THE L. S. STARRETT COMPANY

Consolidated Balance Sheets

(in thousands except share data)

 

 

See Notes to Unaudited Consolidated Financial Statements

 

 

THE L. S. STARRETT COMPANY

Consolidated Statements of Operations

(in thousands except per share data) (unaudited)

 

 

See Notes to Unaudited Consolidated Financial Statements

 

 

THE L. S. STARRETT COMPANY

Consolidated Statements of Comprehensive Income (Loss)

 (in thousands) (unaudited)

 

 

See Notes to Unaudited Consolidated Financial Statements

 

   

THE L. S. STARRETT COMPANY

Consolidated Statements of Stockholders' Equity

(in thousands) (unaudited)

 

For the Three and Nine-Month Period Ended March 31, 2020
 

 

 

THE L. S. STARRETT COMPANY

Consolidated Statements of Stockholders' Equity

(in thousands) (unaudited)

 

For the Three and Nine-Month Period Ended March 31, 2019

 

 

See Notes to Unaudited Consolidated Financial Statements

 

 

THE L. S. STARRETT COMPANY

Consolidated Statements of Cash Flows

(in thousands) (unaudited)

 

 

See Notes to Unaudited Consolidated Financial Statements

 

 

THE L. S. STARRETT COMPANY

Notes to Unaudited Consolidated Financial Statements

March 31, 2020

  

  

 

 

 

   

 

 

ITEM 2.

 

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

RESULTS OF OPERATIONS

 

Three months ended March 31, 2020 and March 31, 2019

 

COVID-19 pandemic event

 

Globally, Starrett is deemed an “essential business”, as our measuring products are criteria in essential manufacturing, including the defense, aerospace, transportation, supply chain and medical industries. The Company meets the criteria outlined in the Cybersecurity and Infrastructure Security Agency (“CISA”) guidance, Department of Homeland Security as an “essential business”. Furthermore, our products are used in the food industry which is critical to the supply chain. As such, the Company has remained globally operational, with a few exceptions, during the COVID-19 pandemic as recently pronounced by the World Health Organization on March 11, 2020.

 

The COVID-19 pandemic has had a negative impact on global sales. The impact was felt as early as January 2020 in our operation in Suzhou, China and most significantly in March 2020 in North America and in the UK. We expect the June quarter revenues to be below March quarter because of the pandemic. We have taken austerity measures, reducing payroll and managing variable operational spending to help mitigate the shortfall, however we expect the June quarter to be a net loss. There are many unknowable pandemic related variables affecting our forecasts of 12 months but our current planning is the September quarter revenues will decline compared to the June quarter with a slow recovery in the automotive and oil related sectors.

 

 

However, it remains very difficult for management to predict when this crisis will have reached its peak and when revenues and order intake will begin to resume their normal course. At present, it is indeterminate what is the new normal. As a result, management has conducted several scenario planning exercises and is prepared to take the necessary steps to preserve the longer-term financial health of the Company.

 

We have increased our allowance for bad debt by $0.1 million in the March quarter.  Although collections remain strong, some customers have been inquiring about extending payment terms.  Our cash balance at March 31, 2020 was $10.2 million and we have $9.1 million available for future borrowing from our line of credit and Term Loan facility.  In accordance with ASC 205 in connection with preparing financial statements for each annual and interim reporting period, our management continues to evaluate whether there are conditions and events, considered in the aggregate, that raise “substantial doubt about an entity’s ability to continue as a going concern within one year after the date the financial statements are issued.”  The Company has been in business 140 years and we believe we are taking appropriate steps in response to the evolving circumstances.  However, past performance is not a promise of future events.  To the extent that pandemic-related events do not provide evidence about conditions that existed at the balance-sheet date, the Company considers it necessary to disclose it cannot estimate all aspects of the on-going impact on the financial statements as a result of COVID-19.

 

Overview

 

Revenue declined overall in the third quarter by 12% from the previous quarter as the impact of the economic slowdown due, in large part, to the COVID-19 pandemic began in our operation in China in January 2020 and in North America and the UK in March 2020.

 

Net sales decreased $8.5 million or 14.5% from $58.5 million in fiscal 2019 to $50.0 million in fiscal 2020 with North America and International posting declines of $2.7 million and $5.8 million, respectively. Operating income decreased $3.4 million due to the decline in sales revenues and a 3% drop in Gross Margins due primarily to lower manufacturing utilization.

 

Net Sales

 

North American sales decreased $2.7 million or 7% from $36.0 million in fiscal 2019 to $33.3 million in fiscal 2020 principally due to a further decline in incoming orders from distribution for precision measuring tools. The high-end metrology businesses continue to grow or remain flat with the previous year.

