Schmitt Industries, Inc.
Annual Report 2005

Plain-text annual report

UNITED STATES SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549 FORM 10-K (Mark One) ýý ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal year ended: May 31, 2005 or oo TRANSITION 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) Oregon 93-1151989(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 registeredNoneNone 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 Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes o No. ý As of July 29, 2005, the aggregate market value of the registrant’s Common Stock held by nonaffiliates of the registrant was $22,173,431based onthe closing sales price of the registrant’s Common Stock on the Nasdaq SmallCap Market. On that date, there were 2,578,306 shares of Common Stockoutstanding. Documents Incorporated by Reference Portions of the registrant’s definitive Proxy Statement for its 2004 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 (the Balancer Segment) primarily to themachine tool industry. Through its wholly owned subsidiary, Schmitt Measurement Systems, Inc. (“SMS”), an Oregon corporation, the Company designs,manufactures and markets precision laser measurement systems (the Measurement Segment). The Company also sells and markets its products in Europethrough its wholly owned subsidiary, Schmitt Europe Ltd. (“SEL”), located in the United Kingdom. Effective May 30, 2005 the Company has liquidated anddissolved the German Subsidiary, Schmitt Europa, GmbH. The Company’s executive offices are located at 2765 N.W. Nicolai Street, Portland, Oregon 97210,and its telephone number is (503) 227-7908. Balancer Segment 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 as an inexpensive highly accurate permanent installation on grinding machines. The Company acquiredits original balancing equipment technology pursuant to a series of agreements from 1987 through 1991, substantially enhancing and advancing thepatented 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), CapcoMachinery (U.S.), Ecotech/SMTW (China/U.S.), Erwin Junker (US), Gleason Works (U.S.), Landis Grinding (U.S.), Kellenberger (US), KoyoMachinery (US, Japan), Micron Machinery Limited (Japan/U.S.), Normac Incorporated (U.S.), NTC Toyama America (U.S./Japan), Okomoto (Japan),Okuma Machine (Japan), Shigiya Machine 2 (Japan), Sumitomo Heavy Industry (Japan), Toyoda Machine (Japan), USACH Technologies, Tschudin (US) and Weldon Machine Tool (U.S.). TheCompany currently sells its products directly to most of the major machine builders in the U.S, Western Europe and Asia. Machine Tool Rebuilders – These customers, found in all industrial nations, develop their business by offering to completely update and refurbisholder grinding machines. 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, Emerson Power Transmission, FordMotor Company, General Electric Corp., General Motors, Getrag Automotive, Ingersoll Rand, Komatsu, Lawrence Berkeley, Sumitomo HeavyIndustries, NSK Bearing, NTN Bearing, Oakridge National Lab, Purdue University, SKF Bearing Industries, Texas Instruments, The TimkenCompany, TRW Automotive Components and Universal Bearing. In Fiscal 2005, 2004 and 2003, net sales of the Company’s balancing products totaled $7,369,487, $5,924,854 and $5,481,010 respectively. Net sales ofbalancing products accounted for 70%, 75% and 74% of the Company’s total sales in Fiscal 2005, 2004 and 2003, respectively. See Note 11 toConsolidated Financial 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 12,500. Competitive products come from European companies located in Switzerland, Germany, Spain and Italy. These competitors produce electromechanical andwater balancers similar to the SBS Systems. The Company considers these companies, with their established European base, to be the major competitors. These balancers have electronic deficiencies, rendering them less effective in solving essential balancing requirements. They cannot achieve the consistentlow 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 cableassemblies that cause down time and high maintenance. Finally, none of these companies can currently compete effectively with the Company in providingmounting adapters for all grinding machines. Water balancers are an older European design still on the market that can be supplied by Schmitt when specifically supplied by users. They requireexpensive plumbing and water chambers to be machined into the wheel hub while the SBS System does not. They are currently priced about 1.25 times thelevel of the SBS System. To install these systems, the grinding machines must be disassembled and parts remachined or replaced within the spindleassembly. This can take two days, far longer than required to install the SBS system. The water system is “tuned” or “calibrated” to the machine by a factoryservice technician while the SBS system can be installed by the operator. Water systems work at mid- and high-speeds but cannot balance in low rpmenvironments while SBS products work in both environments. Water systems require periodic monitoring while the SBS systems require little or no operatormonitoring. 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 believes customers perceive the value of an automatic balancer to be approximately$8,000, a sales price that has been constant for several years. Company pricing is geared to obtaining a dominant market position and meeting competitivesupplier prices. The market strategy is to establish the SBS System as the foremost product with the best quality, reliability and performance and superioreconomic value. Measurement Segment 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 3 detectors to throw a beam of light on a material sample and record its reflection/transmission. Analysis of information can determine material characteristicssuch as surface roughness, defects and dimensional sizing without introducing contaminants and causing changes to the tested material. The principalproducts are laser-based measurement products and technology applicable to both industrial and military markets. The Company has used patents, patentapplications, trademarks and other proprietary technology to focus marketing efforts on industrial markets including electronics, computer disk and siliconwafer 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, with surface roughness outside that narrowband resulting in a reduction in data density or storage capacity. The Company’s technology simultaneously measures disk surface roughness in twodirections, radially, when the read/write head is moving to another disk sector, and circumferentially, when the read/write head is processing information onthe disk. The two separate roughness levels are required for proper head operation. The precise measurement methods provided by the Company’s productsare not possible through any other cost effective measurement means. The following two products meet the challenges of disk drive manufacturers and helpprevent such problems from occurring: • The TMS-2000-RC (Texture Measurement System) product is the world’s fastest and most accurate non-contact texture measurement system. Theproduct (used on aluminum substrates) is currently used worldwide by most major disk drive manufacturers, providing fast, accurate and repeatablemicroroughness measurements while quadrupling production throughput when compared to other testing devices. Surface roughness can bemeasured to levels below 0.5 Angstroms (the point of a needle is one million Angstroms in diameter). • The TMS-2000-DUV-RC product measures the surface microroughness of ceramic rather than aluminum substrates. Manufacturers require thetechnology and products 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 levelsless than 0.5 Angstrom. Customers include Hitachi/IBM, Seagate Substrates, Western Digital and Komag, Inc. There are two products devoted to the silicon wafer industry, the TMS-2000W-RC and TMS-3000W-RC. Both products provide fast, accurate, repeatablemeasurements for manufacturers of silicon wafers, computer chips and memory devices. This industry demands manufacturing precision to increaseperformance and capacity and these products help achieve those goals. Silicon wafers are carefully cut and polished to provide the base upon which acomputer or memory chip is produced. Therefore, chip manufacturing is extremely dependent on the beginning surface roughness of the wafer. Since allsilicon wafers exhibit a microscopic level of surface roughness, stemming from chemical deposition, grinding, polishing, etching, or any number of otherproduction techniques, some method of measuring these surface characteristics is required. The wafer measurement products provide a way for customers inthis industry to quantify and control their manufacturing process. The system provides measurements to a few hundredths of an Angstrom, a levelunachievable by other testing devices. Dimensional Sizing Products: These products are used in a wide range of industrial applications including steel casting, paper production, medical imaging, crane control and micron-levelpart and surface inspection. Presently, there are four product lines: the AR4000 distance measurement sensor, the AR4000 Line Scanner and the AR600 andAR200 series of triangulating laser displacement sensors. 4 The AccuRange 4000 is an optical distance measurement sensor for most diffuse reflective surfaces, but is ideally suited to level and position measurement,machine vision, autonomous vehicle navigation and 3D imaging applications. It operates by emitting a collimated laser beam that is reflected from the targetsurface and collected by a sensor. The sensor is suitable for a wide variety of distance measurement applications that demand high accuracy and fast responsetimes. Notable features include the operating range for most surfaces (zero to fifty feet), fast response time (50 kHz maximum sample rate), compact andlightweight power design and has a tightly collimated output beam for small spot size. There are three output beam configurations available: visible infrared,eye safe infrared and reflective tape targets. 