Schmitt Industries, Inc.
Annual Report 2003

Plain-text annual report

UNITED STATES SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549 FORM 10-K (Mark One) ýANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934 For the Fiscal year ended: May 31, 2003 or ooTRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934 For the transition period from to Commission File Number: 0-23996 SCHMITT INDUSTRIES, INC.(Exact name of registrant as specified in its charter) Oregon91-1151989(State or other jurisdiction ofincorporation or organization)(IRS Employer Identification Number) 2765 N.W. Nicolai StreetPortland, Oregon 97210(Address of principal executive offices) (Zip Code) (503) 227-7908(Registrant’s telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registeredNone None Securities registered pursuant to Section 12(g) of the Act: Common Stock - no par value(Title of each class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 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 filingrequirements for the past 90 days. Yes ý No o Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained,to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendmentto this Form 10-K. ý As of August 1, 2003, the aggregate market value of the registrant’s Common Stock held by nonaffiliates of the registrant was $2,451,975 based onthe closing sales price of the registrant’s Common Stock on the Nasdaq SmallCap Market. On that date, there were 2,478,924 shares of Common Stockoutstanding. Portions of the registrant’s definitive Proxy Statement for its 2003 Annual Meeting of Shareholders are incorporated by reference into Part III hereof.  PART I Item 1. Business Introduction The Company (an Oregon corporation) designs, assembles and markets computer-controlled balancing equipment primarily to the machine tool industry. Through its wholly owned subsidiaries, Schmitt Measurement Systems, Inc. (“SMS”), an Oregon corporation and Acuity Research Incorporated (“ARI”), aCalifornia corporation, the Company designs, manufactures and markets precision laser measurement systems. The Company also sells and markets itsproducts in Europe through its wholly owned subsidiaries, Schmitt Europe Ltd. (“SEL”), located in the United Kingdom and Schmitt Europa GmbH (“SEG”),located in Germany. The Company’s executive offices are located at 2765 N.W. Nicolai Street, Portland, Oregon 97210, and its telephone number is(503) 227-7908. Balancing Products The Company’s principal product is the Schmitt Dynamic Balance System (the “SBS System”), consisting of a computer control unit, sensor, spindle-mounting adapter, and balance head. It is designed to be an inexpensive, yet highly accurate, permanent installation on grinding machines. The Companyacquired its original balancing equipment technology pursuant to a series of agreements from 1987 through 1991 and substantially enhanced and advancedthe patented technology since that time. Since inception the targeted customer base has been operators of grinding machines. The SBS System is fully automated, eliminating the need to pre-balance such devices as grinding wheels. This reduces machine setup time and ensures asmoother and more efficient operation. Operating on a principle of mass compensation for wheel imbalance, the balance head contains two movableeccentric weights, each driven by electric motors through a precision gear train. These weights are repositioned to offset any imbalance in a grinding wheelor other application. Imbalance or vibration is picked up by the sensor that feeds a signal to a controller that filters the signal by revolutions per minute. Thecontroller then drives the balance head weights in a direction that reduces the amplitude of the vibration signal. The balance cycle is complete when theweights are positioned to achieve the lowest vibration level. Notable features of the SBS System include its ability to fit almost all machines, ease of installation, compact and modular construction, ability to balance awheel while on a machine, virtual elimination of wheel vibration, automatic monitoring of balancing, display in both English and metric systems, instrumentgrade calibration, short balance process, measurement of both displacement and/or velocity and minimal user maintenance. Benefits to the system user include improved quality of finished parts, ease of product adaptation, minimal downtime, complete and ready installation,elimination of static balancing, longer life of the grinding wheel, diamond dressings and spindle bearings, the ability to balance within 0.02 microns and itsadaptability to all types of machines. Precision grinding is necessary in all major manufacturing areas including the automotive industry (camshafts, crankshafts, valves), bearings (roller andtapered types), ceramics (precision shaping), electric motors (shafts), pumps (shafts and turbines), aircraft (engine parts), and general manufacturing. Precisiongrinding has an established worldwide presence in all industrialized countries and is expanding as a method of material removal and processing. Therefore,the Company believes there may be an increase in market growth and the need for automatic balancing. Within the industry there are three major marketsegments: Machine Tool Builders - These companies design and manufacture a variety of cylindrical, surface and specialty application grinding machines. SBS Systems are distributed to a variety of world markets through OEM (original equipment manufacturer) accounts, where a special pricing (20%discount) is offered to the machine builder incorporating the SBS System into its machine. Examples of some well-known worldwide machine tool builders who have offered and/or installed the SBS System include ANCA (Australia),Blohm Incorporated (U.S.), Blohm GmbH (Germany), 2 Capco Machinery (U.S.), Cincinnati Milacron (U.S.), Ecotech/SMTW (China/U.S.), Gleason Works (U.S.), Litton IAS/Landis Grinding (U.S.), MicronMachinery Limited (Japan/U.S.), Normac Incorporated (U.S.), NTC Toyama America (U.S./Japan), Okomoto (Japan), Okuma Machine (Japan),Shigiya Machine (Japan), Sumitomo Heavy Industry (Japan), CETOS Hostivar (Czech Republic), TOS Holice (Czech Republic), Toyoda Machine(Japan) and Weldon Machine Tool (U.S.). The Company currently sells its products directly to most of the major machine rebuilders in the U.S. andWestern Europe. Machine Tool Rebuilders – These customers, found in all industrial nations, develop their business by offering to completely update and refurbisholder machine tools. These rebuilders typically tear the old machine apart and install new components, such as the SBS System. The Companycurrently sells its products directly to major machine rebuilders in the U.S. and Western Europe. Grinding Machine Users - These end users become aware of the SBS System through trade shows, trade magazine advertising, distributors, fieldrepresentatives, referrals and new machine suppliers. The Company’s business is conducted worldwide with some better known customersincluding: Black & Decker, Briggs and Stratton, Caterpillar Inc., Daewoo International Corp., Eaton Corporation, Ford Motor Company, GeneralElectric Corp., General Motors, Ingersoll Rand, Sumitomo Heavy Industries, Texas Instruments, The Timken Company, Torrington, TRWAutomotive Components and Westinghouse Electric Corp. The acquisition of SEG added the internal spindle, ring and water balancer designs to the Company’s product line. These proven designs allow Schmitt toprovide products to a broad range of machine applications. In Fiscal 2003, 2002 and 2001, net sales of the Company’s balancing products totaled $5,481,010, $5,275,556 and $6,030,030 respectively. Net sales ofbalancing products accounted for 74% of the Company’s revenue in Fiscal 2003, 77% in Fiscal 2002 and 80% in Fiscal 2001. See Note 9 to ConsolidatedFinancial Statements. Competition: Management believes the SBS System is one of few fully automatic balancing systems marketed in the world. Most competitive products require specialsetup and training or calibration to the specific machine. The Company believes the SBS System is currently the only balancing product that fits all machineswith wheel sizes from 6 to 48 inches in diameter and a spindle rpm of 500 through 7,500. Competitive products come from European companies located in Switzerland, Germany, Spain and Italy. These competitors produce electromechanicalbalancers similar to the SBS System and water balancers similar to the SEG system. The Company considers these companies, with their establishedEuropean base, to be the major competitors. These balancers have electronic deficiencies, rendering them less effective in solving essential balancingrequirements. They cannot achieve the consistent low balance levels at 500-rpm (low speed) or at 7,500 rpm (high speed) as the SBS system can. In addition,these balancers have inferior brush and cable assemblies that cause down time and high maintenance. Finally, none of these companies can currentlycompete effectively with the Company in providing mounting adapters for all grinding machines. Water balancers are the oldest on the market and are employed in the SEG-installed systems. They require expensive plumbing and water chambers to bemachined into the wheel hub while the SBS System does not. They are currently priced about 1.25 times the level of the SBS System. To install thesesystems, the grinding machines must be disassembled and parts remachined or replaced within the spindle assembly. This can take two days, far longer thanrequired to install the SBS system. The water system is “tuned” or “calibrated” to the machine by a factory service technician while the SBS system can beinstalled by the operator. Water systems work at mid- and high-speeds but cannot balance in low rpm environments while SBS products work in bothenvironments. Water systems require periodic monitoring while the SBS systems require little or no operator monitoring. The SBS System list price is generally $7,995 worldwide. Competitors’ electromechanical systems are priced at $8,000 to $10,000 worldwide while waterbalancers are priced at $9,000 to $11,000 worldwide. Management market surveys indicate customers perceive the value of an automatic balancer to beapproximately $8,000; therefore, Company pricing is geared to obtaining a dominant market position and 3 meeting competitive supplier prices. The market strategy is to establish the SBS System as the foremost product with the best quality, reliability andperformance and superior economic value. Measurement Products The Company manufactures and markets a line of laser-based, precision measurement systems and operates a precision laser light scatter measurementlaboratory. Light scatter technology involves using lasers, optics and detectors to throw a beam of light on a material sample and record itsreflection/transmission. Analysis of information can determine material characteristics such as surface roughness, defects and dimensional sizing withoutintroducing contaminants and causing changes to the tested material. The principal products are laser-based measurement products and technologyapplicable to both industrial and military markets. The Company has used patents, patent applications, trademarks and other proprietary technology to focusmarketing efforts on industrial markets, including electronics, computer disk and silicon wafer manufacturers. There are four product lines: laser-based light-scatter measurement, dimensional sizing, research and other laser alignment products and a light-scattermeasurement laboratory. Laser-based light-scatter measurement: These products use a patented laser light scatter technology to perform rapid, accurate, repeatable and non-destructive non-contact surface measurement teststhat quantify surface micro-roughness. Products are sold to manufacturers of disk drives and silicon wafers, both industries with fabrication processes thatrequire precise and reliable measurements. Computer hard disks require exact manufacturing control and a narrow tolerance band for acceptable roughness. The read/write head flies over the disk drivesurface on a cushion of air generated when the rough surface of the rotating disk pulls air under the head. The head may stick or bind to the disk when thesurface is too smooth. If it is too rough, the head will fly too far from the disk surface, causing a reduction in data density or storage capacity. The DUV andTMS product series meet the challenges of disk drive manufacturers. Customers include IBM, Seagate Substrates, Western Digital and Komag, Inc. The original TMS-2000 (Texture Measurement System) product, the world’s fastest and most accurate non-contact texture measurement system,revolutionized disk-manufacturing technology. The product (used on aluminum substrates) is currently used worldwide by most major disk drivemanufacturers and provides fast, accurate and repeatable microroughness measurements and quadruples production throughput when compared to othertesting devices. Surface roughness can now be measured to levels below 0.5 Angstroms (the point of a needle is one million Angstroms in diameter). The TMS-2000-DUV product measures the surface microroughness of glass rather than aluminum substrates. Manufacturers require the technology andproducts to measure surface roughness of these substrates to the same exact levels as those that measure aluminum. The Deep Ultra-violet light (DUV)technology and product uses the patented light scatter technology to measure the surface roughness of glass substrates to levels less than one Angstrom. Both products simultaneously measure disk surface roughness in two directions, radially, when the read/write head is moving to another disk sector andcircumferentially, when the read/write head is processing information on the disk. The two separate roughness levels are required for proper head operation. This measurement method is not possible through any other cost effective measurement means. The TMS-2000W and TMS-3000W provide fast, accurate, repeatable measurements for manufacturers of silicon wafers, computer chips and memory devices.This industry demands manufacturing precision to increase performance and capacity and these products help achieve those goals. Silicon wafers arecarefully cut and polished to provide the base upon which a computer or memory chip is produced. Therefore, chip manufacturing is extremely dependent onthe beginning surface roughness of the wafer. Since all silicon wafers exhibit a microscopic level of surface roughness, stemming from chemical deposition,grinding, polishing, etching, or any number of other production techniques, some method of measuring these surface characteristics is required. The wafermeasurement products provide a way for SMS customers in this industry to quantify and control their manufacturing process. The system providesmeasurements to a few hundredths of an Angstrom, a level unachievable by other testing devices. 