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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 31, 2013
   
OR
   
o
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 incorporation or organization)
 
(I.R.S. Employer 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
 
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 o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). 
 
YES x     NO o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “accelerated filer,” “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check One):
 
Large Accelerated Filer o    Accelerated Filer x    Non-Accelerated Filer o    Smaller Reporting Company o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 
YES o    NO x
 
Common Shares outstanding as of
 
April 30, 2013
 
     
Class A Common Shares
 
6,073,474
 
     
Class B Common Shares
 
739,163
 
 
 
1

 
 
 THE L. S. STARRETT COMPANY

CONTENTS
 
     
Page No.
       
Part I.
Financial Information:
 
       
 
Item 1.
Financial Statements
 
       
   
Condensed Consolidated Balance Sheets - March 31, 2013 (unaudited) and June 30, 2012
3
       
   
Condensed Consolidated Statements of Operations - three and nine months ended March 31, 2013 and March 31, 2012 (unaudited)
4
       
   
Condensed Consolidated Statements of Comprehensive Income (Loss) – three and nine months ended March 31, 2013 and March 31, 2012 (unaudited)
5
       
   
Condensed Consolidated Statements of Stockholders' Equity - nine months ended March 31, 2013 and March 31, 2012 (unaudited)
6
       
   
Condensed Consolidated Statements of Cash Flows - nine months ended March 31, 2013 and March 31, 2012 (unaudited)
7
       
   
Notes to Unaudited Condensed Consolidated Financial Statements
8-12
       
 
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
13-15
       
 
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
15
       
 
Item 4.
Controls and Procedures
15
       
 
Item 5.
Other Information 15
 
Part II.
Other Information:
 
       
 
Item 1A.
Risk Factors
15
       
 
Item 6.
Exhibits
16
       
SIGNATURES
17
 
 
2

 
 
PART I.                      FINANCIAL INFORMATION

ITEM 1.                      FINANCIAL STATEMENTS

THE L. S. STARRETT COMPANY
Condensed Consolidated Balance Sheets
(in thousands except share data)
 
   
March 31,
2013
(unaudited)
   
June 30,
2012
 
             
ASSETS
           
Current assets:
           
Cash
 
$
12,835
   
$
17,502
 
Short-term investments
   
7,627
     
6,282
 
Accounts receivable (less allowance for doubtful accounts of $729 and $965, respectively)
   
35,296
     
42,167
 
Inventories
   
66,783
     
69,895
 
Current deferred income tax asset
   
5,784
     
7,620
 
Prepaid expenses and other current assets
   
6,369
     
7,764
 
Total current assets
   
134,694
     
151,230
 
                 
Property, plant and equipment, net
   
52,829
     
53,597
 
Taxes receivable
   
3,711
     
3,814
 
Deferred tax asset, net
   
30,432
     
29,842
 
Intangible assets, net
   
8,498
     
8,755
 
Goodwill
   
3,034
     
3,034
 
Other assets
   
2,269
     
1,894
 
Total assets
 
$
235,467
   
$
252,166
 
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Current liabilities:
               
Notes payable and current maturities
 
$
1,595
   
$
1,800
 
Accounts payable and accrued expenses
   
13,984
     
20,912
 
Accrued compensation
   
4,928
     
7,299
 
Total current liabilities
   
20,507
     
30,011
 
Deferred tax liabilities
   
2,691
     
2,530
 
Other tax obligations
   
10,209
     
10,590
 
Long-term debt
   
25,431
     
29,387
 
Postretirement benefit and pension obligations
   
52,187
     
51,810
 
Total liabilities
   
111,025
     
124,328
 
                 
Stockholders' equity:
               
Class A Common stock $1 par (20,000,000 shares authorized); 6,064,353 outstanding at 3/31/2013 and 6,017,227 outstanding at 6/30/2012
   
6,064
     
6,017
 
Class B Common stock $1 par (10,000,000 shares authorized); 741,982 outstanding at 3/31/2013 and 753,307 outstanding at 6/30/2012
   
742
     
753
 
Additional paid-in capital
   
52,386
     
51,941
 
Retained earnings
   
91,261
     
94,661
 
Accumulated other comprehensive loss
   
(26,011)
     
(25,534
)
Total stockholders' equity
   
124,442
     
127,838
 
Total liabilities and stockholders’ equity
 
$
235,467
   
$
252,166
 
 
See Notes to Unaudited Condensed Consolidated Financial Statements
 
 
3

 

THE L. S. STARRETT COMPANY
Condensed Consolidated Statements of Operations
(in thousands except per share data) (unaudited)

   
3 Months Ended
   
9 Months Ended
 
   
3/31/2013
   
3/31/2012
   
3/31/2013
   
3/31/2012
 
                         
Net sales
 
$
59,864
   
$
64,540
   
$
176,630
   
$
190,143
 
Cost of goods sold
   
43,925
     
43,085
     
124,249
     
124,991
 
Gross margin
   
15,939
     
21,455
     
52,381
     
65,152
 
% of Net sales
   
26.6
%
   
33.2
%
   
29.7
%
   
34.3
%
                                 
                                 
Selling, general and administrative expenses
   
17,701
     
18,674
     
54,171
     
57,244
 
                                 
Operating (loss)/income
   
(1,762
)
   
2,781
     
(1,790
)
   
7,908
 
                                 
Other income (expense)
   