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 the most compact series of triangulating laser displacement sensors. Four models cover metric measurement ranges from six to fiftymillimeters. All models boast a 1/500 accuracy rating for measurements within twelve microns. The AR200 sensor is the only sensor of its kind to featurepushbutton selection of output signals. All models are standard with Analog, Limit Switch and Serial outputs. The AR200 sensors, much like the longer-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 an angle bya line scan camera and the target’s distance is computed from the image pixel data. The AR200-6M, -12M, -25M and -50M have ranges in millimeters thatmatch their model number. The AR200 displacement sensor can not be overloaded and measures accurately even when a mirror reflects the entire light beamback 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 mScan 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 mScan 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. Testing Laboratory: The Company provides a highly advanced measurement services laboratory, using CASI Scatterometers, to a wide variety of industrial and commercialbusinesses that require precise measurements only advanced laser light scatter technology can provide. The true value of the laboratory is not only itsextremely precise measurement capability but also the test item is not altered, touched or destroyed. Thus, the laboratory is widely used by manufacturers ofcritical optical components in aerospace and defense systems, including such companies as Aerojet, AT&T Bell Labs, Eastman Kodak, General Electric, IBM,NASA and dozens of other industrial companies, universities and government agencies. 5 In Fiscal 2005, 2004 and 2003, net sales of Measurement products totaled $3,160,942, $1,999,912 and $1,938,511 respectively and accounted for 30%, 25%and 26% of the Company’s total sales in Fiscal 2005, 2004 and 2003 respectively. See Note 11 to Consolidated Financial Statements. Business and Marketing Strategy The Company designs, assembles and markets all of its products with operations divided into a number of different areas. Balancer Segment products: The Vice President of Operations directs production of Balancer segment products including production, assembly, and purchasing, engineering andtechnical services. Product marketing for all Balancer segment products is managed by the President/CEO. Two Marketing Managers are responsible fordomestic sales while a third is responsible for sales in Mainland China, Taiwan and Korea. The Company also has one person who performs fieldservice/sales. The President/CEO is responsible for European sales and oversees the efforts of the European Marketing Manager who is headquartered in theUnited Kingdom. Finally, research and development efforts are supervised directly by the President/CEO and the Vice President of Operations. The Company markets and sells the Balancer segment products in a variety of ways. First, are the channels provided by independent manufacturer’srepresentatives and distributors. There are currently approximately 25 individuals and/or organizations in the United States acting in one of these capacities.Independent sales agents are paid a 10% commission; distributors are sold products at a 20% discount. Second, original equipment manufacturers (OEMs) include the Balancer segment products on the machine tools they produce. Users thus purchase theBalancer segment products concurrently with the machine tools. Conversely, end users of grinding machines that have purchased the SBS system directlyfrom the Company, and after enjoying the benefits of the products, often request that SBS products be included with the new equipment they order fromOEMs. The SBS Systems are often installed by machine builders prior to displaying their own machine tools at various trade shows, becoming endorsementsthat prove beneficial to the Company’s sales efforts. Third, 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. In North America and Asia, 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 subsidiary in theUnited Kingdom, who in turn sells and distributes the products. Measurement Segment Products: The Vice President of Operations directs production of all Measurement segment products including production, assembly, and purchasing, engineering andtechnical services. Similar to the Balancer segment, the Measurement segment uses a variety of methods to market and sell its products. First, a Marketing Manager, under thedirection of the President/CEO, directs the overall worldwide marketing efforts for surface measurement products. Second, both a marketing and a salesmanager, again under the direction of the President/CEO, direct the overall worldwide marketing and sales efforts for dimensional sizing products. Third, theCompany has an exclusive distribution agreement with a company in Asia for the promotion and sale of surface measurement products in China, Taiwan,Malaysia, Singapore, Thailand and the Philippines. In addition, there are nonexclusive distribution agreements with two companies in Japan and one inKorea. Fourth, trade shows represent a significant amount of marketing/sales effort. The President/CEO attends these events along with various Companyrepresentatives. These individuals operate a display booth featuring demonstrations of Measurement segment products along with product and technical 6 literature. Representatives from all facets of the market to which the Company directs its sales efforts attend these trade shows. Finally, one of the bestmarketing channels is the testing laboratory. Once customers see the capabilities of the technology, it can lead to orders for the Company’s laser based lightscatter measurement products. All Measurement segment products are assembled in the Portland, Oregon facility and shipped worldwide directly to customers. The Balancer and Measurement segment customer bases each consist of over 250 companies. 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 Silicon Forest Electronics of Vancouver, Washington, a custom supplier of assembled electronic productsfor several Pacific Northwest companies. In the event of supply problems, the Company believes that two or three alternatives could be developed withinthirty days to supplement or replace Silicon Forest Electronics. 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; Davis Tool of Portland, 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. The Company is presently transitioning its certification tothe new ISO-2000 requirements. 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 both Balancer and Measurement products, processes and methods which the Company believes provide it with acompetitive advantage. The Company has a policy of seeking patents where appropriate on inventions concerning new products and improvementsdeveloped as part of its ongoing research, development and manufacturing activities. While patents provide certain legal rights of enforceability, there canbe no assurance the historic legal standards surrounding questions of validity and enforceability will continue to be applied or that current defenses as toissued patents will, in fact, be considered substantial in the future. There can be no assurance as to the degree and range of protection any patent will affordand whether patents will 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 Balancer segment products under copyright protection in the U.S. for electronic board designs. Encapsulation of the finishedproduct further protects the Company’s technologies including software. 7 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 The Company maintains an ongoing research and development program to expand the product lines and capabilities of both product segments. The goal ofthis program is to expand the product base in historic markets and to enter new market areas so as to reduce reliance on historic market segments. In the pastfew Fiscal years, the Company has developed the following new balancing and laser measurement products: The SB-4500 controller is a multi-function unit providing the versatility to control several activities including all balancer products. It controls balancing inapplications with speeds ranging from 300 to 30,000 rpm compared to a range of 500 to 12,500 rpm with the prior Schmitt product. Vibrations are measuredto 0.02 microns or 0.75 millionths of an inch. It also allows customers to balance their grinding machines faster, reducing costly down time and increasingfactory throughput. This computer controller allows the future addition of new products. The Acoustical Emissions Monitoring System (AEMS) is controlled by the SB-4500 controller and monitors the customers’ dressing and grinding processesby direct 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 grinding machine to stop before real damage occurs. The benefits of theAEMS product to the customer include time savings from quick and easy setups, improved dressing and grinding processes, and elimination of expensivepart and machine 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 laser-based light-scatter technology was modified to produce the required light scatter information to provide the necessarymeasurements. The engineering staff developed the DUV (Deep Ultra-violet light) technology to measure surface microroughness of glass substrates to thesame precise levels as existing products and at levels required by the industry. This technology compliments existing products and provides the Companythe ability to supply solutions for all media used by the disk drive industry. During Fiscal 2005, 2004 and 2003, the Company’s research and development expense totaled $42,395, $30,370 and $192,686 respectively. The Fiscal2005 and 2004 levels were lower than in prior years as the Company devoted much of its internal labor efforts (most R&D costs are internal labor costs) toexpanding production levels and the transition of engineering and production of dimensional sizing products from Menlo Park, CA to Portland, OR. Management expects amounts expended for R&D in Fiscal 2006 to return to levels approximating those experienced in Fiscal 2003. 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. 8 • 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 theprices of raw materials.• Fluctuations in quarterly and annual operating results make it difficult to predict future performance.• The Company may not be able to reduce operating costs quickly enough if sales decline.• The Company maintains a significant investment in inventories in anticipation of future sales.• Future success depends in part on attracting and retaining key management and qualified technical and sales personnel.