<PAGE>

                                                                  EXHIBIT 13.1

About Schmitt Industries

Schmitt Industries designs, manufactures and markets two distinct types of
precision measurement systems. Schmitt's automatic balancing systems for
rotating machinery are used by many of the world's leading automotive, aerospace
and bearing manufacturers. The second Schmitt product line, non-contact
measurement laser systems, are targeted to high-tech manufacturers worldwide and
ensure that silicon wafers and computer hard disks meet exacting standards for
surface microroughness.

The company's mission is to provide the best possible products and quality 
for its customers, to provide challenging and rewarding employee 
opportunities and to provide the greatest possible return to shareholders. 
Schmitt recorded fiscal 1998 revenues of $10,626,084. The company currently 
employs 50 people in three international locations: Alsbach, Germany; 
Coventry, England; and at its corporate headquarters in Portland, Oregon. 
Company shares are traded on the NASDAQ National Market under the symbol, 
SMIT.

Financial Highlights

In thousands of dollars except per share information

<TABLE>
<CAPTION>

                      1998         1997         1996         1995         1994
<S>                 <C>         <C>           <C>          <C>          <C>
 Revenues           $  10,626   $  10,542     $  7,080     $  4,415     $  2,575
 Operating Income       1,339       2,296        1,509          697          313
 Net Income After       1,250       1,725        1,217          249          182
 Taxes
 Net Income Per         $ .17      $  .23        $ .16        $ .04        $ .03
 Share, Diluted
 Stockholders'          8,688       7,429        4,887        3,464        3,215
 Equity

</TABLE>

a)   Graph of Schmitt's Revenues, 1994-98
b)   Graph of Schmitt's Operating Income, 1994-98
c)   Graph of Schmitt's Net Income per share, 1994-98

a)   Photo of Wayne A. Case

To our shareholders:

 ...our balance sheet remains strong, even healthier than 
a year ago. Schmitt Industries is debt free and assets approach $10 million. 
For the first six months of fiscal 1998, all signs pointed to another banner 
year of record sales and net profits at Schmitt Industries. Then, with little 
warning, the Asian financial crisis hit, precipitating a sales slump in our 
non-contact measurement product line that serves the high-technology 
industry. As a result, fiscal 1998 ended with slightly increased sales over a 
year ago, but profits fell short of expectations.

The good news, however, is that we further strengthened our hold on the U.S. 
market for balancer systems for the machine-tool industry. And we are making 
significant strides in the European balancer market through Schmitt Hofmann 
Systems (SHS) and Schmitt Europe Limited (SEL). Sales were up 130% in the 
United Kingdom and 91% in Germany. The solid performance in our balancer 
product line helped offset the decline in our Asian markets.

We've also taken another key step toward further solidifying our presence in 
the machine tool industry. We are introducing a strategic new product, the 

<PAGE>

SB-4500 electronic control system, which allows multi-tasking among multiple 
balancers. More importantly, this controller provides a convenient integrated 
platform for introducing additional machine-control products. We plan to 
expand our product offerings to users of grinding machines and other machine 
tools, while continuing to support our existing and growing balancer markets.

As a relatively small company, we have the capability to react rapidly to 
market changes and redeploy our research and development strategies when 
necessary. 

As the situation in Asia plays out, we are concentrating more on the 
worldwide machine-tool market, where demand remains high. To that end, we are 
applying non-contact measurement laser technology to a new series of 
dimensional gauging and microroughness measurement products, which will ship 
in the fourth quarter of this year.

While we are shifting focus away from Asian markets, we must emphasize that 
this is only for the short-term. Our non-contact measurement tools, utilizing 
advanced laser technology, continue to make inroads in the hard-disk and 
silicon wafer markets.  During fiscal 1998, we introduced the DTM-2000, a 
high-speed production-line testing system that has no equal in the industry. 
When the Asian markets rebound, we will be well-positioned to reap the 
benefits. I am pleased to report that our balance sheet remains strong, even 
healthier than a year ago. Schmitt Industries is debt free and assets 
approach $10 million. This solid bottom line provides the impetus as we 
confidently move forward to: aggressively research new products, study 
additional acquisition opportunities, and seek strategic partnerships both in 
the U.S. and abroad.

Wayne A. Case
President and Chairman of the Board


The need to evolve.

Schmitt's automatic balancing systems for grinding machinery are preferred by 
many of the world's leading manufacturers. In fact, the company has garnered 
a greater than 50% market share for its products in the U.S. alone. However, 
to further solidify its presence in the industry, Schmitt recognized the need 
to evolve its balancer product line into ultra-high-speed markets. At the 
same time, the company wanted to broaden its machine-control product 
offerings beyond balancers.

How small is a micron

A human hair is about 50 microns.  Grass grows at about 5 microns a minute. 
One micron is to a drop of water, as a teaspoon of water is to an Olympic 
swimming pool.

a)   Photo of Schmitt's automatic balancing system components.

Beyond traditional balancers.

Schmitt's new SB-4500 electronic control system offers significant 
enhancements, including higher speed balancing, multi-functionality, improved 
balancer control and faster balancing cycles. Since the industry is moving 
toward ever increasing speed requirements and tighter tolerance control, the 
SB-4500 ably supports these increased market needs. The new platform allows 
integrated control of multiple balancers, and supports additional product 
functions. With this control system, Schmitt plans to expand its industrial 
machine-tool product lines and markets.

<PAGE>

The SB-4500 provides a common interface for several different balancer 
products, and it allows for multi-language capabilities, plus worldwide 
compatible voltage and safety specifications. The product will eventually 
replace Schmitt's existing controls for balancers manufactured in the U.S., 
as well as additional controls manufactured in Germany.

Schmitt's latest technology advancement measures and controls vibrations to 
 .04 millionths of an inch, a ten-fold improvement over the company's current 
balancer capability. Industry experts rate this performance as the best in 
the business.

In its goal to tap new markets, Schmitt is broadening its product line beyond 
balancers. The company is developing advanced non-contact dimensional profile 
and surface measurement gauging for the roll-grinder industry, which will be 
introduced by the fourth quarter of 1998.

The Schmitt Industries Story

Back in 1987, the founders of Schmitt Industries conducted comprehensive 
market research into industrial manufacturing. In the process, they learned 
that there was no simple, reliable solution for in-process balancing of 
grinding machines. Precision grinding is a necessary step for nearly every 
industrial manufacturing endeavor.

Over the years, our balancer line has grown to include power transmission 
technology, computer controls and sensors, external balancers and adapters, 
internal balancers, ring balancers and hydro-kompensers. But we've never lost 
focus of our overriding company philosophy: we bring to market products 
customers want.

We currently control over 50% of the U.S. balancer market, and we are 
continuing to make strong gains within the European marketplace. In 1995, we 
acquired a former competitor in Germany, and that strategic business move has 
accelerated our market penetration in Europe, while adding key products to 
our balancer line.

Schmitt balancer systems are production-proven in thousands of major 
manufacturing installations from coast-to-coast and around the world, 
including many of the largest manufacturing firms. Schmitt balancer products 
conform to strict ISO-9001 quality and measurement standards.

The latest addition to the Schmitt balancer family is the SB-4500 electronic 
control system. This new product enables multi-tasking among multiple 
balancers, and serves as an integrated platform for additional machine 
control products in the machine tool industry. The SB-4500 increases balancer 
speed and performance, and enables vibration measurements down to 
one-thousandth of a micron.