526
     
(550
)
   
937
     
1,308
 
                                 
Earnings (loss) before income taxes
   
(1,236
)
   
2,231
     
(853
)
   
9,216
 
                                 
Income tax expense
   
249
     
661
     
507
     
3,682
 
                                 
Net earnings (loss)
 
$
(1,485
)
 
$
1,570
   
$
(1,360
)
 
$
5,534
 
                                 
                                 
                                 
Basic and diluted earnings (loss) per share
 
$
(.22
)
 
$
.23
   
$
(.20
)
 
$
.82
 
                                 
Average outstanding shares used in per share calculations:
                               
Basic
   
6,800
     
6,764
     
6,792
     
6,753
 
Diluted
   
6,800
     
6,799
     
6,792
     
6,788
 
                                 
                                 
                                 
Dividends per share
 
$
.10
   
$
.10
   
$
.30
   
$
.30
 
 
See Notes to Unaudited Condensed Consolidated Financial Statements
 
 
4

 
 
THE L. S. STARRETT COMPANY
Condensed Consolidated Statements of Comprehensive Income (Loss)
 (in thousands) (unaudited)

   
3 Months Ended
   
9 Months Ended
 
   
3/31/2013
   
3/31/2012
   
3/31/2013
   
3/31/2012
 
                         
Net earnings (loss)
 
$
(1,485
)
 
$
1,570
   
$
(1,360
)
 
$
5,534
 
Other comprehensive income (loss), net of tax:
                               
Translation gain (loss)
   
(913
)
   
2,423
     
(445
)
   
(8,800
)
Pension and postretirement plans
   
(9
)
   
29
     
(32
)
   
(2
)
Other comprehensive income (loss)
   
(922
)
   
2,452
     
(477
)
   
(8,802
)
                                 
Total comprehensive income (loss)
 
$
(2,407
)
 
$
4,022
   
$
(1,837
)
 
$
(3,268
)

See Notes to Unaudited Condensed Consolidated Financial Statements
 
 
5

 
 
THE L. S. STARRETT COMPANY
Condensed Consolidated Statements of Stockholders' Equity
For the Nine Months Ended March 31, 2013 and March 31, 2012
(in thousands except per share data) (unaudited)
 
   
Common Stock
Outstanding
   
Addi-
tional
Paid-in
   
Retained
   
Accumulated
Other Com-prehensive
       
   
Class A
   
Class B
   
Capital
   
Earnings
   
Loss
   
Total
 
Balance June 30, 2011
 
$
5,933
   
$
801
   
$
51,411
   
$
96,477
   
$
(1,961
)
 
$
152,661
 
Net earnings
                           
5,534
             
5,534
 
Other comprehensive loss
                                   
(8,802
)
   
(8,802
)
Dividends ($0.30 per share)
                           
(2,027
)
           
(2,027
)
Issuance of stock under ESOP
   
23
             
223
                     
246
 
Issuance of stock under ESPP
           
9
     
72
                     
81
 
Stock-based compensation
                   
121
                     
121
 
Conversion
   
51
     
(51
)
                           
-
 
Balance March 31, 2012
 
$
6,007
   
$
759
   
$
51,827
   
$
99,984
   
$
(10,763
)
 
$
147,814
 
                                                 
Balance June 30, 2012
 
$
6,017
   
$
753
   
$
51,941
   
$
94,661
   
$
(25,534
)
 
$
127,838
 
Net loss
                           
(1,360
)
           
(1,360
)
Other comprehensive loss
                                   
(477
)
   
(477
)
Dividends ($0.30 per share)
                           
(2,040
)
           
(2,040
)
Purchase of stock
   
(5
)
           
(57
)
                   
(62
)
Issuance of stock under ESOP
   
21
             
220
                     
241
 
Issuance of stock under ESPP
           
20
     
141
                     
161
 
Stock-based compensation
                   
141
                     
141
 
Conversion
   
31
     
(31
)
                           
-
 
Balance March 31, 2013
 
$
6,064
   
$
742
   
$
52,386
   
$
91,261
   
$
(26,011
)
 
$
124,442
 
                                                 
Cumulative Balance:
                                               
Translation loss
                                 
$
(16,350
)
       
Pension and postretirement plans net of taxes
                                   
(9,661
)
       
                                   
$
(26,011
)
       
 
See Notes to Unaudited Condensed Consolidated Financial Statements
 
 
6

 
 
THE L. S. STARRETT COMPANY
Condensed Consolidated Statements of Cash Flows
(in thousands of dollars) (unaudited)

   
9 Months Ended
 
   
3/31/2013
   
3/31/2012
 
             
Cash flows from operating activities:
           
Net earnings (loss)
 
$
(1,360
)
 
$
5,534
 
Non-cash operating activities:
               
Depreciation
   
6,434
     
6,775
 
Amortization
   
861
     
697
 
Other tax obligations
   
(282
)
   
(358
)
Deferred taxes
   
1,356
     
284
 
Unrealized transaction gain
   
(9
)
   
(30
)
Equity gain on investment
   
(390
)
   
(117
)
Working capital changes:
               
Receivables
   
6,725
     
1,698
 
Inventories
   
3,799
     
(17,554
)
Other current assets
   
1,118
     
(819
)
Other current liabilities
   
(9,821
)
   
