UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.   20549

FORM 10-Q

 

x                              QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended: February 28, 2007

Or

o                                 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from:               To:              

Commission File Number:  000-23996

SCHMITT INDUSTRIES, INC.

(Exact name of registrant as specified in its charter)

 

 

2765 NW Nicolai Street, Portland, Oregon 97210-1818

(Address of principal executive offices) (Zip Code)

 

(503) 227-7908

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant has (1) filed all reports required to be filed by Section 13 of 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes         x           No           o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (check one):

Large accelerated filer o                 Accelerated filer o                 Non-accelerated filer x

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x

 

The number of shares of each class of common stock outstanding as of March 26 , 2007

Common stock, no par value

2,656,294

 

SCHMITT INDUSTRIES, INC.

INDEX TO FORM 10-Q

Part I - FINANCIAL INFORMATION
Item 1.		Financial Statements:
		Consolidated Balance Sheets: –  February 28, 2007 and May 31, 2006 (unaudited)
		Consolidated Statements of Operations: –  For the Three and Nine Months Ended February 28, 2007 and  2006 (unaudited)
		Consolidated Statements of Cash Flows: –  For the Nine Months Ended February 28, 2007 and  2006 (unaudited)
		Consolidated Statement of Changes in Stockholders’ Equity: –  For the Nine Months Ended February 28, 2007 (unaudited)
		Notes to Consolidated Interim Financial Statements
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.		Quantitative and Qualitative Disclosures About Market Risk
Item 4.		Controls and Procedures
Part II - OTHER INFORMATION
Item 6.		Exhibits
Signatures
Certifications

 

2

PART I - FINANCIAL INFORMATION

Item 1.    Financial Statements

SCHMITT INDUSTRIES, INC.

CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

		February 28, 2007			May 31, 2006
ASSETS
Current assets
Cash and cash equivalents		$	712,756		$	1,552,072
Short-term investments		3,974,687			1,985,940
Accounts receivable, net of allowance of $13,198 and $52,186 at February 28, 2007 and May 31, 2006, respectively		1,983,968			1,983,090
Inventories		3,651,359			3,241,590
Prep aid expenses		128,661			77,626
Income taxes receivable		9,413			—
Deferred tax asset		111,090			116,080
		10,571,934			8,956,398
Property and equipment
Land		299,000			299,000
Buildings and improvements		1,363,131			1,275,922
Furniture, fixtures and equipment		801,463			1,180,648
Vehicles		96,849			96,849
		2,560,443			2,852,419
Less accumulated depreciation and amortization		(1,356,271		)	(1,643,047		)
		1,204,172			1,209,372
Other assets
Long-term deferred tax asset		4,110			552,380
Other assets		307,449			208,405
		311,559			760,785
Total assets		$	12,087,665		$	10,926,555
LIABILITIES & STOCKHOLDERS ‘ EQUITY
Current liabilities
Accounts payable		$	665,027		$	403,490
Accrued commissions		195,855			250,835
Accrued payroll liabilities		69,336			138,801
Other accrued liabilities		183,319			237,149
Income taxes payable		—			60,237
Current portion of long-term obligations		9,566			15,204
Total current liabilities		1,123,103			1,105,716
Long-term obligations					6,408
Stockholders’ equity
Common stock, no par value, 20,000,000 shares authorized, 2,652,128 and 2,625,045 shares issued and outstanding at February 28, 2007 and May 31, 2006, respectively		8,057,133			7,946,976
Accumulated other comprehensive loss		(109,503		)	(220,051		)
Retained earnings		3,016,932			2,087,506
Total stockholders’ equity		10,964,562			9,814,431
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY		$	12,087,665		$	10,926,555

 

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

3

---

SCHMITT INDUSTRIES, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE THREE AND NINE MONTHS ENDED FEBRUARY 28, 2007 AND 2006

(UNAUDITED)

