Schmitt Industries, Inc. Annual Report 2019

Plain-text annual report

Table of ContentsUNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549FORM 10-K(Mark One)☒ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934For the fiscal year ended: May 31, 2019or ☐TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934For the transition period from to Commission File Number: 000-23996SCHMITT 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 Trading Symbol(s) Name of each exchange on which registeredCommon Stock - no par valueSeries A Junior Participating PreferredStock Purchase Rights SMIT NASDAQ Capital MarketSecurities registered pursuant to Section 12(g) of the Act:NoneIndicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐ No ☒Indicate by check mark whether the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes ☐ No ☒Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90days. Yes ☒ No ☐Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T duringthe preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growthcompany. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.(check one): Large accelerated filer ☐ Accelerated filer ☐Non-accelerated filer ☐ Smaller reporting company ☒ Emerging growth company ☐If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financialaccounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒As of the last day of the second fiscal quarter of 2019, the aggregate market value of registrant’s common stock held by non-affiliates of the registrant was approximately$6,820,200 based upon the closing price of $2.94 reported for such date on the NASDAQ Capital Market. As of July 31, 2019, the registrant had 4,032,878 outstanding sharesof Common Stock.Documents Incorporated by ReferencePortions of the registrant’s definitive Proxy Statement for its 2019 Annual Meeting of Shareholders are incorporated by reference into Part III hereof.Table of ContentsSCHMITT INDUSTRIES, INC.INDEX TO FORM 10-K Page Part I Item 1. Business 3 Item 1A. Risk Factors 10 Item 1B. Unresolved Staff Comments 13 Item 2. Properties 13 Item 3. Legal Proceedings 13 Item 4. Mine Safety Disclosures 13 Part II Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 14 Item 6. Selected Financial Data 15 Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations 15 Item 7A. Quantitative and Qualitative Disclosures about Market Risk 24 Item 8. Financial Statements and Supplementary Data 25 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 49 Item 9A. Controls and Procedures 49 Item 9B. Other Information 49 Part III Item 10. Directors, Executive Officers and Corporate Governance 50 Item 11. Executive Compensation. 50 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 50 Item 13. Certain Relationships and Related Transactions and Director Independence 50 Item 14. Principal Accounting Fees and Services 50 Part IV Item 15. Exhibits and Financial Statement Schedules 51 Signatures 53 Exhibits 52 Page 2Table of ContentsPART ICautionary Note Regarding Forward-Looking StatementsCertain statements contained in this report are forward-looking in nature. 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 arenot guarantees of future performance and involve risks, uncertainties and assumptions that are difficult to predict. Therefore, actual outcomes andresults may differ materially from what is expressed or forecasted in such forward-looking statements. Certain of such risks and uncertainty arediscussed in the “Risk Factors” section in Item 1A. ITEM 1.BUSINESSAs a global leader in precision test, measurement and process control products, Schmitt helps customers save money, increase production efficiencyand improve product quality across a variety of industries.Schmitt was founded in 1987 to provide reliable solutions for in-process dynamic balancing of precision grinding machines. The Schmitt DynamicBalance System (“SBS”) can detect and dynamically correct vibration as low as 0.02 microns to ensure product quality, and the SBS acoustic emissionsensors help grinding machine operators maximize the efficiency of the grinding process, thereby increasing part throughput and lowering operatingcosts.The Company’s family of products was expanded in June 2000 with the acquisition of the Acuity™ line of dimensional and distance measurementlasers. These laser products utilize both triangulation and time-of-flight measurement principles and are known for their speed and accuracy. TheAcuity products are used in a wide variety of industrial, commercial and research applications.In 2007, the Company purchased Xact™ ultrasonic measurement technology for the remote monitoring of the fill levels of propane and other liquidtanks. Together with the Xact gauge reader, the satellite-focused Xact systems can detect and communicate fill levels, along with other informationsuch as tank size and configuration, to customers through the “Internet of Things” ecosystem using our satellite provider and a secure website. Typicalusers of Xact systems are bulk propane, diesel, jet fuel suppliers and ammonia users and distributors.Today, Schmitt Industries is a world leader in providing highly precise test, measurement and process control products that help customers save money,increase production efficiency and improve product quality.The Company was originally incorporated under the laws of British Columbia, Canada, in 1984 and was reincorporated under the laws of the State ofOregon in 1995. Schmitt is an ISO 9001 certified company.Schmitt trades on the Nasdaq Composite Index (the “NASDAQ”) under the ticker “SMIT”.We serve our customers and organize our business through the following reportable segments: • Balancer (“Balancer”) Segment. The principle product for the Balancer segment is the SBS product line, which designs, manufacturesand sells computer-controlled vibration detection, balancing and process control systems for the worldwide machine tool industry,particularly for grinding machines. • Measurement (“Measurement”) Segment. Through its wholly owned subsidiary, Schmitt Measurement Systems, Inc., the Measurementsegment manufacturers and sells products in two core product lines, Acuity and Xact: – Acuity sells products, solutions and services that includes laser and white light sensor distance, measurement and dimensionalsizing products; – Xact includes satellite focused remote tank monitoring products and related monitoring services for markets in the Internet ofThings (“IoT”) environment. The Xact products measure the fill Page 3Table of Contents levels of tanks holding propane, diesel and other tank-based liquids and the related monitoring services, which includestransmission of fill data from the tanks via satellite to a secure web site for display.Our two reportable segments provide a wide range of products and services to various customers.Balancer SegmentSCHMITT DYNAMIC BALANCE SYSTEMS (SBS)The Company’s principal product line for the Balancer segment is the Schmitt Dynamic Balance System or SBS. SBS is an industry leader that designs,manufactures and sells computer-controlled vibration detection, balancing and process control systems for the worldwide machine tool industry,particularly for grinding machines. The Company provides sales and service through three primary channels: 1) United States, North America and aportion of the Asia markets through Schmitt Industries (SII), located in Portland, Oregon; 2) Europe and a portion of the Asia markets through theCompany’s wholly owned subsidiary, Schmitt Europe Limited (SEL), located in Coventry, England and 3) China through the Company’s salesrepresentative office, located in Shanghai, China.Products and ServicesSBS products are highly precise measurement and control devices for permanent or portable installation on grinding machines that can detect andcorrect imbalance caused by vibration as small as 0.02 microns. SBS products play a vital role for machine tool builders as they help to 1) improveproduct quality by reducing variability in the grinding process, 2) increase efficiency in the grinding process by eliminating grinding gap time in thegrind cycle and 3) reduce machine downtime by helping to identify abnormalities in the grind cycle. SBS systems offer ease of product adaptation,quick installation and adaptability to all types of machines.The following products are currently offered under the SBS brand:SB-5500 Products – The SB-5500 product line is fully automated, eliminating the need to pre-balance parts, reducing machine setup time andensuring a smoother and more efficient grinding process. The SB-5500 control panel contains up to four slots for additional functions, such asmanual balancing and balancing using hydro chambers and process monitoring, which involves the detection and analysis of high frequencynoise, known as acoustic emission (AE), generated by the grinding process.The optional Acoustic Emission Monitoring System (AEMS) control card uses proprietary acoustic sensor technology to monitor the acousticemissions signal generated on the grinding machine during key events in the grinding process. The AEMS card allows the grinding machine’soperating system to detect any unexpected contact allowing the system to stop the grinding process within one millisecond.The SB-5500 also offers two process control cards to provide enhanced control of the grinding process: the ExactControl™ card and theExactDress™ card. The ExactControl process control card offers multi-functional grinding process control capability by detecting and analyzingeither the acoustic emissions pattern or the machine power fluctuations. Software control strategies include ExactDisplay, ExactGap, ExactTime,ExactIntegral, and ExactDress.SB-2000 and AE-1000 Products – Additional SBS products include the SB-2000 and the AE-1000. The SB-2000 is an easy-to-use, compactmanual balancing system offering both one and two plane manual balancing capabilities. The system comes in a dedicated machine installationversion (SB-2000) and a portable version (SB-2000-P). The AE-1000 is a dedicated AE control platform that reduces air machine grinding timeand alerts the operator to potential grinding wheel crash conditions by using proprietary AE detection technology to monitor the high frequencysignals generated by the grinding process. Page 4Table of ContentsNotable features of the SBS system include its ability to fit almost all grinding machines, ease of installation, compact and modular construction,ability to balance a wheel while on a machine, virtual elimination of wheel vibration, automatic monitoring of balancing, display in a variety oflanguages and units of measurement, instrument grade calibration, short balance process, measurement of both displacement and/or velocity andminimal operator maintenance. The SB-5500 also offers the capability of fully integrating its operation and output within any grinding machine’sCNC operating system by the use of its IVIS (Intelligent Visualization) software.Customers and MarketsPrecision grinding is necessary in major manufacturing areas including the automotive, industrial, aerospace and medical industries wherespecifications and operating tolerances on machined parts are increasingly precise.Within the Company’s customer base for the SBS system, there are three major market segments:Machine Tool Builders – Tool builder companies design and manufacture a variety of specialty application grinding machines. SBS systems aredistributed to markets throughout the world through machine tool original equipment manufacturers (OEMs), who incorporate the SBS systeminto their products. SBS products are designed into world-class machine builder systems.Examples of some well-known worldwide machine tool builders who have offered and/or installed the SBS System include Fritz Studer AG(Switzerland), Shanghai Machine Tool Works (China), ANCA (Australia), Capco Machinery (U.S.), Drake Manufacturing (U.S.), Ecotech/SMTW(China/U.S.), Matrix Machine Tool (UK), Schleifring Group (Germany, China), Shaanxi Qinchuan Machinery Development Co. (China), FivesLandis Grinding (U.S.), Koyo Machinery (U.S./Japan), Micron Machinery Limited (Japan/U.S.), Hardinge (U.S.), and Weldon Solutions (U.S.).Machine Tool Rebuilders – Tool rebuilders develop their business by completely updating and refurbishing older grinding machines. Theserebuilders typically tear the old machine apart and install new components, often including the SBS system. The Company currently sells itsproducts directly to major machine tool 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 customersincluding: Black & Decker, Briggs and Stratton, Schaeffler, Caterpillar, Eaton, Regal Beloit, Cummins Engine, Ford Motor Company, GeneralElectric, General Motors, Ingersoll Rand, Komatsu, Sumitomo Heavy Industries, SKF Bearing Industries, Timken, TRW Automotive Componentsand Universal Bearing.Schmitt works closely with our OEM customers to continually improve our systems. These relationships allow us to better serve our customers as weare better positioned to provide innovative solutions that assist them to be industry leaders in efficiency and effectiveness for their machines.For the years ended May 31, 2019, May 31, 2018 and May 31, 2017 (Fiscal 2019, 2018 and 2016), net revenues of the Company’s Balancer segmentproducts totaled $9,080,719, $9,026,830 and $7,082,474, respectively. Net revenues of Balancer segment products accounted for 66%, 65% and 57%of the Company’s total revenues in Fiscal 2019, 2018 and 2017, respectively. See Note 5 to Consolidated Financial Statements.CompetitionThe Company’s primary competitors in the Balancer segment are Marposs S.p.A., Balance Systems S.r.l. and MPM Micro Prazision Marx GmbH. Page 5Table of ContentsMeasurement SegmentIn the Measurement Segment, our measurement solutions support a wide range of industries through its laser solutions product and applications andour tank monitoring products. These products and services include the Acuity and Xact product lines.ACUITY LASERSAcuity sells products, solutions and services including laser and white light sensor distance, measurement and dimensional sizing products.Products and ServicesProducts sold under the Acuity brand include lasers utilizing both triangulation and time-of-flight methods of measurement, and confocal chromaticwhite light sensors. These lasers are used in a wide range of industrial applications including manufacturing, lumber production, steel casting, glassand paper production, medical imaging, crane control and micron-level part and surface inspection.Customers and MarketsAcuity laser measurement sensors are used for fast and accurate dimensional measurement in a wide range of applications, including factoryautomation, surface profile scanning, crane positioning, road profiling, tire production, semiconductor manufacturing and many other industrial andcommercial applications.The market for Acuity lasers is growing as the industry moves from a products market to a solutions-based market as customers seek tailored solutionsto solve complex problems in a range of industrial and manufacturing businesses.CompetitionThe Company believes the principal elements of competition include quality of ongoing technical support and maintenance coupled withresponsiveness to customer needs, as well as price, product quality, reliability and performance. The Acuity products market is extremely competitive,characterized by rapidly changing technology, and includes multinational competitors. Company pricing is intended to obtain market share and meetcompetitive supplier prices. The market strategy is to establish products with the best quality, reliability and performance and superior economic value.XACT REMOTE TANK MONITORING SYSTEMSXact product line includes satellite focused remote tank monitoring products and related monitoring services for markets in the Internet of Things(“IoT”) environment. The products measure the fill levels of tanks holding propane, diesel and other tank-based liquids and the related monitoringservices includes transmission of fill data from the tanks via satellite to a secure web site for display.Products and ServicesXact Satellite Remote Tank Monitors include both ultrasonic and gauge reader sensors that provide remote fill level monitoring of propane, diesel andother tank-based liquids for tanks anywhere in the world. The Xact systems can be used to monitor tanks as small as 125 gallons (473 liters) and aslarge as 90,000 gallons (340,686 liters). With Xact, users access timely and accurate remote tank data on a consistent schedule or by customized criticalfill alarms to optimize inventory management processes. Page 6Table of ContentsThere are three main components to the Xact Tank Monitoring System:Tank Sensors – Xact offers two sensors, the Xact Ultrasonic sensor and the Xact Gauge Reader.The Xact Ultrasonic sensor incorporates patented technology and is externally mounted to the bottom of the tank with no reliance on existingmechanical gauges. The system employs a small electrical pulse, which is able to calculate the precise fill level inside using patented sonartechnology (measurement accuracy to within ±2% for large tanks and ±1% for small tanks). Ultrasonic sensors work with any tank-based liquidsincluding propane, diesel and natural gas.The Xact gauge reader connects to the face of a float gauge and detects the fill level that is reported by the gauge. The system then transmits thatdata by satellite in the same manner as the Ultrasonic sensor. Float gauges have a typical accuracy range of ±4% to ±8%. Gauge readers areprimarily used in the propane industry to monitor propane tanks and support refill optimization for distributors and customers.Satellite Radio Transmitter – The Xact radio transmitter is placed on the top of the tank and is connected by cable to the tank sensor or gaugereader. The transmitter transmits the tank data using the GlobalStar® satellite network to the secure Xact website. Xact satellite telemetryprovides global coverage with no dependence on land lines, cellular networks or Wi-Fi signals, making it a reliable monitoring solution for tankslocated anywhere in the world.Xact Website – The Xact website is a secured location providing controlled access to the tank data for each customer’s various tank locations.Customers can access the website to check fill levels and additional information such as temperature, battery status, GPS coordinates and maplocation. In addition, the data can also be integrated into customer back-office software via API. This integration can be automatically directed toa customer’s inventory or delivery management system for full automation of the delivery process.The Xact Tank Monitoring Systems are highly dependable, providing the ability to operate in a wide range of environments with temperatures rangingfrom -40ºC to 60ºC.Customers and MarketsAccessing accurate fill level information is essential to effectively manage inventory, improve delivery efficiency, reduce operating costs and increaseprofitability, and justify capital expenditures for fuel providers. Xact focuses on niche satellite solutions, which separates it from intense competitionin the cellular monitoring industry. To reach our customers and fill gaps in cellular monitor customers, Xact partners with select cell providers inproviding our Xact solution. Given our niche market, Xact is well positioned to partner with various providers to offer a full range solution.Customers of the Xact Tank Monitoring System include large, regional and local propane distributors, such as Superior Propane (Canada), SuburbanPropane (U.S.), AmeriGas (U.S.), Dassel Petroleum (U.S.) and TermoGas (Mexico). The Company is currently focusing its business development effortson the propane industry in the United States and Canada.CompetitionCompetitors offer telemetry options based on cellular or closed-loop communication networks, whereas Xact telemetry is satellite based. General tankmonitoring competitors include: Anova (Wesroc), NasCorp (SkyTracker), WACnGO, Silicon Controls, TankScan, SkyBitz, Otodata, Angus Energy(Gremlin), and Tank Utility. Competitors that offer satellite telemetry include Anova (WESROC), NasCorp (SkyTracker), and Micro-Design, Inc.