UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM10-Q

For the quarterly period ended: August 31,November 30, 2019

Or

For the transition period from:                    To:                    

Commission File Number:000-23996 001-38964

SCHMITT INDUSTRIES, INC.

(Exact name of registrant as specified in its charter)

2765 N.W. Nicolai Street

Portland, 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:

Securities registered pursuant to Section 12(g) of the Act:

None

Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ☐    No  ☒

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 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  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically, every Interactive Data File required to be submitted pursuant to Rule 405 of RegulationS-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes  ☒    No  ☐

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of RegulationS-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form10-K or any amendment to this Form10-K.  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule12b-2 of the Exchange Act. (check one):

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 financial accounting 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 Rule12b-2 of the Exchange Act). Yes  ☐     No  ☒

The number of shares of each class of common stock outstanding as of September 30,December 31, 2019

SCHMITT INDUSTRIES, INC.

INDEX TO FORM10-Q

Page 2

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

SCHMITT INDUSTRIES, INC.

CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

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

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SCHMITT INDUSTRIES, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

(UNAUDITED)

FOR THE THREE AND SIX MONTHS ENDED AUGUST 31,NOVEMBER 30, 2019 AND 2018

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

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SCHMITT INDUSTRIES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

FOR THE THREESIX MONTHS ENDED AUGUST 31,NOVEMBER 30, 2019 AND 2018

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

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SCHMITT INDUSTRIES, INC.

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY (UNAUDITED)

FOR THE THREESIX MONTHS ENDED AUGUST 31,NOVEMBER 30, 2019 AND 2018

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

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SCHMITT INDUSTRIES, INC.

NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS

NOTE 1:

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

In the opinion of management, the accompanying unaudited Consolidated Financial Statements of Schmitt Industries, Inc. (the “Company”) 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 August 31,November 30, 2019 and its results of operations and its cash flows for the periods presented. The consolidated balance sheetConsolidated Balance Sheet at May 31, 2019 has been derived from the Annual Report on Form10-K for the fiscal year ended May 31, 2019. The accompanying unaudited financial statements and related notes should be read in conjunction with the audited financial statements included in our Annual Report on Form10-K for the fiscal year ended May 31, 2019. 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, 2020.

As described in Note 8, the Company sold the Schmitt Dynamic Balance Systems (“SBS”) business line on November 22, 2019. After the sale of the SBS business, based on the types of products and services sold, and an analysis of how the Chief Operating Decision Makers review, manage and are compensated, the Company determined that it operates as one segment.

Principles of Consolidation

These consolidated financial statementsConsolidated Financial Statements include those of the Company and its wholly owned subsidiaries: Schmitt Measurement Systems, Inc., Schmitt Europe, Ltd. and Schmitt Industries (Canada) Limited. All significant intercompany accounts and transactions have been eliminated in the preparation of the consolidated financial statements.Consolidated Financial Statements.

Reclassification

Certain amounts in the prior period consolidated balance sheetConsolidated Balance Sheet have been reclassified to conform to the presentation of the current period. These reclassifications had no effect on the statement of operations, comprehensive income (loss) or cash flows.

Revenue Recognition

The Company determines the amount of revenue it recognizes associated with the transfer of each product or service. For sales of products or delivery of monitoring services to all customers, each transaction is evaluated to determine whether there is approval and commitment from both the Company and 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 to sell 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 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. These amounts are recorded within general, administration and sales expense. The Company also incurs costs related to shipping and handling of its products, the costs of which are expensed as incurred as a component of cost of sales. Shipping and handling fees billed to customers, which are recognized at the time of shipment as a component of net revenues, were $37,228$6,534 and $49,240$7,896 for the threesix months ended August 31,November 30, 2019 and August 31,November 30, 2018, respectively.

Cash, Cash Equivalents and Restricted Cash

The Company generally invests its excess cash in money market funds. The Company’s investment policy also allows for cash to be invested in investment grade highly liquid securities, and the Company considers securities that are highly liquid, readily convertible into cash and have original maturities of less than three months when purchased to be cash equivalents. The Company’s cash consists of demand deposits in large financial institutions.institutions and money market funds. At times, balances may exceed federally insured limits.

Restricted cash consists of an amount received from a customerheld in December 2017escrow related to the sale of the balancer business segment, as part of anon-going contract. The services being provided under this contractdescribed in Note 8. Once certain events are expected to be completed in the second half of Fiscal 2020. Once the services under this contract are complete, and acceptance has been provided by the customer, the restrictions on this advance cash payment will be released.