(1,300
)
Postretirement benefit and pension obligations
   
651
     
493
 
Other
   
75
     
893
 
Net cash provided by (used in) operating activities
   
9,157
     
(3,804
)
                 
Cash flows from investing activities:
               
Business acquisition, net of cash acquired
   
-
     
(15,070
)
Additions to property, plant and equipment
   
(6,129
)
   
(8,391
)
Increase in short-term investments
   
(1,662
)
   
-
 
Net cash used in investing activities
   
(7,791
)
   
(23,461
)
                 
Cash flows from financing activities:
               
Proceeds from short-term borrowings
   
-
     
9,195
 
Short-term debt repayments
   
(187
)
   
(104
)
Proceeds from long-term borrowings
   
1,500
     
14,534
 
Long-term debt repayments
   
(5,473
)
   
(678
)
Proceeds from common stock issued
   
402
     
327
 
Shares purchased
   
(62
)
   
-
 
Dividends paid
   
(2,040
)
   
(2,027
)
Net cash provided by (used in) financing activities
   
(5,860
)
   
21,247
 
                 
Effect of exchange rate changes on cash
   
(173
)
   
(1,196
)
                 
Net decrease in cash
   
(4,667
)
   
(7,214
)
Cash, beginning of period
   
17,502
     
21,572
 
Cash, end of period
 
$
12,835
   
$
14,358
 
                 
Supplemental cash flow information:
               
                 
Interest paid
 
$
729
   
$
452
 
Income taxes paid, net
   
1,570
     
3,493
 

See Notes to Unaudited Condensed Consolidated Financial Statements
 
 
7

 
 
THE L. S. STARRETT COMPANY
Notes to Unaudited Condensed Consolidated Financial Statements
March 31, 2013

Note 1:   Basis of Presentation and Summary of Significant Account Policies

The condensed balance sheet as of June 30, 2012, which has been derived from audited financial statements, and the unaudited interim condensed financial statements have been prepared by The L.S. Starrett Company (the “Company”) in accordance with accounting principles generally accepted in the United States of America for interim financial reporting.  Accordingly, they do not include all of the information and notes required by generally accepted accounting principles for complete financial statements.  These unaudited condensed financial statements, which, in the opinion of management, reflect all adjustments (including normal recurring adjustments) necessary for a fair presentation, should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended June 30, 2012.  Operating results are not necessarily indicative of the results that may be expected for any future interim period or for the entire fiscal year.

As discussed further in Note 2, on November 22, 2011, the Company acquired all the assets of Bytewise Development Corporation.  The results of operations for this acquired business are included in the Company’s results of operations as presented herein since such date.

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 amounts reported in the consolidated financial statements and accompanying notes.  Note 2 to the Company’s Consolidated Financial Statements included in the Annual Report on Form 10-K for the year ended June 30, 2012 describes the significant accounting policies and methods used in the preparation of the consolidated financial statements. There were no changes in any of the Company’s significant accounting policies during the nine months ended March 31, 2013.

Note 2:  Acquisition

On November 22, 2011 a wholly-owned subsidiary of the Company entered into an asset purchase agreement (the “Purchase Agreement”) with Bytewise Development Corporation (“Bytewise”) pursuant to which the wholly-owned subsidiary of the Company purchased all of the assets of Bytewise for $15.4 million in cash plus the assumption of certain liabilities.  The asset purchase was financed through a term loan under the Company’s existing security agreement.  The Purchase Agreement contains customary representations, warranties and covenants.  Under the Purchase Agreement, the former owners of Bytewise are entitled to a 40% share of any profits from Bytewise’s operations over each of the three years following consummation of the transaction so long as they remain employed by the Company.  The Company has accrued for such profit sharing as an expense based on Bytewise’s results of operations since the date of acquisition.

Bytewise designs, develops and manufactures non-contact, industrial measurement systems and software that capture the external geometric profile of a product and analyze that data to meet measurement and/or quality control requirements.

The acquisition was accounted for under the acquisition method of accounting.  The total purchase price was allocated to Bytewise’s net tangible assets and identifiable intangible assets based on their estimated fair value as of November 22, 2011.  The allocation of the purchase price was finalized in the fourth quarter of fiscal 2012.

The table below presents the allocation of the purchase price to the acquired net assets of Bytewise (in thousands):

Cash
 
$
298
 
Accounts receivable
   
1,897
 
Inventories
   
1,674
 
Other current assets
   
74
 
Intangibles
   
9,300
 
Goodwill
   
3,034
 
Other long-term assets
   
69
 
Accounts payable
   
(379
)
Accrued compensation costs
   
(270
)
Accrued expenses
   
(329
)
Cash paid to sellers
 
$
15,368
 
 
 
8

 
 
The allocation for definite-lived amortizable intangible assets acquired include approximately $4.95 million for customer relationships, $1.48 million for trademarks and trade names, $2.0 million for completed technology, $0.6 million for non-compete agreements and $0.26 million for order backlog.

The acquisition was completed on November 22, 2011 and, accordingly, results of operations from such date have been included in the Company’s Statements of Operations.

Supplemental Pro Forma Information

The following information reflects the Bytewise acquisition as if the transaction had occurred as of the beginning of the Company’s fiscal 2012.  The unaudited pro forma information does not necessarily reflect the actual results that would have occurred had the Company and Bytewise been combined during the periods presented, nor is it necessarily indicative of the future results of operations of the combined companies.

