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 25, 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 January 31, 2005 :
Class A Common Shares 5,427,869
Class B Common Shares 1,222,985
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 twenty-six weeks ended
December 25, 2004 and December 27, 2003
(unaudited) 3
Consolidated Statements of Cash Flows -
thirteen and twenty-six weeks ended
December 25, 2004 and December 27, 2003
(unaudited) 4
Consolidated Balance Sheets -
December 25, 2004 (unaudited) and
June 26, 2004 5
Consolidated Statements of Stockholders'
Equity - twenty-six weeks ended
December 25, 2004 and December 27, 2003
(unaudited) 6
Notes to Consolidated Financial Statements 7-9
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 9-17
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 17
Item 4. Controls and Procedures 17
Part II. Other information:
Item 2. Unregistered Sales of Equity Securities
and Use of Proceeds 18
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 26 Weeks Ended
12/25/04 12/27/03 12/25/04 12/27/03
Net sales 49,255 45,420 96,050 86,095
Cost of goods sold (35,431) (37,028) (68,868) (67,968)
Selling and general expense (12,067) (11,420) (23,916) (22,834)
Other income (expense) (124) (81) 381 (352)
Earnings (loss) before income taxes 1,633 (3,109) 3,647 (5,059)
Provision (benefit) for federal,
foreign and state income taxes 321 (1,276) 671 (2,131)
Net earnings (loss) 1,312 (1,833) 2,976 (2,928)
Basic and diluted earnings (loss)
per share .20 (.28) .45 (.44)
Average outstanding shares used in per
share calculations (in thousands):
Basic 6,638 6,655 6,643 6,658
Diluted 6,652 6,655 6,657 6,658
Dividends per share .10 .10 .20 .20
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 26 Weeks Ended
12/25/04 12/27/03 12/25/04 12/27/03
Cash flows from operating activities:
Net earnings (loss) 1,312 (1,833) 2,976 (2,928)
Non-cash items included:
Depreciation and amortization 2,651 2,836 5,212 5,591
Deferred taxes 119 (1,013) 171 (1,032)
Retirement benefits (475) (117) (951) (234)
Working capital changes:
Receivables 714 986 1,647 1,235
Inventories (1,977) 6,865 (4,345) 7,579
Other assets and liabilities (883) 1,468 (1,172) 2,087
Prepaid pension cost and other 513 134 128 175
Net operating cash flows 1,974 9,326 3,666 12,473
Cash flows from investing activities:
Additions to plant and equipment (1,718) (2,017) (3,398) (3,295)
Proceeds from sale of real estate 1,522
Change in short-term investments (88) (2,947) (568) (5,227)
Net investing cash flows (1,806) (4,964) (2,444) (8,522)
Cash flows from financing activities:
Short-term borrowings (repayments) 207 (66) 640 457
Long-term debt repayments (491) (1,168) (576) (2,794)
Common stock issued 247 108 373 226
Treasury shares purchased (394) (398) (394) (398)
Dividends (665) (662) (1,330) (1,330)
Net financing cash flows (1,096) (2,186) (1,287) (3,839)
Exchange rate change effect on cash 113 146 104 98
Net increase (decrease) in cash (815) 2,322 39 210
Cash, beginning of period 3,337 1,194 2,483 3,306
Cash, end of period 2,522 3,516 2,522 3,516
See Notes to Consolidated Financial Statements
Page 4 of 18
THE L. S. STARRETT COMPANY
Consolidated Balance Sheets
(in thousands of dollars except share data)
Dec. 25 June 26
2004 2004
ASSETS (unaudited)
Current assets:
Cash 2,522 2,483
Investments 33,043 32,023
Accounts receivable (less allowance for doubtful
accounts of $1,486 and $1,358) 33,246 33,434
Inventories:
Raw materials and supplies 11,477 8,510
Goods in process and finished parts 18,672 16,780
Finished goods 19,400 17,987
49,549 43,277
Prepaid expenses, taxes and other current assets 10,153 11,534
Total current assets 128,513 122,751
Property, plant and equipment, at cost (less
accumulated depreciation of $105,490
and $100,767) 61,795 62,859
Prepaid pension cost 33,128 32,370
Other assets 379 944
223,815 218,924
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable and current maturities 2,668 2,302
Accounts payable and accrued expenses 14,735 16,005
