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 26, 2005
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, 2005:
Class A Common Shares 5,450,127
Class B Common Shares 1,204,733
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 26, 2005 and
March 27, 2004 (unaudited) 3
Consolidated Statements of Cash Flows -
thirteen and thirty-nine
weeks ended March 26, 2005 and
March 27, 2004 (unaudited) 4
Consolidated Balance Sheets - March 26,
2005 (unaudited) and June 26, 2004 5
Consolidated Statements of Stockholders'
Equity - thirty-nine weeks ended
March 26, 2005 and March 27, 2004
(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 17
Item 6. Exhibits and Reports on Form 8-K 17-18
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
3/26/05 3/27/04 3/26/05 3/27/04
Net sales 50,028 44,945 146,078 131,040
Cost of goods sold (37,503) (33,017) (106,371)(100,985)
Selling and general expense (12,663) (11,684) (36,579) (34,518)
Other income (expense) 189 (64) 570 (416)
Earnings (loss) before income taxes 51 180 3,698 (4,879)
Provision (benefit) for federal,
foreign and state income taxes (98) (264) 573 (2,395)
Net earnings (loss) 149 444 3,125 (2,484)
Basic and diluted earnings (loss)
per share .02 .07 .47 (.37)
Average outstanding shares used in per
share calculations (in thousands)
Basic 6,650 6,642 6,645 6,653
Diluted 6,671 6,658 6,662 6,653
Dividends per share .10 .10 .30 .30
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
3/26/05 3/27/04 3/26/05 3/27/04
Cash flows from operating activities:
Net earnings (loss) 149 444 3,125 (2,484)
Non-cash items included:
Depreciation and amortization 2,653 2,658 7,865 8,249
Deferred taxes (1,279) (462) (1,108) (1,494)
Retirement benefits (476) (116) (1,427) (350)
Working capital changes:
Receivables 2,623 2,866 4,270 4,101
Inventories (2,421) 2,144 (6,766) 9,723
Other assets and liabilities 382 (167) (790) 1,920
Prepaid pension cost and other 155 49 283 224
Net operating cash flows 1,786 7,416 5,452 19,889
Cash flows from investing activities:
Additions to plant and equipment (1,014) (1,363) (4,412) (4,658)
Proceeds from sale of real estate 1,522
Change in short-term investments 919 (8,792) 351 (14,019)
Net investing cash flows (95) (10,155) (2,539) (18,677)
Cash flows from financing activities:
Short-term borrowings 97 443 737 900
Long-term borrowings (repayments) (540) 614 (1,116) (2,180)
Common stock issued 82 455 226
Treasury shares purchased (235) (394) (633)
Dividends (665) (663) (1,995) (1,993)
Net financing cash flows (1,026) 159 (2,313) (3,680)
Exchange rate change effect on cash 8 123 112 221
Net increase (decrease) in cash 673 (2,457) 712 (2,247)
Cash, beginning of period 2,522 3,516 2,483 3,306
Cash, end of period 3,195 1,059 3,195 1,059
See Notes to Consolidated Financial Statements
Page 4 of 18
THE L. S. STARRETT COMPANY
Consolidated Balance Sheets
(in thousands of dollars)
March 26 June 26
2005 2004
ASSETS (unaudited)
Current assets:
Cash 3,195 2,483
Investments 32,111 32,023
Accounts receivable (less allowance for doubtful
accounts of $1,494 and $1,358) 31,066 33,434
Inventories:
Raw materials and supplies 14,334 8,510
Goods in process and finished parts 18,267 16,780
Finished goods 20,080 17,987
52,681 43,277
Prepaid expenses, taxes and other current assets 10,631 11,534
Total current assets 129,684 122,751
Property, plant and equipment, at cost (less
accumulated depreciation of $108,500
and $100,767) 60,717 62,859
Prepaid pension cost 33,536 32,370
Other assets 374 944
224,311 218,924
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable and current maturities 2,505 2,302
Accounts payable and accrued expenses 16,143 16,005
Accrued salaries, wages and postretirement benefits 3,986 4,375
Total current liabilities 22,634 22,682
Deferred income taxes 13,090 14,214
Long-term debt 2,661 2,536
Accumulated postretirement medical benefit obligation 17,053 17,209
Stockholders' equity:
Class A Common $1 par (20,000,000 shrs. auth.;
5,444,053 outstanding on 3/26/05, 5,396,679
outstanding on 6/26/04 5,444 5,397
Class B Common $1 par (10,000,000 shrs. auth.;
1,206,801 outstanding on 3/26/05, 1,250,106
outstanding on 6/26/04 1,207 1,250
Additional paid-in capital 50,219 49,934
Retained earnings reinvested and employed in
