UNITED STATES SECURITIES AND EXCHANGE COMMISSION
                                WASHINGTON, D.C. 20549

                                      FORM 10-K
(Mark One)

[ X ]    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
         EXCHANGE ACT OF 1934 [FEE REQUIRED]
         For the fiscal year ended:  May 31, 1996

                                          or

[   ]    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
         EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
         For the transition period from              to
                                        -------------   --------------


                           Commission File Number:  0-23996

                               SCHMITT INDUSTRIES, INC.
                (Exact name of registrant as specified in its charter)

         Oregon                                     91-1151989
(State or other jurisdiction of        (IRS Employer Identification Number)
incorporation or organization)

                               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:

         Title of each class      Name of each exchange on which registered
    ---------------------------   -----------------------------------------
              None                                    None

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

                             Common Stock - no par value
                                (Title of each class)

    Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act 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
    ---        ---

    Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.  [ X ]

    As of August 20, 1996, the aggregate market value of the registrant's
Common Stock held by nonaffiliates of the registrant was $20,107,188 based on
the closing sales price of the registrant's Common Stock on the Nasdaq - Small
Cap Market.  On that date, there were 6,981,889 shares of Common Stock
outstanding.

    Portions of the registrant's 1996 Annual Report to Shareholders are
incorporated by reference into Parts II and IV hereof.



                                        PART I

ITEM 1.  BUSINESS

INTRODUCTION

    The Company designs, assembles and markets computer-controlled balancing
equipment for use primarily by the machine tool industry.  Through its wholly
owned subsidiary acquired in May 1995, Schmitt Measurements Systems, Inc.
("SMS"), a Montana corporation, the Company also designs, manufactures and
markets precision laser measurement systems.  In June 1996, the Company formed
Schmitt Europe, Ltd. under the laws of Great Britain to market and sell the
Company's products in Great Britain.

    The Company was incorporated under the laws of British Columbia, Canada as
CIRA Resources Ltd. in 1984.  The name of the Company was changed to Folkestone
Resources Ltd. in 1984 and to Schmitt Industries Inc. in 1987.  In February
1996, the Company was "continued" from British Columbia to the state of Wyoming
and then merged into its wholly owned subsidiary, Schmitt Industries, Inc., an
Oregon corporation.

    The Company acquired its original balancing equipment technology pursuant
to a series of agreements from 1987 through 1991.  The patented technology has
been substantially enhanced and advanced in the past decade.

    During Fiscal 1995, the Company completely wrote down its home security
alarm technology from $400,599.  This technology was acquired in 1991.  As a
result of the Company's decision to concentrate its resources on the balancing
equipment market during the last several years and, more recently, the precision
measurement equipment market, the technology became obsolete and the Company
decided to abandon its home security alarm business.

    In May 1995, the Company acquired TMA Technologies Inc. ("TMA"), a
designer, assembler and marketer of innovative industrial measurement systems
based on laser light scatter technologies.  For all of the outstanding shares of
TMA, the Company paid $15,000, assumed approximately $515,000 of TMA debt and
agreed to make royalty payments to TMA's shareholders of 5% on sales of TMA
products and future Company products that utilize TMA's technologies, hardware,
software and existing patents, subject to a maximum royalty of $6 million.  In
June 1995, TMA began operations in Portland and subsequently changed its name to
Schmitt Measurement Systems, Inc.

BALANCING PRODUCTS

    The principal product of the Company is the Schmitt Dynamic Balance System
(the "SBS System").  It consists of a computer control unit, sensor, spindle
mounting adapter, and balance head.  It was designed to be an inexpensive, yet
highly accurate, permanent installation on grinding machines.  Today, the SBS
System is beginning to be evaluated by manufacturers for additional applications
including large electric motors, industrial fans, industrial brushing devices,
turbines and similar devices.

    The SBS System is fully automated and consequently the user does not have
to pre-balance such devices as grinding wheels.  This reduces the setup time of
such operations and ensures a smoother and more efficient operation.




                                          2



    The SBS System operates on a principle of mass compensation for wheel
imbalance.  The balance head contains two movable eccentric weights, each of
which is driven by electric motors through a precision gear train.  These
weights can be repositioned to offset any imbalance in a grinding wheel or other
application.  Imbalance or vibration is picked up by the sensor.  The signal is
fed to a controller that filters the signal by revolutions per minute.  The
controller then drives the two balance head weights in the direction that
reduces the amplitude of the vibration signal. When the weights are positioned
so the lowest vibration level is reached, the balance cycle is complete.

    Notable features of the SBS System include its ability to fit almost all
machines, ease of installation, compact and modular construction, ability to
balance a wheel while on a machine, elimination of wheel vibration, automatic
monitor of balance, display in both English and metric systems, instrument grade
calibration, short balance process, measurement of both displacement and/or
velocity, and minimal user maintenance.

    Benefits to the system user include improved quality of finished parts,
ease of product adaptation, minimal downtime, complete and ready installation,
elimination of need for static balancing, longer life for wheels, dressings,
diamonds and spindle bearings, the ability to balance within 0.2 microns and its
adaptability to all types of machines.

    The precision grinding industry has a worldwide presence and is established
in all industrialized countries.  In each major industrialized country there are
three major market segments:  the machine tool builders, the rebuilders and
grinding machine users.

    The first major market segment consists of machine tool builders who
actually design and manufacture a variety of cylindrical, surface, and specialty
application grinding machines that are sold at home and also exported to foreign
markets.  SBS System products are distributed to a variety of world markets
through OEM (original equipment manufacturer) accounts, where a special pricing
(20%) discount is offered to the machine builder if the designer incorporates
the SBS System into its machine.

    Examples of some of well-known worldwide machine tool builders who have
offered and/or installed the SBS System include are ANCA (Australia), Bryant
Grinders Corporation (U.S.), Blohm Incorporated (U.S.), Blohm GmbH (Germany),
Capco Machinery (U.S.), Cincinnati Milacron (U.S.), Ecotech/SMTW (China/U.S.),
Gold Crown Machinery (U.S.), Gleason Works (U.S.), Litton IAS/Landis Grinding
(U.S.), Mattison Machine (U.S.), Micron Machinery Limited (Japan/U.S.), Normac
Incorporated (U.S.), NTC Toyama America (U.S./Japan), Okomoto (Japan), Okuma
Machine (Japan), Royal Master Grinders (U.S.), Shigiya Machine (Japan), Sumitomo
Heavy Industry (Japan), TOS Hostivar (Czech Republic), TOS Holice (Czech
Republic), Toyoda Machine (Japan) and Weldon Machine Tool (U.S.).

    One successful marketing channel to tool builders is the sale of the SBS
System to users who purchase new machines and thereby experience the benefits of
the SBS System and then purchase additional units for application to their older
machines.

    The second major market segment consists of machine tool rebuilders who are
found in all industrial nations and who develop their business with users by
offering to completely update and refurbish older machine tools.  These
rebuilders typically tear the old machine apart and install new bearings, new
electronics, and new advanced features, such as an SBS Automatic Wheel Balancer.
The Company currently sells its product directly to all major machine rebuilders
in the U.S. and to some countries in Western Europe.


                                          3



    Grinding machine users in industrialized countries are the third major
market segment.  Users become aware of the SBS System through trade shows, trade
magazine advertising, distributors, field representatives, referrals and new
machine suppliers.

    Precision grinding is increasing as a worldwide method of material removal
and material processing.  Therefore, the Company believes that there may be an
increase in market growth and an increase in the need for automatic balancers.
Precision grinding is necessary in all major manufacturing areas such as the
automotive industry (camshafts, crankshafts, valves), bearings (roller and
tapered types), ceramics (precision shaping), electric motors (shafts), pumps
(shafts and turbines), aircraft (engine parts), and general manufacturing.

    The Company's business is conducted with many customers located throughout
the world.  Examples of some of the more well known of these include Black &
Decker, Briggs and Stratton, Caterpillar Inc., Daewoo International Corp., Eaton
Corporation, Ford Motor Company, General Electric Corp., General Motors,
Ingersoll Rand, Sumitomo Heavy Industries, Texas Instruments, The Timken
Company, Torrington, TRW Automotive Components and Westinghouse Electric Corp.

    COMPETITION.  Management believes that the SBS System is the only fully
automatic balancing system marketed in the world.  All other competitive
balancing products require special setup and training or calibration to the
specific machine. The Company believes that the SBS System is currently the only
balancing product on the market that fits all machines with wheel sizes from 6
to 48 inches in diameter and spindle rpm of 500 through 7,500.

    Competitive products include European manufacturers building water
balancers and electromechanical balancers similar to the SBS System.  Water
balancers are currently priced at about twice the level of the SBS System
because of expensive plumbing and water chambers machined into the wheel hub.
The machines are disassembled and parts remachined or replaced within the
spindle assembly, a process that takes from one to two days.  The system is
"tuned" or "calibrated" to the machine by a factory service technician.
Although water systems are unable to balance at low or high rpm, they work in
the mid-range when properly monitored by regularly cleaning filters and checking
clearance of water jets.  This technology is the oldest in the market and is
employed in the most installed systems.  The Company considers water balancers
to be the its major competition due to their widespread installation but easy to
compete against.

    Water balancers do not maintain accuracy during grinding and require
constant adjustment due to water leakage.  Once the machine stops, for whatever
reason, it must be rebalanced.  Balancing time is generally anywhere from one to
three minutes.

    Electromechanical balancers similar to the SBS System are produced by
several European companies, located primarily in Switzerland, Germany, Spain and
Italy.  This type of balancer has deficiencies in electronics which render them
less effective in solving essential balancing requirements.  It cannot achieve
the consistent low balance levels obtained by the SBS System and cannot operate
effectively at 500 rpm (low speed) or at 7,500 rpm (high speed).  In addition,
the balancer has proven inferior brush and cable assemblies which cause down
time and high maintenance.  None of these companies can compete effectively with
the Company in providing mounting adapters for all grinding machines.

    The SBS System list price is $7,500 worldwide.  The water balancers from
Germany are priced at $11,000 to $15,000, and the electromechanical systems are
priced at $8,000 to $10,000 worldwide.


                                          4




Market surveys by management indicate that customers perceive values of an
automatic balancer to be less than $8,000; therefore, Company pricing is geared
to obtaining a dominant market position and meeting competitive supplier prices.
The market strategy is to establish the SBS System as the dominant product with
the best quality, reliability and performance and superior economic value.

SCHMITT MEASUREMENT SYSTEMS, INC.

    HISTORICAL BACKGROUND.  SMS manufactures and markets a line of laser-based,
precision measurement systems.  In addition, SMS operates a precision
measurement laboratory which is utilized by third-party equipment manufacturers
and others.

    TMA was founded in Bozeman, Montana in 1984 as Toomay, Mathis and
Associates, to utilize the extensive knowledge and industry familiarity of two
retired U.S. Air Force generals, John Toomay and Robert Mathis.  TMA first
offered consulting services for aerospace companies marketing to the
U.S. Department of Defense.

    By 1986 and 1987, TMA began providing a scatterometer using light scatter
technology, primarily for the U.S. military and other departments.  Light
scatter technology involves using lasers, optics and detectors to throw a beam
of light on a material sample and recording its reflection/transmission.
Analysis of light scatter information can determine material characteristics
such as surface roughness and defects, without introducing contaminants and
causing changes to the tested material.

    In response to declining military and aerospace budgets, TMA began
development of commercial products in 1990 and 1991.  During the next three
years, TMA continued to invest heavily in commercial product development, but
revenue lagged and large operating losses occurred.  Funding came from outside
investors, new officers/directors and a loan from the Montana Science Technology
Alliance.

    Pursuant to the terms of the Acquisition Agreement dated April 21, 1995,
the Company repaid past accrued wages to 24 TMA employees of $155,000, repaid
all 161 unsecured creditors a total of $230,000 and agreed to purchase all of
the TMA shares.  In connection with the acquisition, the Company established a
royalty pool (the "Royalty Pool") in which each TMA shareholder and debt holder
was given an interest equal to the amount invested by shareholders or loaned by
debt holders including interest payable through March 31, 1995.  The Royalty
Pool is to be funded at 5% of net sales (defined as gross sales less returns,
allowances and sales commissions) of SMS's products and future derivative
products developed by the Company, subject to a maximum of $6 million.  As a
party of the Royalty Pool agreement, each of the former TMA shareholders and
debt holders released TMA and the Company from any claims with regard to the
acquisition except their rights to future royalties.

    Three debt holders who were owed a total of $362,094 at May 31, 1995
declined to participate in the Royalty Pool and demanded full payment of their
respective amounts due.  These debt holders filed an action before the
U.S. Bankruptcy Court in Montana to cause repayment through liquidation of the
Company.  The Company successfully converted this action to a reorganization
process.

    In April 1996, the Company's Plan of Reorganization (the "Plan") was
approved by the U.S. Bankruptcy Court.  The Plan requires the three debt holders
to accept the terms of the Royalty Pool agreement but further requires the
Company to purchase the three debt holders' interests as follows:  $91,068 of
the debt is to be purchased on April 29, 1996, $54,640 on March 29, 1997,
$43,713 on March 29, 1998, $34,970 on March 29, 1999, and $139,880 on March 20,
2000.




                                          5



    If the remaining unpaid balance of the Royalty Pool is not purchased by the
Company in full by March 29, 1998, the remaining balance due will accrue
interest at 8% per annum.  The Company has the option of purchasing the
remaining unpaid balance of the Royalty Pool on or before March 29, 1999, at a
10% discount of the amount then due.

    The Plan also requires the Company to segregate the Royalty Pool payments
to the former Chief Executive Officer of TMA in an interest-bearing trust
account pending the outcome of actions brought by TMA and the Company against
Robert C. Mathis and Marvin H. Ball, together with corresponding countersuits
initiated in the U.S. District Court for the District of Montana.  The extent of
potential liability, if any, related to this matter cannot be estimated at this
time.

    In May 1995, the Company relocated TMA assets and equipment to its
Portland, Oregon facility.  Three employees were relocated and three part-time
former TMA employees remained in Montana to assist with sales and marketing
activities.

    SMS PRODUCTS.  The principal products of SMS are laser-based measurement
products and technology that can be applied to both military and industrial
markets.  Historically, TMA did not pursue industrial markets but instead
concentrated on military markets.  The Company believes that this strategy was a
significant contributing factor in the failure of TMA to achieve profitable
operations.

    The Company believes that the patents, patent applications, trademarks and
other proprietary technology acquired with TMA can be successfully refocused
into industrial markets, including electronics, computer disk manufacturers and
flat-panel display manufacturers.

    The Company is developing a detailed product review and marketing plan.
SMS attended and displayed its products at its first industry trade show in
September 1995 to gain valuable customer and market input.  Review of SMS
technology and products for performance, service and competitive marketability
was completed by the end of Fiscal 1996.  Over the long term, the Company
expects TMA technologies and products to add to sales and profitability of the
Company.  During Fiscal 1996, sales of SMS products totaled $2,278,977.

    SMS operates three businesses: a light-scatter measurement laboratory,
laser-based light-scatter measurement products and other laser alignment
products.   SMS provides a highly advanced, extremely precise measurement
services laboratory to a wide variety of industrial and commercial businesses,
using advanced laser, light scatter technology.

    The laboratory uses three TMA CASI Scatterometers for measuring surface
roughness.  The true value of the laboratory is not only its extremely precise
measurement capability but also that the item being tested is not altered,
touched or destroyed.  Thus, the laboratory is widely used by the semiconductor
and computer hard disk industries, as well as manufacturers of critical optical
components in aerospace and defense systems.  Customers of the laboratory have
included Aerojet, AT&T Bell Labs, Eastman Kodak, General Electric, IBM, NASA and
dozens of other industrial companies, universities and government agencies.

    The three TMA CASI Scatterometers in the laboratory are angle-resolved BRDF
measurement instruments providing customers with precise roughness measurements
of optical surfaces, diffuse materials, semiconductor wafers, magnetic storage
media, precision-machined surfaces, as well as surfaces affecting the cosmetic
appearance of consumer products.  A Scatterometer uses ultraviolet or




                                          6



infrared laser light as a nondestructive probe to measure surface quality,
optical performance, smoothness, appearance, defects and contamination on a wide
variety of materials.

    The sample is mounted on stages capable of moving bidirectionally and/or in
rotation.  The incident angle can be set anywhere up to an 85 degree angle from
surface normal.  The detector sweeps around the sample in the incident plane
measuring scattered and specular light.  During the scan, the computer controls
gain, filter and aperture changes through user-defined parameters.  The
instrument background is measured separately and can be compared with the sample
data.

    The CASI Analysis Software simplifies analysis of scatter data.  BRDF
values are used to calculate total integrated scatter, PSD and RMS roughness.
Annotated results print on the HP PaintJet printer as viewgraphs or
publication-ready figures.

    The laboratory generated about 10% of SMS's revenue during Fiscal 1996.
Total revenue for this business is expected to rise modestly in the future while
representing a smaller percentage of SMS's business.  Use of the laboratory,
leading to orders for SMS's laser-based light scatter measurement products by
its customers, represents the best marketing channel for SMS's current and
future products.  Existing products (such as the uScan, the GapMaster and
Model 2002) and products being developed in conjunction with the measurement
services laboratory are being marketed to a variety of industrial customers.

    The muScan* System consists of a hand-held control unit, an interchangeable
measurement head and a separate charging unit.  To perform a measurement, the
operator places the measurement head on the objective area and presses the
button.  Each measurement takes less than five seconds.  The results are
displayed and stored in system memory.  The muScan can store 700 measurements in
255 files and provides the capability to program pass/fail criteria.  Software
is available for control, analysis and file conversion.  From a single
measurement, a user can determine RMS surface roughness, reflectance and scatter
light levels (BRDF) on flat or curved surfaces under any lighting conditions.

    The GapMaster provides the totally automatic solution to measuring gap
width and surface mismatch.  The portable hand-held instrument captures gap
widths up to 0.500 inches and mismatches up to 0.250 inches to an accuracy of
+/-.005 inches, accommodating both flat and curved surfaces.  The GapMaster
eliminates angular alignment problems and resolves complex edges, even when
there are variations in surface finish.  Results are displayed on the LCD
located on the rear of the instrument.  A 486/33 Mhz computer is provided which
instantaneously compares the results to pre-programmable measurement tolerances
and returns a pass/fail indication to the operator.  Each measurement setting is
time and date stamped for statistical process control.

    The Auto-Collimating Alignment Laser System - Model 2002 is an extremely
accurate laser alignment system.  The incorporation of a solid-state laser diode
provides increased beam stability and eliminates warm-up time.  A new unique TMA
See-Thru target design completely eliminates beam displacement and power loss.
The addition of an operator selectable auto-collimating feature provides one arc
second accuracy over a large angular range.  A microprocessor automates system
configuration.  A new bus interconnect reduces setup time and allows up to seven
operator selectable targets, reducing time required to perform measurements.  A
complete Model 2002 system consists of an auto-collimating laser, power supply,
digital display, See-Thru and end targets, carrying case and cable assemblies.

*MuScan is normally written with a Greek letter "mu" follow immediately by 
the word "Scan."

                                          7




BUSINESS AND MARKETING STRATEGY

    MARKETING.  The Company designs, assembles and markets all of its products.
Its operations are divided into a number of different areas.  The production
organization, which is responsible for all assembly, purchasing and production
engineering, is directed by the Vice President of Operations.  The Product
Marketing Division is responsible for the sale of SBS System products.  This
division is managed by the President/CEO and five Marketing Managers.  Four of
the Marketing Managers are responsible for domestic sales.  The fifth Marketing
Manager is responsible for sales in mainland China, Japan and Korea.  The
President/CEO is responsible for sales in both eastern and western Europe and
also oversees the efforts of the five Marketing Managers.  The technical
services division is responsible for providing technical support to customers
and is managed by the Vice President of Operations.  In addition, there is a
research and development group which is supervised directly by the President/CEO
and the Vice President of Operations.

    The Company markets and sells the SBS System in a variety of ways.  First,
the Company uses the conventional channels provided by independent
manufacturer's representatives and distributors.  There are currently 25
individuals and/or organizations in the United States acting in one of these
capacities.  Compensation comes from commissions which are paid only upon
completion of a sale and payment by the customer.  The amount paid to the
selling person or entity varies between 10% (for independent sales agents) and
15% (for distributors) of the sales amount.

    Second, trade shows represent a significant amount of marketing/sales
effort.  These events are held throughout the world and have proven to be
excellent sources of business for the Company.  A representative from the
Company, usually one of the marketing managers and/or Wayne A. Case, attends
these events along with local Company representatives.  These individuals attend
a display booth that features professional products, an SBS System demonstration
stand, product literature, and technical literature.  Representatives from all
facets of the market to which the Company directs its sales efforts attend these
trade shows.

    Third, original equipment manufacturers often include the SBS System on the
machine tools which they produce.  Users thus purchase the SBS System
concurrently with the machine tools.  The SBS Systems are also often installed
by machine builders prior to displaying their own machine tools at various trade
shows.  These samples often become endorsements that prove to be beneficial to
the Company's sales efforts.

    In the United States, most products are shipped directly to customers from
the Company's distribution center in Portland, Oregon.  Where the Company has
distributors, the product is shipped to the distributor, who in turn pays the
Company directly and then delivers and installs the product with the end user.
Western European distribution to customers is handled by shipping the product
directly from the Company's Portland headquarters to the end users.

    The acquisition of SMS (formerly TMA) has resulted in revision of marketing
strategy of both the balancer business and the new measurement products.  The
Company is evaluating all products acquired through the acquisition of TMA and
evaluating existing measurement product and balancing product distributors and
agents to determine the most efficient mix.

    MANUFACTURING.  The Company does not use any unique sources of supply or
raw materials in its products for either SBS System balancing products or SMS
measurement products.  Essential electronic components used are available in
large quantities from various suppliers.  These electronic components


                                          8




are assembled into the SBS System and SMS electronic control units to meet the
Company's quality and assembly standards.  Company-owned software and firmware
are coupled with the electronic components to provide the basis of the Company's
various electronic control units.  The Company believes several sources of
supplies exist for all electronic components and assembly work that is used in
its electronic control system.  The Company's primary outside supplier of
electronic assembly is Bell Industries of Portland, Oregon, a custom supplier of
assembled electronic products for several Pacific Northwest companies.  In the
event of supply problems, the Company feels two or three alternatives could be
developed within 30 days to supplement or replace Bell Industries.

    Mechanical parts for the Company's SBS System and SMS products are produced
to the customers' drawings and specifications by local high quality CNC machine
shops.  Several such CNC machine shops exist in the local area, and the Company
is not dependent on any one supplier of mechanical components.  Principal
suppliers of components for the Company's products include MacKay Manufacturing
of Spokane, Washington; OEM Manufacturing of Corvallis, Oregon; Eagle Industries
of Newberg, Oregon; and Forest City Gear of Roscoe, Illinois.

    The Company uses in-house skilled assemblers to construct and test 
vendor-supplied components.  Component inventory of finished vendor-supplied 
parts is held on the Company property to assure adequate flow of parts to 
meet customer order requirements.  Inventory is monitored by a computer 
control system designed to assure timely re-ordering of components.

    In-house personnel assemble various products and test all finished
components before placing them in the finished goods inventory.  Finished goods
inventory is maintained via computer to assure timely shipment and service to
customers.  All customer shipments are from the finished goods inventory.

    The Company has instituted a Quality Control Program to conform to ISO-9001
European Quality Certification.  Full ISO-9001 certification of the Company's
Quality Control Program is expected by December 1996.

    The Company has established an SBS System customer base consisting of over
250 companies.  No one customer accounts for more than 5% of the Company's total
annual revenues.  TMA had established over 200 customers, many of whom are also
purchasers of the Company's SBS System balancing products.  The major customers
of TMA (now SMS) have been retained by the Company.  No customer of SMS
represents more than 5% of the Company's sales.