• 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: Over the past five fiscal quarters, the Company has experienced increasing demand for its Balancer products in North America and Europe. These increasesare attributed to an improving economy in North America and more focused and aggressive sales and marketing techniques in Europe. The conditions andcircumstances could change in future periods and as a result demand for the Company’s products could decline. Management is responding to these risks intwo ways. First, it appears there is a significant portion of the marketplace that is not using the automatic balancing products of the Company or any of itscompetitors. The Company will therefore continue to devote part of its future R&D efforts toward developing products that will both broaden the scope ofBalancing products offered to the current customer base. Second, there are uses for the Company’s Balancer products in industries other than those in theCompany’s historic customer base. Management is devoting a significant portion of its time to identify these markets and educate those markets on the valueof those products within their operations. The laser light-scatter products of the Measurement segment have relied heavily upon sales to disk drive and silicon wafer manufacturers. Conditions inthose markets adversely affected sales beginning in Fiscal 1999 and those poor conditions continued into Fiscal 2004 and consequently, demand for drivesfell over these periods. As the operations of those companies suffered, they in turn reduced capital spending resulting in minimal demand for and sporadicsales of the Company’s laser light-scatter products. Industry forecasts are for improving conditions and the Company has experienced increasing sales inFiscal 2005 to those industries. However, the long-term impact on demand for the Company’s surface Measurement products cannot be predicted with anycertainty. The semiconductor industry has also faced a down cycle over the past few fiscal years. Beginning in Fiscal 2002 the semiconductor industry experiencedbacklog cancellations, resulting in slower revenue growth and these conditions continued into Fiscal 2004. The result is similar to disk drive manufacturersin that capital spending has declined significantly and consequently so has demand for and sales of the Company’s wafer products. Some improvement inmarket conditions is forecasted to occur sometime in the next several months, although there is no certainty if and when those improvements will occur. Management will continue to market these products to these historic markets as it appears no other technology has been introduced that would make the laserlight-scatter products technologically obsolete. There is the belief that once market conditions improve in the disk drive and silicon wafer markets, demandfor the Company’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 9 obsolete or noncompetitive or a fundamental shift in technologies in the product markets could have a material adverse effect on the Company’s competitiveposition 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. However, should future sales decline significantly and rapidly, thereis no guarantee 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 inventories are recorded using the lower-of-cost or market method, which requires Managementto make certain estimates. Management evaluates the recorded inventory values based on customer demand, market trends and expected future sales andchanges these estimates accordingly. A significant shortfall of sales may result in carrying higher levels of inventories of finished goods and raw materialsthereby increasing the risk of inventory obsolescence and corresponding inventory write-downs. As a result, the Company may not carry adequate reserves tooffset such write-downs. Future success depends in part on attracting and retaining key management and qualified technical and sales personnel: Future success depends on the efforts and continued services of key management, technical and sales personnel. Significant competition exists for 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 10 international sales and operations and, consequently, on business, financial condition and results of operations. International Sales The Company’s sales in the last three Fiscal years by geographic areas are: North AmericaEuropeAsiaOthersFiscal 2005$5,811,940$2,076,089$2,122,384$520,016Fiscal 2004$4,520,940$1,777,250$1,365,840$260,736Fiscal 2003$4,150,797$2,348,102$849,940$70,682 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 9, 2005, the Company employed 37 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 Portland, Oregon in three company-owned buildings with totalapproximate square footage of 40,500 square feet. SEL occupies a 1,893-square foot facility in Coventry, England pursuant to a three-year lease beginningJune 1, 2005 with a basic monthly rent of £1,875 (approximately $3,400 as of July 12, 2005). 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, 2005. 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 the Nasdaq Smallcap Market for the periodsindicated. Year Ended May 31, 2005HighLowFirst Quarter$8.16$2.20Second Quarter$9.54$5.65Third Quarter$9.71$5.82Fourth Quarter$9.70$6.23 Year Ended May 31, 2004HighLowFirst Quarter$1.82$1.24Second Quarter$2.53$1.48Third Quarter$2.69$1.86Fourth Quarter$2.75$1.75 11 As of July 29, 2005, there were 2,578,306 shares of Common Stock outstanding held by approximately 130 holders of record. The number of holders doesnot include individual participants in security position listings; the Company believes that there are more than 2,500 individual holders of shares ofCommon Stock. 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 Ended5/31/05 5/31/04 5/31/03 5/31/02 5/31/01Sales$10,530$7,925$7,420$6,875$7,580Net Income (Loss)$1,608$517$(1,487)$(1,599)$(2,367)Net Income (Loss) Per Share, Basic$.64$.21$(.60)$(.64)$(.90)Weighted Average No. Shares, Basic2,5282,4392,4682,4882,635Net Income (Loss) Per Share, Diluted$.59$.20$(.60)$(.64)$(.90)Weighted Average No. Shares, Diluted2,7092,5242,4682,4882,635Stockholders’ Equity$7,979$6,114$5,665$7,251$8,930Total Assets$9,075$7,100$6,272$8,161$10,291Long-term Debt (including current portion)$53$67$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 Overview Balancer segment sales focus throughout the world on end-users, rebuilders and original equipment manufacturers of grinding machines with the targetgeographic markets in North America, Asia and Europe. Beginning in March 2004, improving economic conditions in North America resulted in increasedsales in that geographic market. Sales people, representatives and distributors throughout these geographic areas spend a large amount of time with targetedcustomers. They are finding many of the customers in the automotive, bearing and aircraft industries refer to improved economic conditions and its impacton the machine tool industry in North America as the reason for their increased orders. While those customers are optimistic regarding short term demand forBalancer products, they remain uncertain as to the strength and duration of current business conditions in North America for their products which incorporatethe Balancer segment product line. Market demand in Asia for the Balancer segment products remains strong, although with increasing competition therewas a small decline in sales volumes in Fiscal 2005 when compared to Fiscal 2004. As with the North American market, the duration of the strong demand inAsia cannot be forecasted with any certainty. Despite a soft European market, there have been some increases in the number of units sold into thatgeographic market. This is attributed to more focused and aggressive sales and marketing techniques by the European based sales and marketing staff. However, until the markets for the products of the Company improve in Europe, there is no guarantee these more aggressive efforts will continue to generateincreasing unit sales. The Measurement segment product line consists of both laser light-scatter and dimensional sizing products. The business operations and prospects for thesetwo product lines are summarized as follows: Laser light-scatter products for disk drive and silicon wafer manufacturers – The primary target markets for Measurement products have been disk drive andsilicon wafer manufacturers and companies and organizations involved in research efforts. Management and the sales staff monitor industry publications andpublic financial information in order to judge the potential demand for products by the targeted industries. Over the past several months, this information hasindicated improving demand for and sales of the products of those industries. Also, frequent discussions with customers have confirmed the information 13 presented in the public information. Sales to customers in these industries can be very cyclical and therefore the impact of this recovery on sales to theCompany’s laser light-scatter products is unknown at this time, although sales personnel have seen increasing interest and inquiries regarding the Company’sproducts. Laser light-scatter products for research organizations – The Company continues to receive inquiries for these products and provide quotes to interestedparties. However, in the current Fiscal year, no sales of these products have been realized. Dimensional sizing products – These products are marketed and sold into a wide array of industries. In Fiscal 2004 Management built a sales distributionnetwork covering all fifty states. As a result of this action, the Company experienced increasing interest and sales in these products in the most recent fiscalperiod when compared to the same period in the prior fiscal year. During the quarter ended August 31, 2003, Management consolidated the operationsrelated to these products (which had been located in Menlo Park, California) into the Measurement segment operations in Portland, Oregon. This actionreduced the engineering and administrative staff by four people and, beginning in November 2003, reduced monthly rental costs by $7,500. As a result ofthe physical relocation of the business in the fiscal quarter ended August 31, 2003, operations were suspended for a period of time and served to dampen thesales volume of dimensional sizing products in that period. The relocation was completed as of August 31, 2003. Since relocation to Portland, sales of theseproducts were $1,763,307 and $1,023,278 in Fiscal 2005 and 2004 respectively. 