as additional stock-based compensation expense during the next fiscal quarter for all options that were outstanding as of February 28, 2019, but which were not yet vested.year ending May 31, 2020.

Options granted, exercised, canceled and forfeited or canceledexpired under the Company’s stock option planstock-based compensation plans during the ninethree months ended February 28,August 31, 2019 are summarized as follows:

Restricted Stock Units

Service-based and market-based restricted stock units are granted to key employees and members of the Company’s Board of Directors. Service-based restricted stock units generally fully vest on the first anniversary date of the award. Market-based restricted stock units are contingent on continued service and vest based on15-day average closing price of the Company’s common stock equal or exceeding certain targets established by the Compensation Committee of the Board of Directors.

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

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

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

NOTE 3:

WEIGHTED AVERAGE SHARES AND RECONCILIATION

Basic earnings (loss)The following table is a reconciliation of the numerators and denominators of the basic and diluted per share is computed usingcomputations for income (loss) from continuing operations for the weighted average number of common shares outstanding. Diluted earnings (loss) per share is computed using the weighted average number of common shares outstanding, adjusted for dilutive incremental shares attributed to outstanding options to purchase common stock. Common stock equivalents for stock options are computed using the treasury stock method. In periods in which a net loss is incurred, no common stock equivalents are included since they are antidilutive and as such all stock options outstanding are excluded from the computation of diluted net loss in those periods.three months ended August 31:

NOTE 4:

INCOME TAXES

The Company accounts for income taxes using the asset and liability method. This approach requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax basis of assets and liabilities. Deferred tax assets are reduced by a valuation allowance if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Management continues to review the level of the valuation allowance on a quarterly basis. There can be no assurance that the Company’s future operations will produce sufficient earnings to allow for the deferred tax asset to be fully utilized. The Company currently maintains a full valuation allowance against net deferred tax assets.

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

Other long-term liabilities related to tax contingencies were $0 as of February 28,both August 31, 2019 and May 31, 2018.2019. Interest and penalties associated with uncertain tax positions are recognized as components of the “Provision for income taxes.” The liability for payment of interest and penalties was $0 as of February 28,August 31, 2019 and May 31, 2018.2019.

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Effective Tax Rate

The effective tax rate on consolidated net loss was 2.1% for the ninethree months ended February 28, 2019.August 31, 2019 was 8.6%. The effective tax rate on consolidated net lossincome for the three months ended August 31, 2019 and 2018 differs from the federal statutory tax rate primarily due to changes in the deferred tax valuation allowance and the impact of certain expenses not being deductible for income tax reporting purposes. Management believes the effective tax rate for Fiscal 20192020 will be approximately 3.2%9.2% due to the items noted above.

NOTE 5:

SEGMENTS OF BUSINESSSEGMENT INFORMATION

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

Segment Information

Inventory reserve adjustmentsGeographic Information

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

(2) “United States” is defined to include remainder of $(291,427) for the Balancer segment and $(116,131) for the Measurement segment areresults not included in operating income (loss) for the three and nine months ended February 28, 2019, respectively.results from the European subsidiary

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Geographic Information – Net Sales by Geographic Area

Segment and Geographic Assets

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

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NOTE 6:The following table summarizes the maturity of the operating lease liabilities on an undiscounted cash flow basis and provides a reconciliation to the operating lease liabilities recognized on our consolidated balance sheet as of August 31, 2019:

RESTRUCTURING AND RELATED CHARGES

In November 2018 Schmitt announced a strategic reorganization following the appointment of two new board members. The reorganization will position the Company to better capitalize on the growing SBS Balancer business while streamlining the company and maximizing shareholder value through the disposition ofnon-core assets. The reorganization has involved a streamlining of contractors and services, and employee severance and termination benefits that have increased operating expenses in the third quarter. In conjunction with these efforts, an inventory adjustment of $(407,558) was recorded during the three months ended February 28, 2019 that was the outcome of efforts to evaluate the types and levels of inventory maintained across the Company’s three product lines.

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

Forward-Looking Statements

This Quarterly Report filed with the SEC on Form10-Q (the “Report”), including “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Item 2, contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 regarding future events and the future results of Schmitt Industries, Inc. and its consolidated subsidiaries (the “Company”) that are based on management’s current expectations, estimates, projections and assumptions about the Company’s business. Words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “sees,” “estimates” and variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve risks, uncertainties and assumptions that are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements due to numerous factors, including, but not limited to, those discussed in the “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this Report as well as those discussed from time to time in the Company’s other Securities and Exchange Commission filings and reports. In addition, such statements could be affected by general industry and market conditions. Such forward-looking statements speak only as of the date of this Report or, in the case of any document incorporated by reference, the date of that document, and we do not undertake any obligation to update any forward-looking statement to reflect events or circumstances after the date of this Report. If we update or correct one or more forward-looking statements, investors and others should not conclude that we will make additional updates or corrections with respect to other forward-looking statements.

RESULTS OF OPERATIONS

Overview

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

The accompanying unaudited financial information should be read in conjunction with our Annual Report on Form10-K for the fiscal year ended May 31, 2018.2019.

Highlights of the Three and Nine MonthsQuarter Ended February 28,August 31, 2019

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Critical Accounting Policies

There were no material changes in our critical accounting policies as disclosed in our Annual Report on Form10-K for the year ended May 31, 2018,2019, other than the adoption of Accounting Standards Update (ASU)No. 2014-09,2016-02, “Revenue from Contracts with Customers“Leases (Topic 606)842)” which the Company adopted on June 1, 2018.2019. See Note 1 “Revenue Recognition”“Leases” for further discussion and disclosures related to the adoption of ASUNo. 2014-09.2016-02.

Discussion of Operating Results