Schmitt Industries, Inc.
Annual Report 2014

Plain-text annual report

UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549 FORM 10-K (Mark One)xANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the fiscal year ended: May 31, 2014or ¨TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934For the transition period from to Commission File Number: 000-23996 SCHMITT INDUSTRIES, INC.(Exact name of registrant as specified in its charter) Oregon 93-1151989(State or other jurisdiction ofincorporation or organization) (IRS EmployerIdentification 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 registeredCommon Stock - no par value The NASDAQ Stock Market LLCSecurities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No xIndicate by check mark whether the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes ¨ No xIndicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934during 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 x No ¨Indicate by check mark whether the registrant has submitted electronically and posted on its Corporate Website, if any, every Interactive Data File required tobe submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required tosubmit and post such files). Yes x No ¨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 bestof registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form10-K. ¨Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. Seedefinitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (check one): Large accelerated filer ¨ Accelerated filer ¨Non-accelerated filer ¨ Smaller reporting company xIndicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No xThe aggregate market value of the voting stock held by non-affiliates of the registrant as of November 30, 2013, the last business day of the registrant’s mostrecently completed second fiscal quarter, was approximately $4,622,100 based upon the closing price of $2.63 reported for such date on the NASDAQCapital Market. For purposes of this disclosure, shares of Common Stock held by persons who hold more than 10% of the outstanding shares of CommonStock and shares held by officers and directors of the registrant, have been excluded because such persons may be deemed to be affiliates. This determinationis not necessarily conclusive for other purposes.As of July 31, 2014, the registrant had 2,995,910 outstanding shares of Common Stock.Documents Incorporated by ReferencePortions of the registrant’s definitive Proxy Statement for its 2014 Annual Meeting of Shareholders are incorporated by reference into Part III hereof. PART I Item 1.BusinessForward-Looking StatementsThis Annual Report on Form 10-K (the “Report”), including “Management’s Discussion and Analysis of Financial Condition and Results of Operations” inItem 7, contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 regarding future events and thefuture results of Schmitt Industries, Inc. and its consolidated subsidiaries (the “Company”) that are based on management’s current expectations, estimates,projections and assumptions about the Company’s business. Words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “sees,” “estimates”and variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees offuture performance and involve risks, uncertainties and assumptions that are difficult to predict. Therefore, actual outcomes and results may differmaterially from what is expressed or forecasted in such forward-looking statements due to numerous factors, including, but not limited to, those discussed inthe “Risk Factors” section in Item 1A, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 and elsewherein this Report as well as those discussed from time to time in the Company’s other Securities and Exchange Commission filings and reports. In addition, suchstatements could be affected by general industry and market conditions. Such forward-looking statements speak only as of the date of this Report or, in thecase of any document incorporated by reference, the date of that document, and we do not undertake any obligation to update any forward-lookingstatement to reflect events or circumstances after the date of this Report. If we update or correct one or more forward-looking statements, investors andothers should not conclude that we will make additional updates or corrections with respect to other forward-looking statements.IntroductionSchmitt Industries, Inc. (the Company), an Oregon corporation, designs, manufactures and sells high precision test and measurement products for two mainbusiness segments: the Balancer Segment and the Measurement Segment. The Company designs, manufactures and sells computer-controlled vibrationdetection, balancing and process control systems for the worldwide machine tool industry, particularly for grinding machines (the Balancer Segment).Through its wholly owned subsidiary, Schmitt Measurement Systems, Inc. (SMS), an Oregon corporation, the Company designs, manufactures and sells laserand white light sensors for distance, dimensional and area measurement for a wide variety of commercial applications, laser-based microroughnessmeasurement products for the semiconductor wafer and hard disk drive industries and for other industrial applications, laser-based surface analysis andmeasurement products for a variety of scientific applications, and ultrasonic measurement products that measure the levels of propane tanks and transmit thatdata via satellite to a secure web site for display (the Measurement Segment). The Company also provides sales and service for Europe and parts of Asiathrough its wholly owned subsidiary, Schmitt Europe Limited (SEL), located in Coventry, England and through its sales representative office located inShanghai, China. The Company’s corporate office is located at 2765 N.W. Nicolai Street, Portland, Oregon.“SBS,” “SMS,” “Acuity,” “Xact,” “Lasercheck” and “AccuProfile” are registered trademarks owned by the Company.Balancer SegmentThe Company’s principal product line for this segment is the Schmitt Dynamic Balance System (SBS), which consists of a vibration sensor, a computercontrol unit, and a balance head that is placed either externally on the grinding wheel spindle with the use of a spindle mounted adaptor or internally insidethe spindle bore. The SB-5500 control panel contains up to four slots for additional circuit boards designed for specific functions, such as manual balancing,balancing using hydro chambers and process monitoring, which involves the detection and analysis of high frequency noise, known as acoustic emission orAE, generated by the grinding process. SBS products are designed as economical yet highly precise measurement and control devices for permanent orportable installation on grinding machines that can detect and correct imbalance caused by vibration as small as 0.02 microns. Customers can also detect andanalyze the AE signal generated during grinding or wheel dressing to help monitor and improve the grinding process. Customers include both end useroperators as well as manufacturers of grinding machines worldwide for a wide variety of industries that utilize the grinding process, including the automotive,industrial, aerospace, and medical industries where specifications and operating tolerances on machined parts are increasingly precise. Page 2The SB-5500 is fully automated, eliminating the need to pre-balance parts such as grinding wheels. This reduces machine setup time and ensures a smootherand more efficient grinding process. Operating on a principle of mass compensation for wheel imbalance, the balance head contains two movable eccentricweights, each driven by electric motors through a precision gear train. These weights are repositioned to offset any imbalance in a grinding wheel or otherapplication. Imbalance or vibration is picked up by the vibration sensor that feeds the detected signal to the control unit, which filters the signal byrevolutions per minute. The controller then automatically drives the balance head weights in a direction that reduces the amplitude of the vibration signal.The balance cycle is complete when the weights are positioned to achieve the lowest vibration level, as low as 0.02 microns.The SB-5500 also includes an optional Acoustic Emission Monitoring System (AEMS) control card, which uses proprietary acoustic sensor technology tomonitor the very high frequency signals (known as acoustic emission or AE) generated on the grinding machine during key events in the grinding process.The AEMS card allows rapid, automatic grinding wheel in-feed, right up to the point of initial contact of the grinding wheel with a new part loaded in themachine. The system can automatically detect the initial contact and very quickly report this event to the machine control, stopping the wheel in-feedwithout operator intervention. Part crash occurs when a part or fixture is incorrectly loaded into a grinding machine or some abnormal condition occurs.Rapid in-feed of the wheel may then result in a dangerous or expensive crash. The AEMS card allows the grinding machine’s operating system (known as acomputer numeric control or CNC system) on the machine to monitor the acoustic levels and detect any unexpected contact when it happens. The systemthen reports that abnormal contact and instructs the CNC program to stop the grinding process, usually within one millisecond.The SB-5500 also offers the ExactDress process control card as part of the AEMS system to automatically monitor and control the grinding wheel dressingprocess by comparing the AE signal pattern of a wheel dress to a stored “master” AE signal pattern and by indicating when the dressing process has beensuccessfully completed. Monitoring for AE levels during wheel dressing permits the operator or CNC control to determine if the wheel is being dressed fullyacross its width, control the aggressiveness of the process and maintain the quality of the dressed wheel to conserve wheel material.Additional SBS products include the SB-2000 and the AE-1000. The SB-2000 is an easy-to-use, compact manual balancing system offering both one and twoplane manual balancing capabilities. The system comes in a dedicated machine installation version (SB-2000) and a portable version (SB-2000-P). Eachversion of the system displays up to four digits of resolution for vibration and six digits for RPM readings and supports a spindle speed range of 30 to100,000 RPM. The portable SB-2000-P version attaches magnetically to any location on the machine for easy setup and use. The AE-1000 is a dedicated AEcontrol platform that reduces air machine grinding time and alerts the operator to potential grinding wheel crash conditions by using proprietary AEdetection technology to monitor the high frequency signals generated by the grinding process.Notable features of the SBS system include its ability to fit almost all grinding machines, ease of installation, compact and modular construction, ability tobalance a wheel while on a machine, virtual elimination of wheel vibration, automatic monitoring of balancing, display in a variety of languages and inmetric units of measurement, instrument grade calibration, short balance process, measurement of both displacement and/or velocity and minimal operatormaintenance. The SB-5500 also offers the capability of fully integrating its operation and output within any grinding machine’s CNC operating system bythe use of its IVIS (Intelligent Visualization) software.Benefits of using the SBS system include improved quality of finished parts, elimination of grinding gap time in the grind cycle resulting in increasedefficiency and part throughput, ease of product adaptation, monitoring and correction of part crash, 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 major manufacturing areas including the automotive industry (gear trains, camshafts, crankshafts, valves), bearings (rollerand tapered types), ceramics (precision shaping), electric motors (shafts), pumps (shafts and turbines), aircraft (engine parts such as turbine blades), andgeneral manufacturing. Precision grinding has an established worldwide presence in all industrialized countries and is expanding as a method of materialremoval and part processing. Within the Company’s customer base for the SBS system, there are three major market segments:Machine Tool Builders – These companies design and manufacture a variety of specialty application grinding machines. SBS systems are distributedto markets throughout the world through machine tool original equipment manufacturers (OEMs), who incorporate the SBS system into their products. Page 3Examples of some well-known worldwide machine tool builders who have offered and/or installed the SBS system include Shanghai Machine ToolWorks, ANCA, Capco Machinery, Drake Manufacturing, Ecotech/SMTW, Erwin Junker, Matrix Machine Tool, Schleifring Group, Shaanxi QinchuanMachinery Development Co., Cinetic Landis Grinding, Koyo Machinery, Micron Machinery Limited, USACH Technologies (U.S.), Tschudin andWeldon Solutions. The Company currently sells its products directly to major machine builders throughout the world.Machine Tool Rebuilders – These customers, found in most, if not all, industrialized nations, develop their business by offering to completely updateand refurbish older grinding machines. These rebuilders typically tear the old machine apart and install new components, such as the SBS system. TheCompany currently sells its products directly to major machine rebuilders throughout the world.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 customers including:Black & Decker, Briggs and Stratton, Schaeffler, Caterpillar, Eaton, Emerson Power Transmission, Cummins Engine, Ford Motor Company, GeneralElectric, General Motors, Ingersoll Rand, Komatsu, Sumitomo Heavy Industries, SKF Bearing Industries, Timken, TRW Automotive Components andUniversal Bearing.For the years ended May 31, 2014, May 31, 2013 and May 31, 2012 (Fiscal 2014, 2013 and 2012), net sales of the Company’s balancing products totaled$7,721,211, $7,714,122 and $9,265,008, respectively. Net sales of balancing products accounted for 64%, 62% and 64% of the Company’s total sales inFiscal 2014, 2013 and 2012, respectively. See Note 6 to Consolidated Financial Statements.CompetitionCompetitors in the Balancer Segment primarily come from Germany and Italy. These competitors produce electromechanical and water balancers and processcontrol products similar to SBS. The Company’s primary competitors are Marposs S.p.A., MPM Micro Prazision Marx GmbH and Balance Systems S.r.l.Measurement SegmentWithin the Measurement Segment, the Company designs, manufactures and sells laser and white light sensors for distance, dimensional and areameasurement for a wide variety of commercial applications, laser-based microroughness measurement products for the semiconductor wafer and hard diskdrive industries and for other industrial applications, laser-based surface analysis and measurement products for a variety of scientific applications, andultrasonic measurement products that accurately measure the fill levels of propane tanks and transmit that data via satellite to a secure web site for display.Laser and White Light SensorsThese products include lasers utilizing both triangulation and time-of-flight methods of measurement, and confocal chromatic white light sensors that areused in a wide range of industrial applications including manufacturing, lumber production, steel casting, glass and paper production, medical imaging,crane control and micron-level part and surface inspection and are sold under the Acuity brand. Presently, there are 11 products offered under the Acuitybrand: The AccuRange (AR)1000, AR2000, AR2500 and AR3000 distance measurement sensors, the AR700, AR500 and AR200 series of triangulating laserdisplacement sensors, the AR CCS Prima and the AR CCS Initial chromatic confocal sensors and the AccuProfile (AP)400 and AP820 laser line scanners. TheCompany designs, manufactures and sells the AR200 and AR700 and distributes the AR500, AR1000, AR2000, AR2500, AR3000, AR