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, including 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 the Company’s domestic and international customers. If theseanalyses lead Management to the conclusion that potential significant accounts are uncollectible, a reserve is provided. 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. 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. In Fiscal 2005 Management concluded future operations would produce sufficient earnings so that aportion of this asset could be used in future periods to reduce Federal and State tax liabilities. As a result, the valuation reserve for this asset was reduced asof May 31, 2005 to reflect the amount of the asset management expects to utilize in future fiscal periods. Management continues to review the level of thevaluation allowance on a quarterly basis. 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 14 fair value of the assets. As of May 31, 2005, Management does not believe impairment, as defined above, exists. Recently issued accounting pronouncements: The Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 151, “Inventory Costs an Amendment to ARB No. 43,Chapter 4” in November 2004. This Statement requires that abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage)costs be recognized as current-period charges. In addition, this Statement requires that allocation of fixed production overheads to the costs of conversion bebased on the normal capacity of the production facilities. The Company does not expect this pronouncement to have a material impact on the financialstatements. The Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 153, “Exchanges of Nonmonetary Assets—anamendment of APB Opinion No. 29” in December 2004. The guidance in APB Opinion No. 29, “Accounting for Nonmonetary Transactions”, is based on theprinciple that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. The guidance in that Opinion, however,included certain exceptions to that principle. This Statement amends Opinion 29 to eliminate the exception for nonmonetary exchanges of similar productiveassets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange hascommercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. The Company does not expectthis pronouncement to have a material impact on the financial statements. The Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 154, “Accounting Changes and Error Corrections—areplacement of APB Opinion No. 20 and FASB Statement No. 3”. This Statement replaces APB Opinion No. 20, “Accounting Changes”, and FASB StatementNo. 3, “Reporting Accounting Changes in Interim Financial Statements”, and changes the requirements for the accounting for and reporting of a change inaccounting principle. This Statement applies to all voluntary changes in accounting principle. It also applies to changes required by an accountingpronouncement in the unusual instance that the pronouncement does not include specific transition provisions. When a pronouncement includes specifictransition provisions, those provisions should be followed. The Company does not expect this pronouncement to have a material impact on the financialstatements. The Financial Accounting Standards Board revised Statement of Financial Accounting Standards No. 123, “Share-Based Payment” in December 2004. Underthe revised standard, the Company will be required to recognize compensation cost, related to its stock options, beginning in the first fiscal quarter of theyear beginning June 1, 2006. The cost of services received from employees in exchange for awards of share-based compensation generally shall be measuredbased on the grant-date fair value of the equity instruments issued. The Company expects the effect of this pronouncement to approximate the proformaamounts disclosed in Note 2. Discussion of operating results: Year ended May 31, 2005 Consolidated BalancerMeasurement Dollars% Dollars%Dollars% Sales$10,530,429100.0%$7,369,487100.0%$3,160,942100.0%Cost of sales4,460,76942.4%3,491,85847.4%968,91130.7%Gross profit6,069,66057.6%$3,877,62952.6%$2,192,03169.3%Operating expenses4,856,20046.1%Operating income$1,213,46011.5% 15 Year Ended May 31, 2004ConsolidatedBalancerMeasurementDollars%Dollars%Dollars%Sales$7,924,766100.0%$5,924,854100.0%$1,999,912100.0%Cost of sales3,405,76143.0%2,727,40546.0%678,35633.9%Gross profit4,519,00557.0%$3,197,44954.0%$1,321,55666.1%Operating expenses4,081,73951.5%Operating income$437,2665.5% Year Ended May 31, 2003ConsolidatedBalancerMeasurementDollars%Dollars%Dollars%Sales$7,419,521100.0%$5,481,010100.0%$1,938,511100.0%Cost of sales:Operations, exclusive ofinventory write-downs3,188,56643.0%2,661,51048.6%527,05627.2%Inventory write-downs401,6735.4%18,5610.3%383,11219.8%Cost of sales3,590,23948.4%2,680,07148.9%910,16847.0%Gross profit3,829,28251.6%$2,800,93951.1%$1,028,34353.0%Operating expenses4,231,69957.0%Operating (loss)$(402,417)(5.4)% Worldwide sales of Balancer products in Fiscal 2005 increased from Fiscal 2004 as sales to the North American and European markets increased by 32% and18%, respectively, while they decreased in the Asian markets by 9%. The increase in North America is attributed to stronger economic conditions in Fiscal2005 compared to Fiscal 2004 and therefore increased customer demand, resulting in higher unit sales. The increase in Europe is attributed to improvingeconomic conditions and more aggressive sales efforts by the European based sales staff, again resulting in higher unit sales. The decrease in Asia isattributed to increased competition in a growing geographic market. Worldwide sales of Balancer products in Fiscal 2004 increased from Fiscal 2003 as salesto the North American and Asian markets increased by 5% and 69% respectively, while they decreased in the European market by 15%. The increase inNorth America was attributed to improving economic conditions and therefore increased customer demand while the increase in Asia was attributed tocontinued strong economic conditions. The decrease in Europe was attributed to ongoing economic weakness in the targeted customer markets. Worldwide sales of Measurement products in Fiscal 2005 increased from Fiscal 2004 as sales of the Company’s surface measurement products increased by43% and dimensional sizing products increased by 72%. The sales of surface measurement products increased as they included more unit sales of large valuelaser light-scatter products than in the same fiscal period in the prior year. The increase in the dimensional sizing products was due to increasing unit saleswhich were directly attributed to the expanding sales and marketing efforts by the Company’s sales staff that is devoted exclusively to the sale of theseproducts. Total sales of Measurement products in Fiscal 2004 were comparable to those experienced in Fiscal 2003, although sales levels of the Company’ssurface measurement products increased by 32% while sales of the Company’s dimensional sizing products decreased by 15%. Sales of surface measurementproducts increased as there were larger sales of large value laser light-scatter products in Fiscal 2004 compared to Fiscal 2003. The decrease in thedimensional sizing products were due to lower unit sales which are directly attributed to the closure in operations during the relocation of the productionoperations for those products into the Portland, Oregon facility in the first two fiscal quarters of Fiscal 2004. Cost of sales, as a percentage of sales, for the Balancer segment in Fiscal 2005 increased slightly from those in Fiscal 2004. This occurred as some vendorsincreased the unit costs of the various raw materials the Company purchases and those increases were not passed along to the customers of the Company. Cost of sales, as a percentage of sales, for the Balancer segment decreased in Fiscal 2004 when compared to Fiscal 2003. The decline can be largelyattributed to the geographic sales mix. Sales to the North American markets were a higher percentage of total Balancer segment sales in Fiscal 2004 than theywere in Fiscal 2003. Unit sales prices in North America are higher than they are in other geographic markets and therefore the costs on those sales are lower asa percentage of sales than in other geographic markets. When sales to the North American market are a higher proportion of total sales, as they were in Fiscal2004 16 compared to Fiscal 2003, the effect is to lower cost of sales as a percentage of sales. Also, the materials costs were in higher in Fiscal 2003 than in Fiscal 2004as the earlier fiscal year included a write-off of $18,561 in excess inventory quantities while in Fiscal 2004 no excess inventory quantities were written off. Cost of sales in the Measurement segment were lower in Fiscal 2005 compared to Fiscal 2004 due to lower material and direct labor costs as a percentage ofsales. Materials costs as a percentage of sales in the current fiscal year were 12% compared to 17% in the same period in the prior fiscal year. In the prior yearthe Company had higher materials costs than normal on a large product order. These higher materials costs occurred because the customer cancelled theorder but the materials purchased for the product were expensed as they had been ordered specifically for that project. If the impact of the higher than normalmaterials costs resulting from that order is excluded from the prior year results, the materials costs as a percentage of sales would have been more in line withthe current fiscal period results. Direct labor costs (as a percentage of sales) for the fiscal period ended May 31, 2005 was 18% compared to 17% for the fiscalperiod ended May 31, 2004. The increase in direct labor costs as a percentage of sales occurred due to the types of products produced. Cost-of-sales in theMeasurement segment increased in Fiscal 2004 when compared to Fiscal 2003. The primary reason for the decrease was that Fiscal 2003 included a write-offof excess inventory quantities of $383,112 while there were no such write-offs in Fiscal 2004. This decrease was offset by overall lower costs of sales as apercentage of sales in Fiscal 2003 compared to Fiscal 2004 due to the mix of products sold. The increase in operating expenses between Fiscal 2005 and 2004 occurred primarily due to the higher levels of sales. The decrease in operating expensesbetween Fiscal 2004 and 2003 occurred primarily due to a decrease in payroll costs at the Acuity Research subsidiary. The costs at Acuity decreased due tothe reduction in engineering and