After conducting careful market research,  Schmitt acquired TMA Technologies 
in May 1995, and along with it the company's fledgling laser technology. 
Schmitt refined this technology, assembled a separate company division called 
Schmitt Measurement Systems (SMS), and developed a new line of non-contact 
surface measurement products.

All smooth surfaces exhibit some degree of microroughness, even if only at 
the atomic level. Using proprietary light-scatter technology, Schmitt 
Measurement Systems provides rapid, accurate, repeatable and non-destructive 
surface measurements. SMS products are proving invaluable to manufacturers of 
hard disks, hard disk drives, and silicon wafers.

In 1997, SMS developed the DTM-2000, an automated production-line system that 
enables 100% testing of hard disks and delivers ten times the throughput of 
conventional systems. The SMS product line also features light-scatter 
measurement products, utilized by NASA and the Department of Defense for 
precision measuring of space optics, cameras, and telescope lenses. Schmitt 
Industries, by virtue of its debt-free balance sheet and $10 million in 
assets, continues to devote significant resources to the research and 
development of new products.

<PAGE>

And our company vision remains steadfast: "To provide the finest quality 
products for our customers, to provide challenging and rewarding employment 
opportunities, and to provide the greatest possible return to our 
shareholders."

The balancer puzzle.

Grinding machines--one of the world's most common machine tools--are designed 
for many different operations. However, all grinding machines have one 
feature in common: a rotating grinding wheel, which requires constant 
balancing. Major manufacturers, including the automotive industry, bearing 
companies and makers of hydraulic systems all incorporate grinding machines 
within their operations. The challenge is to design and fit applicable 
balancers on a wide variety of machines.

a)   Photo of Schmitt's External Balancer, Internal Balancer and
     Hydrokompensers.

Three key answers.

Schmitt Industries designs, manufactures and markets a line of balancers that 
covers the diverse needs of the market--both domestic and international. The 
balancer line is made up of three principal types of products--external 
balancers, internal balancers and hydrokompensers.

Schmitt has become the leader in its industry by responding to market needs. The
company pre-engineers balancer applications, installs complete systems, offers
comprehensive customer service, and maintains ample inventory of all products.

In the U.S., external balancers are far and away the optimum solution for 
most grinding machines. Schmitt external balancers are easy to mount, highly 
reliable and require little operator training, making them exceedingly 
popular. Internal balancers are typically specified by European manufacturers 
of grinding machines, and hydrokompensers fit unique applications when 
external and internal balancers are not appropriate. Hydrokompensers are 
particularly suited for ultra-high speed functions--balancing grinding wheels 
that rotate at more than 15,000 RPM.

Together Schmitt Balance Systems (SBS) and Schmitt Hofmann Systems (SHS) 
offer a breadth of products that satisfies nearly any manufacturing 
requirement. Schmitt also customizes balancers to fit applications. As the 
needs of the machine-tool industry grow more sophisticated, Schmitt will 
maintain its focus on the market, and continue to develop products that meet 
the increasing process control requirements of our customers.

Mitsubishi Siltec, a major supplier of silicon wafers to computer chip 
makers, needed an efficient, non-destructive method for testing the 
microroughness of its products. All silicon wafers exhibit a microscopic 
level of surface roughness, stemming from chemical deposition, grinding, 
polishing, etching, or any number of other production techniques. Silicon 
wafer manu-facturing processes must be very precise and controlled, and these 
processes heavily rely on the surface roughness of the wafer. Quantifying 
microroughness is critical.

a)   Photo of silicon wafer texture measurement system.

Smoothing over market needs.

In 1995, Schmitt acquired TMA Technologies, a U.S. company that researched and
developed laser technology. Schmitt engineers are harnessing this revolutionary
technology within a series of products that conduct non-contact surface

<PAGE>

measurements. And an entirely new company division has been created--Schmitt 
Measurement Systems (SMS).

The flagship product of SMS--the TMS-2000W--provided an ideal solution for 
Mitsubishi Siltec. The TMS-2000W enables fast, repeatable non-destructive 
measurements down to a few hundredths of an angstrom, a level unattainable by 
any other testing method. This system also provides a way for Mitsubishi 
Siltec to quantify and control its manufacturing process. The TMS-2000W and 
the complementary TMS-3000W are marketed worldwide by means of a strategic 
partnership with Veeco Process Metrology.

While the TMS-2000W represents an excellent solution for the silicon 
manufacturing environment, Schmitt engineers also developed the Microscan--a 
mobile light-scatter surface-measurement tool. The Microscan is used by the 
National Aeronautic and Space Administration (NASA) to measure microroughness 
and reflectance on mirrors and space optics.

SMS product developers are aided by the world's most powerful light-scatter 
laboratory, including eight lasers that operate at 20 different wavelengths. 
Consequently, Schmitt contracts with customers to provide them with 
comprehensive light-scatter analysis for industrial, military and space 
optics applications.

The 100% problem.

In magnetic disk manufacturing, surface features are so small they cannot be 
seen visually. Traditional test methods that utilize optical and microscope 
technology do not provide the necessary resolution and speed to measure 100% 
of production.

HMT, one of the world's premier suppliers of magnetic disks for hard drives, 
was experiencing quality errors and omissions, due to a random testing 
policy. The company needed to implement 100% testing, and do it afford-ably. 
Schmitt answered with a technological breakthrough.

How small is an angstrom

The point of a needle is about 1 million angstroms in diameter. Fingernails
grow at about 50 angstroms per second.  One angstrom is to a grain of sand,
as a child's wading pool is to the Atlantic Ocean.

a)   Photo of Schmitt's non-contact texture measurement system used in the
     production of disks.

100% success.

Senior management at Schmitt Industries met with HMT representatives to 
discuss the development of a 100% production-test system for magnetic disks 
for hard drives. Schmitt Measurement Systems (SMS) engineers began research 
and development in earnest, and less than six months later, the company 
unveiled the DTM-2000. This new system utilizes light-scatter measurement 
technology to automatically process hard disks and render microroughness 
measurements at rapid speed--one every three seconds.

HMT conducted extensive preliminary testing on the DTM-2000 with highly 
satisfactory results. The automated system provides throughput of 1,200 hard 
disks per hour at measurement levels as low as one-tenth of an angstrom. In 
addition, the DTM-2000 is the first metrology system that offers disk drive 
manufacturers the ability to make critical non-contact measurements on both 
sides of disks, simultaneously. This technology leap makes 100% inspection 
economically feasible.

HMT purchased seven new DTM-2000 systems, each with a market value of 
$165,000. Schmitt is currently working with Veeco, its worldwide marketing 
partner, to introduce the DTM-2000 to additional prospects in the disk drive 
industry. According to the 1997 annual survey in Data Storage magazine, 400 
million hard disks are manufactured annually, and the industry is expected to 
grow by 15% 

<PAGE>

per year. This should result in strong future demand for SMS non-contact 
measurement products.