CCS Prima, AR CCSInitial, AP400 and the AP820, primarily into North America.The AR1000, AR2000, AR2500 and AR3000 distance measurement lasers utilize pulsed time of flight measurement principles to accurately measuredistances of up to 30 meters (up to 300 meters with retro-reflective tape) with the AR1000, up to 100 meters (500 meters with retro-reflective tape) with theAR2000, up to 50 meters (500 meters with retro-reflective tape) with the AR2500 and up to 300 meters (3000 meters with retro-reflective tape) with theAR3000. These products are highly versatile, being able to measure distances both indoors and outdoors. Applications include, but are not limited to, loadconfirmation, alignment, lumber positioning, crane monitoring, fill level measurement, velocity measurement and laser altimeter. Page 4The AR700 is a triangulation laser displacement sensor that provides superior performance in terms of accuracy, repeatability, and sample speed. The AR700boasts output speeds up to 9400 Hz and resolutions as a micron. The laser will output 9400 distance readings in a single second. The unit is also verycompact, measuring approximately 80% smaller than its predecessor, the AR600. Model variations permit applications up to 50 inches in range. Applicationsinclude high speed road profiling, product dimensional or thickness measurement, rubber thickness measurement, lumber or plywood thickness measurement,carton dimensioning and product positioning.The AR500 is a compact triangulation laser displacement sensor that provides accurate measurements (+/- 0.15% linearity) at high speeds (standard to 9400Hz, high speed option up to 56K Hz). The same compact enclosure houses models with ranges from 5 to 1000 millimeters. Sensor options include blue laserdiodes, faster speeds and cooling jackets. Applications include radiating surfaces and high speed applications such as road texture, ballistics and high speedevent monitoring.The AR200 line is the Company’s most compact series of triangulating laser displacement sensors. Four models cover metric measurement ranges from 6 to100 millimeters. All models boast a 1/500 accuracy rating for measurements within twelve microns. All models are standard with analog, limit switch andserial outputs. The AR200 sensors, much like the longer-range AR700 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 by a line scan camera and the target’s distance is computed from the image pixel data. The AR200-6M, -12M, -25M, -50M, and -100M have ranges in millimeters that match their model number. The AR200 displacement sensor cannot be overloaded andmeasures accurately even when a mirror reflects the entire light beam back to the detector.The AR CCS Prima white light confocal-chromatic displacement sensor is the most precise measurement system from Acuity. Using a novel optical principleof measuring the reflected light’s component wavelengths, these confocal sensors measure distance and position to within nanometers. These compact probescan measure to opaque, shiny or even transparent surfaces. Unlike the other Acuity distance sensors, the Prima Confocal systems are comprised of an opticalmeasurement “pen” and a separate controller. This controller houses all of the electronics, light source, etc. Only emitted white light and reflected signals arepassed between the pen and the controller via a thin fiber-optic transmission cable. The Confocal-Chromatic Sensors (CCS) are offered in a variety ofmeasurement ranges and standoff distances, each with a corresponding resolution. The shortest-range models resolve to 5 nanometers of height change.The AR CCS Initial confocal sensor is an extremely precise point sensor for measuring displacement and thickness. Each system includes a controller unit, afiber optic cable, a measuring probe and all necessary cables and software. The CCS Initial measures distance and topography of varied targets, includingsilicon, polished metals, glass, contoured lenses, polymers, semiconductor masks and natural materials. The technology in the CCS Initial supportsnanometer-scale resolutions and the system comes in five different measurement models that range from 0.4 to 12.0 mm.The AP400 series line sensors are entry-level two-dimensional CMOS digital sensors for industrial surface dimensioning and measurement applications. Thescanner quickly and accurately generates low noise 2D profile scans of objects, surface or scenes. The sensor has an onboard processor and memory andcomes with AcuityView image analysis software. Typical applications include weld gap tracking and weld bead profiling, positional control of objects andsurfaces, tire profiling, wheel profiling, surface profiling, 3D profile generation and dimensional measurement.The AP820 is a two-dimensional laser line scanner that measures surface height profiles by projecting a beam of visible laser light that creates a line on atargeted surface. The AP820 is a highly accurate sensor for industrial surface dimensional and measurement applications. The scanner quickly and accuratelygenerates low-noise 2D or 3D profile scans of objects, surfaces or scenes. The sensor automatically adjusts laser power and detector exposure to compensatefor varying surface conditions. Typical scanner applications include weld gap tracking and weld bead profiling, positional control of objects and surfaces,tire profiling, wheel profiling, surface profiling, 3D profile generation and dimensional measurement.Surface Roughness Measurement ProductsThese products use a patented technology using laser light scatterometry to perform rapid, accurate, repeatable, non-destructive and non-contact surfacemeasurement tests that quantify surface micro-roughness. The technology is extremely precise, measuring surface roughness at the molecular (sub-Angstrom)level. Products are sold to manufacturers of hard disk drives, semiconductors, silicon wafers and optical products and industries involved in fabricationprocesses that require precise and reliable measurements. Page 5Computer hard disk drives require exact manufacturing control and a narrow tolerance band for acceptable roughness, with surface roughness outside thatnarrow band 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 Company believes the precise measurement methods provided by itsproducts are not possible through any other cost-effective measurement means.The Company’s product for the disk industry is the TMS (Texture Measurement System) 2000-RC, an 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 be measured tolevels below 0.5 Angstroms. An Angstrom (Å) is a unit of measure equal to 1 hundred-millionth of a centimeter (the point of a needle is one million Å indiameter).Customers include Hitachi/IBM, Seagate Substrates, Western Digital, Showa Denko, MMC and Komag.The Company offers two products devoted to the semiconductor wafer industry: the TMS2000W-RC and TMS3000W-RC. Both products provide fast,accurate, repeatable measurements for manufacturers of silicon wafers, device quality semiconductors and memory devices. This industry demandsmanufacturing precision to increase performance and capacity and these products help achieve those goals. Silicon wafers are carefully cut and polished toprovide the base upon which a computer or memory chip is produced. Therefore, chip manufacturing is extremely dependent on the beginning surfaceroughness of the wafer. Since all silicon wafers exhibit a microscopic level of surface roughness stemming from production techniques such as chemicaldeposition, grinding, polishing and etching, some method of measuring surface roughness is required. The Company’s wafer measurement products provide away for customers to quantify and control their manufacturing process. The system provides measurements to less than 0.5 Å.The Company also offers the Lasercheck line of surface roughness measurement gauges. Lasercheck is a unique laser-based non-contact roughness gaugeincorporating patented laser light-scatter technology that can make precise and repeatable surface roughness measurements in the 0.025 to 2 micron (<1.0 to80 micro inches) range. Lasercheck provides high-speed in-process measurements in a fraction of a second and is optimized for surface measurements ofground, sanded, polished, hone, super-finished and shot-blasted surfaces.Laser Light-Scatter Surface Measurement ProductsThe Company’s CASI (Complete Angle Scatter Instrument) Scatterometers are sold to companies and institutions involved in scientific research anddevelopment. The CASI Scatterometer uses visible, ultraviolet or infrared laser light as a nondestructive probe to measure surface quality, opticalperformance, smoothness, appearance, defects and contamination on a wide variety of materials. These products are scientific measurement instrumentsproviding customers with molecular-level precision in roughness measurement of optical surfaces, diffuse materials, semiconductor wafers, magnetic storagemedia and precision-machined surfaces, as well as surfaces affecting the cosmetic appearance of consumer products.The MicroScan system is a portable device consisting of a hand-held control unit, an interchangeable measurement head and a separate charging unit. Toperform a measurement, the operator places the measurement head on the objective area and presses a button. Each measurement takes less than five secondswith results displayed and stored in system memory. The MicroScan can store 700 measurements in 255 files and provides the capability to program pass/failcriteria. Software is available for control, analysis and file conversion. From a single measurement, a user can determine Ra (Roughness Average) surfaceroughness, RMS (Root Mean Squared) surface roughness, reflectance and scatter light levels (BRDF) on either flat or curved surfaces and under any lightingconditions.CompetitionManagement believes the TMS and Lasercheck surface measurement products are two of only a few systems that provide fast, accurate, repeatable non-contact microroughness measurement for a wide variety of commercial customers including computer hard disk and silicon wafer manufacturers. TheCompany believes its surface Page 6measurement products are currently the only systems that can provide measurements as low as a few hundredths of an Å, with reproducibility +/- 0.2Å or 1%and repeatability of +/-0.1Å. There are differences between our surface measurement products and other optical techniques (which include profilometers,scanning tunneling microscopes, atomic force microscopes or interferometers). These other technologies require the intervention of a skilled operator toperform measurements relatively slowly, whereas our surface measurement products are much simpler and, consequently, can make measurements morerapidly while still maintaining excellent repeatability and accuracy. Stylus profilometers are simpler devices that require less skilled operators. However,measurements must be conducted under vibration isolation conditions, and large areas require numerous scans; thus, stylus profilometers are generallydestructive to soft materials such as most coated optics.The market for distance measurement and dimensional sizing products is extremely competitive, characterized by rapidly changing technology. TheCompany believes the principal elements of competition include quality of ongoing technical support and maintenance coupled with responsiveness tocustomer needs, as well as price, product quality, reliability and performance. The differences between the Company’s sensors and competitive productsinclude pushbutton selection of output signals in certain models and sensors that can be programmed using serial commands through a PC computer. TheAR200 displacement sensor cannot be overloaded and measures accurately even when a mirror reflects the entire light beam back to the detector.Competing surface measurement products and dimensional sizing products come from established multinational competitors, most of which are significantlylarger and have greater financial, engineering, manufacturing and marketing resources. Company pricing is intended to obtain market share and meetcompetitive supplier prices. The market strategy is to establish measurement products with the best quality, reliability and performance and superioreconomic value.Remote Tank Monitoring ProductsThe Company’s Xact Tank Monitoring System provides remote fuel level monitoring of propane tanks, large or small, anywhere in the world. Accessingaccurate fuel level information is essential to effectively manage inventory, improve delivery efficiency, reduce operating costs and increase profitability,and justify capital expenditures. The Xact system utilizes an ultrasonic sensor that is applied externally to the tank to calculate the fill level inside the tankwith great accuracy (+/- 2% for large tanks, +/-1% for small tanks). The Xact system can also be installed to measure the fill levels of bobtail and transporttrucks. For smaller tanks that are difficult to access or where the precise accuracy provided by the ultrasonic sensor is not as important, Xact also offers asensor that is affixed to the dial of a preinstalled float gauge (known as a “gauge reader”) which detects the fill level that is reported by the gauge. Floatgauges have a typical accuracy of +/- 8% to 12%. Tank fill data is then transmitted via the Globalstar® satellite network to a secure website for display. Thereis no reliance on phone land lines or cellular networks and therefore no dropped data. The use of satellite telemetry permits monitoring of any tank anywherein the world. With the Xact system, minimum or maximum alarm or fill levels can be set to automatically notify operators anytime a particular tank readingexceeds thresholds or needs refilling. The Xact system can be used to monitor tanks as small as 125 gallons (473 liters) and as large as 90,000 gallons(340,686 liters). With Xact, operators can obtain timely and accurate readings of inventory levels and tank refill requirements instantly.There are three main components to the Xact Tank Monitoring System:Tank SensorThe Xact ultrasonic sensor incorporates patented technology and is externally mounted to the bottom of the propane tank. The sensor produces a smallelectrical pulse, or a “ping,” that travels through the tank’s steel shell, which is reflected off the bottom surface of the liquid stored in the tank in theform of an echo that is detected by the sensor. The time of flight between the “ping” and the echo, which is measured in milliseconds, is then calculatedto determine, based upon additional data regarding tank size and shape, the volume of liquid the tank contains. This information is then remotelytransmitted via a satellite radio transmitter. For smaller tanks that are difficult to access or where the precise accuracy provided by the ultrasonic sensoris not as important, Xact also offers a sensor that is affixed to the dial of a preinstalled float gauge (known as a “gauge reader”). The gauge readerdetects the fill level that is reported by the gauge and transmits that data by satellite in the same manner as the ultrasonic sensor. Float gauges have atypical accuracy range of +/- 8% to 12%. Page 7Satellite Radio TransmitterThe Xact radio transmitter is placed on the top of the tank and is connected by cable to the tank sensor or gauge reader. The satellite transmittertransmits the tank data using the GlobalStar® satellite network to a GlobalStar® ground station and then to the Xact secure website where the tank datais displayed or is automatically directed to a customer’s automated inventory or delivery management system.Xact WebsiteThe Xact website is a secured location providing controlled access to the tank data for each customer’s various tank locations. The tank fill level dataand geometry of the tank are used to calculate and display the precise fill level at predetermined measurement times along with additional informationsuch as temperature, battery status, GPS coordinates and map location, fill levels that trigger email notification