4 Dimensional Sizing Products: ARI develops and assembles laser distance sensors for industrial and OEM use. Applications include steel casting, paper production, medical imaging, cranecontrol and micron-level part and surface inspection. Presently, there are four product lines: the AR4000 distance measurement sensor, the AR4000 LineScanner and the AR600 and AR200 series of triangulating laser displacement sensors. The AccuRange 4000 is an optical distance measurement sensor for most diffuse reflective surfaces. It operates by emitting a collimated laser beam that isreflected from the target surface and collected by a sensor. The sensor is suitable for a wide variety of distance measurement applications that demand highaccuracy and fast response times. Notable features include the operating range for most surfaces (zero to fifty feet), fast response time (50 kHz maximumsample rate), compact and lightweight power design and has a tightly collimated output beam for small spot size. The product has three output beamconfigurations available: visible infrared, eye safe infrared and reflective tape targets. It is ideally suited to level and position measurement, machine vision,autonomous vehicle navigation and 3D imaging applications. The AR4000 Line Scanner is used with the AccuRange 4000 to scan and collect distance data over a full circle. The scanner consists of a balanced, rotatingmirror and motor with position encoder and mounting hardware for use with the AccuRange 4000. The scanner deflects the beam 90 degrees, sweeping itthrough a full circle as it rotates. The product can scan at rates of up to 2600 lines per minute, sweeps the laser beam through a full 360 degrees and is bothcompact and lightweight. The AR600 series is a family of triangulating laser displacement sensors with excellent accuracy and sensitivity. The sensor projects a beam of visible laserlight that creates a spot on the target surface. Reflected light from the surface is viewed from an angle by a line scan camera and the target’s distance iscomputed from the image pixel data. The line includes 11 models measuring displacements from 1/8” to 50” and accuracy’s down to .00015” (4 microns).They can operate on all types of surfaces at speeds up to 1250 samples/second. The product is extremely sensitive and can detect glass and liquid surfacesand also detect multiple surfaces of transparent materials, allowing great flexibility in specialized applications. The AR200 line is Acuity Research’s most compact series of triangulating laser displacement sensors. Four models cover metric measurement ranges from sixto fifty millimeters. All models boast a 1/500 accuracy rating for measurements within twelve microns. The AR200 sensor is the only sensor of its kind tofeature pushbutton selection of output signals. All models are standard with Analog, Limit Switch and Serial outputs. The AR200 sensors, much like thelonger-range AR600 sensors, project a beam of visible laser light that creates a spot on the target surface. Reflected light from the surface is viewed from anangle by a line scan camera and the target’s distance is computed from the image pixel data. The AR200-6M, -12M, -25M and -50M have ranges inmillimeters that match their model number. The AR200 displacement sensor can not be overloaded and measures accurately even when a mirror reflects theentire light beam back to the detector. Research and Other Measurement Products: CASI Scatterometers are sold to companies and institutions involved in research efforts. A Scatterometer uses ultraviolet or infrared laser light as anondestructive probe to measure surface quality, optical performance, smoothness, appearance, defects and contamination on a wide variety of materials.These products are measurement instruments providing customers with precise roughness measurements of optical surfaces, diffuse materials, semiconductorwafers, magnetic storage media and precision-machined surfaces, as well as surfaces affecting the cosmetic appearance of consumer products. Customersinclude Pratt & Whitney, Boeing, The U.S. Navy and Rockwell Collins North America. The μScan System is a portable device consisting of a hand-held control unit, an interchangeable measurement head and a separate charging unit. To performa measurement, the operator places the measurement head on the objective area and presses a button. Each measurement takes less than five seconds withresults displayed and stored in system memory. The μScan can store 700 measurements in 255 files and provides the capability to program pass/fail criteria. Software is available for control, analysis and file conversion. From a single measurement, a user can determine RMS surface roughness, reflectance andscatter light levels (BRDF) on flat or curved surfaces under any lighting conditions. 5 Testing Laboratory: The Company provides a highly advanced measurement services laboratory to a wide variety of industrial and commercial businesses that require precisemeasurements only advanced laser light scatter technology can provide. The laboratory uses CASI Scatterometers for measuring surface roughness. The truevalue of the laboratory is not only its extremely precise measurement capability but also the test item is not altered, touched or destroyed. Thus, thelaboratory is widely used by manufacturers of critical optical components in aerospace and defense systems, including such companies as Aerojet, AT&TBell Labs, Eastman Kodak, General Electric, IBM, NASA and dozens of other industrial companies, universities and government agencies. In Fiscal 2003, 2002 and 2001, net sales of Measurement products totaled $1,938,511, $1,599,103 and $1,550,124 respectively and accounted for 26%, 23%and 20% of the Company’s total sales in Fiscal 2003, 2002 and 2001 respectively. Business and Marketing Strategy The Company designs, assembles and markets all of its products with operations divided into a number of different areas. The Vice President of Operationsdirects SBS System production, and is responsible for all assembly, purchasing and production engineering as well as the technical services division thatprovides technical support to customers. The President/CEO directs the production, assembly, purchasing, engineering and technical services functions forthe SMS and ARI product lines. The Product Marketing Division, managed by the President/CEO, is responsible for the sale of SBS System products. TwoMarketing Managers are responsible for domestic sales while a third is responsible for sales in Mainland China, Taiwan and Korea. The Company also hasone person who performs field service/sales. The President/CEO is responsible for European sales and oversees the efforts of the European MarketingManager who is headquartered in the United Kingdom. Finally, there is a research and development group supervised directly by the President/CEO and theVice President of Operations. The Company markets and sells the SBS System in a variety of ways. First, are the channels provided by independent manufacturer’s representatives anddistributors. There are currently approximately 25 individuals and/or organizations in the United States acting in one of these capacities. Independent salesagents are paid a 10% commission; distributors are sold products at a 15% discount. Second, worldwide trade shows have proven to be an excellent source of business. Company representatives, usually one or more of the Marketing Managersand/or the President/CEO, attend these events along with local Company representatives. These individuals operate a display booth featuring an SBS Systemdemonstration stand and product and technical literature. Representatives from all facets of the Company’s target markets attend these trade shows. Third, original equipment manufacturers (OEMs) include the SBS System on the machine tools they produce. Users thus purchase the SBS Systemconcurrently with the machine tools. Conversely, end users of grinding machines that have purchased the SBS system directly from the Company, and afterenjoying the benefits of the products, often request that SBS products be included with the new equipment they order from OEMs. The SBS Systems are ofteninstalled by machine builders prior to displaying their own machine tools at various trade shows, becoming endorsements that prove beneficial to theCompany’s sales efforts. In the United States, most products are shipped directly to customers from the Company’s distribution center in Portland, Oregon. Where the Company hasdistributors, the product is shipped to the distributor, who in turn pays the Company directly and then delivers and installs the product for the end user. European distribution to customers is handled by shipping the product directly from the Company’s Portland headquarters to the European subsidiaries, whoin turn sell and distribute the products. Similar to the parent company, SMS uses a variety of methods to market and sell its measurement products. First, a Marketing Manager, under the directionof the President/CEO, directs the overall worldwide marketing efforts. Second, the Company uses an independent manufacturer’s representative group tomarket and sell products to various customers in the Western United States. That group is paid a 20% commission on units they are responsible for selling. Third, the Company has a nonexclusive distribution agreement with a 6 company in Japan for the promotion and sale of SMS products in Japan, Korea, Malaysia, Singapore, the Philippines and Taiwan. Fourth, trade showsrepresent a significant amount of marketing/sales effort. The President/CEO attends these events along with various Company representatives. Theseindividuals operate a display booth featuring SMS product demonstrations and product and technical literature. Representatives from all facets of the marketto which the Company directs its sales efforts attend these trade shows. Finally, one of the best marketing channels is the testing laboratory. Once customerssee the capabilities of the technology, it can lead to orders for the Company’s laser based light scatter measurement products. All SMS products are assembled in the Portland, Oregon facility and shipped worldwide directly to customers. Acuity exclusively markets and sells its measurement products through a worldwide network of manufacturer’s representatives and distributors. TheMarketing Manager of ARI, under the direction of the Company’s President/CEO, directs the overall marketing efforts. There are seven representatives inNorth America and seven located in countries throughout the world. The United States representatives receive a 15% commission while the foreignrepresentatives receive a 25% commission on all units they sell. Management of both the Company and ARI will also attend trade shows where the productsare displayed and demonstrated. All ARI products are assembled in the Menlo Park, California facility and shipped worldwide directly to customers. The SBS, SMS and ARI customer bases consist of over 250, 200 and 300 companies respectively. Manufacturing There are no unique sources of supply or raw materials in any product lines. Essential electronic components, available in large quantities from varioussuppliers, are assembled into the Balancing and Measurement electronic control units under the Company’s quality and assembly standards. Company-owned software and firmware are coupled with the electronic components to provide the basis of the Company’s various electronic control units. Management believes several supply sources exist for all electronic components and assembly work incorporated into its electronic control systems. Theprimary outside supplier of electronic assemblies is Vanguard EMS of Beaverton, Oregon, a custom supplier of assembled electronic products for severalPacific Northwest companies. In the event of supply problems, the Company believes that two or three alternatives could be developed within 30 days tosupplement or replace Vanguard. Mechanical parts for the Company’s products are produced by high quality CNC machine shops. The Company is not dependent on any one supplier ofmechanical components. Principal