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 March 27, 2004
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 April 30, 2004 :
Class A Common Shares 5,380,818
Class B Common Shares 1,253,752
Page 1 of 18
THE L. S. STARRETT COMPANY
CONTENTS
Page No.
Part I. Financial Information:
Item 1. Financial Statements
Consolidated Statements of Operations -
thirteen and thirty-nine
weeks ended March 27, 2004 and
March 29, 2003 (unaudited) 3
Consolidated Statements of Cash Flows -
thirteen and thirty-nine
weeks ended March 27, 2004 and
March 29, 2003 (unaudited) 4
Consolidated Balance Sheets - March 27,
2004 (unaudited) and June 28, 2003 5
Consolidated Statements of Stockholders'
Equity - thirty-nine weeks ended
March 27, 2004 and March 29, 2003
(unaudited) 6
Notes to Consolidated Financial Statements 7-9
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 9-16
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 17
Item 4. Controls and Procedures 17
Part II. Other information:
Item 2. Changes in Securities and Use of Proceeds 17
Item 6. Exhibits and reports on Form 8-K 18
SIGNATURES 18
Page 2 of 18
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 39 Weeks Ended
3/27/04 3/29/03 3/27/04 3/29/03
Net sales 44,945 41,525 131,040 131,688
Cost of goods sold (33,017) (32,363) (100,985)(103,448)
Selling and general expense (11,684) (11,507) (34,518) (35,165)
Other expense (64) 90 (416) (1,165)
Earnings (loss) before income taxes and
cumulative effect of change in
accounting principle 180 (2,255) (4,879) (8,090)
Benefit from federal, foreign
and state income taxes (264) (988) (2,395) (3,647)
Earnings (loss) before cumulative effect
of change in accounting principle 444 (1,267) (2,484) (4,443)
Cumulative effect of change in
accounting principle for goodwill (6,086)
Net earnings (loss) 444 (1,267) (2,484) (10,529)
Basic and diluted earnings (loss) per
share before cumulative effect of
change in accounting principle .07 (.19) (.37) (.67)
Cumulative effect of change in
accounting principle for goodwill (.93)
Basic and diluted earnings (loss)
per share .07 (.19) (.37) (1.60)
Average outstanding shares used in per
share calculations (in thousands)
Basic 6,642 6,632 6,653 6,591
Diluted 6,658 N/A N/A N/A
Dividends per share .10 .20 .30 .60
See Notes to Consolidated Financial Statements
Page 3 of 18
THE L. S. STARRETT COMPANY
Consolidated Statements of Cash Flows
(in thousands of dollars)(unaudited)
13 Weeks Ended 39 Weeks Ended
3/27/04 3/29/03 3/27/04 3/29/03
Cash flows from operating activities:
Net earnings (loss) 444 (1,267) (2,484) (10,529)
Non-cash items included:
Cumulative effect of change in
accounting principle 6,086
Depreciation and amortization 2,658 2,802 8,249 8,334
Deferred taxes (462) 37 (1,494) (254)
Unrealized exchange losses (gains) (1) (89) (33) 1,371
Retirement benefits (116) (31) (350) (535)
Working capital changes:
Receivables 2,866 1,932 4,101 3,217
Inventories 2,144 4,509 9,723 16,617
Other assets and liabilities (167) (2,777) 1,920 (2,117)
Prepaid pension cost and other 49 88 224 (19)
Net operating cash flows 7,415 5,204 19,856 22,171
Cash flows from investing activities:
Additions to plant and equipment (1,363) (1,681) (4,658) (4,670)
Change in short-term investments (8,792) 422 (14,019) (13,210)
Net investing cash flows (10,155) (1,259) (18,677) (17,880)
Cash flows from financing activities:
Short-term borrowings (repayments) 443 (9) 900 (860)
Long-term borrowings (repayments) 615 (1,014) (2,147) 1,735
Common stock issued 1,041 226 2,350
Treasury shares purchased (235) (98) (633) (455)
Dividends (663) (1,328) (1,993) (3,952)