and the list of email recipients. Inaddition to the data being displayed on the website, the data can also be automatically directed to a customer’s automated inventory or deliverymanagement system for full automation of the delivery process. Operators can now obtain highly accurate readings and tank information from even themost remote tanks conveniently and cost-effectively using their desktop computer, laptop, tablet or smart phone.BenefitsBenefits of using the Xact Tank Monitoring System include external mounting with no reliance on existing mechanical gauges when using the ultrasonicsensors, tank fill data is sent directly and instantly from the tank to the user via satellite, no reliance on telephone lines or cellular networks and no droppeddata, temperature adjusted readings for accuracy within +/- 2% for large tanks and +/- 1% for smaller tanks when using the ultrasonic sensor, user-set alarmlevels and automatic low tank-level messaging via email or cell phone, the ability to operate in a wide range of operating environments from -40ºC to 60ºC,long battery life, quick and easy installation, secure data transmission via satellite, the ability to integrate directly into delivery scheduling managementsystems and the ability to monitor any tank anywhere in the world.CustomersCustomers of the Xact Tank Monitoring System include large, regional and local propane distributors, such as Superior Propane (Canada), Suburban Propane,AmeriGas, Pacific Propane and TermoGas. The Company is focusing its business development efforts on the propane industry in the United States, Canada,Mexico, Central and South America.CompetitionManagement believes that the Xact Tank Monitoring System offers the only ultrasonic sensor specifically designed to provide independent precise tanklevel calculation while most other competitors utilize gauge-reading technology, which reads the tank fill level from a pre-installed float gauge and is lessaccurate. Competitors offer telemetry options based on cellular or closed loop communication networks whereas Xact telemetry is satellite based.Competitors include, but are not limited to, Independent Technologies, Inc. (Wesroc), NasCorp (SkyTracker), WacnGo, Silicon Controls, TankLink,Centeron, TankScan and Enertrack.In Fiscal 2014, 2013 and 2012, net sales of Measurement products totaled $4,413,295, $4,738,130 and $5,172,014, respectively, and accounted for 36%,38% and 36% of the Company’s total sales in Fiscal 2014, 2013 and 2012, respectively. See Note 6 to Consolidated Financial Statements. Page 8Sales by Geographic AreaIn Fiscal 2014, 2013 and 2012, the Company recorded net sales of its products in the United States, its country of domicile, of $6,704,239, $7,431,528 and$8,112,431, respectively. Net sales in the last three fiscal years by geographic areas were: North America Europe Asia Others Fiscal 2014 $7,474,067 $1,773,928 $2,693,767 $192,744 Fiscal 2013 $8,413,970 $1,192,049 $2,499,593 $346,640 Fiscal 2012 $9,074,152 $1,145,449 $3,814,656 $402,765 Business and Marketing StrategyThe Company designs, manufactures and markets all of its products with operations divided into a number of different channels and geographies.Balancer Segment ProductsThe Company markets and sells its SBS products in a variety of ways. First are the channels provided by independent manufacturers’ representatives anddistributors. There are currently approximately 65 individuals and/or organizations throughout the world acting in one of these capacities, includingapproximately 15 in the United States and 15 in China.Second, OEMs integrate the Balancer Segment products on the machine tools they produce. Users thus purchase the SBS products concurrently with themachine tools. Conversely, end users of grinding machines that have purchased the SBS system directly from the Company, and after enjoying the benefits ofthe products, often request that SBS products be included with the new equipment they order from OEMs. The SBS Systems are often installed by machinetool builders prior to displaying their own machine tools at various trade shows, becoming endorsements that 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 the 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 factory in Portland, Oregon. Where the Company has distributors,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. Europeandistribution to customers is handled by shipping the product directly from the Company’s Portland headquarters to its European subsidiary in the UnitedKingdom, which in turn sells and distributes the products.Measurement Segment ProductsSimilar to the Balancer Segment, the Measurement Segment uses a variety of methods to market and sell its products. First, sales and marketing managersdirect the overall worldwide marketing efforts for surface measurement, laser and white light sensor and remote tank monitoring products. Second, both amarketing manager and a sales manager direct the overall worldwide marketing and sales efforts for distance measurement and dimensional sizing products.Third, the Company uses distributors for international markets for the promotion and sale of surface measurement products in China, Taiwan, Japan andKorea. The Xact product line utilizes two business development personnel, in addition to distributors for selected markets. All Measurement Segmentproducts are assembled in the Portland, Oregon facility and shipped worldwide directly to customers.BacklogThe Company does not generally track backlog. Normally, orders are shipped within one to two weeks after receipt unless the customer requests otherwise.ManufacturingThere 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.Mechanical parts for the Company’s products are produced by high quality machine shops. The Company is not dependent on any one supplier ofmechanical components. In the event of supply problems, the Company believes that two or three alternatives could be developed within 30 days. TheCompany is subject to availability and pricing on the various components parts purchased, which has had, and may continue to have, a material impact onoperations. Page 9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 inthe finished goods inventory. Finished goods inventory is maintained via computer to assure timely shipment and service to customers. All customershipments are from the finished goods inventory.The Company’s Quality Control Program first received full ISO 9001 certification in 1996. In 2005, the Company received its certification to the newer ISO9001:2000 requirements and in 2011 received its recertification.Proprietary TechnologyThe Company’s success depends in part on its proprietary technology, which the Company protects through patents, copyrights, trademarks, trade secrets andother measures. The Company has U.S. patents covering both Balancer and Measurement products, processes and methods that the Company believesprovide it with a competitive advantage. The Company has a policy of seeking patents where appropriate on inventions concerning new products andimprovements developed as part of its ongoing research, development and manufacturing activities. While patents provide certain legal rights ofenforceability, there can be no assurance the historic legal standards surrounding questions of validity and enforceability will continue to be applied or thatcurrent defenses with respect to issued patents will, in fact, be considered substantial in the future. There can be no assurance as to the degree and range ofprotection any patent will afford and whether patents will be issued or the extent to which the Company may inadvertently infringe upon patents granted toothers.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.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 trademarks, 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 DevelopmentThe Company maintains an ongoing research and development program to expand the product lines and capabilities of its business 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. Forexample, in the past fiscal year, the Company has developed and introduced the SB-2000, a dual plane manual balancing system, a control card to control thedressing process of grinding wheels, and a new vibration sensor and internal balancer design. The Company has also introduced several new laser productsunder the Acuity line.During Fiscal 2014, 2013 and 2012, the Company’s research and development expense totaled $475,430, $573,461 and $317,993, respectively.EmployeesAs of July 31, 2014, the Company employed 44 individuals worldwide on a full-time basis. There were also two part-time or temporary employees. None ofthe Company’s employees are covered by a collective bargaining agreement. Page 10Item 1A.RISK FACTORSThe following are important factors that could cause actual results or events to differ materially from those contained in any forward-looking statements madeby or on behalf of the Company (see the forward-looking statements disclaimer at the beginning of Part 1, Item 1 in this Report). In addition, the risks anduncertainties described below are not the only ones that the Company faces. Unforeseen risks could arise and problems or issues that the Company now viewsas minor could become more significant. If the Company were unable to adequately respond to any risks, the Company’s business, financial condition orresults of operations could be materially adversely affected. In addition, the Company cannot be certain that any actions taken to reduce known or unknownrisks and uncertainties will be effective.General economic conditions and uncertainties may adversely affect the Company’s business, operating results and financial conditionThe Company’s operations and performance depend significantly on worldwide economic conditions, particularly in the industrial, manufacturing andautomotive sectors in the U.S., Asia and Europe, and their impact on levels of capital spending, which have deteriorated significantly in the past and maybecome depressed, or be subject to further deterioration. Economic factors that could adversely influence demand for the Company’s products includeuncertainty about global economic conditions leading to reduced levels of investment, reduction in demand for our customers’ products, customers’ andsuppliers’ access to credit and the stability of the global financial system, the overall health of our markets, unemployment and other macroeconomic factorsgenerally affecting commercial and industrial spending behavior.The past distress in the global financial markets and global economy has resulted in reduced liquidity and a tightening of credit markets for some customersin our markets. Other customers are delaying investment decisions in response to the slow recovery. As a result of these conditions, the Company couldexperience several potential adverse effects, including the inability of customers to obtain credit to finance purchases of the Company’s products, theinsolvency of customers resulting in reduced sales and bad debts, and the insolvency of key suppliers resulting in product development and productiondelays.The Company’s primary markets are volatile and unpredictableThe Company’s business depends on the demand for our various products in a variety of commercial and industrial markets. In the past, demand for ourproducts in these markets has fluctuated due to a variety of factors, some of which are beyond our control, including: general economic conditions, bothdomestically and internationally, the timing, number and size of orders from, and shipments to, our customers as well as the relative mix of those orders andvariations in the volume of orders for a particular product line in a particular quarter.The Company’s efforts to accelerate growth of the Xact Tank Monitoring System may not be successfulThe Company’s efforts to accelerate the growth of Xact in its two primary markets of North America and Latin America may not be successful, anticipatedmarket demand for the products may not materialize, and additional products or market opportunities may not be identified, developed and brought tomarket in a timely and cost-effective manner. All of this could continue to negatively impact future operating results and result in large and immediate write-offs of recorded intangible asset balances.New products may not be developed to satisfy changes in consumer demandsThe failure to develop new products or enhance existing products or react to changes in existing technologies could result in decreased revenues and a loss ofmarket share to competitors. Financial performance depends on the ability to design, develop, manufacture, assemble, test, market and support new productsand enhancements on a timely and cost-effective basis. New product opportunities may not be identified and developed and brought to market in a timelyand cost-effective manner. Products or technologies developed by other companies may render products or technologies obsolete or noncompetitive, or afundamental shift in technologies in the product markets could have a material adverse effect on the Company’s competitive position within historicindustries. Page 11Competition is intense and the Company’s failure to compete effectively would adversely affect its businessCompetition in the markets for the Company’s products is intense. The speed with which the Company can identify new applications for the Company’svarious technologies, develop products to meet those needs and supply commercial quantities at low prices to those new markets are important competitivefactors. The principal competitive factors in the Company’s markets are product features, performance, reliability and price. Many of the Company’scompetitors have greater financial, technical, engineering, production and marketing resources than we do. Those competitors with greater resources may, inaddition to other things, be able to better withstand periodic downturns, compete more effectively on the basis of price and technology, or more quicklydevelop enhancements to products that compete with the products we manufacture and market. New companies may enter the markets in which we compete,further increasing competition in those markets. No assurance can be given that the Company will be able to compete effectively in the future, and the failureto do so would have a material adverse effect on the Company’s business, financial condition and results of operations.The Company may experience increased pricing pressureWe have experienced and continue to experience pricing pressure in the sale of our products, from both competitors and customers. Pricing pressurestypically have become more intense during cyclical downturns when competitors seek to maintain or increase market share, reduce inventory or introducemore technologically advanced products or lower cost products. In addition, we may agree to pricing concessions or extended payment terms with ourcustomers in connection with volume orders or to reduce cost of ownership in highly competitive applications. Our business, financial condition, margins orresults of operations may be materially and adversely affected by competitive pressure and intense price-based competition.The Company may experience uncertainties resulting from conflict minerals regulationOn August 22, 2012, the SEC adopted a new rule requiring disclosures of specified minerals, known as conflict minerals, that are necessary to thefunctionality or production of products manufactured or contracted to be manufactured by companies filing public reports. The new rule requires a disclosurereport to be filed annually with the SEC and this report will require companies to perform due diligence, disclose and report whether such minerals originatefrom the Democratic Republic of Congo or an adjoining country. The new rule could affect sourcing at competitive prices and availability in sufficientquantities of certain minerals used in the manufacture of our products. The number of suppliers who provide conflict-free minerals may be limited. Inaddition, there may be material costs associated with complying with the disclosure requirements, such as costs related to determining the source of certainminerals used in our products as well as costs of possible changes to products, processes, or sources of supply as a consequence of such verification activities.Since our supply chain is complex, we may not be able to sufficiently verify the origins of the relevant minerals used in our products through the duediligence procedures that we implement, which may harm our reputation. In addition, we may encounter challenges to satisfy those customers who requirethat all of the components of our products be certified as conflict-free, which could place us at a competitive disadvantage if we are unable to do so.