suppliers of components for the Company’s products include MacKay Manufacturing of Spokane, Washington; OEMManufacturing of Corvallis, Oregon; Eagle Industries of Newberg, Oregon; and Forest City Gear of Roscoe, Illinois. The Company uses in-house skilled assemblers to construct and test vendor-supplied components. Component inventory of finished vendor-supplied parts isheld on Company property to assure adequate flow of parts to meet customer order requirements. Inventory is monitored by a computer control systemdesigned to assure timely re-ordering of components. In-house personnel assemble various products and test all finished components before placing them in the finished goods inventory. Finished goodsinventory is maintained via computer to assure timely shipment and service to customers. All customer shipments are from the finished goods inventory. In November 1996, the Company’s Quality Control Program received full ISO-9001 certification. This certification was renewed in November 2002. Proprietary Technology The Company’s success depends in part on its proprietary technology, which the Company attempts to protect through patents, copyrights, trademarks, tradesecrets and other measures. The Company has U.S. patents covering its SBS, SMS and ARI products, processes and methods which the Company believes provide it with a competitiveadvantage. The Company has a policy of seeking patents where appropriate on inventions concerning new products and improvements developed as part ofits 7 ongoing research, development and manufacturing activities. While patents provide certain legal rights of enforceability, there can be no assurance thehistoric legal standards surrounding questions of validity and enforceability will continue to be applied or that current defenses as to issued patents will, infact, be considered substantial in the future. There can be no assurance as to the degree and range of protection any patent will afford and whether patentswill be issued or the extent to which the Company may inadvertently infringe upon patents granted to others. “SBS” and “SMS” are registered trademarks and are affixed to all products and literature created in the Company’s balancer and measurement product lines,respectively. The Company manufactures its SBS products under copyright protection in the U.S. for electronic board designs. Encapsulation of the finished productfurther protects the Company’s technologies including software. The Company also relies upon trade secret protection for its confidential and proprietary information. There can be no assurance that others will notindependently develop substantially equivalent proprietary information and techniques or otherwise gain access to the Company’s trade secrets or disclosesuch technology or that the Company can meaningfully protect its trade secrets. While the Company pursues patent, trademark, trade secret and copyright protection for products and various marks, it also relies on know-how andcontinuing technology advancement, manufacturing capabilities, affordable high-quality products, new product introduction and direct marketing efforts todevelop and maintain its competitive position. Product Development In Fiscal 1997, the Company began a research and development program to expand the product lines and capabilities of SBS and SMS products. That policyhas been incorporated into the operations of ARI as well. The goal of this program is to expand the product base in historic markets and to enter new marketareas so as to reduce reliance on historic market segments. Since that Fiscal year, the Company has continued to develop the following new balancing andlaser measurement products. The SB-4500 unit is now a multi-function unit providing the versatility to control several activities including all of Schmitt’s balancer products. It controlsbalancing in applications with speeds ranging from 300 to 30,000 rpm compared to a range of 500 to 10,000 rpm with the prior Schmitt product. Vibrationsare measured to 0.02 microns or 0.75 millionths of an inch, a ten-fold performance improvement over the prior control unit. It also allows customers tobalance their grinding machines faster, reducing costly down time and increasing factory throughput. This generation of computer control allows the futureaddition of new Schmitt products. The AEMS (Acoustical Emissions Monitoring System) is controlled by the SB-4500 unit and monitors the customers’ dressing and grinding processes bydirect measurement of machine-generated acoustic signals. By monitoring the high frequency sound signal generated by contact between the wheel andwork piece, the system automatically determines when wheel contact is made. Users can eliminate the “gap” time from their grinding process and alsoautomatically detect the beginning of a wheel “crash” and immediately signal the grinder to stop before real damage occurs. The benefits of the AEMSproduct to the customer include time savings from quick and easy setups, improved dressing and grinding processes, and elimination of expensive part andmachine damage. The disk drive industry presented the Company with the challenge of developing the technology and products to measure the surface roughness of glasssubstrates. Existing SMS technology was modified to produce the required light scatter information to provide the necessary measurements. The engineeringstaff developed the DUV (Deep Ultra-violet light) technology to measure surface microroughness of glass substrates to the same precise levels as existingproducts and at levels required by the industry. This technology compliments existing products and provides the Company the ability to supply solutions forall media used by the disk drive industry. During Fiscal 2003, 2002 and 2001, the Company’s research and development expense totaled $192,686, $217,444 and $327,474 respectively. 8 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 statementscan 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 orintentions. For example, this section contains numerous forward-looking statements. All forward-looking statements in this report are made based onmanagement’s current expectations and estimates, which involve risks and uncertainties, including those described in the following paragraphs. Among thesefactors are the following: • Demand for company products may change.• 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 pricesof 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.• The lack of a line of credit agreement could impact future liquidity.• Future success depends in part on attracting and retaining key management and qualified technical and sales personnel.• 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 toplace undue reliance on the forward-looking statements in this report. We assume no obligation to update such information. Demand for Company products may change: For several months, the Company has experienced soft market demand for its Balancer products. While specific reasons are difficult to pinpoint, the lowdemand can generally be attributed to worldwide economic conditions, specifically those in the grinding machine industry, the primary market for theCompany’s Balancer products. Based upon analysis by management and the sales staff, the decline in sales does not appear to arise from the customer baseshifting to competitor products. Management has responded to these soft market conditions in several ways. First, it appears there is a significant portion of the marketplace that is not usingthe automatic balancing products of the Company or any of its competitors. The Company will therefore continue to devote a significant part of its R&Defforts in Fiscal 2004 and 2005 toward developing products that will both broaden the scope of products offered to the current customer base plus offerproducts for new markets thereby reducing the reliance on historic markets. Second, management initiated a restructuring plan in Europe in the fourth Fiscalquarter of 2001 that was intended to increase worldwide operating efficiency. All engineering design and manufacturing operations are now consolidated inthe United States, a step that has reduced operating costs. In addition, all European operations are now focused totally on marketing and sales. Finally,management will continue to evaluate all operating costs and seek to reduce costs where necessary. The Measurement segment has relied heavily upon sales to disk drive and silicon wafer manufacturers. Conditions in those markets adversely affected salesbeginning in Fiscal 1999 and those poor conditions continued into Fiscal 2003. Disk drive demand is largely tied to and dependent upon demand forpersonal computers. In Fiscal 2001, personal computer manufacturers warned of lower sales expectations and many initiated actions to significantly reducecosts. These soft market conditions have continued into Fiscal Years 2002 and 2003. Consequently, demand for drives has fallen and operations of thosecompanies have suffered with one result being reduced capital spending. This has resulted in minimal demand for and sporadic sales of the Company’s TMSproducts. Industry forecasts are for these conditions to continue in the foreseeable future. 9 The semiconductor industry is also currently facing a down cycle. Beginning in Fiscal 2002 the semiconductor industry experienced backlog cancellations,resulting in slower revenue growth and these conditions continued into Fiscal 2003. The result is similar to disk drive manufacturers in that capital spendinghas declined significantly and consequently so has demand for and sales of the Company’s wafer products. Forecasts for that industry are for improvementsin market conditions to begin sometime in calendar 2003, although there is no certainty those improvements will occur during that time period. Management will continue to market these products to these historic markets as it appears no other technology has been introduced that would make theTMS products technologically obsolete. There is the belief that once market conditions improve in the disk drive and silicon wafer markets, demand for theCompany’s products and technology will increase although most likely not to historic levels. Also, management believes there are other uses for theCompany’s laser light scatter technology and continues to evaluate R&D efforts to develop new products and introduce them to the marketplace. 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 couldresult 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 identifiedand developed and brought to market in a timely and cost-effective manner. Products or technologies developed by other companies may render products ortechnologies obsolete or noncompetitive or a fundamental shift in technologies in the product markets could have a material adverse effect on theCompany’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 theirintellectual property rights. The Company relies on patent, trade secret, trademark and copyright law to protect such technologies. There is no assurance anyof 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 rawmaterials: Manufacturing operations depend upon obtaining adequate supplies of raw materials on a timely basis. The results of operations could be adversely affectedif 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 aresult of quarterly operating fluctuations, it is important to realize quarter-to-quarter comparisons of operating results are not necessarily meaningful andshould 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. During the second quarter of Fiscal 2002, Management responded todeclining sales by instituting an expense reduction program that significantly reduced the break-even sales point. However, should sales decline, there is noguarantee management could take actions that would further reduce operating expenses in either a timely manner or without seriously impacting theoperations 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, theCompany has a significant investment in inventories. These 10 inventories are recorded using the lower-of-cost or market method, which requires management to make certain estimates. Management evaluates therecorded inventory values based on customer demand, market trends and expected future sales and changes these estimates accordingly. A significantshortfall of sales may result in carrying higher levels of inventories of finished goods and raw materials thereby increasing the risk of inventory obsolescenceand corresponding inventory write-downs. As a result, the Company may not carry adequate reserves to offset such write-downs. The lack of a line of credit agreement could impact future liquidity: The short-term credit line expired on April 30, 2003 and the commercial bank chose not to renew the arrangement. While management believes it couldsecure credit from another source, there is no guarantee this can be accomplished or, if it is accomplished, the terms may not be as favorable as those under theexpired line of credit. 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 suchpersonnel and there is no assurance key technical and sales personnel can be retained nor assurances there will be the ability to attract, assimilate and retainother highly qualified technical and sales personnel as required. There is also no guarantee key employees will not leave and subsequently compete againstthe Company. The inability to retain key personnel could adversely impact the business, financial condition and results of operations. 