Consolidated Balance Sheets
May 31, 1998 and 1997

<TABLE>
<CAPTION>
                                                                        1998                  1997
<S>                                                                 <C>                   <C>
Assets
Current assets
Cash                                                                $1,127,076            $  504,662
Trading securities                                                          --               168,000
Accounts receivable                                                  1,197,951             2,725,512
Inventories                                                          4,166,755             2,479,820
Prepaid expenses                                                       120,466                30,668
Deferred tax asset                                                      34,623               136,000
Income tax receivable                                                  190,806                    --
    Total current assets                                             6,837,677             6,044,662
Property and Equipment
Land                                                                   299,000               299,000
Buildings and improvements                                           1,190,920             1,025,868
Furniture, fixtures, and equipment                                     906,058               760,596
Vehicles                                                               139,261               146,299
                                                                     2,535,239             2,231,763
Less accumulated depreciation and amortization                         691,258               530,587
                                                                     1,843,981             1,701,176
Other Assets
Long-term deferred tax asset                                           837,560               679,000
Other assets                                                           100,000                90,415
                                                                       937,560               769,415
Total Assets                                                        $9,619,218            $8,515,253

Liabilities and Stockholders' Equity
Current Liabilities
Accounts payable                                                    $  681,524            $  530,667
Accrued royalties                                                       55,335               131,983
Accrued commissions                                                    131,154               111,996
Other accrued liabilities                                               63,076                62,832
Income taxes payable                                                        --                68,563
Current portion of long-term debt                                           --                29,061
    Total current liabilities                                          931,089               935,102
Long-Term Debt, net of current portion                                      --               150,922

Commitments and Contingencies(Note 7)
Stockholders' Equity
Common stock, no par value, 20,000,000 shares authorized,
  7,099,139 and 7,081,889 shares issued and outstanding
at May 31, 1998 and 1997, respectively                               5,072,634             4,952,411
Cumulative foreign exchange translation adjustment                   (147,708)              (36,270)
Retained earnings                                                    3,763,203             2,513,088
    Total stockholders' equity                                       8,688,129             7,429,229
Total Liabilities and Stockholders' Equity                          $9,619,218            $8,515,253

</TABLE>

<PAGE>

<TABLE>
<CAPTION>

 Consolidated Statements of Income
 For the years ended May 31, 1998, 1997 and 1996                 1998                      1997                      1996
<S>                                                           <C>                       <C>                        <C>
 Net Sales                                                    $10,626,084               $10,541,972                $7,080,128
 Cost of Sales                                                  4,632,485                 3,875,790                 2,547,054
     Gross profit                                               5,993,599                 6,666,182                 4,533,074
 General, Administrative, and Sales Expense                     4,275,059                 4,164,271                 3,023,916
 Research and Development Expense                                 379,798                   205,800                        --
     Operating expenses                                         4,654,857                 4,370,071                 3,023,916
 Operating income                                               1,338,742                 2,296,111                 1,509,158

 Other Income and Expense
   Interest expense                                              (42,231)                  (16,273)                  (45,130)
   Interest income                                                 44,581                    25,007                    27,853
   Unrealized gain (loss) on trading securities                        --                    22,400                  (61,222)
   Miscellaneous income                                           259,924                    25,430                    16,132
     Other income and expense                                     262,274                    56,564                  (62,367)

 Income Before Provision for Income Taxes                       1,601,016                 2,352,675                 1,446,791
 Provision for Income Taxes                                       350,901                   627,947                   229,538
 Net income                                                   $ 1,250,115               $ 1,724,728                $1,217,253
 Net income per common share, basic                           $       .18               $       .25                $      .18
 Weighted average number of common
   shares, basic                                                7,091,269                 7,031,449                 6,887,975
 Net income per common share, diluted                         $       .17               $       .23                $      .16
 Weighted average number of common
   shares, diluted                                              7,456,172                 7,561,744                 7,416,713

</TABLE>

 Consolidated Statements
 of Cash Flows

<TABLE>
<CAPTION>

 For the years ended May 31, 1998, 1997 and 1996                1998                      1997                      1996
<S>                                                            <C>                       <C>                       <C>
 Cash Flows Relating to Operating Activities
 Net income                                                    $1,250,115                $1,724,728                $1,217,253
 Adjustments to reconcile net income to net cash
     provided by (used in) operating activities:
   Depreciation                                                   347,228                   264,440                   196,021
   Amortization                                                        --                    72,393                   189,103

<PAGE>

   Unrealized (gain) loss on trading securities                              --                  (22,400)                    61,222
   Deferred taxes                                                      (57,183)                   198,426                  (30,822)
 (Increase) decrease in:
   Trading securities                                                   168,000                        --                   150,000
   Accounts receivable                                                1,527,561               (1,313,707)                 (444,024)
   Inventories                                                      (1,686,935)                 (235,556)                 (613,626)
   Prepaid expenses                                                    (89,798)                  (14,762)                   (4,004)
   Notes receivable                                                          --                        --                    10,000
   Income taxes receivable                                            (190,806)                        --                    50,000
   Other assets                                                         (9,585)                  (90,415)                 (121,907)
 Increase (decrease) in:
   Accounts payable                                                     150,857                   185,839                  (96,215)
   Accrued liabilities, royalties, and                                 (57,246)                    62,198                   126,784
 commissions
   Income taxes payable                                                (44,809)                 (226,186)                   294,749
       Net cash provided by                                           1,307,399                   604,998                   984,534
   operating activities


 Cash Flows Relating to Investing Activities
 Purchase of property and equipment                                   (514,283)                 (461,168)                 (406,675)
 Proceeds from disposal of equipment                                     24,250                    10,651                        --
 Acquisition of assets of Hofmann                                                               (496,000)
   Maschinenbau GmbH



       Net cash used in investing activities                          (490,033)                 (946,517)                 (406,675)
 Cash Flows Relating to Financing Activities
 Repayment of long-term debt                                          (179,983)                  (34,895)                  (69,131)
 Long-term repayments mortgage                                               --                        --                 (233,920)
 Exercise of stock options                                               96,469                   409,106                    92,188
 Net cash (used in) provided by financing                              (83,514)                   374,211                 (210,863)
 activities
 Effect of foreign exchange translation on cash                       (111,438)                  (36,270)                        --
 Increase (Decrease) in Cash                                        $   622,414               $   (3,578)                $  366,996
 Cash, beginning of year                                                504,662                   508,240                   141,244
 Cash, end of year                                                   $1,127,076                  $504,662                  $508,240

 Supplemental Disclosure of Cash Flow
 Information
 Cash paid during the period for interest                            $   42,231                $   15,272                $   45,130
 Cash paid during the period for income taxes                        $  405,800                $  450,871                $   11,600
 Supplemental Schedule of Noncash Investing and
 Financing Activities

<PAGE>

 Discount associated with long-term debt                             $      --                 $      --               $  (78,085)
 Reduction of goodwill                                              $ (155,438)               $ (215,973)               $ (424,011)
 Income tax benefit of stock options exercised                      $  (23,754)               $ (444,793)               $ (113,800)