Accrued salaries and wages 4,248 4,375
Total current liabilities 21,651 22,682
Deferred income taxes 14,382 14,214
Long-term debt 2,693 2,536
Accumulated postretirement medical benefit obligation 17,011 17,209
Stockholders' equity:
Class A Common $1 par (20,000,000 shrs. auth.,
5,416,591 outstanding on 12/25/04, 5,396,679
outstanding on 6/26/04) 5,417 5,397
Class B Common $1 par (10,000,000 shrs. auth.,
1,230,177 outstanding on 12/25/04, 1,250,106
outstanding on 6/26/04) 1,230 1,250
Additional paid-in capital 50,123 49,934
Retained earnings reinvested and employed in
the business 130,769 129,282
Accumulated other comprehensive loss (19,461) (23,580)
Total stockholders' equity 168,078 162,283
223,815 218,924
See Notes to Consolidated Financial Statements
Page 5 of 18
THE L. S. STARRETT COMPANY
Consolidated Statements of Stockholders' Equity
For the Twenty-six Weeks Ended December 25, 2004 and December 27, 2003
(in thousands of dollars except per share data)
(unaudited)
Common Addi- Accumulated
Stock Out- tional Other
standing Paid-in Retained Comprehensive
($1 Par) Capital Earnings Loss Total
Balance June 28, 2003 6,659 49,826 134,547 (26,081) 164,951
Comprehensive income(loss):
Net loss (2,928) (2,928)
Unrealized net gain
on investments 18 18
Translation gain, net 1,405 1,405
Total comprehensive loss (1,505)
Dividends ($.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
Balance June 26, 2004 6,647 49,934 129,282 (23,580) 162,283
Comprehensive income(loss):
Net earnings 2,976 2,976
Unrealized net gain
on investments 78 78
Translation gain, net 4,041 4,041
Total comprehensive income 7,095
Dividends ($.20 per share) (1,330) (1,330)
Treasury shares:
Purchased (25) (210) (159) (394)
Issued 9 118 127
Options exercised 16 281 297
Balance Dec. 25, 2004 6,647 50,123 130,769 (19,461) 168,078
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 December 25,
2004 and June 26, 2004; the results of operations and cash flows for the
thirteen and twenty-six weeks ended December 25, 2004 and December 27, 2003;
and changes in stockholders' equity for the twenty-six weeks ended December
25, 2004 and December 27, 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 26, 2004, 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.
In the December 2003 quarter as well as the December 2003 six month period,
shares used to compute diluted loss per share were the same as shares used
to compute basic loss per share since inclusion of common stock equivalents
(12,226 and 12,694 shares, respectively) is antidilutive in periods with a
loss.
Included in investments at December 25, 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.
Other income (expense) is comprised of the following (in thousands):
Thirteen Weeks Twenty-six Weeks
Ended December Ended December
2004 2003 2004 2003
Interest income 257 190 492 345
Interest expense and com-
mitment fees (186) (235) (381) (563)
Realized and unrealized
exchange gains (losses) (116) 29 (263) (10)
Gain on sale of real estate 662
Other (79) (65) (129) (124)
(124) (81) 381 (352)
Net periodic benefit costs (benefits) for the Company's defined benefit
pension plans consists of the following (in thousands):
Thirteen Weeks Twenty-six Weeks
Ended December Ended December
2004 2003 2004 2003
Service cost 804 813 1,608 1,626
Interest cost 1,648 1,530 3,296 3,060
Expected return on plan assets (2,578) (2,352) (5,156) (4,704)
Amort. of transition obligation (245) (244) (490) (488)
Amort. of prior service cost 107 106 214 212
Amort. of unrecognized loss 73 146
(264) (74) (528) (148)
Page 7 of 18
Net periodic benefit costs (benefits) for the Company's postretirement
medical plan consists of the following (in thousands):
Thirteen Weeks Twenty-six Weeks
Ended December Ended December
2004 2003 2004 2003
Service cost 129 164 258 328
Interest cost 238 259 476 518
Amort. of prior service cost (118) (88) (236) (176)
Amort. of unrecognized loss 16 31 32 62
265 366 530 732
Approximately two thirds of all inventories are valued on the LIFO method.