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 rawmaterialsManufacturing 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.The Company may not be able to ramp up manufacturing to satisfy increasing orders, which may lead to the loss of significant revenue opportunitiesThe Company manufactures several different product lines, all of which involve complicated technology and individual attention for each product made.The production time for each product can vary, depending on a variety of circumstances, including component availability, timing of delivery ofcomponents from suppliers and employee availability. Should the Company receive a large increase in orders, an increase in the size of orders or a shorteningof the required delivery time on existing orders, the Company may not be able to ramp up manufacturing to satisfy customer expectations, which may lead tothe loss of significant revenue opportunities. Page 12The Company maintains a significant investment in inventories in anticipation of future salesThe 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 management tomake 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.The Company’s existing cash and credit facilities may not be sufficient to fund future growthThe Company had an operating line of credit of $2.0 million and a cash balance of $1.5 million as of May 31, 2014; as of that date, the Company had nooutstanding balance on its line of credit and the line will expire on September 1, 2014. The Company believes that its existing cash and investmentscombined with the cash from operating activities will be sufficient to meet its cash requirements for the near term. However, if sales continue to weaken andthe Company is unable to reduce its operating costs in a timely manner or access additional financing, the Company may have to continue to reduce its cashbalance, which could significantly impact the liquidity or operations of the Company.Fluctuations in quarterly and annual operating results make it difficult to predict future performanceQuarterly 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 experience a downturn due to the risks of operating a global businessThe 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. Sales to customers outside the U.S. accounted for 44.8% of total sales in Fiscal 2014. We expect that sales to customers outside theU.S. will continue to represent a significant percentage of sales in the future. We currently have a sales and service office in Coventry, England and a salesoffice in Shanghai, China. We may need to increase our foreign operations in the future. International sales are subject to a number of risks, including: theimposition of governmental controls; trade restrictions; difficulty in collecting receivables; changes in tariffs and taxes; difficulties in protecting intellectualproperty; shipping delays and disruptions; local labor disputes; difficulties in staffing and managing international operations; political and economicinstability; general economic conditions; and fluctuations in the relative value of foreign currencies. No assurances can be given that these factors will nothave a material adverse effect on future international sales and operations and, consequently, on business, financial condition and results of operations.The Company may not be able to reduce operating costs quickly enough if sales declineOperating 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.Future success depends in part on attracting and retaining key management and qualified technical and sales personnelFuture 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 or that other highly qualified technical and sales personnel as requiredcan be attracted, assimilated and retained. There is also no guarantee that key employees will not leave and subsequently compete against the Company. Theinability to attract and retain key personnel could adversely impact the business, financial condition and results of operations.Changes in the effective tax rate may have an adverse effect on the Company’s results of operationsThe Company’s future effective tax rate may be adversely affected by a number of factors including: the jurisdictions in which profits are determined to beearned and taxed; the resolution of issues arising from future, potential tax audits with various tax authorities; changes in the valuation of our deferred taxassets and liabilities; adjustments to estimated taxes upon finalization of various tax returns; increases in expenses not deductible for tax purposes; changesin available tax credits; changes in stock-based compensation expense; changes in tax laws or the interpretations of such tax laws and changes in generallyaccepted accounting principles. Page 13Failure to protect intellectual property rights could adversely affect future performance and growthFailure 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.Changes in securities laws and regulations have increased and could continue to increase Company expensesChanges in the laws and regulations affecting public companies, including the provisions of the Sarbanes-Oxley Act of 2002 and rules promulgated by theSecurities and Exchange Commission, have increased and may continue to increase Company expenses as the Company devotes resources to ensurecompliance with all applicable laws and regulations. In addition, the NASDAQ Capital Market, on which the Company’s common stock is listed, has alsoadopted comprehensive rules and regulations relating to corporate governance. These laws, rules and regulations have increased the scope, complexity andcost of corporate governance, reporting and disclosure practices. The Company may be required to hire additional personnel and use outside legal,accounting and advisory services to address these laws, rules and regulations. The Company also expects these developments to make it more difficult andmore expensive for the Company to obtain director and officer liability insurance in the future, and the Company may be required to accept reduced coverageor incur substantially higher costs to obtain coverage. Further, the Company’s board members, Chief Executive Officer and Chief Financial Officer could facean increased risk of personal liability in connection with the performance of their duties. As a result, we may have difficulty attracting and retaining qualifiedboard members and executive officers, which would adversely affect the Company. Item 1B.Unresolved Staff CommentsNone. Item 2.PropertiesThe Company’s design and assembly facilities and executive offices are located in Portland, Oregon in three company-owned buildings totalingapproximately 40,500 square feet. SEL occupies a 1,080-square foot facility in Coventry, England pursuant to a three-year lease, renewable for an additionalthree-year period. In March 2014, the Company exercised the lease renewal. The current basic monthly rent amount is £1,002 ($1,680 as of May 31, 2014)and the lease will expire in March 2017. Item 3.Legal ProceedingsThere are no material legal proceedings currently pending against the Company. Item 4.Mine Safety DisclosuresNone. Page 14PART II Item 5.Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity SecuritiesThe Company’s Common Stock is traded on the NASDAQ Capital Market under the symbol “SMIT.”The following tables set forth the high and low closing prices of the Company’s Common Stock as reported on the NASDAQ Capital Market for the periodsindicated. Year Ended May 31, 2013 High Low First Quarter $3.75 $3.26 Second Quarter $3.55 $2.90 Third Quarter $3.03 $2.90 Fourth Quarter $3.02 $2.70 Year Ended May 31, 2014 High Low First Quarter $3.05 $2.51 Second Quarter $2.70 $2.44 Third Quarter $2.70 $2.51 Fourth Quarter $3.03 $2.65 As of July 31, 2014, there were 2,995,910 shares of Common Stock outstanding held by approximately 80 holders of record. The number of holders does notinclude individual participants in security position listings; the Company believes that there are more than 900 individual holders of shares of CommonStock.The Company has not paid any dividends on its Common Stock since 1994. The Company’s current policy is to retain earnings to finance the Company’sbusiness. Future dividends will be dependent upon the Company’s financial condition, results of operations, current and anticipated cash requirements,acquisition plans and plans for expansion and any other factors that the Company’s Board of Directors deems relevant. The Company has no presentintention of paying dividends on its Common Stock in the foreseeable future.This table shows information about equity awards under the Company’s equity compensation plans at May 31, 2014: Plan Category Number of Securities to beissued upon exercise ofoutstanding options Weighted-averageexercise price ofoutstanding options Number of Securitiesremaining available forfuture issuance underequity compensationplans (excludingsecurities in column a) (a) (b) (c) Equity compensation plans approvedby security holders 281,666 $3.77 60,000 Equity compensation plans notapproved by security holders 0 0 0 281,666 $3.77 60,000 Page 15Recent Sales of Unregistered SecuritiesNone.Issuer Purchases of Equity SecuritiesNone. Item 6.Selected Financial DataIn thousands, except per share information Year Ended 5/31/2014 5/31/2013 5/31/2012 5/31/2011 5/31/2010 Net sales $12,135 $12,452 $14,437 $11,493 $6,806 Net income (loss) $(540) $(540) $77 $(205) $(1,711) Net income (loss) per common share, basic $(0.18) $(0.18) $0.03 $(0.07) $(0.59) Weighted average number of common shares, basic 2,996 2,991 2,930 2,895 2,887 Net income (loss) per common share, diluted $(0.18) $(0.18) $0.03 $(0.07) $(0.59) Weighted average number of common shares, diluted 2,996 2,991 2,944 2,895 2,887 Stockholders’ equity $9,613 $10,015 $10,484 $10,157 $10,121 Total assets $10,824 $11,625 $12,026 $11,589 $11,352 Long-term debt (including current portion) $0 $0 $0 $0 $0 Item 7.Management’s Discussion and Analysis of Financial Condition and Results of OperationsRESULTS OF OPERATIONSOverviewSchmitt Industries, Inc. (the Company), an Oregon corporation, designs, manufactures and sells high precision test and measurement products for two mainbusiness segments: the Balancer Segment and the Measurement Segment. The Company designs, manufactures and sells computer-controlled vibrationdetection, balancing and process control systems for the worldwide machine tool industry, particularly for grinding machines (the Balancer Segment).Through its wholly owned subsidiary, Schmitt Measurement Systems, Inc. (SMS), an Oregon corporation, the Company designs, manufactures and sells laserand white light sensors for distance, dimensional and area measurement for a wide variety of commercial applications, laser-based microroughnessmeasurement products for the semiconductor wafer and hard disk drive industries and for other industrial applications, laser-based surface analysis andmeasurement products for a variety of scientific applications, and ultrasonic measurement products that accurately measure the fill levels of propane tanksand transmit that data via satellite to a secure web site for display (the Measurement Segment). The Company also provides sales and service for Europe andparts of Asia through its wholly owned subsidiary, Schmitt Europe Limited (SEL), located in Coventry, England and through its sales representative officelocated in Shanghai, China.For the fiscal year ended May 31, 2014 (Fiscal 2014), total sales decreased $317,746, or 2.6%, to $12,134,506 from $12,452,252 in the fiscal year endedMay 31, 2013 (Fiscal 2013). Balancer Segment sales focus throughout the world on end-users, rebuilders and original equipment manufacturers of grindingmachines with the target geographic markets of North America, South America, Asia and Europe. Balancer sales increased $7,089, or 0.1%, to $7,721,211 inFiscal 2014 compared to $7,714,122 in Fiscal 2013. Sales into Europe and Asia increased $344,424, or 10.8%, for Fiscal 2014 as compared to Fiscal 2013.These sales were offset by lower volumes of shipments into North America and other regions of the world. The Measurement Segment product line consists oflaser-based light-scatter, distance measurement and dimensional sizing products and remote tank monitoring products. Total Measurement sales decreased$324,835, or 6.9%, to $4,413,295 for the year ended May 31, 2014 as compared to $4,738,130 for the year ended May 31, 2013. The decrease is primarilydue to lower volumes of shipments of laser-based distance measurement and dimensional-sizing products, offset by increases in sales of remote tankmonitoring products and related services and laser-based light-scatter surface measurement products. Page 16Operating expenses decreased $518,521, or 7.8%, to $6,138,551 in Fiscal 2014 from $6,657,072 in Fiscal 2013. General, administrative and sales expensesdecreased $420,490, or 6.9%, in Fiscal 2014 to $5,663,121 as compared to $6,083,611 in the prior fiscal year. Research and development expenses decreased$98,031, or 17.1%, to $475,430 in Fiscal 2014 from $573,461 in Fiscal 2013.Net loss was $539,624, or $0.18 per fully diluted share, for the year ended May 31, 2014 as compared to net loss of $539,882, or $0.18 per fully diluted share,for the year ended May 31, 2013.Critical Accounting PoliciesRevenue Recognition – The Company recognizes revenue for sales and billing for freight charges upon delivery of the product to the customer at a fixed ordeterminable price with a reasonable assurance of collection, passage of title to the customer as indicated by shipping terms and fulfillment of all significantobligations, pursuant to the guidance provided by Accounting Standards Codification Topic 605. For sales to all customers, including manufacturerrepresentatives, distributors or their third-party customers, these criteria are met at the time product is shipped. When other significant obligations remainafter products are delivered, revenue is recognized only after such obligations are fulfilled. In addition, judgments are required in evaluating the creditworthiness of our customers. Credit is not extended to customers and revenue is not recognized until we have determined that collectability is reasonablyassured. The Company estimates customer product returns based on historical return patterns and reduces sales and cost of sales accordingly.Allowance for Doubtful Accounts – The Company maintains credit limits for all customers based upon several factors, including but not limited to financialcondition and stability, payment history, published credit reports and use of credit references. Management performs various analyses to evaluate accountsreceivable balances to ensure recorded amounts reflect estimated net realizable value. This review includes accounts receivable agings, other operating trendsand relevant business conditions, including general economic factors, as they relate to the Company’s domestic and international customers. If these analyseslead management to the conclusion that potential significant accounts are uncollectible, a reserve is provided.Inventories – Inventories are valued at the lower of cost or market with cost determined on the average cost basis. Costs included in inventories consist ofmaterials, labor and manufacturing overhead, which are related to the purchase