 

International sales decreased $5.8 million or 26% from $22.4 million in fiscal 2019 to $16.6 million in fiscal 2020. The COVID-19 crisis first affected our operations in China, and in March, the impact hit our UK plant, which serves the European markets. Brazil has not yet seen the full effect of COVID-19 but we expect they will be negatively impacted in Q4 FY20. Additionally, the crisis has caused the US Dollar to strengthen even more against the Brazilian currency, causing a $1.3 million reduction in sales due to FX translation only.

 

Gross Margin

 

Gross margin decreased $4.3 million or 22.5% principally due to the drop in sales volume.

 

North American gross margins decreased $2.2 million from $10.9 million in fiscal 2019 to $8.7 million in fiscal 2020 due to the decline in revenues, reduced manufacturing utilization and lower production.

 

International gross margins decreased $2.0 million from $8.2 million in fiscal 2019 to $6.2 million sales in fiscal 2020 based upon overall lower sales volume.

 

Selling, General and Administrative Expenses

 

Selling, general and administrative expenses decreased $0.9 million or 5.7% from $15.7 million in fiscal 2019 to $14.8 million in fiscal 2020.

 

North American expenses, including Corporate, decreased $0.5 million from $9.5 million in fiscal 2019 to $9.0 million in fiscal 2020 due to SG&A reduction measures implemented at the end of the quarter in 2020.

 

International expenses decreased $0.4 million due principally to FX translation as the US Dollar strengthened against the Brazilian currency.

 

 

Other Income (Expense)

 

Other income increased $0.6 million from expense of $0.4 million in fiscal 2019 to a $0.2 million income in fiscal 2020 due to the recognition of unrealized foreign exchange gains.

 

Income Taxes

 

The tax expense for the third quarter of fiscal 2020 was a benefit of $0.3 million on a profit before tax of $0.3 million or an effective tax rate of (100%). The tax rate for the third quarter of fiscal 2020 was lower than the US statutory rate primarily due to GILTI provisions, the jurisdictional mix of earnings, particularly Brazil with a statutory rate of 34%, and the impact of permanent deductible and nondeductible items and research credits. The tax expense for the third quarter of fiscal 2019 was $1.0 million on a profit before tax of $3.0 million or an effective tax rate of 31%. The tax rate for the third quarter of fiscal 2019 was higher than the US statutory rate primarily due to GILTI provisions, which became effective in fiscal 2019, as well as changes in the jurisdictional mix of earnings, particularly Brazil with a statutory rate of 34%.

 

Net Income

 

The Company recorded net income of $0.6 million or $0.09 per basic share in the third quarter of fiscal 2020 compared to net income of $2.0 million or $0.30 per basic share in fiscal 2019 as lower pretax profits were partially offset due to a lower effective tax rate related to the new tax legislation enacted in December 2017.

  

Nine months ended March 31, 2020 and March 31, 2019

 

Overview 

 

Net sales decreased $7.9 million or 5% from $166.9 million in fiscal 2019 to $159.0 million in fiscal 2020. Operating income decreased $3.6 million from $7.8 million in fiscal 2019 to $4.2 million in fiscal 2020 with lower gross margins of $3.2 million and a $0.4 million increase in selling, general and administrative expenses.

 

Net Sales

 

North American sales decreased $3.4 million or 3.4% from $100.9 million in fiscal 2019 to $97.5 million in fiscal 2020 with most of the decline coming from North American precision hand tools sold through industrial distribution. Our high-end metrology businesses continue to show very strong revenue growth, nearly 10%, for the nine months ended March 31, 2020 compared to the nine months ended March 31, 2019.

 

International sales decreased $4.5 million or 6.9% from $66.0 million in fiscal 2019 to $61.5 million in fiscal 2020. As the US Dollar has strengthened against the Brazilian currency, sales have declined as a result of translation of Brazilian sales into US Dollars by about $3.0 million. In constant currency, our Brazilian operation has grown its revenues 4.2% for the nine-month period compared to last year. Additional challenges were incurred by our Chinese operating unit which experienced the negative impact of the COVID-19 crisis two months before the rest of the company.

 

Gross Margin

 

Gross margin decreased $3.2 million or 5.8% from $54.4 million in fiscal 2019 to $51.2 million in fiscal 2020 due primarily to the reduction in sales.

 

North American gross margins decreased $0.8 million due to the corresponding decline in Sales.

 

International gross margins decreased $2.4 million or 9.5% from fiscal 2019 due in part to overall sales volume declines. As our Brazilian operation imports many of its raw materials from China in USD denominated transactions, the increased strength of the USD against the Brazilian currency has caused some gross margin erosion. 

 

Selling, General and Administrative Expenses

 

Selling, general and administrative expense increased $0.4 million or 2% from $46.5 million in fiscal 2019 to $46.9 million in fiscal 2020.

 

North American expenses, including Corporate, remained level with the same nine-month period in fiscal year 2019

 

International expenses increased $0.4 million or 2.3% primarily due to a one-time severance expense in Brazil and higher Sales commissions due to higher Sales in Brazil in constant currency.