</TABLE>

 Consolidated Statements of
 Changes in Stockholders' Equity

<TABLE>
<CAPTION>

 For the years ended May 31,
 1998, 1997 and 1996

                                             Shares             Amount           Cumulative          Retained            Total
                                                                                  Foreign            Earnings
                                                                                  Exchange         (Accumulated
                                                                                Translation          Deficit)
                                                                                 Adjustment
<S>                                         <C>                <C>              <C>                <C>                 <C>
 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                    --            113,800                 --                 --            113,800
 of stock options
 Net income                                          --                 --                 --          1,217,253          1,217,253
 Balance,
   May 31, 1996                               6,918,139          4,098,512                 --            788,360          4,886,872
 Cumulative foreign exchange                         --                 --           (36,270)                 --           (36,270)
 translation adjustment
 Stock options exercised                        163,750            409,106                 --                 --            409,106
 Income tax benefit from exercise                    --            444,793                 --                 --            444,793
 of stock options
 Net income                                          --                 --                 --          1,724,728          1,724,728
 Balance,
   May 31, 1997                               7,081,889          4,952,411           (36,270)          2,513,088          7,429,229
 Cumulative foreign exchange                         --                 --          (111,438)                 --          (111,438)
   translation adjustment
 Stock options exercised                         17,250             96,469                 --                 --             96,469
 Income tax benefit from exercise                    --             23,754                 --                 --             23,754
 of stock options
 Net income                                          --                 --                 --          1,250,115          1,250,115
 Balance,
   May 31, 1998                               7,099,139         $5,072,634        $ (147,708)         $3,763,203         $8,688,129

</TABLE>

<PAGE>

NOTE 1   Organization and Nature of Operations

Schmitt Industries, Inc. (the Company) is engaged in the design, assembly, 
marketing, and distribution of electronic and mechanical components for 
machine tool products and laser measurement systems worldwide.

     On June 13, 1996, the Company established Schmitt Europe, Ltd. (SEL).  
In addition, on December 2, 1996, the Company established Schmitt Hofmann 
Systems GmbH (SHS) which acquired certain assets of the grinding wheel 
balance division of Hofmann Maschinenbau GmbH.

NOTE 2   Summary of Significant Accounting Policies

Principles of Consolidation

The consolidated financial statements as of May 31, 1998 and 1997, and the 
consolidated statements of income for the years ended May 31, 1998, 1997 and 
1996 include those of the Company and its wholly-owned subsidiaries. All 
significant intercompany accounts and transactions have been eliminated in 
the preparation of the consolidated financial statements.

Revenue Recognition

Revenue from product sales is recognized upon shipment. Sales are reported 
net of applicable cash discounts and allowances for returns.

Inventory

Inventory is valued at the lower of cost or market. Cost is determined on the 
average cost basis. As of May 31, 1998 and 1997, inventories consisted of raw 
materials ($2,502,310 and $1,165,554, respectively), work-in-process ($60,075 
and $258,912, respectively), and finished goods ($1,604,370 and $1,055,354, 
respectively).

Property and Equipment

Property and equipment are stated at cost. Depreciation is computed using the 
straight-line method over estimated useful lives of three to seven years for 
furniture, fixtures, and equipment; three years for vehicles; and twenty-five 
years for buildings and improvements.

Technology Rights

From time to time the Company acquires certain rights to technology developed 
by unaffiliated parties. Costs to acquire technology rights are capitalized 
and amortized on a straight-line basis over the estimated useful life. Any 
related royalty costs are expensed as related revenues are earned. 
Capitalized acquired technology is included in other assets net of 
accumulated amortization.

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 ten days, with the net 
amount payable in 30 days. No allowance for doubtful accounts is considered 
necessary.

     For the year ended May 31, 1998, approximately 24% of consolidated sales
were made to one customer. During the year ended May 31, 1998, the Company
renewed a strategic partnership with an entity to distribute systems
manufactured by Schmitt Measurement Systems, Inc., for a period of two years.
For the year ended May 31, 1997 and 1996, approximately 22% and 15% of
consolidated sales were made to one customer, respectively.

Income Taxes

The Company follows the method of accounting for income taxes proscribed by 
the Statement of Financial Accounting Standards No. 109, "Accounting for 
Income Taxes," (FAS 109) 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.

<PAGE>

Research and Development Costs

Research and development costs are charged to expense when incurred.

Trading Securities

Trading securities consist of common stock and are stated at fair value, which
is estimated based on quoted market prices. Unrealized gains or losses are
included in other income and expense. Total realized gain on trading securities
during fiscal 1998 was approximately $186,000 and is included in other income.
No trading securities were held at May 31, 1998.

Use of Estimates

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

Consolidated Statement of Cash Flows

The Company considers short-term investments which are highly liquid, readily 
convertible into cash, and have original maturities of less than three months 
to be cash equivalents for purposes of the cash flows statement.

Stock-Based Compensation

Statement of Financial Accounting Standards No. 123, "Accounting for 
Stock-Based Compensation," (FAS 123) encourages, but does not require, 
companies to record compensation cost for stock-based employee compensation 
plans at fair value. The Company has chosen to continue to account for 
stock-based compensation using the intrinsic value method prescribed in 
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to 
Employees," (APB 25). Accordingly, compensation cost for stock options is 
measured as the excess, if any, of the quoted market price of the Company's 
stock at the date of the grant over the amount an employee must pay to 
acquire the stock.

Foreign Currency Translation

Financial statements for the Company's subsidiaries outside the United States 
are translated into U.S. dollars at year-end exchange rates for assets and 
liabilities and weighted average exchange rates for income and expenses. The 
resulting translation adjustments are recorded as a separate component of 
stockholders' equity titled "Cumulative Foreign Exchange Translation 
Adjustment."

Fair Value of Financial Instruments

The carrying amounts of financial instruments approximate their fair values 
at May 31, 1998. The fair market value of long-term debt approximates 
carrying amounts based on discounted cash flow analyses.

Reclassifications

Certain reclassifications have been made to the 1997 and 1996 consolidated
financial statements to conform with current year presentations.

Earnings Per Share

The Company adopted Statement of Financial Accounting Standards No. 128, 
"Earnings Per Share," (FAS 128), during 1998. All prior earnings per share 
data have been restated to conform to the provisions of this statement. Basic 
earnings per share is computed using the weighted average number of shares 
outstanding. Diluted earnings per share is computed using the weighted 
average number of shares outstanding, adjusted for the incremental shares 
attributed to outstanding options to purchase common stock. Using the 
treasury shares method as required by FAS 128, incremental shares of 364,903, 
530,295 and 528,738 in 1998, 1997 and 1996, respectively, were used in the 
calculation of diluted earnings per share.

New Accounting Pronouncements

Between June 1997 and June 1998, the FASB issued three pronouncements, 
Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive 
Income," (FAS 130), Statement of Financial Accounting Standards No. 131, 

<PAGE>

"Disclosures about Segments of an Enterprise and Related Information," (FAS 
131), and Statement of Financial Accounting Standards No. 133, "Accounting 
for Derivative Instruments and Hedging Activities," (FAS 133), which will be 
effective in future reporting periods. Management has evaluated the 
provisions of these pronouncements and expects that their adoption will have 
no effect on results of operations or the financial position of the Company. 

NOTE 3   Company Acquisitions

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. Subsequent to this acquisition,
the Company changed the name of TMA Technologies, Inc., to Schmitt Measurement
Systems, Inc. (SMS), 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 is funded 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., for any claims with regard to the acquisition except 
their rights to future royalties. Long-term debt of $179,983 was fully paid 
to certain TMA Technologies, Inc. debt holders in fiscal year 1998.

     On December 2, 1996, the Company purchased the inventories ($462,933) 
and equipment ($33,067) of the grinding wheel balancer division of Hofmann 
Maschinenbau GmbH for $496,000 and subsequently established Schmitt Hofmann 
Systems GmbH. (See Note 1)

     The results of both SHS and SMS are included in the accompanying
consolidated financial statements since the date of acquisition.