At December 25, 2004 and June 26, 2004, total inventories are approximately
$20 million less 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 this LIFO inventory reduction was to increase second quarter
2003 net earnings by approximately $.2 million, or $.03 per share.
Long-term debt is comprised of the following (in thousands):
December June
2004 2004
Revolving credit agreement - -
Capitalized lease obligations payable in
Brazilian currency due 2005-2008, 15%-22% 3,945 3,971
Less current portion (1,252) (1,435)
2,693 2,536
Current notes payable, primarily in Brazilian currency, carry interest at up
to 15%.
RECENT ACCOUNTING PRONOUNCEMENTS
FAS 151: In November 2004, the FASB issued Statement No. 151, Inventory
Costs, an amendment of ARB No. 43, Chapter 4. Statement 151 clarifies the
accounting for abnormal amounts of idle facility expense, freight, handling
costs and wasted material. Statement 151 is effective for inventory costs
incurred during fiscal years beginning after June 15, 2005. The Company does
not believe adoption of Statement 151 will have a material effect on its
consolidated financial position, results of operations or cash flows.
FAS 153: In December 2004, the FASB issued Statement No. 153, Exchanges of
Nonmonetary Assets, an amendment of APB Opinion No. 29. Statement 153
addresses the measurement of exchanges of nonmonetary assets and redefines
the scope of transactions that should be measured based on the fair value of
the assets exchanged. Statement 153 is effective for nonmonetary asset
exchanges occurring in fiscal periods beginning after June 15, 2005. The
Company does not believe adoption of Statement 153 will have a material
effect on its consolidated financial position, results of operations or cash
flows.
FSP FASB 109-1 and 109-2: In December 2004, the FASB issued FASB Staff
Position No. 109-1, Application of FASB Statement No. 109 (SFAS 109),
Accounting for Income Taxes, to the Tax Deduction on Qualified Production
Activities Provided by the American Jobs Creation Act of 2004 (FSP 109-1).
FSP 109-1 clarifies that the manufacturer's deduction provided for under the
Page 8 of 18
American Jobs Creation Act of 2004 (AJCA) should be accounted for as a
special deduction in accordance with SFAS 109 and not as a tax rate
reduction. The adoption of FSP 109-1 will have no impact on the Company's
results of operations or financial position for fiscal year 2005 because the
manufacturer's deduction is not available to the Company until fiscal year
2006. The company is evaluating the effect that the manufacturer's deduction
will have in subsequent years.
The FASB also issued FASB Staff Position No. 109-2, Accounting and
Disclosure Guidance for the Foreign Earnings Repatriation Provision within
the American Jobs Creation Act of 2004 (FSP 109-2). The AJCA introduces a
special one-time dividends received deduction on the repatriation of certain
foreign earnings to a U.S. taxpayer (repatriation provision), provided
certain criteria are met. FSP 109-2 provides accounting and disclosure
guidance for the repatriation provision. Until the Treasury Department or
Congress provides additional clarifying language on key elements of the
repatriation provision, the amount of foreign earnings to be repatriated by
the Company, if any, cannot be determined. FSP 109-2 grants an enterprise
additional time beyond the year ended December 31, 2004, in which the AJCA
was enacted, to evaluate the effects of the AJCA on its plan for
reinvestment or repatriation of unremitted earnings. FSP 109-2 calls for
enhanced disclosures of, among other items, the status of a Company's
evaluations, the effects of completed evaluations, and the potential range
of income tax effects of repatriations. The Company has just begun this
evaluation process. At the present time, deferred taxes have not been
recorded on approximately $40 million of undistributed earnings of foreign
subsidiaries or the related unrealized translation adjustments because such
amounts are considered permanently invested, and it is possible that
remittance taxes, if any, would be reduced by U.S. foreign tax credits.
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
QUARTERS ENDED DECEMBER 25, 2004 AND DECEMBER 27, 2003
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 a $2.1 million or a $.32 per
share decrease in the quarter's net results. Management routinely reviews
the results of operations both with and without large, identifiable charges
and credits, like the CMM investigation discussed below, to better
understand the performance of the Company's core business.