 

 

Other Income (Expense)

 

Other expense for the nine months ending March 31, 2020 were essentially flat with the same period the prior year at $0.8 million.

 

Income Taxes

 

The tax expense for the first nine months of fiscal 2020 was $0.8 million on pre-tax income of $3.4 million or an effective tax rate of 23.5%. The tax rate for the first nine months of fiscal 2020 was higher than the US statutory rate primarily due to GILTI provisions, the jurisdictional mix of earnings, particularly Brazil with a statutory rate of 34%, and the impact of permanent deductible and nondeductible items and research credits. The tax expense for the first nine months of fiscal 2019 was $2.4 million on pre-tax income of $7.0 million or an effective tax rate of 34%. The tax rate for the first nine months of fiscal 2019 was higher than the US statutory rate primarily due to GILTI provisions, which became effective in fiscal 2019, as well as changes in the jurisdictional mix of earnings, particularly Brazil with a statutory rate of 34%. 

 

Net Income

 

The Company recorded net income of $2.6 million or $0.38 per basic share for the three quarters of fiscal 2020 compared to net income of $4.6 million or $0.66 per basic share in fiscal 2019. Operating income decreased $3.1 million from $7.3 million in fiscal 2019 to $4.2 million in fiscal 2020 with lower gross margins of $2.8 million and a $0.3 million increase in selling, general and administrative expenses.

 

LIQUIDITY AND CAPITAL RESOURCES

 

Cash flows (in thousands)		Nine Months Ended
		03/31/2020				03/31/2019
Cash provided by (used in) operating activities		$	(3,861	)		$	4,652
Cash (used in) investing activities			(8,618	)			(5,751	)
Cash provided by (used in) financing activities			6,910				(825	)
Effect of exchange rate changes on cash			202				(49	)
Net (decrease) in cash		$	(5,367	)		$	(1,973	)

 

Fiscal 2020 net cash flows for the nine months ended March 31, 2020 decreased $5.4 million as cash from operations decreased $3.9 million and cash from investing activities decreased $8.6 million as a result of $7.6 million in capital expenditures and $1.0 million in software development while cash provided from financing increased $6.9 million. Proceeds from borrowing was $11.6 million and debt retirement were $4.7 million.

 

Liquidity and Credit Arrangements

 

The Company believes it maintains sufficient liquidity and has the resources to fund its operations.  In addition to its cash, the Company maintains a $25.0 million line of credit in connection with the Tenth Amendment of the Loan and Security Agreement, of which, $19.4 million was outstanding as of March 31, 2020.  In addition, the Company entered into a new $10.0 million 5-year Term Loan with a fixed interest rate of 4.0%. The financial covenants under the new agreement are: 1) a Fixed Charge Coverage Ratio must exceed 1:15. The Fixed Charge Coverage Ratio is based upon EBITDA less dividends, unfunded Capital Expenditures, less required pension payments divided by the current portion of term loans, excluding, the Line of Credit and external debt; and 2) maintain consolidated Cash and available Credit Line of not less than $7.5 million on the closing date of any quarter. The Company was in compliance with the covenants of the amended Loan Agreement as of March 31, 2020.

 

The effective interest rate on the borrowings under the Loan and Security Agreement during the nine months ended March 31, 2020 and 2019 was 3.5% and 4.0% respectively. 

 

Although the Company has remained compliant with all debt covenants for the nine months period ending March 31, 2020, the challenges presented by a drop in sales related to the COVID-19 pandemic increase the risk to jeopardize covenant compliance in the June and September quarters ahead and potentially beyond that. As a result, the Company has made an official request of its lender, TD Bank, to waive its covenants, particularly the “Fixed Charge Coverage Ratio” covenant, for the next two quarters with an additional review after that period. TD Bank has acknowledged the receipt of that request and is taking it under consideration. The Company's goal is to work with its lender throughout the quarter to reach a solution before the end of the June 2020 quarter.

 

 

OFF-BALANCE SHEET ARRANGEMENTS

 

The Company does not have any material off-balance sheet arrangements as defined under the Securities and Exchange Commission rules.

 

ITEM 3.             QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

 

One 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, 2019 and updated for pandemic consideration in Item 1A. RISK FACTORS of this Form 10-Q.

 

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, 2019, and they have concluded that our disclosure controls and procedures were effective as of such date. All information required to be filed in this report was recorded, processed, summarized and reported within the time period required by the rules and regulations of the Securities and Exchange Commission, and such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of March 31, 2019, our Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective.

 

There is a potential risk in internal controls to financial reporting due to increased stress levels and remote working of accounting and finance staff as a result of the pandemic. The Company feels this risk currently has a non-material effect on internal control. The COVID-19 related circumstances have created a need for remote work arrangements as well as affecting the stress level of many of our employees globally. The Company has taken action to allow remote access while working within established guidelines for secure access and use of its networks. Further, Sarbanes Oxley internal control testing was on-going during the period ending March 31, 2020.