NOTE 4   Line of Credit

The Company has an unsecured short-term line of credit agreement with Wells
Fargo Bank, to a limit 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, or LIBOR +2.50%. The line of credit is renewable
annually. No balance was outstanding as of May 31, 1998 or May 31, 1997.

NOTE 5   Income Taxes

The provision for income taxes was as follows:

<TABLE>
<CAPTION>

                                              Year ended May 31,
                                 1998                1997                1996
<S>                            <C>                 <C>                 <C>
 Current                        $243,264            $826,368             198,716
 Deferred                        383,887              77,824             312,235
 Decrease in                   (276,250)           (276,245)           (281,413)
 valuation
 allowance
 Total provision                $350,901            $627,947            $229,538
 for income taxes

</TABLE>

Deferred tax assets (liabilities) are comprised of the following components:

<PAGE>

<TABLE>
<CAPTION>

                                                   Year ended May 31,
                                                 1998             1997
     <S>                                      <C>              <C>
     Depreciation                             $  (29,861)      $  (48,000)
     Net operating loss carryforwards          1,038,559        1,314,809
     Inventory basis differences                  34,623           16,760
     Other asset capitalization                   13,840          142,181
     Other deferred assets                        49,254           64,250
     Gross deferred tax assets                 1,136,276        1,538,000
     Deferred tax asset valuation               (234,231)        (675,000)
     allowance
     Net deferred tax asset                   $  872,184       $  815,000

</TABLE>

     Through the acquisition of Schmitt Measurement Systems, Inc., the 
Company acquired approximately $5.5 million of U.S. federal net operating 
loss carryforwards. As of May 31, 1998, approximately $3 million of these net 
operating losses remain (which expire in the years 2007 through 2009). The 
deferred tax asset valuation allowance in fiscal years 1996 through 1998 is 
attributed to these net operating losses. A portion of the reduction in 
valuation allowance related to the net operating loss carryforward 
represented tax asset benefit that reduced intangible assets acquired with 
TMA (see Note 3).

     The provision for income taxes differs from the amount of income taxes 
determined by applying the U.S. statutory federal tax rate to pre-tax income 
due to the following:

<TABLE>
<CAPTION>

                                                   Year ended May 31,
                                               1998       1997       1996
<S>                                            <C>        <C>        <C>
Statutory federal tax rate                     34.0%      34.0%      34.0%
State taxes, net of federal                     3.2        4.4        2.2
benefit
Change in deferred tax                        (27.5)     (20.9)     (48.8)
valuation allowance
Reduction of goodwill
associated with the
acquisition of Schmitt                         10.3        9.2       29.3
Measurement Systems, Inc.
Other permanent differences                     1.9         --       (0.9)
Effective tax rate                             21.9%      26.7%      15.8%

</TABLE>

NOTE 6  Employee Benefit Plans

The Company adopted the Schmitt Industries, Inc. 401(k) Profit Sharing Plan & 
Trust 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 is partially matched by the Company. The Company 
may further make either a profit sharing contribution or a discretionary 
contribution. Contributions made to this Plan during the year ended May 31, 
1998 and May 31, 1997 were $135,335 and $116,248, respectively.

     The Company adopted a Simplified Employee Pension Plan (SEP) during the 
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 during the year ended May 31, 1996. The Plan was terminated 
effective May 31, 1996.

NOTE 7  Contingency

<PAGE>

The Company is party to a legal action initiated 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.

NOTE 8  Segments of Business

The Company operates principally in two segments of business: the 
manufacturing of mechanical components for the machine tool industry, and the 
manufacturing of laser measurement systems for the computer disk and wafer 
industries. The segment, which manufactures mechanical components for the 
machine tool industry, reported gross sales of $8,286,243 for the year ended 
May 31, 1998. This includes inter-company sales of $754,131. This segment 
reported gross sales of $6,488,348 for the year ended May 31, 1997, including 
inter-company sales of $336,875. The segment which manufactures laser 
measurement systems for the computer disk and wafer industries reported gross 
sales of $3,108,769 for the year ended May 31,1998, which includes 
inter-company sales of $14,797. For fiscal year ended May 31, 1997, the 
measurement products segment reported gross sales of $4,390,499. There were 
no inter-company sales. The mechanical components segment and laser 
measurement segment had sales of $4,801,151 and $2,278,977, respectively, for 
the year ended May 31, 1996, which had no inter-company sales. 
Geographically, U.S. sales were $7,873,148 and $8,728,082 for fiscal years 
ended May 31, 1998 and 1997, respectively. Foreign sales were $3,521,864 and 
$2,150,765 for the same years, respectively. This includes inter-company 
sales of $768,928 for the year ended May 31, 1998 and $336,875 for the year 
ended May 31, 1997. For the years ended May 31, 1998 and 1997, respectively, 
export sales by the U.S. segment totaled $344,100 and $612,704.

     Income from operations for the years ended May 31, 1998, 1997 and 1996 
for the mechanical components segment was $363,656, $176,927 and $648,777, 
respectively. Income from operations for the years ended May 31, 1998, 1997 
and 1996 of the laser measurement segment was $975,086, $2,119,184, and 
$830,381, respectively. Consolidated income from operations includes an 
adjustment of $90,000 for the elimination of inter-company rent for the year 
ended May 31, 1998 and $30,000 for the years ended May 31, 1997 and 1996. 
Income from operations for the U.S. segment was $1,423,502 and $2,393,558, 
respectively, for the years ended May 31, 1998 and 1997 and for the foreign 
segment, losses of $84,760 and $97,447, respectively, for the same years. 
Identifiable assets at May 31, 1998, 1997 and 1996, were $6,235,232, 
$5,246,517, and $4,162,209 for the mechanical components segment and 
$3,383,986, $3,268,736, and $1,823,731 for the laser measurement segment. 
Identifiable assets at May 31, 1998 and 1997, were $8,890,325 and $7,034,431 
for the U.S. segment and $728,893 and $1,480,822 for the foreign segment. 
Depreciation expense incurred during the years ended May 31, 1998, 1997 and 
1996, by the mechanical components segment was $206,335, $156,374 and 
$115,778, respectively. The laser measurement segment incurred depreciation 
expense of $140,893, $108,066 and $80,243, for the years ended May 31, 1998, 
1997 and 1996, respectively. Amortization expense incurred during the years 
ended May 31, 1998, 1997 and 1996, by the mechanical components segment was 
$-0-, $72,393 and $91,756, respectively. The laser measurement segment did 
not incur amortization expense for years 1998 and 1997, but incurred 
amortization expense of $97,347 for the year ended May 31, 1996. The 
U.S. segment incurred depreciation expense of $276,102 and $226,735 during 
the years ended May 31, 1998 and 1997, respectively. The foreign segment 
incurred depreciation expense of $71,126 and $37,705, respectively, for these 
same years. The U.S. segment incurred amortization expense of $72,393 in 
fiscal 

<PAGE>

year ended May 31, 1997. The foreign segment has not incurred amortization 
expense. Capital expenditures for the years ended May 31, 1998, 1997 and 
1996, were $238,016, $297,998 and $317,861 by the mechanical components 
segment and $276,267, $163,170 and $88,814 by the laser measurement segment, 
respectively. Capital expenditures for the years ended May 31, 1998 and 1997, 
were $466,801 and $291,128 by the U.S. segment and $47,482 and $170,040 by 
the foreign segment, respectively.