The following table represents selected unaudited consolidated pro forma data (in thousands except per share amounts):

   
9 Months Ended
 
   
3/31/2012
 
       
Unaudited consolidated pro forma revenue
 
$
194,031
 
Unaudited consolidated pro forma net earnings
 
$
5,597
 
Unaudited consolidated pro forma diluted earnings per share
 
$
.82
 
 
Note 3:  Stock-based Compensation

During the quarter ended December 31, 2012, the Company implemented The L.S. Starrett Company 2012 Long Term Incentive Plan (the “2012 Stock Plan”), which was adopted by the Board of Directors September 5, 2012 and approved by shareholders October 17, 2012. The 2012 Stock Plan permits the granting of the following types of awards to officers, other employees and non-employee directors: stock options; restricted stock awards; unrestricted stock awards; stock appreciation rights; stock units including restricted stock units; performance awards; cash-based awards; and awards other than previously described that are convertible or otherwise based on stock. The 2012 Stock Plan provides for the issuance of up to 500,000 shares of common stock.
 
Options granted vest in periods ranging from one year to three years and expire ten years after the grant date. Restricted stock units (“RSU”) granted generally vest from one year to three years. Vested restricted stock units will be settled in shares of common stock. As of March 31, 2013, there were 20,500 stock options and 8,200 restricted stock units outstanding. In addition, there were 471,300 shares available for grant under the 2012 Stock Plan as of March 31, 2013.

For the stock option grant, the fair value of each grant was estimated at the date of grant using the Binomial Options pricing model. The Binomial Options pricing model utilizes assumptions related to stock volatility, the risk-free interest rate, the dividend yield and employee exercise behavior. Expected volatilities utilized in the model are based on the historic volatility of the Company’s stock price. The risk free interest rate is derived from the U.S. Treasury Yield curve in effect at the time of the grant.
 
The fair value of stock options granted during the nine months ended March 31, 2013 of $3.82 was estimated using the following weighted-average assumptions:

Risk-free interest rate
   
1.0
%
Expected life (years)
   
6.0
 
Expected stock volatility
   
52.3
%
Expected dividend yield
   
4.0
%
 
The weighted average contractual term for stock options outstanding as of March 31, 2013 was 9.75 years. The aggregate intrinsic value of stock options outstanding as of March 31, 2013 was $0.1 million. There were no options exercisable as of March 31, 2013.

The Company accounts for RSU awards by recognizing the expense of the fair value ratably over vesting periods generally ranging from one year to three years. The related expense is included in selling, general and administrative expenses.  During the nine months ended March 31, 2013 the Company granted 8,200 RSU awards with approximate fair values of $10.08 per RSU award. There were no RSU awards prior to December 17, 2012.

There were no RSU awards settled during the nine months ended March 31, 2013. The aggregate intrinsic value of RSU awards outstanding as of March 31, 2013 was $0.1 million. There were no RSU awards vested as of March 31, 2013.
 
 
9

 
 
Compensation expense related to stock-based plans (including the ESPP) for the nine month period ended March 31, 2013 was $0.1 million and was recorded as selling, general and administrative expense. As of March 31, 2013, there was $0.1 million of total unrecognized compensation costs related to outstanding stock-based compensation arrangements. The cost is expected to be recognized over a weighted average period of 2.7 years.

Note 4:   Inventories

Inventories consist of the following (in thousands):

   
3/31/2013
   
6/30/2012
 
Raw material and supplies
 
$
33,226
   
$
35,803
 
Goods in process and finished parts
   
23,755
     
24,044
 
Finished goods
   
41,403
     
37,553
 
     
98,384
     
97,400
 
LIFO Reserve
   
(31,601
)
   
(27,505
)
Inventories
 
$
66,783
   
$
69,895
 
 
LIFO inventories were $15.2 million and $19.7 million at March 31, 2013 and June 30, 2012, respectively, or approximately $31.6 million and $27.5 million, respectively, less than their respective balances accounted for on a FIFO basis. The use of LIFO, as compared to FIFO, resulted in a $4.1 million increase in cost of sales for the nine months ended March 31, 2013 compared to a $0.7 million increase in cost of sales in the nine months ended March 31, 2012. The use of LIFO, as compared to FIFO, resulted in a $3.1 million increase in cost of sales for the three months ended March 31, 2013 compared to a $0.9 million increase in cost of sales in the three months ended March 31, 2012.

Note 5:   Goodwill and Intangibles

The Company performed a qualitative analysis in accordance with ASU 2011-08 for its Bytewise reporting unit for its October 1, 2012 annual assessment of goodwill (commonly referred to as “Step Zero”). From a qualitative perspective, in evaluating whether it is more likely than not that the fair value of the reporting units is not less than their respective carrying amount, relevant events and circumstances were taken into account, with greater weight assigned to events and circumstances that most affect the fair value of  Bytewise or the carrying amounts of its assets. Items that were considered included, but were not limited to, the following: macroeconomic conditions, industry and market conditions, cost factors, overall financial performance, changes in management or key personnel, and other Bytewise specific events. After assessing these and other factors the Company determined that it was more likely than not that the fair value of the Bytewise reporting unit was not less than the carrying amount as of October 1, 2012.