PATENTS AND TRADEMARKS

    SBS SYSTEM PRODUCTS.  The Company manufactures its products under copyright
protection in the U.S. for all electronic board designs which are also further
protected with encapsulation of the finished product to protect the Company
technologies and software.  U.S. Patent No. 4951526 was issued to the Company on
August 28, 1990 and covers both the new ring balancer and the existing SBS
Balance Heads that the Company markets to the grinding industries.

    The trademark "SBS" is a registered trademark of the Company and is affixed
to all products and literature created in the Company's balance product line.

    The Company pays no licenses or royalties on its balancing technologies and
has offered no concessions, labor agreements or royalty agreements on its
balancing product lines.


                                          9



    SMS PRODUCTS.  The trademark "SMS" is a registered trademark of the Company
and is affixed to all products and literature created in the Company's
measurement product line.

    The following tables include information about patents and trademarks
issued and patents pending with respect to SMS products.

SMS PATENTS ISSUED
- --------------------------------------------------------------------------------

5196906       March 1993     muScan:  surface measurement
5416590       May 1995       GapMaster:  gap and mismatch
08/349598     April 1996     Pitch, yaw of a single laser beam system and method
                             of measuring angular position
- --------------------------------------------------------------------------------

SMS PATENTS PENDING
- --------------------------------------------------------------------------------
1356.2.4 September 1995      Methods and apparatus for characterizing a surface


SMS TRADEMARKS
- --------------------------------------------------------------------------------

muScan   August 1992         Surface measurement system
CASI     March 1993          Surface inspection system
Accunet  May 1994            Distance measurement NET
FMS      December 1994       Finished measurement systems
Surf-Map April 1995          Surface inspection process
SMS      September 1995      Schmitt Measurement System

PRODUCT DEVELOPMENT

    During Fiscal 1993, 1994 and 1995, research and development activities of
the Company were focused on the enhancement of the existing product lines for
balancers and on development work toward the new ring balance product.  Since
its May 1995 acquisition of TMA, the Company has expended significant efforts
evaluating existing and potential new products for the light-scatter precision
measurement market.

    During Fiscal 1994 and 1995, the Company developed the Ring Balancer, a
dynamic balancer shaped as a "ring" that allows the device to be fitted "around"
a rotating shaft rather than on the end of a shaft where the current Company
products are mounted.  This mounting and configuration will allow the Company to
apply its ring balancers to virtually any rotating device such as fans,
turbines, large motors, centrifuges and other industrial machine tools.

    During the last several years, the Company has developed several new major
offshoot products of its balancing technologies to widen market opportunities.
All costs associated with these developments have been borne directly by the
Company's customers, with minimal development costs to the Company.  Research
and development costs for existing product line enhancements are treated as
product improvements and expenses, including costs toward the new Ring Balancer.

    During Fiscal 1996, the Company continued to develop new balancing products
and expended considerable time and effort in evaluating and developing new
laser-based measurement products.  During Fiscal 1996, the Company developed and
began marketing three new surface measurement light scatter machines:  the
TMS-2000, TMS-2000-W and TMS-3000.


                                          10



INTERNATIONAL SALES

    The Company's sales in the last three fiscal years have been generated from
the following sources:

              NORTH AMERICA            EUROPE              ASIA
              -------------         -----------       -----------

Fiscal 1996   $6,298,170              $442,470          $339,488
Fiscal 1995    4,018,498               220,741           175,593
Fiscal 1994    2,343,250               128,750           102,998


EMPLOYEES

    As of August 1, 1996, the Company employed 28 individuals on a full-time
basis.  There were no regular part-time employees.  None of the Company's
employees is covered by a collective bargaining agreement.

ITEM 2.  PROPERTIES

    The Company's design and assembly facilities and executive offices are
located in a 7,500 square foot building in Portland, Oregon.  A 33,000-square
foot facility located across the street from the executive offices houses SMS's
operations.  The Company believes its facilities are adequate to meet its
current needs.

ITEM 3.  LEGAL PROCEEDINGS

    In May 1995, the Company acquired TMA Technologies Inc. ("TMA") which
became a wholly owned subsidiary of the Company and was renamed Schmitt
Measurement Systems, Inc. ("SMS").  During the third quarter of Fiscal 1996, the
Company and SMS filed an action against Robert C. Mathis and Marvin H. Ball,
former officers and directors of TMA, in the U.S. District Court for the
District of Montana.  The lawsuit claims that these individuals violated their
fiduciary duties to TMA, Schmitt and participants in a TMA royalty pool and are
responsible for a Chapter 7 bankruptcy filing against TMA by three debt holders
of TMA.

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

    No matters were submitted to a vote of the security holders of the Company
during the fourth quarter ended May 31, 1996.


                                       PART II

ITEM 5.   MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
          STOCKHOLDER MATTERS

    The Company's Common Stock was traded on the Vancouver Stock Exchange (the
"VSE") from April 1987 to February 1995 when it was voluntarily delisted.  Since
January 30, 1995, the Common Stock has been traded on the Nasdaq - Small Cap
Market under the symbol "SMITF" through February 16, 1996 and "SMIT" since then.


                                          11



    The following tables set forth the high and low sales prices of the
Company's Common Stock as reported on the VSE and on the Nasdaq - Small Cap for
the periods indicated.

                               VANCOUVER STOCK EXCHANGE
                                  (Canadian dollars)

    YEAR ENDED MAY 31, 1995                            HIGH            LOW
    ----------------------------------------          -------        -------
    First Quarter                                     $  3.60        $  3.00
    Second Quarter                                    $  3.75        $  3.40
    Third Quarter (through February 10, 1995)         $  3.75        $  3.05



                              NASDAQ - SMALL CAP MARKET
                                    (U.S. dollars)

    YEAR ENDED MAY 31, 1995                            HIGH            LOW
    ----------------------------------------          -------        -------
    Third Quarter (from January 30, 1995)             $  2.88        $  2.25
    Fourth Quarter                                    $  2.88        $  2.38

    YEAR ENDED MAY 31, 1996                            HIGH            LOW
    ----------------------------------------          -------        -------
    First Quarter                                     $  2.88        $  2.13
    Second Quarter                                    $  5.13        $  2.63
    Third Quarter                                     $  5.63        $  3.88
    Fourth Quarter                                    $ 14.75        $  5.25

    As of August 1, 1996, there were 6,981,889 shares of Common Stock
outstanding held by approximately 110 holders of record.  The number of holders
does not include individual participants in security position listings.

    In June 1994, the Company paid its only cash dividend, which amounted to
CDN $0.20 per share.  The Company's present policy is to retain earnings to
finance the Company's business.  Any future dividends will be dependent upon the
Company's financial condition, results of operations, current and anticipated
cash requirements, acquisition plans and plans for expansion and any other
factors that the Company's Board of Directors deems relevant.  The Company has
no present intention of paying dividends on its Common Stock in the foreseeable
future.

ITEM 6.  SELECTED FINANCIAL DATA

    The information required by this Item is included in the Company's Annual 
Report to Shareholders for the fiscal year ended May 31, 1996 under the 
heading "Selected Financial Data" and is incorporated herein by reference.

                                          12



ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF
         FINANCIAL CONDITION AND RESULTS OF OPERATIONS

    The information required by this Item is included in the Company's Annual 
Report to Shareholders for the fiscal year ended May 31, 1996 under the 
heading "Management's Discussion and Analysis" and is incorporated herein by 
reference.

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

    The report of independent auditors, financial statements and other 
information required by this Item are included in the Company's Annual Report 
to the Shareholders for the fiscal year ended May 31, 1996 and are 
incorporated herein by reference.

ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
         ON ACCOUNTING AND FINANCIAL DISCLOSURE

    In May 1995, the Company replaced its independent accountant, Bruce
Jamieson of Vancouver, British Columbia, with Moss Adams LLP.  This decision was
made by the Company's Board of Directors and was based on the need for an
accounting firm with greater experience in U.S. accounting and SEC reporting
requirements.

    Mr. Jamieson's reports for the fiscal years ended May 31, 1994 and May 31,
1995 did not contain an adverse opinion or disclaimer of opinion, nor were they
qualified or modified as to uncertainty, audit scope or accounting principles.
During Fiscal 1994 and 1995, there were no disagreements with Mr. Jamieson on
any matter of accounting principles or practices, financial statement disclosure
or auditing scope of procedure, which disagreements, if not resolved to the
satisfaction of Mr. Jamieson, would have caused him to make reference to the
subject matter of the disagreements in connection with his report.


                                       PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

    The Company's directors and executive officers are as follows:

         NAME                AGE                 POSITION
    ------------------       ---       ----------------------------------
    Wayne A. Case            56        Chairman/President/CEO, Director
    David W. Case            33        Vice President of Operations
    Annie Windsor            53        Chief Financial Officer
    Linda M. Case            51        Secretary
    Maynard E. Brown         46        Director
    David L. Dotlich         49        Director
    David M. Hudson          44        Director
    Trevor Nelson            34        Director
    John A. Rupp             56        Director


                                          13



    WAYNE A. CASE has been Chairman of the Board, President and Chief Executive
Officer of the Company since 1986.  Mr. Case holds a Bachelor of Science degree
in Business and Economics from Linfield College and a Master of Business
Administration degree from the University of Portland.  In addition to
overseeing the day-to-day operations of the Company, he is responsible for
international marketing operations.  Mr. Case is married to Linda M. Case and is
the father of David W. Case.

    DAVID W. CASE has been Vice President of Operations of the Company since
1993 and before then was Production Manager.  Mr. Case holds a Bachelor of Arts
degree in Engineering and Business Administration from the University of Oregon.
He has been responsible for many of the design features of the SBS Dynamic
Balance System.  His duties include manufacturing, engineering and quality
assurance.  Mr. Case is the son of Wayne A. Case.

    ANNIE WINDSOR has been Chief Financial Officer of the Company since 1993
and before then acted as Accounting Manager.  Ms. Windsor holds a Bachelor of
Arts degree in psychology from Coe College in Cedar Rapids, Iowa, and a Master
of Arts degree from Southern Illinois University.  Her duties include being
Chief Financial Officer and creating and maintaining a computerized inventory
management and accounting system covering all aspects of the Company's business.

    LINDA M. CASE has been Secretary of the Company since 1994 and before then
was Office Manager.  Her duties include investor relations, office management,
purchasing and inventory management.  Ms. Case holds a B.A. degree in sociology
and psychology from Linfield College in McMinnville, Oregon.  Ms. Case is
married to Wayne A. Case.

    MAYNARD E. BROWN, a director since 1992, resides  in British Columbia,
Canada.  Since November 1993, Mr. Brown has been the senior partner of Brown
McCue of Vancouver, British Columbia, which firm specializes in advising
publicly held corporations in securities and related matters.  Brown McCue acts
as the Company's Canadian counsel.  Prior to November 1993, he was a sole
practitioner in Vancouver.  Mr. Brown has a Bachelor of Law degree from
Dalhousie University in Halifax, Canada.

    DAVID L. DOTLICH, a director since August 1996, is a member of the faculty
of the University of Michigan Business School, where he also serves as Executive
Director of the Michigan Human Resource Partnership, and on the graduate faculty
of the University of Minnesota.  He is a consultant to top management of large
corporations, including four Fortune 500 companies, specializing in corporate
transformation and senior leadership development.  Until 1992, he was Executive
Vice President of Groupe Bull, a computer manufacturer headquartered in Paris.
Mr. Dotlich received a B.A. degree from the University of Illinois, an
M.A. degree from the University of Witwaterstand in Johannesburg, South Africa,
and a Ph.D. in organizational psychology and management from the University of
Minnesota.

    DAVID M. HUDSON, a director since August 1996, is founder and President of
Coldstream Holdings, Inc. and Coldstream Capital Management, Inc., a privately
held registered investment advisory firm which provides advisory services to
individuals, institutions, trusts and endowments and advises clients on a
variety of corporate finance matters.  Mr. Hudson holds a B.S. degree in
mathematics from the University of Oregon where he also pursued post-graduate
studies in economics.

    TREVOR NELSON, a director since 1989, resides in British Columbia, Canada.
Since 1988, Mr. Nelson has been a financial planner for the Stewart Thomas Group
in Vancouver, British Columbia.  He holds a Bachelor of Commerce degree with an
emphasis on accounting management and information systems and is a Chartered
Accountant.


                                          14



    JOHN A. RUPP, a director since August 1996, is Vice President of Beauty
Management, Inc., which owns and manages beauty salons, and manages his personal
investments.  Mr. Rupp holds a B.A. in economics from Harvard University.

ITEM 11. EXECUTIVE COMPENSATION

    The following table sets forth, for each of the three years in the period
ended May 31, 1996, amounts of cash and certain other compensation paid by the
Company to Wayne A. Case, President and Chief Executive Officer (the "Named
Executive").  No other executive officer was paid salary and bonus in excess of
$100,000 in Fiscal 1996.

                              SUMMARY COMPENSATION TABLE

                             ANNUAL COMPENSATION
                  --------------------------------------------
                                                 OTHER ANNUAL   ALL OTHER
NAME/TITLE       YEAR      SALARY      BONUS     COMPENSATION   COMPENSATION
- ----------       ----     --------     -----     ------------   ------------
Wayne A. Case(1)
President/CEO    1996     $125,360        --       $      --      $ 7,146
                 1995       69,837        --              --        6,981
                 1994(2)    61,741        --         183,538        5,950
- ---------------------

    (1)  During Fiscal 1995 and 1996, "Other Annual Compensation" 
         included an allocation for automobile use benefits.  During Fiscal 
         1994, "Other Annual Compensation" included $966 of automobile use 
         benefits and $182,572 of net market value of exercised stock 
         options.  "All Other Compensation" included SEP/IRA and group 
         insurance benefits, which are standardized and equal for all 
         salaried officers.

    (2)  Converted from Canadian to U.S. dollars at a conversion rate of
         U.S. $1.00 = CDN $1.381 (May 1994 average).

                         AGGREGATED OPTION EXERCISES IN LAST
                    FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES

    The following table provides information with respect to the Named
Executive concerning the exercise of options during the fiscal year ended
May 31, 1996 and unexercised options held as of such date.  No options were
granted to the Named Executive in Fiscal 1996.


                                          15



NUMBER OF SHARES UNDERLYING UNEXERCISED VALUE OF UNEXERCISED IN-THE- OPTIONS AT FY-END MONEY OPTIONS AT FY-END(1) ---------------------------- ---------------------------- SHARES ACQUIRED ON VALUE NAME EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE - ------------- ------------ -------- ---------- ------------ ----------- ------------- Wayne A. Case 18,750 $ 37,500 293,250 -- $ 10,410,375 --
- --------------- (1) Amounts reflected are based upon the market value of the Common Stock as of May 31, 1996 ($13.375) minus the exercise price ($2.00), multiplied by the number of shares underlying the options. COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION* EXECUTIVE COMPENSATION PHILOSOPHY The Compensation Committee of the Board of Directors, which is composed of Maynard E. Brown, Wayne A. Case and Trevor Nelson, was established in August 1996 and met then for the first time. Prior to August 1996, the full Board of Directors performed the functions of the Compensation Committee. The Compensation Committee is responsible for setting and administering the policies and programs that govern compensation for the executive officers of the Company. The Board of Directors' Option Committee ("Option Committee"), composed of Maynard E. Brown and Trevor Nelson, administers the Company's Stock Option Plan (the "Option Plan"). The goal of the Company's executive compensation policy is to ensure that an appropriate relationship exists between compensation and corporate performance, while at the same time attracting, motivating and retaining executive officers and other key employees. The key components of the Company's compensation program are base salary and potential long-term compensation through stock options. These components are administered with the goal of providing total compensation that is competitive in the marketplace, rewards successful financial performance and aligns executive officers' interests with those of stockholders. The Compensation Committee reviews executive compensation on an annual basis, or more often if necessary, and determines, subject to the Board's approval, base salary for executive officers. The Option Committee makes all decisions with respect to stock option grants. - --------------------- * The report of the Compensation Committee shall not be deemed incorporated by reference by any general statement incorporating by reference this Proxy Statement into any filing under either the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended (together, the "Acts"), except to the extent that the Company specifically incorporates such report by reference; and further, such report shall not otherwise be deemed filed under the Acts. 16 EQUITY PARTICIPATION The Company uses stock options granted under its Option Plan both to reward past performance and to motivate future performance, especially long-term performance. The Compensation Committee believes that through the use of stock options, executive interests are directly tied to enhancing shareholder value. STOCK OPTIONS As of August 1, 1996, a total of 814,500 shares of Common Stock were subject to outstanding options granted to employees. Wayne A. Case had options to purchase 293,250 shares at an exercise price of CDN $2.67 per share, expiring on February 4, 1999. David W. Case had options to purchase 237,500 shares at an exercise price of CDN $1.96 per share, expiring on January 7, 1999. One other employee had options to purchase 12,500 shares at an exercise price of CDN $1.96 per share, expiring on January 7, 1999. In addition, as of August 1, 1996, options granted under the Option Plan to purchase a total of 271,250 shares of Common Stock with exercise prices of $4.375, $5.50 and $9.75 per share, expiring on January 12, 2002, March 11, 2003 and May 3, 2006, respectively, were outstanding. These options were held by 28 executive officers and employees. A maximum of 500,000 shares of the Company's Common Stock may be issued under the Option Plan. The stock options provide value to the recipients only when the market price of the Company's Common Stock increases above the option grant price and only as the shares vest and become exercisable. While option grants under the Option Plan are made by the Option Committee, the Compensation Committee considers these grants in making its cash compensation decisions. COMPENSATION OF CHIEF EXECUTIVE OFFICER The Chief Executive Officer's compensation is set using the Compensation Committee's general philosophy as described above. In Fiscal 1996, Wayne A. Case received a base salary of $125,000. He received no stock option grants in Fiscal 1996. DEDUCTIBILITY OF EXECUTIVE COMPENSATION The Compensation Committee has considered the impact of Section 162(m) of the Internal Revenue Code adopted under the Omnibus Budget Reconciliation Act of 1993, which section disallows a deduction for any publicly held corporation for individual compensation exceeding $1 million in any taxable year for the CEO and the four other most highly compensated executive officers, unless such compensation meets certain exceptions to the general rule. Compensation paid by the Company to each 17 of its executive officers in 1995 was well below $1 million, and therefore Section 162(m) did not affect the tax deductions available to the Company. The Committee will continue to monitor the applicability of the section to the Company's compensation programs and will determine at a later date what actions, if any, the Company should take to qualify for available tax deductions. COMPENSATION COMMITTEE Maynard E. Brown Wayne A. Case Trevor Nelson COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION Since its formation in August 1996, the Compensation Committee has consisted of Maynard E. Brown, Wayne A. Case and Trevor Nelson. Mr. Case is President and Chief Executive Officer of the Company. Prior to August 1996, the Board of Directors did not have a Compensation Committee; consequently, all directors, including Mr. Case, participated in deliberations concerning executive officer compensation. No member of the Compensation Committee or executive officer of the Company has a relationship that would constitute an interlocking relationship with executive officers or directors of another entity. DIRECTOR COMPENSATION The Company has no formal plan for compensating its directors for their service in their capacity as directors. Directors are entitled to reimbursement for reasonable travel and other out-of-pocket expenses incurred in connection with attendance at meetings of the Board of Directors. The Board of Directors may award special remuneration to any director undertaking any special services on behalf of the Company other than services ordinarily required of a director. During Fiscal 1996, no director received any compensation for his services as a director, including committee participation and/or special assignments. PERFORMANCE GRAPH The following graph compares the yearly percentage change in the Company's cumulative total shareholder return on its common stock with the cumulative total return for the period from May 31, 1991 through May 31, 1996 of (i) the Total Return Index of Nasdaq Stock Market--U.S. and (ii) the Pacific Stock Exchange ("PSE") Technology Index. The PSE Technology Index represents 100 listed and over-the-counter technology stocks from 15 industries. The graph assumes that on May 31, 1991, $100 was invested in the Common Stock of the Company and in each of the comparative indices. The stock price performance on the following graph is not necessarily indicative of future stock price performance. 18 [GRAPH]
05/31/91 05/31/92 05/31/93 05/31/94 05/31/95 05/31/96 ----------------------------------------------------------------------------------- SCHMITT INDUSTRIES, INC. $ 100 $ 117 $ 233 $ 1,199 $ 1,079 $ 6,076 NASDAQ - US 100 117 141 149 177 257 PSE TECHNOLOGY INDEX 100 106 125 144 201 275
19 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth certain information regarding beneficial ownership of the Company's Common Stock as of August 1, 1996 by (i) each person who is known to the Company to own beneficially more than 5% of the Company's outstanding Common Stock, (ii) each of the Company's directors and executive officers, (iii) the Named Executive and (iv) all current directors and executive officers as a group. SHARES BENEFICIALLY OWNED(1) ------------------------------ DIRECTORS, NAMED EXECUTIVE AND 5% SHAREHOLDERS NUMBER PERCENT - ---------------------------------------------- ------------ --------------- Wayne A. Case(2) 2,202,750(3) 30.3% David W. Case(2) 402,500(4) 5.6% Maynard E. Brown -- -- David L. Dotlich 14,500 * David M. Hudson 87,500(5) 1.3% Trevor Nelson -- -- John A. Rupp 227,000 3.3% All directors and executive officers as a group (nine persons) 2,944,050(6) 39.2% - ---------------------- * Less than 1%. (1) A person is deemed to be the beneficial owner of securities that can be acquired by such person within 60 days from the date hereof upon the exercise of options. Each beneficial owner's percentage ownership is determined by assuming that options that are held by such person (but not those held by any other person) and that are exercisable within 60 days from the date hereof have been exercised. Unless otherwise noted, the Company believes that all persons named in the table have sole voting and investment power with respect to all shares of Common Stock beneficially owned by them. (2) The address of the shareholder is care of Schmitt Industries, Inc., 2765 N.W. Nicolai Street, Portland, Oregon 97210. (3) Includes 1,659,783 shares held as trustee of the Wayne A. Case Family Trust with respect to which Mr. Case has sole voting and investment power and 750 shares held by Linda M. Case, Mr. Case's wife, as trustee for the Linda A. Case Family Trust with respect to which Mrs. Case has sole voting and investment power. Also includes 293,250 shares subject to options that are currently exercisable. (4) Includes 237,500 shares subject to options that are currently exercisable. (5) Includes 77,500 shares held by a partnership, the general partner of which is Coldstream Capital Management, Inc. of which Mr. Hudson is president and a shareholder. (6) Includes 530,750 shares subject to options that are currently exercisable. 20 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The Company paid the law firm of Brown McCue, in which Maynard E. Brown, a director of the Company, is a principal, a total of $20,981 in Fiscal 1995 and $15,370 in Fiscal 1996 for legal services. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) Documents filed as part of this report: 1. FINANCIAL STATEMENTS: Annual Report Page Number ------------- A. Consolidated Balance Sheets as of May 31, 1996 and May 31, 1995......................................6 B. Consolidated Statements of Income for each of the years ended May 31, 1996, May 31, 1995 and May 31, 1994...........................................7 C. Consolidated Statements of Cash Flows for each of the years ended May 31, 1996, May 31, 1995 and May 31, 1994............................8-9 D. Consolidated Statements of Changes in Stockholders' Equity for each of the years ended May 31, 1996, May 31, 1995 and May 31, 1994...............................................9 E. Notes to Financial Statements..........................10-14 F. Independent Auditors' Report..............................20 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: See Index to Exhibits on page 24. 21 (b) Reports on Form 8-K: No reports on Form 8-K were filed by the Company during the fourth quarter ended May 31, 1996. 22 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. SCHMITT INDUSTRIES, INC. By: /s/ Wayne A. Case ------------------------------------ Wayne A. Case CHAIRMAN OF THE BOARD, PRESIDENT AND CHIEF EXECUTIVE OFFICER Date: August 28, 1996 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on August 28, 1996. SIGNATURE TITLE /s/ Wayne A. Case Chairman of the Board, President and Chief - ------------------------------- Executive Officer Wayne A. Case (Principal Executive Officer) /s/ Annie Windsor Chief Financial Officer - ------------------------------- (Principal Financial and Accounting Officer) Annie Windsor /s/ Maynard E. Brown Director - ------------------------------- Maynard E. Brown /s/ David M. Hudson Director - ------------------------------- David M. Hudson /s/ Trevor Nelson Director - ------------------------------- Trevor Nelson 23 INDEX TO EXHIBITS EXHIBITS DESCRIPTION - -------- ----------------------------------------------------- 3(i) Restated Articles of Incorporation of Schmitt Industries, Inc. (the "Company"). Incorporated by reference to Exhibit 3.1 to the Company's Registration Statement on Form S-4, File No. 33-98226, as amended. . . . . . . . . . . . . . . . . 3(ii) Restated Bylaws of the Company. Incorporated by reference to Exhibit 3.2 to the Company's Registration Statement on Form S-4, File No. 33-98226, as amended. . . . . . . . . . . . . . . . . *10.1 Schmitt Industries, Inc. Stock Option Plan. . . . . . *10.2 Agreement dated April 21, 1995 between TMA Technologies, Inc. and the Company. . . . . . . . . . *11.1 Schedule of computation of net income per share . . . *13.1 Annual Report to Shareholders of Schmitt Industries, Inc. for fiscal year ended May 31, 1996.. . . . . . . *21.1 Subsidiaries of Schmitt Industries, Inc.. . . . . . . *27.1 Financial Data Schedule . . . . . . . . . . . . . . . - ------------------------- * Filed herewith 24



                                                                    EXHIBIT 10.1



                               SCHMITT INDUSTRIES, INC.