Sales
Sales for the fiscal 2005 December quarter are up $3.8 million or 8%
compared to the fiscal 2004 December quarter. Domestic sales are up 6% and
foreign sales are up 17% (11% in local currency). The increase in sales
reflects the improvement in the U.S. industrial manufacturing sector, which
started to affect us in the December quarter of fiscal 2004, as well as good
economic conditions in the Company's Brazilian market.
Page 9 of 18
Coordinate Measuring Machine (CMM) division
As discussed in greater detail in the Company's annual report on Form 10-K
for the fiscal year ended June 26, 2004, the Company reached a settlement in
August 2004 with the U.S. Department of Justice resulting in the termination
of the Government's investigation of the Company's CMM division. Under the
terms of the settlement, the Company paid the Government $.5 million, and
the Company and its officers, directors, employees and shareholders were
released from any causes of action relating to the false claims allegations
in the qui tam complaint that were the subject of the investigation. The
costs related to this investigation, including legal fees, were all recorded
in fiscal 2003 and 2004, including a $3.2 million pretax write-down of the
CMM division's inventory to net realizable value in the December quarter of
fiscal 2004. See the additional comments below under
"Reorganization/Restructuring Plans" regarding the CMM division.
Earnings (loss) before taxes
Pretax earnings for the quarter were $1.6 million compared to a $3.1 million
loss a year earlier. $3.2 million of last year's loss was attributable to
the CMM inventory write-down discussed above. Excluding this write-down from
the prior year's results, pretax earnings improved $1.5 million or, as a
function of current year sales, 3 percentage points. Domestic operations had
pretax earnings of .1% of sales in the December 2004 quarter compared to a
2% loss in the December 2003 quarter (before the CMM inventory write-down),
while foreign operations had pretax income of about 8% of sales in the
December 2004 quarter and 5% in the December 2003 quarter. The major items
causing the $1.5 million improvement in earnings before the CMM inventory
write-down were increased sales ($.9 million), and improved gross margins
(28.1% this year compared to 25.5% last year, or $1.2 million). These
improvements were offset by a $.6 million increase in selling and general
expense although, as a percentage of sales, selling and general expense
actually improved from 25.1% to 24.5%. The gross margin improvement is due
to lower headcount and higher production levels, offset by the benefit ($.3
million) in fiscal 2004 of liquidating LIFO inventories.
Income Taxes
The effective income tax rate was 20% in the December 2004 quarter and 41%
in the December 2003 quarter. The fluctuation in these rates comes about
because pretax results are so close to breakeven in most jurisdictions 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%. In
addition, the decision in the current quarter to have our wholly-owned
Brazilian subsidiary pay an intercompany dividend in the third quarter of
fiscal 2005 will reduce our tax expense for the full 2005 fiscal year by
approximately $.4 million (5 percentage points on the estimated full year
tax rate), and the tax rate has been adjusted accordingly in the December
2004 quarter. A similar dividend decision was made in fiscal 2004, however
the benefit was recognized beginning in the third quarter of fiscal 2004.
Despite recent losses, the Company continues to believe it will be able to
utilize its tax operating loss carryforwards generated in prior periods.
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 $.20 per share in the December 2004 quarter compared to a $.28 per share
loss in the December 2003 quarter, a $.48 improvement, $.32 of which was a
result of the CMM inventory write-down in the December 2003 quarter.
Page 10 of 18
SIX MONTH PERIODS ENDED DECEMBER 25, 2004 AND DECEMBER 27, 2003
As discussed above 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 a $.32 per
share reduction in the six month results. Management routinely reviews the
results of operations both with and without large, identifiable charges and
credits, like the CMM investigation discussed above, to better understand
the performance of the Company's core business.
Sales
Sales for the first six months of fiscal 2005 are up $10.0 million or 12%
compared to the first six months of fiscal 2004. Domestic sales are up 8%
and foreign sales are up 20% (16% in local currency). The increase in sales
reflects the improvement in the U.S. industrial manufacturing sector, which
started to affect us in the December quarter of fiscal 2004, as well as good
economic conditions in Company's Brazilian market. The magnitude of the
overall increase should be viewed in light of the fact that the September
2003 quarter was the Company's lowest sales quarter in over 10 years because
of the weak U.S. industrial manufacturing sector.