 

PART II.            OTHER INFORMATION

  

ITEM 1A.          RISK FACTORS

  

Risks Related to Our Company and Financial Position

 

We operate in a highly competitive environment, which could adversely affect our sales and pricing if we fail to compete effectively in the future.

 

We operate in a highly competitive environment. We compete on the basis of a variety of factors, including product performance, customer service, quality and price. Additionally, the Company’s products for the building trades, such as tape measures and levels, are under constant margin pressure due to a channel shift to large national home and hardware retailers. Certain large customers also offer their own private labels “own brand” that compete with Starrett branded products. There can be no assurance that our products will be able to compete successfully with other companies’ products. Thus, our share of industry sales could be reduced due to aggressive pricing or product strategies pursued by competitors, unanticipated product or manufacturing difficulties, our failure to price our products competitively or our failure to produce our products at a competitive cost. Lack of customer acceptance of price increases we announce from time to time, changes in customer requirements for price discounts, changes in our customers’ behavior or a weak pricing environment could have an adverse impact on our business, results of operations and financial condition. In addition, our results and ability to compete may be impacted negatively by changes in our geographic and product mix of sales.

 

Economic weakness in the industrial manufacturing sector could adversely affect the Company’s financial results.

 

The market for most of the Company’s products is subject to economic conditions affecting the industrial manufacturing sector, including the level of capital spending by industrial companies and the general movement of manufacturing to low cost foreign countries where the Company does not have a substantial market presence. Accordingly, economic weakness in the industrial manufacturing sector may, and in some cases has, resulted in decreased demand for certain of the Company’s products, which adversely affects sales and performance. Economic weakness in the consumer market will also adversely impact the Company’s performance. In the event that demand for any of the Company’s products declines significantly, the Company could be required to recognize certain costs as well as asset impairment charges on long-lived assets related to those products.

 

 

The novel coronavirus disease (COVID-19) pandemic is expected to have a material adverse effect on our business and results of operations

 

The COVID-19 pandemic has negatively impacted the global economy, disrupted consumer spending and global supply chains, and created significant volatility and disruption of financial markets. We expect the COVID-19 pandemic to have a material adverse impact on our business and financial performance. The extent of the impact of the COVID-19 pandemic on our business and financial performance, including our ability to execute our near-term and long-term business strategies and initiatives in the expected time frame, will depend on future developments, including the duration and severity of the pandemic, which are uncertain and cannot be predicted.

 

As a result of the COVID-19 pandemic and in response to government mandates or recommendations, we have initiated several measures to protect the health and safety of our employees, consumers and communities that has negatively impacted our business, including following state guidelines for social distancing such as, but not limited to, modifying shift schedules, supporting office-base employees working remotely, educating employees and making accommodations related to personal and workplace hygiene, mandating the wearing of masks, daily monitoring of employee’s temperature and regularly communicating accordingly. To immediately address the immediate financial crisis management implemented plans globally in an effort to control variable cost and to preserve cash. These actions included, but are not limited to, wage and salary reductions, furloughs, reduced work weeks and layoffs.

 

In addition, due to uncertain economic conditions resulting in weaker demand, potential supply constraints and the spread of the COVID-19 pandemic and related government actions, we temporarily suspended operations at certain facilities. We will continue to monitor the situation and may suspend operations at additional facilities as the situation warrants.

 

The extent of the impact of the COVID-19 pandemic on our business is highly uncertain and difficult to predict, as information is rapidly evolving with respect to the duration and severity of the pandemic. At this point, we cannot reasonably estimate the duration and severity of the COVID-19 pandemic, or its overall impact on our business.

 

Adverse global economic conditions and world events could affect our operating results, industry and business.

 

The Company’s results of operations may be materially affected by the conditions in the global economy. The demand for our products and services has in the past and continues to be significantly reduced in periods of economic weakness characterized by lower levels of government and business investment, lower levels of business confidence, lower corporate earnings, high real interest rates, lower credit activity or tighter credit conditions, perceived or actual industry overcapacity, higher unemployment and lower consumer spending. A prolonged period of economic weakness may also result in increased expenses due to higher allowances for doubtful accounts and potential goodwill and asset impairment charges. Economic conditions vary across regions and countries, and demand for our products and services generally increases in those regions and countries experiencing economic growth and investment. Slower economic growth or a change in the global mix of regions and countries experiencing economic growth and investment could have an adverse effect on our business, results of operations and financial condition.