                                  STOCK OPTION PLAN





                               SCHMITT INDUSTRIES, INC.

                                  STOCK OPTION PLAN


    1.   PURPOSES.  The purposes of this Schmitt Industries, Inc. Stock Option
Plan ("Plan") are to:

         1.1  retain the services of valued key employees and consultants of
         Schmitt Industries, Inc. ("Company") and such other persons as the
         Plan Administrator shall select in accordance with Section 4 below;

         1.2  provide such persons with an equity ownership in the Company
         commensurate with the Company's performance as reflected in increased
         value of its common shares;

         1.3  provide an aid and inducement in hiring of new employees and to
         provide an equity incentive to directors, consultants and other
         persons selected by the Plan Administrator; and

         1.4  provide a means whereby the Company can continue to attract,
         motivate and retain the services of selected non-employee agents,
         consultants, advisors, persons involved in the sale or distribution of
         the Company's products and independent contractors of the Company.

    2.   ADMINISTRATION.  This Plan shall be administered by the Board of
Directors of the Company ("Board") or, in the event the Board shall appoint
and/or authorize a committee to administer this Plan, by a committee of the
Board consisting of at least two (2) non-employee directors ("Committee").  The
administrator of this Plan, whether the Board or Committee, shall hereinafter be
referred to as the "Plan Administrator."  The Plan Administrator shall
administer the Plan in accordance with the following:

         2.1  INCAPACITY OF PLAN ADMINISTRATOR.  No member of the Board or the
         Committee shall vote with respect to the granting of an option created
         under this Plan ("Option(s)") to himself or herself.  Any Option
         granted to a director for his or her services as such shall not be
         effective until approved by the full Board.

         2.2  REGISTRATION UNDER THE SECURITIES ACT.  If the Company registers
         any of its equity securities pursuant to Section 12(b) or 12(g) of the
         Securities Exchange Act of 1934, as amended ("Exchange Act") and any
         officers or directors are


                                                                    Page 1 of 14



         eligible to receive Options, the following provisions shall apply to
         the administration of this Plan with respect to grants made to
         directors, officers or other Optionees (as hereinafter defined)
         affected by Section 16(b) of the Exchange Act.  The Plan Administrator
         shall be constituted at all times so as to meet the requirements of
         Section 16(b) of the Exchange Act, as amended from time to time.  The
         members of any committee serving as Plan Administrator shall be
         appointed by the Board for such term as the Board may determine. The
         Board may from time to time remove members from, or add members to,
         the committee.  Vacancies on the committee, however caused, may be
         filled by the Board.  Currently, the Plan Administrator is a
         committee.  If, at any time, an insufficient number of disinterested
         non-employee directors is available to serve on such committee,
         interested non-employee directors may serve on the committee; however,
         during such time, no Options shall be granted to any person if the
         granting of such Option would not meet the requirements of Section
         16(b) of the Exchange Act.  For purposes of this Section 2, a
         disinterested director shall be a member of the Board who meets the
         definition of "disinterested person" as set forth in the rules and
         regulations promulgated under Section 16(b) of the Exchange Act, as
         amended from time to time (the "16(b) Rules").  Currently, a
         disinterested director for purposes of this Section 2 is a member of
         the Board who for one (1) year prior to service as an administrator of
         this Plan has not been (and during service as a Plan Administrator,
         will not be) granted or awarded equity securities, including options
         for equity securities pursuant to this Plan or any other plan of the
         Company or its affiliates, except for certain exclusions described in
         Rule 16b-3.  For purposes of this Section 2, a non-employee director
         shall be a member of the Board who meets the definition of
         "non-employee director" as set forth in the 16(b) Rules.  Currently, a
         non-employee director is a member of the Board who (i) is not
         currently an officer of the Company or a parent or subsidiary of the
         Company, or otherwise currently employed by the Company or a parent or
         subsidiary of the Company; (ii) does not receive compensation, either
         directly or indirectly, from the Company or a parent or subsidiary of
         the Company, for services rendered as a consultant or in any capacity
         other than as a director, except for an amount that does not exceed
         the dollar amount for which disclosure would be required pursuant to
         Item 404(a) of Regulation S-K promulgated under the Exchange Act
         (("S-K"); (iii) does not possess an interest in any other transaction
         for which disclosure would be required pursuant to Item 404(b) of S-K;
         and (iv) is not engaged in a business relationship for which
         disclosure would be required pursuant to Item 404(b) of S-K.

         2.3  PROCEDURES.  The Board may designate one of the members of the
         Plan Administrator as chairman.  The Plan Administrator may hold
         meetings at such times and places as it shall determine.  The acts of
         a majority of the members of the Plan Administrator present at
         meetings at which a quorum exists, or acts reduced to or approved in
         writing by all Plan Administrator members, shall be valid acts of the
         Plan Administrator.


                                                                    Page 2 of 14



         2.4  RESPONSIBILITIES.  Except for the terms and conditions explicitly
         set forth in this Plan, the Plan Administrator shall have the
         authority, in its discretion, to determine all matters relating to the
         Options, including selection of the individuals to be granted Options,
         the number of shares to be subject to each Option, the exercise price
         for such Option ("Exercise Price"), and all other terms and conditions
         of the Options.  The interpretation and construction by the Plan
         Administrator of any terms or provisions of this Plan or any Option,
         or of any rule or regulation promulgated in connection with this Plan,
         shall be conclusive and binding on all interested parties, so long as
         such interpretation and construction with respect to incentive stock
         options correspond to the requirements of Section 422 of the Internal
         Revenue Code of 1986, as amended ("Code"), and the regulations issued
         thereunder, and any amendment or successor sections or regulations.

         2.5  SECTION 16(B) COMPLIANCE AND BIFURCATION OF PLAN.  If the Company
         registers any of its equity securities pursuant to Sections 12(b) and
         12(g) of the Exchange Act, it is the intention of the Company that
         this Plan then comply in all respects with Rule 16b-3 under the
         Exchange Act and, if any Plan provision is later found not to be in
         compliance with such Section, the provision shall be deemed null and
         void.  In all events, the Plan shall be construed in favor of its
         meeting the requirements of Rule 16b-3.  Notwithstanding anything in
         the Plan to the contrary, the Board, in its absolute discretion, may
         bifurcate the Plan so as to restrict, limit or condition the use of
         any provision of the Plan to participants who are officers and
         directors subject to Section 16(b) of the Exchange Act without so
         restricting, limiting or conditioning the Plan with respect to other
         participants.


    3.   STOCK SUBJECT TO THIS PLAN.  The stock subject to this Plan shall be
the Company's common stock ("Common Stock").  The Company shall have authorized
and have in reserve for issuance at the time of exercise of any Option a
sufficient number of shares of Common Stock to meet the Company's obligation.
The maximum number of shares of Common Stock which may be issued under the Plan
shall be five hundred thousand (500,000).  If any Option expires or is
surrendered, exchanged for another Option, cancelled or terminated for any
reason without having been exercised in full, the unpurchased shares subject to
such Option shall again be available for purposes of this Plan, including for
replacement Options which may be granted in exchange for such expired,
exchanged, surrendered, cancelled or terminated Options.

    4.   ELIGIBILITY.  An incentive stock option in accordance with Section 422
of the Code ("Incentive Option") may be granted only to an individual who, at
the time the option is granted, is an employee of the Company and who the Plan
Administrator may from time to time select for participation in this Plan.
Members of the Board shall not be eligible for grants of Incentive Options
unless they are also employees of the Company.  At the discretion of the Plan
Administrator, employees, officers, directors of the Company (including non-
employee directors), selected non-employee agents, consultants, advisors,
persons involved in the sale or distribution of the Company's products and
independent contractors of the Company also may receive stock options which are
not qualified under Section 422 of the Code ("Nonqualified


                                                                    Page 3 of 14



Option").  (Qualified and Nonqualified Options are included collectively within
the term "Options" as used in this Plan.)  Any party to whom an Option is
granted shall be referred to as an "Optionee."

    5.   TERMS AND CONDITIONS OF OPTIONS.  Options granted under this Plan
shall be evidenced by written agreements which shall contain such terms,
conditions, limitations and restrictions as the Plan Administrator shall deem
advisable and which are not inconsistent with this Plan.  Notwithstanding the
foregoing, Option agreements shall include or incorporate by reference the
following terms and conditions:

         5.1  NUMBER OF SHARES.  Each Option agreement shall state the number
         of shares of stock subject to the Option.

         5.2  OPTION PRICE.  The Option agreement shall state the Exercise
         Price per share, and the Plan Administrator shall act in good faith to
         establish the Exercise Price as follows:

              5.2.1     INCENTIVE OPTIONS.  Subject to subsection 5.2.3, the
              Exercise Price of Incentive Options shall be not less than the
              fair market value per share of the Common Stock at the time the
              Incentive Option is granted.

              5.2.2     INCENTIVE OPTIONS TO GREATER THAN 10% SHAREHOLDERS.
              With respect to Incentive Options granted to shareholders then
              holding greater than ten percent (10%) of the then-issued and
              outstanding shares of voting stock of the Company, the Exercise
              Price shall be as required by Section 6.

              5.2.3     FAIR MARKET VALUE.  With respect to Incentive Options,
              the fair market value per share of the Common Stock shall be
              determined by the Plan Administrator in good faith at the time
              the Incentive Option is granted.

              5.2.4     SUBSTITUTED OPTIONS.  Options granted in substitution
              for outstanding Options in the Company in connection with the
              merger, consolidation, continuation acquisition of property or
              stock of the Company or a subsidiary of the Company or another
              corporation or any subsidiary of another corporation may be
              granted with an exercise price equal to the exercise price for
              the substituted option of the Company or other corporation,
              subject to any adjustment consistent with the terms of the
              transaction pursuant to which the substitution is to occur.

              5.2.5     NONQUALIFIED OPTIONS.  The Exercise Price of
              Nonqualified Options shall be as is determined by the Plan
              Administrator in good faith at the time of their issuance.

         5.3  TERM, MATURITY AND VESTING.  Subject to the restrictions
         contained in Sections 5.8 and 6, the term of each Incentive Option
         shall be ten (10) years from


                                                                    Page 4 of 14



         the date it is granted unless a shorter period of time is established
         by the Plan Administrator, but in no event shall the term of any
         Incentive Option exceed ten (10) years.  The term of each Nonqualified
         Option shall also be ten (10) years from the date it is granted unless
         a shorter period of time is established by the Plan Administrator.
         The Plan Administrator shall specify which Options granted hereunder
         are Incentive Options and which are Nonqualified Options.

         No Option shall be exercisable until it has vested.  The vesting
         schedule for each Option shall be specified by the Plan Administrator
         at the time of grant;  PROVIDED, that if no vesting schedule is
         specified at the time of grant, the Option shall vest according to the
         following schedule:

                 Number of Years          Percentage of Total
             Following Date of Grant         Option Vested
            -------------------------    ---------------------
                      One                         25%
                      Two                         50%
                      Three                       75%
                      Four                       100%

         The Plan Administrator may specify a vesting schedule for all or any
         portion of an Option based on the achievement of performance
         objectives established in advance of the commencement by the Optionee
         of services related to the achievement of the performance objectives.
         Performance objectives shall be expressed in terms of one or more of
         the following:  return on equity, return on assets, share price,
         market share, sales, earnings per share, costs, net earnings, net
         worth, inventories, cash and cash equivalents, gross margin or the
         Company's performance relative to its internal business plan.
         Performance objectives may be in respect of the performance of the
         Company as a whole (whether on a consolidated or unconsolidated
         basis), a related corporation, or a subdivision, operating unit,
         product or product line of either of the foregoing.  Performance
         objectives may be absolute or relative and may be expressed in terms
         of a progression or a range.  An option which is exercisable (in whole
         or in part) upon the achievement of one or more performance objectives
         may be exercised only following written notice to the  Optionee and
         the Company by the Plan Administrator that the performance objective
         has been achieved.

         5.4  EXERCISE.  Subject to the limitations on exercise described in
         subsection 5.3 above and any additional holding period required by
         applicable law, each Option may be exercised in whole or in part;
         provided, however, that only whole shares will be issued pursuant to
         the exercise of any Option.  During an Optionee's lifetime, any
         Options granted under this Plan are personal to him or her and are
         exercisable solely by such Optionee.  Options shall be exercised by
         delivery to the Company of a written notice of the number of shares
         with respect to which the Option is to be exercised, together with
         payment of the Exercise Price in accordance with Section 5.5.


                                                                    Page 5 of 14




         5.5  PAYMENT OF EXERCISE PRICE.  Payment of the Exercise Price shall
         be made in full at the time the written notice of exercise of an
         Option is delivered to the Company, and shall be in cash, bank
         certified or cashier's check or personal check (unless at the time of
         exercise the Plan Administrator in a particular case determines not to
         accept a personal check) for the Common Stock being purchased.  The
         Plan Administrator can determine in its discretion (i) at the time an
         Incentive Option is granted, or (ii) at any time before exercise of
         Nonqualified Options that additional forms of payment will be
         permitted, including installment payments on such terms and over such
         period as the Plan Administrator may determine.  To the extent
         permitted by the Plan Administrator and applicable laws and
         regulations (including, but not limited to, federal tax and securities
         laws and regulations and state corporate law), an option may be
         exercised by:

              5.5.1     DELIVERY OF COMMON STOCK.  Delivery of shares of Common
              Stock held by an Optionee having a fair market value equal to the
              Exercise Price, such fair market value to be determined in good
              faith by the Plan Administrator;

              5.5.2     DELIVERY OF PROMISSORY NOTE.  Delivery of a
              full-recourse promissory note executed by the Optionee; provided
              that (i) such note if delivered in connection with an Incentive
              Option shall, and such note if delivered in connection with a
              Nonqualified Option may, bear interest at a rate specified by the
              Plan Administrator, but in no case less than the rate required to
              avoid imputation of interest (taking into account any exceptions
              to the imputed interest rules) for federal income tax purposes;
              (ii) the Plan Administrator shall specify the term and other
              provisions of such note at the time an Incentive Option is
              granted or at any time prior to exercise of a Nonqualified
              Option; (iii) the Plan Administrator may require that the
              Optionee pledge the Optionee's shares to the Company for the
              purpose of securing the payment of such note, and may require
              that the certificate representing such shares be held in escrow
              to perfect the Company's security interest; (iv) the note
              provides that ninety (90) days following the Optionee's
              termination of employment with the Company or a related
              Corporation, the entire outstanding balance under the note shall
              become due and payable, if not previously due and payable; and
              (v) the Plan Administrator in its sole discretion may at any time
              after granting an Option restrict or rescind the right to pay
              using a promissory note upon written notification to any
              Optionee;

              5.5.3     DELIVERY OF SALE PROCEEDS.  Delivery of a properly
              executed written exercise notice, together with irrevocable
              instructions to a broker, all in accordance with the regulations
              of the Federal Reserve Board, to promptly deliver to the Company
              the amount of sale or loan proceeds to pay the exercise price and
              any federal, state or local withholding tax obligations that may
              arise in connection with the exercise; provided, that the Plan
              Administrator may at any time determine that this subsection


                                                                    Page 6 of 14




              5.5.3, to the extent the instructions to the broker call for an
              immediate sale of the shares, shall not be available to any
              Optionee who is subject to Section 16(b) of the Exchange Act if
              such transaction would result in a violation of Section 16(b), or
              if such Optionee is not an employee at the time of exercise; or

              5.5.4     DELIVERY OF WITHHOLDING NOTICE.  Delivery of a properly
              executed written exercise notice together with instructions to
              the Company to withhold upon exercise from the shares that would
              otherwise be issued that number of shares having a fair market
              value equal to the Exercise Price.

         5.6  WITHHOLDING TAX REQUIREMENT.  The Company or any related entity
         shall have the right to retain and withhold from any payment of cash
         or Common Stock under this Plan the amount of taxes required by any
         government to be withheld or otherwise deducted and paid with respect
         to such payment.  At its discretion, the Company may require an
         Optionee receiving shares of Common Stock to reimburse the Company for
         any such taxes required to be withheld by the Company, and may
         withhold any distribution in whole or in part until the Company is so
         reimbursed.  In lieu of such withholding or reimbursement, the Company
         shall have the right to withhold from any other cash amounts due or to
         become due from the Company to the Optionee an amount equal to such
         taxes or to retain and withhold a number of shares having a market
         value not less than the amount of such taxes required to be withheld
         by the Company to reimburse the Company for any such taxes and cancel
         (in whole or in part) any such shares so withheld.  If required by
         Section 16(b) of the Exchange Act, the election to pay withholding
         taxes by delivery of shares held by any person who at the time of
         exercise is subject to Section 16(b) of the Exchange Act, shall be
         made during the quarterly 10-day window period required under Section
         16(b) of the Exchange Act for exercises of stock appreciation rights.

         5.7  TRANSFERABILITY OF OPTION.  Options and the rights and privileges
         conferred by this Plan shall not be transferred, assigned or pledged
         in any manner (whether by operation of law or otherwise) other than
         (i) by will or by the applicable laws of descent and distribution, or
         (ii) by gift to members of the Optionee's family, including
         grandparents, parents, spouses, siblings, children, grandchildren and
         great-grandchildren, or trusts for the benefit of such family members
         or to charitable organizations, and shall not be subject to execution,
         attachment or similar process.  Any attempt to transfer, assign,
         pledge or otherwise dispose of any Option or of any right or privilege
         conferred by this Plan, contrary to the Code or to the provisions of
         this Plan, or the sale or levy or any attachment or similar process
         upon the rights and privileges conferred by this Plan shall be null
         and void.  Notwithstanding the foregoing, an Optionee may, during the
         Optionee's lifetime, designate a person who may exercise the Option
         after the Optionee's death by giving written notice of such
         designation to the Plan Administrator.  Such designation may be
         changed from time to time by the


                                                                    Page 7 of 14




         Optionee giving written notice to the Plan Administrator revoking any
         earlier designation and making a new designation.  In the event that
         no such designation is made, the executor or personal representative
         of the Optionee's estate shall have any rights then remaining to the
         Optionee or his estate under this Plan.

         5.8  DURATION OF OPTION.  Vested Options shall terminate, to the
         extent not previously exercised, upon the occurrence of the first of
         the following events:  (i) the expiration of the Option, as designated
         by the Plan Administrator in accordance with section 5.3; (ii)  the
         date of an Optionee's termination of employment with the Company or
         any related corporation for cause (as determined in the sole
         discretion of the Plan Administrator); (iii) the expiration of ninety
         (90) days from the date of an Optionee's termination of employment
         with the Company or any related corporation for any reason whatsoever
         other than cause, death or Disability (as defined below) unless, the
         exercise period is extended by the Plan Administrator until a date not
         later than the expiration date of the Option; or (iv) the expiration
         of one year from (A) the date of death of the Optionee or (B)
         cessation of an Optionee's employment by reason of Disability (as
         defined below) unless, the exercise period is extended by the Plan
         Administrator until a date not later than the expiration date of the
         Option.  If an Optionee's employment is terminated by death, any
         Option held by the Optionee shall be exercisable only by the person or
         persons to whom such Optionee's rights under such Option shall pass by
         the Optionee's will or by the laws of descent and distribution of the
         state or county of the Optionee's domicile at the time of death.  For
         purposes of the Plan, unless otherwise defined in the Agreement,
         "Disability" shall mean any physical, mental or other health condition
         which substantially impairs the Optionee's ability to perform his or
         her assigned duties for one hundred twenty (120) days or more in any
         two hundred forty (240) day period or that can be expected to result
         in death.  The Plan Administrator shall determine whether an Optionee
         has incurred a Disability on the basis of medical evidence acceptable
         to the Plan Administrator.  Upon making a determination of Disability,
         the Plan Administrator shall, for purposes of the Plan, determine the
         date of an Optionee's termination of employment.

         Unless accelerated in accordance with Section 7, unvested Options
         shall terminate immediately upon termination of employment of the
         Optionee by the Company for any reason whatsoever, including death or
         Disability.  For purposes of this Plan, transfer of employment between
         or among the Company and/or any related corporation shall not be
         deemed to constitute a termination of employment with the Company or
         any related corporation.  For purposes of this subsection with respect
         to Incentive Stock Options, employment shall be deemed to continue
         while the Optionee is on military leave, sick leave or other bona fide
         leave of absence (as determined by the Plan Administrator).  The
         foregoing not withstanding, employment shall not be deemed to continue
         beyond the first ninety (90) days of such leave, unless the Optionee's
         re-employment rights are guaranteed by statute or by contract.


                                                                    Page 8 of 14




         5.9  STATUS OF SHAREHOLDER.  Neither the Optionee nor any party to
         which the Optionee's rights and privileges under the Option may pass
         shall be, or shall have any of the rights or privileges of, a
         shareholder of the Company with respect to any of the shares issuable
         upon the exercise of any Option unless and until such Option has been
         exercised.

         5.10 RIGHT TO TERMINATE EMPLOYMENT.  Nothing in this Plan or in any
         Option shall confer upon any Optionee any right to continue in the
         employ of the Company or of a related entity, or to interfere in any
         way with the right of the Company or of any related corporation to
         terminate, at will, his or her employment or other relationship with
         the Company at any time.

         5.11 MODIFICATION AND AMENDMENT OF OPTION.  Subject to the
         requirements of Code Section 422 with respect to Incentive Options and
         to the terms, conditions and limitations of this Plan, the Plan
         Administrator may modify or amend outstanding Options.  The
         modification or amendment of an outstanding Option shall not, without
         the consent of the Optionee, impair or diminish any of his or her
         rights or any of the obligations of the Company under such Option.
         Except as otherwise provided in this Plan, no outstanding Option shall
         be terminated without the consent of the Optionee.  Unless the
         Optionee agrees otherwise, any changes or adjustments made to
         outstanding Incentive Options shall be made in such a manner so as not
         to constitute a "modification" as defined in Code Section 424(h) and
         so as not to cause any Incentive Option to fail to continue to qualify
         as an "incentive stock option" as defined in Code Section 422(b).

         5.12 LIMITATION ON VALUE FOR INCENTIVE OPTIONS.  As to all Incentive
         Options, to the extent that the aggregate fair market value of the
         Common Stock with respect to which Incentive Options are exercisable
         for the first time by the Optionee during any calendar year (under
         this Plan and all other incentive stock option plans of the Company, a
         related corporation or a predecessor corporation) exceeds $100,000,
         those Options (or the portion of an Option) beyond the $100,000
         threshold shall be treated as Nonqualified Options.  If the Internal
         Revenue Service publicly rules, issues a private ruling to the
         Company, any Optionee, or any legatee, personal representative or
         distributee of an Optionee or issues regulations changing or
         eliminating such annual limit, the dollar limitation in the preceding
         sentence shall be adjusted correspondingly.