Earnings (loss) before taxes
Pretax earnings for the first six months of fiscal 2005 were $3.6 million
compared to a $5.1 million loss for the first six months of fiscal 2004.
$3.2 million of last year's loss was attributable to the CMM inventory
write-down discussed above. Excluding this write-down, pretax earnings
improved $5.5 million or, as a function of current year sales, 6 percentage
points. Domestic operations had pretax earnings of .2% of sales in the
December 2004 six month period compared to a 4% loss on sales in the
comparable December 2003 period (before the CMM inventory write-down), while
foreign operations had pretax income of about 9% of sales in the December
2004 six month period and 2% in the comparable December 2003 period. The
major items causing the $5.5 million improvement in earnings before the CMM
inventory write-down were increased sales ($2.5 million), a gain on the sale
of the Company's Skipton, England real estate ($.7 million), and improved
gross margins (28.3% this year compared to 24.8% last year, or $3.4
million). These improvements were offset by a $1.1 million increase in
selling and general expense although, as a percentage of sales, selling and
general expense actually improved from 26.5% to 24.9%. The gross margin
improvement is due to lower headcount and higher production levels, offset
by the benefit ($.3 million) in fiscal 2004 of liquidating LIFO inventories.
Income taxes
The effective income tax rate was 18% in the December 2004 six month period
and 42% in the December 2003 six month period. The fluctuation in these
rates comes about because pretax results are so close to breakeven in most
jurisdictions 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%. An intercompany dividend from our wholly-owned Brazilian
subsidiary will reduce our tax expense for the full 2005 fiscal year by
approximately $.4 million (5 percentage points on the estimated full year
tax rate), and the tax rate has been adjusted accordingly in the December
2004 quarter. A similar dividend decision was made in fiscal 2004, however
the benefit was recognized beginning in the third quarter. In addition, the
$.7 million gain on the Sale of real estate mentioned above carried
Page 11 of 18
practically no tax because cost is indexed for tax purposes in the U.K.
This had the effect of lowering our effective tax rate by an additional 5
percentage points in the fiscal 2005 six month period. Despite recent
losses, the Company continues to believe it will be able to utilize its tax
operating loss carryforwards generated in prior periods. 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
per share for the first six months of fiscal 2005 of $.45 per share compared
to a net loss of $.44 per share in the first six months of fiscal 2004, an
improvement of $.89 per share, $.32 of which was a result of the CMM
inventory write-down in the December 2003 quarter.
RECENT ACCOUNTING PRONOUNCEMENTS
FAS 151: In November 2004, the FASB issued Statement No. 151, Inventory
Costs, an amendment of ARB No. 43, Chapter 4. Statement 151 clarifies the
accounting for abnormal amounts of idle facility expense, freight, handling
costs and wasted material. Statement 151 is effective for inventory costs
incurred during fiscal years beginning after June 15, 2005. The Company does
not believe adoption of Statement 151 will have a material effect on its
consolidated financial position, results of operations or cash flows.
FAS 153: In December 2004, the FASB issued Statement No. 153, Exchanges of
Nonmonetary Assets, an amendment of APB Opinion No. 29. Statement 153
addresses the measurement of exchanges of nonmonetary assets and redefines
the scope of transactions that should be measured based on the fair value of
the assets exchanged. Statement 153 is effective for nonmonetary asset
exchanges occurring in fiscal periods beginning after June 15, 2005. The
Company does not believe adoption of Statement 153 will have a material
effect on its consolidated financial position, results of operations or cash
flows.
FSP FASB 109-1 and 109-2: In December 2004, the FASB issued FASB Staff
Position No. 109-1, Application of FASB Statement No. 109 (SFAS 109),
Accounting for Income Taxes, to the Tax Deduction on Qualified Production
Activities Provided by the American Jobs Creation Act of 2004 (FSP 109-1).