administration staff that occurred due to the consolidation of Acuity operations in Portland during the quarter endedAugust 31, 2003. Net sales outside North America accounted for approximately 45% of the Company’s revenues in Fiscal 2005, 43% in Fiscal 2004 and 44% in Fiscal 2003. Some foreign customers purchase in their own country’s currencies, thereby imposing on the Company a currency risk. Of total sales in Fiscal 2005, 2004and 2003, approximately 20%, 23% and 27% were denominated in currencies other than U.S. dollars. To date, currency fluctuations have had minimalimpact on sales. However, significant variations in the value of the U.S. dollar, relative to currencies of countries in which the Company has significantcompetitors, can impact future sales. The Company does not engage in currency hedging. In addition, the longer payment cycles of international sales canhave a negative impact on liquidity. The Company believes international sales will continue to grow in future periods. The net income for Fiscal 2005 of $1,608,140 ($0.59 per fully diluted share) compared to net income of $516,585 ($0.20 per fully diluted share) and netlosses of $1,487,131 ($0.60 per share) in Fiscal 2004 and 2003 respectively. Net income in Fiscal 2005 included two significant items, a foreign exchangeloss of $174,274 which was incurred due to the closure of the German subsidiary (Schmitt Europa, GmbH) and $640,000 income tax benefit due to thereduction in the deferred tax asset valuation allowance. The net loss in Fiscal 2003 included three significant items: a $612,200 non-operating charge for awrite-down of the Company’s long-term investment in Air Packaging Technologies, Inc, $401,673 in write-downs of excess inventory quantities and anincrease in the deferred tax asset valuation allowance of $636,006. 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 2005, 2004 or 2003, 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. 17 LIQUIDITY AND CAPITAL RESOURCES The Company’s ratio of current assets to current liabilities increased to 6.5 to 1 at May 31, 2005 compared to 5.7 to 1 at May 31, 2004. As of May 31, 2005the Company had $1,176,959 in cash compared to $604,194 at May 31, 2004. During the year ended May 31, 2005, cash provided from operating activities amounted to $451,015 with the changes described as follows: • The net income for the year ended May 31, 2005 of $1,608,140 and three non-cash items: depreciation and amortization of $214,933, an increase in thedeferred tax asset of $640,000 and the increase in the provision for doubtful accounts of $8,816. • Accounts receivable used cash as the balance increased by $302,542 (exclusive of the change in the allowance for doubtful accounts) to a May 31, 2005balance of $2,109,143 compared to $1,815,417 at May 31, 2004. At May 31, 2005, $41,366 in accounts receivable were considered as doubtful ofcollection and therefore a reserve in that amount has been provided for. The Company generally experiences a payment cycle of 30-90 days on invoices,depending on the geographic market. Management believes its credit and collection policies are effective and appropriate for the marketplace. Therecan be no assurance that the Company’s collection procedures will continue to be successful, particularly with current economic conditions. • Inventories increased $618,220 to a May 31, 2005 balance of $3,533,313 compared to $2,915,093 at May 31, 2004. The Company maintains levels ofinventory sufficient to satisfy normal customer demands plus an increasing short-term delivery requirement for a majority of its Balancer products. Management believes its ability to provide prompt delivery gives it a competitive advantage for certain sales. • Prepaid expenses decreased by $20,056 to a May 31, 2005 balance of $104,292 compared to $124,348 at May 31, 2004 due to the amortization ofseveral items including prepaid trade show costs, professional fees and various business and life insurance costs. • Trade accounts payable decreased by $68,340 to a May 31, 2005 balance of $497,206 compared to $565,546 at May 31, 2004 with the increase due toincreased purchasing activities in both the Balancer and Measurement segments. • Other accrued liabilities (including commission, payroll items and other accrued expenses) increased by $166,131 to a May 31, 2005 balance of$520,178 compared to $354,047 at May 31, 2004. During the year ended May 31, 2005, net cash used in investing activities was $93,060 consisting of net additions to property and equipment. Net cashprovided by financing activities amounted to $93,215, which consists of repayments on capitalized obligations of $42,064 and common stock issued toemployees and directors exercising stock options for $135,279. The following summarizes contractual obligations at May 31, 2005 and the effect on future liquidity and cash flows: Years EndingMay 31,Capital Leaseand PurchaseContractOperating LeasesTotalContractualObligations2006$32,114$41,021$73,135200714,38241,02155,40320086,37441,02147,3952009———2010———Thereafter———Total$52,870$123,063$175,933 18 Part of the acquisition of SMS in Fiscal 1995 resulted in the acquisition of a tax net operating loss of approximately $5.5 million, which is available to offsetdomestic earnings through the year 2009. As of May 31, 2005, approximately $550,000 of the losses from SMS remain. Management has responded to business challenges over the past few years by reducing operating expenses, developing new products and attempting topenetrate new markets for the Company’s products. As a result of these efforts, Management believes its cash flows from operations, cash position andoperating line of credit will provide adequate funds on both a short-term and long-term basis to cover currently foreseeable debt payments, leasecommitments and payments under existing and anticipated supplier agreements. Management believes that such cash flow (without the raising of externalfunds) is sufficient to finance current operations, projected capital expenditures, anticipated long-term sales agreements and other expansion-relatedcontingencies during Fiscal 2006. However, in the event the Company fails to achieve its operating and financial goals for Fiscal 2006, Management may berequired to take certain actions to finance operations in that time period. These actions could include, but are not limited to, implementation of cost cuttingmeasures, borrowings from credit facilities or entering into additional borrowing arrangements collateralized by fixed 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, 2005. 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. The Company does have a line of credit but does not have an outstanding balance as of May 31, 2005. Also there is no other debt whose interest rates arebased on variable rates that may fluctuate over time based on economic changes in the environment. Therefore, at this time, the Company is not subject tointerest rate risk if market interest rates fluctuate and does not expect any change in the interest rates to have a material effect on the Company’s results fromoperations. Foreign Currency Risk The Company operates a subsidiary in the United Kingdom. Therefore, the Company’s business and financial condition is sensitive to currency exchangerates or any other restrictions imposed on their currencies. For the years ended May 31, 2005, 2004 and 2003, results of operations included gains (losses) onforeign currency translation of $(184,106), $40,608 and $192,010, respectively. The foreign exchange loss in Fiscal 2005 was directly attributable to theclosure, liquidation and pending dissolution of the Company’s German subsidiary, Schmitt Europa, GmbH. In the fourth quarter of Fiscal 2005 Managementchose to terminate the only two employees in that country, eliminating the need for a separate German company. As there will be no future activity in thatsubsidiary and it will be dissolved early in Fiscal 2006, the accumulated foreign exchange loss, included in other comprehensive income on the balancesheet in prior periods, was recognized in the fourth quarter of Fiscal 2005. The foreign exchange gains in Fiscal 2004 and 2003 are primarily attributable toCompany’s United Kingdom subsidiary, Schmitt Europe, Ltd. (SEL) and the majority of those gains occur from payments to the parent company for productpurchased. SEL purchases the majority of its products from the parent company with the billings denominated in US dollars. The asset and liability at SELare converted to UK currency using the foreign exchange rates at the time of the transaction. When those amounts are repaid to the parent company, paymentis in US currency and therefore gains or losses are recognized at the time the liability is converted to US dollars. In the case of Fiscal 2004 and 2003, theweakening US dollar compared to British Pounds Sterling produced the foreign exchange gains at SEL. 19 Item 8. Financial Statements and Supplementary Data SCHMITT INDUSTRIES, INC.CONSOLIDATED BALANCE SHEETSMAY 31, 2005 AND 2004 2005 2004ASSETS Current AssetsCash$1,176,959$604,194Accounts receivable, net of allowance for doubtful accounts of $41,366 and $32,550 in 2005 and 2004respectively2,109,1431,815,417Inventories3,533,3132,915,093Prepaid expenses104,292124,348Deferred tax asset92,319—Income taxes receivable—35,8947,016,0265,494,946 Property and EquipmentLand299,000299,000Buildings and improvements1,214,3481,214,500Furniture, fixtures and equipment1,120,9461,115,788Vehicles96,84994,2612,731,1432,723,549Less accumulated depreciation and amortization(1,462,637)(1,395,634)1,268,5061,327,915Other AssetsLong-term deferred tax asset547,681—Other assets243,009277,612790,690277,612TOTAL ASSETS$9,075,222$7,100,473 LIABILITIES AND STOCKHOLDERS’ EQUITY Current LiabilitiesAccounts payable$497,206$565,546Accrued commissions275,745189,679Accrued payroll liabilities102,88337,523Other accrued liabilities141,550126,845Income taxes payable26,147—Current portion of long-term obligations32,11439,8311,075,645959,424 Long-term Obligations20,75627,242 Commitments and Contingencies—— Stockholders’ EquityCommon stock, no par value, 20,000,000 shares authorized, 2,559,687 and 2,474,461 shares issued andoutstanding at May 31, 2005 and 2004, respectively7,496,0987,360,819Accumulated other comprehensive loss(254,654)(376,249)Retained earnings (accumulated deficit)737,377(870,763)7,978,8216,113,807TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY$9,075,222$7,100,473 The accompanying notes are an integral part