Net financing cash flows 160 (1,408) (3,647) (1,182)
Exchange rate change effect on cash 123 19 221 (60)
Net increase (decrease) in cash (2,457) 2,556 (2,247) 3,049
Cash, beginning of period 3,516 2,165 3,306 1,672
Cash, end of period 1,059 4,721 1,059 4,721
See Notes to Consolidated Financial Statements
Page 4 of 18
THE L. S. STARRETT COMPANY
Consolidated Balance Sheets
(in thousands of dollars)
Mar. 27 June 28
2004 2003
ASSETS (unaudited)
Current assets:
Cash 1,059 3,306
Investments 36,865 21,995
Accounts receivable (less allowance for doubtful
accounts of $1,573 and $1,392) 29,399 32,175
Inventories:
Raw materials and supplies 9,508 9,859
Goods in process and finished parts 16,578 20,344
Finished goods 19,407 23,832
45,493 54,035
Prepaid expenses, taxes and other current assets 8,404 9,703
Total current assets 121,220 121,214
Property, plant and equipment, at cost (less
accumulated depreciation of $99,203
and $89,223) 64,759 67,093
Prepaid pension cost 31,123 30,565
Other assets 791 868
217,893 219,740
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable and current maturities 1,928 3,585
Accounts payable and accrued expenses 14,972 12,859
Accrued salaries, wages and postretirement benefits 4,562 4,940
Total current liabilities 21,462 21,384
Deferred income taxes 13,253 14,696
Long-term debt 3,117 2,652
Accumulated postretirement medical benefit obligation 16,306 16,057
Stockholders' equity:
Class A Common $1 par (20,000,000 shrs. auth.;
5,374,296 outstanding on 3/27/04, excluding
1,321,553 in treasury; 5,344,033 outstanding
on 6/28/03, excluding 1,294,542 in treasury) 5,374 5,344
Class B Common $1 par (10,000,000 shrs. auth.;
1,259,774 outstanding on 3/27/04, excluding
332,019 in treasury; 1,315,489 outstanding
on 6/28/03, excluding 332,019 in treasury) 1,260 1,315
Additional paid-in capital 49,700 49,826
Retained earnings reinvested and employed in
the business 129,814 134,547
Accumulated other comprehensive loss (22,393) (26,081)
Total stockholders' equity 163,755 164,951
217,893 219,740
See Notes to Consolidated Financial Statements
Page 5 of 18
THE L. S. STARRETT COMPANY
Consolidated Statements of Stockholders' Equity
For the Thirty-nine Weeks Ended March 27, 2004 and March 29, 2003
(in thousands of dollars)
(unaudited)
Common Addi- Accumulated
Stock Out- tional Other
standing Paid-in Retained Comprehensive
($1 Par) Capital Earnings Loss Total
Balance June 29, 2002 6,544 47,858 150,029 (24,090) 180,341
Comprehensive income(loss):
Net loss (10,529) (10,529)
Unrealized net loss
on investments (12) (12)
Translation loss, net (2,647) (2,647)
Total comprehensive loss (13,188)
Dividends ($.60 per share) (3,952) (3,952)
Treasury shares:
Purchased (24) (204) (227) (455)
Issued 135 2,081 2,216
Options exercised 10 124 134
Balance March 29, 2003 6,665 49,859 135,321 (26,749) 165,096
Balance June 28, 2003 6,659 49,826 134,547 (26,081) 164,951
Comprehensive income(loss):
Net loss (2,484) (2,484)
Unrealized net gain
on investments 29 29
Translation gain, net 3,659 3,659
Total comprehensive income 1,204
Dividends ($.30 per share) (1,993) (1,993)
Treasury shares:
Purchased (40) (337) (256) (633)
Issued 13 194 207
Options exercised 2 17 19
Balance March 27, 2004 6,634 49,700 129,814 (22,393) 163,755
See Notes to Consolidated Financial Statements
Page 6 of 18
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 March 27,
2004 and June 28, 2003; the results of operations and cash flows for the
thirteen and thirty-nine weeks ended March 27, 2004 and March 29, 2003; and
changes in stockholders' equity for the thirty-nine weeks ended March 27,
2004 and March 29, 2003.