the business 130,253 129,282
Accumulated other comprehensive loss (18,250) (23,580)
Total stockholders' equity 168,873 162,283
224,311 218,924
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 26, 2005 and March 27, 2004
(in thousands of dollars)
(unaudited)
Common Addi- Accumulated
Stock Out- tional Other
standing Paid-in Retained Comprehensive
($1 Par) Capital Earnings Loss Total
Balance June 28, 2003 6,659 49,826 134,547 (26,081) 164,951
Comprehensive income(loss):
Net loss (2,484) (2,484)
Unrealized net gain
on investments 29 29
Translation gain, net 3,659 3,659
Total comprehensive income 1,204
Dividends ($.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
Balance June 26, 2004 6,647 49,934 129,282 (23,580) 162,283
Comprehensive income(loss):
Net earnings 3,125 3,125
Unrealized net gain
on investments 29 29
Translation gain, net 5,301 5,301
Total comprehensive income 8,455
Dividends ($.30 per share) (1,995) (1,995)
Treasury shares:
Purchased (25) (210) (159) (394)
Issued 13 196 209
Options exercised 16 299 315
Balance March 26, 2005 6,651 50,219 130,253 (18,250) 168,873
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 26, 2005
and June 26, 2004; the results of operations and cash flows for the thirteen
and thirty-nine weeks ended March 26, 2005 and March 27, 2004; and changes
in stockholders' equity for the thirty-nine weeks ended March 26, 2005 and
March 27, 2004.
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.
The Company incurred approximately $1.3 million and $1.2 million in outbound
shipping costs in the March quarters of fiscal 2005 and 2004, respectively,
and $3.8 million and $3.5 million in the nine month periods then ended.
Approximately 25% of these shipping costs were billed to, and reimbursed by,
customers. Beginning with the March 2005 quarter, the Company is recording
all outbound freight as cost of sales rather than the previous practice of
netting such costs against sales. Prior period amounts have not been
reclassified as they are immaterial to the consolidated statements of
operations.
In the nine month period ended March 27, 2004, 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 (13,781 shares) is
antidilutive in periods with a loss.
Included in investments at March 26, 2005 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 Thirty-nine Weeks
Ended March Ended March
2005 2004 2005 2004
Interest income 262 220 754 565
Interest expense and com-
mitment fees (270) (271) (651) (834)
Realized and unrealized
exchange gains (losses) 224 7 (39) (3)
Gain on sale of real estate 662
Other (27) (20) (156) (144)
189 (64) 570 (416)
Page 7 of 18
Net periodic costs (benefits) for the Company's defined benefit pension
plans consist of the following (in thousands):
Thirteen Weeks Thirty-nine Weeks
Ended March Ended March
2005 2004 2005 2004
Service cost 804 813 2,412 2,439
Interest cost 1,648 1,530 4,944 4,591
Expected return on plan assets (2,578) (2,352) (7,734) (7,057)
Amort. of transition obligation (245) (244) (735) (731)
Amort. of prior service cost 107 106 321 317
Amort. of unrecognized loss 73 219
(264) (74) (792) (222)
Net periodic costs (benefits) for the Company's postretirement medical plan
consist of the following (in thousands):
Thirteen Weeks Thirty-nine Weeks
Ended March Ended March
2005 2004 2005 2004
Service cost 129 164 387 493
Interest cost 238 259 714 778
Amort. of prior service cost (118) (88) (354) (265)
Amort. of unrecognized loss 16 31 48 93
265 366 795 1,099
Approximately two thirds of all inventories are valued on the LIFO method.
At March 26, 2005 and June 26, 2004, total inventories are approximately
$20 million less than if determined on a FIFO basis. During the March 2004
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 net earnings in the
March 2004 quarter by approximately $.6 million, or $.05 per share.
Long-term debt is comprised of the following (in thousands):
March June
2005 2004
Revolving credit agreement - -
Capitalized lease obligations payable in
Brazilian currency due 2005-2007, 15%-24% 3,598 3,971
Less current portion 938 1,435
2,661 2,536
Current notes payable carry interest at approximately 5%.
Page 8 of 18
RECENT ACCOUNTING PRONOUNCEMENTS
FSP FASB 109-1: 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.