     Income from operations represents sales less costs and operating 
expenses. In computing income from operations, all overhead expenses have 
been allocated to both industry segments, as they are an integral part of 
profit recognition for each segment. Identifiable assets by segment of 
business are those assets used in the Company's operations in each segment. 
There are no unallocated Company assets.

NOTE 9  Stock Options

Prior to 1995, the Company granted stock options to officers and employees of 
the Company. Stock options for up to 10% of the outstanding shares eligible 
for grant 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 was 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 did not exceed five years and all options were vested and exercisable 
upon grant. The options expire in the year 1999.

     A 1995 Stock Option Plan was adopted by the Board of Directors on 
December 19, 1995, for the benefit of employees other than officers. 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. The purchase price of ISOs 
is fair market value on the date of grant; purchase price of NSOs may vary 
from fair market value. Vesting is generally on a cumulative basis over four 
years at 25% per year. This plan, which originally provided for 300,000 
shares available for option, was amended during the year ended May31, 1997, 
with the maximum number of available shares increased to 500,000. The options 
expire in years 2006 through 2008.

     The following summarizes the options outstanding as of May 31, 1998:

For the 485,750 options granted prior to 1995, the exercise price range was 
$0 to $2.00, the weighted average price was $1.72 and the remaining average 
contractual life was 0.6 years. For the 386,750 shares granted under the 1995 
Stock Option Plan, the exercise price range was $2.01 to $6.00, the weighted 
average price was $5.22 and the remaining average contractual life was 
8.2 years.

     The Company has adopted the disclosure only provisions of SFAS No. 123. 
Accordingly, no compensation cost has been recognized for the stock option 
plans. Options were assumed to be exercised upon vesting for purposes of this 
valuation. Adjustments are made for options forfeited prior to vesting. For 
the years ended May 31, 1998, 1997 and 1996, total value of options granted 
was computed to be $877,963, $395,740 and $801,878, respectively, which would 
be amortized on a straight-line basis over the vesting period of the options. 
Had compensation cost for the Company's stock option plans been determined 
based on the fair value at the grant date for the awards in 1998, 1997 and 
1996, consistent with the provisions of SFAS No. 123, the Company's pro forma 
net income for the years ended May 31, 1998, 1997 and 1996, would be $889,944 
and $1,436,760 and $602,835, respectively. Pro forma basic earnings per share 
for 

<PAGE>

the years ended May 31, 1998, 1997 and 1996 would be $.13, $.20 and $.09, 
respectively. Pro forma diluted earnings per share for the years ended May 31, 
1998, 1997 and 1996 would be $.12, $.19 and $.18, respectively.

     The fair value of each option granted is estimated on the date of grant 
using the Black-Scholes option and pricing model. The weighted average 
assumptions used for fiscal 1998, 1997 and 1996 were a risk-free interest 
rate of 5.6%, 7.5% and 7.5%, respectively, an expected dividend yield of 0%, 
0% and 0%, respectively, an expected life of 8, 10, and 10 years, 
respectively, and a volatility of 52%, 51% and 51%, respectively.

     The effects of applying SFAS No. 123 in the pro forma disclosure are not 
indicative of future amounts.

<TABLE>
<CAPTION>

                                                  Options prior to 1995                    1995 Stock Option               Combined
                                                                                                 Plan                       Plans
                                                                   Weighted                              Weighted
                                                                   Average                               Average
                                                                   Exercise                              Exercise          Combined
                                               Shares               Price             Shares              Price             Shares
<S>                                            <C>                 <C>                <C>                <C>               <C>
Options outstanding, May 31, 1995              614,500              $1.72                 --              $  --            614,500
Options granted in 1996                             --              $  --            295,000              $5.83            295,000
Options exercised in 1996                      (18,750)             $1.96            (12,500)             $4.38            (31,250)
Options outstanding, May 31, 1996              595,750              $1.72            282,500              $5.83            878,250
Options granted in 1997                             --                 --             67,500              $5.83             67,500
Options exercised in 1997                     (110,000)             $1.72            (53,750)             $4.38           (163,750)
Options forfeited in 1997                           --                 --            (14,000)                --            (14,000)
Options outstanding, May 31, 1997              485,750              $1.72            282,250              $5.83            768,000
Options granted in 1998                             --                 --            174,000              $6.63            174,000
Options exercised in 1998                           --                 --            (17,250)             $5.59            (17,250)
Options forfeited in 1998                           --                 --            (52,250)             $8.33            (52,250)
Options outstanding, May 31, 1998              485,750              $1.72            386,750              $5.22            872,500
Options vested at May 31, 1998                 485,750                               113,000                               598,750

</TABLE>

Management's Discussion and Analysis

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 industry and 
the risk factors listed from time to time in the Company's SEC reports, 
including but not limited to the Current Report on Form 8-K dated June 5, 
1996. Accordingly, actual results may differ, possibly materially, from the 
predictions contained herein.

<PAGE>

     During fiscal 1998 the measurement markets the Company serves declined, 
particularly in the Asian region during the third and fourth quarters. The 
Company has responded to this decline in demand for its products by launching 
new products for both the laser measurement markets and the mechanical 
balancer markets. As a result of these changes by management, the Company's 
sales in fiscal 1998 increased slightly from fiscal 1997. The Company expects 
current levels of product sales and profitability to continue in the near 
future. However, there can be no assurance that the Company will continue to 
be profitable with increased sales levels in future time periods.

     Sales outside the United States accounted for approximately 20% of the 
Company's revenues in each of the fiscal 1996, 1997 and 1998. Some foreign 
customers will purchase in their own country's currencies, thereby imposing 
on the Company a currency risk. All U.S. sales (74% of total sales in fiscal 
1998) were in U.S. dollars and less than 10% of total sales in fiscal 1998 
were 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, the 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 is derived from sales to 
end users through selling agents and directly to builders of machine tools. 
For fiscal 1997 and 1998, sales to a single customer did not exceed 10% of 
total balancer revenues. In fiscal 1997 the Company entered into a strategic 
partnership with Veeco Instruments Inc. (NASDAQ:VECO) to act as the exclusive 
sales and marketing agent for SMS's laser light scatter products. As a result 
of this agreement, 24% of consolidated fiscal 1998 sales were through Veeco 
as compared with 22% in fiscal 1997. 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 1996, 1997 and 1998 principally have 
been the result of increased volume of product shipments. Product 
improvements and available features have resulted in modestly increased 
average product prices.

     The Company operates in a highly competitive industry characterized by 
increasingly rapid technological changes. The Company's competitive advantage 
and future success are therefore dependent on its ability to develop new 
products, to qualify these new products with its customers, to successfully 
introduce these products to the marketplace on a timely basis, to commence 
production to meet customer demands and to develop new markets in the 
industries for its products and services. The successful introduction of new 
technology and products is increasingly complex. If the Company is unable, 
for whatever reason, to develop and introduce new products in a timely manner 
in response to changing market conditions or customer requirements, its 
results of operations could be adversely impacted.

a)   Graph of Schmitt's Shareholders' Equity, 1994-98.

Results of Operations

<PAGE>

Sales in fiscal 1998 increased to $10,626,084 from $10,541,972 in fiscal 1997 
and $7,080,128 in fiscal 1996.  Schmitt Measurement System (SMS) sales 
accounted for $3,093,972 of fiscal 1998 sales compared with fiscal 1997 sales 
of $4,390,499. Net income for fiscal 1998 totaled $1,250,115 vs. fiscal 1997 
totals of $1,724,728. This decline was directly attributable to reduced sales 
of SMS measurement products.