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.
Except in the fiscal 2004 March quarter, which had net earnings, shares used
to compute basic and diluted loss per share are the same since the inclusion
of common stock equivalents (8,553 shares in the quarter ended March 29,
2003, 13,781 shares in the nine months ended March 27, 2004, and 7,394
shares in the nine months ended March 29, 2003) 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 first
quarter of fiscal 2003 in connection with a government investigation of its
Coordinate Measuring Machine (CMM) division, and additional charges were
incurred thereafter. As of March 27, 2004, 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 in connection with this matter.
Effective with the beginning of the first quarter of fiscal 2004, the
Company has adopted the fair value method of accounting for stock-based
compensation on a prospective basis as described in SFAS 123 and 148. The
Company incurred $27,000 in stock-based compensation costs in the December
2003 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 one-time,
non-cash, 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 first quarter of fiscal 2003 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 March 27, 2004 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 18
Other income (expense) is comprised of the following (in thousands):
Thirteen Weeks Thirty-nine Weeks
Ended March Ended March
2004 2003 2004 2003
Interest income 220 212 565 602
Interest expense and com-
mitment fees (271) (230) (834) (448)
Realized and unrealized
exchange gains (losses) 7 187 (3) (1,155)
Other (20) (79) (144) (164)
(64) 90 (416) (1,165)
Net periodic benefit costs (benefits) for the Company's defined benefit
pension plans consists of the following (in thousands):
Thirteen Weeks Thirty-nine Weeks
Ended March Ended March
2004 2003 2004 2003
Service cost 813 820 2,439 2,459
Interest cost 1,530 1,623 4,591 4,868
Expected return on plan assets (2,352) (2,568) (7,057) (7,703)
Amort. of transition obligation (244) (239) (731) (717)
Amort. of prior service cost 106 102 317 306
Amort. of unrecognized (gain)loss 73 (15) 219 (44)
(74) (277) (222) (831)
Net periodic benefit costs (benefits) for the Company's postretirement
medical plan consists of the following (in thousands):
Thirteen Weeks Thirty-nine Weeks
Ended March Ended March
2004 2003 2004 2003
Service cost 164 158 493 475
Interest cost 259 264 778 793
Amort. of prior service cost (88) (88) (265) (265)
Amort. of unrecognized (gain)loss 31 14 93 42
366 348 1,099 1,045
Approximately 70% of all inventories are valued on the LIFO method. At
March 27, 2004 and June 28, 2003, total inventories are approximately $22
million less than if determined on a FIFO basis. During fiscal 2004, the
Company has 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 reductions was to increase the March 2004 quarter and year-
to-date net earnings by approximately $.6 million and $.9 million,
respectively ($.05 and $.08 per share).
Page 8 of 18
Long-term debt is comprised of the following (in thousands):
March June
2004 2003 .
Note payable at 3.1% due 12/03 2,318
Capitalized lease obligations
payable in Brazilian currency
due 2003 - 2007, 15%-21% 3,666 3,433
3,666 5,751
Less current portion 549 3,099
3,117 2,652
The Company is considering various reorganization and restructuring 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 reorganization or restructuring plans are implemented
or obligations are incurred.
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
QUARTERS ENDED MARCH 27, 2004 AND MARCH 29, 2003
Sales
Total Company sales for the March 2004 quarter were approximately 8% higher
than the corresponding quarter of a year ago, approximately half the
increase being the result of exchange rate changes. Domestic sales were up
7% and foreign sales were up 12%, although in local currency foreign sales
were actually down 4% because of the weak U.S. dollar. Domestic sales are
improving, although the U.S. industrial manufacturing sector, particularly
in metal working, will continue to be affected by the migration of
manufacturing, both customers and competitors, to lower cost countries.