FSP FASB 109-2: In December 2004, the FASB 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 MARCH 26, 2005 AND MARCH 27, 2004
Sales
Sales for the fiscal 2005 March quarter are up $3.8 million or 8% compared
to the fiscal 2004 March quarter. This is before the reclassification of
outbound freight costs as discussed in the Notes to Consolidated Financial
Statements. Foreign sales are up 31% (18% in local currency), but domestic
sales are flat. The overall increase in sales reflects the good economic
conditions in the Company's Brazilian market, and modest improvement in the
U.S. industrial manufacturing sector offset to some degree by the loss of
approximately $2 million in business with W.W. Grainger (one of the
Company's three largest distributors in fiscal 2004). It is very difficult
to calculate the effect of the loss of this business early in fiscal 2005
since many of the Grainger end users have the ability to continue to buy our
products through other distributors.
Page 9 of 18
Earnings before taxes
Pretax earnings for the quarter were $.1 million compared to $.2 million a
year earlier. Domestic operations had a pretax loss of $.9 million in the
March 2005 quarter compared to income of $.2 million in the March 2004
quarter, while foreign operations had pretax income of $1.0 million in the
March 2005 quarter compared to a $.1 million loss in the March 2004 quarter.
The major items having a favorable effect on the quarter to quarter
comparison are improved foreign sales ($1.1 million) and gross margins ($1.0
million). These are being more than offset by higher foreign selling
expenses ($1.0 million, half of which is from exchange rate changes), the
favorable impact in the March 2004 quarter of domestic LIFO inventory layer
liquidations ($.6 million), and the double personnel and occupancy costs($.5
million, which are being incurred as part of domestic operations) associated
with transferring manufacturing operations from Puerto Rico to the Company's
new Dominican Republic facility, which is beginning to manufacture measuring
tapes and levels. Domestic margins were flat in the quarter to quarter
comparison excluding the effects of LIFO inventory liquidations and the
transfer of manufacturing to the Dominican Republic described above.
Income Taxes
There was an income tax benefit of $.1 million and $.3 million on pretax
income of $.1 million and $.2 million in the March 2005 and 2004 quarters,
respectively. An effective tax rate comparison is not meaningful under these
circumstances because large fluctuations in these rates come about when
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, an intercompany dividend from our Brazilian subsidiary had a
significant favorable effect on last year's March tax provision. This is
having an unfavorable effect on the quarter to quarter tax provision
comparison of approximately $.3 million. The Company continues to believe it
will be able to utilize its tax operating loss carryforwards, but the
situation is continually monitored and could change in the future.
Net earnings per share
As a result of the above factors, the Company had basic and diluted earnings
of $.02 per share in the March 2005 quarter compared to $.07 per share in
the March 2004 quarter. $.05 of the decrease in the quarter to quarter
comparison was due to LIFO inventory liquidation profits in the March 2004
quarter, which are not expected to recur in the near future.
NINE MONTH PERIODS ENDED MARCH 26, 2005 AND MARCH 27, 2004
As discussed below under "Coordinate Measuring Machine (CMM) division," the
Company took a pretax charge of $3.2 million in the December 2003 quarter in
order to write down its CMM inventory to net realizable value. After giving
effect to income taxes, this charge amounted to $2.1 million, or a $.32 per
share reduction in the results for the nine months ended March 2004.
Management routinely reviews the results of operations both with and without
large, identifiable charges and credits to better understand the performance
of the Company's core business.
Sales
Sales for the first nine months of fiscal 2005 are up $13.7 million or 10%
compared to the first nine months of fiscal 2004. This is before the
Page 10 of 18
reclassification of freight out discussed in the Notes to Consolidated
Financial Statements. Domestic sales are up 5% and foreign sales are up 24%
(18% in local currency). The increase in sales reflects the improvement,
mainly in the first two quarters of the fiscal year, 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 weakening U.S. dollar noted above and the fact that the September
quarter of fiscal 2004 was the Company's lowest sales quarter in over 10
years because of the weak U.S. industrial manufacturing sector. In addition,
see the remarks related to the loss of W.W. Grainger business under the
quarter to quarter sales comparison above. The nine month to nine month
decrease in sales to Grainger was approximately $5.7 million.
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 first nine months of fiscal 2005 were $3.7 million
compared to a $4.9 million loss for the first nine months of fiscal 2004.