 

The metalworking, construction, machinery, equipment, aerospace and automotive industries are major users of our products. Customers in these industries frequently base their decisions to purchase our products and services on the expected future performance of these industries, which in turn are dependent in part on commodity prices. Prices of commodities in these industries are frequently volatile and can change abruptly and unpredictably in response to general economic conditions and trends, government actions, regulatory actions, commodity inventories, production and consumption levels, technological innovations, commodity substitutions, market expectations and any disruptions in production or distribution or changes in consumption. Economic conditions affecting the industries we serve have in the past and may in the future also lead to reduced capital expenditures by our customers. Reduced capital expenditures by our customers are likely to lead to a decrease in the demand for our products and services and may also result in a decrease in demand for aftermarket parts as customers are likely to extend preventative maintenance schedules and delay major overhauls when possible. The rates of infrastructure spending and commercial construction also play a significant role in our results. Our products are an integral component of these activities, and as these activities decrease, demand for our products may be significantly impacted, which could negatively impact our results.

 

Sustained increases in funding obligations under the pension plans may impair our liquidity or financial condition.

 

The Company maintains certain defined benefit pension plans in both the United States and the United Kingdom for the benefit of its employees.  Defined benefit pension plans impose certain funding obligations on the Company.  The Company froze the domestic defined benefit pension plan as of December 31, 2016, and therefore no future benefits will accrue to employees under that plan. (Additionally, the Company limited eligibility under the postretirement benefit plan as of December 31, 2013, reducing the liability for the plan.)  Nevertheless, the Company expects to be required to provide more funding to the domestic pension (and postretirement) plan in the future.

 

 

The Company’s United Kingdom pension plan, which is also underfunded, required Company contributions of $1.0 million and $1.1 million during fiscal 2019 and 2018, respectively. The Company expects to make a $1.0 million contribution to its United Kingdom pension plan in fiscal 2020.

 

In determining our future payment obligations under the plans, we assume certain rates of return on the plan assets and a certain level of future benefit payments. Significant adverse changes in credit or capital markets could result in actual rates of return being materially lower than projected and result in increased contribution requirements. Our assumptions for future benefit payments may also change over time, and could be materially higher than originally projected.

 

We expect to make contributions to our pension plans in the future, and may be required to make contributions that could be material. We may fund contributions through the use of cash on hand, the proceeds of borrowings, shares of our common stock, or a combination of the foregoing, as permitted by applicable law. We may also explore other strategic alternatives in order to address expected pension liability, including de-risking options or acquisitions or sales of assets or divestitures, in order to meet the Company’s liquidity needs. Divestitures could result in decreased future revenues and profits, and an obligation to make contributions to our pension plans could reduce the cash available for working capital and other corporate uses, and may have an adverse impact on our operations, financial condition and liquidity.

 

We are subject to certain risks as a result of our financial borrowings.

 

As of March 31, 2020, our total indebtedness was $28.5 million as compared to indebtedness of $21.6 million as of December 31, 2019.

 

On December 31, 2019, the Company entered into the Tenth Amendment of its Loan and Security Agreement (“Tenth Amendment”). Under the revised agreement, the credit limit for the Revolving Loan was increased from $23.0 million to $25.0 million. In addition, the Company entered into a new $10.0 million 5-year Term Loan with a fixed interest rate of 4.0%. The new Term Loan will require interest only payments for 12 months and will convert to a term loan requiring both interest and principal payments commencing January 1, 2021. Also, under the Tenth Amendment, the credit limit for external borrowing was increased from $2.5 million to $5.0 million.

 

Total debt increased $5.7 million and $6.9 million during the three months and nine months ending March 31, 2020.  During the three months ended March 31, 2020 the Company retired $3.5 million of the Bytewise term loan (November, 2011) from proceeds of borrowing $6.5 million on the Loan and Security Agreement Term Loan.  The line of credit balance increase $2.5 million and Brazil loans increased $0.2 million.

 

Although the Company has remained compliant with all debt covenants for the nine months period ending March 31, 2020, the challenges presented by a drop in Sales related to the COVID-19 pandemic increase the risk to jeopardize covenant compliance in the June and September quarters ahead and potentially beyond that. As a result, the Company has made an official request of its lender, TD Bank, to waive its covenants, particularly the “Fixed Charge Coverage Ratio” covenant, for the next two quarters with an additional review after that period. TD Bank has acknowledged the receipt of that request and is taking it under consideration. The Company's goal is to work with its lender throughout the quarter to reach a solution before the end of the June 2020 quarter.

 

An event of default under the credit facility, if not waived, could prevent additional borrowings and could result in the acceleration of the Company’s debt. Additionally, the amount of debt we maintain could have consequences, including increasing our vulnerability to general adverse economic and industry conditions; requiring a substantial portion of our cash flows from operations be used for the payment of interest rather than to fund working capital, capital expenditures, acquisitions and general corporate requirements; limiting our ability to obtain additional financing; and limiting our flexibility in planning for, or reacting to, changes in our business and the end markets in which we operate.