of these consolidated financial statements 20 Schmitt Industries, Inc.CONSOLIDATED STATEMENTS OF OPERATIONSFOR THE YEARS ENDED MAY 31, 2005, 2004 AND 2003 200520042003Net Sales$10,530,429$7,924,766$7,419,521 Cost of SalesOperations, exclusive of inventory write-downs4,460,7693,405,7613,188,566Inventory write-downs——401,673Total cost of sales4,460,7693,405,7613,590,239 Gross profit6,069,6604,519,0053,829,282 Operating expenses:General, administrative and selling4,813,8054,051,3694,039,013Research and development42,39530,370192,686Total operating expenses4,856,2004,081,7394,231,699 Operating income (loss)1,213,460437,266(402,417) Other income and (expense):Gain (loss) on foreign currency exchange(184,106)40,608192,010Miscellaneous (expense) income(27,214)45,511(28,518)Loss on write-down of long-term investment—(6,800)(612,200)Other income and (expense)(211,320)79,319(448,708) Income (loss) before provision for income taxes1,002,140516,585(851,125) (Benefit from) provision for income taxes(606,000)—636,006 Net income (loss)$1,608,140$516,585$(1,487,131) Net income (loss) per common share, basic$0.64$0.21$(0.60) Weighted average number of common shares, basic2,527,6652,438,8952,467,651 Net income (loss) per common share, diluted$0.59$0.20$(0.60) Weighted average number of common shares, diluted2,708,7972,524,0502,467,651 The accompanying notes are an integral part of these consolidated financial statements 21 Schmitt Industries, Inc.CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITYFOR THE YEARS ENDED MAY 31, 2005, 2004 AND 2003 SharesAmountAccumulatedOtherComprehensiveIncome (Loss)RetainedEarnings(AccumulatedDeficit)TotalTotalComprehensiveIncome (Loss) Balance, May 31, 20022,468,432$7,343,621$(192,747)$99,783$7,250,657Common shares repurchased(10,500)(10,637)——(10,637)Net (loss)———(1,487,131)(1,487,131)$(1,487,131)Other comprehensive (loss)——(87,616)—(87,616)(87,616)Balance, May 31, 20032,457,9327,332,984(280,363)(1,387,348)5,665,273Comprehensive (loss), year ended May 31, 2003(1,574,747) Common shares repurchased(40,000)(40,000)——(40,000)Stock options exercised56,52967,835——67,835Net income———516,585516,585516,585Other comprehensive (loss)——(95,886)—(95,886)(95,886)Balance, May 31, 20042,474,4617,360,819(376,249)(870,763)6,113,807Comprehensive income, year ended May 31, 2004420,699 Stock options exercised85,226135,279——135,279Net income———1,608,1401,608,1401,608,140Other comprehensive income——121,595—121,595121,595Balance, May 31, 20052,559,687$7,496,098$(254,654)$737,377$7,978,821Comprehensive income, year ended May 31, 2005$1,729,735 The accompanying notes are an integral part of these consolidated financial statements 22 Schmitt Industries, Inc.CONSOLIDATED STATEMENTS OF CASH FLOWSFOR THE YEARS ENDED MAY 31, 2005, 2004 AND 2003 200520042003Cash Flows Relating to Operating ActivitiesNet income (loss)$1,608,140$516,585$(1,487,131)Adjustments to reconcile net income (loss) to net cash provided by operating activitiesWrite-down of long-term investment—6,800612,200Write-down of excess inventory quantities——401,673Depreciation and amortization214,933188,314240,265Deferred taxes(640,000)—636,006Provision for bad debts8,8168,49024,060(Increase) decrease in:Accounts receivable(302,542)(499,707)(213,224)Inventories(618,220)(189,162)80,518Prepaid expenses20,05642,844(5,312)Income taxes receivable35,894(3,235)123,977Increase (decrease) in:Accounts payable(68,340)210,217116,321Accrued commissions and other accrued liabilities166,131127,01435,730Income taxes payable26,147——Net cash provided by operating activities451,015408,160565,083 Cash Flows Relating to Investing ActivitiesPurchase of property and equipment(93,060)(108,796)(74,505)Disposal of property and equipment—(1,686)26,399Net cash used in investing activities(93,060)(110,482)(48,106) Cash Flows Relating to Financing ActivitiesLine of credit repayments——(200,000)Proceeds of long-term borrowings——38,250Repayment of long-term debt(42,064)(35,678)(294,408)Common stock issued135,27967,835—Common stock repurchased—(40,000)(10,637)Net cash provided by (used in) financing activities93,215(7,843)(466,795) Effect of foreign exchange translation on cash121,595(95,886)(87,616) Increase (decrease) in cash572,765193,949(37,434) Cash, beginning of year604,194410,245447,679 Cash, end of year$1,176,959$604,194$410,245 Supplemental Disclosure of Cash Flow InformationCash paid during the period for interest$1,083$4,330$22,824Cash paid during the period for income taxes$7,853$4,035$26,110 Supplemental Schedule of Noncash Investing and Financing ActivitiesFixed assets financed$27,861$78,447$— The accompanying notes are an integral part of these consolidated statements 23 Schmitt Industries, Inc.NOTES TO CONSOLIDATED FINANCIAL STATEMENTSFOR THE YEARS ENDED MAY 31, 2005, 2004 AND 2003 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) and Schmitt Europa GmbH (SEG). Effective May 31, 2005 SEG has been liquidated. All significant intercompany accounts andtransactions have been eliminated in the preparation of the consolidated financial statements. 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. 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 based upon several factors, included but not limited to payment history, published credit reports anduse of credit references. On a monthly basis, Management performs various analyses to evaluate accounts receivable balances to ensure recorded amountsreflect estimated net realizable value. This review includes accounts receivable agings, other operating trends and relevant business conditions, includinggeneral economic factors, as they relate to each of the Company’s domestic and international customers. If these analyses lead Management to the conclusionthat potential significant accounts are uncollectible, a reserve is provided. Inventory Inventory is valued at the lower of cost or market with cost determined on the average cost basis. As of May 31, 2005 and 2004, inventories consisted of rawmaterials ($1,830,748 and $1,824,897, respectively), work-in-process ($127,001 and $68,287, respectively), and finished goods ($1,575,564 and $1,021,909,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 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.” Advertising Advertising costs included in general, administrative and selling, are expensed when the advertising first takes place. Advertising expense was $87,853,$86,648 and $67,530 for the fiscal years ended May 31, 2005, 2004 and 2003, respectively. Research and Development Costs Research and development costs are charged to expense when incurred. Stock-Based Compensation The Company has elected to follow the accounting provisions of Accounting Principles Board Opinion No. 25 (“APB 25”), “Accounting for Stock Issued toEmployees”, for stock-based compensation and to furnish the pro forma disclosures required under SFAS No. 148, “Accounting for Stock-BasedCompensation – Transition and Disclosure.” No stock-based employee compensation cost is reflected in net income because all options granted under thoseplans had an exercise price equal to the market value of the underlying common stock on the date of the grant. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS 123to stock-based compensation: 200520042003Net income (loss), as reported$1,608,140$516,585$(1,487,131)Add: Stock-based employee compensation expense included in reported netincome, net of tax———Deduct: Total stock-based employee compensation expense determined underfair value based method for all awards, net of tax(230,865)(28,937)(104,190)Pro forma net income (loss)$1,377,275$487,648$(1,591,321) Earnings (loss) per share – basicAs reported$0.64$0.21$(0.60)Pro forma$0.54$0.20$(0.64)Earnings (loss) per share – dilutedAs reported$0.59$0.20$(0.60)Pro forma$0.51$0.19$(0.64) The effects of applying SFAS No. 123 in this pro forma disclosure are not necessarily 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 as 25 measured by the enacted tax rates which are expected to be in effect when these differences reverse. Income tax expense is the tax payable for the period andthe change during the period in net deferred tax assets and liabilities. Management establishes a valuation allowance against its net deferred tax assets toreduce the net asset to the amount that, based upon their evaluation, will more likely than not be realized. Earnings Per Share Basic earnings per share is computed using the weighted average number of shares outstanding. Diluted earnings per share is computed using the weightedaverage number of shares outstanding, adjusted for dilutive incremental shares attributed to outstanding options to purchase common stock. 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 Based on borrowing rates currently available to the Company for bank loans with similar terms and maturities, the fair value of the Company’s long-term debtapproximates the carrying value. Furthermore, the carrying value of all other financial instruments potentially subject to valuation risk (principallyconsisting of cash and cash equivalents, accounts receivable and accounts payable) also approximate fair value because of their short-term maturities. 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 The Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 151, “Inventory Costs an Amendment to ARB No. 43,Chapter 4” in November 2004. This Statement requires that abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage)costs be recognized as current-period charges. In addition, this Statement requires that allocation of fixed production overheads to the costs of conversion bebased on the normal capacity of the production facilities. The Company does not expect this pronouncement to have a material impact on the financialstatements. The Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 153, “Exchanges of Nonmonetary Assets—anamendment of APB Opinion No. 29” in December 2004. The guidance in APB Opinion No. 29, “Accounting for Nonmonetary Transactions”, is based on theprinciple that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. The guidance in that Opinion, however,included certain exceptions to that principle. This Statement amends Opinion 29 to eliminate the exception for nonmonetary exchanges of similar productiveassets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange hascommercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. The Company does not expectthis pronouncement to have a material impact on the financial statements. The Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 154, “Accounting Changes and Error Corrections—areplacement of APB Opinion No. 20 and FASB Statement No. 3”. This Statement replaces APB Opinion No. 20, “Accounting Changes”, and FASB StatementNo. 