or production of inventories. Write-downs, when required, are made to reduceexcess inventories to their net realizable values. Such estimates are based on assumptions regarding future demand and market conditions. If actualconditions become less favorable than the assumptions used, an additional inventory write-down may be required.Deferred Taxes – The Company applies the asset and liability method in recording income taxes, under which deferred income tax assets and liabilities aredetermined, based on the differences between the financial reporting and tax bases of assets and liabilities and are measured using currently enacted tax ratesand laws. Additionally, deferred tax assets are evaluated and a valuation allowance is established if it is more likely than not that all or a portion of thedeferred tax asset will not be realized. Management continues to review the level of the valuation allowance on a quarterly basis. There can be no assurancethat the Company’s future operations will produce sufficient earnings so that the deferred tax assets can be fully utilized.Intangible Assets – Intangible and other long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate the carryingamount of the asset may not be recoverable. Recoverability is determined by comparing the forecasted future undiscounted net cash flows from theoperations to which the assets relate, based on management’s best estimates using the appropriate assumptions and projections at the time, to the carryingamount of the assets. If the carrying value is determined to be in excess of future operating cash flows, the asset is considered impaired and a loss isrecognized equal to the amount by which the carrying amount exceeds the estimated fair value of the assets.Recently issued accounting pronouncementsRefer to Note 2 of the Notes to Consolidated Financial Statements for a discussion of recently issued accounting pronouncements. Page 17Discussion of Operating Results Year Ended May 31, 2014 2013 2012 Balancer sales $7,721,211 63.6% $7,714,122 61.9% $9,265,008 64.2% Measurement sales 4,413,295 36.4% 4,738,130 38.1% 5,172,014 35.8% Total sales 12,134,506 100.0% 12,452,252 100.0% 14,437,022 100.0% Cost of sales 6,508,360 53.6% 6,357,452 51.1% 8,094,386 56.1% Gross profit 5,626,146 46.4% 6,094,800 48.9% 6,342,636 43.9% Operating expenses: General, administration and sales 5,663,121 46.7% 6,083,611 48.9% 5,967,359 41.3% Research and development 475,430 3.9% 573,461 4.6% 317,993 2.2% Total operating expenses 6,138,551 50.6% 6,657,072 53.5% 6,285,352 43.5% Operating income (loss) (512,405) (4.2%) (562,272) (4.5%) 57,284 0.4% Other income (expense) (17,887) (0.1%) 14,106 0.1% 37,260 0.3% Income (loss) before income taxes (530,292) (4.4%) (548,166) (4.4%) 94,544 0.7% Provision (benefit) for income taxes 9,332 0.1% (8,284) (0.1%) 17,123 0.1% Net income (loss) $(539,624) (4.4%) $(539,882) (4.3%) $77,421 0.5% Sales – Sales in the Balancer Segment increased $7,089, or 0.1%, to $7,721,211 for Fiscal 2014 compared to $7,714,122 for Fiscal 2013. This increase wasprimarily due to increased sales into Europe and Asia, offset by lower shipments into North America and other regions of the world. Sales into Europeincreased $199,287, or 21.5%, in Fiscal 2014 compared to Fiscal 2013. Sales into Asia increased $145,137, or 6.4%, in Fiscal 2014 compared to the prioryear. North American sales decreased $218,349, or 5.1%, in Fiscal 2014 compared to Fiscal 2013. Sales in other regions of the world decreased $118,986, or52.4%, during Fiscal 2014 as compared to the prior year. The increases in sales in Europe and Asia were due to a gradual increase in demand for theCompany’s SBS products, while the decline in sales in North America and other regions of the world reflected fluctuations in demand due to uncertaintiesabout the pace of economic recovery in the markets we serve. The levels of demand for our Balancer products in any of these geographic markets cannot beforecasted with any certainty given current economic trends and the historical volatility experienced in this market.Sales in the Measurement Segment decreased $324,835, or 6.9%, to $4,413,295 in Fiscal 2014 compared to $4,738,130 in Fiscal 2013. Sales of laser-baseddistance measurement and dimensional-sizing products decreased $626,701, or 20.1%, primarily due to a reduction in orders as the uncertainty andinconsistency in the U.S. economic recovery continues to have a negative impact in the markets we serve. Sales of laser-based surface measurement productsincreased $196,281, or 37.5%, primarily due to an increase in demand for these products. Sales of remote tank monitoring products increased $95,691 to$972,344 during Fiscal 2014 due to the higher volume of shipments and the developing monitoring revenues associated with unit sales. Future sales of laser-based or ultrasonic measurement products cannot be forecasted with any certainty given the historical volatility experienced in this market.Sales in the Balancer Segment decreased $1,550,886, or 16.7%, to $7,714,122 for Fiscal 2013 compared to $9,265,008 for Fiscal 2012. This decrease wasprimarily due to lower volumes of shipments into Asia, particularly China, and also to a lesser extent to North America. North American sales decreased$310,871, or 6.7%, in Fiscal 2013 compared to Fiscal 2012. Sales into Asia decreased $1,198,772, or 34.7%, in Fiscal 2013 compared to the prior year. Salesinto Europe increased $34,086, or 3.8%, in Fiscal 2013 compared to Fiscal 2012. Sales in other regions of the world decreased $75,329, or 24.9%, duringFiscal 2013 as compared to the prior year. The decreases in Asia and North America were due to reductions in orders as economic growth in China has slowedand the uncertainty regarding the U.S. economy continued to have a negative impact on manufacturing in the markets we serve. The levels of demand for ourBalancer products in any of these geographic markets cannot be forecasted with any certainty given current economic trends and the historical volatilityexperienced in this market.Sales in the Measurement Segment decreased $433,884, or 8.4%, to $4,738,130 in Fiscal 2013 compared to $5,172,014 in Fiscal 2012. Sales of laser-baseddistance measurement and dimensional-sizing products decreased $379,667, or 10.9%, primarily due to a large sale during the fourth quarter of Fiscal 2012that was not repeated in the fourth quarter of Fiscal 2013. Sales of remote tank monitoring products increased $295,771 to $876,653 during Fiscal 2013 dueto the higher volume of shipments and the developing monitoring revenues associated with unit sales. Sales of laser-based surface measurement productsdecreased $360,963, or 40.8%, primarily due to slowing demand for these products. Future sales of laser-based or ultrasonic measurement products cannot beforecasted with any certainty given the historical volatility experienced in this market. Page 18Gross margin – Gross margin in Fiscal 2014 decreased to 46.4% compared to 48.9% in Fiscal 2013. The variance in gross margin was primarily due to shiftsin the product sales mix involving our five product lines and the impact of increased costs associated with the products sold. Gross margin in Fiscal 2013increased to 48.9% compared to 43.9% in Fiscal 2012. This increase was primarily due to the impact of lower sales volumes through the Asian distributionchannels, which typically have higher discounts and lower margins, and as a result of the Company’s efforts to reduce the material costs from certain keysuppliers and a shift in the product sales mix towards higher margin products.Operating expenses – Operating expenses decreased $518,521, or 7.8%, to $6,138,551 for Fiscal 2014 compared to $6,657,072 in Fiscal 2013. General,administrative and sales expenses decreased $420,490, or 6.9%, to $5,663,121 in Fiscal 2014 compared to $6,083,611 in the prior year. This decrease was theresult of lower sales and marketing and travel and entertainment expenses. Research and development expenses decreased $98,031, or 17.1%, to $475,430 inFiscal 2014 compared to $573,461 in Fiscal 2013. The decrease in research and development expense was primarily due to the completion of some of thedevelopment projects within our existing product lines.Operating expenses increased $371,720, or 5.9%, to $6,657,072 for Fiscal 2013 compared to $6,285,352 in Fiscal 2012. General, administrative and salesexpenses increased $116,252, or 1.9%, to $6,083,611 in Fiscal 2013 compared to $5,967,359 in the prior year. This increase was due primarily to higherexpenses associated with an international trade show that occurs every two years. Research and development expenses increased $255,468, or 80.3%, to$573,461 in Fiscal 2013 compared to $317,993 in Fiscal 2012. The increase in research and development expense was primarily due to new productdevelopment and product enhancements related to existing product lines.Other income (expense) – Other income (expense) consists of interest income, foreign currency exchange gain (loss) and other income (expense). Interestincome was $1,558, $1,226 and $1,726 in Fiscal 2014, 2013 and 2012, respectively. Fluctuations in interest income are impacted by the levels of our averagecash and investment balances and changes in interest rates. Foreign currency exchange loss was $23,375 in Fiscal 2014. Foreign currency exchange gain was$12,884 and $17,565 in Fiscal 2013 and 2012, respectively. The foreign currency exchange gain (loss) fluctuated with the strength of foreign currenciesagainst the U.S. dollar during the respective periods. In Fiscal 2014, other income consisted of a gain in the amount of $13,667 on the sale of fixed assets.Income tax provision – The effective tax rate in Fiscal 2014 was 1.8%. The effective tax rate on consolidated net loss in Fiscal 2014 differed from the federalstatutory tax rate primarily due to changes in the deferred tax valuation allowance and certain expenses not being deductible for income tax reporting, offsetby tax credits related to research and experimentation expenses. The effective tax rate in Fiscal 2013 was (1.5)%. The effective tax rate on consolidated netloss in Fiscal 2013 differed from the federal statutory tax rate primarily due to changes in the deferred tax valuation allowance and certain expenses not beingdeductible for income tax reporting offset by tax credits related to research and experimentation expenses. The effective tax rate in Fiscal 2012 was 18.1%.The effective tax rate on consolidated net income in Fiscal 2012 differed from the federal statutory tax rate primarily due to the amount of income fromforeign jurisdictions, changes in the deferred tax valuation allowance and certain expenses not being deductible for income tax reporting, offset by taxcredits related to research and experimentation expenses.Net income (loss) – Net loss decreased $258 to a net loss of $539,624, or $0.18 per diluted share, for Fiscal 2014 as compared to net loss of $539,882, or$0.18 per diluted share, for Fiscal 2013. Net loss for Fiscal 2014 reflected decreased sales and a lower gross margin percentage, which was partially offset byreduced operating expenses. Net income decreased $617,303 to a net loss of $539,882, or $0.18 per diluted share, for Fiscal 2013 as compared to net incomeof $77,421, or $0.03 per diluted share, for Fiscal 2012. Net income (loss) decreased due primarily to lower sales and related gross profit, higher research anddevelopment expenses and higher general, administrative and selling expenses, offset by higher gross margin percentage during Fiscal 2013.LIQUIDITY AND CAPITAL RESOURCESThe Company’s working capital decreased $123,877 to $7,478,073 as of May 31, 2014 compared to $7,601,950 as of May 31, 2013. Cash and cashequivalents decreased $398,506 from $1,909,071 as of May 31, 2013 to $1,510,565 as of May 31, 2014.Cash used in operating activities was $392,376 in Fiscal 2014 as compared to cash used in operations of $679,112 in Fiscal 2013. The decrease in theamount of cash used for operating activities was primarily due to the reduction in inventories, offset by the decrease in accounts payable and accruedliabilities and the increase in accounts receivable.At May 31, 2014, accounts receivable increased $254,509 to $2,235,194 compared to $1,980,685 as of May 31, 2013. The increase in accounts receivablewas due to the timing of receipts. Inventories decreased $264,265 to $4,789,822 as of May 31, 2014 compared to $5,054,087 at May 31, 2013 as a result ofour targeted inventory purchase program Page 19which was focused on right-sizing the levels of inventories held for each of the Company’s product lines. At May 31, 2014, total current liabilities decreased$398,396 to $1,211,084 as compared to $1,609,480 at May 31, 2013. The decrease was primarily due to the timing of payments on accounts payable andlower accruals for commissions resulting from the decrease in sales, offset by an increase in other accrued liabilities.During the year ended May 31, 2014, net cash used in investing activities was $36,692, which primarily consisted of additions to property and equipment fornew manufacturing equipment, offset by the disposition of one of the Company’s vehicles.The Company has a $2.0 million bank line of credit secured by U.S. accounts receivable, inventories, general intangibles, and a depository account. Interestis payable at the bank’s prime rate (3.25% as of May 31, 2014), or LIBOR plus 2.0%, (2.15% as of May 31, 2014). The agreement expires on September 1,2014. There were no outstanding balances on the line of credit at May 31, 2014 and 2013.We believe that our existing cash and investments combined with the cash we anticipate to generate from operating activities, and our available line of creditand financing available from other sources will be sufficient to meet our cash requirements for the foreseeable future. We do not have any significantcommitments nor are we aware of any significant events or conditions that are likely to have a material impact on our liquidity or capital resources.QUARTERLY FINANCIAL DATAIn thousands, except per share information (unaudited) 2013 Quarter Ended August31 November30 February28 May31 Sales $3,681 $2,702 $2,796 $3,273 Gross profit $1,874 $1,542 $1,358 $1,321 Net income (loss) $120 $(105) $(191) $(364) Net income (loss) per share, basic $.04 $(.03) $(.06) $(.12) Net income (loss) per share, diluted $.04 $(.03) $(.06) $(.12) 2014 Quarter Ended August31 November30 February28 May31 Sales $2,899 $3,143 $3,066 $3,026 Gross profit $1,331 $1,468 $1,458 $1,369 Net loss $(147) $(163) $(72) $(158) Net loss per share, basic $(.05) $(.05) $(.02) $(.05) Net loss per share, diluted $(.05) $(.05) $(.02) $(.05) Item 7A.Quantitative and Qualitative Disclosures about Market RiskInterest Rate RiskThe Company did not have any derivative financial instruments as of May 31, 2014. However, the Company could be exposed to interest rate risk at any timein the future and, therefore, employs established policies and procedures to manage its exposure to changes in the market risk of its cash equivalents.The Company’s interest income and expense are most sensitive to changes in the general level of U.S. and European interest rates. In this regard, changes inU.S. and European interest rates affect the interest earned on the Company’s interest bearing cash equivalents and short term investments. The Company has avariable rate line of credit facility with a bank, but there is no outstanding balance as of May 31, 2014. Also, there is no other long-term obligation whoseinterest rates are based on variable rates that may fluctuate over time based on economic changes in the environment. Therefore, at this time, the Company isnot subject to interest rate risk on outstanding interest bearing obligations if market interest rates fluctuate and does not expect any change in the interestrates to have a material effect on the Company’s results from operations. Page 20Foreign Currency RiskThe 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. The Company operates a subsidiary in the United