    6.   GREATER THAN 10% SHAREHOLDERS.  In the case of Incentive Options
granted to employees who own at the time of their grant ten percent (10%) or
more of the then-issued and outstanding voting stock of the Company, the
following rules shall apply:

         6.1  EXERCISE PRICE AND TERM OF INCENTIVE OPTIONS.  If Incentive
         Options are granted to employees who own more than ten percent (10%)
         of the total combined voting power of all classes of stock of the
         Company or any related corporation, the term of such individual's
         Incentive Options shall not exceed five (5) years and the Exercise
         Price shall be not less than one hundred ten percent (110%) of the


                                                                    Page 9 of 14




         fair market value of the Common Stock at the time the Incentive Option
         is granted.  This provision shall control notwithstanding any contrary
         terms contained in an Option agreement or any other document.

         6.2  ATTRIBUTION RULE.  For purposes of subsection 6.1, in determining
         stock ownership, an employee shall be deemed to own such shares as are
         owned by those persons or entities defined in Code Section 424.  For
         purposes of this Section 6, stock owned by an employee shall include
         all stock actually issued and outstanding immediately before the grant
         of the Incentive Option to the employee.

    7.   ADJUSTMENTS UPON CHANGES IN CAPITALIZATION.  The aggregate number and
class of shares for which Options may be granted under this Plan, the number and
class of shares covered by each outstanding Option and the Exercise Price per
share thereof (but not the total price), and each such Option, shall all be
proportionately adjusted for any increase or decrease in the number of issued
shares of Common Stock of the Company resulting from a split-up or consolidation
of shares or any like capital adjustment, or the payment of any stock dividend.

         7.1  EFFECT OF LIQUIDATION, REORGANIZATION OR CHANGE IN CONTROL.

              7.1.1     CASH, STOCK OR OTHER PROPERTY FOR STOCK.  Except as
              provided in subsection 7.1.2, upon a merger (other than a merger
              of the Company in which the holders of Common Stock immediately
              prior to the merger have the same proportionate ownership of
              Common Stock in the surviving corporation immediately after the
              merger), consolidation, acquisition of property or stock,
              separation, reorganization (other than a mere reincorporation or
              the creation of a holding company) or liquidation of the Company,
              as a result of which the shareholders of the Company receive
              cash, stock or other property in exchange for or in connection
              with their shares of Common Stock, any Option granted under this
              Plan shall terminate, but the Optionee shall have the right
              immediately prior to any such merger, consolidation, acquisition
              of property or stock, separation, reorganization or liquidation
              to exercise such Option in whole or in part, to the extent the
              vesting requirements set forth in the Option agreement have been
              satisfied, unless stated otherwise in the Optionee's individual
              Option agreement.

              7.1.2     CONVERSION OF OPTIONS ON STOCK-FOR-STOCK EXCHANGE.  If
              the shareholders of the Company receive capital stock of another
              corporation ("Exchange Stock") in exchange for their shares of
              Common Stock in any transaction involving a merger (other than a
              merger of the Company in which the holders of Common Stock
              immediately prior to the merger have the same proportionate
              ownership of Common Stock in the surviving corporation
              immediately after the merger), consolidation, acquisition of
              property or stock, separation or reorganization (other than a
              mere reincorporation or the creation of a holding company), all
              Options granted under this Plan shall be converted into options
              to purchase shares of


                                                                   Page 10 of 14




              Exchange Stock unless the Company and the Corporation issuing the
              Exchange Stock, in their sole discretion, determine that any or
              all such Options shall not be converted into options to purchase
              shares of Exchange Stock, but instead shall terminate in
              accordance with the provisions of subsection 7.1.1.  The amount
              and price of converted options shall be determined by adjusting
              the amount and price of the Options in the same proportion as
              used for determining the number of shares of Exchange Stock the
              holders of the Common Stock receive in such merger,
              consolidation, acquisition of property or stock, separation or
              reorganization.  Unless accelerated by the Board, the exercise
              limitations set forth in the Option agreement and the Plan shall
              continue to apply for the Exchange Stock.

              7.1.3     CHANGE IN CONTROL.  In the event of a "Change in
              Control," as defined below, of the Company, unless otherwise
              determined by the Board prior to the occurrence of such Change in
              Control, any Options or portions of such Options outstanding as
              of the date such Change in Control is determined to have occurred
              that are not yet fully vested on such date shall become
              immediately exercisable in full.

              7.1.4     DEFINITION OF "CHANGE IN CONTROL".  For purposes of
              this Plan, a "Change in Control" shall mean (a) the first
              approval by the Board or by the stockholders of the Company of an
              Extraordinary Event, (b) a Purchase or (c) a Board Change.  For
              purposes of the Plan, such terms shall have the following
              meanings:

                   7.1.4.1   An "Extraordinary Event" shall mean any of the
                   following actions: (i) any consolidation or merger of the
                   Company in which the Company is not the continuing or
                   surviving corporation or pursuant to which shares of Common
                   Stock would be converted into cash, securities or other
                   property, other than a merger of the Company in which the
                   holders of Common Stock immediately prior to the merger have
                   the same proportionate ownership of common stock of the
                   surviving corporation immediately after the merger; (ii) any
                   sale, lease, exchange or other transfer (in one transaction
                   or a series of related transactions) of all, or
                   substantially all, the assets of the Company; or, (iii) the
                   adoption of any plan or proposal for liquidation or
                   dissolution of the Company.

                   7.1.4.2   A "Purchase" shall mean the acquisition by any
                   person (as such term is defined in Section 13(d) of the
                   Exchange Act) of any shares of Common Stock or securities
                   convertible into Common Stock without the prior approval of
                   a majority of the Continuing Directors (as defined below) of
                   the Company, if after making such acquisition such person is
                   the beneficial owner (as


                                                                   Page 11 of 14




                   such term is defined in Rule 13d-3 under the Exchange Act)
                   directly or indirectly of Securities of the Company
                   representing twenty percent (20%) or more of the combined
                   voting power of the Company's then outstanding securities
                   (calculated as provided in paragraph (d) of such Rule
                   13d-3).

                   7.1.4.3   A "Board Change" shall have occurred if
                   individuals who constitute the Board of the Company at the
                   time of adoption of this Plan (the "Continuing Directors")
                   cease for any reason to constitute at least a majority of
                   the Board, provided that any person becoming a Director
                   subsequent to the date of adoption of this Plan whose
                   nomination for election was approved by a vote of at least a
                   majority of the Continuing Directors (other than a
                   nomination of an individual whose initial assumption of
                   office is in connection with an actual threatened election
                   contest relating to the election of the Directors of the
                   Company, as such terms are used in Rule 14a-11 of Regulation
                   14A under the Exchange Act) shall be deemed to be a
                   Continuing Director.

         7.2  FRACTIONAL SHARES.  In the event of any adjustment in the number
         of shares covered by any Option, any fractional shares resulting from
         such adjustment shall be disregarded and each such Option shall cover
         only the number of full shares resulting from such adjustment.

         7.3  DETERMINATION OF BOARD TO BE FINAL.  All Section 7 adjustments
         shall be made by the Board, and its determination as to what
         adjustments shall be made, and the extent of such adjustments, shall
         be final, binding and conclusive.  Unless an Optionee agrees
         otherwise, any change or adjustment to an Incentive Option shall be
         made in such a manner so as not to constitute a "modification" as
         defined in Code Section 424(h) and so as not to cause his or her
         Incentive Option to fail to continue to qualify as an incentive stock
         option as defined in Code Section 422(b).

    8.   SECURITIES REGULATION.  Shares shall not be issued with respect to an
Option unless the exercise of such Option and the issuance and delivery of such
shares pursuant to the exercise of such Option shall comply with all relevant
provisions of law, including, without limitation, any applicable state
securities laws, the Securities Act of 1933, as amended, the Exchange Act, the
rules and regulations promulgated thereunder, and the requirements of any stock
exchange upon which the shares may then be listed, and shall be further subject
to the approval of counsel for the Company with respect to such compliance,
including the availability of an exemption from registration for the issuance
and sale of any shares under this Plan.  Inability of the Company to obtain from
any regulatory body having jurisdiction, the authority deemed by the Company's
counsel to be necessary for the lawful issuance and sale of any shares under
this Plan or the unavailability of an exemption from registration for the
issuance and sale of any shares under this Plan shall relieve the Company of any
liability in respect of the non-issuance or sale of such shares as to which such
requisite authority shall not have been obtained.


                                                                   Page 12 of 14




    As a condition to the exercise of any Option, the Company may require the
Optionee to represent and warrant at the time of any such exercise that the
shares are being purchased only for investment and without any present intention
to sell or distribute such shares if, in the opinion of counsel for the Company,
such a representation is required by any relevant provision of the
aforementioned laws.  At the option of the Company, a stop-transfer order
against any shares of stock may be placed on the official stock books and
records of the Company, and a legend indicating that the stock may not be
pledged, sold or otherwise transferred unless an opinion of counsel is provided
(concurred in by counsel for the Company) stating that such transfer is not in
violation of any applicable law or regulation, may be stamped on stock
certificates in order to assure exemption from registration.  The Plan
Administrator may also require such other action or agreement by the Optionees
as may from time to time be necessary to comply with the federal and state
securities laws.  THIS PROVISION SHALL NOT OBLIGATE THE COMPANY TO UNDERTAKE
REGISTRATION OF THE OPTIONS OR STOCK HEREUNDER.  Should any of the Company's
capital stock of the same class as the stock subject to Options be listed on a
national securities exchange, all stock issued under this Plan if not previously
listed on such exchange shall be authorized by that exchange for listing on such
exchange prior to the issuance of such stock.

    9.   AMENDMENT AND TERMINATION.  This Plan may be amended from time to time
as follows:

         9.1  BOARD ACTION.  The Board may at any time suspend, amend or
         terminate this Plan; provided, that except as set forth in Section 7,
         the approval of the Company's shareholders is necessary within twelve
         (12) months before or after the adoption by the Board of any amendment
         which will:

              9.1.1     increase the number of shares which are to be reserved
              for the issuance of Options;

              9.1.2     permit the granting of stock options to a class of
              persons other than those presently permitted to receive Options;
              or

              9.1.3     require shareholder approval under applicable law,
              including Section 16(b) of the Exchange Act.

         Any amendment made to this Plan which would constitute a
         "modification" to Incentive Options outstanding on the date of such
         amendment, shall not be applicable to such outstanding Incentive
         Options, but shall have prospective effect only, unless the Optionee
         agrees otherwise.

         9.2  AUTOMATIC TERMINATION.  Unless sooner terminated by the Board,
         this Plan shall terminate ten (10) years from the earlier of (i) the
         date on which this Plan is adopted by the Board or (ii) the date on
         which this Plan is approved by the shareholders of the Company.  No
         Option may be granted after such termination or during any suspension
         of this Plan.  The amendment or termination of this


                                                                   Page 13 of 14




         Plan shall not, without the consent of the option holder, alter or
         impair any rights or obligations under any option previously granted
         under this Plan.

    10.  EFFECTIVENESS OF THIS PLAN.  This Plan shall become effective upon
adoption by the Board so long as it is approved by the Company's shareholders
any time within twelve (12) months before or after the adoption of this Plan.


                                                                   Page 14 of 14




                                                                    EXHIBIT 10.2


                  THIS AGREEMENT IS SUBJECT TO ARBITRATION UNDER THE
                           MONTANA UNIFORM ARBITRATION ACT


                                      AGREEMENT


    This Agreement ("Agreement") is entered into this date, is by TMA
TECHNOLOGIES, INC., a Montana corporation, hereinafter referred to as "Seller,"
and SCHMITT INDUSTRIES, INC., an Oregon corporation, hereinafter referred to as
"Purchaser."

    Other parties to this agreement are TMA shareholders, hereinafter referred
to as "Shareholders," and TMA debt holders, hereinafter referred to as "Debt
Holders."  Purchaser agrees that Seller may not force action by Shareholders and
Debt Holders.

    WHEREAS, Seller presently has outstanding a single class of common stock
("Shares"), of which 4,568,000 Shares have been issued; and

    WHEREAS, said Shares are the only issued and outstanding capital stock of
Seller; and

    WHEREAS, Purchaser desires to purchase from Seller and from Seller's
Shareholders, and Seller desires to facilitate sale to Purchaser, all of the
shares of the company on the terms and subject to the conditions set forth
herein; and

    WHEREAS, Purchaser acknowledges that Seller is insolvent, notwithstanding
the efforts by Seller's management which Purchaser acknowledges as being in
accordance with sound business practices given the financial restraints of the
business; and

    WHEREAS, Purchaser acknowledges that Seller currently holds an
international leadership position in certain technologies relating to surface
characterization and industrial alignment; and

    WHEREAS, Purchaser desires to purchase Seller's business, to relocate it to
Portland Oregon, and to continue to operate the business as an on-going
business;

    NOW THEREFORE, IT IS AGREED AS FOLLOWS:

    SECTION I..    PURCHASE OF SHARES.

         A.   PURCHASE OF SHARES.  Subject to the terms and conditions set
forth herein, at the Closing (as defined below) Seller will sell all of its
assets and property, subject to all outstanding debts, liabilities and claims,
to Purchaser and Purchaser will purchase all of the outstanding Shares from
Shareholders that Shareholders will sell to Purchaser, Shares constituting
4,568,889 shares, which if all are sold constitute


                                          1



all of the issued and outstanding capital stock of Seller as of the Closing, and
Purchaser will purchase all outstanding debt from Debt Holders that Debt Holders
will sell to Purchaser, debt constituting as of April 18, 1995 of approximately
$2,827,347, which if all are sold constitute all of the outstanding debt of
Seller as of the Closing.

         B.   PURCHASE PRICE.  Purchase will pay to each Selling Shareholder
and Debt Holder a cash price of .0025 cents per dollar actually invested by that
Shareholder in Seller or loaned (includes loan interest through 3/31/95) to
Seller and each Shareholder or Debt Holder so selling shall have a transferable
interest in a royalty pool (which royalty pool is presently estimated to total
approximately $6,038,000), in accordance with a Certificate of Vesting in
Royalty Pool, attached hereto and incorporated herein by reference.  The
effective start date of the royalty pool shall be June 1, 1995.  The royalty
pool will be reviewed (unaudited) before it is established by Moss-Adams, from
Seller's books and records.  During the life of the royalty pool Moss-Adams, of
Portland, Oregon, will administer the royalty pool.  Audited statements shall be
provided at least annually to all members of the royalty pool.  Until all
royalty pool participants have received a return equal to their originally
established dollar value of their interest in the royalty pool, if Purchaser, or
its assigns or subsequent purchasers, sell, license, transfer, or convey in any
manner any or all of Seller's technologies covered by this agreement, Purchaser
will pay the following amounts into the royalty pool:  (1) 25% of the
consideration received for the right to utilize the technology; and (2) a
royalty of 7% of net sales of the products and services incorporating those
technologies for the longer of (1) a period of 10 years from the date the rights
to the technologies are purchased from Purchaser and the entity purchasing
rights to the technologies.

Purchaser may be required to file a petition for relief from Seller's creditors
under Chapter 11 of the Bankruptcy Act.  Purchaser agrees to reaffirm in any
bankruptcy proceeding its obligations in the royalty pool to each Shareholder
and Debt Holder participant, so that Purchaser's obligations contained in the
royalty pool as to each participant thereof shall not be discharged by the
bankruptcy proceeding.

Purchaser agrees to purchase all of the outstanding debts and obligations of
Seller, as set forth on Section 1.1, effective at the execution of this
agreement unless specifically disaffirmed in writing signed by both parties.
These obligations as of April 18, 1995 are approximately:

    $155,000 in employee payables
    $205,000 in accounts payable
    $123,397 SBA guaranteed loan with First Security Bank
    $38,344 line of credit with First Security Bank


                                          2



    $1,752,503.39 convertible debenture with Montana Science and Technology
         Alliance (amount as agreed between Purchaser and MSTA including
         principal and interest through March 31, 1995).  [Purchaser plans to
         purchase title and interest in this debt by separate agreement.]
    $10,000 promissory note to Quentin Peterson secured against receipt of
         payment from future account receivable from Komag
    $1,064,844 all remaining convertible debentures and notes payable
         [Purchaser plans to purchase title and interest in this debt by
         separate agreement.]
    $3,212,212 - In addition to purchasing Seller's current debt obligations,
         Purchaser assumes future royalty obligations related to Seller's
         current Equity.  The Equity portion of the royalty pool is estimated
         to be greater than $3.2 Million.

The obligations set forth above will be collectively referred herein to as the
"Purchase Price".

         C.   PAYMENT OF PURCHASE PRICE.  According to the terms of the
Certificate of Vesting in Royalty Pool, the Purchase Price will be paid to
Shareholders and Debt Holders as follows:  The cash price of .0025 cents per
dollar actually invested or loaned (including principal and interest through
3/31/95) upon the receipt of the stock certificate or agreement to sell the loan
debt to Purchaser for approximately $15,000.

Additionally, each Shareholder and Debt Holder shall receive payments as royalty
pool participants in accordance with the royalty pool agreement, until the
entire interest in the royalty pool has been paid.  Royalty pool total is
greater than $6.0 Million.

Employee payables - including wages, applicable payroll taxes, FTO balances,
employee benefits payable, Seller reimbursable expenses, and other related
payables - will be paid through April 15, 1995 on or before the second day
following the date on which Purchaser has purchased a majority of the
outstanding shares of Seller.  Employee payables will be paid through April 30,
1995 on or before May 5, 1995.  Employee payables accruing after April 30, 1995
will be paid through May 15, 1995 on or before May 20, 1995.  Employee payables
accruing after May 15, 1995 will be paid through May 31, 1995 on or before
June 5, 1995.  Employee payables accruing after May 31, 1995 will be paid on the
same 5th and 2Oth schedule.

Delinquent accounts payable will be paid on or before April 28, 1995.  SBA
guaranteed loan with First Security Bank, and the line of credit with First
Security Bank will be paid on or before May 26, 1995.

MSTA and other convertible debenture holders and holders of promissory Notes
will be purchased by May 25, 1995, to the extent


                                          3



to which these debt holders have agreed, by separate agreement, to sell their
interest to Purchaser.

    SECTION II..   REPRESENTATIONS AND WARRANTIES OF SELLER.  As a material
inducement to Purchaser to enter into this Agreement and purchase the Shares,
Seller, jointly and severally, represents and warrants that:

         A.   ORGANIZATION AND CORPORATE POWER.  Seller is a corporation duly
incorporated and validly existing under the laws of the state of Montana and
Seller is qualified to do business in every jurisdiction in which its ownership
of property or conduct of business requires it to qualify.  Seller has all
requisite corporate power and authority and all material licenses, permits, and
authorizations necessary to own and operate its properties and to carry on its
business as now conducted.  The copies of Seller's charter documents and bylaws
which have been furnished to Purchaser reflect all amendments made thereto at
any time prior to the date of this Agreement and are correct and complete.

         B.   CAPITAL STOCK AND RELATED MATTERS.  The authorized capital stock
of Seller consists of 12,000,000 shares of common stock, 4,568,889 of which are
issued and outstanding and are owned, beneficially and of record, by
Shareholders and no other stock of Seller is issued and outstanding.  All of the
outstanding shares of Seller's capital stock are validly issued, fully paid, and
nonassessable.

         C.   SUBSIDIARIES.  Seller does not own or hold any rights to acquire
any shares of stock or any other security or interest in any other corporation
or entity.

         D.   CONDUCT OF BUSINESS; LIABILITIES.  Purchaser acknowledges that
Seller is insolvent.  Seller is unable, and has been unable, for some time to
pay current employees and suppliers that are integral in Sellers business.
Purchaser acknowledges that with each passing day that those obligations remain
unpaid the probability increases that there will be a continuing adverse effect
on business opportunities.  Except as set forth in Schedule 2.4, Seller is not
in default under, and no condition exists that with notice would constitute a
default of Seller under (i) any mortgage, loan agreement, evidence of
indebtedness, or other instrument evidencing borrowed money to which Seller is a
party or by which Seller or the properties of Seller are bound or (ii) any
judgment, order, or injunction of any court, arbitrator, or governmental agency
that would reasonably be expected to affect materially and adversely the
business, financial condition, or results of operations of Seller taken as a
whole.

         E.   FINANCIAL STATEMENTS.  The unaudited balance sheet of Seller as
of February 28, 1995, in the form attached to this Agreement as Exhibit 2.5(A)
and the income statement for the


                                          4



month and year-to-date ending February 28, 1995, in the form attached to this
Agreement as Exhibit 2.5(B) (collectively the "February 28, 1995 Financial
Statements"), fairly presents the financial position of Seller as of
February 28, 1995, and has been prepared in accordance with generally accepted
accounting principles, consistently applied, and in a manner substantially
consistent with prior financial statements of Seller, except for differences
resulting from normally occurring audit adjustments, including, but not limited
to, income tax and tax accrual adjustments, or as noted in the Financial
Statements or the notes thereto.  Except as contemplated by or permitted under
this Agreement, there are no adjustments that would be required on review of the
Financial Statements that would, individually or in the aggregate, have a
material negative effect upon Seller's reported financial condition.

         F.   NO UNDISCLOSED LIABILITIES.  Except for (i) liabilities and
obligations incurred in the ordinary course of business since February 28, 1995
("Statement Date"), and (ii) liabilities or obligations described in
Schedule 2.6, neither Seller nor any of the property of Seller is subject to any
material liability or obligation that was required to be included or adequately
reserved against in the Financial Statements or described in the notes thereto
and was not so included, reserved against, or described.

         G.   ABSENCE OF CERTAIN CHANGES.  Except as contemplated or permitted
by this Agreement or as described in Schedule 2.7, since the Statement Date
there has not been:

              1.   Any damage, destruction, or loss, whether covered by
insurance or not materially adversely affecting the properties or business of
Seller;

              2.   Prior to March 30, 1995 Seller agreed to sell some tangible
assets for cash other than in the ordinary course of business, which sales have
been completed and disclosed.  Other than these enumerated transactions Seller
has not entered into any agreement to sell or transfer tangible or intangible
assets other than in the ordinary course of business, nor entered into any
mortgage or pledge or the creation of any security interest, lien, or
encumbrance on any such asset, or any lease of property, including equipment,
other than tax liens with respect to taxes not yet due and contract rights of
customers in inventory;

              3.   Any declaration, setting aside, or payment of a distribution
in respect of or the redemption or other repurchase by Seller of any stock of
Seller;

              4.   Any material transaction not in the ordinary course of
business of Seller;



                                          5




              5.   The lapse of any material trademark, assumed name, trade
name, service mark, copyright, or license or any application with respect to the
foregoing;

              6.   The grant of any increase in the compensation of officers or
employees (including any such increase pursuant to any bonus, pension,
profit-sharing, or other plan) other than customary increases on a periodic
basis or required by agreement or understanding in the ordinary course of
business and in accordance with past practice;

              7.   The discharge or satisfaction of any material lien or
encumbrance or the payment of any material liability other than current
liabilities in the ordinary course of business;

              8.   The making of any material loan, advance, or guaranty to or
for the benefit of any person except the creation of accounts receivable in the
ordinary course of business; or

              9.   An agreement to do any of the foregoing.

         H.   TITLE AND RELATED MATTERS.  Except as set forth in Schedule 2.8,
Seller has good and marketable title to all of its property and other assets
included in the Financial Statements (except properties and assets sold or
otherwise disposed of subsequent to the Statement Date or otherwise disclosed in
Section G (3), in the ordinary course of business or as contemplated in this
Agreement), free and clear of all security interests, mortgages, liens, pledges,
charges, claims, or encumbrances of any kind or character, except (i) statutory
liens for property taxes not yet delinquent or payable subsequent to the date of
this Agreement and statutory or common law liens securing the payment or
performance of any obligation of Seller, the payment or performance of which is
not delinquent, or that is payable without interest or penalty subsequent to the
date on which this representation is given, or the validity of which is being
contested in good faith by Seller; (ii) the rights of customers of Seller with
respect to inventory under orders or contracts entered into by Seller in the
ordinary course of business; (iii) claims, easements, liens, and other
encumbrances of record pursuant to filings under personal property recording
statutes; and (iv) as described in the Unaudited Statements or the notes
thereto, or are of public record, which include the financing statement filed by
First Security Bank, and Montana Science and Technology.