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 significantportion 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 economicinstability; general economic conditions; and fluctuations in foreign currencies. No assurances can be given these factors will not have a material adverseeffect on future international sales and operations and, consequently, on business, financial condition and results of operations. International SalesThe Company’s sales in the last three Fiscal years by geographic areas are: North AmericaEuropeAsia and OthersFiscal 2003$4,150,797$2,348,102$920,622Fiscal 2002$4,337,917$1,627,203$909,539Fiscal 2001$5,041,830$1,950,395$587,929 Backlog The Company does not generally track backlog. Normally, orders are shipped within a few days after receipt unless the customer requests otherwise. Employees As of July 7, 2003, the Company employed 43 individuals worldwide on a full-time basis. There were no regular part-time employees. None of theCompany’s employees is covered by a collective bargaining agreement. Item 2. Properties The Company’s design and assembly facilities and executive offices are located in a 7,500-square foot Company-owned building in Portland, Oregon andSMS operations are in a 33,000-square foot Company-owned facility located across the street from the executive offices. SEL occupies a 1,893-square footfacility 11 in Coventry, England pursuant to a three-year lease beginning June 1, 2002 with a basic monthly rent of £1,875 (approximately $2,750 as of July 7, 2003). SEG occupies a 620 square foot facility in Pfungstadt, Germany pursuant to a five-year lease beginning December 1, 2001 with a basic monthly rent of 658Euros (approximately $775 as of July 7, 2003). ARI occupies a 3,670 square foot facility in Menlo Park, California pursuant to a one-year lease beginningNovember 1, 2002 with a current monthly rent of $7,487 as of July 5, 2003. Management believes its facilities are adequate to meet its currently foreseeableneeds. Item 3. Legal Proceedings There are no material legal proceedings currently pending against the Company. Item 4. Submission of Matters to a Vote of Security Holders No matters were submitted to a vote of the security holders of the Company during the fourth quarter ended May 31, 2003. PART II Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters The Company’s Common Stock is traded on the Nasdaq SmallCap Market under the symbol “SMIT.” The following tables set forth the high and low sales prices of the Company’s Common Stock as reported on the Nasdaq National Market and The NasdaqSmallcap Market (after May 23, 2002) for the periods indicated. Year Ended May 31, 2003HighLowFirst Quarter$1.65$1.05Second Quarter$1.95$1.11Third Quarter$1.50$1.07Fourth Quarter$1.60$0.80 Year Ended May 31, 2002HighLowFirst Quarter$3.27$2.13Second Quarter$2.76$0.87Third Quarter$1.68$1.05Fourth Quarter$2.16$1.02 As of July 7, 2003, there were 2,417,932 shares of Common Stock outstanding held by approximately 130 holders of record. The number of holders does notinclude individual participants in security position listings; the Company believes that there are more than 2,500 individual holders of shares of CommonStock. The Company has not paid any dividends on its Common Stock since 1994. The Company’s current policy is to retain earnings to finance the Company’sbusiness. Future dividends will be dependent upon the Company’s financial condition, results of operations, current and anticipated cash requirements,acquisition plans and plans for expansion and any other factors that the Company’s Board of Directors deems relevant. The Company has no presentintention of paying dividends on its Common Stock in the foreseeable future. 12 Item 6. Selected Financial Data In thousands, except per share information Year Ended5/31/035/31/025/31015/31/005/31/99Sales$7,420$6,875$7,580$8,854$7,958Net (Loss) Income$(1,487)$(1,599)$(2,367)$561$(259)Net (Loss) Income Per Share, Basic$(.60)$(.64)$(.90)$0.21$(0.09)Weighted Average No. Shares, Basic2,4682,4882,6352,7012,531Net (Loss) Income Per Share, Diluted$(.60)$(.64)$(.90)$0.21$(0.09)Weighted Average No. Shares, Diluted2,4682,4882,6352,8692,531Stockholders’ Equity$5,665$7,251$8,930$10,128$10,587Total Assets$6,272$8,161$10,291$10,953$11,282Long-term debt (including current portion)$24$280$353$—$— Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following information contains certain forward-looking statements that anticipate future trends or events. These statements are based on certainassumptions that may prove to be erroneous and are subject to certain risks including but not limited to the uncertainties of the Company’s new productintroductions, the risks of increased competition and technological change in the Company’s industries and other factors detailed in the Company’s SECfilings. Accordingly, actual results may differ, possibly materially, from the predictions contained herein. RESULTS OF OPERATIONS Critical Accounting Policies Revenue Recognition – The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixedor determinable and collectibility is probable. 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 aftersuch obligations are fulfilled. Accounts Receivable – The Company maintains credit limits for all customers that are developed based upon several factors, included but not limited topayment history, published credit reports and use of credit references. On a monthly basis, Management performs various analyses to evaluate accountsreceivable balances to ensure recorded amounts reflect estimated net realizable value. This review includes accounts receivable agings, other operatingtrends and relevant business conditions, including general economic factors, as they relate to each of the Company’s domestic and international customers. Ifthese analyses lead Management to the conclusion that potential significant accounts are uncollectible, a reserve will be provided. The Company has had nosignificant bad debt write-offs since its inception in 1986. As of May 31, 2003, management established a reserve of $24,060 to cover potential doubtfulaccounts. Inventories – These assets are stated at the lower of cost or market on an average cost basis. Each Fiscal quarter, Management utilizes various analyses basedon sales forecasts, historical sales and inventory levels to ensure the current carrying value of inventory accurately reflects current and expected requirementswithin a reasonable timeframe. As a result of this analysis at May 31, 2003, Management believes the inventory levels are sufficient based upon the expectedrequirements in Fiscal 2004 and beyond. Based upon the same analysis in Fiscal 2003 and 2001, Management determined $401,673 and $1,646,517respectively of inventories were in excess of expected requirements and therefore these amounts were written off. 13 Long-term Deferred Tax Asset– The Company applies the asset and liability method in recording income taxes, under which deferred income tax assets andliabilities are determined based on the differences between the financial reporting and tax bases of assets and liabilities and are measured using currentlyenacted tax rates and laws. Additionally, deferred tax assets are evaluated and a valuation allowance is established if it is more likely than not that all or aportion of the deferred tax asset will not be realized. During the year ended May 31, 2003, and based upon the losses in the past three Fiscal years,Management believed it was prudent for the Company to increase the valuation reserve to fully offset the estimated value of the deferred tax assets. Intangible Assets – There is a periodic review of intangible and other long-lived assets for impairment. This review consists of the analysis of events orchanges in circumstances that would indicate the carrying amount of the asset may not be recoverable. Recoverability is determined by comparing theforecasted future net cash flows from the operations to which the assets relate, based on management’s best estimates using the appropriate assumptions andprojections at the time, to the carrying amount of the assets. If the carrying value is determined to be in excess of future operating cash flows, the asset isconsidered impaired and a loss is recognized equal to the amount by which the carrying amount exceeds the estimated fair value of the assets. As of May 31,2003, Management does not believe impairment, as defined above, exists. Discussion of operating results: Sales were $7,419,521, $6,874,659 and $7,580,154 in Fiscal 2003, 2002 and 2001 respectively. Worldwide sales of Schmitt Balancing products in Fiscal2003 increased to $5,481,010 from $5,275,556 in Fiscal 2002 but decreased from $6,030,030 in Fiscal 2001. Measurement sales increased to $1,938,511from $1,599,103 and $1,550,124 in Fiscal 2002 and 2001 respectively. The net loss for Fiscal 2003 of $1,487,131 compares to net losses of $1,598,619 and$2,366,953 in Fiscal 2002 and 2001 respectively. The net loss in Fiscal 2003 was due to four items; a $612,200 non-operating charge for a write-down of theCompany’s long-term investment in Air Packaging Technologies, Inc, $401,673 in write-downs of excess inventory quantities, an increase in the deferred taxasset valuation allowance of $636,006 and a $24,060 reserve for doubtful accounts. When these items are excluded, the net income would have been$186,808. The net loss in Fiscal 2002 was primarily attributable to a $1,516,000 non-operating charge for a write-down of the Company’s long-terminvestment in Air Packaging Technologies, Inc. When that item is excluded, the net loss in Fiscal 2002 would have been $82,619. The net loss in Fiscal2001 was primarily attributable to a $1,536,267 write-off of excess inventory in the subsidiary which designs and assembles laser light scatter products. Also,late in Fiscal 2001 Management restructured operations in Europe and recognized expenses of $226,525 in association with that restructure. When those twoitems are excluded, the net loss would have been $604,161. The final item contributing to the losses in Fiscal 2002 and 2001 was decreasing sales, primarilyin the Balancer segment, with the general economic slowdown in North America and Europe believed to be the biggest cause. Domestic and foreign revenues in the past several months have been affected by the slowdown in the global economy, resulting in soft demand for Balancerproducts and reduced demand for Measurement devices. The Balancer segment sales focus on end-users, rebuilders and original equipment manufacturersthroughout the world. Sales staff, representatives and distributors throughout these geographic areas spend a large amount of time with the targetedcustomers. They have found many of the customers in the automotive, bearing and aircraft industries have referred to the state of the economy and its impacton the machine tool industry as reasons for their reduced ordering activity. The primary target markets for Measurement products have historically been diskdrive and silicon wafer manufacturers. Management and sales staff monitor industry publications and public financial information in order to judge thepotential demand for Measurement products by these targeted industries. As in the prior Fiscal year, this information has discussed at length decliningdemand for and sales of the products of those two industries and has generally defined industries that are in a severe recession. Also, frequent discussionswith customers have confirmed the information presented in the public information and their inability to purchase Measurement products due to their lack ofa capital budget. Historically, the Company has enjoyed low cost of sales percentages, with those on its Balancing products less than 50% and those on its Measurementproducts less than 40%. Fiscal 2003 consolidated cost of sales as a percentage of sales totaled 47% compared to those in Fiscal 2002 and 2001 of 41% and68% respectively. The cost of sales in Fiscal 2003 includes $401,673 for the write-off of excess inventory 14 quantities, which, when excluded from cost of sales would decrease the percentage to 42%. Fiscal 2001 cost of sales includes $1,646,517 for the write-off ofexcess inventory quantities, which when excluded from cost of sales would decrease the percentage to 47%. Cost of sales in the Balancer segment increasedto 49% from 46% in Fiscal 2002 and decreased from 51% in Fiscal 2001. The percentage increased in Fiscal 2003 due to the higher percentage of sales in theEuropean markets. Market conditions in that geographic market are more competitive than in other areas and therefore unit sales prices are lower andconversely cost of sales percentages are higher. The cost of sales for Balancer products in Fiscal 2003 also includes $18,561 for the write-off of excessinventory quantities. The cost of sales percentage in Fiscal 2001 includes a write-off of obsolete inventory in the German subsidiary of $110,250 which,when excluded from cost of sales, would decrease the percentage to 49%. Cost of sales for Measurement products was 42%, up from 25% in Fiscal 2002 anddown from 136% in 2001. The cost of sales in Fiscal 2003 included write-off of excess inventory quantities in the amount of $383,112 which, whenexcluded from cost of sales, would reduce the percentage to 22%. Fiscal 2001 includes an inventory writedown of $1,536,267 and, when the inventory write-down is excluded, the cost of sales percentage for Fiscal 2001 would be 37%. The variation from the percentage in the prior years is due to the sales mix. Management expects the trends in sales