FSP 109-1 clarifies that the manufacturer's deduction provided for under the
American Jobs Creation Act of 2004 (AJCA) should be accounted for as a
special deduction in accordance with SFAS 109 and not as a tax rate
reduction. The adoption of FSP 109-1 will have no impact on the Company's
results of operations or financial position for fiscal year 2005 because the
manufacturer's deduction is not available to the Company until fiscal year
2006. The company is evaluating the effect that the manufacturer's deduction
will have in subsequent years.
The FASB also issued FASB Staff Position No. 109-2, Accounting and
Disclosure Guidance for the Foreign Earnings Repatriation Provision within
the American Jobs Creation Act of 2004 (FSP 109-2). The AJCA introduces a
special one-time dividends received deduction on the repatriation of certain
foreign earnings to a U.S. taxpayer (repatriation provision), provided
certain criteria are met. FSP 109-2 provides accounting and disclosure
guidance for the repatriation provision. Until the Treasury Department or
Congress provides additional clarifying language on key elements of the
repatriation provision, the amount of foreign earnings to be repatriated by
the Company, if any, cannot be determined. FSP 109-2 grants an enterprise
additional time beyond the year ended December 31, 2004, in which the AJCA
was enacted, to evaluate the effects of the AJCA on its plan for
reinvestment or repatriation of unremitted earnings. FSP 109-2 calls for
Page 12 of 18
enhanced disclosures of, among other items, the status of a Company's
evaluations, the effects of completed evaluations, and the potential range
of income tax effects of repatriations. The Company has just begun this
evaluation process. At the present time, deferred taxes have not been
recorded on approximately $40 million of undistributed earnings of foreign
subsidiaries or the related unrealized translation adjustments because such
amounts are considered permanently invested, and it is possible that
remittance taxes, if any, would be reduced by U.S. foreign tax credits.
LIQUIDITY AND CAPITAL RESOURCES
Cash flows (in thousands) 13 Weeks Ended 26 Weeks Ended
12/25/04 12/27/03 12/25/04 12/27/03
Operating cash flow 1,974 9,326 3,666 12,473
Investing cash flow (1,806) (4,964) (2,444) (8,522)
Financing cash flow (1,096) (2,186) (1,287) (3,839)
Despite operating results being close to breakeven, cash provided by
operations has been positive. Non-cash depreciation charges of approximately
$3 million per quarter contribute to this, but fiscal 2004 benefited
significantly by reductions in inventories both in the quarter and six month
periods. "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 $.2 million of non-cash income per
quarter ($.1 million per quarter in the prior year). On an accrual basis,
retirement benefit expense is approximately $.1 million per quarter in the
current year and $.4 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. Except for a reduction in long-term debt
repayments, activity in these areas has not fluctuated significantly in the
periods presented.
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
maintain consistent profitability, steps may have to be taken in order to
maintain liquidity, including plant consolidations and workforce and
dividend reductions. The Company maintains a $15 million line of credit, but
is not currently borrowing under it. The Company had a working capital ratio
of 5.9 to one as of December 25, 2004 and 5.4 to one as of June 26, 2004.
REORGANIZATION/RESTRUCTURING INITIATIVES
As discussed in greater detail in the Company's annual report on Form 10-K
for the fiscal year ended June 26, 2004, 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
Page 13 of 18
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. The outlook for the CMM
division is problematic, and actions being considered range from staying in
the business, to outsourcing, to exiting altogether. During the past two
years, the Company consolidated its Skipton, England optical comparator
manufacturing into its manufacturing facility in Jedburgh, Scotland; closed,
and is currently trying to sell, its Alum Bank, Pennsylvania level plant and
relocated that manufacturing operation to the Dominican Republic; closed its
Cleveland warehouse, and is in the process of closing its Chicago warehouse
as well as consolidating a small Gardner, Massachusetts production facility
into the Company's Athol, Massachusetts facility; and is in the process of
relocating its tape measure production to the Dominican Republic. The
Company's goal is to achieve labor savings and maintain margins while
satisfying the requirements of its customers with lower prices. No material
unrecorded costs or asset write-downs are currently known as a result of
these potential initiatives. There can be no assurances that the
implementation of these or other steps will result in savings to the
Company. It is also possible that the Company may need to incur additional
charges in connection with these initiatives.