		Three Months Ended February 28,						Nine Months Ended February 28,
		2007			2006			2007			2006
Net sales		$	2,970,877		$	2,707,123		$	8,973,125		$	7,977,607
Cost of sales		1,250,165			1,293,476			4,012,190			3,630,222
Gross profit		1,720,712			1,413,647			4,960,935			4,347,385
Operating expenses :
General, administration and sales		1,105,394			1,146,765			3,512,636			3,439,926
Research and development		15,041			26,070			54,490			59,709
Total operating expenses		1,120,435			1,172,835			3,567,126			3,499,635
Operating income		600,277			240,812			1,393,809			847,750
Other income		44,372			21,464			130,617			21,012
Income before income taxes		644,649			262,276			1,524,426			868,762
Provision for income taxes		257,000			64,500			595,000			33,543
Net income		$	387,649		$	197,776		$	929,426		$	835,219
Net income per common share:
Basic		$	0.15		$	0.08		$	0.35		$	0.32
Diluted		$	0.14		$	0.07		$	0.34		$	0.30

 

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

4

---

SCHMITT INDUSTRIES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE NINE MONTHS ENDED FEBRUARY 28, 2007 AND 2006

(UNAUDITED)

		Nine Months Ended February 28,
		2007			2006
Cash flows relating to operating activities
Net income		$	929,426		$	835,219
Adjustments to reconcile net income to net cash provided by operating activities :
Depreciation and amortization		157,147			158,412
Stock based compensation		40,377			—
Deferred taxes		553,260			(243,124		)
Tax benefit related to s tock options		8,739			175,365
Loss on disposal of property and equipment		7,220			—
(Increase) decrease in :
Accounts receivable		(878		)	436,650
Inventories		(409,769		)	146,504
Prepaid expenses		(51,035		)	(6,452		)
Income taxes receivable		(9,413		)	—
Increase (decrease) in :
Accounts payable		261,537			19,196
Accrued liabilities and customer deposits		(178,275		)	(91,705		)
Income taxes payable		(60,237		)	3,367
Net cash provided by operating activities		1,248,099			1,433,432
Cash flows relating to investing activities
Purchase of short-term investments		(7,488,747		)	(1,475,940		)
Maturities of short-term investments		5,500,000			—
Purchas e of property and equipment		(133,211		)	(97,642		)
Disposals of property and equipment		—			—
Advance on convertible promissory note		(125,000		)	—
Net cash used in investing activities		(2,246,958		)	(1,573,582		)
Cash flows relating to financing activities
Repayments on long-term obligations		(12,046		)	(20,655		)
Common stock issued on exercise of stock options		61,041			93,547
Net cash provided by financing activities		48,995			72,892
Effect of foreign exchange translation on cash		110,548			(2,290		)
Increase (decrease) in cash and cash equivalents		(839,316		)	(69,548		)
Cash and cash equivalents , beginning of period		1,552,072			1,176,959
Cash and cash equivalents, end of period		$	712,756		$	1,107,411
Supplemental Disclosure of Cash Flow Information
Cash paid during the period for interest		$	303		$	489
Cash paid during the period for income taxes		$	143,734		$	113,365

 

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

5

---

SCHMITT INDUSTRIES, INC.

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

FOR THE NINE MONTHS ENDED FEBRUARY 28, 2007

(UNAUDITED)

							Accumulated
							other									Total
							comprehensive			Retained						comprehensive
		Shares		Amount			loss			earnings			Total			income
Balance, May 31 , 2006		2,625,045		$	7,946,976		$	(220,051	)	$	2,087,506		$	9,814,431
Stock options exercised and related tax benefit of $8,739		27,083		69,780			—			—			69,780
Stock-based compensation		—		40,377			—			—			40,377
Net income		—		—			—			929,426			929,426			$	929,426
Other comprehensive income		—		—			110,548			—			110,548			110,548
Balance, February 28 , 2007		2,652,128		$	8,057,133		$	(109,503	)	$	3,016,932		$	10,964,562
Comprehensive income, nine months ended February 28, 2007																$	1,039,974

 

6

SCHMITT INDUSTRIES, INC.

NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS

Note 1:                   Basis of Presentation

The consolidated financial information included herein has been prepared by Schmitt Industries, Inc. (the Company) and its wholly owned subsidiaries.  In the opinion of management, the accompanying unaudited Consolidated Financial Statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission and contain all adjustments, consisting only of normal recurring adjustments, necessary to present fairly its financial position as of February 28, 2007 and its results of operations and its cash flows for the nine months ended February 28, 2007 and 2006.  The consolidated balance sheet at May 31, 2006 has been derived from the Annual Report on Form 10-K for the fiscal year ended May 31, 2006.  The accompanying unaudited financial statements and related notes should be read in conjunction with the audited financial statements included in our Annual Report on Form 10-K for the fiscal year ended May 31, 2006.  Operating results for the interim periods presented are not necessarily indicative of the results that may be experienced for the fiscal year ending May 31, 2007.  Certain amounts in prior periods’ financial statements have been reclassified to conform to the current periods’ presentation.  These reclassifications did not affect consolidated net income.

During the current fiscal quarter the Company determined that (under certain circumstances) a portion of net income from the Company’s wholly owned subsidiary located in the United Kingdom, Schmitt Europe Ltd. (SEL) is subject to income tax in the United States.  The provision for income taxes for the nine months ended February 28, 2007 includes the Company’s provision for such income taxes.  The provision for income taxes as previously reported in our Quarterly Report on Form 10-Q for the three and six months ended November 30, 2006 did not consider such income taxes and was understated by $53,000.  Following restatements for such income taxes, the company’s net income for the three months ended November 30, 2006 was $271,185, ($.10 per fully diluted share) compared to previously reported net income of $324,185, ($.12 per fully diluted share) and net income for the six months ended November 30, 2006 was $541,777, ($.20 per fully diluted share) compared to previously reported net income of $594,777, ($.22 per fully diluted share).  No restatement is required for the first fiscal quarter of 2007 or for any quarterly periods in fiscal 2006 as SEL did not report net income subject to income tax in the United States in any of those periods.

Note 2:                   Revenue Recognition

The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable and collectibility is probable.  For sales to all customers, including manufacturer representatives, distributors or their third-party customers, these criteria are met at the time product is shipped.  When other significant obligations remain after products are delivered, revenue is recognized only after such obligations are fulfilled.

Note 3:                   Recent Accounting Pronouncements

The Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (FIN 48) in June 2006.  FIN 48 clarifies the accounting for uncertainty in income taxes recognized in our financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes”.  The provisions of FIN 48 are effective for our fiscal year beginning June 1, 2007.  We are currently evaluating the impact of the provisions of FIN 48.

In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin (SAB) No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements,” which addresses how the effects of prior-year uncorrected misstatements should be considered when quantifying misstatements in current-year financial statements. SAB No. 108 requires companies to quantify misstatements using both the balance sheet and income statement approaches and to evaluate whether either approach results in quantifying an error that is material in light of relevant quantitative and qualitative factors.  SAB No. 108 is effective for our fiscal year ending May 31, 2007.  We believe that the implementation of SAB No. 108 will not have any effect on our financial position or results of operations.

7

---

Note 4:                   Stock Options and Stock-Based Compensation

Stock-based compensation includes expense charges for all stock-based awards to employees and directors granted under the Company’s stock option plan.  On June 1, 2006, the Company adopted SFAS No. 123(R), “Share-Based Payment (Revised 2004)”, which requires the measurement and recognition of compensation for all stock-based awards made to employees and directors including stock options based on estimated fair values.  SFAS 123(R) supersedes previous accounting under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (APB 25), for periods beginning in fiscal 2007. In March 2005, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 107 relating to application of SFAS 123(R).  The Company has applied the provisions of SAB 107 in our adoption of SFAS 123(R).

The Company adopted SFAS 123(R) using the modified prospective transition method, which requires the application of the accounting standard as of June 1, 2006, the first day of our 2007 fiscal year. In accordance with the modified prospective transition method, the Company’s Consolidated Financial Statements for periods prior to the first quarter of fiscal 2007 have not been restated to reflect this change.  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.  The compensation cost for awards granted prior to May 31, 2006 is based on the grant date fair value estimated in accordance with the pro forma provisions of SFAS 123 while awards granted on or after June 1, 2006 follow the provisions of SFAS 123(R) to determine the grant date fair value and compensation cost. Compensation cost for all stock-based awards is recognized using the straight-line method.  Stock-based compensation recognized in the Company’s Consolidated Financial Statements for the nine months ended February 28, 2007 includes compensation cost for stock-based awards granted prior to, but not fully vested as of, May 31, 2006.  There were no stock-based awards granted subsequent to May 31, 2006.