Amortizable intangible assets consist of the following (in thousands):

   
3/31/2013
   
6/30/2012
 
Non-compete agreement
 
$
600
   
$
600
 
Trademarks and trade names
   
1,480
     
1,480
 
Completed technology
   
2,292
     
2,292
 
Customer relationships
   
4,950
     
4,950
 
Backlog
   
-
     
260
 
Software development
   
345
     
-
 
Other intangible assets
   
324
     
6,276
 
Total
 
$
9,991
   
$
15,858
 
Accumulated amortization
   
(1,493
)
   
(7,103
)
Total net balance
 
$
8,498
   
$
8,755
 
 
Amortizable intangible assets are being amortized on a straight-line basis over the period of expected economic benefit.

The estimated useful lives of the intangible assets subject to amortization are 14 years for trademarks and trade names, 8 years for non-compete agreements, 10 years for completed technology,  8 years for customer relationships and 5 years for software development.

The estimated aggregate amortization expense for the remainder of fiscal 2013, for each of the next five years and thereafter, is as follows (in thousands):

2013 (Remainder of year)
 
$
290
 
2014
 
$
1,158
 
2015
 
$
1,158
 
2016
 
$
1,158
 
2017
 
$
1,157
 
Thereafter
 
$
3,577
 
 
 
10

 
 
Note 6:    Pension and Post-retirement Benefits

Net periodic benefit costs for the Company's defined benefit pension plans consist of the following (in thousands):

   
Three Months Ended
   
Nine Months Ended
 
   
3/31/2013
   
3/31/2012
   
3/31/2013
   
3/31/2012
 
Service cost
 
$
734
   
$
573
   
$
2,210
   
$
1,720
 
Interest cost
   
1,477
     
1,656
     
4,464
     
4,970
 
Expected return on plan assets
   
(1,490
)
   
(1,654
)
   
(4,497
)
   
(4,962
)
Amortization of prior service cost
   
59
     
59
     
176
     
176
 
Amortization of net gain
   
-
     
(1
)
   
-
     
(3
)
   
$
780
   
$
633
   
$
2,353
   
$
1,901
 
 
Net periodic benefit costs for the Company's postretirement medical plan and life insurance consists of the following (in thousands):
   
Three Months Ended
   
Nine Months Ended
 
   
3/31/2013
   
3/31/2012
   
3/31/2013
   
3/31/2012
 
Service cost
 
$
127
   
$
96
   
$
383
   
$
288
 
Interest cost
   
136
     
155
     
409
     
467
 
Amortization of prior service credit
   
(185
)
   
(226
)
   
(557
)
   
(679
)
Amortization of accumulated loss
   
40
     
4
     
119
     
14
 
   
$
118
   
$
29
   
$
354
   
$
90
 
 
The Company’s pension plans use fair value as the market-related value of plan assets and recognize net actuarial gains or losses in excess of ten percent (10%) of the greater of the market-related value of plan assets or of the plans’ projected benefit obligation in net periodic (benefit) cost as of the plan measurement date, which is the same as the fiscal year end of the Company. Net actuarial gains or losses that are less than 10% of the thresholds noted above are accounted for as part of the accumulated other comprehensive income (loss).

Note 7:   Debt

Debt, including capitalized lease obligations, is comprised of the following (in thousands):

   
3/31/2013
   
6/30/2012
 
Notes payable and current maturities
           
Loan and Security Agreement
 
$
1,333
   
$
1,289
 
Short-term foreign credit facility
   
43
     
231
 
Capitalized leases
   
219
     
280
 
   
$
1,595
   
$
1,800
 
Long-term debt
               
Loan and Security Agreement
   
25,178
   
$
28,985
 
Capitalized leases
   
253
     
402
 
     
25,431
     
29,387
 
   
$
27,026
   
$
31,187
 
 
The Company completed the negotiations for an amended Loan and Security Agreement (Line of Credit) and executed the agreement as of April 25, 2012. The Line of Credit is effective for three years commencing April 25, 2012 and expires on April 30, 2015. The agreement continues the previous line of $23.0 million and interest rate of LIBOR plus 1.5%. On September 7, 2012, the Company completed another amendment to change the financial covenants. The material financial covenants of the amended Loan and Security Agreement are: 1) funded debt to EBITDA, excluding non-cash and retirement benefit expenses (“maximum leverage”), cannot exceed 1.45 to 1, 2) annual capital expenditures cannot exceed $15.0 million, 3) maintain a Debt Service Coverage Rate of a minimum of 1.25 to 1 and 4) maintain consolidated cash plus liquid investments of not less than $10.0 million at any time.

The effective interest rate on the Line of Credit under the Loan and Security Agreement for the nine months ended March 31, 2013 and 2012 was 1.80% and 1.91%, respectively.
 
 
11

 
 
On November 22, 2011, in conjunction with the Bytewise acquisition, the Company entered into a $15.5 million term loan (the “Term Loan”) under the existing Loan and Security Agreement with TD Bank N.A.  The term loan is a ten year loan bearing a fixed interest rate of 4.5% and is payable in fixed monthly payments of principal and interest of $160,640.  The term loan, which had a balance of $13.8 million at March 31, 2013, is subject to the same financial covenants as the Loan and Security Agreement.