         I.   LITIGATION.  Except as set forth in Schedule 2.9, there are no
material actions, suits, proceedings, orders, investigations, or claims pending
or, to the best of Seller's knowledge, overtly threatened against Seller or any
property of Seller, at law or in equity, or before or by any governmental
department, commission, board, bureau, agency, or instrumentality; Seller is not
subject to any arbitration


                                          6



proceedings under collective bargaining agreements or otherwise or, to the best
of Seller's knowledge, any governmental investigations or inquiries; and, to the
best knowledge of Seller, including the directors and responsible officers of
Seller, there is no basis for any of the foregoing.

         J.   TAX MATTERS.  Except as set forth on Schedule 2.10, (i) Seller
has prepared in a substantially correct manner and has filed all federal, state,
local, and foreign tax returns and reports heretofore required to be filed by
them and have paid all taxes shown as due thereon; and (ii) no taxing authority
has asserted any deficiency in the payment of any tax or informed Seller that it
intends to assert any such deficiency or to make any audit or other
investigation of Seller for the purpose of determining whether such a deficiency
should be asserted against Seller.

         K.   COMPLIANCE WITH LAWS.  To the best of Seller knowledge, Seller
is, in the conduct of its business, in substantial compliance with all laws,
statutes, ordinances, regulations, orders, judgments, or decrees applicable to
them, the enforcement of which, if Seller was not in compliance therewith, would
have a materially adverse effect on the business of Seller, taken as a whole.
Seller has received no notice of any asserted present or past failure by Seller
to comply with such laws, statutes, ordinances, regulations, orders, judgments,
OR DECREES.

         L.   NO BROKERS.  There are no claims for brokerage commissions,
finders' fees, or similar compensation in connection with the sale of stock
based on any arrangement or agreement binding upon any of the parties hereto.

         M.   INSURANCE.  Schedule 2.13 contains a list of each insurance
policy maintained by Seller with respect to its properties, assets, and
businesses, and each such policy is in full force and effect until April
28, 1995.  Seller is past due on the current payment due on the policies, but
otherwise is not in material default with respect to its obligations under any
such policy maintained by it.  Seller has not received formal notification of
the cancellation of any of the insurance policies listed on Schedule 2.13 or of
any material increase in the premiums to be charged for such insurance policies.

         N.   EMPLOYEES AND LABOR RELATIONS MATTERS.  Except as set forth in
Schedule 2.14 or as provided in this Agreement:

              1.   The Seller is aware that all remaining employees of Seller
may be terminated by Purchaser on the Closing Date;

              2.   To the best of Seller's knowledge, Seller has substantially
complied in all material respects with all labor and employment laws, including
provisions thereof relating to


                                          7



wages, hours, equal opportunity, collective bargaining, Americans With
Disabilities Act, and the payment of social security and other taxes;

              3.   There is no unfair labor practice charge, complaint, or
other action against Seller pending or, to Seller and the Seller best knowledge,
threatened before the National Labor Relations Board and Seller is not subject
to any order to bargain by the National Labor Relations Board;

              4.   No questions concerning representation have been raised or,
to Seller's best knowledge, are threatened with respect to employees of Seller;

              5.   No grievance that might have a material adverse effect on
Seller and no arbitration proceeding arising out of or under any collective
bargaining agreement is pending and, to the best knowledge of Seller and the
directors and responsible officers of Seller, no basis exists for any such
grievance or arbitration proceeding; and

              6.   Seller recognizes that three documents exist which govern
the behavior of Seller's current and former employees: (1) Employment Agreement,
(2) Employee Confidential Nondisclosure Agreement, and (3) Employee Handbook -
Dated February 1, 1995.  Seller understands that Purchaser intends to force (if
necessary) full compliance with the regulations of these documents for the
purpose of protecting the future business prospects.  Seller will maintain the
security of employee records, with special care being given to the security of
documents related to these three documents, for the purpose of supporting
Purchaser's efforts to insure full compliance.

         O.   DISCLOSURE.  Neither this Agreement nor any of the schedules,
attachments, written statements, documents, certificates, or other items
prepared or supplied to Purchaser by or on behalf of the Seller with respect to
this purchase contain any untrue statement of a material fact or omit a material
fact necessary to make each statement contained herein or therein not
misleading.  No responsible officer or director of Seller has intentionally
concealed any fact known by such person to have a material adverse effect upon
Seller's existing or expected financial condition, operating results, assets,
customer relations, employee relations, or business prospects taken as a whole.

         P.   POWER OF ATTORNEY.  Except as set forth in Schedule 2.16, no
material power of attorney or similar authorization given by Seller is presently
in effect.

         Q.   ACCOUNTS RECEIVABLE.  All accounts receivable of Seller reflected
in the Financial Statements represent bona fide sales actually made in the
ordinary course of business.


                                          8



         R.   AGREEMENTS AND COMMITMENTS.  Schedule 2.18 contains a complete
and accurate list of each agreement, contract, instrument, and commitment
(including license agreements) to which Seller is a party or whose term is in
excess of one year and is not cancelable upon 30 or fewer days' notice without
any liability, penalty, or premium, other than a nominal cancellation fee or
charge ("Third Party Agreements").  The agreements contained in Schedule 2.18
Purchaser agrees to perform.  Except as otherwise set forth in Schedule 2.18.

              1.   Corporation has no collective bargaining or union contracts
agreement in effect or being negotiated;

              2.   There is no labor strike, dispute, request for
representation, slowdown, or stoppage pending or, to Seller's best knowledge,
threatened against Seller;

         S.   PERSONAL PROPERTY.  Without material exception, Schedule 2.19
contains lists of all tangible personal property and assets owned or held by
Seller and used or useful in the conduct of the business of Seller.  Except as
set forth in Schedule 2.19, Seller owns and has good title to such properties
subject to any security interest, mortgage, pledge, conditional sales agreement,
or other lien or encumbrance.  Seller has delivered to Purchaser copies of all
leases and other agreements relating to property described in Schedule 2.19
(including any and all amendments and other modifications to such leases and
other agreements) all of which are valid and binding.  Seller is in default
under certain of such leases and agreements.  Purchaser has negotiated directly
with the lessor of the Seller business premises.  Except as set forth in
Schedule 2.19 and to the best of Seller's knowledge, all material properties
listed therein are generally in good operating condition and repair (ordinary
wear and tear excepted), are performing satisfactorily, and are available for
immediate use in the conduct of the business and operations of Seller.  To the
best of Seller's knowledge, all such tangible personal property is in compliance
in all material respects with all applicable statutes, ordinances, rules, and
regulations.  The properties listed in Schedule 2.19 include substantially all
such properties necessary to conduct the business and operations of Seller as
now conducted.

         T.   REAL PROPERTY.  Seller does not own any real property.  No
interest in real property will pass by this agreement.

         U.   PATENTS, TRADEMARKS, TRADE NAMES, ETC.  Schedule 2.21 contains an
accurate and complete list of all patents, trademarks, tradenames, service
marks, and copyrights, and all applications therefor, presently owned or held
subject to license by Seller and, to Seller's best knowledge, the use thereof by
Seller does not materially infringe on any patents, trademarks, or copyrights or
any other rights of any person.  To


                                          9



Seller's best knowledge, Seller has not operated and is not operating its
business in a manner that infringes the proprietary rights of any other person
in any patents, trademarks, trade names, service marks, copyrights, or
confidential information.  Except as set forth in Schedule 2.21, Seller has not
received any written notice of any infringement or unlawful use of such
property.

         V.   ERISA AND RELATED MATTERS.  Schedule 2.22 sets forth a
description of all "Employee Welfare Benefit Plans" and "Employee Pension
Benefit Plans" (as defined in Sections  3(1) and 3(2), respectively, of the
Employee Retirement Income Security Act of 1974, as amended ("ERISA")) existing
on the date hereof that are or have been maintained or contributed to by Seller.
Except as listed on Schedule 2.22, Seller does not maintain any retirement or
deferred compensation plan, savings, incentive, stock option or stock purchase
plan, unemployment compensation plan, vacation pay, severance pay, bonus or
benefit arrangement, insurance or hospitalization program or any other fringe
benefit arrangement for any employee, consultant or agent of Seller, whether
pursuant to contract, arrangement, custom or informal understanding, which does
not constitute an "Employee Benefit Plan" (as defined in Section  3(3) of
ERISA), for which Seller may have any ongoing material liability after Closing.
Seller does not maintain nor has it ever contributed to any Multiemployer Plan
as defined by Section  3(37) of ERISA.  Seller does not currently maintain any
Employee Pension Benefit Plan subject to Title IV of ERISA.  There have been no
"prohibited transactions" (as described in Section  406 of ERISA or Section
4975 of the Code) with respect to any Employee Pension Benefit Plan or Employee
Welfare Benefit Plan maintained by Seller as to which Seller has been party a
party.  As to any employee pension benefit plan listed on Schedule 2.22 and
subject to Title IV of ERISA, there have been no reportable events (as such term
is defined in Section  4043 of ERISA).

    SECTION III..   REPRESENTATIONS AND WARRANTIES OF PURCHASER.  As a material
inducement to Seller to enter into this agreement and as a material inducement
to Shareholders to sell their shares and Debt Holders to sell their interest in
debt, Purchaser hereby represents and warrants to Seller, Shareholders, and Debt
Holders as follows:

         A.   ORGANIZATION; POWER.  Purchaser is a corporation duly
incorporated and validly existing under the laws of the state of Oregon, and has
all requisite corporate power and authority to enter into this Agreement and
perform its obligations hereunder.

         B.   AUTHORIZATION.  The execution, delivery, and performance by
Purchaser of this Agreement and all other agreements contemplated hereby to
which Purchaser is a party have been duly and validly authorized by all
necessary corporate action of Purchaser, and this Agreement and each such other
agreement, when executed and delivered by the parties thereto,


                                          10



will constitute the legal, valid, and binding obligation of Purchaser
enforceable against it in accordance with its terms.

         C.   NO CONFLICT WITH OTHER INSTRUMENTS OR AGREEMENTS.  The execution,
delivery, and performance by Purchaser of this Agreement and all other
agreements contemplated hereby to which Purchaser is a party will not result in
a breach or violation of, or constitute a default under, its Articles of
Incorporation or Bylaws or any material agreement to which Purchaser is a party
or by which Purchaser is bound.

         D.   GOVERNMENTAL AUTHORITIES.  Except as set forth in Schedule 3.4,
(i) Purchaser is not required to submit any notice, report, or other filing with
any governmental or regulatory authority in connection with the execution and
delivery by Purchaser of this Agreement and the consummation of the purchase and
(ii) no consent, approval, or authorization of any governmental or regulatory
authority is required to be obtained by Purchaser or any affiliate in connection
with Purchaser's execution, delivery, and performance of this Agreement and the
consummation of this purchase.

         E.   LITIGATION.  There are no actions, suits, proceedings, or
governmental investigations or inquiries pending or, to the knowledge of
Purchaser, threatened against Purchaser or its properties, assets, operations,
or businesses that might delay, prevent, or hinder the consummation of this
purchase.

         F.   INVESTMENT REPRESENTATIONS

              1.   Purchaser is acquiring the Shares for its own account for
purposes of investment and without expectation, desire, or need for resale and
not with the view toward distribution, resale, subdivision, or fractionalization
of the Shares.

              2.   During the course of the negotiation of this Agreement,
Purchaser has reviewed all information provided to it by Seller and has had the
opportunity to ask questions of and receive answers from representatives of
Seller concerning Seller, the securities offered and sold hereby, and this
purchase, and to obtain certain additional information requested by Purchaser.

              3.   Purchaser understands that the Shares to be purchased have
not been registered under Securities Act of 1933 ("1933 Act"), or under any
state securities law.

              4.   Purchaser understands that the Shares cannot be resold in a
transaction to which the 1933 Act and state securities laws apply unless
(i) subsequently registered under the 1933 Act and applicable state securities
laws or (ii) exemptions from such registrations are available.  Purchaser is
aware of the provisions of Rule 144 promulgated under the 1933


                                          11



Act which permit limited resale of shares purchased in a private transaction
subject to the satisfaction of certain conditions.

              5.   Purchaser understands that no public market now exists for
the Shares and that it is uncertain that a public market will ever exist for the
Shares.

              6.   Purchaser understands that the certificates for the Shares
will bear the following legend:

    THIS CERTIFICATE HAS NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933.
    THE CORPORATION WILL NOT TRANSFER THIS CERTIFICATE UNLESS (i) THERE IS AN
    EFFECTIVE REGISTRATION COVERING THE SHARES REPRESENTED BY THIS CERTIFICATE
    UNDER THE SECURITIES ACT OF 1933 AND ALL APPLICABLE STATE SECURITIES LAWS,
    (ii) IT FIRST RECEIVES A LETTER FROM AN ATTORNEY, ACCEPTABLE TO THE BOARD
    OF DIRECTORS OR ITS AGENTS, STATING THAT IN THE OPINION OF THE ATTORNEY THE
    PROPOSED TRANSFER IS EXEMPT FROM REGISTRATION UNDER THE SECURITIES ACT OF
    1933 AND UNDER ALL APPLICABLE STATE SECURITIES LAWS, OR (iii) THE TRANSFER
    IS MADE PURSUANT TO RULE 144 UNDER THE SECURITIES ACT OF 1933.

    3.6.7     Purchaser has reviewed the books and records of Seller regarding
transfer of shares.  Seller has made no representations or warranties regarding
the transfer of those shares or compliance with state or federal securities
regulations.  Purchaser is purchasing the shares based upon its own
investigation and not upon any warranties, expressed or implied, by Seller or
any of Seller's directors, officers, employees, or agents.

         G.   BROKERAGE.  There are no claims for brokerage commissions,
finders' fees, or similar compensation in connection with this purchase based on
any arrangement or agreement entered into by Purchaser and binding upon any of
the parties hereto.

         H.   OPERATION.  Purchaser will not relocate any of the furniture,
fixtures, equipment, inventory, records, or other assets or property of Seller
until the payments set forth in paragraph I.C.  Payment of Purchase Price, have
been discharged, except payments to royalty pool participants in accordance with
the royalty pool agreement.  Thereafter, Purchaser may move the assets,
technology, and equipment of Seller to its facility at Portland, Oregon.
Purchaser will operate the business in such a manner as to maximize the sale of
products and services from Seller technology until Purchaser obligations under
the royalty pool agreement have been fully discharged.  Purchaser agrees to
adequately capitalize facilities, equipment, and personnel necessary to maintain
Seller technology leadership.

    SECTION IV..  CONDUCT OF SELLER'S BUSINESS PENDING THE CLOSING.  From the
date hereof until the Closing, to the extent to which Purchaser provides
adequate funding, and except as


                                          12



otherwise consented to or approved by Purchaser and Seller, Seller covenants and
agrees with Purchaser as follows:

         A.   REGULAR COURSE OF BUSINESS.  Purchaser and Seller will jointly
provide operating management, operating the business in accordance with the
reasonable judgment diligently and in good faith and to preserve its present
relationships with persons having business dealings with it.

         B.   DISTRIBUTIONS.  Seller will not declare, pay, or set aside for
payment any dividend or other distribution in respect of its capital stock.

         C.   CAPITAL CHANGES.  Except in facilitating sales of shares by
Shareholders to Purchaser, Seller will not issue any shares of its stock, or
issue or sell any securities convertible into, or exchangeable for, or options,
warrants to purchase, or rights to subscribe to, any shares of its stock or
subdivide or in any way reclassify any shares of its capital stock, or
repurchase reacquire, cancel, or redeem any such shares.

         D.   ASSETS.  The assets, property, and rights now owned by Seller
will be used, preserved, and maintained, as far as practicable, in the ordinary
course of business, to the same extent and in the same condition as said assets,
property, and rights are on the date of this Agreement, and no unusual or novel
methods of manufacture, purchase, sale, management, or operation of said
properties or business or accumulation or valuation of inventory will be made or
instituted.  Without the prior consent of Purchaser, Seller will not encumber
any of its assets or make any commitments relating to such assets, property, or
business, except in the ordinary course of its business.

         E.   INSURANCE.  Seller will keep or cause to be kept in effect the
insurance now in effect on its various properties and assets, and will purchase
such additional insurance, at Purchaser's cost, as Purchaser may request.

         F.   EMPLOYEES.  Seller will not grant to any employee any promotion,
any increase in compensation, or any bonus or other award.

         G.   NO VIOLATIONS.  Seller will comply in all material respects with
all statutes, laws, ordinances, rules, and regulations applicable to it in the
ordinary course of business.

         H.   PUBLIC ANNOUNCEMENTS.  No press release or other announcement to
the employees, customers, or suppliers of Seller related to this Agreement or
this purchase will be issued without the joint approval of the parties, unless
required by law, in which case Purchaser and Seller will consult with each other
regarding the announcement.


                                          13



    SECTION V..    COVENANTS OF SELLER.  Seller covenants and agrees with
Purchaser as follows:

         A.   SATISFACTION OF CONDITIONS.  Seller will use reasonable efforts
to obtain as promptly as practicable the satisfaction of the conditions to
Closing set forth in Section 7 and any necessary consents or waivers under or
amendments to agreements by which Seller is bound.

         B.   SUPPLEMENTS TO SCHEDULES.  As needed prior to the Closing, Seller
will promptly supplement or amend the Schedules with respect to any matter
hereafter arising that, if existing or occurring at the date of this Agreement,
would have been required to be set forth or described in any Schedule and will
promptly notify Purchaser of any breach by either of them that either of them
discovers of any representation, warranty, or covenant contained in this
Agreement.  No supplement or amendment of any Schedule made pursuant to this
section will be deemed to cure any breach of any representation of or warranty
made in this Agreement unless Purchaser specifically agrees thereto in writing;
provided, however, that if this purchase is closed, Purchaser will be deemed to
have waived its rights with respect to any breach of a representation, warranty,
or covenant or any supplement to any Schedule of which it shall have been
notified pursuant to this Section 5.2.

         C.   NO SOLICITATION.  Until the Closing or termination pursuant to
Section 10 of this Agreement, neither Seller, nor any of Seller's respective
directors, officers, employees, or agents shall, directly or indirectly,
encourage, solicit, initiate, or enter into any discussions or negotiations
concerning any disposition of any of the capital stock or all or substantially
all of the assets of Seller (other than pursuant to this Agreement), or any
proposal therefor, or furnish or cause to be furnished any information
concerning Seller to any party in connection with any transaction involving the
acquisition of the capital stock or assets of Seller by any person other than
Purchaser.  Seller will promptly inform Purchaser of any inquiry (including the
terms thereof and the person making such inquiry) received by any responsible
officer or director of Seller after the date hereof and believed by such person
to be a bona fide, serious inquiry relating to any such proposal.

         D.   ACTION AFTER THE CLOSING.  Upon the reasonable request of any
party hereto after the Closing, any other party will take all action and will
execute all documents and instruments necessary or desirable to consummate and
give effect to this purchase.  These include, by way of illustration and not by
way of limitation, the following:

                   1.   Various conditions relating to filing, payment, and
                        collecting of refunds relating to taxes;


                                          14



              2.   Resignations of each of the directors of Seller.

                   However, it is now agreed by Seller that when controlling
                   ownership of Seller's shares passes to Schmitt Industries
                   (half of the outstanding shares plus one share), each of
                   Seller's Directors and Officers will submit his resignation.
                   These resignations shall be in writing and shall be
                   effective on the Closing Date.  Until the later of the
                   Closing Date or May 31, 1995 Dan Hershberger and Cheryl
                   Petersen shall remain employed by Seller, their costs and
                   expenses during this time being specifically recognized as
                   part of legitimate employee payables.  Bob Mathis and Marvin
                   Ball shall be continually informed by Purchaser so as to be
                   aware of Purchaser's decisions and intended actions relative
                   to Seller's assets and interests.;

              3.   Provisions relating to delivery of Corporate books and
                   records;

              4.   Provisions relating to treatment of confidential proprietary
                   information obtained in the acquisition process;

    SECTION VI..   COVENANT OF PURCHASER.  Purchaser will use its best efforts
to cause the conditions set forth in Section 8 to be satisfied.

    SECTION VII..  CONDITIONS PRECEDENT TO THE OBLIGATIONS OF PURCHASER.  Each
and every obligation of Purchaser under this Agreement is subject to the
satisfaction, at or before the Closing, of each of the following conditions:

         A.   REPRESENTATIONS AND WARRANTIES; PERFORMANCE.  Each of the
representations and warranties made by Seller herein will be true and correct in
all material respects as of the Closing with the same effect as though made at
that time except for changes contemplated, permitted, or required by this
Agreement; Seller will have performed and complied with all agreements,
covenants, and conditions required by this Agreement to be performed and
complied with by them prior to the Closing; and Purchaser will have received, at
the Closing, a certificate of Seller's, signed by the Chief Executive Officer of
Seller, stating that each of the representations and warranties made by Seller
herein is true and correct in all material respects as of the Closing except for
changes contemplated, permitted, or required by this Agreement and that Seller
has performed and complied with all agreements, covenants, and conditions
required by this Agreement to be performed and complied with by them prior to
the Closing.


                                          15



         B.   NO PROCEEDING OR LITIGATION.  No material action, suit, or
proceeding before any court, governmental or regulatory authority will have been
commenced and be continuing, and no investigation by any governmental or
regulatory authority will have been commenced and be continuing, and no action,
investigation, suit, or proceeding will be threatened at the time of Closing,
against Seller or any of Seller's affiliates, associates, officers, or
directors, seeking to restrain, prevent, or change this purchase, questioning
the validity or legality of this purchase, or seeking damages in connection with
this purchase.

         C.   MATERIAL CHANGE.  From the date of this Agreement to the Closing,
Seller shall not have suffered any material adverse change (whether or not such
change is referred to or described in any supplement to any Exhibit or Schedule
to this Agreement) in its business prospects, financial condition, working
capital, assets, liabilities (absolute, accrued, contingent, or otherwise), or
operations.

         D.   CORPORATE ACTION.  Seller will have furnished to Purchaser:

              1.   The corporate articles and all amendments thereto and
restatements thereof of Seller in the jurisdiction of incorporation of Seller in
question;

              2.   The current bylaws and minutes of all meetings and consents
of shareholders and directors of Seller;

              3.   Each certificate of qualification to do business as a
foreign corporation of Seller;

              4.   All stock transaction records of Seller; and

              5.   A certificate of the Assistant Secretary of Seller as to the
accuracy, currency, and completeness of each of the above documents, the
incumbency and signatures of officers of Seller, the absence of any amendment to
the charter documents of Seller, and the absence of any proceeding for
dissolution or liquidation of Seller.

    SECTION VIII.. CONDITIONS PRECEDENT TO THE OBLIGATIONS OF SELLER.  Each and
every obligation of Seller under this Agreement is subject to the satisfaction,
at or before the Closing, of each of the following conditions:

         A.   REPRESENTATIONS AND WARRANTIES: PERFORMANCE.  Each of the
representations and warranties made by Purchaser herein will be true and correct
in all material respects as of the Closing with the same effect as though made
at that time except for changes contemplated, permitted, or required by this
Agreement; Purchaser will have performed and complied with all agreements,
covenants, and conditions required by this Agreement


                                          16



to be performed and complied with by it prior to the Closing; and Seller will
have received, at the Closing, a certificate of Purchaser, signed by the
President and the Chief Financial Officer of Purchaser, stating that each of the
representations and warranties made by Purchaser herein is true and correct in
all material respects as of the Closing except for changes contemplated,
permitted, or required by this Agreement and that Purchaser has performed and
complied with all agreements, covenants, and conditions required by this
Agreement to be performed and complied with by it prior to the Closing.