Upon adoption of SFAS 123(R), the Company continued to use the Black-Scholes option pricing model as its method of valuation for stock-based awards. The Company’s determination of the fair value 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 number of highly complex and subjective variables.  Although the fair value of stock-based awards is determined in accordance with SFAS 123(R) and SAB 107, the Black-Scholes option pricing model requires the input of highly subjective assumptions, and other reasonable assumptions could provide differing results.  These variables include, but are not limited to:

·                  Risk-Free Interest Rate.  The Company bases the risk-free interest rate on the implied yield currently available on U.S. Treasury issues with an 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 Company determines the expected life based on historical experience with similar awards, giving consideration to the contractual terms, vesting schedules 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 its common stock. The volatility factor the Company uses is based on its historical stock prices over the most recent period commensurate with the estimated expected life of the award. These historical periods may exclude portions of time when unusual transactions occurred.

·                  Expected Dividend Yield.  The Company has never paid any cash dividends on its common stock and does not anticipate paying any cash dividends in the foreseeable future. Consequently, the Company uses an expected dividend yield of zero.

·                  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 three and nine months ended February 28, 2007 and for pro forma disclosure purposes for the three and nine months ended February 28, 2006, the value of all stock options granted using the Black-Scholes option pricing model as prescribed by SFAS No. 123(R) using the following assumptions:

 

8

---

Stock-Based Compensation Under FAS 123(R)

The following table summarizes stock-based compensation expense related to stock-based awards under SFAS 123(R) for the three and nine months ended February 28, 2007 and what certain operating results would have been without the effects of applying SFAS No. 123(R).

		Three Months Ended						Nine Months Ended
		February 28, 2007						February 28, 2007
					Pro Forma without						Pro Forma without
					effects of applying						effects of applying
		As reported			SFAS No. 123(R)			As reported			SFAS No. 123(R)
General, administration and sales		$	1,105,394		$	1,118,853		$	3,512,636		$	3,553,013
Income before income taxes		$	644,649		$	658,108		$	1,524,426		$	1,564,803
Net income		$	387,649		$	395,940		$	929,426		$	954,298
Cash flow from operating activities								$	1,248,099		$	1,248,099
Cash flow from financing activities								$	48,995		$	48,995
Basic earnings per share		$	0.15		$	0.15		$	0.35		$	0.36
Diluted earnings per share		$	0.14		$	0.14		$	0.34		$	0.35

 

At February 28, 2007 the Company had a total of 188,162 outstanding stock options (171,538 vested and exercisable and 16,624 non-vested) with a weighted average exercise price of $2.53.  The Company estimates that a total of approximately $50,517 will be recorded as additional stock-based compensation expense over the period beginning with the quarter ending May 31, 2007 through the fiscal year ending May 31, 2009, for all options which are outstanding as of February 28, 2007, but which were not yet vested.

 

Options granted, exercised, canceled and expired under the Company’s stock option plan during the three and nine months ended February 28, 2007 are summarized as follows:

		Three Months Ended					Nine Months Ended
		February 28, 2007					February 28, 2007
				Weighted					Weighted
		Number of		Average			Number of		Average
		Shares		Exercise Price			Shares		Exercise Price
Options outstanding - beginning of period		188,162		$	2.53		216,496		$	2.52
Options granted		—		—			—		—
Options exercised		—		—			(27,084	)	2.25
Options forfeited/cancelled		—		—			(1,250	)	6.58
Options outstanding February 28, 2007		188,162		$	2.53		188,162		$	2.53

 

9

---

Pro Forma Information under SFAS 123 and APB 25

Prior to June 1, 2006, the Company elected to follow the accounting provisions of APB 25 for stock-based compensation and to furnish the pro forma disclosures required under SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure.”  No stock-based employee compensation cost was reflected in net income because all options granted under the Company’s stock option plan had an exercise price equal to the market value of the underlying common stock on the date of the grant. The following table illustrates the effect on the Company’s net income and basic and diluted net income per share for the three and nine months ended February 28, 2006 had compensation cost for the plans been determined based on the fair value at the grant dates for awards under those plans consistent with the method of SFAS 123.