OFF-BALANCE SHEET ARRANGEMENTS
The Company does not have any material off-balance sheet arrangements as
defined under the Securities and 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; and normal expense accruals for
such things as workers compensation and employee medical expenses. Actual
results could differ from these estimates.
The allowance for doubtful accounts and sales returns is based on our
assessment of the collectibility of specific customer accounts, the aging of
our accounts receivable and trends in product returns. While we believe that
our 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 our previous experience, or actual future returns do not
reflect historical trends, our estimates of the recoverability of the
amounts due us and our 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 our products or
there is a higher risk of inventory obsolescence because of rapidly changing
technology and requirements, we may be required to increase our inventory
reserve and, as a result, our gross profit margin could be adversely
affected. Page 14 of 18
Accounting for income taxes requires estimates of our 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 arising from these
differences on future tax payments. With respect to recorded tax assets, we
assess the likelihood that the asset will be realized. If realization is in
doubt because of uncertainty regarding future profitability or enacted tax
rates, we provide a valuation allowance related to the asset. Tax reserves
are also established to cover risks associated with activities or
transactions that may be at risk for additional taxes. Should any
significant changes in the tax law or our estimate of the necessary
valuation allowances or reserves occur, we would record the impact of the
change, which could have a material effect on our financial position or
results of operations.
Pension and postretirement medical costs and obligations are dependent on
assumptions used by our 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 our
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 fiscal 2004 annual report to
stockholders, including the President's letter, and the fiscal 2004 Annual
Report on Form 10-K, contain forward-looking statements about the Company's
business, competition, sales, expenditures, foreign operations, 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 evaluate possible
consolidations and reorganizations 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. If the Company is unable to maintain consistent profitability,
additional steps will have to be taken, including further plant
consolidations and workforce and dividend reductions.
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.
Page 15 of 18
Risks Related to Foreign Operations: Approximately a third of the Company's
sales and 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. As a result, the future
performance of the Brazilian operations is inherently unpredictable.
Risks Related to Manufacturing Sector: The Company's primary customers are
in the industrial manufacturing business and, in particular, in the metal
working 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 wage foreign countries where the
Company does not have a substantial market presence. Economic weakness in
the industrial manufacturing sector as well as the shift of manufacturing to
low wage counties where the Company does not have a substantial market
presence may, and in some cases has, resulted in decreased demand for
certain of the Company's products, which adversely affects performance.
Economic weakness in the consumer market could adversely impact the
Company's performance as well. 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 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 accounted for approximately 25% of revenues in fiscal
2004. The Company has significantly reduced its relationship with
W.W.Grainger, one of the three customers, during fiscal 2005. The effect
this has had on total Company sales and profits is very difficult to
determine since much of the Grainger business is currently expected to be
picked up by other Company distributors, although no such assurances can be
made that this will in fact happen. The loss or reduction in orders by any
of the remaining customers, including reductions due to market, economic or
competitive conditions, or the failure of the Company to replace the
Grainger sales could adversely affect business and results of operations.
Indeed, the Company's major 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
Page 16 of 18
the form of deductibles and sublimits. Depending on the risk, deductibles
can be as high as $.5 million and, in certain circumstances, 5% of the loss.
Risks 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.
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
2004 and 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 are less than $5
million.
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 $33.3 million and debt
of $5.4 million at December 25, 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
approximately $2.3 million by $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 December 25, 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.
Page 17 of 18
PART II. OTHER INFORMATION
Item 2. Unregistered Sale of Equity Securities and Use of Proceeds
A summary of the Company's repurchases of shares of its common stock for the
three months ended December 25, 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
9/26/04-
10/30/04 25,000 15.75 none
10/31/04-
11/27/04 none none
11/28/04-
12/25/04 none none
All of the above shares were repurchased by the Company on October 21, 2004
directly from the Company's 401(k) plan in connection with diversifications
made by participants in the plan.
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.
(b) Reports on Form 8-K - None
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 3, 2005 S/R.U.WELLINGTON, JR.
R. U. Wellington, Jr. (Vice President,
Treasurer and Chief Financial Officer)
Date February 3, 2005 S/S.G.THOMSON
S. G. Thomson (Chief Accounting Officer)
Page 18 of 18