 

Furthermore, the agreements governing our debt include covenants that restrict, among other matters, our ability to incur additional debt, pay dividends on or repurchase our equity, make certain investments, and consolidate, merge or transfer all or substantially all of our assets. Certain of our debt facilities require or will require us to maintain specified financial ratios and satisfy certain financial condition tests. Our ability to comply with these covenants may be affected by events beyond our control, including prevailing economic, financial and industry conditions. Adhering to these covenants may also require that we take disadvantageous actions, including reducing spending on marketing, advertising and new product innovation, reducing future financing for working capital, capital expenditures and general corporate purposes, selling assets or dedicating an unsustainable level of cash flows from operations to the payment of principal and interest on our indebtedness. Our leverage could also put us at a disadvantage compared to any competitors that are less leveraged.

 

 

Our operational results are dependent on how well we can scale our manufacturing capacity and resources to the level of our customers’ demand.

 

We sell our products in industries that require manufacturers to make highly efficient use of manufacturing capacity. Insufficient or excess capacity threatens our ability to generate competitive profit margins and may expose us to liabilities such as contractual commitments. Although from time to time we close or consolidate facilities, adapting or modifying our capacity is difficult, as modifications take substantial time to execute, are inherently disruptive and costly and, in some cases, may require regulatory approval. Additionally, delivering products during process or facility modifications requires special coordination. The cost and resources required to adapt our capacity, such as through facility acquisitions, facility closings or process moves between facilities, may negate any planned cost reductions or may result in costly delays, product quality issues or material shortages, all of which could adversely affect our operational results and our reputation with our customers.

 

We may not realize all of the anticipated benefits of our acquisitions, joint ventures or divestitures, or these benefits may take longer to realize than expected.

 

Acquisitions involve special risks, including the potential assumption of unanticipated liabilities and contingencies, difficulty in assimilating the operations and personnel of the acquired businesses, disruption of the Company’s existing business, dissipation of the Company’s limited management resources, and impairment of relationships with employees and customers of the acquired business as a result of changes in ownership and management.

 

In pursuing our business strategy, we routinely evaluate targets and enter into agreements regarding possible acquisitions, divestitures and joint ventures. To be successful, we conduct due diligence to identify valuation issues and potential loss contingencies and manage post-closing matters such as the integration of acquired businesses. Further, while we seek to mitigate risks and liabilities of such transactions through due diligence, among other things, there may be risks and liabilities that our due diligence efforts fail to discover that are not accurately or completely disclosed to us or that we inadequately assess. We may incur unanticipated costs or expenses following a completed acquisition, including post-closing asset impairment charges, expenses associated with eliminating duplicate facilities, litigation, and other liabilities. Risks associated with our past or future acquisitions also include the following:

 

●

the failure to achieve the acquisition's revenue or profit forecast;

●

technological and product synergies, economies of scale and cost reductions may not occur as expected;

●

unforeseen expenses, delays or conditions may be imposed upon the acquisition, including due to required regulatory approvals or consents;

●

the acquisition or assumption of unexpected liabilities or the incurrence of unexpected penalties or other enforcement actions;

●

unforeseen difficulties integrating operations, processes and systems;

●

failure to retain, motivate and integrate key management and other employees of the acquired business; and

●

problems in retaining customers and integrating customer bases.

 

Many of these factors will be outside of our control and any one of them could result in increased costs, decreases in the amount of expected revenues and diversion of management’s time and attention. They may also delay the realization of the benefits we anticipate when we enter into a transaction. Failure to successfully integrate and realize the expected benefits of such acquisitions or to implement our acquisition strategy, including successfully integrating acquired businesses, could have an adverse effect on our business, financial condition and results of operations.

 

Furthermore, we consider strategic divestitures from time to time, including divestures of underperforming or non-core assets or divestitures designed to generate cash to extinguish or reduce our liabilities. In the case of divestitures, we may agree to indemnify acquiring parties for certain liabilities arising from our former businesses. These divestitures may also result in continued financial involvement in the divested businesses following the transaction, including through guarantees or other financial arrangements. Lower performance by those divested businesses could affect our future financial results and divestitures of profitable operations to generate cash could reduce our future revenues and profits.

 

We may not be able to convert our order backlog into revenue. 

 

Our backlog consists of orders believed to be firm as of the balance sheet date. We may not receive revenue from some of these orders, and the order backlog we report may not be indicative of our future revenue. Many events can cause an order to be delayed or not completed at all, some of which may be out of our control. If we delay fulfilling customer orders, or if customers reconsider their orders, those customers may seek to cancel or modify their orders with us. Customers may otherwise seek to cancel or delay their orders even if we are prepared to fulfill them. If our orders in backlog do not result in sales, our operating results may suffer.

 

 

If we do not meet customers’ product quality, reliability standards and expectations, we may experience increased or unexpected product warranty claims and other adverse consequences to our business.