         B.   NO PROCEEDING OR LITIGATION.  No action, suit, or proceeding
before any court and any governmental or regulatory authority will have been
commenced and be continuing, and no investigation by any governmental or
regulatory authority will have been commenced and be continuing, and no action,
investigation, suit, or proceeding will be threatened at the time of Closing,
against Purchaser or any of Purchaser's affiliates, associates, officers, or
directors, seeking to restrain, prevent, or change this purchase, questioning
the validity or legality of this purchase, or seeking damages in connection with
this purchase.

         C.   CORPORATE ACTION.  Purchaser will have furnished to Seller a
copy, certified by the Secretary of Purchaser, of the resolutions of Purchaser
authorizing the execution, delivery, and performance of this Agreement.

    SECTION IX..   CLOSING.

         A.   TIME, PLACE AND MANNER OF CLOSING.  Unless this Agreement has
been terminated and this purchase has been abandoned pursuant to the provisions
of Section 10, the closing ("Closing") will be held at the offices of Seller, or
such other place as the parties may agree, on May 26, 1995, or as soon as
practicable after the satisfaction of the various conditions precedent to the
Closing set forth herein.  At the Closing the parties to this Agreement will
exchange records of transaction of share certificates, Notes, Guaranties, and
other instruments and documents in order to determine whether the terms and
conditions of this Agreement have been satisfied.  Upon the determination of
each party that its conditions to consummate this purchase have been satisfied
or waived, Seller shall deliver to Purchaser the records of transaction of share
certificate(s) evidencing the Shares, and Purchaser shall deliver to Seller
evidence that Purchaser has discharged the obligations contained in paragraph
I.C.  Payment of Purchase Price.

         B.   CONSUMMATION OF CLOSING.  All acts, deliveries, and confirmations
comprising the Closing regardless of chronological sequence shall be deemed to
occur contemporaneously and simultaneously upon the occurrence of the last act,
delivery, or confirmation of the Closing and none of such acts, deliveries, or
confirmations shall be effective unless and until the last of


                                          17



the same shall have occurred.  The time of the Closing has been scheduled to
correspond with the close of business at the principal office of Seller and,
regardless of when the last act, delivery, or confirmation of the Closing shall
take place at the principal office of Seller on the date of the Closing, but no
later than May 30, 1995.

    SECTION X..    TERMINATION.

         A.   TERMINATION FOR CAUSE.  If, pursuant to the provisions of
Section 7 or 8 of this Agreement, Seller or Purchaser is not obligated at the
Closing to consummate this Agreement, then the party who is not so obligated may
terminate this Agreement.  If this agreement is terminated Purchaser will
retransfer all shares it has purchased in exchange for return of the
consideration paid for the share, to Seller who shall reissue new share
certificates to Shareholders.  If Seller is in compliance with the terms of this
agreement and Purchaser elected to terminated this agreement Seller shall not be
obligated to reimburse Purchaser for any expenses it has incurred by reason of
this agreement.  If Purchaser is in compliance with the terms of this agreement
and Seller elected to terminated this agreement Seller shall be required to
reimburse Purchaser for monies paid by Purchaser under paragraph I.C.

         B.   TERMINATION WITHOUT CAUSE.  Anything herein or elsewhere to the
contrary notwithstanding, this Agreement may be terminated and abandoned at any
time without further obligation or liability on the part of any party in favor
of any other (1) by mutual consent of Purchaser and Seller or (2) if Closing is
not consummated by the end of business on May 30, 1995, by no fault of the
Seller.

         C.   TERMINATION PROCEDURE.  Any party having the right to terminate
this Agreement due to a failure of a condition precedent contained in Sections 7
or 8 hereto may terminate this Agreement by delivering to the other party
written notice of termination.

    SECTION XI..   MISCELLANEOUS PROVISIONS.

         A.   AMENDMENT AND MODIFICATION.  Subject to applicable law, this
Agreement may be amended, modified, or supplemented only by a written agreement
signed by Purchaser and Seller.

         B.   WAIVER OF COMPLIANCE; CONSENTS

              1.   Any failure of any party to comply with any obligation,
covenant, agreement, or condition herein may be waived by the party entitled to
the performance of such obligation, covenant, or agreement or who has the
benefit of such condition, but such waiver or failure to insist upon strict
compliance with such obligation, covenant, agreement, or


                                          18



condition will not operate as a waiver of, or estoppel with respect to, any
subsequent act or other failure.

              2.   Whenever this Agreement requires or permits consent by or on
behalf of any party hereto, such consent will be given in a manner consistent
with the requirements for a waiver of compliance as set forth above.

         C.   NOTICES.  All notices, requests, demands, and other
communications required or permitted hereunder will be in writing and will be
deemed to have been duly given when delivered by hand or three days after being
mailed by certified or registered mail, return receipt requested, with postage
prepaid:

    Purchaser:          Schmitt Industries, Inc.
                        2765 NW Nicolai
                        Portland, OR 97210

    Seller:             TMA Technologies, Inc.
                        601 Haggerty Lane
                        Bozeman, Montana 59715

         D.   TITLES AND CAPTIONS.  All section titles or captions contained in
this Agreement are for convenience only and shall not be deemed part of the
context nor effect the interpretation of this Agreement.

         E.   ENTIRE AGREEMENT.  This Agreement contains the entire
understanding between and among the parties and supersedes any prior
understandings and agreements among them respecting the subject matter of this
Agreement.

         F.   AGREEMENT BINDING.  This Agreement shall be binding upon the
heirs, personal representatives, executors, administrators, successors and
assigns of the parties hereto.

         G.   ATTORNEY FEES.  In the event an arbitration, suit or action is
brought by any party under this Agreement to enforce any of its terms, or in any
appeal therefrom, it is agreed that the prevailing party shall be entitled to
reasonable attorneys fees to be fixed by the arbitrator, trial court, and/or
appellate court.

         H.   COMPUTATION OF TIME.  In computing any period of time pursuant to
this Agreement, the day of the act, event or default from which the designated
period of time begins to run shall be included, unless it is a Saturday, Sunday,
or a legal holiday, in which event the period shall begin to run on the next day
which is not a Saturday, Sunday, or legal holiday, in which event the period
shall run until the end of the next day thereafter which is not a Saturday,
Sunday, or legal holiday.

         I.   PRONOUNS AND PLURALS.  All pronouns and any variations thereof
shall be deemed to refer to the masculine,




                                          19



feminine, neuter, singular, or plural as the identity of the person or persons
may require.

         J.   GOVERNING LAW.  This Agreement shall be governed by and construed
in accordance with the laws of the State of Montana.  The parties stipulate that
the proper venue for any action commenced as a result of this agreement is
Gallatin County, Montana.

         K.   ARBITRATION.  If at any time during the term of this Agreement
any dispute, difference, or disagreement shall arise upon or in respect of the
Agreement, and the meaning and construction hereof, every such dispute,
difference, and disagreement shall be referred to a single arbiter agreed upon
by the parties, or if no single arbiter can be agreed upon, an arbiter or
arbiters shall be selected in accordance with the rules of the American
Arbitration Association and such dispute, difference, or disagreement shall be
settled by arbitration in accordance with the then prevailing commercial rules
of the American Arbitration Association, and judgment upon the award rendered by
the arbiter may be entered in any court having jurisdiction thereof.

         L.   PRESUMPTION.  This Agreement or any section thereof shall not be
construed against any party due to the fact that said Agreement or any section
thereof was drafted by said party.

         M.   FURTHER ACTION.  The parties hereto shall execute and deliver all
documents, provide all information and take or forbear from all such action as
may be necessary or appropriate to achieve the purposes of the Agreement.

         N.   PARTIES IN INTEREST.  Nothing herein shall be construed to be to
the benefit of any third party except for Shareholders and Debt Holders, nor is
it intended that any provision shall be for the benefit of any third party
except for Shareholders and Debt Holders.

         O.   SAVINGS CLAUSE.  If any provision of this Agreement, or the
application of such provision to any person or circumstance, shall be held
invalid, the remainder of this Agreement, or the application of such provision
to persons or circumstances other than those as to which it is held invalid,
shall not be affected thereby.

         P.   INDEMNITY.  Seller agrees hold Purchaser harmless against all
actions occurring prior to closing and Purchaser agrees to hold harmless Seller,
its officers, directors, representatives, attorneys, accountants, or employees
for any and all acts occurring prior to closing.

Notes - relative to preliminary signing of this Agreement:


                                          20



    *    This agreement is signed with the agreement and understanding of those
         signing, that this Agreement is subject to the following:

                   Completion of the Schedules and other information required
                   by this Agreement to be attached.

    *    Upon initial signature of this Agreement on April 19, 1995, even
         though the Agreement is subject to the action listed above, Purchaser
         has loaned $200,000 to Seller for immediate payment of Seller's
         delinquent employee payables, certain critical accounts payable.

         Seller specifically agrees to disperse these funds only in accordance
         with Purchaser's direction.

Dated:      April 21     , 1995
       ------------------

SCHMITT INDUSTRIES, INC.,         TMA TECHNOLOGIES, INC., a
an Oregon corporation             Montana corporation

By: /s/ Wayne A. Case             By: /s/ Marvin H. Ball
    ---------------------             ----------------------
Its:  President - CEO             Its:  CEO
     --------------------              ---------------------


                                          21



                                LISTING OF ATTACHMENTS

- - Certificate of Vesting in Royalty Pool    {Reference Section I.B.}

    Purchaser's separate agreement with Shareholders and Debt Holders.

- - Schedule 1.1 Seller's Debts and Obligations    {Reference Section I.B.}

    All of the outstanding debts and obligations of Seller, which Purchaser -
    by acting upon this Agreement - will purchase .

- - Copies of Seller's Charter and Bylaws     {Reference Section II.A.}

    Current copies of Seller's charter documents and bylaws, including all
    amendments.

- - Schedule 2.1  [Agreement does not specify this Schedule]
- - Schedule 2.2  [Agreement does not specify this Schedule]
- - Schedule 2.3  [Agreement does not specify this Schedule]

- - Schedule 2.4  Seller in Default   {Reference Section II.D.}

    Listing of conditions in which Seller is currently in default, or in which
    Seller would be in default with notice.

- - Exhibit 2.5(A) and Exhibit 2.5(B)    Seller's Financial Statements
    {Reference Section II.E.}

    Seller's Financial Statements with Notes, including the unaudited balance
    sheet of Seller as of February 28, 1995 [Exhibit 2.5(A)], and the income
    statement for the month and year-to-date ending February 28, 1995
    [Exhibit 2.5(B)].

- - Schedule 2.6 Seller's Liabilities    {Reference Section II.F.}

    Listing of Seller's material liabilities or obligations, not elsewhere
    disclosed, i.e. which are not included, adequately reserved against, or
    described in the Financial Statements or the notes thereto.

- - Schedule 2.7 Changes by Seller  {Reference Section II.G.}

    Listing of Seller's following actions, or Seller's agreement to the
    following actions, or Seller's knowledge of the conditions described,
    except as contemplated or permitted by this Agreement: significant damage
    to Seller's property; agreement to sell assets; encumbrance of assets;
    redemption of repurchase of stock; any material transaction not in the
    ordinary course of business; lapse of trademarks, copyrights




                                          22



Listing of Attachments - (continued) -

    etc.; grant of any increase in compensation; discharge or satisfaction of
    any material lien or encumbrance; payment of any material liability; or
    making any material loan, advance, or guaranty.

- - Transaction Record of Seller's sale of assets.
    {Reference Section II.G.2}

    Listing of tangible assets recently sold for cash, prior to March 30, other
    than in the ordinary course of business.

- - Schedule 2.8 Title    {Reference II.H.}

    Listing of property and other assets included in the Financial Statements
    to which Seller does not have good and marketable title.

- - Schedule 2.9 Litigation    {Reference II.I.}

    Listing of material actions pending or threatened.

- - Schedule 2.10 Tax Matters  {Reference II.J.}

    Listing of deficiencies by Seller to prepare and submit required forms
    relative to taxes, and of deficiencies by Seller in paying taxes.

- - Schedule 2.13 Seller's Insurance     {Reference II.M.}

    Listing of list of each insurance policy maintained by Seller.

- - Schedule 2.14    Seller's Employees and Labor Relations  {Reference II.N.}

    Listing of exceptions to statements in Section II.N of the Agreement.

- - Schedule 2.16    Power of Attorney   {Reference Section II.P.}

    Listing of Seller's authorizations given for power of attorney, still in
    effect.

- - Schedule 2.17    [Agreement does not specify this Schedule]

- - Schedule 2.18    Seller's Agreements and Commitments     {Reference
Section II.R.}

    Complete and accurate listing of each of Seller's agreements.


                                          23



Listing of Attachments - (conclusion) -

- - Schedule 2.19    Seller's Personal Property {Reference Section II.S.}

    Listing of all tangible personal property and assets owned or held by
    Seller and used or useful in the conduct of the business of Seller.
    Notation of any such properties to which Seller does not have good title.

    Copies of all leases and other agreements relating to the listed property.

- - Schedule 2.21    Seller's Patents, Trademarks, Tradenames, etc.

    {Reference Section II.U.}

    Accurate and complete listing of Seller's currently held and applied for
    patents, trademarks, tradenames, service marks, and copyrights.  Listing of
    all written notices received by Seller alleging infringement of unlawful
    use of this property.

- - Schedule 2.22    Seller's ERISA and Related Matters
{Reference Section II.V.}

    A description of all "Employee Welfare Benefit Plans" and "Employee Pension
    Benefit Plans" currently maintained or contributed to by Seller.  Listing
    of Seller's retirement or deferred compensation plan, savings, incentive,
    stock option or stock purchase plan, unemployment compensation plan,
    vacation pay, severance pay, bonus or benefit arrangement, insurance or
    hospitalization program, and any other fringe benefit arrangement for any
    employee, consultant or agent.

- - Schedule 3.1     [Agreement does not specify this Schedule]
- - Schedule 3.2     [Agreement does not specify this Schedule]
- - Schedule 3.3     [Agreement does not specify this Schedule]

- - Schedule 3.4  Purchaser's Obligations to Governmental Authorities Relative to
This Agreement  {Reference Section III.D.}

    Description of Purchaser's obligations relative to this Agreement to
    governmental authorities.


                                          24



                                     EXHIBIT 11.1

                               SCHMITT INDUSTRIES, INC.

                   SCHEDULE OF COMPUTATION OF NET INCOME PER SHARE

YEARS ENDED MAY 31, ---------------------------------------- 1996 1995 1994 ---------- ---------- ---------- PRIMARY Net income for primary income per common share $1,217,253 $248,805 $181,503 ---------- ---------- ---------- ---------- ---------- ---------- Weighted average number of shares outstanding 6,887,975 6,886,889 5,977,668 during the year Add: common equivalent shares (determined using the "treasury stock" method) representing shares issuable upon exercise of employee stock options 528,738 228,905 225,210 ---------- ---------- ---------- Weighted average number of shares used in calculation of primary income per share 7,416,713 7,115,794 6,202,878 ---------- ---------- ---------- ---------- ---------- ---------- Primary income per common share $.16 $.04 $.03 ---------- ---------- ---------- ---------- ---------- ---------- FULLY DILUTED Net income for fully diluted net income per share $1,217,253 $248,805 $181,503 ---------- ---------- ---------- ---------- ---------- ---------- Weighted average number of shares used in calculating primary income per common share 7,416,713 7,115,794 6,202,878 Add (deduct) incremental shares representing: Shares issuable upon exercise of stock options included in primary calculation above (528,738) (228,905) (225,210) Shares issuable upon exercise of stock options based on year-end market price 557,374 228,905 225,210 ---------- ---------- ---------- Weighted average number of shares used in calculation of fully diluted income per share 7,445,349 7,115,794 6,202,878 ---------- ---------- ---------- ---------- ---------- ---------- Fully diluted income per common share $.16 $.04 $.03 ---------- ---------- ---------- ---------- ---------- ----------



TO OUR SHAREHOLDERS

1996 was a year of accelerated growth and increasing profitability for 
Schmitt Industries, Inc. Fiscal 1996 saw many changes in personnel and 
product diversification for the Company.  The acquisition of SMS, Schmitt 
Measurement Systems, Inc., brought the state of the art laser based surface 
and distance measurement technologies into the Company.

SMS successfully introduced several new products to the computer disk drive 
and micro electronic wafer markets.  The Company's new TMS-2000 computer disk 
measurement system is becoming the industry standard for surface measurement 
of disks for hard drives.  It provides users the fastest, most accurate 
measurements of any product in the market.

Operating results for the year continued to show we have the correct 
combination of product, people, and management.  Our sales increased 60% to
$7.1 million for the year, with net profits after tax increasing 390% to 
$1.2 million.  We expect sales of Balancer and Measurement products to 
increase again in fiscal 1997.

The Company continues to evolve and change in products, people, technology, 
and opportunities. The addition of the SMS subsidiary has brought new 
customers in the semiconductor, wafer, and computer hard disk drive markets.  
Newly patented laser based technologies created in Fiscal Year 1996 will 
continue to impact our future upward growth.

I am proud of the people and the results our Company has achieved during 
Fiscal 1996.  Major changes and adjustments have been successfully 
implemented, such as:  two new patents on the SMS TMS-2000 machine, 
completion of the remodeling of the SMS facility,  over 50 new Balancer 
applications, more international customer demand for our products, and new 
SMS measurement products added to our product offering for the future.

As we look toward the future, we are reminded of our vision for the Company:

"TO PROVIDE THE BEST POSSIBLE PRODUCTS AND QUALITY FOR OUR CUSTOMER, TO 
PROVIDE CHALLENGING AND REWARDING EMPLOYEE OPPORTUNITIES, AND TO PROVIDE THE 
GREATEST POSSIBLE RETURN TO OUR SHAREHOLDERS"

[Photo]         It is our goal in fiscal 1997 and beyond to continue to
                seek fulfillment of this vision for our Company.

                Thank you for your continued interest and support.

                /s/Wayne A. Case

                Wayne A. Case                                
                President &        
                Chairman of the Board

               P.S. VISIT OUR NEW WEB SITE - http://www.schmitt-ind.com

                                                                              1
                                                        


COMPANY GROWTH

Increasing efficiency, excellent products, and the ability to recognize 
market opportunities has resulted in the dramatic growth, year after year, of
our Company since its inception in 1986.

The fact that the SBS Dynamic Balance System operates at a much higher degree 
of accuracy and reliability than similar products and yet maintains a 10% to 
20% pricing advantage has resulted in it becoming the standard of the 
industry.

The new SMS laser based measurement products brought into Schmitt in May of 
1995 have added substantial technological depth to our product offerings, 
which has resulted in increased sales and profits.

Our products are utilized throughout the world by such industrial giants as 
The Boeing Company, General Motors Corporation, Ford Motor Company, Timken 
Bearings, Torrington Bearings, Mercedes Benz, and Daewoo International 
Corporation.  New machine builders offer our SBS product integrated into 
their machine to worldwide users.  The Schmitt SBS Dynamic Balance System, or 
similar products, are employed in the machine tool industry.  They are 
utilized in instances where circular devices such as grinding wheels, fans, 
turbines, etc., need to be balanced initially and subsequently kept in 
balance in order to operate efficiently.

Our SBS Dynamic Balance System is production proven in over 4,500 major 
manufacturing installations.  It is made in the U.S.A. to strict ISO-9001 
quality and measurement standards. Most of our worldwide customers are sold 
on the spot when they see how quickly it installs and how fast it balances 
and pays for itself on their machine.

Our Company can measure surfaces via Laser Light Scatter to accuracy levels 
of one angstrom - a single angstrom is equal to 4 billionths of one inch!  
This level of accuracy is well beyond competitive measurement technologies 
and is an emerging requirement in the manufacture of silicon wafers for the 
semiconductor industry and in the manufacture of hard disks for the computer 
industry.

Laser based, positional measurement and alignment products are also offered 
by the company. Angles of alignment are now measured by Schmitt in 6/100th of 
a single degree.  These SMS products represent extraordinary technological 
achievements that we will continue to refocus into the industrial markets.

NET PROFITS PER SHARE (After Tax)
OPERATING INCOME PER SHARE (Before Tax)

[Graph]

                              1993      1994      1995      1996

Net Profits per Share          .04       .03       .04       .16
Operating Income per Share     .04       .05       .10       .20


2




OPERATING INCOME FOR 
THE YEAR          
[Graph]

                 1993          1994           1995          1996

              $231,831       $313,129       $697,410      $1,509,158


SALES GROWTH                              [Graph]


         1993         1994           1995           1996

      $1,728,608   $2,574,998     $4,414,832      $7,080,128
                                                                              3


COMPANY PROFILE

Schmitt Industries, Inc. is a global leader in the design, manufacturing and 
marketing of automatic balancing devices for rotating equipment, as well as 
laser based measurement products. Our primary objectives are to ensure total 
customer satisfaction by continually improving the quality and value of 
Schmitt products and services, providing all employees with challenging and 
rewarding opportunities to fully utilize their skills and talents in 
contributing to the success of Schmitt Industries, Inc., and earning above 
average profits and earnings for all of our shareholders.

A principal product of the Company is the Schmitt Balance System (SBS).  It 
consists of a computer control unit, sensor, spindle mounting adapter, and 
balance head.  It was designed to be an inexpensive, yet highly accurate, 
permanent installation on grinding machines.  Today, the SBS System is 
beginning to be evaluated by manufacturers for additional applications which 
include large electric motors, industrial fans, industrial brushing devices, 
turbines and similar devices.

The SBS system is fully automated and consequently, the user does not have to 
pre-balance such devices as grinding wheels.  This reduces the setup time of 
such operations and ensures a smoother running and more efficient operation.

The SBS Dynamic Balance System operates on a principle of mass compensation 
for wheel imbalance. The balance head contains two movable eccentric weights, 
each of which is driven by electric motors through a precision gear train.  
These weights can be repositioned to offset any imbalance in a grinding wheel 
or other application.  Imbalance or vibration is picked up by the sensor.  
The signal is fed to the controller, which filters the signal by revolutions 
per minute.  The controller then drives the two balance head weights in the 
direction that reduces the amplitude of the vibration signal. When the 
weights are positioned so the lowest vibration level is reached, the balance 
cycle is complete.

[Graphic]  [Graphic]

Typical end users own fleets of precision grinding machinery dedicated to 
production grinding where close tolerance of finished parts and consistency, 
wheel change time, part finish, and overall quality are all judged to be 
important.  Users in these markets typically pay for their SBS System in four 
to six months through cost savings of downtime, wheel life improvements, as 
well as scrap reduction and part quality improvement.

Precision grinding is necessary in all major manufacturing areas such as the 
automotive industry (camshafts, crankshafts, valves), bearings (roller and 
tapered types), ceramics (precision shaping), electric motors (shafts), pumps 
(shafts turbines), aircraft (engine parts), and general manufacturing.

Precision grinding is increasing as a worldwide method of material removal and 
material processing. Therefore, the Company expects to see an increase 
in market growth and an increase in the need for automatic balancers.

The SBS Dynamic Balance System serves a variety of industrial markets 
throughout the world.  The precision grinding industry is worldwide in scope 
and is established within all industrialized countries.

The Company's new subsidiary, SMS, Schmitt Measurement Systems, Inc., 
designs, produces and markets micro measurement products based on proprietary 
laser based technologies.  These products include industrial measurement 
equipment for determining surface roughness at extremely accurate angstrom 
levels.  Users of these technologies are producers of disks for computer hard 
drives and silicon wafer manufacturers.  The new TMS-2000 non-contact laser 
based measurement machine consists of a measurement module as well as a 
stand-alone standard computer to provide software and record keeping for the 
user.

The SMS product line also includes laser light-scatter products utilized in 
space optics and military markets to measure the surface of precision ground 
camera and telescope lens.

4



SMS also provides laser surface measurement services to an international 
client list from the world's most powerful Light Scatter Laboratory.  The 
CASI scatterometer is a research instrument for measuring scattered light. 
The way a surface scatters light relates to its roughness.