Earnings (Loss) Before Income Taxes
The Company had pretax earnings for the quarter of $.2 million, compared to
a $2.3 million loss a year earlier. The current and prior year quarters
included charges of $.1 million and $.6 million, respectively, for
professional fees associated with the government investigation of the
Company's Coordinate Measuring Machine (CMM) division (see below). Domestic
operations had pretax earnings of 1% of sales compared to a loss of 6% of
sales last year (before considering the $.1 million and $.6 million for
professional fees mentioned above). Foreign operations essentially broke
even on a pretax basis for the March quarters in both years. Excluding the
$.1 million and $.6 million charges for professional fees, the major item
contributing to the $1.9 million improvement in earnings was improved gross
margins (26.5% in the March 2004 quarter compared to 22% in the March 2003
quarter, or $2.0 million). The gross margin improvement is primarily
domestic and resulted from higher production levels and the benefit ($.6
million) of liquidating LIFO inventories; all partially offset by higher
retirement and group medical costs ($.5 million) and costs associated with
the consolidation of the Company's Skipton, England plant into its Scotland
facilities ($.3 million). Although selling and general expense decreased as
a percent of sales from 28% last year to 26% this year, the dollars reported
remained about the same because foreign currencies strengthened against the
U.S. dollar, accounting for approximately half the increase in sales.
Page 9 of 18
Income Tax Benefit
The effective income tax rate was over 100% in the March 2004 quarter and
accounted for $.05 per share of the Company's net earnings for the quarter.
The rate was 44% 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 very difficult 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. In
addition, the decision in the quarter to have our wholly-owned Brazilian
subsidiary pay a dividend increased our expected tax benefit for the full
fiscal year by $.5 million, three quarters of which has been recorded in
the current quarter. The effect of this was to increase earnings per share
by approximately $.02 in the quarter. Despite recent losses, the Company
currently expects that 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 earnings (loss) per share
As a result of the above factors, the Company had basic and diluted earnings
of $.07 per share in the March 2004 quarter compared to a loss of $.19 per
share in the March quarter a year ago (earnings of $.08 per share and a loss
of $.13 per share a year ago excluding the charges for professional fees
mentioned above).
NINE MONTH PERIODS ENDED MARCH 27, 2004 AND MARCH 29, 2003
OVERVIEW
As more fully discussed below, results for the first nine months of fiscal
2004 show the Company incurred a net loss of $2.5 million, or $.37 per
share, compared to a net loss of $10.5 million, or $1.60 per share, in the
comparable prior year nine 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 to net realizable
value of CMM inventories and $.3 million, or $.03 per share after tax, in
charges for professional fees in connection with the government's
investigation of the Company's CMM division; and in the prior year the
write-off of $6.1 million, or $.93 per share before and after tax, of
goodwill in connection with the adoption of SFAS 142 and $3.7 million, or
$.36 per share after tax, in charges in connection with the CMM division
investigation and replacement program. Excluding these unusual charges, the
Company incurred a net loss for the first nine months of fiscal 2004 of $.3
million, or $.04 per share compared to a net loss of $2.1 million or $.31
per share in the corresponding prior year nine month period.
Sales
Sales for the first nine months of fiscal 2004 were about the same as the
corresponding period a year ago. Domestic sales were down 4.5% and foreign
sales were up 10%. In local currency foreign sales were actually down 4% in
fiscal 2004 since the dollar has continued to weaken against the British
pound and Brazilian real. The decrease in domestic sales results primarily
from low first quarter 2004 sales.
Loss before income taxes and cumulative effect of change in accounting
The pretax losses for the first nine months of fiscal 2004 and 2003 were
$4.9 million and $8.1 million, respectively. Both nine month periods contain
Page 10 of 18
unusual charges: in the current fiscal year, $3.2 million to write down the
CMM inventory to net realizable value and $.3 million for additional
professional fees in connection with the government investigation; and, in
the prior fiscal year, $3.7 million in connection with the government
investigation ($2.1 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 nine month periods were $1.4 million in fiscal 2004
and $4.4 million in fiscal 2003, a $3.0 million improvement.