As of March 31, 2013, the Company was in compliance with three of the four financial covenants.  However, the Company was not in compliance with the maximum leverage covenant.  The Company received a waiver of default of this covenant as of March 31, 2013.  On May 9, 2013, the Company executed a new amendment to the Loan and Security Agreement.  The new amendment changes the current funded debt to EBITDA ratio from 1.45 to 1, to 2.25 to 1 for the fourth quarter of fiscal 2013 and the first quarter of fiscal 2014.  Thereafter, and through the end of the agreement on April 30 of 2015, the funded debt to EBITDA covenant reverts to 1.45 to 1.  The Company expects to be able to meet this covenant in future periods.

Note 8:    Income Tax

The Company is subject to U.S. federal income tax and various state, local and foreign income taxes in numerous jurisdictions.  The Company’s domestic and foreign tax liabilities are subject to the allocation of revenues and expenses in different jurisdictions and the timing of recognizing revenues and expenses.  Additionally, the amount of income taxes paid is subject to the Company’s interpretation of applicable tax laws in the jurisdictions in which it files.
 
The Company provides for income taxes on an interim basis based on an estimate of the effective tax rate for the year.  This estimate is reassessed on a quarterly basis.  Discrete tax items are accounted for in the quarterly period in which they occur.

The tax expense for the third quarter of fiscal 2013 was $249,000 on a loss before tax for the quarter of $1,236,000 (an effective tax rate of (20.1%)). The tax expense for the third quarter of 2012 was $661,000 on income before tax of $2,231,000 (an effective tax rate of 29.6%).  For the first nine months of 2013, tax expense was $507,000 on a loss before tax of $853,000 (an effective tax rate of (59.4%)) and for the nine months ended March 31, 2012 it was $3,682,000 on income before tax of $9,216,000 (an effective tax rate of 40%).   The primary reasons for the negative effective tax rate in the third quarter of fiscal 2013 are as follows:  1.  no tax benefit has been recognized for losses in certain foreign subsidiaries;  2.  there was a cash dividend from the Company’s subsidiary in Australia which caused a discrete increase to tax expense of $178,000; 3.  there was a reduction in the effective state tax rate applied to deferred tax balances (based on both actual and expected future state tax apportionments and profitability) which caused a discrete tax expense of $675,000;  4.  the changes on the fiscal 2012 tax return from amounts estimated at provision, including the impact of a changed position on the 2012 and prior year returns to take the foreign tax credit rather than a deduction , created a discrete tax benefit of $414,000; and  5.  other discrete taxes increased tax expense by $66,000  In the first quarter of fiscal 2013, a discrete tax benefit was booked reducing the Company’s net tax liability for uncertain tax positions of $91,000.

U.S. Federal tax returns through fiscal 2008 are generally no longer subject to review by tax authorities; however, tax loss carryforwards from years before fiscal 2009 are still subject to review.   As of March 31, 2013, the Company has substantially resolved all open income tax audits.  There were no other local or federal income tax audits in progress as of March 31, 2013.  In international jurisdictions including Argentina, Australia, Brazil, Canada, China, UK, Germany, New Zealand, Singapore, Japan and Mexico, which comprise a significant portion of the Company’s operations, the years that may be examined vary by country.  The Company’s most significant foreign subsidiary in Brazil is subject to audit for the years 2008 – 2012.

The Company has identified no new uncertain tax positions during the nine month period year ended March 31, 2013 for which it is currently likely that the total amount of unrecognized tax benefits will significantly increase or decrease within the next twelve months.

No valuation allowance has been recorded for the Company’s domestic federal net operating loss (NOL) carry forwards. The Company continues to believe that due to forecasted future taxable income and certain tax planning strategies available, it is more likely than not that it will be able to utilize the federal NOL carry forwards.
 
Note 9:  Contingencies

The Company is involved in some legal matters which arise in the normal course of business, which are not expected to have a material impact on the Company’s financial condition, results of operations or cash flows.

 
12

 

ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

RESULTS OF OPERATIONS

Three Months Ended March 31, 2013 and March 31, 2012

Overview
A slower than anticipated domestic economy and continued weakness in the global economy depressed demand for the Company’s products to the industrial sector. Net sales declined $4.6 million or 7% from $64.5 million in fiscal 2012 to $59.9 million in fiscal 2013 as a result of reduced demand for saw and capital equipment products, a weakening Brazilian Real and a recession in Europe.  An operating loss of $1.8 million was a $4.5 million decline compared to fiscal 2012 as a $5.5 million reduction in gross margin was only partially offset by a $1.0 million reduction in selling, general and administrative expenses.

Net Sales
North American sales declined $1.0 million or 3% from $33.3 million in fiscal 2012 to $32.3 million in fiscal 2013 as softening demand for capital equipment in the semi-conductor sector offset a rebound in precision tool revenue.
International sales declined $3.6 million from $31.2 million in fiscal 2012 to $27.6 million in fiscal 2013 with a weakening Brazilian Real representing $2.5 million of the decrease.  Economic slowdowns in Latin America and Asia accounted for the remaining $1.1 million deficit.

Gross Margin
Gross margin declined $5.5 million or 25% from 33.2% of sales in fiscal 2012 to 26.6% of sales in fiscal 2013 with lower revenues and margin erosion representing $1.5 million and $4.0 million, respectively.  Unfavorable exchange rates and LIFO inventory valuation were the key drivers in the $4.0 million margin decline.
North American gross margins declined $3.3 million from $10.8 million or 32% of sales in fiscal 2012 to $7.5 million or 23% of sales in fiscal 2013.  An increase in the LIFO reserve represented $2.2 million of the comparative decline with higher manufacturing costs and an unfavorable product mix accounting for the remaining $1.1 million decline.
International gross margins declined $2.1 million from 34% of sales in fiscal 2012 to 31% of sales in fiscal 2013 with unfavorable exchange rates contributing $0.9 million of the decrease.  Lower revenues in Latin America and Asia contributed the remaining $1.2 million to the shortfall.