and profits during Fiscal 2004 for the Balancer segment to improve slightly while those of the Measurement segmentwill approximate results for Fiscal 2003 (when the write-off of excess inventory quantities is excluded). However, no assurances can be made that theCompany will be profitable or will generate increased sales in future time periods. General, administrative and sales expenses as a percentage of net sales were 56% in Fiscal 2003 compared to 56% in Fiscal 2002 and 57% in Fiscal 2001. Interms of dollars, these expenses were $4,139,013, $3,856,354 and $4,297,130 in Fiscal 2003, 2002 and 2001 respectively. The increase in expenses in themost recent Fiscal year was due to higher sales and a higher level of employees at the Acuity subsidiary. Late in Fiscal 2003, Management reduced thenumber of employees at Acuity. The decrease in expenses in Fiscal 2002 occurred as a result of management actions initiated in the second Fiscal quarter ofthat year. In future Fiscal periods, Management believes the Company’s costs will not increase at the same rate that sales are anticipated to increase, althoughthere can be no such assurance. Research and development expenses as a percentage of net sales were 2.6% in Fiscal 2003 compared to 3.2% and 4.3% in Fiscal 2002 and 2001 respectively. In terms of dollars, these expenses were $192,686, $217,444 and $327,474 in Fiscal 2003, 2002 and 2001 respectively. The Company’s future operatingresults depend, to a considerable extent, on its ability to maintain a competitive advantage in both the products and services it provides. For this reason,Management believes future investments in research and development are critical to ensure the flow of innovative, productive, high-quality products andsupport services. Accordingly, Management expects to continue to place a high priority on research and development projects in the future. The Company realized a net loss of $1,487,131 ($0.60 per share) compared to net losses of $1,598,619 ($0.64 per share) and $2,366,953 ($0.90 per share) inFiscal 2002 and 2001 respectively. The loss in Fiscal 2003 was due to four items, a $612,200 non-operating charge for a write-down of the Company’s long-term investment in Air Packaging Technologies, Inc. ($0.25 per share), a $401,673 in write-downs of excess inventory quantities ($0.16 per share), anincrease in the deferred tax asset valuation allowance of $636,006 ($0.26 per share) and a $24,060 reserve for doubtful accounts ($0.01 per share). Whenthese items are excluded, net income would have been $186,808 or ($0.08 per share). The loss in Fiscal 2002 was primarily attributable to a $1,516,000 non-operating charge ($0.61 per share) for a write-down of the Company’s long-term investment in Air Packaging Technologies, Inc. The loss in Fiscal 2001 wasprimarily attributable to a write-off of $1,646,517 ($0.62 per share) related to the write-off of excess inventories in the Measurement segment and obsoleteinventories of the German subsidiary and $116,275 ($0.04 per diluted share) related to the expenses incurred in relation to the restructure of the Germansubsidiary. Net sales outside North America accounted for approximately 44% of the Company’s revenues in Fiscal 2003, 37% in Fiscal 2002 and 33% in Fiscal 2001. Some foreign customers purchase in their own country’s currencies, thereby imposing on the Company a currency risk. All U.S. sales (56% of total sales inFiscal 2003) were in U.S. dollars and the remaining Fiscal 2003 sales were in currencies other than U.S. dollars. To date, currency fluctuations have hadminimal impact on revenues. However, significant variations in the value of the U.S. dollar, relative to currencies of countries in which the Company hassignificant competitors, can impact future sales. The Company does not engage in currency hedging. In 15 addition, the longer payment cycles of international sales can have a negative impact on liquidity. The Company believes international sales will continueto grow in future periods. A substantial portion of the Company’s revenues are derived from sales to end users through selling agents. The Company is dependent on the sales activitiesof its selling agents, and there can be no assurance these agents will continue to be successful in their efforts to market the Company’s products. TheCompany enjoys substantial repeat business from a broad base of customers, but there is no assurance these customers will continue to buy the Company’sproducts. For Fiscal years 2003, 2002 and 2001, sales to a single customer did not exceed 10% of total revenues. The Company operates in highly competitive industries characterized by increasingly rapid technological changes. The Company’s competitive advantageand future success are therefore dependent on its ability to develop new products, qualify these new products with its customers, successfully introduce theseproducts to the marketplace on a timely basis, commence production to meet customer demands and develop new markets in the industries for its productsand services. The successful introduction of new technology and products is increasingly complex. If the Company is unable, for whatever reason, todevelop and introduce new products in a timely manner in response to changing market conditions or customer requirements, its results of operations couldbe adversely impacted. LIQUIDITY AND CAPITAL RESOURCES The Company’s ratio of current assets to current liabilities increased to 7.7 to 1 at May 31, 2003 compared to 5.7 to 1 at May 31, 2002. As of May 31, 2003the Company had $410,245 in cash compared to $447,679 at May 31, 2002. During the year ended May 31, 2003, cash provided from operating activities amounted to $565,083 with the changes described as follows: • The net loss for the year ended May 31, 2003 of $1,487,131 plus five non-cash items: depreciation and amortization of $240,265, the write-down of thelong-term investment of $612,200, the write-down of the excess inventory quantities of $401,673, the increase in the valuation allowance for thedeferred tax asset of $636,006 and the provision for doubtful accounts of $24,060. • Accounts receivable used cash as the balance increased by $213,224 (exclusive of the allowance for doubtful accounts) to a May 31, 2003 balance of$1,324,200 compared to $1,135,036 at May 31, 2002. At May 31, 2003, $24,060 in accounts receivable were considered a doubtful collection andtherefore a reserve in that amount has been provided for. The Company generally experiences a payment cycle of 30-90 days on invoices, depending onthe geographic market. Management believes its credit and collection policies are effective and appropriate for the marketplace. There can be noassurance that the Company’s collection procedures will continue to be successful, particularly with current economic conditions. • Inventories decreased $80,518 (exclusive of the inventory write-downs of $401,673) to a May 31, 2003 balance of $2,725,931 compared to $3,208,122at May 31, 2002. The Company maintains levels of inventory sufficient to satisfy normal customer demands plus an increasing short-term deliveryrequirement for a majority of its Balancer products. Management believes its ability to provide prompt delivery gives it a competitive advantage forcertain sales. • Prepaid expenses increased by $5,312 due to the addition of prepaid trade show costs less the amortization of several items including prepaid trade showcosts, professional fees and various business and life insurance costs. • Income taxes receivable declined by $123,977 due to Federal and local tax refunds received during the year ended May 31, 2003. • Trade accounts payable increased by $116,321 with the increase due to increased purchasing activities of the Balancer segment and an extension ofpayment terms from thirty to forty-five days. 16 • Other accrued liabilities (including commission, payroll items and other accrued expenses) increased by $35,730. During the year ended May 31, 2003, net cash used in investing activities was $48,106 consisting of net additions to property and equipment. Net cash usedin financing activities amounted to $466,795, which consists of repayments of long-term debt of $294,408, additions to long-term debt of $38,250,repayment on the credit line of $200,000 and repurchases of common stock for $10,637. The following summarizes contractual obligations at May 31, 2003 and the effect on future liquidity and cash flows: Years EndingMay 31,Capital LeaseObligationsOperating LeasesTotalContractualObligations2004$20,030$96,939$116,96920054,27442,19346,4672006—9,2899,2892007—4,6454,6452008———Thereafter———Total$24,304$153,066$177,370 The acquisition of SMS in Fiscal 1995 resulted in a tax loss of approximately $5.5 million, which is available to offset domestic earnings through the year2009. As of May 31, 2003, approximately $2.0 million of these losses remain. The Company’s $500,000 short-term line of credit agreement with a commercial bank expired on April 30, 2003. While management believes it could securecredit from another source, there is no guarantee this could be accomplished or, if it is accomplished, the terms will be as favorable as those under the currentline of credit. Specific business challenges faced by the Company over the past few years have had a negative impact on operations. Management has responded to thesechallenges by reducing operating expenses, developing new products and attempting to penetrate new markets for the Company’s products. As a result ofthese efforts, Management believes its cash flows from operations and its cash position will provide adequate funds on both a short-term and long-term basisto cover currently foreseeable debt payments, lease commitments and payments under existing and anticipated supplier agreements. Management believesthat such cash flow (without the raising of external funds) is sufficient to finance current operations, projected capital expenditures, anticipated long-termsales agreements and other expansion-related contingencies during Fiscal 2004. However, in the event the Company fails to achieve its operating andfinancial goals for Fiscal 2004, 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 additional cost cutting measures, increased borrowings from existing credit facilities or entering into additionalborrowing arrangements collateralized by assets. Item 7A. Qualitative and Quantitative Disclosures about Market Risk Interest Rate Risk The Company did not have any derivative financial instruments as of May 31, 2003. However, the Company is exposed to interest rate risk. The Companyemploys 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. Therefore, changes in U.S.and European interest rates affect the interest earned on the Company’s cash equivalents and marketable securities as well as interest paid on debt. 17 The Company has lines of credit and other debt whose interest rates are based on various published prime rates that may fluctuate over time based oneconomic changes in the environment. The Company is subject to interest rate risk and could be subject to increased interest payments if market interestrates fluctuate. The Company does not expect any change in the interest rates to have a material adverse effect on the Company’s results from operations. Foreign Currency Risk The Company operates subsidiaries in the United Kingdom and Germany. The Company’s business and financial condition is, therefore, sensitive tocurrency exchange rates or any other restrictions imposed on their currencies. To date, the foreign currency exchange rates have not significantly impactedthe Company’s profitability. 