The major items causing the $3.0 million improvement were lower ($1.2
million) exchange losses, primarily in Brazil, and better gross margins (25%
compared to 23% or $3.4 million excluding unusual charges). Despite slightly
lower sales and excluding the effect on cost of sales in both years of the
unusual charges related to the CMM division, the gross margin improved over
2 percentage points due primarily to lower headcount, higher production
levels, and LIFO inventory liquidation profits ($.9 million), all partially
offset by costs ($.6 million) associated with the consolidation of the
Company's Skipton, England plant into its Scotland facilities. The exchange
rate and margin improvements were partially offset by higher interest
expense ($.4 million) in Brazil due to borrowing in local currency and an
overall $1.2 million increase in selling and general expense. Contributing
to this $1.2 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.
Income tax benefit
The effective income tax rate was 49% in the first nine months of fiscal
2004 and 45% in the corresponding prior year nine 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. In addition, the decision in the
fiscal 2004 March quarter to have our wholly-owned Brazilian subsidiary pay
a dividend increased our expected tax benefit for the full fiscal year by
$.5 million, three quarters of which has been recorded as of the end of the
first nine months of fiscal 2004. Despite recent losses, the Company
currently expects that 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 nine months of fiscal
2004 of $.37 per share compared to $1.60 per share in the corresponding
period a year ago. Excluding the unusual charges related to the CMM division
($.35 per share in the current year and $.36 in the prior year) and
excluding the $.93 per share related to the adoption of SFAS 142 (write-off
of goodwill) discussed in the notes to the financial statements, the Company
incurred a net loss of $.02 per share in the first nine months of fiscal
2004 compared to a net loss of $.31 per share in the corresponding period a
year ago.
Coordinate Measuring Machine (CMM) division
As discussed in more detail in the Company's Annual Report on Form 10-K for
fiscal 2003, the Company's CMM division is 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
Page 11 of 18
investigation apparently was prompted by a qui tam action filed under seal
in federal court in 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, $.2 million in the
September 2003 quarter, and $.1 million in the March 2004 quarter. As of
March 27, 2004, approximately $.2 million remains reserved for professional
fees. In addition, the Company charged cost of sales and wrote down the
carrying cost of its CMM inventory by $3.2 million to net realizable value
in the December 2003 quarter. No assurances can be made that these reserves
and write-downs reflect the actual additional costs that will be incurred by
the Company. See the additional comments below under "Reorganization and
Restructuring Plans" regarding the CMM division.
LIQUIDITY AND CAPITAL RESOURCES
Cash Flows 13 Weeks Ended 39 Weeks Ended
3/27/04 3/29/03 3/27/04 3/29/03
Operating cash flow 7,415 5,204 19,856 22,171
Investing cash flow (10,155) (1,259) (18,677) (17,880)
Financing cash flow 160 (1,408) (3,647) (1,182)
Despite recurring 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 the most
significant factor contributing to positive operating cash flow has been the
reduction in inventories, which has been slowing and is unlikely to continue
much longer. "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 increase in cash used for investing activities in the current quarter is
partially a result of the increase in cash available for investment from
operations, but mainly reflects the timing of activity from quarter to
quarter.
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 2003 fiscal year worth approximately $3 million
that reduced the 2003 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.
Page 12 of 18
Liquidity and credit arrangements
The Company believes it maintains sufficient liquidity and has the resources
to fund its operations in the near term. If 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 and Restructuring Plans"
section below). The Company and its lender have amended 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 is not
currently borrowing under its line of credit. The Company has a working
capital ratio of 5.6 to one as of March 27, 2004 and 5.7 to one as of June
28, 2003.