(LevelCon). Page 7Table of ContentsOther Measurement Segment ProductsAlso included in the Measurement segment are the following products, however, these products are either being phased out, have been sold or are nolonger actively being produced:TMS – TMS (Texture Measurement System) 2000-RC is an accurate non-contact texture measurement system. The product (used on aluminumsubstrates) provides fast, accurate and repeatable microroughness measurements while quadrupling production throughput when compared toother testing devices. Surface roughness can be measured to levels below 0.5 Angstroms. An Angstrom (Å) is a unit of measure equal to 1hundred-millionth of a centimeter (the point of a needle is one million Å in diameter).In Fiscal 2019, 2018 and 2017, net revenues of Measurement products totaled $4,729,442, $4,861,233 and $5,315,169, respectively, and accounted for34%, 35% and 43% of the Company’s total revenues in Fiscal 2019, 2018 and 2017, respectively. See Note 5 to Consolidated Financial Statements.Revenues by Geographic AreaIn Fiscal 2019, 2018 and 2017, the Company recorded net revenues of its products in the United States, its country of domicile, of $6,819,118,$6,932,943 and $6,797,469, respectively. Net revenues in the last three fiscal years by geographic areas were: NorthAmerica Europe Asia Others Fiscal 2019 $8,217,025 $2,094,627 $3,327,352 $171,157 Fiscal 2018 $8,371,376 $2,258,495 $3,122,484 $135,708 Fiscal 2017 $8,162,340 $1,451,293 $2,500,191 $283,819 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, selling channels are provided by approximately 65 individualsorganizations (including approximately 15 in the United States and four in China) that are independent manufacturers’ representatives and distributors.Second, OEMs integrate the SBS products on the machine tools they produce. Users purchase the SBS products concurrently with the machine tools.End users of grinding machines that have purchased the SBS system directly from the Company, after enjoying the benefits of our products, oftenrequest that SBS products be included with the new equipment they order from OEMs. The SBS systems are often installed by machine tool buildersprior 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. Representatives from all facets of the Company’s target markets attendthese trade shows where Company representatives are able to interact with these attendees and highlight SBS products.Measurement Segment ProductsSimilar to the Balancer segment, the Measurement segment uses a variety of methods to market and sell its products. Primarily, our sales and marketingmanagers direct the overall worldwide sales and marketing efforts Page 8Table of Contentsfor the Acuity and Xact products, including the employment and management of representatives and distributors in various markets. In addition, tradeshows have recently proven to be an excellent source of business. Representatives from all facets of the Company’s target markets attend these tradeshows.BacklogThe Company does not generally track backlog. Normally, orders are shipped within one to three weeks after receipt unless the customer requestsotherwise.ManufacturingThe Company uses a variety of sources for the supply of raw materials for the product lines. Essential electronic components, available in largequantities from various suppliers, are assembled into the Balancing and Measurement electronic control units under the Company’s quality andassembly standards. Company-owned software and firmware are coupled with the electronic components to provide the basis of the Company’s variouselectronic control units. Management believes several supply sources exist for all electronic components and assembly work incorporated into itselectronic control systems. Mechanical parts for the Company’s products are produced by high quality machine shops. The Company is not dependenton any one supplier of mechanical components. In the event of supply problems, the Company believes that two or three alternatives could bedeveloped within 30 days. The Company is subject to availability and pricing on the various components parts purchased, which has had, and maycontinue to have, a material impact on operations.The Company uses in-house skilled assemblers to construct and test vendor-supplied components. Component inventory of finished vendor-suppliedparts is held on Company property to assure adequate flow of parts to meet customer order requirements. Inventory is monitored by a computer controlsystem designed to assure timely re-ordering of components. In-house personnel assemble various products and test all finished components beforeplacing them in the finished goods inventory. Finished goods inventory is maintained via computer to assure timely shipment and service tocustomers. All customer shipments 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 newerISO 9001:2000 requirements and received subsequent recertification in 2011, 2014 and 2017.Proprietary TechnologyThe Company’s success depends in part on its proprietary technology, which the Company protects through patents, copyrights, trademarks, tradesecrets and other measures. Ten patents and several trademarks and copyrights currently offer protection of this proprietary technology. The Companyhas a policy of seeking patents, where appropriate, on inventions concerning new products and improvements developed as part of its ongoingresearch, development and manufacturing activities. While patents provide certain legal rights of enforceability, there can be no assurance the historiclegal standards surrounding questions of validity and enforceability will continue to be applied or that current defenses with respect to issued patentswill, in fact, be considered substantial in the future. There can be no assurance as to the degree and range of protection any patent will afford andwhether patents will be issued or the extent to which the Company may inadvertently infringe upon patents granted to others.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 ordisclose such 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-howand continuing technology advancement, manufacturing capabilities, Page 9Table of Contentsaffordable high-quality products, new product introduction and direct marketing efforts to develop 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. DuringFiscal 2019, 2018 and 2017, the Company’s research and development expense totaled $129,040, $327,317 and $256,164, respectively.EmployeesAs of July 31, 2019, the Company employed 50 individuals, none of which were covered by a collective bargaining agreement. ITEM 1A.RISK FACTORSThe following are important factors that could cause actual results or events to differ materially from those contained in any forward-lookingstatements made by or on behalf of the Company (see the forward-looking statements disclaimer at the beginning of Part 1, Item 1 in this Report). Inaddition, the risks and uncertainties described below are not the only ones that the Company faces. Unforeseen risks could arise and problems or issuesthat the Company now views as minor could become more significant. If the Company were unable to adequately respond to any risks, the Company’sbusiness, financial condition or results of operations could be materially adversely affected. In addition, the Company cannot be certain that anyactions taken to reduce known or unknown risks 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. Economic factors that could adversely influencedemand for the Company’s products include uncertainty about global economic conditions leading to reduced levels of investment, reduction indemand for our customers’ products, customers’ and suppliers’ access to credit and the stability of the global financial system, the overall health of ourmarkets, unemployment and other macroeconomic factors generally affecting commercial and industrial spending behavior.Past distress in the global financial markets and global economy resulted in reduced liquidity and a tightening of credit markets. If these conditionswere to reoccur, the Company could experience several potential adverse effects, including the inability of customers to obtain credit to financepurchases of the Company’s products, the insolvency of customers resulting in reduced revenues and bad debts, and the insolvency of key suppliersresulting in product development and production delays.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,both domestically and internationally, the timing, number and size of orders from, and shipments to, our customers as well as the relative mix of thoseorders and variations in the volume of orders for a particular product line in a particular quarter. Further, as a result of efforts to reduce carbon dioxideemissions, the automotive industry is expected to move towards electric propulsion vehicles, with a lower count of parts requiring grinding per drivesystem. This shift may negatively affect Balancer sales in the future as fewer grinding machines are used. Page 10Table of ContentsTechnology advance and potential competitionThe failure to develop new products or enhance existing products or react to changes in existing technologies could result in decreased revenues and aloss of market share to competitors.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 theCompany’s various technologies, develop products to meet those needs and supply commercial quantities at low prices to those new markets areimportant competitive factors. The principal competitive factors in the Company’s markets are product features, performance, reliability and price.Many of the Company’s competitors have greater financial, technical, engineering, production and marketing resources than we do. Those competitorswith greater resources may, in addition to other things, be able to better withstand periodic downturns, compete more effectively on the basis of priceand technology, or more quickly develop enhancements to products that compete with the products we manufacture and market. New companies mayenter the markets in which we compete, further increasing competition in those markets. No assurance can be given that the Company will be able tocompete effectively in the future, and the failure to do so would have a material adverse effect on the Company’s business, financial condition andresults 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. Our business,financial condition, margins or results of operations may be materially and adversely affected by competitive pressure and intense price-basedcompetition.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 ofraw materialsManufacturing operations could be adversely affected if adequate supplies of raw materials cannot be obtained in a timely manner or if raw materialcosts increase 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 productmade. The production time for each product can vary, depending on a variety of circumstances, including component availability, timing of deliveryof components from suppliers and employee availability. Should the Company receive a large increase in orders, an increase in the size of orders or ashortening of the required delivery time on existing orders, the Company may not be able to ramp up manufacturing to satisfy customer expectations,which may lead to the loss of significant revenue opportunities.The Company maintains a significant investment in inventories in anticipation of future revenuesThe Company believes it maintains a competitive advantage by shipping product to its customers more rapidly than its competitors and thereforemaintains a significant investment in inventories. These inventories are recorded using the lower of cost or net realizable method, which requiresmanagement to make certain estimates. Management evaluates the recorded inventory values based on customer demand, market trends and expectedfuture revenues, and changes valuation estimates accordingly. A significant shortfall of revenues may result in carrying higher levels of finished goodsand raw materials thereby increasing the risk of inventory obsolescence and corresponding inventory write-downs. As a result, the Company may notcarry adequate reserves to offset such write-downs. Page 11Table of ContentsThe Company faces risks from international sales and currency fluctuationsThe Company markets and sells its products worldwide and international sales have accounted for and are expected to continue to account for asignificant portion of future revenue. International sales are subject to a number of risks, including: the imposition of governmental controls; traderestrictions; difficulty in collecting receivables; changes in tariffs and taxes; difficulties in staffing and managing international operations; politicaland economic instability; general economic conditions; and fluctuations in foreign currencies. Specifically, currency fluctuations will impactrevenues, costs and earnings. No assurances can be given that these factors will not have a material adverse effect on future international sales andoperations and, consequently, on business, financial condition and results of operations.The Company may not be able to reduce operating costs quickly enough if revenues declineOperating expenses are generally fixed in nature and largely based on anticipated revenues. However, should future revenues decline significantly andrapidly, there is no guarantee management could take actions that would further reduce operating expenses in either a timely manner or withoutseriously impacting the operations 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 asrequired can be attracted, assimilated and retained. There is also no guarantee that key employees will not leave and subsequently compete against theCompany. The inability 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 tobe earned and taxed; the resolution of issues arising from future, potential tax audits with various tax authorities; changes in the valuation of ourdeferred tax assets and liabilities; adjustments to estimated taxes upon finalization of various tax returns; increases in expenses not deductible for taxpurposes; changes in available tax credits; changes in stock-based compensation expense; changes in tax laws or the interpretations of such tax lawsand changes in generally accepted accounting principles.