$3.2 million of last year's loss was attributable to the CMM inventory
write-down discussed above. The remaining improvement of $5.4 million was,
as a function of current year sales, 4 percentage points. Domestic
operations had a pretax loss of .9% of sales in the March 2005 nine month
period compared to a 2.5% loss on sales in the comparable March 2004 period
(before the CMM inventory write-down), while foreign operations had pretax
income of about 8% of sales in the March 2005 nine month period and 1% in
the comparable March 2004 period. The major items causing the $5.4 million
improvement in earnings before the CMM inventory write-down were increased
sales ($3.8 million), a gain on the sale of the Company's Skipton, England
real estate ($.7 million), and improved gross margins (27.4% this year
compared to 25.4% last year, or $2.9 million). These improvements were
offset by a $2.0 million increase in selling and general expense although,
as a percentage of sales, selling and general expense actually improved from
26.3% to 25.3%. Included in this selling and general expense increase are
external costs incurred as a result of compliance with Section 404 of the
Sarbanes-Oxley Act (internal controls) estimated to be at least $.5 million,
as well as $.6 million as a result of exchange rate changes. The gross
margin improvement is due to lower headcount and higher production levels,
offset by the benefit ($.9 million) in fiscal 2004 of liquidating LIFO
inventories and the costs in 2005 mentioned above associated with
establishing a Dominican Republic manufacturing facility for the Company's
measuring tapes and levels.
Income taxes
The effective income tax rate was 15% in the March 2005 nine month period
and 49% in the March 2004 nine month period. The fluctuation in these rates
is due to the fact that pretax results are so close to breakeven in most
Page 11 of 18
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%. Intercompany dividends from our wholly-owned Brazilian
subsidiary in both fiscal 2005 and 2004 has, and is expected to continue to,
reduce our tax expense for both fiscal years by approximately $.4, and the
nine month tax provisions have been adjusted accordingly. In addition, the
$.7 million gain on the sale of Skipton, England real estate mentioned above
carried 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 nine 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 nine months of fiscal 2005 of $.47 per share
compared to a net loss of $.37 per share in the first nine months of fiscal
2004, an improvement of $.84 per share. $.32 of the fiscal 2004 nine month
loss was a result of the CMM inventory write-down in the December 2003
quarter.
RECENT ACCOUNTING PRONOUNCEMENTS
See "RECENT ACCOUNTING PRONOUNCEMENTS" in "Notes to Consolidated Financial
Statements" above.
LIQUIDITY AND CAPITAL RESOURCES
Cash flows (in thousands) 13 Weeks Ended 39 Weeks Ended
3/26/05 3/27/04 3/26/05 3/27/04
Operating cash flow 1,786 7,416 5,452 19,889
Investing cash flow (95) (10,155) (2,539) (18,677)
Financing cash flow (1,026) 159 (2,313) (3,680)
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 nine
month periods. This inventory trend has reversed slightly in fiscal 2005.
"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 $.5 million of non-cash income per quarter ($.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
nine month comparison, is a result of the decrease in cash being generated
by operations.
Page 12 of 18
Cash flows related to financing activities are primarily the payment of
dividends and repayment of debt. 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 5.7 to one as of March 26, 2005 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
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. Actions being considered
for the CMM division (see "Coordinate Measuring Machine (CMM) division"
above) 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 and selling 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 transferring its Puerto
Rico and South Carolina 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
Page 13 of 18
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.
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.
Page 14 of 18
CHIEF FINANCIAL OFFICER
As previously disclosed in the Current Report on Form 8-K filed on February
25, 2005, Roger U. Wellington, Jr., a director and the Chief Financial
Officer (CFO) of the Company, has announced his intention to retire from the
Company in June 2005. His replacement has been identified subject to Board
approval at its June 1, 2005 meeting.
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, if identified
and implemented, will result in cost savings to the Company. The
implementation of any 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.
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
Page 15 of 18
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 early fiscal 2005. The
effect this has had on total Company sales and profits is very difficult to
determine since much of the Grainger business could potentially be picked up
by other Company distributors, although no such assurances can be made that
this will in fact happen. In recent years, Grainger has accounted for
approximately $2 million in sales per quarter. 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
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
Page 16 of 18
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 March 26, 2005, 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.
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 March 26, 2005 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
12/26/04-
1/29/05 none none
1/30/05-
2/26/05 none none
2/27/05-
3/26/05 none none
Page 17 0f 18
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
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 filed a report on Form 8-K on February 25, 2005
announcing it was conducting a search for a new Chief
Financial Officer to replace Roger Wellington, Jr., who had
announced his intention to retire in June 2005.
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 5, 2005 S/R.U.WELLINGTON, JR.
R. U. Wellington, Jr. (Vice President,
Treasurer and Chief Financial Officer)
Date: May 5, 2005 S/S.G.THOMSON
S. G. Thomson (Chief Accounting Officer)
Page 18 of 18