 

Product quality and reliability are significant factors influencing customers' decisions to purchase our products. Inability to maintain the high quality of our products relative to the perceived or actual quality of similar products offered by competitors could result in the loss of market share, loss of revenue, reduced profitability, an increase in warranty costs, government investigations and/or damage to our reputation.

 

Product quality and reliability are determined in part by factors that are not entirely within our control. We depend on our suppliers for parts and components that meet our standards. If our suppliers fail to meet those standards, we may not be able to deliver the quality of products that our customers expect, which may impair our reputation, resulting in lower revenue and higher warranty costs.

 

We provide our customers a warranty covering workmanship, and in some cases materials, on products we manufacture. Our warranty generally provides that products will be free from defects for 1 year. If a product fails to comply with the warranty, we may be obligated, at our expense, to correct any defect by repairing or replacing the defective product. Although we maintain warranty reserves in an amount based primarily on the number of units shipped and on historical and anticipated warranty claims, there can be no assurance that future warranty claims will follow historical patterns or that we can accurately anticipate the level of future warranty claims. While the Company has historically not incurred significant warranty expense, an increase in the rate of warranty claims or the occurrence of unexpected warranty claims, for which we are not insured or where we cannot recover from our vendors to the extent their materials or workmanship were defective, could materially and adversely affect our financial condition, results of operations and cash flows.

 

If our manufacturing processes and products do not comply with applicable statutory and regulatory requirements, or if we manufacture products containing design or manufacturing defects, demand for our products may decline and we may be subject to product liability claims.

 

Our designs, manufacturing processes and facilities need to comply with applicable statutory and regulatory requirements. We may also have the responsibility to ensure that products we design satisfy safety and regulatory standards including those applicable to our customers and to obtain any necessary certifications. As a result, products that we manufacture may at times contain manufacturing or design defects, and our manufacturing processes may be subject to errors or not be in compliance with applicable statutory and regulatory requirements or demands of our customers. Potential defects in the products we manufacture or design, whether caused by a design, manufacturing or component failure or error, or deficiencies in our manufacturing processes, may result in delayed shipments to customers, replacement costs or reduced or canceled customer orders. If these defects or deficiencies are significant, our business reputation may also be damaged. The failure of the products that we manufacture or our manufacturing processes and facilities to comply with applicable statutory and regulatory requirements may subject us to legal fines or penalties and, in some cases, require us to shut down or incur considerable expense to correct a manufacturing process or facility.

 

Any manufacturing or design defects may also result in product liability claims. Furthermore, customers use some of our products in potentially hazardous applications that can cause injury or loss of life and damage to property, equipment or the environment. We may be named as a defendant in product liability or other lawsuits asserting potentially large claims if an accident occurs at a location where our equipment and services have been or are being used. We also maintain certain insurance policies which may limit our financial exposures. Any significant liabilities which are not covered by insurance could have an adverse effect on our financial condition, results of operation and cash flows. Likewise, a substantial increase in the number of claims that are made against us or the amounts of any judgments or settlements could materially and adversely affect our reputation and our financial condition, results of operations and cash flows.

 

Volatility in the price of energy and raw materials, large or rapid increases in the cost of raw materials or components parts, substantial decreases in their availability, or our dependence on particular suppliers of raw materials and component parts could materially and adversely affect our operating results. 

 

Steel is the principal raw material used in the manufacture of the Company’s products. Historically, market prices of some of our key raw materials have fluctuated on a cyclical basis and have often depended on a variety of factors over which the Company has no control, including as a result of tariffs or other trade barriers. If in the future we are not able to reduce product costs in other areas or pass raw material price increases on to our customers, our margins could be adversely affected. In addition, because we maintain limited raw material and component inventories, even brief unanticipated delays in delivery by suppliers—including those due to capacity constraints, labor disputes, impaired financial condition of suppliers, weather emergencies, global pandemics, such as COVID-19, or other natural disasters— may impair our ability to satisfy our customers and could adversely affect our financial performance. The cost of producing the Company’s products is also sensitive to the price of energy. If we are unable to manage pricing from these suppliers effectively or pass future cost increases through to our customers, our financial performance could be adversely affected. Likewise, if our suppliers terminate these agreements and we are unable to procure alternate products at substantially similar competitive pricing, our financial performance could be adversely affected.

 

 

We may not be able to maintain our engineering, technological and manufacturing expertise.

 

The markets for our products are characterized by changing technology and evolving process development. The continued success of our business will depend upon our ability to:

 

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hire, retain and expand our pool of qualified engineering and technical personnel;

 

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maintain technological leadership in our industry;

 

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successfully anticipate or respond to changes in manufacturing processes in a cost-effective and timely manner; and

 

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successfully anticipate or respond to changes in cost to serve in a cost-effective and timely manner.