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The following table provides a reconciliation of cash and cash equivalents and restricted cash as reported within the Consolidated Balance Sheets as of August 31,November 30, 2019 and May 31, 2019 to the sum of the same such amounts as shown in the Consolidated Statement of Cash Flows for the threerespective periods then ended:

Statement of Cash Flows for the six months ended AugustNovember 30, 2019 and year ended May 31, 2019:

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On June 1, 2019,Lease Accounting

The Company determines if an arrangement is a lease or a service contract at inception. Where an arrangement is a lease the Company adopteddetermines if it is an operating lease or a finance lease. Subsequently, if the new standard on June 1,arrangement is modified the Company reevaluates the classification.

Buildings leased to others under operating leases are included in property, plant and equipment. See Note 6.

Intangible Assets

Amortizable intangible assets, which include purchased technology and patents, are amortized over their estimated useful lives ranging from five to seventeen years. As of November 30, 2019 using the modified retrospective approach and electing the option to not apply the guidance to comparative periods, which continue to be presented under the accounting methods in effect for those periods.

Long-Term Liabilities and Current Portion of Long-Term Liabilities

Long-term liabilities consist of a financing arrangement executed for the purchase of certain property and equipment over a term of 36 months. Future minimum commitments under this agreement for the each of the years ending May 31, are2019, amortizable intangible assets were $2,200,883, and accumulated amortization was $1,860,989 and $1,808,698, respectively. Amortization expense for both the six months ended November 30, 2019 and 2018 was $52,291.

Customer Deposits and Prepayments

Customer deposits and prepayments consists of amounts received from customers as follows:prepayments for orders that have been received and have been produced but have not yet shipped, credit balances for items returned by customers for which refunds have not yet been provided and deposits made by customers in advance of production.

Use of Estimates

The preparation of the consolidated financial statementsConsolidated Financial Statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statementsConsolidated Financial Statements and accompanying notes. Actual results could differ from those estimates.

NOTE 2:

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In February 2016, the Financial Accounting Standards Board (“FASB”) issued a new accounting standard on leasing. The new standard requires companies to record most leased assets and liabilities on the balance sheet, and also proposed a dual model for recognizing expense. The Company adopted the standard as of June 1, 2019, with retroactive reporting for prior periods (the comparative option). Adoption of these accounting changes did not have a material impact on the Consolidated Financial Statements.

In January 2017, the FASB issued a new accounting standard which clarifies the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions or disposals of assets or businesses. This guidance was effective for the Company beginning in 2019. Adoption of these accounting changes did not have a material impact on the Consolidated Financial Statements.

In May 2017, the FASB issued a new accounting standard which provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in ASC Topic 718. Under the new guidance, modification accounting is required only if the fair value, the vesting conditions, or the classification of the award (as equity or liability) changes as a result of the change in terms or conditions. This guidance is effective for the Company beginning in 2019. Adoption of these accounting changes did not have a material impact on the Consolidated Financial Statements.

In June 2018, the FASB issued a new accounting standard which provides guidance that expands the scope of Topic 718 to include share-based payment transactions for acquiring goods and services from nonemployees. The new guidance is effective for the Company beginning in 2019, with early adoption permitted. Adoption of these accounting changes did not have a material impact on the Consolidated Financial Statements.

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NOTE 2:3:

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. Stock-based compensation recognized during the period is based on the portion of the grant date fair value 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.

Stock Options

The Company uses the Black-Scholes option pricing model as its method of valuation for stock-based awards. 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:

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Options granted, exercised, canceled and expired under the Company’s stock-based compensation plans during the threesix months ended August 31,November 30, 2019 are summarized as follows:

Restricted Stock Units

Service-based and market-based restricted stock units are granted to key employees and members of the Company’s Board of Directors. Service-based restricted stock units generally fully vest on the first anniversary date of the award. Market-based restricted stock units are contingent on continued service and vest based on15-day average closing price of the Company’s common stockCommon Stock equal or exceeding certain targets established by the Compensation Committee 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 and calculates the fair value of each restricted stock unit. The Company used the following assumptions in determining the fair value of the restricted stock units:

During the threesix months ended August 31,November 30, 2019, 30,528three tranches of the market-based restricted stock units granted in Fiscal 2019 vested.