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 noassurance any of the Company’s U.S. patents will not be invalidated, circumvented, challenged or licensed to other companies.Failure to protect our technology systems from cybersecurity occurrences may have an adverse effect on the Company’s operationsOur information technology systems, or those of certain key vendors or other third parties on which we rely, are subject to an increasing threat ofcontinually evolving cybersecurity risks. A breach in the security of our systems or our key business partners’ systems could result in businessdisruptions, which could have a material adverse effect on our financial condition, results of operations or cash flows. The Company does not retainany customer credit card or financial information on our technology systems. Page 12Table of ContentsOur reorganization activities and cost saving initiatives may not achieve the results we anticipate.Beginning in the second half of Fiscal 2019, The Company has undergone management changes and initiated a Company reorganization and costreduction to improve profitability and optimize operational efficiencies. For example, we initiated an in-depth review of inventory carried, our salessupport staff, and our pricing and cost structures. We cannot be certain that we will be able to complete these initiatives as planned or without businessinterruption, that these initiatives will not generate additional costs, such as severance or other charges, or that the estimated operating efficiencies orcost savings from such activities will be fully realized or maintained over time.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 bythe Securities and Exchange Commission, have increased and may continue to increase Company expenses as the Company devotes resources toensure compliance with all applicable laws and regulations. In addition, the NASDAQ Capital Market, on which the Company’s common stock islisted, has also adopted comprehensive rules and regulations relating to corporate governance. These laws, rules and regulations have increased thescope, complexity and cost of corporate governance, reporting and disclosure practices. The Company may be required to hire additional personneland use outside legal, accounting and advisory services to address these laws, rules and regulations. The Company also expects these developments tomake it more difficult and more expensive for the Company to obtain director and officer liability insurance in the future, and the Company may berequired to accept reduced coverage or incur substantially higher costs to obtain coverage. Further, the Company’s board members, Chief ExecutiveOfficer and Chief Financial Officer could face an increased risk of personal liability in connection with the performance of their duties. As a result, wemay have difficulty attracting and retaining qualified board 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 monthly lease. The current basicmonthly rent amount is £1,167 ($1,472 as of May 31, 2019). ITEM 3.LEGAL PROCEEDINGSOn January 8, 2019, Schmitt was served with a complaint filed by North American Satellite Corp., Insite Platform Partners, and Rick Humphreys(collectively, the “Plaintiffs”) in the Circuit Court of the State of Oregon against the Company. The complaint made various allegations specific topatent infringement, tortious interference, unfair competition, conspiracy, conspiracy to induce breach of contract, and conversion, with the totalamount of $10,000,000 being sought by the Plaintiffs. The Company believed the complaint was without merit and intended to defend the claimvigorously. On April 1, 2019, Schmitt and Plaintiffs settled the complaint. Though the terms of the settlement agreement are confidential, thesettlement amount was immaterial to the Company.There are no material legal proceedings currently pending against the Company. ITEM 4.MINE SAFETY DISCLOSURESNot applicable. Page 13Table of ContentsPART II ITEM 5.MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OFEQUITY 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 theperiods indicated. Year Ended May 31, 2018 High Low First Quarter $1.90 $1.57 Second Quarter $2.48 $1.65 Third Quarter $3.06 $2.25 Fourth Quarter $2.78 $1.96 Year Ended May 31, 2019 High Low First Quarter $3.11 $2.29 Second Quarter $3.01 $2.59 Third Quarter $2.99 $2.55 Fourth Quarter $2.57 $2.16 As of July 31, 2019, there were 4,032,878 shares of Common Stock outstanding held by approximately 60 holders of record.The Company has not paid any dividends on its Common Stock since 1994. The Company’s current policy is to retain earnings to finance theCompany’s business. Future dividends will be dependent upon the Company’s financial condition, results of operations, current and anticipated cashrequirements, acquisition plans and plans for expansion and any other factors that the Company’s Board of Directors deems relevant. The Company hasno present intention 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, 2019: Plan Category Number of Securities tobe issued upon exercise ofoutstanding options Weighted-averageexercise price ofoutstanding options Number of Securities remaining availablefor future issuance under equitycompensation plans (excluding securitiesin column a) (a) (b) (c) Equity compensation plans approved by security holders 380,166 $2.68 144,000 Equity compensation plans not approved by security holders 0 0 0 380,166 $2.68 144,000 Recent Sales of Unregistered SecuritiesNone.Issuer Purchases of Equity SecuritiesNone. Page 14Table of ContentsITEM 6.SELECTED FINANCIAL DATAIn thousands, except per share information Year Ended 5/31/2019 5/31/2018 5/31/2017 5/31/2016 5/31/2015 Net sales $13,810 $13,888 $12,398 $11,685 $13,069 Net income (loss) $(1,211) $211 $(1,073) $(1,515) $(94) Net income (loss) per common share, basic $(0.30) $0.06 $(0.36) $(0.51) $(0.03) Weighted average number of common shares, basic 4,006 3,423 2,996 2,996 2,996 Net income (loss) per common share, diluted $(0.30) $0.06 $(0.36) $(0.51) $(0.03) Weighted average number of common shares, diluted 4,006 3,460 2,996 2,996 2,996 Stockholders’ equity $8,473 $9,516 $6,977 $8,004 $9,489 Total assets $9,865 $11,286 $9,006 $9,635 $11,104 Long-term debt (including current portion) $29 $0 $0 $0 $0 ITEM 7.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSOVERVIEWWe are a global leader in precision test, measurement and process control products, Schmitt’s family of products help customers save money, increaseproduction efficiency and improve product quality across a variety of industries. The Company’s family of products included SBS, Acuity and Xactand serves a variety of industries. Schmitt trades on the NASDAQ under the ticker “SMIT”.We serve our customers and organize our business through two reportable business segments, Balancer and Measurement, as described below under“Segment Results”.RECENT DEVELOPMENTSStrategic ReorganizationFollowing the election of new Board members in October 2018, we announced a strategic reorganization on November 30, 2018. The announcedstrategic reorganization was to better position the Company to capitalize on the growing SBS Balancer business, while streamlining the Company andmaximizing shareholder value through the disposition of non-core assets.On July 2, 2019, we announced that the Board of Directors adopted a stockholder rights plan in an effort to protect its net operating loss carryforwards(“NOLs”) under Section 382 of the Internal Revenue Code. As of May 31, 2019, Schmitt had federal and state NOLs of approximately $5.6 million and$6.1 million, respectively, which could be used in certain circumstances to offset Schmitt’s future taxable income or otherwise payable taxes andtherefore reduce its federal and state income tax liabilities. Our ability to use the NOLs would be limited in the event of an “ownership change” underSection 382 of the Internal Revenue Code and related U.S. Treasury regulations. The stockholder rights plan is intended to reduce the likelihood of anunintended ownership change occurring through the buying of Schmitt common stock and is not meant to be an anti-takeover measure.Key Leadership ChangesOn November 30, 2018, we announced, effective December 1, 2018, the transition of David Case from CEO and President to Special Advisor to theBoard of Directors. Mr. Case helped to steward the reorganization through April 2019. We also announced the appointment of Michael R. Zapata asPresident and Executive Chairman, effective December 1, 2018. Last, we announced the retirement of Michael Ellsworth, as Chairman and director. Mr.Ellsworth was a director since 2006 and served as Chairman from 2017. Page 15Table of ContentsOn June 26, 2019, we announced the appointment of Steven Strom as the fifth member of the Company’s Board, effective June 21, 2019. Steven Stromis an “independent director” according to the rules of the Securities and Exchange Commission and the NASDAQ and his appointment created amajority of independent directors on the Board in compliance with NASDAQ requirements. Mr. Strom is the founder of Odinbrook Global Advisors andhas more than thirty years of experience advising companies in the US, Canada, Latin America, Europe and Asia.On August 1, 2019, we announced the appointment of Michael R. Zapata as President and Chief Executive Officer, effective July 30, 2019.Highlights of the Fiscal Year Ended May 31, 2019 • Consolidated revenue decreased $77,902, or 0.6%, to $13,810,161 in the fiscal year ended May 31, 2019 (Fiscal 2019) from $13,888,063in the fiscal year ended May 31, 2018 (Fiscal 2018); • Balancer segment revenue increased $53,889, or 0.6%, to $9,080,719 in Fiscal 2019 compared to $9,026,830 in Fiscal 2018.Measurement segment revenue decreased $131,791, or (2.7%), to $4,729,442 in Fiscal 2019 compared to $4,861,233 in Fiscal 2018. • Within the Measurement segment, Xact’s products and services in the “Internet of Things” industry continue to grow with monitoringrevenue increasing 16.2% to $1,367,329 in Fiscal 2019 compared to $1,176,323 in Fiscal 2018. • Gross margin decreased to 36.0% for Fiscal 2019 from 43.7% in Fiscal 2018. This decrease is due, in part, to the inventory adjustments of$(407,558) and $(189,990) recorded during the third and fourth quarters of Fiscal 2019. These inventory adjustments were the outcome ofnew management’s requirement to complete an in-depth review of the inventory, with standards of the review focused on more currentturnover. This review was driven by the organizational changes to the business models for the Company’s three product lines as a result ofthe overall reorganization efforts. These adjustments are direct charges to cost of sales and resulted in a reduction of gross margin from40.3%, before adjustment, to 36.0% for Fiscal 2019. • Operating expenses increased $170,863, or 2.9%, to $6,080,805 in Fiscal 2019 compared to $5,909,942 in Fiscal 2018. These resultsinclude non-recurring reorganization, legal and other professional expenses of $752,481 incurred during Fiscal 2019 that were notincurred during the prior year. • Net loss was $(1,210,990), or $(0.30) per fully diluted share, for Fiscal 2019 as compared to net income of $210,639, or $0.06 per fullydiluted share, for Fiscal 2018. • Non-GAAP EPS for Fiscal 2019 was $0.03 per fully diluted share compared to $0.06 per fully diluted share for Fiscal 2018. Page 16Table of ContentsRESULTS OF OPERATIONS Year Ended May 31, 2019 2018 2017 Balancer segment revenue $9,080,719 65.8% $9,026,830 65.0% $7,082,474 57.1% Measurement segment revenue 4,729,442 34.2% 4,861,233 35.0% 5,315,169 42.9% Total revenue, net 13,810,161 100.0% 13,888,063 100.0% 12,397,643 100.0% Cost of sales 8,836,856 64.0% 7,822,749 56.3% 7,511,836 60.6% Gross profit 4,973,305 36.0% 6,065,314 43.7% 4,885,807 39.4% Operating expenses: General, administration and sales 5,951,765 43.1% 5,582,625 40.2% 5,618,327 45.3% Research and development 129,040 0.9% 327,317 2.4% 256,164 2.1% Total operating expenses 6,080,805 44.0% 5,909,942 42.6% 5,874,491 47.4% Operating income (loss) (1,107,500) (8.0%) 155,372 1.1% (988,684) (8.0%) Other income (expense), net (77,051) (0.6%) 81,182 0.6% (56,671) (0.5%) Income (loss) before income taxes (1,184,551) (8.6%) 236,554 1.7% (1,045,355) (8.4%) Provision for income taxes 26,439 0.2% 25,915 0.2% 28,009 0.2% Net income (loss) $(1,210,990) (8.8%) $210,639 1.5% $(1,073,364) (8.7%) Fiscal Year Ended May 31, 2019 Compared to Fiscal Year Ended May 31, 2018Consolidated Revenue – Consolidated revenue decreased $77,902, or 0.6%, to $13,810,161 in Fiscal 2019 from $13,888,063 in Fiscal 2018.Balancer segment revenue increased $53,889, or 0.6%, to $9,080,719 in Fiscal 2019 compared to $9,026,830 in Fiscal 2018. Revenue by geographicmarkets for the Balancer segment for the years ended May 31, 2019 and 2018 were as follows: Year Ended May 31, 2019 2018 Variance North America $3,868,166 $3,835,913 $32,253 0.8% Asia 3,094,888 2,854,504 240,384 8.4% Europe 1,981,228 2,222,747 (241,519) (10.9%) Other 136,437 113,666 22,771 20.0% Total Balancer segment revenue $9,080,719 $9,026,830 $53,889 0.6% The continued growth in Fiscal 2019 is due to growth in Asian markets, which was offset by a reduction of revenues into the Europe market drivenprimarily by an OEM customer’s adjustment to their project schedule and timing. While there is concern tariffs could impact our sales into the Asiamarket, only marginal impact has been experienced to date. Page 17Table of ContentsMeasurement segment revenue decreased $131,791, or 2.7%, to $4,729,442 in Fiscal 2019 as compared to $4,861,233 in Fiscal 2018. Revenue byproduct line for the Measurement segment for Fiscal 2019 compared to Fiscal 2018 were as follows: Year Ended May 31, 2019 2018 Variance Acuity $2,128,136 $2,363,083 $(234,947) (9.9%) Xact - product 1,203,893 1,196,071 7,822 0.7% Xact - monitoring 1,367,329 1,176,323 191,006 16.2% Lasercheck 7,500 95,046 (87,546) (92.1%) SMS 22,584 30,710 (8,126) (26.5%) Total Measurement segment revenue $4,729,442 $4,861,233 $(131,791) (2.7%) The decrease in Measurement segment revenue is a reflection of two discontinued product lines, Lasercheck and SMS and a reduction in Acuityrevenue due to the loss of key sales staff at the end of Fiscal 2018. The Company is taking steps to address the sales staffing levels to continue to moveAcuity from a products-based business to a solutions-based business. These decreases were partially offset by the increases in Xact monitoring revenue.Gross margin – In Fiscal 2019, gross margin decreased to 36.0% in Fiscal 2019 from 43.7% in Fiscal 2018. This decrease was due, in part, to inventoryadjustments of $(407,558) and $(189,990) recorded in the third and fourth quarters of Fiscal 2019, respectively. These adjustments were the outcome ofnew management’s requirement to complete an in-depth review of the inventory, with standards of the review focused on more current turnover. Thisreview was driven by the organizational changes to the business models for the Company’s three product lines as a result of the overall reorganizationefforts. These adjustments are direct charges to cost of sales and resulted in a reduction of gross margin from 40.3%, before adjustment, to 36.0% forFiscal 2019. The remainder of the variance in gross margin between the periods presented was primarily influenced by focused efforts to reduce productcosts and targeted efforts to increase prices where possible, as well as shifts in the product sales mix from lower to higher margin product line sales.Operating expenses – Operating expenses increased $170,863, or 2.9%, to $6,080,805 in Fiscal 2019 compared to $5,909,942 in Fiscal 2018. Theseresults include non-recurring reorganization and legal expenses of $752,481 incurred during Fiscal 2019 that are not expected to be incurred in futureperiods.Items included in the non-recurring reorganization and legal expenses were as follows: • Employee severance and termination benefits of $248,522; • Cancellation of agreements with certain contractors and service providers amounting to $42,525 in non-recurring expense; • Legal and other professional expenses incurred totaling $403,751 related to the Company’s 2018 proxy and certain legal proceedingsassociated with a complaint filed against the Company, which occurred primarily during the third quarter of Fiscal 2019, and; • Curtailment of work provided by certain consultants, which amounted to $57,683 in Fiscal 2019 expense.Other items that impacted operating expenses in Fiscal 2019 include: • Decrease in commission expense in the amount of $179,876, or 19.6%, as a result of the restructuring of the Company’s salescommissions programs that occurred during Fiscal 2018; Page 18Table of Contents • Decrease in trade show expenses in the amount of $39,949, or 17.2%, and decrease in sales travel in the amount of $51,326, or 29.7%, dueto timing of certain trade shows for our three product lines; and • Decrease in research and development expense in the amount of $198,277, or 60.6%, as a result of the shift of engineering resourcestowards support of existing product initiatives rather than research and development.Other income (expense) – Other income (expense) consists of interest income, interest expense, foreign currency exchange gain (loss) and other income(expense). Interest income was $24,221 in Fiscal 2019 compared to $10,955 in Fiscal 2018. Fluctuations in interest income are impacted by the levelsof our average cash and investment balances and changes in interest rates. Interest expense was $12,160 in Fiscal 2019 compared to $1,401 in Fiscal2018. Foreign currency exchange loss was $89,162 for the year ended May 31, 2019 compared to foreign currency exchange gain of $72,216 for theyear ended May 31, 2018. The foreign currency exchange gain and loss fluctuates with the strength of foreign currencies against the U.S. dollar duringthe respective periods.Adjusted EBITDA – Adjusted EBITDA, which excludes the non-recurring reorganization, legal and other professional expense and the inventoryadjustments, was $365,986 for Fiscal 2019 as compared to Adjusted EBITDA of $443,194 for Fiscal 2018.Reconciliation of EBITDA to Adjusted EBITDA – Adjusted EBITDA for Fiscal 2019 and 2018 is calculated as follows: Fiscal YearEnded May 31,2019 Fiscal YearEnded May 31,2018 Net loss $(1,210,990) $210,639 Provision for income taxes 26,439 25,915 Depreciation and amortization 188,348 205,239 Interest expense 12,160 1,401 EBITDA (984,043) 443,194 Inventory adjustments 597,548 - Non-recurring reorganization, legal and other professional expenses 752,481 - Adjusted EBITDA (non-GAAP) $365,986 $443,194 Provision for income taxes – The effective tax rate in Fiscal 2019 was (2.2)%. The effective tax rate in Fiscal 2018 was 11.0%. The effective tax rate onconsolidated net income in Fiscal 2019 and Fiscal 2018 differs from the federal statutory tax rate primarily due to changes in the deferred tax valuationallowance and the impact of certain expenses not being deductible for income tax reporting purposes.Net income (loss) – Net loss was $(1,210,990), or $(0.30) per fully diluted share, for the year ended May 31, 2019 compared to net income of $210,639,or $0.06 per fully diluted share, for the year ended May 31, 2018. Page 19Table of ContentsReconciliation of Adjusted Net Income and Non-GAAP EPS — Adjusted net income excludes the inventory adjustments and non-recurringreorganization, legal and other professional expenses. See reconciliation of net loss to adjusted net income and the resulting impact on earnings perfully diluted share as follows: Fiscal YearEnded May 31,2019 Net loss $(1,210,990) Inventory adjustments 597,548 Non-recurring reorganization, legal and other professional expenses 752,481 Adjusted net income (non-GAAP) $139,039 Non-GAAP earnings per fully diluted share $0.03 Adjusted EBITDA and adjusted net income are not financial measures defined by Generally Accepted Accounting Principles (GAAP). Generally a non-GAAP financial measure is a numerical measure that either excludes or includes amounts that are not normally excluded or included in the most directcomparable measure calculated and presented in accounting with GAAP. Adjusted EBITDA and adjusted net income should not be construed as asubstitute for net income (loss) as Adjusted EBITDA and adjusted net income are not defined by GAAP.Fiscal Year Ended May 31, 2018 Compared to Fiscal Year Ended May 31, 2017Consolidated Revenue – Consolidated revenue increased $1,490,420, or 12.0%, to $13,888,063 for the fiscal year ended May 31, 2018 (Fiscal 2018)from $12,397,643 in the fiscal year ended May 31, 2017 (Fiscal 2017).Balancer segment revenue increased $1,944,356, or 27.5%, to $9,026,830 in Fiscal 2018 compared to $7,082,474 in Fiscal 2017. This increase wasattributed to stronger sales in each of our target markets. Revenue by geographic markets for the Balancer segment for the years ended May 31, 2018and 2017 were as follows: Year Ended May 31, 2018 2017 Variance North America $3,835,913 $3,337,215 $498,698 14.9% Asia 2,854,504 2,300,682 553,822 24.1% Europe 2,222,747 1,261,387 961,360 76.2% Other 113,666 183,190 (69,524) (38.0%) Total Balancer segment revenue $9,026,830 $7,082,474 $1,944,356 27.5% Measurement segment revenue decreased $453,936, or 8.5%, to $4,861,233 in Fiscal 2018 as compared to $5,315,169 in Fiscal 2017. During Fiscal2017, the Company made the decision to no longer focus on and eventually phase out the SMS and Lasercheck product lines, which have historicallybeen included in the Measurement segment. Revenue by product line for the Measurement segment for Fiscal 2018 compared to Fiscal 2017 were asfollows: Year Ended May 31, 2018 2017 Variance Acuity $2,363,083 $2,471,684 $(108,601) (4.4%) Xact - product 1,196,071 1,414,586 (218,515) (15.4%) Xact - monitoring 1,176,323 1,022,209 154,114 15.1% Lasercheck 95,046 90,911 4,135 4.5% SMS 30,710 315,779 (285,069) (90.3%) Total Measurement segment revenue $4,861,233 $5,315,169 $(453,936) (8.5%) Page 20Table of ContentsGross margin – In Fiscal 2018, gross margin increased to 43.7% compared to 39.4% in Fiscal 2017. The variances in gross margin between the periodspresented were primarily influenced by focused efforts to reduce product costs and targeted efforts to increase prices where possible, as well as shifts inthe product sales mix from lower to higher margin product line sales.Operating expenses – Operating expenses increased $35,451, or 0.6%, to $5,909,942 in Fiscal 2018 to $5,874,491 in Fiscal 2017. The increase inoperating expenses was in part due to the following: • Increases in research and development expenses; • Increases in professional expenses; and • Increases in other administrative expenses;These increases were partially offset by: • Decreases in sales and commissions expense due to restructuring of some of the commissions programs; and • Decreases in sales related travel and entertainment expenses.Other income (expense) – Other income (expense) consists of interest income, interest expense, foreign currency exchange gain (loss) and other income(expense). Interest income was $10,955 in Fiscal 2018 compared to $2,309 in Fiscal 2017. Fluctuations in interest income are impacted by the levels ofour average cash and investment balances and changes in interest rates. Interest expense, which is primarily related to the capital lease of a piece ofmanufacturing equipment, was $1,401 in Fiscal 2018 compared to $2,982 in Fiscal 2017. Foreign currency exchange gain was $72,216 for the yearended May 31, 2018 compared to foreign currency exchange loss of $63,744 for the year ended May 31, 2017. The foreign currency exchange gainand loss fluctuates with the strength of foreign currencies against the U.S. dollar during the respective periods.Provision for income taxes – The effective tax rate in Fiscal 2018 was 11.0%. The effective tax rate on consolidated net income in Fiscal 2018 differsfrom the federal statutory tax rate primarily due to changes in the deferred tax valuation allowance and the impact of certain expenses not beingdeductible for income tax reporting purposes. The effective tax rate in Fiscal 2017 was 2.7%. The effective tax rate on consolidated net loss in Fiscal2017 differed from the federal statutory tax rate primarily due to changes in the deferred tax valuation allowance.Net income (loss) – Net income was $210,639, or $0.06 per fully diluted share, for the year ended May 31, 2018 as compared to net loss of $1,073,364,or $(0.36) per fully diluted share, for the year ended May 31, 2017. Net income for Fiscal 2018 was the result of the combination of increased revenuesin the Balancing segment and increases in the overall gross margin.LIQUIDITY AND CAPITAL RESOURCESWhile cash, cash equivalents and restricted cash decreased $644,098 from $2,111,533 as of May 31, 2018 to $1,467,435 as of May 31, 2019, theCompany finished Fiscal 2019 by increasing its cash, cash equivalents and restricted cash balance by $241,670 from $1,225,765 at February 28, 2019.The Company’s working capital decreased $978,056 to $7,269,917 as of May 31, 2019 compared to $8,247,973 as of May 31, 2018. The reduction inworking capital in Fiscal 2019 was primarily impacted by the reduction in inventories and the use of cash for accounts payable.Accounts payable decreased $527,894 from $1,024,256 at May 31, 2018 to $496,362 at May 31, 2019, which was driven by the reorganization effortsand the re-evaluation of the Company’s policies and procedures, including reductions in the timelines for accounts payable. The reduction in accountspayable is a reflection of a healthier balance sheet and bringing accounts payable current. Page 21Table of ContentsInventories decreased $691,844 to $5,019,044 as of May 31, 2019 compared to $5,710,888 as of May 31, 2018. This decrease was due, in part, toinventory adjustments of $(407,558) and $(189,990) recorded in the third and fourth quarters of Fiscal 2019, respectively. These inventory adjustmentswere the outcome of new management’s requirement to complete an in-depth review of the inventory, with standards of the review focused on morecurrent turnover. This review was driven by the organizational changes to the business models for the Company’s three product lines as a result of theoverall reorganization efforts. Additional reduction in inventory is a reflection of the Company’s efforts to streamline inventory purchases as theyfocus on increased turns and lean purchasing.Other items that impacted working capital included the changes in accounts receivable, customer deposits and prepayments and other accruedliabilities. At May 31, 2019, accounts receivable decreased $50,792 to $1,996,240 compared to $2,047,032 as of May 31, 2018. The decrease inaccounts receivable was due to the timing of collections. Customer deposits and prepayments, which fluctuate from period to period depending on thenature of the customer orders and their credit profile, decreased from $249,579 at May 31, 2018 to $188,236 at May 31, 2019. Other accrued liabilitiesincreased $109,057 to $218,268 at May 31, 2019 compared to $109,211 at May 31, 2018. This increase was driven by the short-term financing of thepurchased enterprise resource planning software, with the remainder of the increase due to amounts owing for services rendered in Fiscal 2019 forwhich invoices had not yet been received.Cash used in operating activities was $716,613 in Fiscal 2019 as compared to cash used in operating activities of $1,002,849 and $148,288 in Fiscal2018 and Fiscal 2017, respectively. The net loss and decrease in the accounts payable balance were the primary drivers of the overall operating cashusage for Fiscal 2019. The most significant component of the cash used in operating activities for Fiscal 2018 was the cash used for the investment ininventory, which occurred after the successful completion of the Rights Offering in December 2017. The amount of cash used in operating activities forFiscal 2017 was primarily impacted by the amount of net loss and the increase in accounts receivable, offset by decreases in inventories and increasesin accounts payable.Net cash used in investing activities of $6,473, $6,967 and $98 for Fiscal 2019, 2018 and 2017, respectively, includes purchases of computers andother office-related equipment. Fiscal 2017 also includes the results of the purchase of one vehicle and the proceeds from the disposition of twovehicles.Net cash provided by financing activities of $52,122 for the year ended May 31, 2019 was primarily due to the proceeds associated with the exercise ofoptions for the issuance of common stock. On December 20, 2017, the Company completed its Subscription Rights Offering (the “Rights Offering”) inwhich 998,635 common shares were issued, resulting in proceeds to the Company, net of expenses, of $2,386,029 which is reflected in net cashprovided by financing activities for the year ended May 31, 2018. Pursuant to the Rights Offering, the Company issued one right for each commonshare to shareholders of record as of November 27, 2017. Holders of the rights were entitled to purchase common shares by submitting three rights and$2.50 for each share to be purchased. The new shares were issued on December 27, 2017.We believe that our existing cash balances combined with the cash we anticipate to generate from operating activities and financing available fromother sources will be sufficient to meet our cash requirements for the foreseeable future. We do not have any significant commitments nor are we awareof any significant events or conditions that are likely to have a material impact on our liquidity or capital resources. Page 22Table of ContentsQUARTERLY FINANCIAL DATAIn thousands, except per share information (unaudited) 2019 Quarter Ended August31 November30 February28 May 31 Consolidate revenue $3,440 $3,503 $3,082 $3,785 Gross profit $1,340 $1,363 $1,012 $1,274 Net loss $(212) $(255) $(475) $(269) Net loss per share, basic $(0.05) $(0.06) $(0.12) $(0.07) Net loss per share, diluted $(0.05) $(0.06) $(0.12) $(0.07) 2018 Quarter Ended August31 November30 February28 May31 Consolidate revenue $3,084 $3,771 $3,239 $3,794 Gross profit $1,400 $1,726 $1,322 $1,617 Net income (loss) $(134) $103 $16 $226 Net income (loss) per share, basic $(0.04) $0.03 $0.00 $0.07 Net income (loss) per share, diluted $(0.04) $0.03 $0.00 $0.07 Critical Accounting PoliciesRevenue Recognition – The Company determines the amount of revenue it recognizes associated with the transfer of each product or service. For salesof products or delivery of monitoring services to all customers, each transaction is evaluated to determine whether there is approval and commitmentfrom both the Company and the customer for the transaction; whether the rights of each party are specifically identified; whether the transaction hascommercial substance; whether collectability from the customer is probable at the inception of the contract and whether the transaction amount isdefined. If a transaction to sell products or provide monitoring services meets all of the above criteria, revenue is recognized for the sales of product atthe time of shipment or for monitoring services at the completion of the month in which monitoring services are provided.The Company incurs commissions associated with the sales of products, which are accrued and expensed at the time the product is shipped. Theseamounts are recorded within general, administration and sales expense. The Company also incurs costs related to shipping and handling of itsproducts, the costs of which are expensed as incurred as a component of cost of sales. Shipping and handling fees billed to customers are recognized atthe time of shipment as a component of net revenues.Allowance for Doubtful Accounts – The Company maintains credit limits for all customers based upon several factors, including but not limited tofinancial condition and stability, payment history, published credit reports and use of credit references. Management performs various analyses toevaluate accounts receivable balances to ensure recorded amounts reflect estimated net realizable value. This review includes accounts receivableagings, other operating trends and relevant business conditions, including general economic factors, as they relate to the Company’s domestic andinternational customers. In the event there is doubt about whether a customer’s account is collectible, a reserve is provided. If these analyses leadmanagement to the conclusion that the customer’s account is uncollectible, the balance will be directly charged to bad debt expense.Inventories – Inventories are valued at the lower of cost or net realizable value with cost determined on the average cost basis. Costs included ininventories consist of materials, labor and manufacturing overhead, which are related to the purchase or production of inventories. Write-downs, whenrequired, are made to reduce excess inventories to their net realizable values. Such estimates are based on assumptions regarding future demand andmarket conditions. If actual conditions become less favorable than the assumptions used, an additional inventory write-down may be required. Page 23Table of ContentsDeferred Taxes – The Company applies the asset and liability method in recording income taxes, under which deferred income tax assets and liabilitiesare determined, based on the differences between the financial reporting and tax bases of assets and liabilities and are measured using currently enactedtax rates and laws. Additionally, deferred tax assets are evaluated, and a valuation allowance is established if it is more likely than not that all or aportion of the deferred tax asset will not be realized. Management continues to review the level of the valuation allowance on a quarterly basis. Therecan be no assurance that 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 thecarrying amount of the asset may not be recoverable. Recoverability is determined by comparing the forecasted future undiscounted net cash flowsfrom the operations to which the assets relate, based on management’s best estimates using the appropriate assumptions and projections at the time, tothe carrying amount of the assets. If the carrying value is determined to be in excess of future operating cash flows, the asset is considered impaired anda loss is recognized equal to the amount by which the carrying amount exceeds the estimated fair value of the assets.Recent Accounting PronouncementsRefer to Note 2 of the Notes to Consolidated Financial Statements for a discussion of recent accounting pronouncements. ITEM 7A.