		Three Months Ended			Nine Months Ended
		February 28, 2006			February 28, 2006
Net income, as reported		$	197,776		$	835,219
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of tax		(4,811		)	(14,436		)
Pro forma net income		$	192,965		$	820,783
Earnings per share – basic
As reported		$	0.08		$	0.32
Pro forma		$	0.07		$	0.32
Earnings per share – diluted
As reported		$	0.07		$	0.30
Pro forma		$	0.07		$	0.30

 

Note 5:                   EPS Reconciliation

		Three Months Ended				Nine Months Ended
		February 28,				February 28,
		2007		2006		2007		2006
Weighted average shares (basic)		2,642,919		2,614,734		2,645,655		2,601,840
Effect of dilutive stock options		188,162		222,807		194,768		223,761
Weighted average shares (diluted)		2,831,081		2,837,541		2,840,423		2,825,601

 

Basic earnings per share are computed using the weighted average number of shares outstanding.  Diluted earnings per share are computed using the weighted average number of shares outstanding, adjusted for dilutive incremental shares attributed to outstanding options to purchase common stock.

Note 6:                   Deferred Tax Assets

The 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 and laws.  Deferred tax assets are evaluated and a valuation allowance is established if it is more likely than not that all or a portion of the deferred tax asset will not be realized.  The Company has recorded a substantial deferred tax asset related to the expected realization of net operating loss carryforwards for federal income tax purposes and other temporary differences between book and tax bases of assets and liabilities.  Due to the uncertainty of utilization of the Company’s net operating losses and in consideration of other factors, management recorded a valuation allowance on the deferred tax asset at May 31, 2003.

During Fiscal 2005 and 2006, management concluded future operations would produce sufficient earnings so that portions of this asset could be used in future periods to reduce federal and state tax liabilities and the allowance was reduced to reflect the amount of the deferred tax asset management believes can be utilized in future periods.  Our effective tax rate on consolidated net income was 38.7% and 3.9% in the first nine months of fiscal 2007 and 2006, respectively.  Our

10

---

effective tax rate on consolidated net income differs from the federal statutory tax rate in the first nine months of fiscal 2007 primarily due to certain expenses not deductible for income tax reporting offset by lower effective tax rates on net income reported by the Company’s wholly owned subsidiary, Schmitt Europe Ltd. (SEL), located in the United Kingdom.   The net effective tax expense on consolidated net income in the first nine months of fiscal 2006 is primarily due to a reduction in the valuation allowance of $281,000 at November 30, 2005.  Management believes the effective tax rate on consolidated net income in future periods will reflect a normal combined state and federal rate, net of the effect from expenses not deductible for income tax reporting and net income or losses reported by SEL.

Note 7:                   Segments of Business

Segment Information

		Three Months Ended February 28,
		2007						2006
		Balancer			Measurement			Balancer			Measurement
Gross sales		$	2,070,654		$	1,080,632		$	2,143,741		$	764,694
Intercompany sales		(168,646		)	(11,763		)	(178,746		)	(22,566		)
Net sales		$	1,902,008		$	1,068,869		$	1,964,995		$	742,128
Operating income		$	276,903		$	323,374		$	118,121		$	122,691
Intercompany rent expense (income)		$	(7,500	)	$	7,500		$	(7,500	)	$	7,500
Depreciation expense		$	37,560		$	6,473		$	34,657		$	8,771
Amortization expense		$	—		$	8,652		$	—		$	8,651
Advances on convertible note		$	125,000		$	—		$	—		$	—
Capital expenditures		$	86,701		$	—		$	551		$	—

 