18 Item 8. Financial Statements and Supplementary Data SCHMITT INDUSTRIES, INC.CONSOLIDATED BALANCE SHEETSMAY 31, 2003 AND 2002 20032002ASSETSCurrent AssetsCash$410,245$447,679Accounts receivable, net of allowance for doubtful accounts of $24,060 and $0 in 2003 and 2002respectively1,324,2001,135,036Inventories2,725,9313,208,122Prepaid expenses167,192161,880Income taxes receivable32,659156,6364,660,2275,109,353 Property and EquipmentLand299,000299,000Buildings and improvements1,208,4171,206,346Furniture, fixtures and equipment991,828947,866Vehicles93,887139,0912,593,1322,592,303Less accumulated depreciation and amortization1,307,1001,174,5601,286,0321,417,743Other AssetsLong-term investment6,800619,000Long-term deferred tax asset—636,006Other assets318,880379,328325,6801,634,334TOTAL ASSETS$6,271,939$8,161,430 LIABILITIES AND STOCKHOLDERS’ EQUITY Current LiabilitiesLine of credit$—$200,000Accounts payable355,329239,008Accrued commissions148,953157,325Other accrued liabilities78,08033,978Current portion of long-term debt20,031264,845602,393895,156 Long-term Debt4,27315,617 Commitments and Contingencies (Note 8) Stockholders’ EquityCommon stock, no par value, 20,000,000 shares authorized, 2,457,932 and 2,468,424 shares issued andoutstanding at May 31, 2003 and 2002, respectively7,332,9847,343,621Accumulated other comprehensive loss(280,363)(192,747)(Accumulated deficit) retained earnings(1,387,348)99,7835,665,2737,250,657TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY$6,271,939$8,161,430 The accompanying notes are an integral part of these consolidated statements 19 SCHMITT INDUSTRIES, INC.CONSOLIDATED STATEMENTS OF OPERATIONSFOR THE YEARS ENDED MAY 31, 2003, 2002 AND 2001 200320022001Net Sales$7,419,521$6,874,659$7,580,154 Cost of SalesOperations, exclusive of inventory write-downs3,088,5662,844,9373,529,991Inventory write-downs401,673—1,646,517Total cost of sales3,490,2392,844,9375,176,508 Gross profit3,929,2824,029,7222,403,646 Operating expenses:General, administrative, and sales4,139,0133,856,3544,297,130Research and development192,686217,444327,474Restructure expenses——116,275Total operating expenses4,331,6994,073,7984,740,879 Operating loss(402,417)(44,076)(2,337,233) Other income and (expense):Interest expense(22,824)(53,468)(15,016)Interest income5584,66536,513Loss on write-down of long-term investment(612,200)(1,516,000)—Gain (loss) on foreign currency exchange192,010(15,470)(63,855)Rental income22,80022,80018,407Miscellaneous (expense) income(29,052)2,930(5,769)Other income and (expense)(448,708)(1,554,543)(29,720) Loss before provision for income taxes(851,125)(1,598,619)(2,366,953) Provision for income taxes636,006—— Net loss$(1,487,131)$(1,598,619)$(2,366,953) Net loss per common share, basic$(0.60)$(0.64)$(0.90) Weighted average number of common shares, basic2,467,6512,488,4582,634,933 Net loss per common share, diluted$(0.60)$(0.64)$(0.90) Weighted average number of common shares, diluted2,467,6512,488,4582,634,933 The accompanying notes are an integral part of these consolidated financial statements 20 SCHMITT INDUSTRIES, INC.CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITYFOR THE YEARS ENDED MAY 31, 2003, 2002 AND 2001 SharesAmountAccumulatedOtherComprehensive(Loss)RetainedEarnings(AccumulatedDeficit)TotalTotalComprehensive(Loss) Balance, May 31, 20002,660,129$7,259,399$(1,196,683)$4,065,355$10,128,071$Common shares issued to purchase AcuityResearch91,666747,725——747,725Common shares retired(97,750)(586,500)——(586,500)Note cancelled in return for stock—586,500——586,500Common shares repurchased(152,114)(599,648)——(599,648)Net (loss)———(2,366,953)(2,366,953)(2,366,953)Other comprehensive income——1,020,729—1,020,7291,020,729Balance, May 31, 20012,501,9317,407,476(175,954)1,698,4028,929,924Comprehensive loss, year ended May 31,2001$(1,346,224) Common shares repurchased(33,499)(63,855)——(63,855)Net (loss)———(1,598,619)(1,598,619)(1,598,619)Other comprehensive loss——(16,793)—(16,793)(16,793)Balance, May 31, 20022,468,432$7,343,621$(192,747)$99,783$7,250,657Comprehensive loss, year endedMay 31, 2002$(1,615,412) Common shares repurchased(10,500)(10,637)——(10,637)Net (loss)———(1,487,131)(1,487,131)(1,487,131)Other comprehensive loss——(87,616)—(87,616)(87,616)Balance, May 31, 20032,457,932$7,332,984$(280,363)$(1,387,348)$5,665,273Comprehensive loss, year endedMay 31, 2003$(1,574,747) The accompanying notes are an integral part of these consolidated financial statements 21 SCHMITT INDUSTRIES, INC.CONSOLIDATED STATEMENTS OF CASH FLOWSFOR THE YEARS ENDED MAY 31, 2003, 2002 AND 2001 200320022001Cash Flows Relating to Operating ActivitiesNet loss$(1,487,131)$(1,598,619)$(2,366,953)Adjustments to reconcile net loss to net cash provided by (used in) operating activitiesWrite-down of long-term investment612,2001,516,000—Write-down of excess inventory quantities401,673—1,646,517Depreciation and amortization240,265245,138269,631Deferred taxes636,006122,865—Provision for bad debts24,060——(Increase) decrease in:Accounts receivable(213,224)92,121215,525Inventories80,518350,916(495,524)Prepaid expenses(5,312)24,690(115,202)Income taxes receivable123,977(122,975)(8,743)Increase (decrease) in:Accounts payable116,321(179,079)(59,226)Accrued commissions and other accrued liabilities35,730(198,594)36,847Net cash provided by (used in) operating activities565,083252,463(877,128) Cash Flows Relating to Investing ActivitiesPurchase of property and equipment(74,505)(110,458)(147,616)Disposal of property and equipment26,39939,37717,067Cash acquired in purchase of wholly-owned subsidiary——113,604Net cash used in investing activities(48,106)(71,081)(16,945) Cash Flows Relating to Financing ActivitiesLine of credit repayments(200,000)(400,000)—Line of credit borrowings—400,000200,000Proceeds of long-term borrowings38,25033,877—Repayment of long-term debt(294,408)(106,015)(119,400)Common stock repurchased(10,637)(63,855)(127,648)Net cash used in financing activities(466,795)(135,993)(47,048) Effect of foreign exchange translation on cash(87,616)111,207(32,271) (Decrease) increase in cash(37,434)156,596(973,392) Cash, beginning of year447,679291,0831,264,475 Cash, end of year$410,245$447,679$291,083 Supplemental Disclosure of Cash Flow InformationCash paid during the period for interest$22,824$58,771$15,016Cash paid during the period for income taxes$26,110$110$20,132 Supplemental Schedule of Noncash Investing and Financing ActivitiesIncrease (decrease) in market value of long-term investment$—$(273,000)$1,596,000Increase (decrease) in long-term deferred tax asset$—$145,000$(543,000)Common stock issued to purchase wholly-owned subsidiary$—$—$747,725Wholly-owned subsidiary – net tangible assets acquired$—$—$(325,901)Wholly owned subsidiary – intangible assets acquired$—$—$(421,824)Long-term debt incurred to repurchase stock$—$—$472,000 The accompanying notes are an integral part of these consolidated statements 22 SCHMITT INDUSTRIES, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTSFOR THE YEARS ENDED MAY 31, 2003, 2002 AND 2001 NOTE 1ORGANIZATION AND NATURE OF OPERATIONS Schmitt Industries, Inc. (the Company) designs, assembles, markets and distributes electronic and mechanical components for machine tool products and lasermeasurement systems worldwide. NOTE 2SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation These consolidated financial statements include those of the Company and its wholly owned subsidiaries: Schmitt Measurement Systems, Inc. (SMS),Schmitt Europe, Ltd. (SEL), Schmitt Europa GmbH (SEG) and Acuity Research Incorporated (ARI). All significant intercompany accounts and transactionshave been eliminated in the preparation of the consolidated financial statements. Foreign Currency Translation Financial statements for the Company’s subsidiaries outside the United States are translated into U.S. dollars at year-end exchange rates for assets andliabilities and weighted average exchange rates for income and expenses. The resulting translation adjustments are included as a separate component ofstockholders’ equity titled “Accumulated Other Comprehensive Loss.” Revenue Recognition The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable andcollectibility is probable. For sales to all customers, including manufacturer representatives, distributors or their third-party customers, these criteria are metat the time product is shipped. When other significant obligations remain after products are delivered, revenue is recognized only after such obligations arefulfilled. Research and Development Costs Research and development costs are charged to expense when incurred. Stock-Based Compensation Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation,” (FAS 123) encourages, but does not require, companiesto record compensation cost for stock-based employee compensation plans at fair value. The Company has chosen to continue to account for stock-basedcompensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees”(APB 25). Accordingly, compensation cost for stock options is measured as the excess, if any, of the quoted market price of the Company’s stock at the dateof the grant over the amount an employee must pay to acquire the stock. The Company has adopted the disclosure only provisions of SFAS 123. Accordingly, no compensation cost has been recognized for the stock option plans.Adjustments are made for options forfeited prior to vesting. For the years ended May 31, 2003, 2002 and 2001, total value of options granted was computedto be $7,158, $110,532 and $621,850, respectively, which would be amortized on the straight-line basis over the vesting period of the options. Hadcompensation cost for the Company’s stock option plans been determined based on the fair value at the grant date for the awards in 2003, 2002 and 2001,consistent with the provisions of SFAS 123, the Company’s pro forma net (loss) income for the years ended May 31, 2003, 2002 and 2001, would be$(1,591,321), $(1,709,151) and $(2,758,930), respectively. Pro forma basic 23 (loss) earnings per share for the years ended May 31, 2003, 2002 and 2001 would be $(.64) $(.69) and $(1.05) respectively. Pursuant to SFAS 123, the fair value of each option granted is estimated on the date of the grant using the Black-Scholes option and pricing model. Theweighted average assumptions used for Fiscal 2003, 2002 and 2001 were a risk-free interest rate of 3.50% for 2003, 4.00% for 2002 and 5.00% for 2001, anexpected dividend yield of 0% for all years, an expected life of four years for Fiscal 2003 and 2002 and eight years for Fiscal 2001, and a volatility of 119%,121% and 80%, respectively. The effects of applying SFAS No. 123 in the proforma disclosure are not indicative of future amounts. Income Taxes Deferred tax assets and liabilities are recognized for the future tax consequences of differences between the financial statement carrying amounts of existingassets and liabilities and their respective tax bases. Earnings Per Share Basic earnings per share are computed using the weighted average number of shares outstanding. Diluted earnings per share are computed using theweighted average number of shares outstanding, adjusted for dilutive incremental shares attributed to outstanding options to purchase common stock. InFiscal 2003, 2002 and 2001, 243,290, 380,142 and 384,442 incremental shares were excluded from the diluted loss per share calculation, as their effect wasanti-dilutive. Cash and Cash Equivalents The Company considers short-term investments that are highly liquid, readily convertible into cash and have original maturities of less than three months tobe cash equivalents. Accounts Receivable The Company maintains credit limits for all customers that are developed based upon several factors, included but not limited to payment history, publishedcredit reports and use of credit references. On a monthly basis, Management performs various analyses to evaluate accounts receivable balances to ensurerecorded amounts reflect estimated net realizable value. This review includes accounts receivable agings, other operating trends and relevant businessconditions, including general economic factors, as they relate to each of the Company’s domestic and international customers. If these analyses leadManagement to the conclusion that potential significant accounts are uncollectible, a reserve will be provided. The Company has had no significant baddebt write-offs since its inception in 1986. As of May 31, 2003, management established a reserve of $24,060 to cover potential doubtful accounts. Inventory Inventory is valued at the lower of cost or market with cost determined on the average cost basis. As of May 31, 2003 and 2002, inventories consisted of rawmaterials ($1,346,513 and $1,870,507, respectively), work-in-process ($1,527 and $1,151, respectively), and finished goods ($1,377,891 and $1,336,464,respectively). Property and Equipment Property and equipment are stated at cost. Depreciation is computed using the straight-line method over estimated useful lives of three to seven years forfurniture fixtures, and equipment; three years for vehicles; and twenty-five years for buildings and improvements. 24 Concentration of Credit Risk Financial instruments that potentially expose the Company to concentration of credit risk are trade accounts receivable. Credit terms generally include adiscount of 1-1/2% if the invoice is paid within ten days, with the net amount payable in 30 days. Financial Instruments The carrying amounts of financial instruments approximate their fair values at May 31, 2003. Use of Estimates The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of Americarequires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. New Accounting Pronouncements In July 2002, FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities,” which replaces Emerging Issues Task Force(EITF) Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain CostsIncurred in a Restructuring).” SFAS No. 146 requires companies to recognize costs associated with exit or disposal activities, such as lease termination costsand certain employee severance costs, when they are incurred rather than at the date of a commitment to an exit or disposal plan. The principal effect ofapplying SFAS No. 146 will be on the timing of recognition of costs associated with exit or disposal activities. The Company will apply SFAS No. 146 toexit or disposal activities initiated after December 31, 2002. In December 2002, the FASB issued Statement No. 148 (SFAS 148), “Accounting for Stock-Based Compensation – Transition and Disclosure: an amendmentof FASB Statement 123” (SFAS 123), to provide alternative transition methods for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS 148 amends the disclosure requirements of SFAS 123 to require prominent disclosures in annual financialstatements about the method of accounting for stock-based employee compensation and the pro forma effect on reported results of applying the fair valuebased method for entities that use the intrinsic value method of accounting. The pro forma effect disclosures are also required to be prominently disclosed ininterim period financial statements. This statement is effective for financial statements for fiscal years ending after December 15, 2002 and is effective forfinancial reports containing condensed financial statements for interim periods beginning after December 15, 2002, with earlier application permitted. TheCompany does not plan a change to the fair value based method of accounting