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKInterest Rate RiskThe Company did not have any derivative financial instruments as of May 31, 2019. However, the Company could be exposed to interest rate risk atany time in the future and, therefore, employs established policies and procedures to manage its exposure to changes in the market risk of its cashequivalents.The Company’s interest income and expense are most sensitive to changes in the general level of U.S. interest rates. In this regard, changes in the U.S.interest rates affect the interest earned on the Company’s interest bearing cash equivalents and short term investments. The Company has no creditline or other long-term obligations whose interest rates are based on variable rates that may fluctuate over time based on economic changes in theenvironment. Therefore, at this time, the Company is not subject to interest rate risk on outstanding interest bearing obligations if market interest ratesfluctuate and does not expect any change in the interest rates to have a material effect on the Company’s results from operations.Foreign Currency RiskThe Company markets and sells its products worldwide and international sales have accounted for and are expected to continue to account for asignificant portion of future revenue. The Company operates a subsidiary in the United Kingdom and acquires certain materials and services fromvendors transacted in foreign currencies. Therefore, the Company’s business and financial condition is sensitive to currency exchange rates or anyother restrictions imposed on their currencies. Results of operations included foreign exchange gains/(losses) of $(89,162), $72,216 and $(63,744) forFiscal 2019, 2018 and 2017, respectively. The foreign exchange gains or losses are primarily attributable to Company’s United Kingdom subsidiary,Schmitt Europe, Ltd. Page 24Table of ContentsItem 8.Financial Statements and Supplementary DataSCHMITT INDUSTRIES, INC.CONSOLIDATED BALANCE SHEETS May 31, 2019 May 31, 2018 ASSETS Current assets Cash and cash equivalents $1,411,732 $2,053,181 Restricted cash 55,703 58,352 Accounts receivable, net 1,996,240 2,047,032 Inventories 5,019,044 5,710,888 Prepaid expenses 150,975 148,924 8,633,694 10,018,377 Property and equipment, net 839,374 770,915 Other assets Intangible assets, net 392,185 496,768 TOTAL ASSETS $9,865,253 $11,286,060 LIABILITIES & STOCKHOLDERS’ EQUITY Current liabilities Accounts payable $496,362 $1,024,256 Accrued commissions 200,116 194,797 Accrued payroll liabilities 239,476 188,568 Customer deposits and prepayments 188,236 249,579 Other accrued liabilities 218,268 109,211 Income taxes payable 491 3,993 Current portion of long-term liabilities 20,828 0 Total current liabilities 1,363,777 1,770,404 Long-term liabilities 28,543 0 Commitments and contingencies (Note 4) Stockholders’ equity Common stock, no par value, 20,000,000 shares authorized, 4,032,878 shares issued and outstanding at May31, 2019 and 3,994,545 shares issued and outstanding at May 31, 2018 13,245,439 13,085,652 Accumulated other comprehensive loss (527,827) (536,307) Accumulated deficit (4,244,679) (3,033,689) Total stockholders’ equity 8,472,933 9,515,656 TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY $9,865,253 $11,286,060 The accompanying notes are an integral part of these consolidated financial statements. Page 25Table of ContentsSCHMITT INDUSTRIES, INC.CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) Year Ended May 31, 2019 2018 2017 Net sales $13,810,161 $13,888,063 $12,397,643 Cost of sales 8,836,856 7,822,749 7,511,836 Gross profit 4,973,305 6,065,314 4,885,807 Operating expenses: General, administration and sales 5,951,765 5,582,625 5,618,327 Research and development 129,040 327,317 256,164 Total operating expenses 6,080,805 5,909,942 5,874,491 Operating income (loss) (1,107,500) 155,372 (988,684) Other income (expense), net (77,051) 81,182 (56,671) Income (loss) before income taxes (1,184,551) 236,554 (1,045,355) Provision for income taxes 26,439 25,915 28,009 Net income (loss) $(1,210,990) $210,639 $(1,073,364) Net income (loss) per common share, basic $(0.30) $0.06 $(0.36) Weighted average number of common shares, basic 4,005,795 3,422,724 2,995,910 Net income (loss) per common share, diluted $(0.30) $0.06 $(0.36) Weighted average number of common shares, diluted 4,005,795 3,460,339 2,995,910 Comprehensive income (loss) Net income (loss) $(1,210,990) $210,639 $(1,073,364) Foreign currency translation adjustment 8,480 (108,735) (33,054) Total comprehensive income (loss) $(1,202,510) $101,904 $(1,106,418) The accompanying notes are an integral part of these consolidated financial statements. Page 26Table of ContentsSCHMITT INDUSTRIES, INC.CONSOLIDATED STATEMENTS OF CASH FLOWS Year Ended May 31, 2019 2018 2017 Cash flows relating to operating activities Net income (loss) $(1,210,990) $210,639 $(1,073,364) Adjustments to reconcile net income (loss) to net cash used in operating activities: Depreciation and amortization 188,348 205,239 219,082 (Gain) loss on disposal of property and equipment 0 619 (7,223) Stock based compensation 94,621 50,336 79,765 Inventory adjustment 597,548 0 0 (Increase) decrease in: Accounts receivable 24,538 311,433 (272,506) Inventories 96,610 (1,494,009) 478,532 Prepaid expenses (3,119) (32,463) 14,267 Income taxes receivable 0 7,310 1,122 Increase (decrease) in: Accounts payable (523,410) (78,049) 230,242 Accrued liabilities and customer deposits and prepayments 22,743 (187,897) 181,795 Income taxes payable (3,502) 3,993 0 Net cash used in operating activities (716,613) (1,002,849) (148,288) Cash flows relating to investing activities Purchase of property and equipment (6,473) (8,467) (52,633) Proceeds from sale of property and equipment 0 1,500 52,535 Net cash used in investing activities (6,473) (6,967) (98) Cash flows relating to financing activities Common stock issued through rights offering, net of expenses 0 2,386,029 0 Payments on long-term liabilities (13,044) 0 0 Common stock issued through exercise of options 65,166 0 0 Net cash provided by financing activities 52,122 2,386,029 0 Effect of foreign exchange translation on cash 26,866 (132,287) 27,307 Increase (decrease) in cash and cash equivalents (644,098) 1,243,926 (121,079) Cash, cash equivalents and restricted cash, beginning of period 2,111,533 867,607 988,686 Cash, cash equivalents and restricted cash, end of period $1,467,435 $2,111,533 $867,607 Supplemental disclosure of non-cash investing and financing activities Acquisition of property and equipment through financed payables $145,784 $0 $0 Supplemental disclosure of cash flow information Cash paid during the year for income taxes $29,940 $14,661 $27,772 Cash paid during the year for interest $12,160 $1,401 $2,982 The accompanying notes are an integral part of these consolidated financial statements. Page 27Table of ContentsSCHMITT INDUSTRIES, INC.CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY Shares Amount Accumulatedothercomprehensiveloss Retainedearnings Total Balance, May 31, 2016 2,995,910 $10,569,522 $(394,518) $(2,170,964) $8,004,040 Stock based compensation 0 79,765 0 0 79,765 Net loss 0 0 0 (1,073,364) (1,073,364) Other comprehensive loss 0 0 (33,054) 0 (33,054) Balance, May 31, 2017 2,995,910 10,649,287 (427,572) (3,244,328) 6,977,387 Stock based compensation 0 50,336 0 0 50,336 Common stock issued in connection with rights offering, netof expenses 998,635 2,386,029 0 0 2,386,029 Net income 0 0 0 210,639 210,639 Other comprehensive loss 0 0 (108,735) 0 (108,735) Balance, May 31, 2018 3,994,545 13,085,652 (536,307) (3,033,689) 9,515,656 Stock options exercised net of related tax benefit of $0 38,333 65,166 0 0 65,166 Stock-based compensation 0 94,621 0 0 94,621 Net loss 0 0 0 (1,210,990) (1,210,990) Other comprehensive income 0 0 8,480 0 8,480 Balance, May 31, 2019 4,032,878 $13,245,439 $(527,827) $(4,244,679) $8,472,933 The accompanying notes are an integral part of these consolidated statements. Page 28Table of ContentsSchmitt Industries, Inc.NOTES TO CONSOLIDATED FINANCIAL STATEMENTSFOR THE YEARS ENDED MAY 31, 2019, 2018 AND 2017NOTE 1:THE COMPANYSchmitt was founded in 1987 to provide reliable solutions for in-process dynamic balancing of precision grinding machines. The Schmitt DynamicBalance System (“SBS”) was created to serve this precision grinding industry. The SBS systems can detect and dynamically correct vibration as low as0.02 microns to ensure product quality, and the SBS acoustic emission sensors help grinding machine operators maximize the efficiency of thegrinding process, thereby increasing part throughput and lowering operating costs.The Company’s family of products was expanded in June 2000 with the acquisition of the Acuity™ line of dimensional and distance measurementlasers. These laser products utilize both triangulation and time-of-flight measurement principles and are known for their speed and accuracy. TheAcuity products are used in a wide variety of industrial, commercial and research applications.In 2007, the Company purchased Xact™ ultrasonic measurement technology for the remote monitoring of the fill levels of propane and other liquidtanks. Together with the Xact gauge reader, the satellite-focused Xact systems can detect and communicate fill levels, along with other informationsuch as tank size and configuration, to customers through the “Internet of Things” ecosystem using our satellite provider and a secure website. Typicalusers of Xact systems are bulk propane, diesel, jet fuel suppliers and ammonia users and distributors.The Company was originally incorporated under the laws of British Columbia, Canada, in 1984 and was reincorporated under the laws of the State ofOregon in 1995. Schmitt is an ISO 9001 certified company.We serve our customers and organize our business through the following reportable segments: • Balancer (“Balancer”) Segment. The principle product for the Balancer segment is the SBS product line, which designs, manufacturesand sells computer-controlled vibration detection, balancing and process control systems for the worldwide machine tool industry,particularly for grinding machines. • Measurement (“Measurement”) Segment. Through its wholly owned subsidiary, Schmitt Measurement Systems, Inc., the Measurementsegment manufacturers and sells products in two core product lines, Acuity and Xact: – Acuity sells products, solutions and services that includes laser and white light sensor distance, measurement and dimensionalsizing products; – Xact includes satellite focused remote tank monitoring products and related monitoring services for markets in the Internet ofThings (“IoT”) environment. The Xact products measure the fill levels of tanks holding propane, diesel and other tank-basedliquids and the related monitoring services, which includes transmission of fill data from the tanks via satellite to a secure web sitefor display.NOTE 2:SIGNIFICANT ACCOUNTING POLICIESPrinciples of ConsolidationThese consolidated financial statements include those of the Company and its wholly owned subsidiaries: Schmitt Measurement Systems, Inc., SchmittEurope, Ltd. and Schmitt Industries (Canada) Limited. All significant intercompany accounts and transactions have been eliminated in the preparationof the consolidated financial statements. Page 29Table of ContentsSchmitt Industries, Inc.NOTES TO CONSOLIDATED FINANCIAL STATEMENTSFOR THE YEARS ENDED MAY 31, 2019, 2018 AND 2017 ReclassificationCertain amounts in the prior period consolidated balance sheet have been reclassified to conform to the presentation of the current period. Thesereclassifications had no effect on the statement of operations, comprehensive income (loss) or cash flows.Revenue RecognitionOn June 1, 2018, the Company adopted Accounting Standards Update (ASU) No. 2014-09, “Revenue from Contracts with Customers (Topic 606)”using the modified retrospective approach. The adoption of this standard did not have a material impact on the Company’s consolidated financialstatements or related disclosures.The Company determines the amount of revenue it recognizes associated with the transfer of each product or service. For sales of products or deliveryof monitoring services to all customers, each transaction is evaluated to determine whether there is approval and commitment from both the Companyand the customer for the transaction; whether the rights of each party are specifically identified; whether the transaction has commercial substance;whether collectability from the customer is probable at the inception of the contract and whether the transaction amount is defined. If a transaction tosell products or provide monitoring services meets all of the above criteria, revenue is recognized for the sales of product at the time of shipment or formonitoring services at the completion of the month in which monitoring services are provided.The Company incurs commissions associated with the sales of products, which are accrued and expensed at the time the product is shipped. Theseamounts are recorded within general, administration and sales expense. The Company also incurs costs related to shipping and handling of itsproducts, the costs of which are expensed as incurred as a component of cost of sales. Shipping and handling fees billed to customers, which arerecognized at the time of shipment as a component of net revenues, were $202,615, $207,501 and $155,077 for the years ended May 31, 2019, 2018and 2017, respectively.Cash, Cash Equivalents and Restricted CashThe Company generally invests its excess cash in money market funds. The Company’s investment policy also allows for cash to be invested ininvestment grade highly liquid securities, and the Company considers securities that are highly liquid, readily convertible into cash and have originalmaturities of less than three months when purchased to be cash equivalents. The Company’s cash consists of demand deposits in large financialinstitutions. At times, balances may exceed federally insured limits.Restricted cash consists of an amount received from a customer in December 2017 as part of an on-going contract. The services being provided underthis contract are on-going and expected to be completed in the first half of Fiscal 2020. Once the services under this contract are complete andacceptance has been provided by the customer, the restrictions on this advance cash payment will be released.The following table provides a reconciliation of cash and cash equivalents and restricted cash as reported within the Consolidated Balance Sheets as ofMay 31, 2019 and 2018 to the sum of the same such amounts as shown in the Consolidated Statement of Cash Flows for the respective years thenended: 2019 2018 Cash and cash equivalents $1,411,732 $2,053,181 Restricted cash 55,703 58,352 Total cash, cash equivalents, and restricted cash shown in the ConsolidatedStatement of Cash Flows $1,467,435 $2,111,533 Page 30Table of ContentsSchmitt Industries, Inc.NOTES TO CONSOLIDATED FINANCIAL STATEMENTSFOR THE YEARS ENDED MAY 31, 2019, 2018 AND 2017 Accounts ReceivableThe Company maintains credit limits for all customers based upon several factors, including but not limited to financial condition and stability,payment history, published credit reports and use of credit references. Management performs various analyses to evaluate accounts receivable balancesto ensure recorded amounts reflect estimated net realizable value. This review includes using accounts receivable agings, other operating trends andrelevant business conditions, including general economic factors, as they relate to each of the Company’s domestic and international customers. In theevent there is doubt about whether a customer account is collectible, a reserve is provided. If these analyses lead management to the conclusion that acustomer account is uncollectible, the balance will be directly charged to bad debt expense. The allowance for doubtful accounts was $43,388 and$95,207 as of May 31, 2019 and 2018, respectively.InventoriesInventories are valued at the lower of cost or net realizable value with cost determined on the average cost basis. Costs included in inventories consistof materials, labor and manufacturing overhead, which are related to the purchase or production of inventories. Write-downs, when required, are madeto reduce excess inventories to their net realizable values. Such estimates are based on assumptions regarding future demand and market conditions. Ifactual conditions become less favorable than the assumptions used, an additional inventory write-down may be required. As of May 31 inventoriesconsisted of: 2019 2018 Raw materials $2,222,245 $2,796,691 Work-in-process 1,020,683 1,009,424 Finished goods 1,776,116 1,904,773 $5,019,044 $5,710,888 Property and EquipmentProperty and equipment are stated at cost, less depreciation and amortization. Depreciation is computed using the straight-line method over estimateduseful lives of three to seven years for furniture, fixtures, and equipment; three years for vehicles; and twenty-five years for buildings andimprovements. Expenditures for maintenance and repairs are charged to expense as incurred. As of May 31 property and equipment consisted of: 2019 2018 Land $299,000 $299,000 Buildings and improvements 1,814,524 1,814,524 Furniture, fixtures and equipment 1,403,755 1,252,598 Vehicles 44,704 44,704 3,561,983 3,410,826 Less accumulated depreciation (2,722,609) (2,639,911) $839,374 $770,915 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, 2019 and 2018, amortizable intangible Page 31Table of ContentsSchmitt Industries, Inc.NOTES TO CONSOLIDATED FINANCIAL STATEMENTSFOR THE YEARS ENDED MAY 31, 2019, 2018 AND 2017 assets were $2,200,883, and accumulated amortization was $1,808,698 and $1,704,115, respectively. Amortization expense for each of the followingyears ending May 31 is expected to be as follows: Year ending May 31, 2020 $104,583 2021 104,583 2022 104,583 2023 78,436 2024 0 Thereafter 0 $392,185 Intangible and other long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate the carrying amount of theasset may not be recoverable. Recoverability is determined by comparing the forecasted future net cash flows from the operations to which the assetsrelate, based on management’s best estimates using the appropriate assumptions and projections at the time, to the carrying amount of the assets. If thecarrying value is determined to be in excess of future operating cash flows, the asset is considered impaired and a loss is recognized equal to theamount by which the carrying amount exceeds the estimated fair value of the assets. As of May 31, 2019, no impairment existed.Customer deposits and prepaymentsCustomer deposits and prepayments consists of amounts received from customers as prepayments for orders that have been received and have beenproduced but have not yet shipped, credit balances for items returned by customers for which refunds have not yet been provided and deposits made bycustomers in advance of production. For