The measurements laboratory uses over 20 different wavelengths or "colors" of 
lasers from 0.325 microns in the ultraviolet to 10.6 microns in the infrared. 
Analysis software allows the user to calculate roughness and total integrated 
scatter.  A Class 10 clean environment encloses the measurement area for 
measurement of semiconductor materials and space optics.  Some applications 
include the semiconductor and hard disk industries, as well as critical 
optical components in aerospace and defense systems.  The measurement lab is 
used for contract measurements, new instruments research and development, and 
proof of concept measurements.

The Company's business is conducted with many customers who are located 
throughout the world.

[Photos}

                                                                              
                                                                            5



FOR THE YEAR ENDED MAY 31, 1996

(WITH COMPARATIVE AUDITED FIGURES FOR THE YEAR ENDED MAY 31, 1995)

CONSOLIDATED BALANCE SHEETS





1996 1995 ASSETS Current Assets: Cash $ 508,240 $ 141,244 Trading securities 145,600 356,822 Accounts receivable 1,411,805 967,781 Inventories 1,781,331 1,182,913 Prepaid expenses 15,906 11,902 Notes receivable -- 10,000 Income taxes receivable -- 50,000 Deferred tax asset 593,740 -- ------------ ---------- Total current assets 4,456,622 2,720,662 Property and Equipment: Land 299,000 299,000 Building and leasehold improvements 834,850 589,320 Furniture, fixtures, and equipment 556,245 396,917 Vehicles 104,126 104,126 ------------ ---------- 1,794,221 1,389,363 Less accumulated depreciation 312,189 117,985 ------------ ---------- 1,482,032 1,271,378 ------------ ---------- Other Assets: Marketing rights, net of accumulated amortization of $663,521 and $588,803 at May 31, 1996 and 1995, respectively 72,393 147,111 Goodwill -- 433,839 Intellectual property -- 45,527 ------------ ---------- Total other assets 72,393 626,477 ------------ ---------- TOTAL ASSETS $6,011,047 $4,618,517 ------------ ---------- ------------ ---------- LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Trade accounts payable $ 344,828 $ 441,043 Accrued liabilities 244,613 117,829 Current portion of long-term debt 40,346 -- Current portion of mortgage loan payable -- 12,871 Income taxes payable 294,749 -- ------------ ---------- Total current liabilities 924,536 571,743 Mortgage Loan Payable, net of current portion -- 221,049 Long-Term Debt, net of current portion 174,532 362,094 Long-Term Deferred Tax Liability 25,107 -- Commitments and Contingencies Stockholders' Equity Common stock, no par value, 20,000,000 and 19,000,000 shares authorized and 6,918,139 and 6,886,889 shares issued and outstanding at May 31, 1996 and 1995, respectively 4,098,512 3,892,524 Retained earnings (accumulated deficit) 788,360 (428,893) ------------ ---------- TOTAL STOCKHOLDERS' EQUITY 4,886,872 3,463,631 ------------ ---------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $6,011,047 $4,618,517 ------------ ---------- ------------ ----------
The accompanying notes are an integral part of these consolidated financial statements. 6 FOR THE YEAR ENDED MAY 31, 1996 (WITH COMPARATIVE AUDITED FIGURES FOR THE YEARS ENDED MAY 31, 1995 AND 1994) CONSOLIDATED STATEMENTS OF INCOME
1996 1995 1994 SALES $7,080,128 $4,414,832 $2,574,998 COST OF SALES 2,547,054 1,656,462 1,025,157 ---------- ---------- --------- GROSS PROFIT 4,533,074 2,758,370 1,549,841 ---------- ---------- --------- GENERAL, ADMINISTRATIVE, AND SALES EXPENSE 3,023,916 2,045,117 1,126,049 RESEARCH AND DEVELOPMENT EXPENSE -- 15,843 110,663 ---------- ---------- --------- OPERATING EXPENSES 3,023,916 2,060,960 1,236,712 ---------- ---------- --------- OPERATING INCOME 1,509,158 697,410 313,129 ---------- ---------- --------- OTHER INCOME AND EXPENSE Interest expense (45,130) (26,756) (20,536) Interest income 27,853 56,978 6,309 Gain (loss) on sale of assets -- 2,512 (7,560) Loss on write down of assets (61,222) (333,832) -- Miscellaneous income 16,132 19,263 7,389 ---------- ---------- --------- (62,367) (281,835) (14,398) INCOME BEFORE PROVISION FOR INCOME TAXES 1,446,791 415,575 298,731 PROVISION FOR INCOME TAXES 229,538 166,770 117,228 ---------- ---------- --------- NET INCOME $1,217,253 $ 248,805 $ 181,503 ---------- ---------- --------- NET INCOME PER COMMON SHARE AND COMMON SHARE EQUIVALENT $.16 $.04 $.03 ---------- ---------- --------- ---------- ---------- --------- WEIGHTED AVERAGE NUMBER OF COMMON SHARES AND COMMON SHARE EQUIVALENTS OUTSTANDING 7,416,713 7,115,794 6,202,878 ---------- ---------- --------- ---------- ---------- ---------
The accompanying notes are an integral part of these consolidated financial statements. 7 For The Year Ended May 31, 1996 (WITH COMPARATIVE AUDITED FIGURES FOR THE YEARS ENDED MAY 31, 1995 AND 1994) CONSOLIDATED STATEMENTS OF CASH FLOWS
1996 1995 1994 CASH FLOWS RELATING TO OPERATING ACTIVITIES Net income $ 1,217,253 $ 248,805 $ 181,503 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation 196,021 77,211 32,528 Amortization 189,103 148,325 116,230 Write-down of investments 61,222 - - Deferred taxes (30,822) 51,000 (51,000) Write-down of marketing rights - 333,382 (Gain) loss on sale of assets - (2,512) 7,560 (Increase) decrease in: Trading securities 150,000 (356,822) - Accounts receivable (444,024) (210,472) (218,006) Inventory (613,626) (482,485) (227,138) Prepaid expenses (4,004) 2,213 (8,703) Notes Receivable 10,000 (10,000) - Income taxes receivable 50,000 (50,000) - Other assets (121,907) 372 473 Increase (decrease) in: Accounts payable (96,215) 59,492 91,822 Accrued liabilities 126,784 52,048 - Income taxes payable 294,749 (168,228) 169,228 ------------ -------------- ------------ Net cash provided by (used in) operating activities 984,534 (307,671) 93,497 ------------ -------------- ------------ CASH FLOWS RELATING TO INVESTING ACTIVITIES Purchase of property and equipment (406,675) (561,799) (464,736) Proceeds from sale of equipment - 5,000 390 Acquisition of TMA Technologies, Inc. - (530,240) - ------------ -------------- ------------ Net cash used in investing activities (406,675) (1,087,039) (464,346) ------------ -------------- ------------ CASH FLOWS RELATING TO FINANCING ACTIVITIES Net increase (decrease) in short-term debt - (200,000) 200,000 Repayment of long-term debt (69,131) - - Long-term borrowings (repayments) - mortgage (233,920) (38,202) 272,122 Net change in lease payable - (4,431) (5,906) Dividends paid - (99,630) - Issuance of common stock (net of issuance costs of $84,000) - - 1,427,848 Exercise of stock options 92,188 - 115,150 ------------ -------------- ------------ Net cash (used in) provided by financing activities (210,863) (342,263) 2,009,214 ------------ -------------- ------------ INCREASE (DECREASE) IN CASH $ 366,996 $(1,736,973) $ 1,638,365 CASH, BEGINNING OF YEAR 141,244 1,878,217 239,852 ------------ -------------- ------------ CASH, END OF YEAR $ 508,240 $ 141,244 $1,878,217 ------------ -------------- ------------ ------------ -------------- ------------
The accompanying notes are an integral part of these consolidated financial statements. - -------------------------------------------------------------------------------- 8
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION 1996 1995 1994 Cash paid during the period for interest $ 45,130 $ 26,756 $ 20,536 ----------- ----------- ----------- ----------- ----------- ----------- Cash paid during the period for income taxes $ 11,600 $ 321,997 $ - ----------- ----------- ----------- ----------- ----------- ----------- SUPPLEMENTAL SCHEDULE OF NON CASH INVESTING AND FINANCING ACTIVITIES Discount associated with long-term debt $ (78,085) ----------- ----------- Reduction of goodwill and intangible assets $(424,011) ----------- ----------- Income tax benefit of stock options exercised $(113,800) ----------- ----------- On May 23, 1995, Schmitt Industries, Inc. acquired TMA Technologies, Inc. The purchase price consisted of the following: Accounts receivable $ 208,574 Inventory 72,342 Property, plant, and equipment 306,714 Intellectual property 45,527 Goodwill 433,839 Accounts payable (174,662) Long term debt (362,094) ----------- Net cash paid to acquire TMA Technologies, Inc. $ 530,240 ----------- ----------- Cash dividend declared, payable June 30, 1994 $ - $ - $ 99,630 ----------- ----------- ----------- ----------- ----------- -----------
For The Year Ended May 31, 1996 (WITH COMPARATIVE AUDITED FIGURES FOR THE YEARS ENDED MAY 31, 1995, 1994 AND 1993) CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
ISSUED SHARE CAPITAL RETAINED -------------------- EARNINGS TOTAL NUMBER OF AMOUNT (ACCUMULATED SHAREHOLDERS' SHARES $ DEFICIT) EQUITY --------------------------------------------------------------- BALANCE, MAY 31, 1993 5,723,058 $2,349,526 $(759,571) $1,589,955 Stock options exercised 563,831 115,150 - 115,150 Issuance of stock ($2.38 per share) 600,000 1,427,848 - 1,427,848 Cash dividend declared ($.015 per share payable on June 30, 1994) - - (99,630) (99,630) Net income for the year - - 181,503 181,503 ---------- ----------- ---------- ----------- BALANCE, MAY 31, 1994 6,886,889 3,892,524 (677,698) 3,214,826 Net income for the year - - 248,805 248,805 ---------- ----------- ---------- ----------- BALANCE, MAY 31, 1995 6,886,889 3,892,524 (428,893) 3,463,631 Stock options exercised 31,250 92,188 - 92,188 Income tax benefit from exercise of stock options - 113,800 - 113,800 Net income - - 1,217,253 1,217,253 ---------- ----------- ---------- ----------- BALANCE, MAY 31, 1996 6,918,139 $4,098,512 $ 788,360 $4,886,872 ---------- ----------- ---------- ----------- ---------- ---------- ---------- -----------
The accompanying notes are an integral part of these consolidated financial statements. - -------------------------------------------------------------------------------- 9 NOTES 1. ORGANIZATION AND NATURE OF OPERATIONS Schmitt Industries, Inc. is engaged in the design, assembly, marketing and distribution of electronic and mechanical components for industrial products and laser measurement systems throughout the United States, the Far East, and Europe. Schmitt Industries Inc. was incorporated in 1984 under the laws of British Columbia, Canada. On December 7, 1993, Schmitt Industries Inc. established a wholly-owned subsidiary, Schmitt Industries, Inc. (an Oregon corporation), and transferred all assets and liabilities to the wholly-owned subsidiary in exchange for 1,000 shares of common stock. On February 16, 1996, the shareholders of Schmitt Industries Inc., approved the continuance of the entity from British Columbia, Canada, to Wyoming and the simultaneous merger of the continued company into its wholly-owned subsidiary, Schmitt Industries, Inc. (the Company). As a result of the continuation and merger, the Company changed its legal domicile to Oregon and is no longer subject to the laws of British Columbia, Canada. On October 16, 1995, the Company restated its Articles of Incorporation to authorize 20,000,000 shares of common stock. On May 23, 1995, the Company acquired TMA Technologies, Inc. As of June 1, 1995, the name of this company was changed to Schmitt Measurement Systems, Inc. The financial statements as of May 31, 1996 and 1995, and for the fiscal years ended May 31, 1996, 1995, and 1994, include those of the Company and its wholly-owned subsidiary. All significant intercompany accounts and transactions have been eliminated in the preparation of the consolidated financial statements. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES A. OTHER ASSETS MARKETING RIGHTS The capitalized costs of marketing rights are recorded at cost and are amortized on a straight-line basis over five to ten years. Amortization expense for the fiscal years ended May 31, 1996, 1995, and 1994, was $74,718, $141,936, and $116,230, respectively. GOODWILL AND INTELLECTUAL PROPERTY Goodwill and intellectual property were acquired in the purchase of TMA Technologies, Inc., on May 23, 1995. The cost of both assets together with additionally acquired goodwill (see Note 3) are being amortized using the straight-line method over five years. Amortization expense for the fiscal year ended May 31, 1996, was $99,177. B. INVENTORY Inventory is valued at the lower of cost or market. Cost is determined on the average cost basis. The classification of inventories is as follows: Years Ended May 31, 1996 1995 Raw materials . . . . . . . . . . . . . $ 931,095 $ 515,608 Work-in-process . . . . . . . . . . . . 122,403 73,277 Finished goods. . . . . . . . . . . . . 727,833 594,028 ---------- ---------- $1,781,331 $1,182,913 ---------- ---------- ---------- ---------- C. DEPRECIATION Depreciation is computed by the straight-line method over the following estimated useful lives: Vehicles. . . . . . . . . . . . . . . . 3 years Furniture, fixtures, and equipment . . . . . . . . . . . . . . 3 - 7 years Building and leasehold improvements. . . . . . . . . . . . . 25 years Depreciation expense for the fiscal years ended May 31, 1996, 1995, and 1994, was $196,021, $77,211, and $32,528, respectively. D. CAPITAL STOCK The Company follows the practice of recording amounts received upon the exercise of options by crediting common stock. No charges are reflected in the consolidated statements of operations as a result of the grant or exercise of stock options. The Company realizes an income tax benefit from the exercise or early disposition of certain stock options. This benefit results in an increase in common stock and deferred tax assets. E. CONCENTRATION OF CREDIT RISK Financial instruments which potentially expose the Company to concentration of credit risk are trade accounts receivable. Credit terms generally include a discount of 1 1/2% if the invoice is paid within 10 days, with the net amount payable in 3 days. No allowance for doubtful accounts is considered necessary. For the fiscal years ended May 31, 1996, approximately 15.4% of consolidated sales were made to one customer by Schmitt Measurement Systems, Inc. As of May 31, 1996, the total amount of receivables from this customer was current. For the fiscal years ended May 31, 1995 and May 31, 1994, sales to a single customer did not exceed 10% of total sales. F. INCOME TAXES The Company follows the asset and liability method of accounting for income taxes whereby deferred tax assets and liabilities are recognized for the future tax consequences of differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. G. RESEARCH AND DEVELOPMENT COSTS Research and development costs are charged to expense when incurred. - -------------------------------------------------------------------------------- 10 H. TRADING SECURITIES Trading securities consist of common stock and are stated at fair value, which is estimated based on quoted market prices. I. USE OF ESTIMATES The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Significant estimates include the costing of inventory, labor and overhead, and the valuation of deferred tax assets. J. FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amounts of financial instruments approximate their fair values at May 31, 1996. The fair market value of long-term debt approximates carrying amounts based on discounted cash flow analyses. K. RECLASSIFICATIONS Certain reclassifications have been made to the 1995 and 1994 financial statements to conform with current year presentations. NOTES 3. ACQUISITION OF TMA TECHNOLOGIES, INC. (SCHMITT MEASUREMENT SYSTEMS, INC.) On May 23, 1995, in a business combination accounted for as a purchase, the Company acquired TMA Technologies, Inc., which designs, manufactures, and markets optical quality assurance instruments. The results of operations of TMA Technologies, Inc., are included in the accompanying consolidated financial statements since the date of acquisition. The total cost of the acquisition was $530,240, which exceeded the fair value of the net assets of TMA Technologies, Inc., by $433,839. The excess is being amortized by the straight-line method over five years. The summarized assets and liabilities of TMA Technologies, Inc., on May 23, 1995, the date of acquisition, were as follows: Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 4,877 Accounts receivable. . . . . . . . . . . . . . . . . . . . . 208,574 Inventory. . . . . . . . . . . . . . . . . . . . . . . . . . 72,342 Property, plant, and equipment . . . . . . . . . . . . . . . 306,714 Intellectual property. . . . . . . . . . . . . . . . . . . . 45,527 Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . 433,839 Accounts payable . . . . . . . . . . . . . . . . . . . . . . (173,662) Long-term debt . . . . . . . . . . . . . . . . . . . . . . . (362,094) -------- 535,117 Less cash included above . . . . . . . . . . . . . . . . . . (4,877) -------- Net cash paid to acquire TMA Technologies, Inc. . . . . . . . . . . . . . . . . . $ 530,240 -------- -------- Subsequent to this addition, the Company changed the name of TMA Technologies, Inc., to Schmitt Measurement Systems, Inc., and moved the operations to Portland, Oregon. In transactions related to the acquisition, the Company established a royalty pool and has vested each shareholder and debt holder an interest in the royalty pool equal to the amount actually invested by shareholders or loaned by debt holders including interest payable through March 31, 1995. The royalty pool will be funded in the future at 5% of net sales (defined as gross sales less returns, allowances and sales commissions) of Schmitt Measurement Systems, Inc.'s, products and future derivative products developed by Schmitt Industries, Inc., which utilize these technologies. As part of the royalty pool agreement, each of the former shareholders and debt holders released TMA Technologies, Inc., and Schmitt Industries, Inc., for any claims with regard to the acquisition except their rights to future royalties. Three debt holders, with a combined amount outstanding at May 31, 1995, of $362,094, declined to participate in the royalty pool which was established as part of the acquisition of TMA Technologies, Inc., and demanded full payment of the amount due. The debt holders filed an action before the U.S. Bankruptcy Court in Montana in an attempt to cause repayment through liquidation of the Company. The Company successfully converted this action to a reorganization process. In April 1996, the Company's Plan of Reorganization was approved by the U.S. Bankruptcy Court for the District of Montana. The approved Plan requires the three debt holders to accept the terms of the royalty pool agreement but further requires the Company to purchase the three debtors' interests, as follows: April 29, 1996 - $91,068; March 29, 1997 - $54,640; March 29, 1998 - $43,713; March 29, 1999 - $34,970; March 20, 2000 - $139,880. The outstanding balance at May 31, 1996, based on the present value of the debt, discounted at 8% per annum, was $214,878, of which $40,346 was classified as current. In the event that the remaining unpaid balance of the royalty pool interest is not purchased in full on or before March 29, 1998, the remaining balance due will accrue interest at 8% per annum. In addition, the Company has the option of purchasing the remaining unpaid balance of the royalty pool interests on or before March 29, 1999, at a 10% discount of the amount then due. The approved Plan also requires the Company to segregate the royalty pool payments to the former Chief Executive Officer of TMA Technologies, Inc., in an interest-bearing trust account pending the outcome of actions involving TMA Technologies, Inc., - -------------------------------------------------------------------------------- 11 a/k/a Toomay, Mathis & Associates, Inc., and Schmitt Industries, Inc., plaintiffs, v. Robert C. Mathis and Marvin H. Ball, defendants together with corresponding countersuits initiated in the U.S. District Court for the District of Montana. The extent of potential liability, if any, related to this matter cannot be estimated at this time. NOTES 4. LINE OF CREDIT The Company has a line of credit with the Union Bank of California, Portland, Oregon, to a maximum of $250,000. The line is secured by accounts receivable, investments, and inventory. Interest is payable monthly on the outstanding balance at the bank prime lending rate plus 1% per annum. The Company has no balance owing at either May 31, 1996 or 1995. This line of credit expires September 30, 1996. Subsequent to May 31, 1996, the Company entered into an unsecured short-term line of credit agreement with Wells Fargo Bank, to a maximum of $1,500,000. The line is guaranteed by the Company's wholly-owned subsidiary, Schmitt Measurement Systems, Inc. Interest is payable at the bank's prime rate, fully floating. 5. MORTGAGE LOAN PAYABLE The mortgage loan payable of $233,920 at May 31, 1995, was secured by a first mortgage on the land and building located at 2765 N.W. Nicolai Street, Portland, Oregon. The mortgage was payable in 60 monthly payments of $2,831, including interest at 9.25% per annum, commencing February 1, 1994, with the balance due in full on January 1, 1999. The balance outstanding was paid in full during the fiscal year ended May 31, 1996. 6. CONTINGENCY The Company is party to a legal action by a competitor alleging wrongful misrepresentation of the competitor's product. The claim is considered by management and the Company's legal counsel, to be without merit. The extent of potential liability, if any, cannot be estimated at this time. 7. STOCK OPTIONS Prior to 1995, the Company periodically granted stock options to Directors and employees of the Company. Stock options for up to 10% of the number of outstanding shares may have been granted provided that the stock options for any one individual did not exceed 5% of the issued and outstanding shares of common stock. The purchase price of the optioned shares must have been equal to not less than the average closing price of the Company's common stock for the ten trading days immediately preceding the grant date of the stock options. The maximum term of each stock option may not exceed five years and all stock options were vested and exercisable upon granting. The following summarizes the options outstanding as of May 31, 1996: Number of Price Per Expiration Shares Share Date Options granted in 1994: 277,500 $1.93 2/4/1999 312,000 $1.42 1/7/1999 25,000 $1.42 1/7/1999 ------- Options under grant, May 31, 1994...........................614,500 ------- Options exercised in 1995............... - Options expired in 1995................. - Options granted in 1995................. - ------- Options under grant, May 31, 1995...........................614,500 ------- Options exercised in 1996 ..............(18,750) $1.42 Options expired in 1996 ................ - Option granted in 1996 ................. - ------- Options under grant, May 31, 1996...........................595,750 ------- ------- On April 19,1996, the Company filed a Form S-8 Registration Statement under the Securities Act of 1933 with the Securities and Exchange Commission in order to register 300,000 shares of common stock for future issuance under the Schmitt Industries, Inc., 1995 Stock Option Plan. The 1995 Stock Option Plan was adopted by the Board of Directors on December 19, 1995. An option granted under the Plan may be either an incentive stock option ("ISO"), or a nonstatutory stock option ("NSO"). ISOs may be granted only to employees of the Company and are subject to certain limitations, in addition to restrictions applicable to all stock options under the Plan. Options not meeting these limitations will be treated as NSOs. Options granted under the Plan are not exercisable until vested. Vesting is generally on a cumulative basis over four years at 25% per year. The following summarizes the options outstanding under the 1995 Stock Option Plan as of May 31, 1996: NUMBER OF PRICE PER EXPIRATION SHARES SHARE DATE Options granted in 1996 295,000 $4.375-9.75 2006 Options exercised in 1996 (12,500) $ 4.375 ------- Options under grant May 31, 1996 282,500 ------- ------- In October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (SFAS 123), which is effective for transactions entered into for fiscal years that begin after December 15, 1995. SFAS 123 established a fair value-based method of accounting for stock-based compensation plans. The Company will adopt the disclosure method - -------------------------------------------------------------------------------- 12 in 1997. The Company does not anticipate SFAS 123 to have a material effect on the Company's financial position or results of operations in fiscal 1997. 8. EMPLOYEE BENEFIT PLANS The Company adopted a Simplified Employee Pension Plan (SEP) during the fiscal year ended May 31, 1993. All permanent employees were eligible to participate once they met the age and length of employment requirements. Contributions were $41,840, $40,500, and $24,000 during the fiscal years ended May 31, 1996, 1995, and 1994, respectively. The Plan was terminated effective May 31, 1996. The Company adopted the Schmitt Industries, Inc. 401(k) Profit Sharing Plan & Trust on May 15, 1996, to be effective June 1, 1996. Employees must meet certain age and service requirements to be eligible. Participants may contribute up to 15% of their eligible compensation which will be matched by the Company. The Company may further contribute matching contributions (to employees who have deferred a certain percentage of their compensation), a profit sharing contribution, or a discretionary contribution. No contributions were made to this Plan during the fiscal year ended May 31, 1996. NOTES 9. SEGMENTS OF BUSINESS The Company operates principally in two segments of business. Schmitt Industries, Inc., manufactures mechanical components for the machine tool industry and Schmitt Measurement Systems, Inc., manufactures laser measurement systems for the computer disk industry. There were no intersegment sales and, therefore, revenues from unaffiliated customers represent total revenues as reported in the Company's consolidated statement of income and were $4,801,151 and $2,278,977, for Schmitt Industries, Inc., and Schmitt Measurement Systems, Inc., respectively for the year ended May 31, 1996. Income from operations for the year ended May 31, 1996 was $648,777 for Schmitt Industries, Inc., and $860,381 for Schmitt Measurement Systems, Inc. Identifiable assets at May 31, 1996, were $4,187,316 and $1,823,731 for Schmitt Industries, Inc., and Schmitt Measurement Systems, Inc., respectively. The operations of Schmitt Measurement Systems, Inc., were immaterial for the year ended May 31, 1995. Income from operations represents sales less costs and operating expenses. Depreciation expense incurred during the year ended May 31, 1996, by Schmitt Industries, Inc., and Schmitt Measurement Systems, Inc., was $115,778 and $80,243, respectively. Amortization expense was $91,756 and $97,347, and capital expenditures were $317,861 and $88,814, for Schmitt Industries, Inc., and Schmitt Measurement Systems Inc., respectively. Identifiable assets by segment of business are those assets used in the Company's operations in each segment. There are no unallocated corporate assets. 