		Nine Months Ended February 28,
		2007						2006
		Balancer			Measurement			Balancer			Measurement
Gross sales		$	6,316,374		$	3,218,325		$	6,127,988		$	2,368,605
Intercompany sales		(454,730		)	(106,844		)	(451,816		)	(67,170
Net sales		$	5,861,644		$	3,111,481		$	5,676,172		$	2,301,435
Operating income		$	561,698		$	832,111		$	441,730		$	406,020
Intercompany rent expense (income)		$	(22,500	)	$	22,500		$	(22,500	)	$	22,500
Depreciation expense		$	109,993		$	21,198		$	105,135		$	27,325
Amortization expense		$	—		$	25,956		$	—		$	25,952
Advances on convertible note		$	125,000		$	—		$	—		$	—
Capital expenditures		$	114,601		$	18,610		$	36,945		$	60,697

 

11

---

Geographic Information

		Three Months Ended February 28,						Nine Months Ended February
Geographic Sales		2007			2006			2007			2006
North American
United States		$	1,207,350		$	1,319,078		$	4,170,577		$	4,093,625
Canada and Mexico		33,480			82,181			154,671			136,445
North American total		1,240,830			1,401,259			4,325,248			4,230,070
European
Germany		54,043			115,961			198,570			277,328
Intercompany		—			(10,119		)	—			(10,293		)
Germany total		54,043			105,842			198,570			267,035
United Kingdom		228,230			273,168			816,930			756,562
Intercompany		(180,409		)	(191,193		)	(561,574		)	(505,160		)
United Kingdom total		47,821			81,975			255,356			251,402
Other European		340,264			334,251			1,126,696			748,889
Total European		442,128			522,068			1,580,622			1,267,326
Asia		811,167			559,713			2,147,637			1,718,079
Other markets		476,752			224,083			919,618			762,132
Total Net Sales		$	2,970,877		$	2,707,123		$	8,973,125		$	7,977,607

 

		Three Months Ended February 28,
		2007						2006
		United States			Europe			United States			Europe
Operating income (loss)		$	468,550		$	131,727		$	243,791		$	(2,979	)
Depreciation expense		$	41,218		$	2,815		$	40,519		$	2,909
Amortization expense		$	8,652		$	—		$	8,651		$	—
Advances on convertible note		$	125,000		$	—		$	—		$	—
Capital expenditures		$	86,701		$	—		$	—		$	551

 

		Nine Months Ended February 28,
		2007						2006
		United States			Europe			United States			Europe
Operating income (loss)		$	1,159,303		$	234,506		$	877,668		$	(29,918	)
Depreciation expense		$	122,653		$	8,538		$	123,852		$	8,608
Amortization expense		$	25,956		$	—		$	25,952		$	—
Advances on convertible note		$	125,000		$	—		$	—		$	—
Capital expenditures		$	132,644		$	567		$	94,845		$	2,797

 

Note — Europe is defined as the European subsidiary, Schmitt Europe,Ltd.

Long-term Assets

		February 28, 2007			May 31, 2006
Segment:
Balancer		$	1,061,366		$	1,483,166
Measurement		454,365			486,991
Geographic:
United States		$	1,503,854		$	1,949,390
Europe		11,877			20,767

 

Note 8:                   Related Party Transactions

12

---

Effective June 1, 2004, the Company entered into a contract to provide consulting services to PulverDryer USA, Inc., (“PulverDryer”) pursuant to which PulverDryer paid the Company $8,000 a month from June 2004 through October 2004.  PulverDryer also buys certain products from the Company at normal prevailing rates.  The Company and PulverDryer extended the contract from November 1, 2004 forward at that same monthly fee of $8,000.  Product sales to PulverDryer during the three months ended February 28, 2007 and 2006 totaled $11,710 and $13,531, respectively.  Product sales to PulverDryer during the nine months ended February 28, 2007 and 2006 totaled $31,233 and $86,099, respectively.

In connection with the contract, the Board authorized Wayne Case, the Company’s Chief Executive Officer, to provide advisory services to PulverDryer, and permitted Mr. Case to receive as compensation the total consulting fees paid by PulverDryer from June 2004 through October 2004.  Effective November 1, 2004, Mr. Case receives 40% of the ongoing consulting fee from PulverDryer, which percentage was determined by the Compensation Committee.  Mr. Case also serves on the board of directors of PulverDryer.