the years ended May 31, 2019 and 2018, the balance also includes an amount received from a customer inDecember 2017 as part of an on-going contract. The services being provided under this contract are expected to be completed in the first half of Fiscal2020, at which time the amount will be considered to be earned.Other accrued liabilitiesOther accrued liabilities include an accrual for warranty reserve and sales return reserve, amount financed on a short-term arrangement for the purchaseof the Company’s new enterprise resource planning software and amounts owing under various professional fee contracts for which invoices have notyet been received. Page 32Table of ContentsSchmitt Industries, Inc.NOTES TO CONSOLIDATED FINANCIAL STATEMENTSFOR THE YEARS ENDED MAY 31, 2019, 2018 AND 2017 Long-term liabilities and current portion of long-term liabilitiesLong-term liabilities consist of a financing arrangement executed for the purchase of certain property and equipment over a term of 36 months. Futureminimum commitments under this agreement for the each of the years ending May 31 are as follows: Years ending May 31, 2020 $24,105 2021 24,105 2022 6,009 2023 0 2024 0 Total future minimum payments 54,219 Less: amount representing interest (4,848) Present value of minimum payments of long-term liabilities $49,371 Current portion of long-term liabilities 20,828 Long-term liabilities 28,543 $49,371 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 componentof stockholders’ 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 $28,187,$71,280 and $30,500 for the years ended May 31, 2019, 2018 and 2017, 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 ofwarranty claims for each particular product type. For new product types without a warranty history, preliminary estimates are based on historicalinformation for similar product types. The warranty reserve accruals, included in other accrued liabilities, are reviewed periodically and updated basedon warranty trends. Page 33Table of ContentsSchmitt Industries, Inc.NOTES TO CONSOLIDATED FINANCIAL STATEMENTSFOR THE YEARS ENDED MAY 31, 2019, 2018 AND 2017 Stock-Based CompensationStock-based compensation includes expense charges for all stock-based awards to employees and directors granted under the Company’s stock optionplan. The Company requires the measurement and recognition of compensation for all stock-based awards made to employees and directors includingstock options 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,based on the differences between the financial reporting and tax bases of assets and liabilities and are measured using currently enacted tax rates andlaws. 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 noassurance that the Company’s future operations will produce sufficient earnings so that the deferred tax asset can be fully utilized. The Companycurrently maintains a full valuation allowance against net deferred tax assets.Earnings (Loss) Per ShareBasic earnings (loss) per share is computed using the weighted average number of common shares outstanding. Diluted earnings (loss) per share iscomputed using the weighted average number of common shares outstanding, adjusted for dilutive incremental shares attributed to outstandingoptions to purchase common stock. Common stock equivalents for stock options are computed using the treasury stock method. In periods in which anet loss is incurred, no common stock equivalents are included since they are antidilutive and as such all stock options outstanding are excluded fromthe computation of diluted net loss in those periods. 43,751, 0 and 0 potentially dilutive common shares from outstanding stock options have beenexcluded from diluted earnings (loss) per share for the years ended May 31, 2019, 2018 and 2017, respectively.Concentration of Credit RiskFinancial instruments that potentially expose the Company to concentration of credit risk are trade accounts receivable. Credit terms generally requirean invoice to be paid within 30 to 60 days or include a discount of up to 1.5% if the invoice is paid within ten days, with the net amount payable in 30days. Terms are set for each account depending on the customer’s credit standing with the Company.Financial InstrumentsThe carrying value of all other financial instruments potentially subject to valuation risk (principally consisting of cash and cash equivalents, accountsreceivable, accounts payable and the current portion of long-term liability) 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 costof sales. Shipping and handling charges related to the receipt of raw materials are also incurred, which are recorded as a cost of the related inventory. Page 34Table of ContentsSchmitt Industries, Inc.NOTES TO CONSOLIDATED FINANCIAL STATEMENTSFOR THE YEARS ENDED MAY 31, 2019, 2018 AND 2017 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 accompanyingnotes. Actual results could differ from those estimates.Recent Accounting PronouncementsIn February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), in order to increase transparency and comparability among organizations byrecognizing lease assets and lease liabilities on the balance sheet for most leases previously classified as operating leases. Subsequent amendmentshave been issued by the FASB to clarify the codification and to correct unintended application of the new guidance. The ASU is required to be appliedusing a retrospective approach with two disclosure methods permissible. The full retrospective approach requires that the guidance be applied to eachlease that existed at the beginning of the earliest comparative period presented. The modified retrospective approach requires that the guidance beapplied to each lease that existed as of the beginning of the reporting period in which the entity first applied the standard. The Company will adopt thenew standard on June 1, 2019 using the modified retrospective approach. The Company is substantially complete with its lease contract and businessprocess review to support recognition and disclosures under this new guidance. Based on these efforts, the Company expects the adoption will notresult in a material increase in the assets and liabilities on its Consolidated Balance Sheets and is not expected to have a material effect on the results ofoperations or cash flows.NOTE 3:INCOME TAXESOn December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “TaxAct”). The Tax Act made broad and complex changes to the U.S. tax code by reducing the U.S. federal corporate tax rate from 34 percent to 21 percent,requiring companies to pay a one-time transition tax on certain unrepatriated earnings of foreign subsidiaries, generally eliminating U.S. federalincome taxes on dividends from foreign subsidiaries, creating a new limitation on deductible interest expense and changing rules related to uses andlimitations of net operating loss carryforwards created in tax years beginning after December 31, 2017.The SEC staff subsequently issued Staff Accounting Bulletin 118 (“SAB 118”), which provides a one-year measurement for companies to complete theaccounting for the effects of the Tax Act. In accordance with SAB 118, where accounting is complete, a company must reflect the income tax effects ofthose aspects, but to the extent that a company’s accounting is incomplete but a reasonable estimate may be made, a provisional estimate should berecorded in the financial statements. Where a company is unable to determine a provisional estimate, SAB 118 permits application of the tax laws thatwere in effect immediately before the enactment.Due to the reduction of the corporate tax rate as part of the Tax Act, the Company recorded during the third quarter of Fiscal 2018 a provisionaldecrease to deferred tax assets of $780,195 and corresponding decrease to the valuation allowance. The change in tax rate did not impact tax expensedue to the valuation allowance recorded against the net deferred tax asset.The Act also provided for a tax on the deemed repatriation of previously untaxed accumulated earnings and profits of foreign subsidiaries. TheCompany was not subject to this tax due to an accumulated loss in the Company’s foreign subsidiary. Page 35Table of ContentsSchmitt Industries, Inc.NOTES TO CONSOLIDATED FINANCIAL STATEMENTSFOR THE YEARS ENDED MAY 31, 2019, 2018 AND 2017 The provision for income taxes is as follows: Year ended May 31, 2019 2018 2017 Current $26,439 $25,915 $28,009 Deferred 329,035 (808,548) 356,169 Change in valuation allowance (329,035) 808,548 (356,169) Total provision for income taxes $26,439 $25,915 $28,009 Deferred tax assets are comprised of the following components: 2019 2018 Basis difference of assets $182,654 $202,763 Inventory related items 169,585 189,893 Other reserves and liabilities 74,694 87,519 Net operating loss carryforward 1,507,141 1,136,358 General business and other credit carryforward 489,327 456,343 Other deferred items, net 7,692 29,182 Gross deferred tax assets 2,431,093 2,102,058 Deferred tax asset valuation allowance (2,431,093) (2,102,058) 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 willnot be realized. The Company has recorded a substantial deferred tax asset related to temporary differences between book and tax bases of assets andliabilities. During the year ended May 31, 2019, the Company increased its valuation allowance $329,035 as a result of the increase in the Company’sdeferred tax assets most of which was due to the increase in net operating losses carryforwards generated by the Fiscal 2019 results. During the yearended May 31, 2018, the Company decreased its valuation allowance $808,548 as a result of the decrease in the Company’s deferred tax assets due tothe impact of the reduction of the corporate rate as part of the Tax Act and income generated in Fiscal 2018. During year ended May 31, 2017, theCompany increased its valuation allowance $356,169 as a result of the increase in the Company’s deferred tax assets. The Company has provided a fullvaluation allowance against all of its deferred tax assets as the recent losses have been given more weight than projected future income whendetermining the need for a valuation allowance.The Company has federal net operating loss carryforwards of approximately $5.6 million which begin to expire in 2030 along with the federal generalbusiness and other credit carryforwards. The Company has state net operating loss carryforwards of approximately $6.1 million which begin to expirein 2024. Page 36Table of ContentsSchmitt Industries, Inc.NOTES TO CONSOLIDATED FINANCIAL STATEMENTSFOR THE YEARS ENDED MAY 31, 2019, 2018 AND 2017 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 tothe following: Year ended May 31, 2019 2018 2017 Statutory federal tax rate 21.0% 28.6% 34.0% State taxes, net of federal benefit 5.3 2.6 4.4 Change in deferred tax valuation allowance (25.7) (350.8) (34.1) Impact of Tax Act 0.0 329.8 0.0 Stock-based compensation (1.8) 6.6 (2.2) R&E tax credits 1.8 1.6 (1.6) Effect of foreign income tax rates (3.4) 1.3 0.3 Deferred tax true-up 4.1 (12.6) (1.8) State minimum taxes (1.0) 5.1 (1.1) Permanent and other differences (2.5) (1.2) (0.6) Effective tax rate (2.2)% 11.0% (2.7)% Each year the Company files income tax returns in the various federal, state and local income taxing jurisdictions in which it operates. These taxreturns are subject to examination and possible challenge by the taxing authorities. Positions challenged by the taxing authorities may be settled orappealed by the Company. As a result, there is an uncertainty in income taxes recognized in the Company’s financial statements in accordance withASC Topic 740. The Company applies this guidance by defining criteria that an individual income tax position must meet for any part of the benefit ofthat position to be recognized in an enterprise’s financial statements and provides guidance on measurement, derecognition, classification, accountingfor interest and penalties, accounting in interim periods, disclosure, and transition. The liability for unrecognized tax benefits was $0 as of May 31,2019 and 2018.Interest and penalties associated with uncertain tax positions are recognized as components of the “Provision for income taxes.” The liability forpayment of interest and penalties was $0 as of May 31, 2019 and 2018.Several tax years are subject to examination by major tax jurisdictions. In the United States, federal tax years for the years ended May 31, 2016 andafter are subject to examination. In the United Kingdom, tax year for the year ended May 31, 2018 is subject to examination.NOTE 4:COMMITMENTS 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, 2019 and 2018. The leaseended in May 2019 and the ownership for the asset was transferred to the Company in June 2019 when the Company executed the buy-out option forthe lease.The Company leases certain vehicles and equipment to support operations under non-cancelable operating leases and other contractual obligations.Total lease expense under operating leases for the years ended May 31, 2019, 2018 and 2017 amounted to $49,349, $47,829 and $47,695,respectively. The Company also has certain office leases that are currently month-to-month. Page 37Table of ContentsSchmitt Industries, Inc.NOTES TO CONSOLIDATED FINANCIAL STATEMENTSFOR THE YEARS ENDED MAY 31, 2019, 2018 AND 2017 The future minimum commitments under operating leases for each of the years ending May 31 are as follows: Year ending May 31, 2020 $43,039 2021 19,080 2022 19,080 2023 15,900 2024 0 Thereafter 0 In a transaction related to the acquisition of Schmitt Measurement Systems, Inc., formerly TMA Technologies, Inc. (“TMA”), the Company establisheda royalty pool and vested in each shareholder and debt holder of the acquired company an interest in the royalty pool equal to the amount invested orloaned including interest payable through March 1995. The royalty pool is funded at 5% of net sales (defined as gross sales less returns, allowancesand sales commissions) of the Company’s surface measurement products and future derivative products developed by Schmitt Industries, Inc., whichutilize these technologies. As part of the royalty pool agreement, each former shareholder and debt holder released TMA from any claims with regard tothe acquisition except their rights to future royalties. Royalty expense applicable to the years ended May 31, 2019, 2018 and 2017 amounted to$1,126, $1,527 and $15,407, respectively.NOTE 5:SEGMENT INFORMATIONThe Company has two reportable business segments, Balancer and Measurement. Balancer focuses on dynamic balancing and process control systemsfor the machine tool industry and Measurement focuses on laser-based test and measurement systems and ultrasonic measurement products. TheCompany operates in three principal geographic markets: North America, Europe and Asia. Year Ended May 31, 2019 2018 2017 Balancer Measurement Balancer Measurement Balancer Measurement Net revenues $9,080,719 $4,729,442 $9,026,830 $4,861,233 $7,082,474 $5,315,169 Operating income (loss) $(1,508,058) $400,558 $(50,686) $206,058 $(931,770) $(56,914) Depreciation expense $47,768 $35,997 $63,390 $37,266 $70,018 $37,534 Amortization expense $0 $104,583 $0 $104,583 $0 $111,530 Capital expenditures $152,257 $0 $4,353 $4,114 $46,495 $6,138 Inventory adjustments of $(384,295) for the Balancer segment and $(213,253) for the Measurement segment are included in operating income (loss) forFiscal 2019. Page 38Table of ContentsSchmitt Industries, Inc.NOTES TO CONSOLIDATED FINANCIAL STATEMENTSFOR THE YEARS ENDED MAY 31, 2019, 2018 AND 2017 Geographic Information Year Ended May 31, 2019 2018 2017 North America $8,217,025 $8,371,376 $8,162,340 Europe 2,094,627 2,258,495 1,451,293 Asia 3,327,352 3,122,484 2,500,191 Other markets 171,157 135,708 283,819 Total net revenues $13,810,161 $13,888,063 $12,397,643 Year Ended May 31, 2019 2018 2017 United States(2) Europe(1) United States(2) Europe(1) United States(2) Europe(1) Operating income (loss) $(1,290,664) $183,164 $(225,594) $380,966 $(947,514) $(41,170) Depreciation expense $83,765 $0 $100,656 $0 $107,552 $0 Amortization expense $104,583 $0 $104,583 $0 $111,530 $0 Capital expenditures $152,257 $0 $8,467 $0 $52,633 $0 (1)“Europe” is defined in the above chart to include results from the European subsidiary, Schmitt Europe Ltd.(2)“United States” is defined to include remainder of the results not included in the results from the European subsidiary.Segment and Geographic Assets May 31, 2019 May 31, 2018 Segment assets to total assets Balancer $5,805,796 $6,461,974 Measurement 2,592,022 2,712,553 Corporate assets 1,467,435 2,111,533 Total assets $9,865,253 $11,286,060 Geographic assets to long-lived assets United States(2) $837,228 $770,915 Europe (1) 2,146 0 Total assets $839,374 $770,915 Geographic assets to total assets United States(2) $8,578,770 $10,110,683 Europe(1) 1,286,483 1,175,377 Total assets $9,865,253 $11,286,060 (1)“Europe” is defined in the above chart to include assets held by the European subsidiary, Schmitt Europe Ltd.