10. INCOME TAXES Deferred income taxes are recognized for all significant temporary differences between the tax and financial accounting bases of assets and liabilities. The classification of the resulting deferred tax assets and liabilities is based upon the classification of the related balance sheet asset or liability. The deferred tax asset results principally from net operating loss carryforwards and temporary differences in the expense recognition of certain accounts. The deferred tax liability results from using accelerated depreciation methods for tax purposes. The principal components of the deferred tax assets and liabilities are as follows: YEARS ENDED MAY 31, 1996 1995 DEFERRED TAX ASSETS: Net operating loss carry forward................... $ 1,591,229 $ 1,872,642 Exercise of sock options.......... 113,800 - Inventory capitalization.......... 39,066 - Other deferred assets............. 16,863 - ------------ ----------- 1,760,958 1,872,642 Valuation allowance............... (1,167,218) (1,872,642) ------------ ----------- $ 593,740 $ - ------------ ----------- ------------ ----------- DEFERRED TAX LIABILITIES: Depreciation...................... $ 25,107 $ - ------------ ----------- ------------ ----------- NET DEFERRED TAX ASSETS:........... $ 568,633 $ - ------------ ----------- ------------ ----------- Through the acquisition of Schmitt Measurement Systems, Inc., the Company acquired net operating loss carry forwards in the amount of $5,507,768. These carryforwards expire in the years 2002 through 2010 and as of May 31, 1996, $4,680,084 of the net operating loss carryforwards remain. A valuation allowance is provided when it is more likely than not that some portion or all of the operating loss will not be realized. Since all of the net operating losses associated with the acquisition might not be realized, a valuation allowance was established for the entire balance at May 31, 1995. As of May 31, 1996, the valuation allowance has been reduced since it is more likely than not that some portion of the operating loss will be realized. The reduction in the valuation allowance has been accounted for as a reduction of goodwill and intangible assets associated with the purchase acquisition. - -------------------------------------------------------------------------------- 13 A reconciliation between the statutory federal income tax rate and the effective tax rate is as follows: YEARS ENDED MAY 31, 1996 1995 1994 Federal income taxes at statutory rate...................$ 491,909 $141,296 $101,568 State income taxes, net of federal income tax benefit.......................... 31,511 18,103 13,013 Change in deferred tax valuation allowance.............. (705,424) - - Reduction of goodwill and intangible assets associated with the acquisition of Schmitt Measurement Systems, Inc..................... 424,011 - - Canadian income taxes.............. - - 57,728 Effect of research and development costs capitalized for tax purposes................. - - (51,000) Other.............................. (12,469) 7,371 (4,081) ---------- -------- -------- Provision for income taxes- current..........................$ 229,538 $166,770 $117,228 ---------- -------- -------- ---------- -------- -------- Effective tax rate................. 16% 40% 39% ---------- -------- -------- ---------- -------- -------- 11. EARNINGS PER SHARE Earnings per share were computed by dividing net income by the weighted average number of shares of common stock and common stock equivalents outstanding for the years ended May 31, 1996, 1995, and 1994. Common stock equivalents include the number of shares issuable on exercise of the outstanding options less the number of shares that would have been purchased with the proceeds from the exercise of the options based on the average price of common stock during the year for primary net income per common share and the closing market price of common stock for fully diluted net income per common share. There is no difference between primary and fully diluted net income per share calculations for the years ended May 31, 1996, 1995, and 1994. - -------------------------------------------------------------------------------- 14 GENERAL The following information contains certain forward-looking statements that anticipate future trends or events. These statements are based on certain assumptions that may prove to be erroneous and are subject to certain risks including but not limited to the uncertainties of the Company's new product introduction and the risks of increased competition and technological change in the Company's industry and the risk factors listed from time to time in the Company's SEC reports, including but not limited to the Current Report in Form 8-K dated June 5, 1996. Accordingly, actual results may differ, possibly materially, from the predictions contained herein. MANAGEMENT'S DISCUSSION & ANALYSIS The Company began initial product deliveries in 1988, focusing primarily on the sale of earlier versions of the SBS Dynamic Balance System for machine tool builders producing grinding machines. The Company established itself as a major supplier in the automatic balancing market. The Company became profitable in Fiscal 1991, and has reported profitable results for each succeeding year with increases in sales and earnings for each year. There can be no assurance that the Company will continue to be profitable with increased sales levels in future periods. Sales outside the United States accounted for approximately 10% of the Company's revenues in each of the Fiscal 1994, 1995 and 1996. Some foreign customers will purchase in their own country's currencies, thereby imposing on the Company a currency risk. All U.S. sales (90% of total sales) are in U.S. dollars and less than 2% of total sales are in currencies other than U.S. dollars; as a result, currency fluctuations have historically had little impact on revenue realization. However, significant variations in the value of the U.S. dollar, relative to currencies of countries in which the Company has significant competitors, can impact future sales. The Company does not engage in currency hedging. In addition, longer payment cycles of international sales can have a negative impact on liquidity. The Company believes that international sales will continue to grow in future periods. A substantial portion of the Company's revenues are derived from sales to end users through selling agents and directly to builders of machine tools. For Fiscal 1995 and 1996, sales to a single customer did not exceed 10% of total revenues. The Company is dependent on the sales activities of its selling agents, and there can be no assurance that these agents will continue to be successful in their efforts to market the Company's products. The Company enjoys substantial repeat business from a broad base of customers, but there can be no assurance that these customers will continue to buy the Company's products in the future. Increased revenues during Fiscal 1994, 1995 and 1996 principally have been the result of increased volume of product shipments. Product improvements and available features have resulted in modestly increased average product prices. RESULTS OF OPERATIONS Sales in Fiscal 1996 increased to $7,080,628 from $4,414,832 in Fiscal 1995 and $2,574,998 in Fiscal 1994. The 60.4% increase in Fiscal 1996 was driven by across-the-board gains in orders from both domestic and international customers. Management believes that the increase in sales resulted from improved marketing coverage and advertising and the weakening of domestic competitors. Additionally, SMS sales accounted for $2,278,977 of Fiscal 1996 sales as the newly introduced TMS-2000 Non-Contact Laser Texture Measurement machine had increased shipments. The Company has enjoyed a high gross profit on its SBS Dynamic Balancing products and its SMS measurement products. Its cost of sales (cost of material and labor) as a percentage of sales has been declining over the last three fiscal years because of economies of scale associated with growth and shifting product mix. Costs of sales as a percentage of sales for Fiscal 1994, 1995 and 1996 was 39.4%, 37.5% and 35.9%, respectively. The introduction of the TMS-2000 during the third quarter of Fiscal 1996 had a positive impact on gross earnings and net earnings for Fiscal 1996. Cost of sales of SMS products was 28% of sales of such products for Fiscal 1996. SMS products accounted for sales of $2,278,977 in Fiscal 1996 with income from SMS operations of $860,381 in that period. Management anticipates that cost of sales as a percentage of sales for SMS products well be similar to the SBS products. Management expects that added costs associated with operating SMS will continue to be more than offset by increased revenue, although no assurances can be made that the new subsidiary will be profitable or will generate increased sales. Operating expenses as a percentage of sales in Fiscal 1994, 1995, and 1996 are 48%, 46% and 43% respectively. Sales expense was the largest category, consuming 21%, 18% and 15.3% of operating expenses during Fiscal 1994, 1995 and 1996, respectively. Sales expense increased primarily as a result of expansion and upgrading of the Company's sales force and the hiring of additional sales people to allow top Company management to devote a greater percentage of time to corporate operations and less to sales. The acquisition of Schmitt Measurement Systems, Inc., ("SMS") late in Fiscal 1995 and relocation of the business from Montana to Oregon required additional expenditures for travel, legal, accounting, moving costs, literature and miscellaneous office equipment in Fiscal 1995 and 1996. The Company has had minor variable cost increases in periods of increased sales; therefore, fixed costs have been in past years amortized over an increasing sales revenue - -------------------------------------------------------------------------------- 15 as unit sales of SBS products increased. Even with two operating businesses, management believes the Company's cost of sales will not increase at the same rate that sales are anticipated to increase in Fiscal 1997, although there can be no such assurance. Net income for Fiscal 1996 rose to $1,217,253, a 489% increase over Fiscal 1995 and 671% increase over Fiscal 1994. Net income per share increased to $0.16 in Fiscal 1996 from $0.04 in Fiscal 1995 and $0.03 in Fiscal 1994. LIQUIDITY & CAPITAL RESOURCES The Company satisfied its cash requirements from 1986 through 1988 from sales of common stock and the exercising of stock options as well as from operations. Since 1989, the Company's cash requirements have been satisfied primarily through operations, although in Fiscal 1994 the Company completed a $1.4 million Common Stock offering. At May 31, 1996, the Company had cash and cash equivalents on hand of $653,840 compared with $498,066 at May 31, 1995 and $1,878,217 at May 31, 1994. Accounts receivable have increased as revenue has increased. At May 31, 1996 accounts receivable totaled $1,411,805 compared with $967,781 at May 31, 1995 and $548,735 at May 31, 1994. At May 31, 1996, none of the Company's accounts receivable were considered a doubtful collection. The Company generally experiences a payment cycle of 30 - 80 days on invoices, with some customers taking advantage of the 1.5% cash discount offered by the Company. Most Company customers are Fortune 500 companies, which creates minimal risk of accounts receivable collection. In the event of repeated collection problems, the Company ships on a C.O.D. basis, and currently has only one customer on a C.O.D. basis. Management believes its credit policies and collection policies are effective and appropriate for the marketplace that it serves and has had no bad debt write-offs since its inception in 1986. There can be no assurance that the Company's collection procedures will continue to be successful. Working capital increased from $2,331,399 at May 31, 1994 to $2,148,919 at May 31, 1995 and to $3,532,086 at May 31, 1996. Capital expenditures for property and equipment totaled $464,736, $561,799 and $406,675 during Fiscal 1994, 1995 and 1996, respectively. Increases in capital expenditures during Fiscal 1994 and 1995 were the result of the purchases of new and additional facilities. In addition, the Company spent $530,240 during Fiscal 1995 on the acquisition of SMS. Fiscal 1996 capital expenditures totaled $88,814 for SMS. Although the Company has no current material commitments for capital expenditures, product development to extend SBS products to new markets and to bring SMS products to advanced commercial status is expected to result in modest capital expenditures for equipment in Fiscal 1997. The Company maintains levels of inventory sufficient to satisfy normal customer demands, plus an increasing short term delivery requirement for a majority of its products. Additionally, inventories are periodically adjusted according to management's forecast for future business activity. Management believes its ability to provide prompt deliveries gives it a competitive advantage for certain sales. It is expected that current inventory levels will be maintained or increased as new products are introduced. The average inventory turnover ratio for Fiscal 1994, 1995, and 1996 was 4.9x, 4.9x and 4.9x, respectively. The large increase in inventory during Fiscal 1994 (69% increase from May 31, 1993) was the result of the Company's commitment to supplying field demonstration units, increased sales demand, a diversification of the product line with a disproportionately large increase in inventory, and temporary increase in inventory above "normal" levels to take advantage of quantity purchase opportunities at fiscal year end. The large increase in inventory during Fiscal 1995 (86% increase from May 31, 1994) related to increased sales demand, advantageous acquisition of quantity purchases, and the addition of SMS product inventory. The 50% increase in inventory from May 31, 1995 to May 31, 1996 was the result of establishing additional inventory to support both finished goods and raw materials for SMS products. In December 1993, the Company acquired an office/manufacturing facility, tripling the square footage relative to its prior facility. As a result of the new facility, operational efficiency has been improved; in addition, the monthly costs of the mortgage, heat and lights in Fiscal 1996 was less than the monthly amounts expended for the two previous fiscal years for the leased space the Company had utilized. In April and May 1995, the Company expended $530,240 in the acquisition of SMS and invested approximately $300,000 in additional funds in the remodeling of an older 33,000 square foot building to house the business. SMS currently occupied 7,000 square feet of that facility with some of the remaining space leased to third parties of offset expenses. During Fiscal 1995, the Company implemented several actions which resulted in the deferral or reduction of income taxes in Fiscal 1995 and beyond. The Company wrote down its investment in the Infrasonic Alarm System to $0 ($333,832 writedown), and wrote-off more than $50,000 in inventory. These actions reduced income tax payments during Fiscal 1995 by approximately $150,000. Additionally, the acquisition of SMS during the next fifteen years, at the rate of approximately $325,000 of tax savings per year. Management believes that its cash flow from operations, available credit resources and its improving cash position will provide adequate funds on both a short-term and long-term basis to cover currently foreseeable debt payments, lease commitments and payments under existing and anticipated supplier agreements. Management believes that such cash flow (without the raising of external funds) is sufficient to finance current operations, projected capital expenditures, anticipated long-term sales agreements and other expansion-related contingencies during Fiscal 1997. - -------------------------------------------------------------------------------- 16
- -------------------------------------------------------------------------------------------------------- SELECTED FINANCIAL DATA In thousands, except per share information YEAR YEAR YEAR YEAR YEAR ENDED ENDED ENDED ENDED ENDED 5/31/96 5/31/95 5/31/94 5/31/93 5/31/92 - --------------------------------------------------------------------------------------------------------- Sales $7,080 $4,415 $2,575 $1,729 $1,102 Net Income $1,217 $ 249 $ 182 $ 236 $ 91 Earnings Per Share Before Extraordinary Item $ 0.16 $ 0.04 $ 0.03 $ 0.03 $ 0.01 Extraordinary Item - - - $ 0.01 $ 0.01 Net Income Per Share $ 0.16 $ 0.04 $ 0.03 $ 0.03 $ 0.01 Weighted Avg. No. Shares (000) 7,417 7,116 6,203 5,661 5,623 Deferred Development Costs-Current Period - - $ 111 $ 31 $ 14 Deferred Development Costs-Cumulative - - $ 419 $ 376 $ 379 Stockholders' Equity $4,887 $3,464 $3,215 $1,590 $1,339 Total Assets $6,011 $4,619 $4,232 $1,781 $1,454 - ---------------------------------------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION & ANALYSIS SUMMARIZED QUARTERLY FINANCIAL DATA (UNAUDITED) BEFORE TAX
- ------------------------------------------------------------------------------------------------- 1996 QUARTER ENDED AUGUST 31 NOVEMBER 31 FEBRUARY 28 MAY 31 Sales $1,340,771 $1,520,028 $1,855,938 $2,363,391 Gross Profit $ 838,464 $ 927,754 $1,274,354 $1,452,502 Net Income $ 83,392 $ 208,099 $ 484,288 $ 441,474 Net Income Per Share $0.01 $0.03 $0.06 $0.06 Cash Dividends Per Share - - - - Market Price of Common Stock (1) Low $2.13 $2.63 $3.88 $5.25 High $2.88 $5.13 $5.63 $14.75 1995 QUARTER ENDED AUGUST 31 NOVEMBER 30 FEBRUARY 28 MAY 31 Sales $ 1,085,820 $ 907,792 $ 1,141,585 $1,279,635 Gross Profit $ 664,955 $ 583,890 $ 741,448 $ 768,077 Net Income $ 162,795 $ 35,551 $ 137,669 $ (87,210) Net Income Per Share $0.02 $0.01 $0.02 $(0.01) Cash Dividends Per Share - - - - Market Price of Common Stock (1) Low $2.66* $2.86* $2.25 $2.38* High $2.70* $2.86* $2.78 $2.78* - -------------------------------------------------------------------------------------------------
* Share prices from this period have been converted from the original trading values in Canadian Dollars, at the rate of $0.76/CDN$1.00 COMMON STOCK INFORMATION AND DIVIDEND POLICY As of August 1, 1996, there were 6,981,889 shares of Common Stock outstanding held by approximately 110 holders of record. The number of holders does not include individual participants in security position listings. In June 1994, the Company paid its only cash dividend, which dividend equaled CDN $0.02 per share. The Company's present policy is to retain earnings to finance the Company's business. Any future dividends will be dependent upon the Company's financial condition, results of operations, current and anticipated cash requirements, acquisition plans and plans for expansion, and any other factors that the Company's Board of Directors deems relevant. The Company has no present intention of paying dividends on its common stock in the foreseeable future. - -------------------------------------------------------------------------------- 17 THE PROBLEM: Grinding is the most precise of machining techniques, and the method most commonly used to produce parts with exacting tolerances, both in finish and geometry. Accurately balancing grinding wheels is critical to achieving the increasing demands placed on the grinding process today. Only a small amount of wheel imbalance will cause vibration in the rotating grinding machine, and damage the form and surface of a ground piece. Traditionally, balancing was time-consuming and imprecise. SBS PRODUCTS [LOGO] THE SOLUTION: The Schmitt SBS Dynamic Balance System consists of a computer control, sensor, spindle mounting adaptor and balance head. It was successfully designed to be an inexpensive yet highly accurate, permanent installation on grinding machines. Schmitt Industries, Inc. continues to introduce new products for the grinding machine industry. The SBS multichannel control units allow the SBS system to balance, monitor and report machine vibration levels for up to four grinders operating in a work group, or manufacturing cell. [PICTURE] The Easy to install SBS Dynamic Balance System accurately balances grinding machines in seconds. [PICTURE] - -------------------------------------------------------------------------------- 18 THE PROBLEM: Accurately measuring surface roughness is critical in a variety of industrial applications. Performance of precision components such as computer hard disks, silicon wafers, and flat panel electronic displays rely on control of surface roughness or smoothness. In much of today's world of manufacturing, measurement of distance and alignment in closely toleranced products is critical in obtaining required results. Traditionally, micro measurements have been time consuming and costly due to existing contact measurement technologies. [Logo] SMS PRODUCTS THE SOLUTION: Schmitt Measurement Systems, Inc. (SMS) operates three non-contact laser based technology businesses: 1) Light Scatter Measurement Laboratory which provides highly advanced, extremely precise measurement services to a wide variety of industrial and commercial businesses, utilizing advanced laser light scatter technology. 2) A series of laser based light scatter measurement products utilized to measure surface roughness of a variety of materials in industrial and commercial operations. 3) Laser alignment products which determine accurate angle and distance measurements for commercial aircraft, automotive, and other industrial applications. [Photographs] SMS Products perform precision measurement of surface, dimension, and alignment quickly and accurately. [Photographs] - -------------------------------------------------------------------------------- 19 [Letterhead] INDEPENDENT AUDITOR'S REPORT TO THE BOARD OF DIRECTORS AND STOCKHOLDERS SCHMITT INDUSTRIES, INC. We have audited the accompanying consolidated balance sheets of Schmitt Industries, Inc., and Subsidiary as of May 31, 1996 and 1995, and the related consolidated statements of income, changes in stockholders' equity, and cash flows for the fiscal years ended May 31, 1996, 1995, and 1994. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Schmitt Industries, Inc., and Subsidiary as of May 31, 1996 and 1995, and the results of their operations and cash flows for each of the three years ended May 31, 1996, 1995, and 1994, in conformity with generally accepted accounting principles. /s/ Moss Adams LLP Portland, Oregon July 16, 1996 - -------------------------------------------------------------------------------- 20 END USERS: Allied Signal Aerospace Company Alumax Mill Products American Axle American Koyo Bearing Mfg. Corp. Amada Engineering & Services SCHMITT WORLDWIDE THE SBS WORLDWIDE CUSTOMER LIST Barden Corporation Black & Decker Corporation Boeing Company Briggs & Stratton Caterpillar Incorporated Chrysler Corporation Cummins Engine Company Daimler Benz Daewoo International Corporation Dana Corporation Deere & Company Diesel Technology Corporation Dresser-Rand Eaton Corporation Electrolux Corporation Emerson Power Transmission FAG Bearing Ltd. Federal Mogul Corporation Ford Motor Company General Electric Corporation General Motors Corporation Greenfield Industries Harley-Davidson Motor Company Hamilton Standard INA Bearing Corporation Milwaukee Electric Tool Mitsubishi Motor Company Ltd. Navistar International transportation Nissan Motors Ltd. Norton Company Parker Hannifin Corporation Pfauter-Maag Cutting Tool Pratt & Whitney Reliance Electric Company Rexnord Corporation Robert Bosch Corporation Siemens Automotive SKF Bearing Industries Stanley Works Sumitomo Heavy Industries Texas Instruments The Timken Company The Torrington Company TRW Automotive Components University of Connecticut Grinding Research Center Westinghouse Electric Corporation Weyburn-Bartel AVAILABLE FROM MACHINE TOOL BUILDERS: ANCA USA, Inc. Bryant Grinder Corporation Blohm, GMBH Capco Machinery Cincinnati Milacron Elb America, Inc. Gleason Works Goldcrown Machinery K.O. Lee Koyo Machine Landis Grinding Machines, Landis Lund Mattison Machine Mitsubishi Machine Tool Normac Incorporated Okamoto Okuma Royal Master Grinders S.E. Huffman Shigiya Machinery Works Shanghai Machine Tool Works, SMTW/Ecotech TOS Hostivar, TOS Holice Toyoda Machinery USA, Toyoda Machinery, Ltd. Unison Corporation United Grinding Technologies - Korber Group Blohm Studer Jones & Shipman Weldon Machine Tool AVAILABLE FROM REBUILDERS: Abbott Machine Airtronics C&B Machinery Centerless Rebuilders Cincinnati Milacron Dayton Machine Tool Drake Manufacturing Services Goldcrown Machinery Grinders Clearinghouse Toyoda/Grinders for Industry Inter-Motion Machine Tool Specialists Vermont Rebuilders Wyandotte Machine AVAILABLE IN ASIA: Kanetec Ltd. - Japan Ecotech, Shanghai - China Power-EMI - Korea - -------------------------------------------------------------------------------- 21


                                                                    EXHIBIT 21.1
                       SUBSIDIARIES OF SCHMITT INDUSTRIES, INC.
                                  AS OF MAY 31, 1996


                                         STATE OF INCORPORATION OR
  SUBSIDIARY                             COUNTRY IN WHICH ORGANIZED
  ------------------------------------   ---------------------------------
  Schmitt Measurement Systems, Inc.      Montana


                                          26

 


5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM SCHMITT INDUSTRIES, INC. INDEPENDENT AUDITORS' REPORT AND CONSOLIDATED FINANCIAL STATEMENTS MAY 31, 1996, 1995 AND 1994 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. YEAR MAY-31-1996 JUN-01-1995 MAY-31-1996 508,240 145,600 1,411,805 0 1,781,331 4,456,622 1,794,221 312,189 6,011,047 924,536 174,532 0 0 4,098,512 788,360 6,011,047 7,080,128 7,080,128 2,547,054 3,023,916 17,237 0 45,130 1,446,791 299,538 1,509,158 0 0 0 1,217,253 .16 .16