for stock-based employee compensation and has included the disclosurerequirements of SFAS 148 above. In November 2002, the FASB issued Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including IndirectGuarantees of Indebtedness of Others” (“FIN 45”). FIN 45 expands previously issued accounting guidance and disclosure requirements for certainguarantees. FIN 45 requires an entity to recognize an initial liability for the fair value of an obligation assumed by issuing a guarantee. The disclosurerequirements of FIN 45 are effective for all financial statements issued after December 15, 2002. The provision for initial recognition and measurement of theliability will be applied on a prospective basis to guarantees issued or modified after December 31, 2002. The adoption of FIN 45 is not expected to have amaterial adverse impact on the Company’s financial position, results of operations or cash flows. In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51,” (“FIN 46”). FIN 46requires all Variable Interest Entities (“VIEs”) to be consolidated by the primary beneficiary. The primary beneficiary is the entity that holds the majority ofthe 25 beneficial interests in the VIE. In addition, FIN 46 expands disclosure requirements for both VIEs that are consolidated as well as VIEs from which the entityis the holder of a significant amount of the beneficial interest, but not the majority. The disclosure requirements of FIN 46 are effective for all financialstatements issued after January 31, 2003. The consolidation requirements of this interpretation are effective for all periods beginning after June 15, 2003. Theadoption of FIN 46 is not expected to have a material adverse impact on the Company’s financial position, results of operations or cash flows at this time. NOTE 3LONG-TERM INVESTMENTSThe Company owns 1,375,716 shares or approximately 9% of the outstanding shares of Air Packaging Technologies, Inc. That company is engaged in thedesign, manufacture, marketing and sales of “Air Box” patented packaging systems used in the retail, industrial protective and promotional packagingmarkets worldwide. This investment is classified as “Available-for-sale securities” under Statement of Financial Accounting Standards No. 115 (SFAS No.115). As required under that statement, all unrealized gains and losses are reported in Accumulated Other Comprehensive Loss and included as a separatecomponent in Other Comprehensive Loss in Stockholders’ Equity until realized or until unrealized losses are deemed to be “other than temporary”. At May 31, 2003 Management determined the decline in value of the investment from acquisition cost was “other than temporary”, and, as required underSFAS No. 115, the long-term investment was written down by $612,200 to its fair market value as of May 31, 2003. Fair market value was the closing priceof the stock on the over-the-counter market at May 31, 2003. As required under SFAS No. 115, the new cost basis shall not be changed for subsequentrecoveries in fair value. Future temporary gains and losses will be reported as required under SFAS No. 115. NOTE 4LINE OF CREDIT The Company had a $500,000 short-term line of credit agreement with a commercial bank, secured by U.S. accounts receivable and inventories, that expiredon April 30, 2003. The line was guaranteed by the Company’s wholly owned subsidiary, Schmitt Measurement Systems, Inc. Interest was payable at thebank’s prime rate plus 1.50%. As of May 31, 2002, $200,000 was outstanding on this line of credit. NOTE 5INCOME TAXES The provision (benefit) for income taxes was as follows Years ended May 31,200320022001Current$—$—$—Deferred(363,021)(533,183)(718,431)Increase in valuation allowance999,027533,183718,431Total provision for income taxes$636,006$—$— Deferred tax assets (liabilities) are comprised of the following components: 26 2003 2002 Depreciation$19,679$19,679Net operating loss carryforwards1,448,4631,319,512Deferred taxes related to the decline in fair market value of long-term investment817,229582,144Other deferred assets89,50190,516Gross deferred tax assets2,374,8722,011,851 Deferred tax asset valuation allowance(2,374,872)(1,375,845) Net deferred tax asset$—$636,006 The Company has approximately $2.0 million of U.S. federal net operating loss carryforwards that were acquired as part of the acquisition of SchmittMeasurement Systems, Inc. These NOLs are subject to limitations that restrict their use and expire in the years 2007 through 2009. Due to the uncertainty of utilization of certain of the Company’s NOLs and in consideration of other factors, management has recorded a valuation allowanceon the deferred tax asset in 2003 and 2002 to reduce the net deferred tax asset to the amount that it has deemed will more likely than not be realized. The provision for income taxes differs from the amount of income taxes determined by applying the U.S. statutory federal tax rate to pre-tax (loss) income dueto the following: Years Ended May 31,200320022001Statutory federal tax rate(34.0)%(34.0)%(34.0)%State taxes, net of federal benefit———Change in deferred tax valuation allowance117.4%29.830.3Permanent and other differences(8.7)4.23.7 Effective tax rate74.7%—%—% NOTE 6EMPLOYEE BENEFIT PLANS The Company adopted the Schmitt Industries, Inc. 401(k) Profit Sharing Plan & Trust effective June 1, 1996. Employees must meet certain age and servicerequirements to be eligible. Participants may contribute up to 15% of their eligible compensation which may be partially matched by the Company. TheCompany may further make either a profit sharing contribution or a discretionary contribution. There were no contributions made by the Company to thisPlan during the year ended May 31, 2003 while during the years ended May 31, 2002 and 2001 contributions were $47,881 and $128,543 respectively. NOTE 7LONG-TERM DEBT During Fiscal 2002, the Company entered into two equipment lease agreements for $33,877. The agreements call for monthly principal and interestpayments of $534 and $580 with one requiring no interest payments and the other bearing interest of 13.8%. One lease expires in Fiscal 2004 and the secondin Fiscal 2005. During Fiscal 2001, the Company purchased 400,000 shares of its common stock from a private investor for $472,000. Under the terms of the stock purchaseagreement, the Company paid $94,400 in cash at closing with the remainder due under a note agreement. The agreement called for quarterly principalpayments of $25,000, plus interest at 9.00%.The remaining balance was paid prior to December 31, 2002. 27 As of May 31, 2003, future capital lease payments are: Year Ending May 31, 2004$20,0312005$4,273 NOTE 8COMMITMENTS AND CONTINGENCIES In a transaction related to the acquisition of Schmitt Measurement Systems, Inc., formerly TMA Technologies, Inc. (TMA), the Company established a royaltypool and vested in each shareholder and debt holder of the acquired company an interest in the royalty pool equal to the amount invested or loanedincluding interest payable through March 1995. The royalty pool will be funded at 5% of net sales (defined as gross sales less returns, allowances and salescommissions) of Schmitt Measurement Systems, Inc.’s products and future derivative products developed by Schmitt Industries, Inc., which utilize thesetechnologies. As part of the royalty pool agreement, each former shareholder and debt holder released TMA from any claims with regard to the acquisitionexcept their rights to future royalties. Royalty expense applicable to the years ended May 31, 2003, 2002 and 2001 amounted to $48,517, $27,763 and$36,964, respectively. The Company has entered into various non-cancelable leases for facilities used to support operations in the United Kingdom, Germany and California. Rentexpense for the years ended May 31, 2003, 2002 and 2001 amounted to $136,953, $136,374 and $136,388 respectively. Lease commitments Year Ending May 31,2004$96,9392005$42,1932006$9,2892007$4,6452008$—Thereafter$— During Fiscal 2003, the Company agreed to purchase 74,859 shares of its outstanding common stock from the former President of its wholly ownedsubsidiary, Acuity Research Incorporated, for $74,859. The agreement calls for three payments of $20,000 each and the balance to be paid on August 15,2003. At the time of each note payment, the stockholder will surrender an amount of shares equal in value to the payment amount. The note does not requireany interest. No shares have been surrendered to the Company and accordingly, no payments have been made as of May 31, 2003. Specific business challenges faced by the Company over the past few years have had a negative impact on operations and liquidity. Management hasresponded to these challenges by reducing operating expenses, developing new products and penetrating new markets for the Company’s products. As aresult of these efforts, Management believes its cash flows from operations 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. Managementbelieves that such cash flow (without the raising of external funds) is sufficient to finance current operations, projected capital expenditures, anticipatedlong-term sales agreements and other expansion-related contingencies during Fiscal 2004. However, in the event the Company fails to achieve its operatingand financials goals in for Fiscal 2004, management may be required to take certain actions to finance operations in that time period. These actions couldinclude, but are not limited to, implementation of additional cost cutting measures, increased borrowings from existing credit facilities or entering intoadditional borrowing arrangements that are collateralized by assets. 28 NOTE 9SEGMENTS OF BUSINESS The Company operates principally in two segments of business: the design and assembly of dynamic balancing systems and components (Balancing) for themachine tool industry, and the design and assembly of laser measurement systems (Measurement). The Company also operates in two principal geographicmarkets, United States and Europe. Segment Information Year Ended May 31,200320022001MechanicalComponentsMeasurementSystemsMechanicalComponentsMeasurementSystemsMechanicalComponentsMeasurementSystemsGross sales$6,283,987$1,961,086$6,197,649$1,605,288$7,112,415$1,644,309Intercompany sales$802,977$22,575$922,093$6,185$1,082,385$94,185Net sales$5,481,010$1,938,511$5,275,556$1,599,103$6,030,030$1,550,124 Income (loss) from operations$(281,900)$(120,517)$(270,416)$226,340$(353,064)$(1,984,169) Intercompany rent$—$30,000$—$30,000$—$30,000 Depreciation expense$119,331$60,486$136,864$53,671$147,719$67,352 Amortization expense$20,002$40,446$20,000$34,603$20,000$34,560 Capital expenses$38,970$35,535$80,491$29,967$98,014$49,602 Geographic InformationYear Ended May 31,Geographic Sales200320022001North American SalesUnited States$3,985,882$4,230,818$5,181,886Intercompany$22,134$72,319$396,660$3,963,748$4,158,499$4,785,226Canada$153,022$151,732$242,115Mexico$34,027$27,686$14,489North America total$4,150,797$4,337,917$5,041,830 European SalesGermany$781,375$897,670$1,317,399Intercompany$—$206,824$320,354Germany total$781,375$690,846$997,045 United Kingdom$1,253,639$1,065,416$1,278,375Intercompany$803,418$649,135$459,556United Kingdom total$450,221$416,281$818,819 Other European Sales$1,116,506$520,076$134,531 Total Europe$2,348,102$1,627,203$1,950,395 Asia$849,940$887,093$542,485Others$70,682$22,446$45,444$7,419,521$6,874,659$7,580,154 Year Ended May 31,200320022001United StatesEuropeUnited StatesEuropeUnited StatesEuropeIncome (loss) from operations$(292,905)$(109,512)$113,812$(157,888)$(2,032,282)$(304,951) Depreciation expense$164,877$14,940$177,851$12,684$174,593$40,478 Amortization expense$60,448$—$54,603$—$54,560$— Capital expenses$68,363$6,142$107,388$3,070$133,153$14,463 29 Long-term Assets May 31, 2003May 31, 2002Segment:Mechanical$994,798$2,191,973Measurement$616,914$860,104 Geographic:United States$1,588,599$3,021,905Europe$23,113$30,172 Note – Europe is defined as the two European subsidiaries, Schmitt Europe, Ltd. and Schmitt Europa, GmbH NOTE 10STOCK OPTIONS The Board of Directors adopted a Stock Option Plan in December 1995, which plan was amended in August 1996 and restated in August 1998. An optiongranted under the Amended and Restated Stock Option Plan might be either an incentive stock option (ISO), or a nonstatutory stock option (NSO). ISOs maybe granted only to employees and members of the Board of Directors of the Company and are subject to certain limitations, in addition to restrictionsapplicable to all stock options under the Plan. Options not meeting these limitations will be treated as NSOs. The purchase price of ISOs is fair market valueon the date of grant; the purchase price of NSOs may vary from fair market value. Vesting is at the discretion of the option committee of the Board ofDirectors but generally is 50% at grant date and 16.7% on each anniversary thereafter. The Company has 400,000 shares reserved for issuance under thestock option plan. All outstanding options will expire no later than 2012. The following summarizes the options outstanding as of May 31, 2003: SharesWeightedAverageExercisePriceWeightedAverageRemainingContractualLifeOptions outstanding, May 31, 2000194,416$8.82 Options granted215,000$4.08Options repurchased(109,750)$9.00Options forfeited/cancelled(74,000)$8.46 Options outstanding May 31, 2001225,666$4.32 Options granted287,334$1.44Options forfeited/cancelled(269,000)$4.08 Options outstanding May 31, 2002244,000$1.20Options granted6,666$1.20Options forfeited/cancelled(6,677)$1.20 Options outstanding May 31, 2003243,989$1.208.79 Years Options vested at May 31, 2003160,433$1.208.79 Years 30 NOTE 11COMPREHENSIVE OTHER LOSS Years ended May 31,200320022001Significant components of net (loss) income:Write-down of long-term investment to fair market value$(612,200)$(1,516,000)$—Inventory write-downs(401,673)—(1,646,517)Restructure costs——(116,275)Increase in reserve for deferred tax asset(636,006)——Reserve for doubtful accounts(24,060)——Income (loss) from operations exclusive of inventory write-downs, restructure costsincrease in reserve for deferred tax asset and reserve for doubtful accounts186,808(82,619)(604,161)Net loss(1,487,131)(1,598,619)(2,366,953) Other comprehensive (loss) income:Increase (decrease) in fair market value of long-term Investment, net of taxes—(128,000)1,053,000Foreign currency translation adjustment(87,616)111,207(32,271) Total comprehensive loss$(1,574,747)$(1,615,412)$(1,346,224) The long-term investment is considered an “Available-for-sale security”. As required under Statement of Financial Accounting Standards No. 115, allunrealized gains and losses, net of tax benefits, are reported in Accumulated Other Comprehensive (Loss) Income and included as a separate component ofOther Comprehensive (Loss) Income in Stockholders’ Equity until realized or until unrealized losses are deemed to be “other than temporary”. Thecumulative translation adjustment consists of unrealized gains/losses from translation adjustments on intercompany foreign currency transactions that are ofa long-term investment nature. 