(2)“United States” is defined to include the remainder of the assets not held by the European subsidiary. Page 39Table of ContentsSchmitt Industries, Inc.NOTES TO CONSOLIDATED FINANCIAL STATEMENTSFOR THE YEARS ENDED MAY 31, 2019, 2018 AND 2017 NOTE 6:STOCKHOLDER RIGHTS AGREEMENTOn July 1, 2019, the Company entered into a Section 382 Rights Agreement with Broadridge Corporate Issuer Solutions, Inc., as Rights Agent (the“Rights Agreement”) in an effort to protect stockholder value by attempting to diminish the risk that the Company’s ability to use its net operatinglosses (“NOLs”) to reduce U.S. taxable income and tax liabilities in future taxable periods may become substantially limited.The Rights Agreement is intended to act as a deterrent to any person acquiring beneficial ownership of 4.9% or more of the Company’s outstandingcommon stock, no par value (“Common Stock”) without the approval of the Company’s Board of Directors (the “Board”). Stockholders whobeneficially own 4.9% or more of the outstanding Common Stock as of the close of business on July 1, 2019 will not trigger the Rights Agreement solong as they do not acquire beneficial ownership of additional shares of Common Stock representing 0.5% or more of the outstanding Common Stock(other than pursuant to a dividend or distribution paid or made by the Company on the outstanding shares of Common Stock or pursuant to a split orsubdivision of the outstanding shares of Common Stock) at a time when they still beneficially own 4.9% or more of the outstanding Common Stock. Inaddition, the Board retains the sole discretion to exempt any person or group from the penalties imposed by the Rights Agreement.The Board remains open to all alternatives to maximize stockholder value, and may in its sole discretion, exempt a proposed acquisition of CommonStock from the Rights Agreement, including if it determines that the acquisition is in the Company’s best interests, or if it will not jeopardize the TaxBenefits. The Rights Agreement is not expected to interfere with any merger or other business combination approved by the Board.The Board authorized the issuance of one right (a “Right”) for each outstanding share of Common Stock payable to stockholders of record as of theclose of business on July 19, 2019 (the “Record Date”). One Right will also be issued together with each share of the Company’s Common Stock issuedafter the Record Date but before the Distribution Date (as defined below) and, in certain circumstances, after the Distribution Date. Subject to the terms,provisions and conditions of the Rights Agreement, if the Rights become exercisable, each Right would initially represent the right to purchase fromthe Company one one-thousandth of a share of Series A Junior Participating Preferred Stock, no par value, of the Company (the “Series A PreferredStock”) for a purchase price of $11.25 (the “Purchase Price”). If issued, each one-thousandth of a share of Series A Preferred Stock would give thestockholder approximately the same dividend, voting and liquidation rights as does one share of Common Stock. However, prior to exercise, a Rightdoes not give its holder any rights as a stockholder of the Company, including, without limitation, any dividend, voting or liquidation rights.The Rights will not be exercisable until the earlier of (i) ten business days after a public announcement that a person has become an “AcquiringPerson” by acquiring beneficial ownership of 4.9% or more of outstanding Common Stock (or, in the case of a person that had beneficial ownership of4.9% or more of the outstanding Common Stock as of the close of business on July 1, 2019, by obtaining beneficial ownership of any additional sharesof Common Stock representing 0.5% or more of the shares of Common Stock then outstanding (other than pursuant to a dividend or distribution paidor made by the Company on the outstanding shares of the Common Stock or pursuant to a split or subdivision of the outstanding shares of CommonStock) at a time such person still beneficially owns 4.9% or more of the outstanding Common Stock), and (ii) ten business days (or such later date asmay be specified by the Board prior to such time as any person becomes an Acquiring Person) after the commencement of a tender or exchange offer byor on behalf of a person that, if completed, would result in such person becoming an Acquiring Person (the “Distribution Date”). Page 40Table of ContentsSchmitt Industries, Inc.NOTES TO CONSOLIDATED FINANCIAL STATEMENTSFOR THE YEARS ENDED MAY 31, 2019, 2018 AND 2017 Until the Distribution Date, Common Stock certificates or the ownership statements issued with respect to uncertificated shares of Common Stock willevidence the Rights. Any transfer of shares of Common Stock prior to the Distribution Date will also constitute a transfer of the associated Rights. Afterthe Distribution Date, separate rights certificates will be issued and the Rights may be transferred other than in connection with the transfer of theunderlying shares of Common Stock unless and until the Board has determined to effect an exchange pursuant to the Rights Agreement (as describedbelow).In the event that a person becomes an Acquiring Person, each holder of a Right, other than Rights that are or, under certain circumstances, werebeneficially owned by the Acquiring Person (which will thereupon become void), will thereafter have the right to receive upon exercise of a Right andpayment of the Purchase Price, a number of shares of the Company’s Common Stock (or, in certain circumstances, cash, property or other securities ofthe Company) having a market value equal to two times the Purchase Price. However, Rights are subject to redemption and exchange at the option ofthe Company.In the event that, at any time following a person becoming an Acquiring Person, (i) the Company engages in a merger or other business combinationtransaction in which the Company is not the surviving corporation; (ii) the Company engages in a merger or other business combination transaction inwhich the Company is the surviving corporation and the Common Stock is changed or exchanged; or (iii) 70% or more of the Company’s assets, cashflow or earning power is sold or transferred, each holder of a Right (except Rights which have previously been voided as set forth below) shallthereafter have the right to receive, upon exercise of the Right, common stock of the acquiring company having a value equal to two times thePurchase Price.At any time until the earlier of July 1, 2022, and ten calendar days following the first date of public announcement that a person has become anAcquiring Person or that discloses information which reveals the existence of an Acquiring Person or such earlier date as a majority of the Boardbecomes aware of the existence of an Acquiring Person, the Board may redeem the Rights in whole, but not in part, at a price of $0.001 per Right (the“Redemption Price”). The redemption of the Rights may be made effective at such time, on such basis and with such conditions as the Board in its solediscretion may establish. Immediately upon any redemption of the Rights, the right to exercise the Rights will terminate and the only right of theholders of Rights will be to receive the Redemption Price.At any time after a person becomes an Acquiring Person, the Board may, at its option, exchange the Rights (other than Rights that have become void),in whole or in part, at an exchange ratio of one share of Common Stock, or a fractional share of Series A Preferred Stock (or of a share of a similar classor series of the Company’s preferred stock having similar rights, preferences and privileges) of equivalent value, per Right (subject to adjustment).Immediately upon an exchange of any Rights, the right to exercise such Rights will terminate and the only right of the holders of Rights will be toreceive the number of shares of Common Stock (or fractional share of Series A Preferred Stock or of a share of a similar class or series of the Company’spreferred stock having similar rights, preferences and privileges) equal to the number of such Rights held by such holder multiplied by the exchangeratio.Each one one-thousandth of a share of Series A Preferred Stock, if issued: (i) will be junior to any other series of preferred stock the Company may issue(unless otherwise provided in the terms of such other series), (ii) will entitle holders to preferential cumulative quarterly dividends in an amount pershare of Series A Preferred Stock equal to the greater of (a) $1 or (b) 1,000 times the aggregate the dividends, if any, declared on one share of theCompany’s Common Stock, (iii) will entitle holders upon liquidation (voluntary or otherwise) to receive $1,000 per share of Series A Preferred Stockplus an amount equal to accrued and unpaid dividends and distributions thereon, whether or not declared, (iv) will have the same voting power as oneshare of Common Stock, and Page 41Table of ContentsSchmitt Industries, Inc.NOTES TO CONSOLIDATED FINANCIAL STATEMENTSFOR THE YEARS ENDED MAY 31, 2019, 2018 AND 2017 (v) will entitle holders to a per share payment equal to the payment made on one share of the Company’s Common Stock, if shares of the CommonStock are exchanged via merger, consolidation, or a similar transaction. Because of the nature of the Series A Preferred Stock’s dividend, liquidationand voting rights, the value of one one-thousandth of a share of Series A Preferred Stock purchasable upon exercise of each Right should approximatethe value of one share of Common Stock.The Rights and the Rights Agreement will expire on the earliest of (i) July 1, 2022, (ii) the time at which the Rights are redeemed pursuant to theRights Agreement, (iii) the time at which the Rights are exchanged in full pursuant to the Rights Agreement, (iv) the date that the Board determinesthat the Rights Agreement is no longer necessary for the preservation of material valuable Tax Benefits, (v) the beginning of a taxable year of theCompany to which the Board determines that no tax benefits may be carried forward, and (vi) a determination by the Board, prior to the time anyPerson becomes an Acquiring Person, that the Rights Agreement and the Rights are no longer in the best interests of the Company and its stockholders.The Board may adjust the Purchase Price, the number of shares of Series A Preferred Stock or other securities or assets issuable and the number ofoutstanding Rights to prevent dilution that may occur as a result of certain events, including among others, a stock dividend, a stock split or areclassification of the Series A Preferred Stock or Common Stock. With certain exceptions, no adjustments to the Purchase Price will be required untilcumulative adjustments amount to at least 1% of the Purchase Price.For so long as the Rights are redeemable, the Board may supplement or amend any provision of the Rights Agreement in any respect without theapproval of the holders of the Rights. From and after the time the Rights are no longer redeemable, the Board may supplement or amend the RightsAgreement only to cure an ambiguity, to alter time period provisions, to correct inconsistent provisions, or to make any additional changes to theRightsAgreement which the Company may deem necessary or desirable, but only to the extent that those changes do not impair or adversely affect any Rightsholder (other than an Acquiring Person or any Affiliate or Associate of an Acquiring Person or certain of their transferees) and do not result in theRights again becoming redeemable or the Rights Agreement again becoming amendable other than in accordance with this sentence.NOTE 7:STOCK BASED COMPENSATIONThe Board of Directors adopted the 2014 Equity Incentive Plan (2014 Plan) in August 2014, the 2004 Stock Option Plan (2004 Plan) in August 2004and the 1995 Stock Option Plan (1995 Plan) in December 1995, which was amended in August 1996 and restated in August 1998. The 2014 Planprovides for the grant of (i) stock options (both nonqualified and incentive stock options), (ii) stock appreciation rights or SARs, (iii) restricted stock,(iv) restricted stock units or RSUs, (v) performance awards, and (vi) other share-based awards. An incentive stock option granted under the 2014 Plan isintended to qualify as an incentive stock option (ISO) and nonstatutory stock options granted under the 2014 Plan are not intended to qualify as anISO. An option granted under the 2004 Plan and/or 1995 Plan (the Plans) might be either an ISO or an NSO. ISOs may be granted only to employeesand members of the Board of Directors of the Company and are subject to certain limitations, in addition to restrictions applicable to all stock optionsunder the Plan. Options not meeting these limitations will be treated as NSOs. The purchase price of ISOs is fair market value on the date of grant; thepurchase price of NSOs may vary from fair market value. Vesting is at the discretion of the compensation committee of the Board of Directors, butvesting schedules have generally been established as 50% at grant date and 16.7% on each anniversary thereafter; 25% at grant date and 25% on eachanniversary thereafter or 0% at grant date and 33% on each anniversary thereafter. The Company initially reserved 400,000 shares for issuance underthe 1995 Plan and 300,000 shares for issuance under the 2004 Plan. The Company initially reserved 300,000 shares for issuance under the 2014 Plan,which was Page 42Table of ContentsSchmitt Industries, Inc.NOTES TO CONSOLIDATED FINANCIAL STATEMENTSFOR THE YEARS ENDED MAY 31, 2019, 2018 AND 2017 increased to 500,000 shares in October 2017. The 1995 Plan expired in December 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 who received stock grants under the 1995 Plan. The 2004 Plan expired inAugust 2015 and no additional options may be issued under the 2004 Plan. Stock-based compensation recognized in the Company’s ConsolidatedFinancial Statements for the years ended May 31, 2019, 2018 and 2017 includes compensation cost for stock-based awards granted. All outstandingoptions will expire no later than 2027.Stock OptionsThe Company uses the Black-Scholes option pricing model as its method of valuation for stock-based awards. The Company’s determination of the fairvalue of 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 numberof highly complex and subjective variables. The Black-Scholes option pricing model requires the input of highly subjective assumptions, and otherreasonable 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 withan equivalent remaining term approximately equal to the expected life of the award. • Expected Life. The expected life of awards granted represents the period of time that they are expected to be outstanding. The Companydetermines the expected life based on historical experience with similar awards, giving consideration to the contractual terms, vestingschedules and pre-vesting and post-vesting forfeitures. • Expected Volatility. The Company estimates the volatility of its common stock at the date of grant based on the historical volatility of itscommon stock. The volatility factor the Company uses is based on its historical stock prices over the most recent period commensuratewith the estimated 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, theCompany uses an expected dividend yield of 0. • Expected Forfeitures. The Company uses relevant historical data to estimate pre-vesting option forfeitures. The Company records stock-based compensation only for those awards that are expected to vest.The Company has computed, to determine stock-based compensation expense recognized for the years ended May 31, 2019, 2018 and 2017, the valueof all stock options granted using the Black-Scholes option pricing model using the following assumptions: Year Ended May 31, 2019 2018 2017 Risk-free interest rate 3.1% N/A 2.8%Expected life 6.0 years N/A 4.7 yearsExpected volatility 46.3% N/A 43.4%During Fiscal 2019, 2018 and 2017, total stock option compensation expense recognized was $6,576, $50,336 and $79,765, respectively, and hasbeen recorded as general, administration and sales expense in the Consolidated Statements of Operations and Comprehensive Loss. Page 43Table of ContentsSchmitt Industries, Inc.NOTES TO CONSOLIDATED FINANCIAL STATEMENTSFOR THE YEARS ENDED MAY 31, 2019, 2018 AND 2017 As of May 31, 2019, the Company had a total of 254,166 outstanding stock options (254,166 vested and exercisable and 0 non-vested) with aweighted average exercise price of $2.41. As all options outstanding are currently vested, the Company estimates that a total of $0 will be recorded asadditional stock-based compensation expense for all options which were outstanding as of May 31, 2019. Options outstanding and exercisable consistof the following as of May 31, 2019: Outstanding Options Exercisable Options Numberof Shares WeightedAverageExercisePrice WeightedAverageRemainingContractualLife (yrs) Numberof Shares WeightedAverageExercisePrice 124,166 $1.70 7.9 124,166 $1.70 15,000 2.53 4.3 15,000 2.53 70,000 2.85 4.8 70,000 2.85 45,000 3.65 2.0 45,000 3.65 254,166 $2.41 5.8 254,166 $2.41 Options granted, exercised, canceled and expired under the Company’s stock-based compensation plans during the years ended May 31, 2019, 2018and 2017 are summarized as follows: Number ofShares WeightedAverageExercisePrice Options outstanding - May 31, 2016 147,500 $3.11 Options granted 212,500 1.70 Options exercised 0 0.00 Options forfeited/cancelled 0 0.00 Options outstanding - May 31, 2017 360,000 2.28 Options granted 0 0.00 Options exercised 0 0.00 Options forfeited/cancelled (41,668) 1.70 Options outstanding - May 31, 2018 318,332 2.36 Options granted 15,000 2.45 Options exercised (38,333) 1.70 Options forfeited/cancelled (40,833) 2.66 Options outstanding - May 31, 2019 254,166 $2.41 The total intrinsic value of both outstanding and exercisable options was $0 as of May 31, 2019 and 2018. The total intrinsic value of optionsexercised was $0 in each of the years ended May 31, 2019, 2018 and 2017.Restricted Stock AwardsDuring the year ended May 31, 2019, the Company issued a total of 12,000 shares of restricted stock awards to certain key employees and members ofthe Company’s Board of Directors. The grant date fair