3, 26 “Reporting Accounting Changes in Interim Financial Statements”, and changes the requirements for the accounting for and reporting of a change inaccounting principle. This Statement applies to all voluntary changes in accounting principle. It also applies to changes required by an accountingpronouncement in the unusual instance that the pronouncement does not include specific transition provisions. When a pronouncement includes specifictransition provisions, those provisions should be followed. The Company does not expect this pronouncement to have a material impact on the financialstatements. The Financial Accounting Standards Board revised Statement of Financial Accounting Standards No. 123R, “Share-Based Payment” in December 2004. Under the revised standard, The Company will be required to recognize compensation cost, related to its stock options, beginning in the first fiscal quarter ofthe year beginning June 1, 2006. The cost of services received from employees in exchange for awards of share-based compensation generally shall bemeasured based on the grant-date fair value of the equity instruments issued. The Company expects the effect of this pronouncement to approximate theproforma amounts disclosed in Note 2. Reclassifications Certain reclassifications have been made to the 2004 and 2003 amounts to conform to 2005 presentations. NOTE 3ACCOUNTS RECEIVABLE Changes in the Company’s allowance for doubtful accounts are as follows: 20052004Beginning balance$32,550$24,060Bad debt expense40,52717,742Accounts written off(31,711)(9,252)Ending balance$41,366$32,550 NOTE 4INVENTORIES Changes in the Company’s allowance for slow moving inventories are as follows: 20052004Beginning balance$172,696$53,097Items added to allowance94,664121,968Items used in production(103,946)(2,369)Ending balance$163,414$172,696 NOTE 5LONG-TERM INVESTMENTS The 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 (SFASNo. 115). As required under that statement, all unrealized gains and losses are reported in Accumulated Other Comprehensive Loss and included as a separatecomponent in 27 Other Comprehensive Loss in Stockholders’ Equity until realized or until unrealized losses are deemed to be “other than temporary”. At May 31, 2004 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 $6,800 to its fair market value of zero as of May 31, 2004. Fair market value was the closingprice of the stock on the over-the-counter market at May 31, 2004. 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 6LINE OF CREDIT The Company has a $1.0 million short-term line of credit agreement with Bank of America, secured by U.S. accounts receivable, inventories and generalintangibles. The line is guaranteed by the Company’s wholly owned subsidiary, Schmitt Measurement Systems, Inc. Interest is payable at the bank’s primerate and expires on September 1, 2006. NOTE 7INCOME TAXES The provision (benefit) for income taxes was as follows: Years ended May 31, 2005 2004 2003 Current$34,000$—$—Deferred420,167226,827(363,021)(Decrease) increase in valuation allowance(1,060,167)(226,827)999,027Total (benefit from) provision for income taxes$(606,000)$—$636,006 Deferred tax assets (liabilities) are comprised of the following components: 20052004Depreciation$—$—Net operating loss carryforwards530,2551,244,724Deferred taxes related to the decline in fair market value of long-term investment694,696819,840Other deferred items, net502,92783,481Gross deferred tax assets1,727,8782,148,045 Deferred tax asset valuation allowance(1,087,878)(2,148,045) Net deferred tax asset$640,000$— The Company has approximately $550,000 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 2010. The Company also has approximately $0.9million of U.S. Federal and State net operating loss carryforwards, the utilization of which could be limited upon a change in control of the Company, andexpire in the year 2024. 28 In 2005, Management believed business and economic conditions had improved to the point where a portion of the valuation allowance on the deferred taxasset could be reduced. Therefore, the allowance was reduced to a level which management believes can be utilized in Fiscal 2006 forward. In 2003, due to the uncertainty of utilization of certain of the Company’s NOLs and in consideration of other factors, Management had recorded a valuationallowance on the deferred tax asset 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 31,200520042003Statutory federal tax rate34.0%34.0%(34.0)%State taxes, net of federal benefit4.4——Change in deferred tax valuation allowance(105.8)(43.9)117.4Permanent and other differences6.99.9(8.7) Effective tax rate(60.5)%—%74.7% NOTE 8EMPLOYEE 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 years ended May 31, 2005, 2004 and 2003. As of June 1, 2005 the Company resumed matching contributions in conjunction with Employeecontributions to the plan. NOTE 9LONG-TERM OBLIGATIONS During Fiscal 2005, the Company entered into a purchase contract for $27,861. The agreement calls for monthly principal and interest payments of $810 andcarries interest at 1.9%. During Fiscal 2004, the Company entered into an equipment lease, which was treated as a capital lease, and a purchase contract for$78,477. The agreements call for monthly principal payments of $832 and $2,131 and both carry no interest. One lease expires in Fiscal 2006 and thesecond in Fiscal 2007. Equipment recorded under the capital lease was $48,477, with related accumulated depreciation of $21,545 at May 31, 2005. As of May 31, 2005, future capital lease and purchase contract payments are: Year Ending May 31,2006$32,1142007$14,3822008$6,374 29 NOTE 10COMMITMENTS 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 the Company’s surface measurement 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, 2005, 2004 and 2003 amounted to $79,268, $41,430 and$48,517, respectively. The Company has entered into various non-cancelable leases for facilities used to support operations in the United Kingdom. Rent expense for the yearsended May 31, 2005, 2004 and 2003 amounted to $41,806, $67,133 and $125,096 respectively. Lease commitments under these leases for each of the years ending May 31 are as follows: Year Ending May 31,2006$41,0212007$41,0212008$41,021Thereafter$— NOTE 11SEGMENTS OF BUSINESS The Company operates principally in two segments of business: the design and assembly of dynamic balancing systems and components (Balancer) 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 31,200520042003BalancerMeasurementBalancerMeasurementBalancerMeasurementGross sales$8,215,458$3,188,941$6,644,781$2,017,494$6,283,987$1,961,086Intercompany sales$(845,971)$(27,999)$(719,927)$(17,582)$(802,977)$(22,575)Net sales$7,369,487$3,160,942$5,924,854$1,999,912$5,481,010$1,938,511 Income (loss) from operations$271,044$942,416$2,674$434,592$(281,900)$(120,517) Intercompany rent$—$30,000$—$30,000$—$30,000 Depreciation expense$137,184$43,146$111,282$35,764$119,331$60,486 Amortization expense$—$34,603$6,665$34,603$20,002$40,446 Capital expenditures$103,658$17,263$169,295$17,948$38,970$35,535 30 Geographic Information Year Ended May 31,Geographic Sales200520042003 North American SalesUnited States$5,549,474$4,320,421$3,985,882Intercompany$—$—$(22,134)$5,549,474$4,320,421$3,963,748Canada$220,676$154,738$153,022Mexico$41,790$45,781$34,027North America total$5,811,940$4,520,940$4,150,797 European SalesGermany$552,438$469,342$781,375Intercompany$—$—$—Germany total$552,438$469,342$781,375 United Kingdom$1,276,968$1,136,035$1,253,639Intercompany$(873,970)$(737,509)$(803,418)United Kingdom total$402,998$398,526$450,221 Other European Sales$1,120,653$909,382$1,116,506 Total Europe$2,076,089$1,777,250$2,348,102 Asia$2,122,384$1,365,840$849,940Others$520,016$260,736$70,682$10,530,429$7,924,766$7,419,521 Year Ended May 31,200520042003United StatesEuropeUnited StatesEuropeUnited StatesEuropeIncome (loss) from operations$1,544,349$(330,889)$623,887$(186,621)$(292,905)$(109,512) Depreciation expense$172,903$7,427$137,606$9,440$164,877$14,940 Amortization expense$34,603$—$41,268$—$60,448$— Capital expenditures$120,921$—$182,094$5,149$68,363$6,142 Long-term Assets May 31, 2005May 31, 2004Segment:Balancer$1,656,783$1,041,032Measurement$495,728$564,495 Geographic:United States$2,124,902$1,585,021Europe$27,609$20,506 Note – Europe is defined as the European subsidiary, Schmitt Europe, Ltd. NOTE 12STOCK OPTIONS The Board of Directors adopted a Stock Option Plan in December 1995, which plan was amended in August 1996 and October 2004 and restated inAugust 1998. An option granted under the Amended and Restated Stock Option Plan might be either an incentive stock option (ISO), or a nonstatutory stockoption (NSO). ISOs may be granted only to employees and members of the Board of Directors of the Company and are subject to certain limitations, inaddition to restrictions applicable to all stock options under the Plan. Options not meeting these limitations will be treated as NSOs. The purchase price ofISOs is fair market value on the date of grant; the purchase price of NSOs may vary from fair market value. Vesting is at the discretion of the optioncommittee of the Board of Directors, but is either 50% at grant date and 16.7% on each anniversary thereafter or 50% at grant date and 25% on eachanniversary thereafter. The Company initially reserved 400,000 shares for issuance under the stock option plan and in October 2004 the shareholdersapproved another 400,000 shares for issuance under the stock option plan. All outstanding options will expire no later than 2014. 