31 SUMMARIZED QUARTERLY FINANCIAL DATAIn thousands, except per share information(unaudited) 2003 Quarter EndedAugust31November30February28May31Sales$2,001$1,794$1,621$2,004Gross Profit$1,178$1,074$487$1,190Net (Loss) income$55$33$(1,715)$140Net (Loss) income Per Share, Basic$.03$.01$(.69)$.05Net (Loss) income Per Share, Diluted$.03$.01$(.69)$.05Market Price of Common StockHigh$1.65$1.95$1.50$1.60Low$1.05$1.11$1.07$0.80 2002 Quarter EndedAugust31November30February28May31Sales$1,585$1,879$1,453$1,958Gross Profit$868$1,119$861$1,182Net (Loss) income$(252)$71$(65)$(1,353)Net (Loss) income Per Share, Basic$(.09)$.03$(.03)$(0.54)Net (Loss) income Per Share, Diluted$(.09)$.03$.(03)$(0.54)Market Price of Common StockHigh$3.27$2.76$1.68$2.16Low$2.13$0.87$1.05$1.02 Report of Independent Accountants: Board of Directors and ShareholdersSchmitt Industries, Inc. We have audited the accompanying consolidated balance sheet of Schmitt Industries, Inc. and its subsidiaries as of May 31, 2003, and the relatedconsolidated statements of operations, changes in stockholders’ equity and cash flows for the year then ended. These financial statements are theresponsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan andperform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on atest basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used andsignificant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides areasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Schmitt Industries, Inc.and its subsidiaries as of May 31, 2003, and the consolidated results of their operations and their consolidated cash flows for the year then ended, inconformity with accounting principles generally accepted in the United States of America. /s/ GRANT THORNTON LLP Portland, OregonJuly 11, 2003 32 Report of Independent Auditors: To the Board of Directors and Shareholders ofSchmitt Industries, Inc. In our opinion, the accompanying consolidated balance sheet and the related consolidated statements of operations, of changes in shareholders’ equity andof cash flows present fairly, in all material respects, the financial position of Schmitt Industries, Inc. and its subsidiaries at May 31, 2002, and the results oftheir operations and their cash flows for the two years in the period ended May 31, 2002 in conformity with accounting principles generally accepted in theUnited States of America. These financial statements are the responsibility of the Company’s management; our responsibility is to express an opinion onthese financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in theUnited States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free ofmaterial misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessingthe accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe thatour audits provide a reasonable basis for our opinion. PricewaterhouseCoopers LLP Portland, OregonJuly 3, 2002 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure • Form 8-K filed May 30, 2003 to announce the dismissal of PricewaterhouseCoopers LLP as principal accountant to audit theCompany’s financial statements. • Form 8-K filed June 23, 2003 to announce the retention of Grant Thornton LLP as principal accountant to audit the Company’sfinancial statements. ITEM 9A. CONTROLS AND PROCEDURES (a) Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, weconducted an evaluation of our disclosure controls and procedures, as such term is defined under Rule 13a-14(c) promulgated under the SecuritiesExchange Act of 1934, as amended, as of the end of the period covered by this report. Based on their evaluation, our principal executive officer andprincipal 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 isreasonably likely to materially affect, our internal control over financial reporting. PART III Certain information required by Part III is included in the Company’s definitive Proxy Statement for its 2003 Annual Meeting of Shareholders (“ProxyStatement”) and is incorporated herein by reference. The Proxy Statement will be filed pursuant to Regulation 14A of the Securities Exchange Act of 1934not later than 120 days after the end of the Fiscal year covered by this Report. Items 10 and 11. Directors and Executive Officers of the Registrant and Executive Compensation The information required by these items is included in the Proxy Statement under the headings “Election of Directors”, “Equity Compensation Plan,”“Executive Compensation,” “Summary Compensation Table,” “Options Grants in Fiscal 2002,” “Aggregated Option Expenses in Fiscal 2003 and FiscalYear-End Option Values” and “Section 16(a) Beneficial Ownership Reporting Compliance” and is incorporated herein by reference. 33 Item 12. Security Ownership of Certain Beneficial Owners and Management The information required by this item is included in the Proxy Statement under the heading “Principal Shareholders” and is incorporated herein by reference. Item 13. Certain Relationships and Related Transactions The information required by this item is included in the Proxy Statement under the heading “Certain Transactions” and is incorporated herein by reference. Item 14 Principal Accounting Fees and Services The information required by this item is included in the Proxy Statement under the heading “Independent Public Accountants” and is incorporated herein byreference. PART IV Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K(a) Financial Statements: (1)Consolidated Balance Sheets as of May 31, 2003 and 2002 Consolidated Statements of Operations for the years ended May 31, 2003, 2002 and 2001 Consolidated Statements of Changes in Stockholders’ Equity for the years ended May 31, 2003, 2002 and 2001 Consolidated Statements of Cash Flows for the years ended May 31, 2003, 2002 and 2001 Notes to Consolidated Financial Statements Report of Independent Accountants (2)Financial Statement Schedules: All financial statement schedules are omitted either because they are not applicable, notrequired, or the required information is included in the financial statements or notes thereto. (3)Exhibits: Reference is made to the list on page 36 of the Exhibits filed with this report. (b) Reports on Form 8-K:• Form 8-K filed May 30, 2003 to announce the dismissal of PricewaterhouseCoopers LLP as principal accountant to audit theCompany’s financial statements. • Form 8-K filed June 23, 2003 to announce the retention of Grant Thornton LLP as principal accountant to audit the Company’sfinancial statements. 34 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized. SCHMITT INDUSTRIES, INC. By:/s/ Wayne A. CaseWayne A. CaseChairman of the Board, President and Chief ExecutiveOfficer Date:August 27, 2003 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrantand in the capacities indicated on August 27, 2003. SignatureTitle /s/ Wayne A. CaseChairman of the Board, President and ChiefWayne A. CaseExecutive Officer(Principal Executive Officer) /s/ Robert C. ThompsonChief Financial Officer/TreasurerRobert C. Thompson(Principal Financial and Accounting Officer) /s/ Maynard BrownDirectorMaynard Brown /s/ Timothy D.J. HennessyDirectorTimothy D.J. Hennessy /s/ Trevor NelsonDirectorTrevor Nelson /s/ John A. RuppDirectorJohn A. Rupp 35 INDEX TO EXHIBITS ExhibitsDescription 3(i)Second Restated Articles of Incorporation of Schmitt Industries, Inc. (the “Company”). Incorporated by reference to Exhibit 3(i) to theCompany’s Annual Report on Form 10-K for the Fiscal year ended May 31, 1999 3(ii)Second Restated Bylaws of the Company Incorporated by reference to Exhibit 3(ii) to the Company’s Annual Report on Form 10-K forthe Fiscal year ended May 31, 1999 *10.1Schmitt Industries, Inc. Amended & Restated Stock Option Plan. Incorporated by reference to Exhibit 10.1 to the Company’s AnnualReport on Form 10-K for the Fiscal year ended May 31, 1999 **21.1Subsidiaries of Schmitt Industries, Inc. **23.1Consent of Grant Thornton LLP **23.2Consent of PricewaterhouseCoopers **31.1Certification 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 **31.2Certification 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 **32.1Certification of Principal Executive Officer and Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant toSection 906 of The Sarbanes-Oxley Act of 2002 *Management contract or compensatory plan. **Filed herewith 36EXHIBIT 21.1 SUBSIDIARIES OF SCHMITT INDUSTRIES, INC.AS OF MAY 31, 2003 SubsidiaryState of Incorporation or Country in WhichOrganizedSchmitt Measurement Systems, Inc.MontanaSchmitt Europa Systems, GmbHGermanySchmitt Europe, Ltd.United KingdomAcuity Research IncorporatedCalifornia 1 EXHIBIT 23.1 CONSENT OF INDEPENDENT ACCOUNTANTS We have issued our report dated July 11, 2003, accompanying the financial statements included in the Annual Report of Schmitt Industries, Inc. on Form 10-K for the year ended May 31, 2003. We hereby consent to the incorporation by reference in the Registration Statement on Form S-8 (No. 333-3910). Grant Thornton LLP Portland, OregonAugust 27, 2003 1EXHIBIT 23.2 CONSENT OF INDEPENDENT AUDITORS We hereby consent to the incorporation by reference in the Registration Statement on Form S-8 (No. 333-3910) of Schmitt Industries, Inc. of our report datedJuly 3, 2002 relating to the financial statements, which appears in this Form 10-K. PricewaterhouseCoopers LLP Portland, OregonAugust 27, 2003 1EXHIBIT 31.1 CERTIFICATION PURSUANT TO18 U.S. C. SECTION 1350,AS ADOPTED PURSUANT TOSECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Wayne A. Case, certify that: 1. I have reviewed this annual report on Form 10-K of Schmitt Industries, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined inExchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, toensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities,particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about theeffectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recentfiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, theregistrant’s internal control over financial reporting; and 5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to theregistrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonablylikely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controlover financial reporting. Date:August 27, 2003/s/ Wayne A. CaseWayne A. Case, President/CEO/Director 1EXHIBIT 31.2 CERTIFICATION PURSUANT TO18 U.S. C. SECTION 1350,AS ADOPTED PURSUANT TOSECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Robert C. Thompson, certify that: 1. I have reviewed this annual report on Form 10-K of Schmitt Industries, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined inExchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, toensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities,particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about theeffectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recentfiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, theregistrant’s internal control over financial reporting; and 5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to theregistrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonablylikely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controlover financial reporting. Date:August 27, 2003/s/ Robert C. ThompsonRobert C. Thompson, Chief Financial Officer/Treasurer 1Exhibit 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Schmitt Industries, Inc. (the “Company”) on Form 10-K for the Fiscal year ended May 31, 2003 as filed with theSecurities and Exchange Commission on the date hereof (the “Report”), we, Wayne A. Case and Robert C. Thompson, Chief Executive Officer and ChiefFinancial Officer , respectively, of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, thatto our knowledge:(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and(2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. /s/ Wayne A. CaseWayne A. CaseChief Executive OfficerAugust 27, 2003 /s/ Robert C. ThompsonRobert C. ThompsonChief Financial OfficerAugust 27, 2003 1

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