value of the restricted stock awards was $2.66, and the awards vested immediately upon issuance.During Fiscal 2019, total restricted stock award compensation expense recognized was $31,920 and has been recorded as general, administration andsales expense in the Consolidated Statements of Operations and Comprehensive Loss. Page 44Table of ContentsSchmitt Industries, Inc.NOTES TO CONSOLIDATED FINANCIAL STATEMENTSFOR THE YEARS ENDED MAY 31, 2019, 2018 AND 2017 Restricted Stock UnitsService-based and market-based restricted stock units are granted to key employees and members of the Company’s Board of Directors. Service-basedrestricted stock units generally vest on the first anniversary date. Market-based restricted stock units are contingent on continued service and vestbased on 15-day average closing price of the Company’s common stock equal or exceeding certain targets established by the CompensationCommittee of the Board of Directors.The lattice model utilizes multiple input variables that determine the probability of satisfying the market conditions stipulated in the award andcalculates the fair value of each restricted stock unit. The Company used the following assumptions in determining the fair value of the restricted stockunits: Year Ended May 31, 2019Expected stock price volatility 50.1%-57.5%Expected dividend yield 0%Average risk-free interest rate 2.55%-2.98%The expected stock price volatility for each grant is based on the historical volatility of the Company’s stock for a period equivalent to the derivedservice period of each grant. The expected dividend yield is based on annual expected dividend payments. The average risk-free interest rate is basedon the treasury yield rates as of the date of grant for a period equivalent to the derived service period of each grant. The fair value of each restrictedstock unit is amortized over the requisite or derived service period, which is up to five years. The restricted stock units granted during the year endedMay 31, 2019 have a grant date fair value of $172,224.The following table summarizes the vesting terms for the market-based restricted stock units granted in Fiscal 2019: Number ofRestrictedStock Units Target Price 16,000 $2.70 12,000 2.90 12,000 3.10 12,000 3.30 12,000 3.50 12,000 3.70 12,000 3.90 12,000 4.10 During the year ended May 31, 2019, the first tranche of the market-based restricted stock units granted in Fiscal 2019 vested.During the year ended May 31, 2019, 14,000 service-based restricted stock units were granted and will vest on the first anniversary date of the grants. Page 45Table of ContentsSchmitt Industries, Inc.NOTES TO CONSOLIDATED FINANCIAL STATEMENTSFOR THE YEARS ENDED MAY 31, 2019, 2018 AND 2017 Restricted stock unit activity under the Company’s stock-based compensation plans during the year ended May 31, 2019 is summarized as follows: Number ofUnits Weighted AveragePrice atTime of Grant AggregateIntrinsicValue Non-vested restricted stock units - May 31, 2018 0 $0.00 Restricted stock units granted 114,000 2.94 Restricted stock units vested (16,000) 2.99 Non-vested restricted stock units - May 31, 2019 98,000 $2.94 $105,840 During Fiscal 2019, total restricted stock unit compensation expense recognized was $56,125 and has been recorded as general, administration andsales expense in the Consolidated Statements of Operations and Comprehensive Loss.NOTE 8:WEIGHTED AVERAGE SHARES AND RECONCILIATIONThe following table is a reconciliation of the numerators and denominators of the basic and diluted per share computations for income (loss) fromcontinuing operations for each of the three years in the period ended May 31: Net income/(loss)(Numerator) WeightedAverage Shares(Denominator) Per ShareAmount Year ended May 31, 2019 Basic earnings per share Loss available to common stockholders $(1,210,990) 4,005,795 $(0.30) Effect of dilutive securities stock options 0 0 Diluted earnings per share Loss available to common stockholders $(1,210,990) 4,005,795 $(0.30) Year ended May 31, 2018 Basic earnings per share Income available to common stockholders $210,639 3,422,724 $0.06 Effect of dilutive securities stock options 0 37,615 Diluted earnings per share Income available to common stockholders $210,639 3,460,339 $(0.06) Year ended May 31, 2017 Basic earnings per share Loss available to common stockholders $(1,073,364) 2,995,910 $(0.36) Effect of dilutive securities stock options 0 0 Diluted earnings per share Loss available to common stockholders $(1,073,364) 2,995,910 $(0.36) Page 46Table of ContentsSchmitt Industries, Inc.NOTES TO CONSOLIDATED FINANCIAL STATEMENTSFOR THE YEARS ENDED MAY 31, 2019, 2018 AND 2017 NOTE 9:EMPLOYEE BENEFIT PLANSThe Company adopted the Schmitt Industries, Inc. 401(k) Profit Sharing Plan & Trust effective June 1, 1996. Employees must meet certain age andservice requirements to be eligible. Participants may contribute up to 15% of their eligible compensation which may be partially matched by theCompany. The Company may make further contributions in the form of a profit sharing contribution or a discretionary contribution. The Companymade matching contributions in conjunction with employee contributions to the plan totaling $40,336, $51,550 and $62,622 during the years endedMay 31, 2019, 2018 and 2017, respectively.NOTE 10:MAJOR CUSTOMERSThe Company had one customer whose revenue individually represented 11.4% and 10.1% of the Company’s total net sales for the years endedMay 31, 2019 and 2018, respectively. There were no customers were greater than 10% of the Company’s total net sales for the year ended May 31,2017.As of May 31, 2019, one customer accounted for 11.9% of accounts receivable, net. As of May 31, 2018, one customer accounted for 11.4% ofaccounts receivable, net.NOTE 11:RESTRUCTURING AND RELATED CHARGESIn November 2018, Schmitt announced a strategic reorganization following the appointment of two new board members. The reorganization willposition the Company to better capitalize on the growing SBS Balancer business while streamlining the company and maximizing shareholder valuethrough the disposition of non-core assets. In conjunction with these efforts, inventory adjustments of $(407,558) and $(189,990) were recorded in thethird and fourth quarters of the fiscal year, respectively. These inventory adjustments were the outcome of new management’s requirement to completean in-depth review of the inventory, with standards of the review focused on more current turnover. This review was driven by the organizationalchanges to the business models for the Company’s three product lines as a result of the overall reorganization efforts. The reorganization also involveda streamlining of contractors and services and employee severance and termination benefits which resulted in non-recurring reorganization, legal andother professional expenses to be incurred in the third and fourth quarters of the year ended May 31, 2019. Page 47Table of ContentsReport of Independent Registered Public Accounting FirmTo the Shareholders and the Board of Directors ofSchmitt Industries, Inc.Opinion on the Financial StatementsWe have audited the accompanying consolidated balance sheets of Schmitt Industries, Inc. and subsidiaries (the “Company”) as of May 31, 2019 and2018, the related consolidated statements of operations and comprehensive income (loss), stockholders’ equity and cash flows for the years endedMay 31, 2019, 2018 and 2017, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, theconsolidated financial statements present fairly, in all material respects, the consolidated financial position of the Company as of May 31, 2019 and2018, and the consolidated results of its operations and its cash flows for the years ended May 31, 2019, 2018 and 2017, in conformity with accountingprinciples generally accepted in the United States of America.Basis for OpinionThese consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on theCompany’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company AccountingOversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federalsecurities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtainreasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Companyis not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required toobtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of theCompany’s internal control over financial reporting. Accordingly, we express no such opinion.Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error orfraud, and performing procedures to respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts anddisclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates madeby management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basisfor our opinion./s/ Moss Adams LLPPortland, OregonAugust 21, 2019We have served as the Company’s auditor since 2009. Page 48Table of ContentsITEM 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 submittedunder the Securities Exchange Act of 1934, as amended (Exchange Act), is recorded, processed, summarized and reported within the time periodsspecified in SEC rules and forms. Our disclosure controls and procedures include, without limitation, controls and procedures designed to ensure thatinformation required to be disclosed in our reports filed under the Exchange Act is accumulated and communicated to management as appropriate toallow timely decisions regarding required disclosures. There are inherent limitations to the effectiveness of any system of disclosure controls andprocedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effectivedisclosure controls and procedures can only provide reasonable assurance of achieving their control objectives, and management necessarily isrequired to use its judgment in evaluating 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 thisreport as defined in 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 endof the period covered by this report, the Company’s disclosure controls and procedures are effective in ensuring that information required to bedisclosed in our Exchange Act reports is (1) recorded, processed, summarized and reported in a timely manner, and (2) accumulated and communicatedto our management, including the our CEO and 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 Rules13a-15(f) and 15d-15(f)). Under the supervision and with the participation of our management, including our CEO and CFO, we conducted anevaluation of the effectiveness of our internal controls over financial reporting based on the framework in Internal Controls – Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal Control– Integrated Framework, our management concluded that our internal controls over financial reporting were effective as of May 31, 2019.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, 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. ITEM 9B.OTHER INFORMATIONNone. Page 49Table of ContentsPART IIICertain information required by Part III is included in the Company’s definitive Proxy Statement for its 2019 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 of1934 not 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 2019 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 2019 Annual Meeting of Shareholders and isincorporated herein by reference. ITEM 12.SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERSThe information required by this item is included in the Company’s Proxy Statement relating to the 2019 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 2019 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 2019 Annual Meeting of Shareholders and isincorporated herein by reference. Page 50Table of ContentsPART IV ITEM 15.EXHIBITS AND FINANCIAL STATEMENT SCHEDULES (a)Financial Statements: (1)Consolidated Balance Sheets as of May 31, 2019 and 2018Consolidated Statements of Operations and Comprehensive Income (Loss) for the years ended May 31, 2019, 2018 and 2017Consolidated Statements of Cash Flows for the years ended May 31, 2019, 2018 and 2017Consolidated Statements of Stockholders’ Equity for the years ended May 31, 2019, 2018 and 2017Notes to Consolidated Financial Statements for the years ended May 31, 2019, 2018 and 2017Reports 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 the required information is included in the financial statements or notes thereto. (3)Exhibits: Reference is made to the list on page 53 of the Exhibits filed with this report. Page 51Table of ContentsINDEX TO EXHIBITS Exhibits DescriptionExhibits marked with an asterisk (*) are incorporated by reference to exhibits or appendices previously filed with the Securities and ExchangeCommission, as indicated by the references in brackets. All other exhibits are filed herewith. *2.1 Asset Purchase Agreement between Schmitt Industries, Inc., and Glenn Valliant, an individual doing business as Optical Dimensions,dated September 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, 1998, Exhibit 3(i)] *3.2 Second Restated Bylaws of Schmitt Industries, Inc.[Form 10-K for the fiscal year ended May 31, 1998, 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. 2014 Equity Incentive Plan.[Appendix A to Schedule 14A filed on August 26, 2014]*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, 2019. 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 Act of 2002. 31.2 Certification of Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification of Principal Executive Officer and Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant toSection 906 of the Sarbanes-Oxley Act of 2002.100.INS XBRL Instance Document100.SCH XBRL Taxonomy Extension Schema Document100.CAL XBRL Taxonomy Extension Calculation Linkbase Document100.LAB XBRL Taxonomy Extension Label Linkbase Document100.PRE XBRL Taxonomy Extension Presentation Linkbase Document100.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 52Table of ContentsSIGNATURESPursuant 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/ Michael R. Zapata Michael R. Zapata President and Chief Executive OfficerDate: August 21, 2019Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of theregistrant and in the capacities indicated on August 21, 2019. Signature Title/s/ Michael R. ZapataMichael R. Zapata 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/ Charles DavidsonCharles Davidson Director/s/ Andrew P. HinesAndrew P. Hines Director/s/ David M. HudsonDavid M. Hudson Director/s/ Steven StromSteven Strom Director Page 53EXHIBIT 21.1SUBSIDIARIES OF SCHMITT INDUSTRIES, INC.AS OF MAY 31, 2019 Subsidiary State of Incorporation orCountry in Which OrganizedSchmitt Measurement Systems, Inc. OregonSchmitt Europe, Ltd. United KingdomSchmitt Industries Canada, Ltd. CanadaEXHIBIT 23.1CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMWe consent to the incorporation by reference in the Registration Statements (Form S-3 No. 333-226581 and Form S-8 Nos. 333-03910 and333-229591) of our report dated August 21, 2019, relating to the consolidated financial statements of Schmitt Industries, Inc. and subsidiaries,appearing in this Annual Report (Form 10-K) for the year ended May 31, 2019./s/ Moss-Adams LLPPortland, OregonAugust 21, 2019EXHIBIT 31.1CERTIFICATION PURSUANT TO18 U.S. C. SECTION 1350,AS ADOPTED PURSUANT TOSECTION 302 OF THE SARBANES-OXLEY ACT OF 2002I, Michael R. Zapata, 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 thisreport;3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined inExchange Act 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 registrant and have:(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, toensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities,particularly during the period in which this report is being prepared;(b) 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 externalpurposes in 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 recentfiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materiallyaffect, the registrant’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 arereasonably likely 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 internalcontrol over financial reporting. Date: August 21, 2019 /s/ Michael R. Zapata Michael R. Zapata, President and Chief Executive OfficerEXHIBIT 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 thisreport;3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined inExchange Act 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 registrant and have:(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, toensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities,particularly during the period in which this report is being prepared;(b) 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 externalpurposes in 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 recentfiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materiallyaffect, the registrant’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 arereasonably likely 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 internalcontrol over financial reporting. Date: August 21, 2019 /s/ Ann M. Ferguson Ann M. Ferguson, Chief Financial Officer and TreasurerExhibit 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, 2019 as filed withthe Securities and Exchange Commission on the date hereof (the “Report”), we, Michael R. Zapata, President and Chief Executive Officer and Ann M.Ferguson, Chief Financial Officer and Treasurer, 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 theCompany. /s/ Michael R. ZapataMichael R. ZapataPresident and Chief Executive OfficerAugust 21, 2019/s/ Ann M. FergusonAnn M. FergusonChief Financial Officer and TreasurerAugust 21, 2019

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