Kingdom and acquires certain materials and services from vendors transacted inforeign currencies. Therefore, the Company’s business and financial condition is sensitive to currency exchange rates or any other restrictions imposed ontheir currencies. For Fiscal 2014, 2013 and 2012, results of operations included gains (losses) on foreign currency translation of $(23,375), $12,884 and$17,565, respectively. The foreign exchange gains or losses in Fiscal 2014, 2013 and 2012 are primarily attributable to Company’s United Kingdomsubsidiary, Schmitt Europe, Ltd. Page 21Item 8.Financial Statements and Supplementary DataSCHMITT INDUSTRIES, INC.CONSOLIDATED BALANCE SHEETS May 31, 2014 May 31, 2013 ASSETS Current assets Cash and cash equivalents $1,510,565 $1,909,071 Accounts receivable, net 2,235,194 1,980,685 Inventories 4,789,822 5,054,087 Prepaid expenses 152,237 219,492 Income taxes receivable 1,339 48,095 8,689,157 9,211,430 Property and equipment, net 1,191,591 1,334,890 Other assets Intangible assets, net 943,643 1,078,278 TOTAL ASSETS $10,824,391 $11,624,598 LIABILITIES & STOCKHOLDERS’ EQUITY Current liabilities Accounts payable $512,219 $918,094 Accrued commissions 204,772 273,307 Accrued payroll liabilities 127,035 131,772 Other accrued liabilities 366,848 286,307 Income taxes payable 210 0 Total current liabilities 1,211,084 1,609,480 Commitments and contingencies (Note 5) Stockholders’ equity Common stock, no par value, 20,000,000 shares authorized, 2,995,910 shares issued and outstanding at May 31, 2014and 2,990,910 shares issued and outstanding at May 31, 2013 10,438,750 10,369,524 Accumulated other comprehensive loss (263,337) (331,924) Accumulated deficit (562,106) (22,482) Total stockholders’ equity 9,613,307 10,015,118 TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY $10,824,391 $11,624,598 The accompanying notes are an integral part of these consolidated financial statements. Page 22SCHMITT INDUSTRIES, INC.CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS Year Ended May 31, 2014 2013 2012 Net sales $12,134,506 $12,452,252 $14,437,022 Cost of sales 6,508,360 6,357,452 8,094,386 Gross profit 5,626,146 6,094,800 6,342,636 Operating expenses: General, administration and sales 5,663,121 6,083,611 5,967,359 Research and development 475,430 573,461 317,993 Total operating expenses 6,138,551 6,657,072 6,285,352 Operating income (loss) (512,405) (562,272) 57,284 Other income (expense) (17,887) 14,106 37,260 Income (loss) before income taxes (530,292) (548,166) 94,544 Provision (benefit) for income taxes 9,332 (8,284) 17,123 Net income (loss) $(539,624) $(539,882) $77,421 Net income (loss) per common share, basic $(0.18) $(0.18) $0.03 Weighted average number of common shares, basic 2,995,910 2,990,910 2,930,314 Net income (loss) per common share, diluted $(0.18) $(0.18) $0.03 Weighted average number of common shares, diluted 2,995,910 2,990,910 2,944,081 Comprehensive loss Net income (loss) $(539,624) $(539,882) $77,421 Foreign currency translation adjustment 68,587 (18,629) (86,714) Total comprehensive loss $(471,037) $(558,511) $(9,293) The accompanying notes are an integral part of these consolidated financial statements. Page 23SCHMITT INDUSTRIES, INC.CONSOLIDATED STATEMENTS OF CASH FLOWS Year Ended May 31, 2014 2013 2012 Cash flows relating to operating activities Net income (loss) $(539,624) $(539,882) $77,421 Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization 328,293 347,715 344,553 (Gain) loss on disposal of property and equipment (13,667) 0 (18,014) Stock based compensation 57,726 89,888 199,396 Tax benefit related to stock options 0 0 (1,134) (Increase) decrease in: Accounts receivable (224,309) 510,531 (686,578) Inventories 292,594 (1,082,931) 159,002 Prepaid expenses 69,201 (33,509) (20,529) Income taxes receivable 46,756 (40,315) (7,780) Increase (decrease) in: Accounts payable (411,954) 149,574 (66,729) Accrued liabilities and customer deposits 2,398 (80,183) 185,863 Income taxes payable 210 0 (2,073) Net cash provided by (used in) operating activities (392,376) (679,112) 163,398 Cash flows relating to investing activities Purchase of property and equipment (56,192) (175,835) (277,045) Proceeds from sale of property and equipment 19,500 0 47,180 Decrease (increase) in other long term assets 0 291 1,745 Net cash used in investing activities (36,692) (175,544) (228,120) Cash flows relating to financing activities Common stock issued on exercise of stock options 11,500 0 136,330 Increase in line of credit 400,000 0 0 Payments on line of credit (400,000) 0 0 Excess tax benefit from stock-based compensation 0 0 1,134 Net cash provided by financing activities 11,500 0 137,464 Effect of foreign exchange translation on cash 19,062 (13,090) (56,431) Increase (decrease) in cash and cash equivalents (398,506) (867,746) 16,311 Cash and cash equivalents, beginning of period 1,909,071 2,776,817 2,760,506 Cash and cash equivalents, end of period $1,510,565 $1,909,071 $2,776,817 Supplemental disclosure of cash flow information Cash paid during the year for income taxes $8,989 $39,635 $19,476 Cash paid during the year for interest $9,159 $0 $0 The accompanying notes are an integral part of these consolidated financial statements. Page 24SCHMITT INDUSTRIES, INC.CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY Shares Amount Accumulatedothercomprehensiveloss Retainedearnings Total Balance, May 31, 2011 2,895,635 $9,943,910 $(226,581) $439,979 $10,157,308 Stock options exercised net of related tax benefit of $1,134 95,275 136,330 0 0 136,330 Stock based compensation 0 199,396 0 0 199,396 Net income 0 0 0 77,421 77,421 Other comprehensive loss 0 0 (86,714) 0 (86,714) Balance, May 31, 2012 2,990,910 10,279,636 (313,295) 517,400 10,483,741 Stock based compensation 0 89,888 0 0 89,888 Net loss 0 0 0 (539,882) (539,882) Other comprehensive loss 0 0 (18,629) 0 (18,629) Balance, May 31, 2013 2,990,910 10,369,524 (331,924) (22,482) 10,015,118 Stock options exercised net of related tax benefit of $0 5,000 11,500 0 0 11,500 Stock based compensation 0 57,726 0 0 57,726 Net loss 0 0 0 (539,624) (539,624) Other comprehensive income 0 0 68,587 0 68,587 Balance, May 31, 2014 2,995,910 $10,438,750 $(263,337) $(562,106) $9,613,307 The accompanying notes are an integral part of these consolidated statements. Page 25Schmitt Industries, Inc.NOTES TO CONSOLIDATED FINANCIAL STATEMENTSFOR THE YEARS ENDED MAY 31, 2014, 2013 AND 2012NOTE 1THE COMPANYSchmitt Industries, Inc. (the “Company”) designs, manufactures, and sells high precision test and measurement products for two main business segments: theBalancer Segment and the Measurement Segment. The Company designs, manufactures, and sells computer-controlled vibration detection, balancing andprocess control systems for the worldwide machine tool industry, particularly for grinding machines (the “Balancer Segment”). Through its wholly ownedsubsidiary, Schmitt Measurement Systems, Inc., the Company designs, manufactures and sells laser and white light sensors for distance, dimensional and areameasurement products for a variety of scientific applications, and ultrasonic measurement products that accurately measure the liquid levels of propane tanksand transmit that data via satellite to a secure web site for display (the “Measurement Segment”).NOTE 2SIGNIFICANT ACCOUNTING POLICIESPrinciples of ConsolidationThese consolidated financial statements include those of the Company and its wholly owned subsidiaries: Schmitt Measurement Systems, Inc. (“SMS”),Schmitt Europe, Ltd. (“SEL”) and Schmitt Industries (Canada) Limited. All significant intercompany accounts and transactions have been eliminated in thepreparation of the consolidated financial statements.Revenue RecognitionThe Company recognizes revenue for sales and billing for freight charges upon delivery of the product to the customer at a fixed and determinable price witha reasonable assurance of collection, passage of title to the customer as indicated by shipping terms and fulfillment of all significant obligations, pursuant tothe guidance provided by Accounting Standards Codification (“ASC”) Topic 605. 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 aredelivered, revenue is recognized only after such obligations are fulfilled. In addition, judgments are required in evaluating the credit worthiness of ourcustomers. Credit is not extended to customers and revenue is not recognized until we have determined that collectability is reasonably assured. TheCompany estimates customer product returns based on historical return patterns and reduces sales and cost of sales accordingly.Cash EquivalentsThe Company generally invests excess cash in money market funds and investment grade highly liquid securities. The Company considers securities that arehighly liquid, readily convertible into cash and have original maturities of less than three months when purchased to be cash equivalents. The Company’scash consists of demand deposits in large financial institutions. At times, balances may exceed federally insured limits.Accounts ReceivableThe Company maintains credit limits for all customers based upon several factors, including but not limited to financial condition and stability, paymenthistory, published credit reports and use of credit references. Management performs various analyses to evaluate accounts receivable balances to ensurerecorded amounts reflect estimated net realizable value. This review includes using accounts receivable agings, other operating trends and relevant businessconditions, including general economic factors, as they relate to each of the Company’s domestic and international customers. If these analyses leadmanagement to the conclusion that potential significant accounts are uncollectible, a reserve is provided. The allowance for doubtful accounts was $63,297and $30,576 as of May 31, 2014 and 2013, respectively. Page 26Schmitt Industries, Inc.NOTES TO CONSOLIDATED FINANCIAL STATEMENTSFOR THE YEARS ENDED MAY 31, 2014, 2013 AND 2012 InventoriesInventories are valued at the lower of cost or market with cost determined on the average cost basis. Costs included in inventories consist of materials, laborand manufacturing overhead, which are related to the purchase or production of inventories. Write-downs, when required, are made to reduce excessinventories to their net realizable values. Such estimates are based on assumptions regarding future demand and market conditions. If actual conditionsbecome less favorable than the assumptions used, an additional inventory write-down may be required. As of May 31 inventories consisted of: 2014 2013 Raw materials $1,888,985 $2,225,295 Work-in-process 994,009 1,132,534 Finished goods 1,906,828 1,696,258 $4,789,822 $5,054,087 Property and EquipmentProperty 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. Expenditures for maintenance and repairsare charged to expense as incurred. As of May 31 property and equipment consisted of: 2014 2013 Land $299,000 $299,000 Buildings and improvements 1,805,951 1,805,951 Furniture, fixtures and equipment 1,370,131 1,312,028 Vehicles 86,838 121,835 3,561,920 3,538,814 Less accumulated depreciation (2,370,329) (2,203,924) $1,191,591 $1,334,890 Intangible AssetsAmortizable intangible assets, which include purchased technology and patents, are amortized over their estimated useful lives ranging from five toseventeen years. As of May 31, 2014 and 2013, amortizable intangible assets were $2,200,883, and accumulated amortization was $1,257,240 and$1,122,604, respectively. Amortization expense for each of the following years ending May 31 is expected to be as follows: Year ending May 31, 2015 $119,233 2016 111,531 2017 111,531 2018 104,583 2019 104,583 Thereafter 392,182 $943,643 Intangible and other long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate the carrying amount of the assetmay not be recoverable. Recoverability is determined by comparing the forecasted future net cash flows from the operations to which the assets relate, basedon management’s best estimates using the appropriate assumptions and projections at the time, to the carrying amount of the assets. If the carrying value isdetermined to be in excess of future operating cash flows, the asset is considered impaired and a loss is recognized equal to the amount by which the carryingamount exceeds the estimated fair value of the assets. As of May 31, 2014, no impairment existed. Page 27Schmitt Industries, Inc.NOTES TO CONSOLIDATED FINANCIAL STATEMENTSFOR THE YEARS ENDED MAY 31, 2014, 2013 AND 2012 Foreign CurrencyFinancial 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.” Transaction gains and losses are included in net income (loss).AdvertisingAdvertising costs included in general, administration and sales, are expensed when the advertising first takes place. Advertising expense was $45,155,$82,289 and $98,093 for the years ended May 31, 2014, 2013 and 2012, respectively.Research and Development CostsResearch and development costs, predominately internal labor costs and costs of materials, are charged to expense when incurred.Warranty ReserveWarranty costs are estimated and charged to operations to cover a defined warranty period. The estimated warranty cost is based on the history of warrantyclaims for each particular product type. For new product types without a warranty history, preliminary estimates are based on historical information for similarproduct types. The warranty reserve accruals, included in other accrued liabilities, are reviewed periodically and updated based on warranty trends.Stock-Based CompensationStock-based compensation includes expense charges for all stock-based awards to employees and directors granted under the Company’s stock option plan.The Company requires the measurement and recognition of compensation for all stock-based awards made to employees and directors including stockoptions based on estimated fair values.Stock-based compensation recognized during the period is based on the value of the portion of the stock-based award that will vest during the period,adjusted for expected forfeitures. Compensation cost for all stock-based awards is recognized using the straight-line method.Income TaxesThe Company applies the asset and liability method in recording income taxes, under which deferred income tax assets and liabilities are determined, basedon the differences between the financial reporting and tax bases of assets and liabilities and are measured using currently enacted 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 a portion of the deferred taxasset will not be realized. Management continues to review the level of the valuation allowance on a quarterly basis. There can be no assurance that theCompany’s future operations will produce sufficient earnings so that the deferred tax asset can be fully utilized. The Company currently maintains a fullvaluation allowance against net deferred tax assets. Page 28Schmitt Industries, Inc.NOTES TO CONSOLIDATED FINANCIAL STATEMENTSFOR THE YEARS ENDED MAY 31, 2014, 2013 AND 2012 Earnings (Loss) Per ShareBasic earnings (loss) per share is computed using the weighted average number of common shares outstanding. Diluted earnings (loss) per share is computedusing the weighted average number of common shares outstanding, adjusted for dilutive incremental shares attributed to outstanding options to purchasecommon stock. Common stock equivalents for stock options are computed using the treasury stock method. In periods in which a net loss is incurred, nocommon stock equivalents are included since they are antidilutive and as such all stock options outstanding are excluded from the computation of dilutednet loss in those periods. 