13

---

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

Schmitt Industries, Inc. designs, assembles and markets computer controlled balancing equipment (the Balancer Segment) primarily to the machine tool industry.  Through its wholly owned subsidiary, Schmitt Measurement Systems, Inc. (SMS), the Company designs, manufactures and markets precision laser measurement systems (the Measurement Segment). The Company also sells and markets its products in Europe through its wholly owned subsidiary, Schmitt Europe Ltd. (SEL), located in the United Kingdom.  The accompanying unaudited financial information should be read in conjunction with our Annual Report on Form 10-K for the fiscal year ended May 31, 2006.  Certain amounts in prior periods’ financial information have been reclassified to conform to the current periods’ presentation.  These reclassifications did not affect consolidated net income.

RESULTS OF OPERATIONS

Overview

Balancer segment sales focus throughout the world on end-users, rebuilders and original equipment manufacturers of grinding machines with the target geographic markets in North America, Asia and Europe.  Combined Balancer sales increased 3.3% for the nine months ended February 28, 2007 compared to the nine months ended February 28, 2006.  Balancer sales for the three months ended February 28, 2007 decreased 3.2% compared to the same fiscal quarter ended February 28, 2006.  North American sales declined (11.4%) in the three months ended February 28, 2007 compared to the three months ended February 28, 2006.  Recent weakness in industrial production toward the end of 2006 especially in the motor vehicle sectors, has caused production in other manufacturing industries to soften.  General economic data indicates a slowing in the growth of business capital spending on orders and shipments of equipment other than high-tech and transportation equipment. These economic conditions in the worldwide automotive, bearing and aircraft industries and its impact on the machine tool industry are the reason for softening Balancer orders.  Machine tool industry customers are optimistic regarding short term demand for grinding machines although the recent weakness in industrial production and business conditions in North America and indicate growth rates for their products which incorporate the Balancer segment product line will be lower than those experienced over the past three years.  Market demand in Asia for the Balancer segment products remains strong with that region showing a 29.3% increase for the three months ended February 28, 2007 compared to the three months ended February 28, 2006.  The European market growth rates slowed as total Balancer sales into that geographic market decreased (10.8%) during the three months ended February 28, 2007 compared to the three months ended February 28, 2006.  Sales in all Other markets decreased to $181,147 in the three months ended February 28, 2007 compared to $194,831 for the three months ended February 28, 2006, a 7% decrease.  As with the North American market, the duration of the stronger demand in Asia and conditions in the European market cannot be forecasted with any certainty.

The Measurement segment product line consists of both laser light-scatter and dimensional sizing products. Combined Measurement sales increased 35.2% for the nine months ended February 28, 2007 compared to the nine months ended February 28, 2006.  Measurement sales for the three months ended February 28, 2007 increased 44% when compared to the same fiscal quarter ended February 28, 2006.  The increased sales volume is primarily due to the delivery of a CASI Scatterometer during the second fiscal quarter and increased shipments of laser light-scatter products to the disk drive manufacturers.  As noted below sales can be very cyclical in the Measurement segment.  The business operations and prospects for these two product lines are summarized as follows:

Laser light-scatter products for disk drive and silicon wafer manufacturers – The primary target markets for Measurement products have been disk drive and silicon wafer manufacturers and companies and organizations involved in research efforts. Certain segments of these targeted industries have seen consolidation into very large international manufacturers.  Sales totaled $1,383,589 for the nine months ended February 28, 2007 compared to the $884,817 for the nine months ended February 28, 2006.  Information has indicated continued improving demand for and sales of disk drive products.  U.S. retail sales of external drives by disk drive manufacturers rose an estimated 75% during the third calendar quarter of 2006 citing demand fueled by need to convert photos, video and other content into digital form.  The disk drive industry has recently announced they expect to start delivering drives that store a trillion bytes of data, known as a terabyte.  Sales to customers in these industries can be very cyclical and therefore the impact of the strong demand in the disk drive industry on sales to the Company’s laser light-scatter products is unknown at this time and cannot be forecasted with any certainty.

14