     Historically the Company has enjoyed a high gross profit margin in 
excess of 60% on its SBS Dynamic Balancing products and its SMS measurement 
products. Fiscal year 1998 gross profits totaled 56%. Cost of sales as a 
percentage of sales for fiscal 1996, 1997 and 1998 was 35.9%, 36.7% and 
43.6%, respectively. The introduction of the TMS-2000 during the third 
quarter of fiscal 1996 had a positive impact on sales and net earnings for 
fiscal 1996 and 1997. The fiscal 1998 decline in sales of TMS-2000 and 
TMS-2000W series products resulted in a negative impact on sales and net 
earnings. Management expects these trends in sales and profits of the TMS 
series products to continue throughout the 1998 calendar year. Management 
anticipates that cost of sales as a percentage of sales will be similar in 
future time periods to the Company's historical performance. No assurances 
can be made that the Company will be profitable or will generate increased 
sales in future time periods.

     General selling and administrative expenses as a percentage of net sales 
were 40% in fiscal 1998, 40% in fiscal 1997, and 43% in fiscal 1996. During 
each of these fiscal years, the Company increased spending in marketing and 
selling programs to support the development of international markets, 
particularly in the European and Asia-Pacific regions, and to increase the 
awareness of new products. Administrative expenses have increased during each 
of the last three fiscal years to support the Company's growth, improve 
information technology capability and protect the Company's intellectual 
property rights.

     The Company has had minor variable cost increases in periods of 
increased sales; therefore, fixed costs have been spread over an increasing 
sales revenue as unit sales of SBS and SMS products increased. Even with two 
operating segments, management believes the Company's costs will not increase 
at the same rate that sales are anticipated to increase in fiscal 1999 and 
beyond, although there can be no such assurance.

     Net income for fiscal 1998 decreased to $1,250,511, a 28% decrease from 
fiscal 1997 and 3% increase over fiscal 1996. Net income per basic share 
decreased to $0.18 in fiscal 1998 from $0.25 in fiscal 1997 and remained the 
same as fiscal 1996.

     The Company's future operating results depend, to a considerable extent, 
on its ability to maintain a competitive advantage in both the products and 
services it provides. For this reason, the Company believes it is critical to 
continue to make future investments in research and development to ensure the 
flow of innovative, productive, high-quality products and support services. 
Accordingly, the Company expects research and development expenses to 
continue to increase in the immediate future.

a)   Graph of Schmitt's Total Assets, 1994-98.

Liquidity and Capital Resources

The Company's financial condition remained very strong, with a ratio of 
current assets to current liabilities of 7.3:1 at May 31, 1998, compared with 
6.5:1 at May 31, 1997. As of May 31, 1998, the Company had $1,127,076 in 
cash, and trading securities, compared with $672,662 at May 31, 1997.

     Accounts receivable have decreased as revenue growth has slowed. At May 31,
1998, accounts receivable totaled $1,197,951 compared with $2,725,512 at May 31,
1997. At May 31, 1998, none of the Company's accounts receivable were 

<PAGE>

considered a doubtful collection. The Company generally experiences a payment 
cycle of 30-80 days on invoices. Management believes its credit policies and 
collection policies are effective and appropriate for the marketplace that it 
serves and the Company 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 $5,109,560 at May 31, 1997 to $5,906,588 
at May 31, 1998. During fiscal 1997 the Company spent $496,000 to acquire 
certain assets of a former European competitor, Hofmann Maschinenbau GmbH 
(SHS). Additionally the Company spent $461,168 on the purchase of worldwide 
corporate assets of property and equipment in fiscal 1997. During fiscal 1998 
the Company spent $514,283 to acquire certain worldwide corporate assets of 
property and equipment to assist in production and product development. 
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 
increased capital expenditures for equipment in fiscal 1999.

     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 
finished goods inventory turnover ratio for fiscal 1996, 1997 and 1998 was 
1.7, 2.1 and 1.4, respectively.

     The acquisition of SMS resulted in a tax loss carryforward in excess 
$5 million, which is available to offset earnings from SMS through the year 
2010. As of May 31, 1998 the Company's gross deferred tax asset balance was 
$3,233,155.

a)   Graph of Schmitt's Return on Equity (in percent), 1994-98.

     The Company has completed an evaluation of Year 2000 computer 
information processing problems and Year 2000 program requirements for 
internal operations and Company products and does not expect to experience 
Year 2000 problems in those areas. A survey analysis of external vendors is 
in process and is anticipated to be complete by December 31, 1998. The 
Company's Year 2000 compliance evaluation will then be complete. The Company 
does not believe it has significant exposure to Year 2000 problems with 
significant vendors, customers and financial institutions and does not expect 
that Year 2000 will have a material cost or impact on Company operations. 
However, there can be no assurance that the systems of other companies on 
which the Company relies will not have an adverse effect on the Company's 
systems.

     Management believes that its cash flows 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 1998.

b)   Graph of Schmitt's Working Capital, 1994-98.

Summarized Quarterly Financial Data
In thousands, except per share information (unaudited)

<PAGE>

<TABLE>
<CAPTION>

1998 Quarter Ended         August 31       November 30       February 28         May 31
<S>                        <C>             <C>               <C>               <C>
Sales                      $2,666,941       $3,220,475        $2,372,320       $2,366,348
Gross Profit                1,504,589        1,833,637         1,059,200        1,596,173
Net Income                    354,551          695,449           101,794           98,321
Net Income Per Share,            0.05             0.10              0.01             0.01
Basic
Net Income Per Share,            0.05             0.09              0.01             0.01
Diluted
Market Price of Common
Stock
  Low                            7.50             8.00              7.38             5.69
  High                           9.75            12.00             10.13             8.13

<CAPTION>

1997 Quarter Ended         August 31*      November 30*      February 28*        May 31*
<S>                        <C>             <C>               <C>               <C>
Sales                      $1,793,698       $2,738,314        $2,918,912       $3,091,048
Gross Profit                1,069,558        1,725,676         1,827,858        2,043,090
Net Income                    140,276          607,344           458,655          518,453
Net Income Per Share,            0.02             0.09              0.07             0.07
Basic
Net Income Per Share,            0.02             0.08              0.06             0.07
Diluted
Market Price of Common
Stock
  Low                            8.88             7.88              7.88             7.00
  High                          13.75            11.00             11.00            10.75

</TABLE>

*Quarterly data have been restated to account for inter-company transactions.

Common Stock Information and Dividend Policy

As of July 15, 1998, there were 7,099,139 shares of Common Stock outstanding 
held by approximately 129 holders of record. The number of holders does not 
include individual participants in security position listings. Management 
estimates that there are over 2,500 shareholders who own the Company's stock.

     The Company has not paid any dividends on its Common Stock since 1994. 
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 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.

     The sum of quarterly earnings per share does not equal annual earnings 
per share as a result of the computation of quarterly versus annual average 
shares outstanding.