31 The following summarizes the options outstanding as of May 31, 2005: SharesWeightedAverageExercisePriceOptions outstanding, May 31, 2002244,000$1.20Options granted6,666$1.20Options forfeited/cancelled(6,677)$1.20 Options outstanding May 31, 2003243,989$1.20 Options granted—$—Options exercised(56,529)$1.20Options forfeited/cancelled(16,944)$1.20 Options outstanding May 31, 2004170,516$1.20Options granted165,500$2.30Options exercised(85,226)$1.59Options forfeited/cancelled—$— Options outstanding May 31, 2005250,790$1.79 The Company continues to measure compensation cost for the Plan using the method of accounting prescribed by APB 25. In electing to continue to followAPB 25 for expense recognition purposes, the Company is required to provide the expanded disclosures required under SFAS No. 148 for stock-basedcompensation granted, including disclosure of pro forma net income and earnings per share, as if the fair value based method of accounting defined in theSFAS No. 123, had been adopted. The Company has computed, for pro forma disclosure purposes, the value of all stock options granted during Fiscal 2005, 2004 and 2003 using the Black-Scholes option pricing model as prescribed by SFAS No. 123 using the following assumptions: 200520042005Risk-free interest rate6.00%3.50%3.50%Expected dividend yield0%0%0%Expected life5.3 years4.0 years4.0 yearsExpected volatility87%91%119% Using the Black-Scholes methodology, the total value of stock options granted during Fiscal 2005 and 2003 was $265,517 and $7,158 respectively, whichwould be amortized on a pro forma basis over the vesting period of the options. The average fair value of the options granted in Fiscal 2005 and 2003 was$2.30 and $1.20 respectively. No stock options were granted during Fiscal 2004. 32 The following table summarized information about stock options outstanding at May 31, 2005: Outstanding OptionsExercisable OptionsExercisePriceNumberofSharesWeightedAverageExercisePriceWeighted AverageRemainingContractual Life(yrs)Numberof SharesWeightedAverageExercise Price$1.20115,291$1.204.3115,291$1.20$2.30135,500$2.306.652,750$2.30250,791$1.795.3168,041$1.55 NOTE 13EARNINGS PER SHARE Basic earnings per share is computed using the weighted average number of shares outstanding. Diluted earnings per share is computed using the weightedaverage number of shares outstanding, adjusted for dilutive incremental shares attributed to outstanding options to purchase common stock. The followingtable is a reconciliation of the numerators and denominators of the basic and diluted per share computations for each of the three years in the period endedMay 31, 2005: Income(Numerator)WeightedAverageShares(Denominator)PerShareAmountYear ended May 31, 2005Basic earnings per shareIncome available to common stockholders$1,608,1402,527,665$0.64 Effect of dilutive securities stock options—181,132 Diluted earnings per shareIncome available to common stockholders$1,608,1402,708,797$0.59 Year ended May 31, 2004Basic earnings per shareIncome available to common stockholders$516,5852,438,895$0.21 Effect of dilutive securities stock options—85,155 Diluted earnings per shareIncome available to common stockholders$516,5852,524,050$0.20 Year ended May 31, 2003Basic and diluted loss per shareLoss available to common stockholders$(1,487,131)2,467,651$(0.60) In Fiscal 2003 243,290 incremental shares were excluded from the diluted loss per share calculation, as their effect was anti-dilutive. NOTE 14RELATED PARTY TRANSACTIONS The Company has identified a potential new market segment for its Balancer products with PulverDryer USA, Inc., a manufacturer of a specializedpulverizing and drying machine. Due to the market potential with this customer, in October 2003 the Board of Directors of the Company authorized the CEO, 33 Mr. Wayne Case, to actively pursue this new market segment by supporting PulverDryer in its product design, development and guidance on management. Mr. Case thus expanded this new market segment by generating additional sales to the Company of over $360,000 for the period from July 2003 toMay 2005. Mr. Case also serves on the board of directors of PulverDryer. As these efforts expanded, effective June 1, 2004, the Company entered into a contract with PulverDryer to provide consulting services to PulverDryer,pursuant to which PulverDryer paid the Company $8,000 a month from June 2004 through October 2004. Those services generated successful results, andthe Company and PulverDryer extended the contract from November 1, 2004 forward at that same monthly fee of $8,000. The contract may be terminated byeither party upon 30 days written notice. As of May 31, 2005 the contract was in effect between the two companies. 34 SUMMARIZED QUARTERLY FINANCIAL DATA In thousands, except per share information(unaudited) 2005 Quarter Ended August31November30February28May31 Sales$2,429$2,432$2,554$3,115Gross Profit$1,358$1,433$1,456$1,823Net income$280$289$253$786(1)Net income Per Share, Basic$.11$.11$.10$.32Net income Per Share, Diluted$.10$.11$.09$.29Market Price of Common StockHigh$8.16$9.54$9.71$9.70Low$2.20$5.65$5.82$6.23 (1) – Includes $606,000 income tax benefit. 2004 Quarter Ended August31November30February29May31Sales$1,648$1,736$1,773$2,768Gross Profit$884$930$979$1,726Net (Loss) income$(67)$47$1$536Net (Loss) income Per Share, Basic$(.03)$.02$.00$.22Net (Loss) income Per Share, Diluted$(.03)$.02$.00$.22Market Price of Common StockHigh$1.82$2.53$2.69$2.75Low$1.24$1.48$1.86$1.75 Report of Independent Registered Public Accounting Firm: 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, 2005 and 2004, and the relatedconsolidated statements of operations, changes in stockholders’ equity and cash flows for each of the three years in the period ended May 31, 2005. Thesefinancial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based onour audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require thatwe plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. The Company is not required to have, nor were weengaged to perform an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as abasis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of theCompany’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management,as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable 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, 2005 and 2004, and the consolidated results of their operations and their consolidated cash flows for each of the three yearsin the period ended May 31, 2005, in conformity with accounting principles generally accepted in the United States of America. /s/ GRANT THORNTON LLP Portland, Oregon July 19, 2005 35 ITEM 9A. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Not applicable 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 Rules 13a-15(e) and 15d – 15(e) promulgatedunder the Securities Exchange Act of 1934, as amended, as of the end of the period covered by this report. Based on their evaluation, our principalexecutive officer and principal financial officer concluded that our disclosure controls and procedures are effective as of the end of the periodcovered 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. Item 9A. Other Information None PART III Certain information required by Part III is included in the Company’s definitive Proxy Statement for its 2005 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 “Management”, “Executive Compensation,” “SummaryCompensation Table,” “Options Grants in Fiscal 2005,” “Aggregated Option Expenses in Fiscal 2005 and Fiscal Year-End Option Values,” and“Section 16(a) Beneficial Ownership Reporting Compliance” and “Code of Ethics” and is incorporated herein by reference. 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 “Security Ownership of Certain Beneficial Owners” and isincorporated 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 Relationships and Related Transactions” and isincorporated 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. 36 PART IV Item 15. Exhibits and Financial Statement Schedules (a) Financial Statements: (1)Consolidated Balance Sheets as of May 31, 2005 and 2004 Consolidated Statements of Operations for the years ended May 31, 2005, 2004 and 2003 Consolidated Statements of Changes in Stockholders’ Equity for the years ended May 31, 2005, 2004 and 2003 Consolidated Statements of Cash Flows for the years ended May 31, 2005, 2004 and 2003 Notes to Consolidated Financial Statements for the years ended May 31, 2005, 2004 and 2003 Report of Independent Registered Public Accounting Firm (2)Financial Statement Schedules: All financial statement schedules are omitted either because they are not applicable, not required, orthe required information is included in the financial statements or notes thereto. (3)Exhibits: Reference is made to the list on page 39 of the Exhibits filed with this report. 37 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, Presidentand Chief Executive Officer Date: August 29, 2005 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 29, 2005. 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 38 INDEX TO EXHIBITS Exhibits Description 3.1Second 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 3.2Second Restated Bylaws of the Company Incorporated by reference to Exhibit 3(ii) to the Company’s Annual Report on Form 10-K for theFiscal year ended May 31, 1999 4.1See exhibits 3.1 and 3.2 for provisions of the Articles of Incorporation and Bylaws defining the rights of security holders. *10.1Schmitt Industries, Inc. Amended & Restated Stock Option Plan. Incorporated by reference to Exhibit 10.1 to the Company’s Annual Reporton Form 10-K for the Fiscal year ended May 31, 1999 **21.1Subsidiaries of Schmitt Industries, Inc. as of May 31, 2005 **23.1Consent of Independent Registered Public Accounting Firm **31.1Certification of Principal Executive Officer pursuant to 18 U.S. C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-OxleyAct 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 Actof 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 39EXHIBIT 21.1 SUBSIDIARIES OF SCHMITT INDUSTRIES, INC.AS OF MAY 31, 2005 SubsidiaryState of Incorporation or Country in Which OrganizedSchmitt Measurement Systems, Inc.OregonSchmitt Europe, Ltd.United KingdomSchmitt Europa, GmbHGermany 1EXHIBIT 23.1 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We have issued our report dated July 19, 2005, accompanying the financial statements included in the Annual Report of Schmitt Industries, Inc. on Form 10-K for the year ended May 31, 2005. We hereby consent to the incorporation by reference in the Registration Statement on Form S-8 (No. 333-3910). /s/Grant Thornton LLP Portland, OregonAugust 29, 2005 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 29, 2005/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 29, 2005/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, 2005 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, as amended; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. Wayne A. CaseChief Executive OfficerAugust 29, 2005 Robert C. ThompsonChief Financial OfficerAugust 29, 2005 1

Continue reading text version or see original annual report in PDF format above