During the six months ended November 30, 2019, 41,976 service-based restricted stock units were granted and were35,754 immediately vested on the date of the grants.

Restricted stock unit activity under the Company’s stock-based compensation plans during the threesix months ended August 31,November 30, 2019 is summarized as follows:

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NOTE 3:4:

WEIGHTED AVERAGE SHARES AND RECONCILIATION

The following tableBasic net income (loss) per share is computed using the weighted average number of shares of Common Stock outstanding. Diluted net income (loss) per share is computed using the weighted average number of shares of Common Stock outstanding, adjusted for dilutive incremental shares attributed to outstanding options to purchase Common Stock and restricted stock units vested but not issued.    Common stock equivalents for stock options are computed using the treasury stock method. In periods in which a reconciliationnet loss is incurred, no common stock equivalents are included since they are antidilutive and as such all stock options outstanding are excluded from the computation of diluted net loss in those periods.

For the three and six months ended November 30, 2019, potentially dilutive securities consisted of options of 236,666 shares of Common Stock at prices ranging from $1.70 to $3.65 per share. Of these potentially dilutive securities, none of the numerators and denominatorsshares of Common Stock underlying the basic andoptions are included in the computation of diluted earnings per share computations for income (loss)because the Company incurred a net loss from continuing operations. In periods when a net loss is incurred in continuing operations, no Common Stock equivalents are included in the calculation of diluted net income or loss from discontinued operations or overall Company net income or loss since they are antidilutive. As such, all stock options outstanding are excluded from the computation of diluted net income in those periods.

Basic weighted average shares for the three and six months ended August 31:November 30 is as follows:

NOTE 4:5:

INCOME TAXES

The Company accounts for income taxes using the asset and liability method. This approach requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax basis of assets and liabilities. Deferred tax assets are reduced by a valuation allowance if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Management continues to review the level of the valuation allowance on a quarterly basis. There can be no assurance that the Company’s future operations will produce sufficient earnings to allow for the deferred tax asset to be fully utilized. The Company currently maintains a full valuation allowance against net deferred tax assets.

Each year the Company files income tax returns in the various national, state and local income taxing jurisdictions in which it operates. These tax returns are subject to examination and possible challenge by the taxing authorities. Positions challenged by the taxing authorities may be settled or appealed by the Company. As a result, there is an uncertainty in income taxes recognized in the Company’s financial statements in accordance with ASC Topic 740. The Company applies this guidance by defining criteria that an individual income tax position must meet for any part of the benefit of that position to be recognized in an enterprise’s financial statements and provides guidance on measurement,de-recognition, classification, accounting for interest and penalties, accounting in interim periods, disclosure, and transition.

Other long-term liabilities related to tax contingencies were $0 as of both August 31,November 30, 2019 and May 31, 2019. Interest and penalties associated with uncertain tax positions are recognized as components of the “Provision for income taxes.” The liability for payment of interest and penalties was $0 as of August 31,November 30, 2019 and May 31, 2019.

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Several tax years are subject to examination by major tax jurisdictions. In the United States, federal tax years ended May 31, 2016 and after are subject to examination. In the United Kingdom, tax years for the years ended May 31, 2018 and after are subject to examination.

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The consideration included $9,940,000 in unrestricted cash from the Buyer at closing, plus $420,000 to be placed into an escrow account, net of $140,000 in minimum cash settled via the funds flow at closing. Remaining escrow funds become unrestricted after certain events are completed and after one year from closing. The Purchase Agreement requires an adjustment to purchase price after closing based on the difference between (a) the calculated amount of working capital at closing and (b) the target working capital of $4,200,000. The closing working capital calculation has not been completed; however, the Company does not expect any resulting adjustment to be significant.

In connection with the Purchase Agreement, the Company entered into a Transition Service Agreement (“TSA”) with the Buyer during the transition of certain accounting and treasury processes. The Company has collected $196,000 of cash on behalf of the Buyer via the TSA that is included in the cash and cash equivalents and other accrued liabilities balances at November 30, 2019.

The following table summarizes the maturityconsideration and gain recognized in the quarter ended November 30, 2019 associated with the sale of the operating lease liabilities on an undiscounted cash flow basis and provides a reconciliation to the operating lease liabilities recognized on our consolidated balance sheet as of August 31, 2019:SBS Business:

The following are the carrying amounts of assets and liabilities classified as held for sale and included as a part of discontinued operations:

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The following is a composition of the line items constituting income from discontinued operations: