UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 27, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 1-367
THE L. S. STARRETT COMPANY
(Exact name of registrant as specified in its charter)
MASSACHUSETTS 04-1866480
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
121 CRESCENT STREET, ATHOL, MASSACHUSETTS 01331-1915
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code 978-249-3551
Former name, address and fiscal year, if changed since last report.
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 whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
YES X NO
Common Shares outstanding as of January 31, 2004 :
Class A Common Shares 5,363,596
Class B Common Shares 1,285,474
Page 1 of 17
THE L. S. STARRETT COMPANY
CONTENTS
Page No.
Part I. Financial Information:
Item 1. Financial Statements
Consolidated Statements of Operations -
thirteen and twenty-six
weeks ended December 27, 2003 and
December 28, 2002 (unaudited) 3
Consolidated Statements of Cash Flows -
thirteen and twenty-six
weeks ended December 27, 2003 and
December 28, 2002 (unaudited) 4
Consolidated Balance Sheets - December 27,
2003 (unaudited) and June 28, 2003 5
Consolidated Statements of Stockholders'
Equity - twenty-six weeks ended
December 27, 2003 and December 28, 2002
(unaudited) 6
Notes to Consolidated Financial Statements 7-8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 8-16
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 16
Item 4. Controls and Procedures 16
Part II. Other information:
Item 6. Exhibits and reports on Form 8-K 16-17
SIGNATURES 17
Page 2 of 17
Part I. Financial Information
Item 1. Financial Statements
THE L. S. STARRETT COMPANY
Consolidated Statements of Operations
(in thousands of dollars except per share data)(unaudited)
13 Weeks Ended 26 Weeks Ended
12/27/03 12/28/02 12/27/03 12/28/02
Net sales 45,420 44,828 86,095 90,163
Cost of goods sold (37,028) (34,486) (67,968) (71,085)
Selling and general expense (11,420) (11,106) (22,834) (23,658)
Other expense (81) (575) (352) (1,255)
Loss before income taxes and
cumulative effect of change in
accounting principle (3,109) (1,339) (5,059) (5,835)
Benefit from federal, foreign
and state income taxes (1,276) (698) (2,131) (2,659)
Loss before cumulative effect
of change in accounting principle (1,833) (641) (2,928) (3,176)
Cumulative effect of change in
accounting principle for goodwill (6,086)
Net loss (1,833) (641) (2,928) (9,262)
Basic and diluted loss per
share before cumulative effect of
change in accounting principle (.28) (.09) (.44) (.48)
Cumulative effect of change in
accounting principle for goodwill (.93)
Basic and diluted loss per share (.28) (.09) (.44) (1.41)
Average outstanding shares used in
per share calculations (in thousands) 6,655 6,589 6,658 6,570
Dividends per share .10 .20 .20 .40
See Notes to Consolidated Financial Statements
Page 3 of 17
THE L. S. STARRETT COMPANY
Consolidated Statements of Cash Flows
(in thousands of dollars)(unaudited)
13 Weeks Ended 26 Weeks Ended
12/27/03 12/28/02 12/27/03 12/28/02
Cash flows from operating activities:
Net loss (1,833) (641) (2,928) (9,262)
Non-cash items included in net loss:
Cumulative effect of change in
accounting principle 6,086
Depreciation and amortization 2,836 2,746 5,591 5,532
Deferred taxes (1,013) (64) (1,032) (291)
Unrealized exchange losses (gains) (19) 735 (32) 1,460
Retirement benefits (117) (276) (234) (504)
Working capital changes:
Receivables 986 3,097 1,235 1,285
Inventories 6,865 6,179 7,579 12,108
Other assets and liabilities 1,468 590 2,087 660
Prepaid pension cost and other 134 51 175 (107)
Net operating cash flows 9,307 12,417 12,441 16,967
Cash flows from investing activities:
Additions to plant and equipment (2,017) (2,253) (3,295) (2,989)
Change in short-term investments (2,947) (10,206) (5,227) (13,632)
Net investing cash flows (4,964) (12,459) (8,522) (16,621)
Cash flows from financing activities:
Short-term borrowings (repayments) (66) (979) 457 (851)
Long-term borrowings (repayments) (1,149) 2,749 (2,762) 2,749
Common stock issued 108 529 226 1,309
Treasury shares purchased (398) (117) (398) (357)
Dividends (662) (1,314) (1,330) (2,624)
Net financing cash flows (2,167) 868 (3,807) 226
Exchange rate change effect on cash 146 6 98 (79)
Net increase in cash 2,322 832 210 493
Cash, beginning of period 1,194 1,333 3,306 1,672
Cash, end of period 3,516 2,165 3,516 2,165
See Notes to Consolidated Financial Statements
Page 4 of 17
THE L. S. STARRETT COMPANY
Consolidated Balance Sheets
(in thousands of dollars)
Dec. 27 June 28
2003 2003
ASSETS (unaudited)
Current assets:
Cash 3,516 3,306
Investments 27,513 21,995
Accounts receivable (less allowance for doubtful
accounts of $1,536 and $1,392) 31,440 32,175
Inventories:
Raw materials and supplies 9,885 9,859
Goods in process and finished parts 15,585 20,344
Finished goods 21,433 23,832
46,903 54,035
Prepaid expenses, taxes and other current assets 8,304 9,703
Total current assets 117,676 121,214
Property, plant and equipment, at cost (less
accumulated depreciation of $95,275
and $89,223) 65,299 67,093
Prepaid pension cost 30,956 30,565
Other assets 817 868
214,748 219,740
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable and current maturities 1,713 3,585
Accounts payable and accrued expenses 14,360 12,859
Accrued salaries and wages 3,574 3,940
Total current liabilities 19,647 20,384
Deferred income taxes 13,651 14,696
Long-term debt 2,238 2,652
Accumulated postretirement medical benefit obligation 17,268 17,057
Stockholders' equity:
Class A Common $1 par (20,000,000 shrs. auth.;
5,360,457 outstanding on 12/27/03, excluding
1,306,553 in treasury; 5,344,033 outstanding
on 6/28/03, excluding 1,294,542 in treasury) 5,360 5,344
Class B Common $1 par (10,000,000 shrs. auth.;
1,288,613 outstanding on 12/27/03, excluding
332,019 in treasury; 1,315,489 outstanding
on 6/28/03, excluding 332,019 in treasury) 1,289 1,315
Additional paid-in capital 49,827 49,826
Retained earnings reinvested and employed in
the business 130,126 134,547
Accumulated other comprehensive loss (24,658) (26,081)
Total stockholders' equity 161,944 164,951
214,748 219,740
See Notes to Consolidated Financial Statements
Page 5 of 17
THE L. S. STARRETT COMPANY
Consolidated Statements of Stockholders' Equity
For the Twenty-six Weeks Ended December 27, 2003 and December 28, 2002
(in thousands of dollars)
(unaudited)
Common Addi- Accumulated
Stock Out- tional Other
standing Paid-in Retained Comprehensive
($1 Par) Capital Earnings Loss Total
Balance June 29, 2002 6,544 47,858 150,029 (24,090) 180,341
Comprehensive income(loss):
Net loss (9,262) (9,262)
Unrealized net gain
on investments 11 11
Translation loss, net (3,258) (3,258)
Total comprehensive loss (12,509)
Dividends ($.40 per share) (2,624) (2,624)
Treasury shares:
Purchased (18) (148) (191) (357)
Issued 67 1,108 1,175
Options exercised 10 124 134
Balance Dec. 28, 2002 6,603 48,942 137,952 (27,337) 166,160
Balance June 28, 2003 6,659 49,826 134,547 (26,081) 164,951
Comprehensive income(loss):
Net loss (2,928) (2,928)
Unrealized net gain
on investments 18 18
Translation gain, net 1,405 1,405
Total comprehensive loss (1,505)
Dividends ($.20 per share) (1,330) (1,330)
Treasury shares:
Purchased (25) (210) (163) (398)
Issued 13 194 207
Options exercised 2 17 19
Balance Dec. 27, 2003 6,649 49,827 130,126 (24,658) 161,944
See Notes to Consolidated Financial Statements
Page 6 of 17
THE L. S. STARRETT COMPANY
Notes to Consolidated Financial Statements
In the opinion of management, the accompanying financial statements contain
all adjustments, consisting only of normal recurring adjustments, necessary
to present fairly the financial position of the Company as of December 27,
2003 and June 28, 2003; the results of operations and cash flows for the
thirteen and twenty-six weeks ended December 27, 2003 and December 28, 2002;
and changes in stockholders' equity for the twenty-six weeks ended December
27, 2003 and December 28, 2002.
The Company follows the same accounting policies in the preparation of
interim statements as described in the Company's annual report filed on Form
10-K for the year ended June 28, 2003, other than the change for stock based
compensation as discussed below, and these financial statements should be
read in conjunction with said annual report. Certain reclassifications have
been made to prior period data to conform with current year presentation.
Shares used to compute basic and diluted loss per share are the same since
the inclusion of common stock equivalents (12,226 shares in the quarter
ended December 27, 2003, 3,059 shares in the quarter ended December 28,
2002, 12,694 shares in the six months ended December 27, 2003, and 6,814
shares in the six months ended December 28, 2002) would be antidilutive.
As discussed under Management's Discussion and Analysis of Financial
Condition and Results of Operations, the Company took reserves and charged
pretax operations with $3.1 million ($.30 per share after tax) in the
September 2002 quarter in connection with an investigation of its Coordinate
Measuring Machine (CMM) division, and additional charges were incurred
thereafter. As of December 27, 2003, approximately $.2 million remains
reserved for future legal and professional costs related to this matter. No
assurances can be made that this amount reflects the actual future costs
that will be incurred by the Company or that the Company will not need to
take additional reserves.
Effective with the beginning of the September 2003 quarter, the Company has
adopted the fair value method of accounting for stock-based compensation on
a prospective basis as described in SFAS No.s 123 and 148. The Company
incurred $27,000 in stock-based compensation costs in the current quarter.
Historically, stock-based compensation has not been material.
The Company adopted SFAS 142, Goodwill and Other Intangible Assets, as of
June 30, 2002, the first day of fiscal 2003, and performed a transitional
fair value based impairment test as of that date. As a result, a onetime,
non-cash, non-operational impairment charge of $6,086,000 ($.93 per share
before and after taxes since there were no income taxes associated with the
charge), relating primarily to the acquisition of the Company's Evans Rule
division in 1986, was recorded as of the first day of the September 2002
quarter and related amortization of $67,000 per quarter was discontinued.
The charge is reflected as the cumulative effect of a change in accounting
principle in the accompanying Statements of Operations.
Included in investments at December 27, 2003 is $2.3 million of AAA rated
Puerto Rico debt obligations that have maturities greater than one year but
carry the benefit of possibly reducing repatriation taxes. These investments
represent "core cash" and are part of the Company's overall cash management
and liquidity program and, under SFAS 115, are considered "available for
sale." The investments themselves are highly liquid, carry no early
redemption penalties, and are not designated for acquiring non-current
assets.
Page 7 of 17
Other income (expense) is comprised of the following (in thousands):
Thirteen Weeks Twenty-six Weeks
Ended December Ended December
2003 2002 2003 2002
Interest income 190 215 345 390
Interest expense and com-
mitment fees (235) (124) (563) (218)
Realized and unrealized
exchange gains (losses) 29 (622) (10) (1,342)
Other (65) (44) (124) (85)
(81) (575) (352) (1,255)
Approximately 70% of all inventories are valued on the LIFO method. At
December 27, 2003 and June 28, 2003, total inventories are $23,166,000 and
$23,204,000 less, respectively, than if determined on a FIFO basis. During
the December 2003 quarter, the Company reduced the levels of certain LIFO
inventories that were carried in the aggregate at lower costs prevailing in
prior years. The effect of the LIFO inventory reduction was to increase
second quarter 2004 net earnings by approximately $.2 million or $.03 per
share.
Long-term debt is comprised of the following (in thousands):
December June
2003 2003 .
Note payable at 3.1% due 12/03 123 2,318
Capitalized lease obligations
payable in Brazilian currency
due 2003 - 2007, 17%-25% 2,891 3,433
3,014 5,751
Less current portion 776 3,099
2,238 2,652
The Company is considering various reorganization plans and options as
discussed under "Management's Discussion and Analysis of Financial Condition
and Results of Operations" below. These considerations could result in asset
impairments and additional costs that will be recognized if and when actions
are finalized or obligations are incurred.
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
QUARTERS ENDED DECEMBER 27, 2003 AND DECEMBER 28, 2002
OVERVIEW
As discussed below under "Coordinate Measuring Machine (CMM) division," the
Company took a pretax charge of $3.2 million in the December 2003 quarter in
order to write down its CMM inventory to net realizable value. After giving
effect to income taxes, this charge amounted to $2.1 million or $.32 per
share. Excluding this charge, the Company would have reported net income for
the quarter of $.3 million ($.04 per share) compared to a net loss of $.6
million ($.09 per share) in the prior year's December quarter.
Sales
Total Company sales for the December quarter were approximately 1% higher
than the corresponding quarter of a year ago. Domestic sales were down 2%
Page 8 of 17
and foreign sales were up 11%, although in local currency foreign sales were
up only 3% because of the weak U.S. dollar. The Company's sales remain under
pressure because the U.S. industrial manufacturing sector, particularly in
metal working, continues to be affected by the migration of manufacturing,
both customers and competitors, to lower cost countries.
Loss Before Taxes
Before the $3.2 million CMM inventory write-down, pretax earnings for the
quarter were $.1 million, compared to a $1.3 million loss a year earlier.
Excluding this write-down, domestic operations had a pretax loss of 2% of
sales compared to 6% last year, while foreign operations had pretax income
of about 4% of sales in both years. The major items causing the $1.4 million
improvement in earnings before inventory write-down were lower ($.7 million)
exchange losses, primarily in Brazil, and improved gross margins (25.5% this
year compared to 23.1% last year, or $1.1 million). The gross margin
improvement is domestic and due primarily to lower headcount, slightly
higher production levels, and the benefit ($.3 million) of liquidating LIFO
inventories; all partially offset by higher retirement costs ($.3 million).
Income Taxes
The effective income tax rate was 41% in the December 2003 quarter and 52%
in the prior year's corresponding quarter. The fluctuation in these rates
comes about because pretax results are so close to breakeven that permanent
book/tax differences and varying tax rates among jurisdictions get
exaggerated when converted to percentages. As a result, it is not
practicable to predict what the effective rate is going to be for the full
year. Puerto Rico tax incentives and somewhat lower foreign income tax rates
all contribute to an overall effective tax rate that is normally slightly
lower than the combined U.S. state and federal rate of approximately 38%.
However, in the periods presented, the least profitable operations have been
in the jurisdictions with the highest tax rates. Despite recent losses, the
Company continues to believe it will be able to realize the income tax
benefits it has recorded. This is continually monitored and could change in
the future.
Loss per share
As a result of the above factors, the Company had a basic and diluted loss
of $.28 per share in the December 2003 quarter compared to $.09 in the
December quarter a year ago. Excluding the effect of the CMM inventory
write-down, the Company had basic and diluted earnings of $.04 per share
compared to a loss of $.09 per share in the prior year's quarter.
SIX MONTH PERIODS ENDED DECEMBER 27, 2003 AND DECEMBER 28, 2002
OVERVIEW
As more fully discussed below, results for the first six months of fiscal
2004 show the Company incurred a net loss of $2.9 million, or $.44 per
share, compared to a net loss of $9.3 million, or $1.41 per share, in the
comparable prior year six month period. A significant portion of current and
prior year losses was caused by unusual charges: in the current year the
$3.2 million, or $.32 per share after tax, write-down of CMM inventories;
and in the prior year the write-off of $6.1 million, or $.93 per share
before and after tax, of goodwill and a $3.1 million pretax, or $.30 per
share after tax, provision in connection with a government investigation of
the Company's CMM division. Excluding these unusual charges, the Company
incurred a net loss for the first six months of fiscal 2004 of $.8 million,
or $.12 per share compared to a net loss of $1.3 million or $.18 per share
in the corresponding prior year six month period.
Page 9 of 17
Sales
Sales for the first six months of fiscal 2004 were down 4.5% compared to the
corresponding period a year ago. Domestic sales were down 10% and foreign
sales were up 10%. In local currency foreign sales were actually down 3%,
since the dollar has been weakening against the British pound and Brazilian
real. Most of the decrease in domestic sales occurred in the first quarter
of fiscal 2004, reflecting in part the weak U.S. industrial manufacturing
sector.
Loss before taxes and cumulative effect of change in accounting principle
The pretax losses for the first six months of fiscal 2004 and 2003 were $5.1
million and $5.8 million, respectively. Both six month periods contain
unusual charges: in the current fiscal year, $3.2 million for the CMM
inventory write-down and $.2 million for additional investigation charges;
and, in the prior fiscal year, $3.1 million in connection with the
investigation ($1.5 million of this was charged to selling and general
expense and $1.6 million to cost of sales). Excluding these unusual charges,
pretax losses for the six month periods were $1.7 million in fiscal 2004 and
$2.7 million in fiscal 2003.
By itself, the 4.5% decrease in sales had the effect of increasing the
pretax loss by about $1.0 million. The major items causing the remaining
$2.0 million decrease in the pretax loss were lower ($1.3 million) exchange
losses, primarily in Brazil, and better gross margins (24.8% compared to
22.9% or $1.6 million). These improvements were partially offset by higher
interest expense ($.3 million) in Brazil due to borrowing in local currency
and a $.4 million increase in selling and general expense. Contributing to
this $.4 million increase in selling and general expense were higher
retirement benefit costs and the effect of a weaker U.S. dollar this year
compared to last year. Despite lower sales and excluding the effect on cost
of sales in both years of the unusual charges related to the CMM division,
gross margins improved approximately 1.9 percentage points year to year due
primarily to lower headcount, slightly higher production levels, and LIFO
inventory liquidation profits ($.3 million).
Coordinate Measuring Machine (CMM) division
As discussed in more detail in the Company's fiscal 2003 Annual Report on
Form 10-K, the Company's CMM division is presently the subject of a federal
government investigation being coordinated through the Department of
Justice. The Company became aware of the investigation on September 5, 2002,
when federal agents conducted a search of the CMM division. The
investigation apparently was prompted by a qui tam action filed under seal
in federal court in Boston, Massachusetts. The division, which is located in
the Company's Mt. Airy, North Carolina facility, accounted for less than 2%
of the Company's net sales during fiscal 2003. The CMM division manufactures
and sells coordinate measuring machines. The government is investigating
allegations apparently made by a former independent contractor that the CMM
division defrauded its customers and the government in connection with the
sale of coordinate measuring machines and software. In response to a
September 2002 newspaper article, the Company denied allegations that the
Company defrauded its customers or the government. The Company has not been
served with any qui tam complaint, and is cooperating with the government.
As a result of the investigation and the CMM replacement program initiated
prior thereto in March 2002, the Company took reserves and charged pretax
operations with $3.1 million ($.30 per share after tax) in the September
2002 quarter, $.6 million in the March 2003 quarter, and $.2 million in the
September 2003 quarter. As of December 27, 2003, approximately $.2 million
remains reserved for future professional fees. In addition, the Company
charged cost of sales and wrote down the carrying cost of its CMM inventory
by $3.2 million in the December 2003 quarter. No assurances can be made that
Page 10 of 17
these reserves and write-downs reflect the actual additional costs that will
be incurred by the Company. See the additional comments below under
"Reorganization Plans" regarding the CMM division.
Income Taxes
The effective income tax rate was 42% in the first six months of fiscal 2004
and 46% in the corresponding prior year six month period. Puerto Rico tax
incentives, and somewhat lower foreign income tax rates all contribute to an
overall effective tax rate that is normally slightly lower than the combined
U.S. state and federal rate of approximately 38%. However, in the periods
presented, the least profitable operations have been in the jurisdictions
with the highest tax rates. Despite recent losses, the Company continues to
believe it will be able to utilize its tax operating loss carryforwards and
is therefore recognizing their benefit against current losses. This is
continually monitored and could change in the future.
Net loss per share
As a result of the above factors and before the change in accounting
principle (adoption of SFAS 142 in fiscal 2003), the Company incurred a
basic and diluted net loss per share for the first six months of fiscal 2004
of $.44 per share compared to a net loss of $1.41 per share in the
corresponding period a year ago. Excluding the unusual charges related to
the CMM division ($.32 per share in the current year and $.30 in the prior
year) and excluding the $.93 related to the write-off of goodwill discussed
in the notes to the financial statements, the Company incurred a net loss of
$.12 per share in the first six months of fiscal 2004 compared to a net loss
of $.18 per share in the corresponding period a year ago.
LIQUIDITY AND CAPITAL RESOURCES
13 Weeks Ended 26 Weeks Ended
12/27/03 12/28/02 12/27/03 12/28/02
Operating cash flow 9,307 12,417 12,441 16,967
Investing cash flow (4,964) (12,459) (8,522) (16,621)
Financing cash flow (2,167) 868 (3,807) 226
Despite operating results being close to breakeven before the unusual
charges discussed above, cash provided by operations has been significant in
all periods presented. Non-cash depreciation charges of approximately $3
million per quarter contribute to this, but by far the biggest factor
contributing to positive operating cash flow has been the reduction in
inventories of over $26 million during the past eighteen months. "Retirement
benefits" under non-cash expenses in the detailed cash flow statement shows
the effect on operating cash flow of the Company's pension and retiree
medical plans. Primarily because the Company's domestic defined benefit plan
is overfunded, retirement benefits in total are currently generating
approximately $.1 million of non-cash income per quarter ($.3 million per
quarter in the prior year). On an accrual basis, retirement benefit expense
is approximately $.4 million per quarter in the current year and $.2
million in the prior year.
The Company's investing activities consist of expenditures for plant and
equipment and the investment of cash not immediately needed for operations.
The decrease in cash used for investing activities, both in the quarter and
six month comparison, is a result of the decrease in cash available for
investment from operations.
Cash flows related to financing activities are primarily the payment of
dividends and repayment of debt. The Company entered into a lease financing
arrangement in Brazil in the December 2002 quarter worth approximately $2.7
Page 11 of 17
million that reduced the quarter and year to date cash required for
financing activities. In addition, the Company reduced the quarterly
dividend from $.20 to $.10 beginning in the fourth quarter of fiscal 2003,
but this was more than offset by increased debt repayments.
The Company believes it maintains sufficient liquidity and has the resources
to fund its operations in the near term. If revenues decline further and the
Company is unable to return to consistent profitability, additional steps
will have to be taken in order to maintain liquidity, including plant
consolidations and further workforce and dividend reductions (see
"Reorganization Plans" section below). Although it is not currently
borrowing under its line of credit, the Company and its lender are in the
process of amending the Company's credit agreement, including reducing the
line to $15 million. Although the credit line is not currently
collateralized, it is possible, based on the Company's financial
performance, that in the future the Company will have to provide collateral
in order to maintain the credit agreement. The Company has a working capital
ratio of 6.0 to one as of December 27, 2003 and 5.9 to one as of June 28,
2003.
REORGANIZATION PLANS
The Company has determined that it must make substantial changes in the way
it does business if it is to prosper in the years ahead. Manufacturing
globalization has adversely affected its customer base and competitive
position, particularly in North America, as more and more products are
produced in low wage countries. The Company's activities in China have
expanded since 1998, but it needs more low-cost capacity and outsourcing
partners. Because of the erosion of the Company's domestic customer base and
increasing pricing pressure from low wage manufacturers overseas, the
Company has been rethinking almost all aspects of its business. It is
formulating plans for consolidation of operations as well as reorganization
in order to move the strategic focus from manufacturing location to product
group and distribution channel as well as to facilitate achieving the goals
of enhanced marketing focus and global procurement. Although there have been
(see CMM division comments above) and may in the future be non-recurring
costs associated with these changes, it is premature to take additional
charges at this time. What follows are some of the specific actions being
considered. There can be no assurances that the Company will implement all
these actions and that, if such actions are implemented, they will result in
savings to the Company. It is also possible that the Company may need to
incur additional charges in connection with these initial reorganization
plans.
CMM division. The Company is in the process of evaluating the potential
actions it may take with respect to the CMM division. The investigation
continues, and even if it is resolved favorably, the outlook for the
division is problematic. Since the investigation started, sales of CMM
machines have dropped significantly. At the current level of operations, it
is difficult if not impossible to be competitive. Whether the Company
continues as it is, outsources production, or exits the business entirely,
the Company has determined that it will not be able to realize book value
for its existing inventory. Consequently the Company has written its CMM
inventories down $3.2 million in the current quarter to its anticipated net
realizable value of approximately $1 million.
Consumer tool production . The Company plans to close its Alum Bank,
Pennsylvania level producing plant before the end of the fiscal year and is
finalizing plans to relocate the manufacturing to the Dominican Republic.
The relocation of additional manufacturing capacity is also being
considered. The Company has recently consolidated its consumer hardware
Page 12 of 17
products activities under one business unit head and created a new consumer
hardware sales and marketing position. The Company believes these changes
may result in labor savings and allow the Company to maintain its margins
and satisfy the requirements of its largest customers with lower prices.
Severance and relocation costs associated with these activities, including
potential plant and equipment write-downs, could be in the $1-2 million
range, although no assurances can be made that the costs will not be
greater.
Optical comparator manufacturing. The Company is in the process of
consolidating its optical comparator manufacturing in Skipton, England into
its manufacturing facility in Jedburgh, Scotland. It is anticipated that the
cost of this move, including severance costs, should ultimately be offset by
a gain on the sale of the Skipton real estate, although no assurances can be
made that such costs will be offset by any gain.
Distribution Logistics. The Company has closed one warehouse and will
evaluate consolidating or eliminating three other warehouses in North
America, about 80,000 square feet in total. Depending on how this capacity
is replaced, this could reduce inventory requirements and may save $1
million annually in operating costs with the potential of a net gain due to
the market value of the related real estate. No material costs or asset
write-downs are expected as a result of these actions pertaining to
distribution facilities.
OFF-BALANCE SHEET ARRANGEMENTS
The Company does not have any material off-balance sheet arrangements as
defined under Securities Exchange Commission rules.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements and related disclosures in conformity
with accounting principles generally accepted in the United States of America
requires management to make judgments, assumptions and estimates that affect
the amounts reported in the consolidated financial statements and accompanying
notes. The footnotes to the Company's Annual Report on Form 10-K describe the
significant accounting policies and methods used in the preparation of the
consolidated financial statements.
Judgments, assumptions, and estimates are used for, but not limited to, the
allowance for doubtful accounts receivable and returned goods; inventory
allowances; income tax reserves; employee turnover, discount, and return
rates used to calculate pension obligations; normal expense accruals for
such things as workers compensation and employee medical expenses; and, of
particular importance, the previously discussed charges connected with the
government investigation of the Company's CMM division. Actual results could
differ from these estimates.
The allowance for doubtful accounts and sales returns is based on the
Company's assessment of the collectibility of specific customer accounts,
the aging of our accounts receivable and trends in product returns. While
the Company believes that the allowance for doubtful accounts and sales
returns is adequate, if there is a deterioration of a major customer's
credit worthiness, actual defaults are higher than previous experience, or
actual future returns do not reflect historical trends, estimates of
recoverability of amounts due, and sales, could be adversely affected.
Inventory purchases and commitments are based upon future demand forecasts.
If there is a sudden and significant decrease in demand for the Company's
products or there is a higher risk of inventory obsolescence because of
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rapidly changing technology and requirements, the Company may be required to
increase its inventory reserves and, as a result, gross profit margins could
be adversely affected.
Accounting for income taxes requires estimates of future tax liabilities.
Due to timing differences in the recognition of items included in income for
accounting and tax purposes, deferred tax assets or liabilities are recorded
to reflect the impact on future tax payments of these differences. With
respect to recorded tax assets, the Company assesses the likelihood that the
asset will be realized. If realization is in doubt because of uncertainty
regarding future profitability or enacted tax rates, the Company provides a
valuation allowance related to the asset. Should any significant changes in
the tax law or estimate of the necessary valuation allowance occur, the
Company would record the impact of the change, which could have a material
effect on financial position or results of operations.
Pension and postretirement medical costs and obligations are dependent on
assumptions used by the Company's actuaries in calculating such amounts.
These assumptions include discount rates, healthcare cost trends, inflation,
salary growth, long-term return on plan assets, retirement rates, mortality
rates, and other factors. These assumptions are made based on a combination
of external market factors, actual historical experience, long-term trend
analysis, and an analysis of the assumptions being used by other companies
with similar plans. Actual results that differ from our assumptions are
accumulated and amortized over future periods. Significant differences in
actual experience or significant changes in assumptions would affect the
Company's pension and other postretirement benefit costs and obligations.
SAFE HARBOR STATEMENT
UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
This Quarterly Report on Form 10-Q, the 2003 Annual Report to stockholders,
including the President's letter, and the 2003 Annual Report on Form 10-K
include forward-looking statements about the Company's business, competition,
sales, expenditures, environmental regulatory compliance, foreign operations,
progress and effect of the government investigation, write-downs and reserves
relating to the consolidation of manufacturing and distribution facilities,
plans for reorganization, interest rate sensitivity, debt service, liquidity
and capital resources, and other operating and capital requirements. In
addition, forward-looking statements may be included in future Company
documents and in oral statements by Company representatives to security
analysts and investors. The Company is subject to risks that could cause
actual events to vary materially from such forward-looking statements,
including the following risk factors:
Risks Related to Reorganization. The Company is developing plans to
consolidate and reorganize some of its manufacturing and distribution
operations. There can be no assurance that the Company will be successful
in these efforts or that any consolidation or reorganization will result in
cost savings to the Company. The implementation of these reorganization
measures may disrupt the Company's manufacturing and distribution activities
and could adversely affect operations.
Risks related to government investigation: Based on information currently
known to management, the Company has recorded an estimate of the costs
related to the government investigation of its CMM division. However, no
assurances can be made that charges recorded for this matter reflect the
actual costs that will ultimately be incurred by the Company or that the
Company will not need to take additional charges.
Risks Related to Technology: Although the Company's strategy includes
investment in research and development of new and innovative products to meet
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technology advances, there can be no assurance that the Company will be
successful in competing against new technologies developed by competitors.
Risks Related to the Euro: The United Kingdom has not adopted the euro and the
Company's Scottish subsidiary transacts a significant amount of business with
euro countries. There can be no assurance that this situation will not result
in unforseen economic conditions that affect the Company's business.
Risks Related to Foreign Operations: Approximately a third of the Company's
sales and a quarter of net assets relate to foreign operations. Foreign
operations are subject to special risks that can materially affect the sales,
profits, cash flows, and financial position of the Company, including taxes
and other restrictions on distributions and payments, currency exchange rate
fluctuations, political and economic instability, inflation, minimum capital
requirements, and exchange controls. In particular, the Company's Brazilian
operations, which constitute over half of the Company's revenues from foreign
operations, can be very volatile, changing from year to year due to the
political situation and economy. As a result, the future performance of the
Brazilian operations is inherently unpredictable.
Risks Related to Cyclical Nature of the Industry: The market for most of the
Company's products is subject to economic conditions affecting the industrial
manufacturing sector, including the level of capital spending by industrial
companies and the general movement of manufacturing to low cost foreign
countries where the Company does not have a substantial market presence.
Accordingly, economic weakness in the industrial manufacturing sector has and
will result in decreased demand for the Company's products and will adversely
affect performance. Economic weakness in the consumer market also impacts the
Company's performance.
Risks Related to Shift in Manufacturing: The Company's primary customers are
in the manufacturing business and, in particular, in the metal working
industry. Manufacturing is shifting to low wage countries where the Company
does not have a substantial market presence. As a result, unless the Company
can penetrate these markets, the Company's sales and performance may be
adversely affected.
Risks Related to Competition: The Company's business is subject to direct and
indirect competition from both domestic and foreign firms. In particular,
low-wage foreign sources have created severe competitive pricing pressures.
Under certain circumstances, including significant changes in U.S. and foreign
currency relationships, such pricing pressures tend to reduce unit sales
and/or adversely affect the Company's margins.
Risks Related to Customer Concentration: Sales to the Company's three biggest
customers account for approximately 25% of revenues. The loss or reduction in
orders by any of these customers, including reductions due to market, economic
or competitive conditions, could adversely affect business and results of
operations. In addition, these customers have, and may continue to, place
pressure on the Company to reduce its prices. This pricing pressure may affect
the Company's margins and revenues and could adversely affect business and
results of operations.
Risks Related to Insurance Coverage. The Company carries liability, property
damage, workers' compensation, medical, and other insurance coverages that
management considers adequate for the protection of its assets and operations.
There can be no assurance, however, that the coverage limits of such policies
will be adequate to cover all claims and losses. Such uncovered claims and
losses could have a material adverse effect on the Company. The Company self-
insures for health benefits and retains risk in the form of deductibles and
sublimits. Depending on the risk, deductibles can be as high as 5% of the loss
or $500,000.
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Risks Related to Stock Market Performance. Although the Company's domestic
defined benefit pension plan is significantly overfunded, a significant
(over 30%) drop in the stock market, even if short in duration, could cause
the plan to become temporarily underfunded and require the temporary
reclassification of prepaid pension cost on the balance sheet from an asset
to a contra equity account, thus reducing stockholders equity and book value
per share.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Market risk is the potential change in a financial instrument's value caused
by fluctuations in interest and currency exchange rates, and equity and
commodity prices. The Company's operating activities expose it to risks that
are continually monitored, evaluated, and managed. Proper management of
these risks helps reduce the likelihood of earnings volatility. At December
2003 and June 2003, the Company was not a party to any derivative
arrangement and the Company does not engage in trading, market-making or
other speculative activities in the derivatives markets. The Company does
not enter into long-term supply contracts with either fixed prices or
quantities. The Company does not engage in regular hedging activities to
minimize the impact of foreign currency fluctuations. Net foreign monetary
assets total approximately $7 million as of December 27, 2003.
A 10% change in interest rates would not have a significant impact on the
aggregate net fair value of the Company's interest rate sensitive financial
instruments (primarily variable rate investments of $29 million and debt of
$4 million at December 27, 2003) or the cash flows or future earnings
associated with those financial instruments. A 10% change in interest rates
would impact the fair value of the Company's fixed rate investments of $2.3
million by approximately $35,000.
Item 4. CONTROLS AND PROCEDURES
The Company's management, under the supervision and with the participation
of the Company's President and Chief Executive Officer and Chief Financial
Officer, have evaluated the Company's disclosure controls and procedures as
of December 27, 2003, and they have concluded that these controls and
procedures are effective. There have been no significant changes in internal
control over financial reporting that have materially affected, or are
reasonably likely to materially affect, the Company's internal control over
financial reporting. In August, 2003, as reported in the Company's Annual
Report on Form 10-K for fiscal 2003, the Company's management and its
outside auditors reported to the Audit Committee one reportable condition
related to computer file access and the Company has corrected the condition.
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
31a Certification of Chief Executive Officer Pursuant to Rule
13a-14(a), filed herewith.
31b Certification of Chief Financial Officer Pursuant to Rule
13a-14(a), filed herewith.
32 Certification of Chief Executive Officer and Chief Financial
Officer Pursuant to Rule 13a-14(b) and Section 906 of the
Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of Section
1350, Chapter 63 of Title 18, United States Code), filed
herewith.
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(b) Reports on Form 8-K
The following reports on Form 8-K were filed with or furnished to
the SEC in the quarter covered by this report:
1. The Company furnished a report on Form 8-K on November 7,
2003 announcing it had issued a Quarterly Shareholder
Earnings Letter containing a summary of its first quarter
consolidated financial results for fiscal 2004.
SIGNATURES
Pursuant to the requirements 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.
THE L. S. STARRETT COMPANY
(Registrant)
Date: February 6, 2004 S/R.U.WELLINGTON, JR.
R. U. Wellington, Jr. (Vice President,
Treasurer and Chief Financial Officer)
Date: February 6, 2004 S/S.G.THOMSON
S. G. Thomson (Chief Accounting Officer)
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