7,636, 13,002 and 0 potentially dilutive common shares from outstanding stock options have been excluded from diluted earnings(loss) per share for the years ended May 31, 2014, 2013 and 2012, respectively.Concentration of Credit RiskFinancial instruments that potentially expose the Company to concentration of credit risk are trade accounts receivable. Credit terms generally include adiscount of 1.5% if the invoice is paid within ten days, with the net amount payable in 30 days.Financial InstrumentsThe carrying value of all other financial instruments potentially subject to valuation risk (principally consisting of cash and cash equivalents, accountsreceivable and accounts payable) approximates fair value because of their short-term maturities.Shipping and Handling ChargesThe Company incurs costs related to shipping and handling of its manufactured products. These costs are expensed as incurred as a component of cost ofsales. Shipping and handling charges related to the receipt of raw materials are also incurred, which are recorded as a cost of the related inventory.Use of EstimatesThe 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.NOTE 3LINE OF CREDITThe Company has a $2 million bank line of credit secured by U.S. accounts receivable, inventories, general intangibles and a depository account. The line ofcredit is subject to certain covenant requirements if draws on the line are executed. Interest is payable at the bank’s prime rate (3.25% as of May 31, 2014) orLIBOR plus 2.0%, (2.15% as of May 31, 2014). The line expires September 1, 2014. The outstanding balance on the line of credit was $0 of May 31, 2014and 2013.NOTE 4INCOME TAXESThe provision for income taxes is as follows: Year ended May 31, 2014 2013 2012 Current $9,332 $(8,284) $17,123 Deferred (155,252) (283,447) (6,753) Change in valuation allowance 155,252 283,447 6,753 Total provision for income taxes $9,332 $(8,284) $17,123 Page 29Schmitt Industries, Inc.NOTES TO CONSOLIDATED FINANCIAL STATEMENTSFOR THE YEARS ENDED MAY 31, 2014, 2013 AND 2012 Deferred tax assets are comprised of the following components: 2014 2013 Basis difference of assets $346,939 $311,441 Inventory related items 269,916 271,790 Other reserves and liabilities 80,513 81,482 Net operating loss carryforward 880,373 752,372 General business and other credit carryforward 437,786 443,190 Other deferred items, net 1,994 1,994 Gross deferred tax assets 2,017,521 1,862,269 Deferred tax asset valuation allowance (2,017,521) (1,862,269) Net deferred tax asset $0 $0 Deferred tax assets are evaluated and a valuation allowance is established if it is more likely than not that all or a portion of the deferred tax asset will not berealized. The Company has recorded a substantial deferred tax asset related to temporary differences between book and tax bases of assets and liabilities.During the years ended May 31, 2014, 2013 and 2012, the Company increased its valuation allowance $155,252, $283,447, and $6,753 respectively, as aresult of the increase in the Company’s deferred tax assets. The Company has provided a full valuation allowance against all of its deferred tax assets as therecent losses have been given more weight than projected future income when determining the need for a valuation allowance.The Company has federal net operating loss carryforwards of approximately $1.9 million which expire in 2030, 2033 and 2034 along with the federal generalbusiness and other credit carryforwards. The Company has state net operating loss carryforwards of approximately $2.5 million which expire in 2024, 2025,2028 and 2029.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 due to thefollowing: Year ended May 31, 2014 2013 2012 Statutory federal tax rate (34.0)% (34.0)% 34.0% State taxes, net of federal benefit (4.4) (4.4) 4.4 Change in deferred tax valuation allowance 29.3 51.7 7.1 Stock-based compensation 4.2 6.3 71.7 R&E tax credits 1.5 (17.7) (42.3) Effect of foreign income tax rates 1.8 1.9 3.2 Permanent and other differences 3.4 (5.3) (60.0) Effective tax rate 1.8% (1.5)% 18.1% Each year the Company files income tax returns in the various federal, state and local income taxing jurisdictions in which it operates. These tax returns aresubject to examination and possible challenge by the taxing authorities. Positions challenged by the taxing authorities may be settled or appealed by theCompany. As a result, there is an uncertainty in income taxes recognized in the Company’s financial statements in accordance with ASC Topic 740. TheCompany applies this guidance by defining criteria that an individual income tax position must meet for any part of the benefit of that position to berecognized in an enterprise’s financial statements and provides guidance on measurement, derecognition, classification, accounting for interest and penalties,accounting in interim periods, disclosure, and transition. The liability for unrecognized tax benefits was $0 as of May 31, 2014 and 2013. Page 30Schmitt Industries, Inc.NOTES TO CONSOLIDATED FINANCIAL STATEMENTSFOR THE YEARS ENDED MAY 31, 2014, 2013 AND 2012 Interest and penalties associated with uncertain tax positions are recognized as components of the “Provision for income taxes.” The liability for payment ofinterest and penalties was $0 as of May 31, 2014 and 2013.Several tax years are subject to examination by major tax jurisdictions. In the United States, federal tax years for Fiscal 2011 and after are subject toexamination. In the United Kingdom, tax years for Fiscal 2012 and after are subject to examination. In Canada, tax years for Fiscal 2005 and after are subjectto examination.NOTE 5COMMITMENTS AND CONTINGENCIESThe Company entered into a 5-year lease of manufacturing equipment in May 2014. The lease is classified as a capital lease and the asset, valued at $38,890,is included in the furniture, fixtures and equipment amount in Note 2 – Property and Equipment as of May 31, 2014.The future minimum lease payments under the capital lease for each of the years ending May 31 are as follows: Year ending May 31, 2015 $9,019 2016 9,019 2017 9,019 2018 9,019 2019 9,019 Thereafter 3,887 Total minimum lease payments 48,982 Less: amount representing interest (10,092) Present value of minimum lease payments (1) $38,890 (1)Reflected in other accrued liabilities on the balance sheet as of May 31, 2014.The Company leases certain facilities and equipment to support operations under non-cancelable operating leases and other contractual obligations. Totallease expense under operating leases for the years ended May 31, 2014, 2013 and 2012 amounted to $58,517, $56,721 and $75,005, respectively.The future minimum commitments under operating leases for each of the years ending May 31 are as follows: Year ending May 31, 2015 $40,633 2016 40,633 2017 32,886 2018 0 2019 0 Thereafter 0 In a transaction related to the acquisition of Schmitt Measurement Systems, Inc., formerly TMA Technologies, Inc. (“TMA”), the Company established aroyalty pool and vested in each shareholder and debt holder of the acquired company an interest in the royalty pool equal to the amount invested or loanedincluding interest payable through March 1995. The royalty pool is 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, 2014, 2013 and 2012 amounted to $30,386, $28,797 and$40,840, respectively. Page 31Schmitt Industries, Inc.NOTES TO CONSOLIDATED FINANCIAL STATEMENTSFOR THE YEARS ENDED MAY 31, 2014, 2013 AND 2012 In a transaction related to the acquisition of Xtero Datacom Inc., a British Columbia corporation (“Xtero”), former Xtero shareholders were eligible to receiveshares of stock that were exchangeable for shares of Schmitt common stock on a one-for-one basis based on 50% of the after-tax earnings derived from Xteroproducts during a five-year earn-out program that ended on May 31, 2013. This additional consideration would have increased the value of the intangibleasset recorded in connection with the acquisition. No additional shares of stock were issued to former Xtero shareholders during the five-year earn-outprogram.NOTE 6SEGMENT INFORMATIONThe Company has two reportable business segments: the design and assembly of dynamic balancing systems and components for the machine tool industry(Balancer), and the design and assembly of laser-based test and measurement systems (Measurement). The Company operates in three principal geographicmarkets: United States, Europe and Asia. Year Ended May 31, 2014 2013 2012 Balancer Measurement Balancer Measurement Balancer Measurement Gross sales $8,675,628 $4,472,945 $8,546,010 $4,796,620 $10,194,525 $5,231,238 Intercompany sales (954,417) (59,650) (831,888) (58,490) (929,517) (59,224) Net sales $7,721,211 $4,413,295 $7,714,122 $4,738,130 $9,265,008 $5,172,014 Operating income (loss) $(316,863) $(195,542) $(63,622) $(498,650) $422,528 $(365,244) Depreciation expense $137,808 $55,849 $142,288 $70,794 $142,576 $67,342 Amortization expense $0 $134,636 $0 $134,633 $0 $134,635 Capital expenditures $56,192 $0 $80,492 $95,343 $129,148 $147,897 Geographic Information Year Ended May 31, 2014 2013 2012 North America $7,474,067 $8,413,970 $9,074,152 Europe 1,773,928 1,192,049 1,145,449 Asia 2,693,767 2,499,593 3,814,656 Other markets 192,744 346,640 402,765 Total Net Sales $12,134,506 $12,452,252 $14,437,022 Year Ended May 31, 2014 2013 2012 United States Europe United States Europe United States Europe Operating income (loss) $(479,218) $(33,187) $(442,939) $(119,333) $54,265 $3,019 Depreciation expense $193,657 $0 $213,082 $0 $209,918 $0 Amortization expense $134,636 $0 $134,633 $0 $134,635 $0 Capital expenditures $56,192 $0 $175,835 $0 $277,045 $0 Page 32Schmitt Industries, Inc.NOTES TO CONSOLIDATED FINANCIAL STATEMENTSFOR THE YEARS ENDED MAY 31, 2014, 2013 AND 2012 Segment and Geographic Assets May 31, 2014 May 31, 2013 Segment assets to total assets Balancer $4,863,423 $5,489,976 Measurement 4,449,064 4,177,456 Corporate assets 1,511,904 1,957,166 Total assets $10,824,391 $11,624,598 Geographic assets to long-lived assets United States $1,191,591 $1,334,890 Europe 0 0 Total assets $1,191,591 $1,334,890 Geographic assets to total assets United States $10,090,242 $11,021,901 Europe 734,149 602,697 Total assets $10,824,391 $11,624,598 Note – Europe is defined as the European subsidiary, Schmitt Europe, Ltd.NOTE 7STOCK OPTIONS AND STOCK BASED COMPENSATIONThe Board of Directors adopted the 2004 Stock Option Plan (2004 Plan) in August 2004 and the 1995 Stock Option Plan (1995 Plan) in December 1995,which was amended in August 1996 and restated in August 1998. An option granted under the 2004 Plan and/or 1995 Plan (the Plans) might be either anincentive stock option (ISO), or a nonstatutory stock option (NSO). ISOs may be granted only to employees and members of the Board of Directors of theCompany and are subject to certain limitations, in addition to restrictions applicable to all stock options under the Plan. Options not meeting theselimitations will be treated as NSOs. The purchase price of ISOs is fair market value on the date of grant; the purchase price of NSOs may vary from fair marketvalue. Vesting is at the discretion of the compensation committee of the Board of Directors, but generally is either 50% at grant date and 16.7% on eachanniversary thereafter; 25% at grant date and 25% on each anniversary thereafter or 0% at grant date and 33% on each anniversary date thereafter. TheCompany initially reserved 400,000 shares for issuance under the 1995 Plan and 300,000 shares for issuance under the 2004 Plan. The 1995 Plan expired inDecember 2005 and no additional options may be issued under the 1995 Plan, although expiration of the 1995 Plan did not affect the rights of persons whoreceived stock grants under the 1995 Plan. Stock-based compensation recognized in the Company’s Consolidated Financial Statements for the years endedMay 31, 2014, 2013 and 2012 includes compensation cost for stock-based awards granted. All outstanding options will expire no later than 2023.The Company uses the Black-Scholes option pricing model as its method of valuation for stock-based awards. The Company’s determination of the fair valueof stock-based awards on the date of grant using an option pricing model is affected by our stock price as well as assumptions regarding a number of highlycomplex and subjective variables. Although the fair value of stock-based awards is determined in accordance with ASC Topic 718, the Black-Scholes optionpricing model requires the input of highly subjective assumptions, and other reasonable assumptions could provide differing results. These variables include,but are not limited to: • Risk-Free Interest Rate. The Company bases the risk-free interest rate on the implied yield currently available on U.S. Treasury issues with anequivalent remaining term approximately equal to the expected life of the award. • Expected Life. The expected life of awards granted represents the period of time that they are expected to be outstanding. The Companydetermines the expected life based on historical experience with similar awards, giving consideration to the contractual terms, vesting schedulesand pre-vesting and post-vesting forfeitures. Page 33Schmitt Industries, Inc.NOTES TO CONSOLIDATED FINANCIAL STATEMENTSFOR THE YEARS ENDED MAY 31, 2014, 2013 AND 2012 • Expected Volatility. The Company estimates the volatility of its common stock at the date of grant based on the historical volatility of itscommon stock. The volatility factor the Company uses is based on its historical stock prices over the most recent period commensurate with theestimated expected life of the award. These historical periods may exclude portions of time when unusual transactions occurred. • Expected Dividend Yield. The Company does not anticipate paying any cash dividends in the foreseeable future. Consequently, the Companyuses an expected dividend yield of 0. • Expected Forfeitures. The Company uses relevant historical data to estimate pre-vesting option forfeitures. The Company records stock-basedcompensation only for those awards that are expected to vest.The Company has computed, to determine stock-based compensation expense recognized for the years ended May 31, 2014, 2013 and 2012, the value of allstock options granted using the Black-Scholes option pricing model as prescribed by ASC Topic 718 using the following assumptions: Year Ended May 31, 2014 2013 2012 Risk-free interest rate 3.5% 2.5% N/A Expected life 4.3 years 4.2 years N/A Expected volatility 62.5% 63.8% N/A Stock-Based Compensation Under ASC Topic 718The total stock-based compensation expense recognized under ASC Topic 718 was $57,726, $89,888 and $199,396 during Fiscal 2014, 2013 and 2012,respectively. All stock-based compensation expense has been recorded as general, administration and sales expense in the Consolidated FinancialStatements.As of May 31, 2014, the Company had a total of 281,666 outstanding stock options (208,332 vested and exercisable and 73,334 non-vested) with a weightedaverage exercise price of $3.77. The Company estimates that a total of $41,237 will be recorded as additional stock-based compensation expense for alloptions which were outstanding as of May 31, 2014, but which were not yet vested.Options outstanding and exercisable consist of the following as of May 31, 2014: Outstanding Options Exercisable Options Number ofShares WeightedAverageExercise Price WeightedAverageRemainingContractualLife (yrs) Number ofShares WeightedAverageExercise Price 36,666 $2.30 0.1 36,666 $2.30 35,000 2.53 9.3 0 0.00 25,000 2.90 8.9 8,334 2.90 130,000 3.65 7.0 108,332 3.65 5,000 5.80 1.4 5,000 5.80 50,000 6.25 4.0 50,000 6.25 281,666 3.77 5.9 208,332 4.06 Options granted, exercised, canceled and expired under the Company’s stock option plan during the years ended May 31, 2014, 2013 and 2012 aresummarized as follows: Page 34Schmitt Industries, Inc.NOTES TO CONSOLIDATED FINANCIAL STATEMENTSFOR THE YEARS ENDED MAY 31, 2014, 2013 AND 2012 Number ofShares WeightedAverageExercise Price Options outstanding - May 31, 2011 387,776 $3.47 Options granted 0 0.00 Options exercised (95,275) 1.43 Options forfeited/cancelled (10,835) 3.46 Options outstanding - May 31, 2012 281,666 4.16 Options granted 25,000 2.90 Options exercised 0 0.00 Options forfeited/cancelled (5,000) 3.65 Options outstanding - May 31, 2013 301,666 4.06 Options granted 35,000 2.53 Options exercised (5,000) 2.30 Options forfeited/cancelled (50,000) 4.82 Options outstanding - May 31, 2014 281,666 3.77 The total intrinsic value of both outstanding and exercisable options as of May 31, 2014 and 2013 was $31,366 and $26,875, respectively. The total intrinsicvalue of options exercised during the years ended May 31, 2014, 2013 and 2012 was $3,025, $0 and $189,063, respectively.NOTE 8EARNINGS PER SHAREBasic 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: Page 35Schmitt Industries, Inc.NOTES TO CONSOLIDATED FINANCIAL STATEMENTSFOR THE YEARS ENDED MAY 31, 2014, 2013 AND 2012 Netincome/(loss)(Numerator) WeightedAverage Shares(Denominator) Per ShareAmount Year ended May 31, 2014 Basic earnings per share Loss available to common stockholders $(539,624) 2,995,910 $(0.18) Effect of dilutive securities stock options 0 0 Diluted earnings per share Loss available to common stockholders $(539,624) 2,995,910 $(0.18) Year ended May 31, 2013 Basic earnings per share Income available to common stockholders $(539,882) 2,990,910 $(0.18) Effect of dilutive securities stock options 0 0 Diluted earnings per share Income available to common stockholders $(539,882) 2,990,910 $(0.18) Year ended May 31, 2012 Basic earnings per share Loss available to common stockholders $77,721 2,930,314 $0.03 Effect of dilutive securities stock options 0 13,767 Diluted earnings per share Loss available to common stockholders $77,721 2,944,081 $0.03 NOTE 9EMPLOYEE BENEFIT PLANSThe 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 make further contributions in the form of a profit sharing contribution or a discretionary contribution. The Company made matchingcontributions in conjunction with employee contributions to the plan totaling $55,917, $56,633 and $65,672 during the years ended May 31, 2014, 2013and 2012, respectively. Page 36Report of Independent Registered Public Accounting FirmBoard of Directors and ShareholdersSchmitt Industries, Inc.We have audited the accompanying consolidated balance sheets of Schmitt Industries, Inc. and its subsidiaries (the “Company”) as of May 31, 2014 and2013, and the related consolidated statements of operations and comprehensive loss, stockholders’ equity and cash flows for the years ended May 31, 2014,2013 and 2012. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion onthese financial statements based on our audits.We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require thatwe plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. TheCompany is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included considerationof internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose ofexpressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An auditalso includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accountingprinciples used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believethat our audits provide a reasonable basis for our opinions.In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of SchmittIndustries, Inc. as of May 31, 2014 and 2013 and the consolidated results of its operations and its cash flows for the years ended May 31, 2014, 2013 and2012 in conformity with accounting principles generally accepted in the United States of America./s/ MOSS-ADAMS LLPPortland, OregonAugust 8, 2014 Page 37Item 9.Changes in and Disagreements with Accountants on Accounting and Financial DisclosureNone. Item 9A.Controls and ProceduresEvaluation of Disclosure Controls and ProceduresWe maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted underthe Securities Exchange Act of 1934, as amended (Exchange Act), is recorded, processed, summarized and reported within the time periods specified in SECrules and forms. Our disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required tobe disclosed in our reports filed under the Exchange Act is accumulated and communicated to management as appropriate to allow timely decisionsregarding required disclosures. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including thepossibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls andprocedures can only provide reasonable assurance of achieving their control objectives, and management necessarily is required to use its judgment inevaluating the cost-benefit relationship of possible controls and procedures.An evaluation was carried out under the supervision and with the participation of the Company’s management, including the Chief Executive Officer (CEO)and Chief Financial Officer (CFO), of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report as definedin Exchange Act Rule 13a-15(e) and Rule 15d-15(e). Based on that evaluation, the CEO and CFO have concluded that, as of the end of the period covered bythis report, the Company’s disclosure controls and procedures are effective in ensuring that information required to be disclosed in our Exchange Act reportsis (1) recorded, processed, summarized and reported in a timely manner, and (2) accumulated and communicated to our management, including the our CEOand CFO, as appropriate, to allow timely decisions regarding required disclosure.Management’s Report on Internal Control Over Financial ReportingOur management is responsible for establishing and maintaining adequate internal controls over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)). Under the supervision and with the participation of our management, including our CEO and CFO, we conducted an evaluation of theeffectiveness of our internal controls over financial reporting based on the framework in Internal Controls – Integrated Framework issued by the Committeeof Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal Control – Integrated Framework, ourmanagement concluded that our internal controls over financial reporting were effective as of May 31, 2014.This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financialreporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to SEC rules adopted inconformity with the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.Changes in Internal Control over Financial ReportingThere were no changes in our internal control over financial reporting (as defined in Exchange Rules 13a-15(f) and 15d-15(f)) that occurred during thequarter ended May 31, 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Item 9B.Other InformationNone. Page 38PART IIICertain information required by Part III is included in the Company’s definitive Proxy Statement for its 2014 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. Item 10.Directors, Executive Officers and Corporate GovernanceThe information required by this item is included in the Company’s Proxy Statement relating to the 2014 Annual Meeting of Shareholders and isincorporated herein by reference. Item 11.Executive CompensationThe information required by this item is included in the Company’s Proxy Statement relating to the 2014 Annual Meeting of Shareholders and isincorporated herein by reference. Item 12.Security Ownership of Certain Beneficial Owners and Management and Related Stockholder MattersThe information required by this item is included in the Company’s Proxy Statement relating to the 2014 Annual Meeting of Shareholders and isincorporated herein by reference. Item 13.Certain Relationships and Related Transactions and Director IndependenceThe information required by this item is included in the Company’s Proxy Statement relating to the 2014 Annual Meeting of Shareholders and isincorporated herein by reference. Item 14.Principal Accounting Fees and ServicesThe information required by this item is included in the Company’s Proxy Statement relating to the 2014 Annual Meeting of Shareholders and isincorporated herein by reference. Page 39PART IV Item 15.Exhibits and Financial Statement Schedules (a)Financial Statements: (1)Consolidated Balance Sheets as of May 31, 2014 and 2013Consolidated Statements of Operations and Comprehensive Loss for the years ended May 31, 2014, 2013 and 2012Consolidated Statements of Cash Flows for the years ended May 31, 2014, 2013 and 2012Consolidated Statements of Stockholders’ Equity for the years ended May 31, 2014, 2013 and 2012Notes to Consolidated Financial Statements for the years ended May 31, 2014, 2013 and 2012Reports of Independent Registered Public Accounting Firms (2)Financial Statement Schedules: All financial statement schedules are omitted either because they are not applicable, not required, or therequired information is included in the financial statements or notes thereto. (3)Exhibits: Reference is made to the list on page 42 of the Exhibits filed with this report. Page 40SIGNATURESPursuant 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/ James A. Fitzhenry James A. Fitzhenry President and Chief Executive OfficerDate: August 8, 2014Pursuant 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 8, 2014. Signature Title/s/ Wayne A. CaseWayne A. Case Chairman of the Board/s/ James A. FitzhenryJames A. Fitzhenry Director, President and Chief Executive Officer(Principal Executive Officer)/s/ Ann M. FergusonAnn M. Ferguson Chief Financial Officer and Treasurer(Principal Financial and Accounting Officer)/s/ Maynard BrownMaynard Brown Director/s/ David M. HudsonDavid M. Hudson Director/s/ Michael J. EllsworthMichael J. Ellsworth Director Page 41INDEX TO EXHIBITS Exhibits DescriptionExhibits marked with an asterisk (*) are incorporated by reference to exhibits or appendices previously filed with the Securities and Exchange Commission,as indicated by the references in brackets. All other exhibits are filed herewith. *2.1 Arrangement Agreement by and among Schmitt Industries, Inc., Schmitt Industries (Canada) Limited, and Xtero Datacom Inc. dated December14, 2007.[Form 10-Q for the fiscal quarter ended February 29, 2008, Exhibit 2.1] *2.2 Amending Agreement to Arrangement Agreement by and among Schmitt Industries, Inc., Schmitt Industries (Canada) Limited, and XteroDatacom Inc. dated February 7, 2008.[Form 10-Q for the fiscal quarter ended February 29, 2008, Exhibit 2.2] *2.3 Asset Purchase Agreement between Schmitt Industries, Inc., and Glenn Valliant, an individual doing business as Optical Dimensions, datedSeptember 30, 2009.[Form 10-Q for the fiscal quarter ended November 30, 2009, Exhibit 2.1] *3.1 Second Restated Articles of Incorporation of Schmitt Industries, Inc.[Form 10-K for the fiscal year ended May 31, 1999, Exhibit 3(i)] *3.2 Second Restated Bylaws of Schmitt Industries, Inc.[Form 10-K for the fiscal year ended May 31, 1999, Exhibit 3(ii)] *4.1 See exhibits 3.1 and 3.2 for provisions of the Articles of Incorporation and Bylaws defining the rights of security holders.*10.1† Schmitt Industries, Inc. Amended & Restated Stock Option Plan.[Form 10-K for the fiscal year ended May 31, 1999, Exhibit 10.1]*10.2† Schmitt Industries, Inc. 2004 Stock Option Plan.[Appendix B to Schedule 14A filed on August 23, 2004]*10.3 Amendment No. 1 to Loan Agreement between the Company and Bank of America, N.A. dated February 28, 2012.[Form 10-Q for the fiscal quarter ended February 29, 2012, Exhibit 10.1]*10.4 Form of Indemnification Agreement.[Form 8-K filed on April 11, 2014, Exhibit 10.1]*10.5 First Amended and Restated Loan Agreement with Bank of America, N.A.[Form 8-K filed on April 11, 2014, Exhibit 10.2]*10.6 Security Agreement (Multiple Use) with Bank of America, N.A.[Form 10-Q for the quarterly period ended February 28, 2009, Exhibit 10.2]*10.7 Security Agreement (Deposit Account - Specific) with Bank of America, N.A.[Form 8-K filed on April 11, 2014, Exhibit 10.4]*14.1 Code of Ethics and Business Conduct.[Form 10-K for the fiscal year ended May 31, 2004, Exhibit 14.1] 21.1 Subsidiaries of Schmitt Industries, Inc. as of May 31, 2014. 23.1 Consent of Independent Registered Public Accounting Firm. 31.1 Certification of Principal Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Actof 2002. 31.2 Certification of Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Actof 2002. 32.1 Certification of Principal Executive Officer and Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section906 of the Sarbanes-Oxley Act of 2002.101.INS XBRL Instance Document.101.SCH XBRL Taxonomy Extension Schema Document.101.CAL XBRL Taxonomy Extension Calculation Linkbase Document.101.LAB XBRL Taxonomy Extension Label Linkbase Document.101.PRE XBRL Taxonomy Extension Presentation Linkbase Document.101.DEF XBRL Taxonomy Extension Definition Linkbase Document. †Management contract or compensatory plan or arrangement required to be filed as an exhibit to this Form 10-K. Page 42EXHIBIT 21.1SUBSIDIARIES OF SCHMITT INDUSTRIES, INC.AS OF MAY 31, 2014 Subsidiary State of Incorporation orCountry in Which OrganizedSchmitt Measurement Systems, Inc. OregonSchmitt Europe, Ltd. United KingdomSchmitt Industries Canada, Ltd. CanadaEXHIBIT 23.1CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMWe consent to the incorporation by reference in the Registration Statement (No. 333-03910) on Form S-8 of our report dated August 8, 2014, relating to theconsolidated financial statements appearing in this Annual Report on Form 10-K of Schmitt Industries, Inc. for the year ended May 31, 2014./s/ Moss-Adams LLPPortland, OregonAugust 8, 2014EXHIBIT 31.1CERTIFICATION PURSUANT TO18 U.S. C. SECTION 1350,AS ADOPTED PURSUANT TOSECTION 302 OF THE SARBANES-OXLEY ACT OF 2002I, James A. Fitzhenry, 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 the financialcondition, 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 and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in ExchangeAct Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13-15(f) and 15d-15(f)) for the registrantand 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) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under oursupervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposesin accordance with generally accepted accounting principles;(c) 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(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscalquarter (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; and5. The registrant’s other certifying officer 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 8, 2014 /s/ James A. Fitzhenry James A. Fitzhenry, President and Chief Executive OfficerEXHIBIT 31.2CERTIFICATION PURSUANT TO18 U.S. C. SECTION 1350,AS ADOPTED PURSUANT TOSECTION 302 OF THE SARBANES-OXLEY ACT OF 2002I, Ann M. Ferguson, 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 the financialcondition, 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 and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in ExchangeAct Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13-15(f) and 15d-15(f)) for the registrantand 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) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under oursupervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposesin accordance with generally accepted accounting principles;(c) 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(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscalquarter (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; and5. The registrant’s other certifying officer 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 8, 2014 /s/ Ann M. Ferguson Ann M. Ferguson, Chief Financial Officer and TreasurerExhibit 32.1CERTIFICATION PURSUANT TO18 U.S.C. SECTION 1350,AS ADOPTED PURSUANT TOSECTION 906 OF THE SARBANES-OXLEY ACT OF 2002In connection with the Annual Report of Schmitt Industries, Inc. (the “Company”) on Form 10-K for the fiscal year ended May 31, 2014 as filed with theSecurities and Exchange Commission on the date hereof (the “Report”), we, James A. Fitzhenry and Ann M. Ferguson, President and Chief Executive Officerand Chief Financial Officer and Treasurer, respectively, of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that to 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 results of operations of the Company./s/ James A. FitzhenryJames A. FitzhenryPresident and Chief Executive OfficerAugust 8, 2014/s/ Ann M. FergusonAnn M. FergusonChief Financial Officer and TreasurerAugust 8, 2014

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