Selling, General and Administrative Expenses
Selling, general and administrative expense declined $1.0 million or 5% from $18.7 million in fiscal 2012 to $17.7 million in fiscal 2013.
North American expenses declined $0.9 million from $9.9 million in fiscal 2012 to $9.0 million in fiscal 2013 as a result of savings in salaries, benefits, professional fees and sales commissions.
International expenses declined $0.1 million as a $0.7 million increase in local currency spending was offset by a favorable currency exchange of $0.8 million.

Other Income (Expense)
Other income/(expense) improved to income of $0.5 million in fiscal 2013 compared to a loss of $0.5  million in fiscal 2012 principally due to exchange rate variations in U. S. dollar denominated transactions and unsettled balances in Scotland and Brazil.

Net Earnings (Loss)
The Company recorded a net loss of $1.5 million or $0.22 per share in the third quarter of fiscal 2013 compared to net earnings of $1.6 million or $0.23 per share in fiscal 2012 principally due to lower sales, the unfavorable impact of LIFO inventory valuation and a higher effective tax rate.

Nine Months Ended March 31, 2013 and March 31, 2012

Overview
The continued impact of a sluggish domestic economy, the debt crisis in Europe and the strengthening of the U. S. dollar weighed heavily on the Company’s performance for the first nine months of fiscal 2013. Net sales declined $13.5 million or 7% from $190.1 million in fiscal 2012 to $176.6 million in fiscal 2013 with unfavorable exchange contributing $10.2 million or 76% of the decline.  An operating loss of $1.8 million was a $9.7 million decline compared to fiscal 2012 as a gross margin decline of $12.7 million was only partially offset by a $3.0 million reduction in selling, general and administrative expenses.

Net Sales
North American sales declined $2.9 million or 3% from $94.9 million in fiscal 2012 to $92.0 million in fiscal 2013 as demand for capital equipment products slowed and demand for saw products weakened.  Bytewise, acquired in the second quarter of fiscal 2012, contributed a comparative revenue increase of $4.0 million.  International sales declined $10.6 million or 11% from $95.2 million in fiscal 2012 to $84.6 million in fiscal 2013 with the weakening Brazilian Real representing $10.1 million of the deficit.  Revenue in local currencies was flat in Latin America, Southeast Asia and China.
 
 
13

 

Gross Margin
Gross margin declined $12.7 million or 20% from 34.3% of sales in fiscal 2012 to 29.7% of sales in fiscal 2013 with lower revenues and margin erosion representing $4.6 million and $8.1 million, respectively.  Unfavorable exchange rates accounted for $3.4 million while an increase in the LIFO reserve resulting from higher production costs due to a planned reduction in inventory levels accounted for $4.7 million of the margin erosion.
North American gross margins declined $4.7 million from $30.2 million or 32% of sales in fiscal 2012 to $25.5 million or 28% of sales in fiscal 2013.  An unfavorable LIFO inventory swing of $4.7 million caused by the aforementioned higher production costs was the principal factor contributing to the lower gross margins.  International gross margins declined $8.0 million from 37% of sales in fiscal 2012 to 32% of sales in fiscal 2013 with lower revenues and margin erosion accounting for $3.9 million and $4.1 million, respectively.  Unfavorable exchange rates resulted in $3.4 million or 83% of the margin erosion.

Selling, General and Administrative Expenses
Selling, general and administrative expense declined $3.0 million or 5% from $57.2 million in fiscal 2012 to $54.2 million in fiscal 2013.  North American expenses decreased $0.6 million despite a $1.5 million increase in expenses for the Bytewise division, acquired in the second quarter of fiscal 2012.  The $1.9 million reduction was the result of reduced salaries, benefits, professional fees and sales commissions.  International expenses declined $2.4 million as a $0.8 million increase in local currency spending was more than offset by a favorable currency exchange of $3.2 million.

Other Income (Expense)
Other income declined $0.4 million to $0.9 million in fiscal 2013 compared to $1.3 million in fiscal 2012 principally due to exchange rate variations in U. S. dollar denominated transactions and unsettled balances in Scotland and Brazil.
 
Net Earnings (Loss)
The Company recorded a net loss of $1.4 million or $0.20 per share in the first nine months of fiscal 2013 compared to net earnings of $5.5 million or $0.82 per share in fiscal 2012 principally due to lower sales, the unfavorable impact of  increases in the LIFO inventory reserve and a higher effective tax rate.

LIQUIDITY AND CAPITAL RESOURCES

Cash flows (in thousands)
 
Nine Months Ended
 
   
3/31/2013
   
3/31/2012
 
             
Cash provided by (used in) operating activities
 
$
9,157
   
$
(3,804
)
Cash used in investing activities
   
(7,791
)
   
(23,461
)
Cash provided by (used in) financing activities
   
(5,860
)
   
21,247
 
Effect of exchange rate changes on cash
   
(173
)
   
(1,196
)
                 
Net decrease in cash
 
$
(4,667
)
 
$
(7,214
)
 
Net cash for the nine months ended March 31, 2013 declined $4.7 million as a $9.2 million contribution from operations was more than offset by $5.5 million in loan repayments, $6.1 million for capital equipment and $2.0 million for dividends.