Selected Financial Data
In thousands, except per share information

<TABLE>
<CAPTION>

Year Ended                5/31/98    5/31/97    5/31/96    5/31/95    5/31/94
<S>                       <C>        <C>        <C>        <C>        <C>
Sales                     $10,626    $10,542    $7,080     $4,415     $2,575
Net Income                $ 1,250    $ 1,725    $1,217     $  249     $  182
Net Income Per            $  0.18    $  0.25    $ 0.18     $ 0.04     $ 0.03
Share, Basic
Weighted Average
  Number of Shares          7,091      7,031     6,888      6,887      5,978
(000)
Net Income Per            $  0.17    $  0.23    $ 0.16     $ 0.04     $ 0.03
Share, Diluted

<PAGE>

Weighted Average
  Number of Shares          7,456      7,562     7,417      7,116      6,203
(000)
Stockholders'             $ 8,688    $ 7,429    $4,887     $3,464     $3,215
Equity
Total Assets              $ 9,619    $ 8,515    $5,986     $4,619     $4,232

</TABLE>

Report of Independent Accountants
To the Board of Directors and Shareholders of
Schmitt Industries, Inc.

In our opinion, the accompanying consolidated balance sheet and the related 
consolidated statements of income, of cash flows and of changes in 
stockholders' equity present fairly, in all material respects, the financial 
position of Schmitt Industries, Inc. and its subsidiaries at May 31, 1998, 
and the results of their operations and their cash flows for the year then 
ended in conformity with generally accepted accounting principles. These 
financial statements are the responsibility of the Company's management; our 
responsibility is to express an opinion on these financial statements based 
on our audit. We conducted our audit of these statements in accordance with 
generally accepted auditing standards which require that we plan and perform 
the audit to obtain reasonable assurance about whether the financial 
statements are free of material misstatement. An audit includes examining, on 
a test basis, evidence supporting the amounts and disclosures in the 
financial statements, assessing the accounting principles used and 
significant estimates made by management, and evaluating the overall 
financial statement presentation. We believe that our audit provides a 
reasonable basis for the opinion expressed above. The financial statements of 
Schmitt Industries, Inc. for the years ended May 31, 1996 and 1997 were 
audited by other independent accountants whose report dated July 10, 1997 
expressed an unqualified opinion on those statements.




PricewaterhouseCoopers LLP
Portland, Oregon
July 17, 1998


Schmitt Worldwide Customers
Adam Opel AG
Akashic Memories Corporation
Allied Signal Aerospace Company
Allison Engine Company
American Axel
American Koyo Bearing Mfg. Corp.
American NTN Bearing Company
Asahi Komag
Atlas Copco Airpower N.V.
Audi AG
Barden Corporation
Black & Decker Corporation
Blohm Maschinenbau Gmbh
BMW Motoren GmbH
Boeing Company
Briggs & Stratton

<PAGE>

Bryant Grinder Corporation
Caterpillar Belgium S.A.
Caterpillar Incorporated
Chrysler Corporation
Cincinnati Milacron
Cummins Engine Company
Daewoo International Corporation
Daimler Benz
Dana Corporation
Deere & Company
Diesel Technology Corporation
Dresser-Rand
Eaton Corporation
Emerson Power Transmission
Erwin Junker

FAG Bearing Ltd.
Federal Mogul Corporation
Fiat
Ford France S.A.
Ford Motor Company
Fuji Electric
General Electric Corporation
General Motors Corporation
Goldcrown Machinery
Greenfield Industries
Gyhring Automation
Harley-Davidson Motor Company
HMT Technology Corporation
Honda Motor Company,  Honda
  Of America
IBM Deutschland
INA Bearing Corporation
Jones & Shipman, Inc.
Komag, Inc.
Koube Steel
Koyo Machinery USA
Landis, Landis Lund
Lockheed Martin
Mercedes Benz AG
Milwaukee Electric Tool
Mitsubishi Chemical
Mitsubishi Material Silicon
Mitsubishi Motor Company Ltd.
NASA
Navistar International Transportation
New Venture Gear
Nissan Motors Ltd.
Normac, Inc.
Norton Company
Okamoto Corporation
Okunia Machinery, Inc.
Opel Austria GmbH

Parker Hannifin Corporation
Pratt & Whitney
Raytheon

<PAGE>

Reliance Electric Company
Rexnord Corporation
Reynolds Metals
Robert Bosch Corporation
Robert Bosch GmbH
Saturn Corporation
Seagate Substrates
SEH America, Inc.
Siemens Automotive Systems
SKF Bearing Industries
SKF GmbH
Sumitomo Heavy Industries
Texas Instruments
The Timken Company
The Torrington Company
Timken France
Toyoda Machinery USA, Toyoda
  Machinery, Ltd.
TRW Automotive Components
United Grinding Technologies
University Of Connecticut Grinding
  Research Center
Volkswagen AG
Volvo
Weldon Machine Tool
Western Digital
Weyburn-Bartel

Corporate Offices
Schmitt Industries, Inc.
2765 NW Nicolai St.
Portland, OR 97210
Phone: (503) 227-7908
Fax: (503) 223-1258
Web: www.schmitt-ind.com

Schmitt Europe Ltd.
University of Warwick Science Park
Sir William Lyons Road
Coventry, England CV4 7EZ
Phone: 44-1203-697192
Fax: 44-1203-412697

Schmitt Hofmann Systems GmbH
Schwingungsmesstechnik
Birkenweg 8 (Gewerbegebiet)
D - 64665 Alsbach, Germany
Phone: 49-6257-9351-21
Fax: 49-6257-9351-23
Transfer Agent & Registrar
Interwest Transfer Company
Salt Lake City, Utah U.S.A.
Banking Reference
Wells Fargo Bank
Portland, Oregon U.S.A.
Certified Public Accountants
PricewaterhouseCoopers, LLP

<PAGE>

Portland, Oregon U.S.A.
Stock Listing
NASDAQ National Market
Symbol: SMIT

Officers
Wayne A. Case
President & Chief Executive Officer
David W. Case
Vice President of Operations
Annie N. Windsor
Chief Financial Officer
Linda M. Case
Corporate Secretary
Directors
Wayne A. Case
President & Chief Executive Officer
Schmitt Industrties
Maynard Brown
Partner, Brown McCue, Attorneys
David L. Dotlich, Ph.D.
Faculty, University of Michigan
Business School, Business Consultant
David M. Hudson
President, Coldstream Holdings, Inc.
Trevor Nelson
Financial Consultant
The Stewart Thomas Group
Dennis T. Pixton
President, Chief Operating Officer
Michaels of Oregon Co.
John A. Rupp
Business Executive - Self Employed


Form 10-K Available

A copy of the Company's Form 10-K as filed with the Securities and Exchange 
Commission is available to shareholders free of charge upon request addressed 
to the Secretary at the Company's Corporate Offices.

Annual Meeting

The annual meeting of shareholders will be held Friday, October 9, 1998 at 
3:00 p.m. at the Corporate Offices.

Forward-looking Statements

This summary annual report, other than the historical financial information, 
contains statements regarding future sales and earnings growth and projects 
or processes currently under development which are forward-looking statements 
that involve risks and uncertainties that could cause actual results to 
differ materially from those set forth in the forward-looking statements, 
including delays in technology or product developments, shipment or 
cancellation of orders, timing of future orders, customer reorganizations, 
fluctuations in demand and the other risks detailed from time-to-time in the 
Company's reports which are filed with the Securities and Exchange Commission.

Schmitt Industries, Inc.
2765 NW Nicolai Street

<PAGE>

Portland, Oregon 97210
Phone: (503) 227-7908
Fax: (503) 223-1258
Web: www.schmitt-ind.com