Reorganization and Restructuring Plans
As discussed in greater detail in the Company's Form 10-Q for the quarter
ended December 27, 2003, manufacturing globalization has adversely affected
the Company's customer base and competitive position, particularly in North
America, as more and more products are produced in low wage countries. As a
result, the Company has been rethinking almost all aspects of its business
and is formulating plans to lower wage costs, consolidate operations, move
the strategic focus from manufacturing location to product group and
distribution channel as well as achieving the goals of enhanced marketing
focus and global procurement. Although there have been and may in the future
be non-recurring costs associated with these plans (see CMM division
comments above), Management believes it is premature to take additional
charges at this time. Regardless of the outcome of the ongoing government
investigation, the outlook for the CMM division is problematic. Specific
actions being considered for the CMM division range from staying in the
business, to outsourcing, to exiting altogether. In the December 2003
quarter, the Company wrote down its CMM inventories by $3.2 million to an
estimated net realizable value of $1.0 million (see above). The Company is
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. The Company has closed, and
is trying to sell, its Alum Bank, Pennsylvania level manufacturing plant and
is relocating the manufacturing to the Dominican Republic. Relocation of
other manufacturing capacity is also being considered. In addition, the
Company has recently consolidated its consumer hardware products activities
under one business unit head and created a new consumer hardware sales and
marketing organization. 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. The Company has
closed one warehouse and is evaluating consolidating or eliminating others.
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 currently expected as a result of
these actions pertaining to distribution facilities. 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 plans.
Page 13 of 18
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 for fiscal
2003 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
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.
Page 14 of 18
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 Annual Report on Form 10-K for
fiscal 2003 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 continues to develop 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, could adversely affect operations, and could result in asset
impairment charges and other costs that will be recognized if and when
reorganization or restructuring plans are implemented or obligations are
incurred.
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
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 unforeseen 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 the Weakness of the Industrial Manufacturing Sector: 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
Page 15 of 18
market presence. Accordingly, economic weakness in the industrial
manufacturing sector has and may continue to result in decreased demand for
certain of the Company's products and will adversely affect performance.
Economic weakness in the consumer market will also adversely impact the
Company's performance. In the event that demand for any of the Company's
products declines significantly, the Company could be required to recognize
certain costs as well as asset impairment charges on long-lived assets
related to those products.
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.
Risk Related to Raw Material and Energy Costs. Steel is the principal raw
material used in the manufacture of the Company's products. The price of
steel has historically fluctuated on a cyclical basis and has often depended
on a variety of factors over which the Company has no control. The cost of
producing the Company's products is also sensitive to the price of energy.
The selling prices of the Company's products have not always increased in
response to raw material, energy or other cost increases, and the Company is
unable to determine to what extent, if any, it will be able to pass future
cost increases through to its customers. The Company's inability to pass
increased costs through to its customers could materially and adversely
affect its financial condition or results of operations.
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.
Page 16 of 18
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 March
2004 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 March 27, 2004.
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 March 27, 2004) 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 $30,000.
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 March 27, 2004, 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 2. Changes in Securities and Use of Proceeds
A summary of the Company's repurchases of shares of its common stock for the
three months ended March 27, 2004 is as follows:
ISSUER PURCHASES OF EQUITY SECURITIES
Shares Purchased Shares yet to be
Shares Average Under Announced Purchased Under
Period Purchased Price Programs Announced Programs
12/28/03-
1/27/04 none
1/28/04-
2/27/04 15,000 15.61 none none
2/28/04-
3/27/04 none
All of the above shares were repurchased by the Company on February 23, 2004
directly from the Company's 401(k) plan in connection with diversifications
made by participants in the plan.
Page 17 of 18
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
10g Amendment dated as of March 1, 2004 to the Company's
$25,000,000 Revolving Credit Agreement, filed herewith.
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.
(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 February 6,
2004 announcing it had issued a Quarterly Shareholder
Earnings Letter containing a summary of its fiscal 2004
second quarter consolidated financial results.
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: May 7, 2004 S/R.U.WELLINGTON, JR.
R. U. Wellington, Jr. (Vice President,
Treasurer and Chief Financial Officer)
Date: May 7, 2004 S/S.G.THOMSON
S. G. Thomson (Chief Accounting Officer)
Page 18 of 18