The change in net cash for the nine months ended March 31, 2013 improved $2.5 million compared to fiscal 2012 due  to  significant improvements in the use of cash for working capital purposes, particularly inventory, which negated the unfavorable impact of lower profits.

Liquidity and Credit Arrangements

The Company believes it maintains sufficient liquidity and has the resources to fund its operations.  In addition to its cash and investments, the Company maintains a $23 million line of credit in connection with its Loan and Security Agreement, of which, $12.7 million was outstanding as of March 31, 2013.  Availability under the agreement is further reduced by open letters of credit totaling $0.2 million. The Loan and Security Agreement matures in April of 2015.  The Loan and Security Agreement was modified in the first quarter of fiscal 2013 at which time certain financial covenants were amended.  As of March 31, 2013, the Company was not in compliance with all debt covenants related to its Loan and Security Agreement.  The Company received a waiver on the non-conformance with one debt covenant and has amended the loan agreement as described in Note 7 of the Notes to Unaudited Condensed Consolidated Financial Statements.
 
 
14

 

The effective interest rate on the short term borrowings under the Loan and Security Agreement during the nine months ended March 31, 2013 was 1.80%.

INFLATION

The Company has experienced modest inflation relative to its material cost, much of which cannot be passed on to the customer through increased prices.

OFF-BALANCE SHEET ARRANGEMENTS

The Company has no off-balance sheet arrangements, other than operating leases, that have or are reasonably likely to have a current or future material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources.
 
ITEM 3.             QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

There have been no material changes in qualitative and quantitative disclosures about market risk from what was reported in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2012.
 
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, has evaluated the Company’s disclosure controls and procedures as of March 31, 2013. After considering the matter disclosed in the following paragraph, they have concluded that our disclosure controls and procedures were not effective as of March 31, 2013 in providing reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America.

A material weakness is a control deficiency, or combination of control deficiencies, such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis. A material weakness in our internal control over financial reporting was identified in the preparation of our unaudited condensed consolidated financial statements as of March 31, 2013, which led to an adjustment of the change in the LIFO reserve for the three and nine month periods then ended. The Company’s management believes that the control weakness which led to the adjustment involved an inadequate review of the information prepared to record the LIFO reserve as of March 31, 2013.

Since March 31, 2013, Company management has initiated additional review controls which are designed to prevent errors in the reporting of its interim LIFO reserve. These controls are expected to be implemented in connection with the Company’s next month-end closing.

There have been no other changes in internal control over financial reporting during the quarter that materially affected, or are reasonably likely materially affect, the Company’s internal control over financial reporting.
 
ITEM 5.             OTHER INFORMATION
 
The Board of directors adopted The L.S. Starrett Company 2013 Employee Stock Ownership Plan and Trust Agreement during the quarter ended March 31, 2013.  The purpose of the plan is to supplement existing company programs through an employer funded individual account plan dedicated to investment in common stock of the Company, thereby encouraging increased ownership of the Company while providing an additional source of retirement income.  The plan is intended as an employee stock ownership plan within the meaning of section 4975 (e) (7) of the Internal Revenue Code of 1986, as amended.  The foregoing description does not purport to be complete and is qualified in its entirety by the complete test of the plan, a copy of which is attaché hereto as Exhibit 10.7.
 
PART II.            OTHER INFORMATION

ITEM 1A.           RISK FACTORS
 
SAFE HARBOR STATEMENT
UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

This Quarterly Report on Form 10-Q contains 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 securities analysts and investors.  The Company is subject to risks that could cause actual events to vary materially from such forward-looking statements.  You should carefully review and consider the information regarding certain factors which could materially affect our business, financial condition or future results set forth under Item 1A. “Risk Factors” in our Form 10-K for the year ended June 30, 2012. There have been no material changes from the factors disclosed in our Form 10-K for the year ended June 30, 2012.

 
15

 
 
ITEM 6.             EXHIBITS
 
10.7
The L. S. Starrett Company 2013 Employee Stock Ownership Plan and Trust Agreement.
 
31a
Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, filed herewith.

31b
Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, filed herewith.

32
Certifications of the Principal Executive Officer and the Principal Financial Officer pursuant to Section 1350, Chapter 63 of Title 18, United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101
The following materials from The L. S. Starrett Company’s Quarterly Report on Form 10-Q for the quarter ended March 31,  2013 are furnished herewith, formatted in XBRL (Extensible Business Reporting Language): (i) the Condensed Consolidated Balance Sheets, (ii) the Condensed Consolidated Statements of Operations, (iii) the Condensed Consolidated Statements of Comprehensive Income (Loss), (iv) the Condensed Consolidated Statements of Stockholders' Equity, (v)the Condensed Consolidated Statements of Cash Flows, and (vi) Notes to Condensed Consolidated Financial Statements, tagged as blocks of text.

 
16

 
 
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 10, 2013
 
/S/R. Douglas A. Starrett
     
Douglas A. Starrett - President and CEO
       
Date
May 10, 2013
 
/S/R. Francis J. O’Brien
     
Francis J. O’Brien - Treasurer and CFO
 
 
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