 

We cannot be certain that we will develop the capabilities required by our customers in the future. The emergence of new technologies, industry standards or customer requirements may render our equipment, inventory or processes obsolete or uncompetitive. We may have to acquire new technologies and equipment to remain competitive. The acquisition and implementation of new technologies and equipment may require us to incur significant expense and capital investment, which could reduce our margins and affect our operating results. When we establish new facilities, we may not be able to maintain or develop our engineering, technological and manufacturing expertise due to a lack of trained personnel, effective training of new staff or technical difficulties with machinery. Failure to anticipate and adapt to customers’ changing technological needs and requirements or to hire and retain a sufficient number of engineers and maintain engineering, technological and manufacturing expertise may have a material adverse effect on our business.

 

Increased information technology security threats and more sophisticated computer crime pose a risk to our systems, networks, products and services. Any inadequacy, interruption, integration failure or security failure with respect to our information technology could harm our ability to effectively operate our business.

 

The efficient operation of the Company's business is dependent on its information systems, including its ability to operate them effectively and to successfully implement new technologies, systems, controls and adequate disaster recovery systems. In addition, the Company must protect the confidentiality of data of its business, employees, customers and other third parties. Information technology security threats -- from user error to cybersecurity attacks designed to gain unauthorized access to our systems, networks and data – are increasing in frequency and sophistication. Cybersecurity attacks may range from random attempts to coordinated and targeted attacks, including sophisticated computer crime and advanced persistent threats. These threats pose a risk to the security of our systems and networks and the confidentiality, availability and integrity of our data. Cybersecurity attacks could also include attacks targeting customer data or the security, integrity and/or reliability of the hardware and software installed in our products. It is possible that our information technology systems and networks, or those managed by third parties, could have vulnerabilities, which could go unnoticed for a period of time. The failure of the Company's information systems to perform as designed or its failure to implement and operate them effectively could disrupt the Company's business or subject it to liability and thereby harm its profitability. While the Company continues to enhance the applications contained in the Enterprise Resource Planning (ERP) system as well as improvements to other operating systems, there can be no guarantee that the actions and controls we have implemented and are implementing, or which we cause or have caused third party service providers to implement, will be sufficient to protect our systems, information or other property.

 

If we fail to protect our intellectual property rights or maintain our rights to use licensed intellectual property, our business could be adversely affected.

 

Our intellectual property, including our patents, trade secrets, trademarks and licenses are important in the operation of our business. Although we intend to protect our intellectual property rights vigorously, we cannot be certain that we will be successful in doing so. Third parties may assert or prosecute infringement claims against us in connection with the services and products that we offer, and we may or may not be able to successfully defend these claims. Litigation, either to enforce our intellectual property rights or to defend against claimed infringement of the rights of others, could result in substantial costs and in a diversion of our resources.

 

In addition, if a third party would prevail in an infringement claim against us, then we would likely need to obtain a license from the third party on commercial terms, which would likely increase our costs. Our failure to maintain or obtain necessary licenses or an adverse outcome in any litigation relating to patent infringement or other intellectual property matters could have a material adverse effect on our financial condition, results of operations and cash flows.

 

 

Risks Related to Legal and Regulatory

 

International operations and our financial results in those markets may be affected by legal, regulatory, political, currency exchange and other economic risks.

 

During the third quarter of 2020, revenue from sales outside of the United States was $16.6 million, representing approximately 33 % of consolidated sales. In addition, a significant amount of our manufacturing and production operations are located, or our products are sourced from, outside the United States. As a result, our business is subject to risks associated with international operations. These risks include the burdens of complying with foreign laws and regulations, unexpected changes in tariffs, taxes or regulatory requirements, changes in governmental monetary and fiscal policies, and political unrest and corruption. Regulatory changes could occur in the countries in which we sell, produce or source our products or significantly increase the cost of operating in or obtaining materials originating from certain countries. Restrictions imposed by such changes can have a significant impact on our business.

 

In addition, the functional currency for most of our foreign operations is the applicable local currency. As a result, fluctuations in foreign currency exchange rates affect the results of our operations and the value of our foreign assets and liabilities, which in turn may adversely affect results of operations and cash flows and the comparability of period-to-period results of operations. Changes in foreign currency exchange rates may also affect the relative prices at which we and foreign competitors sell products in the same market. Foreign governmental policies and actions regarding currency valuation could result in actions by the United States and other countries to offset the effects of such fluctuations. Given the unpredictability and volatility of foreign currency exchange rates, ongoing or unusual volatility may adversely impact our business and financial conditions.

 

Countries in which our products are manufactured or sold may from time to time impose additional new regulations, or modify existing regulations, including:

 

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changes in duties, taxes, tariffs and other charges on imports;

 

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limitations on the quantity of goods which may be imported into the United States from a particular country;

 

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requirements as to where products and/or inputs are manufactured or sourced;

 

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creation of export licensing requirements, imposition of restrictions on export quantities or specification of minimum export pricing and/or export prices or duties;

 

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currency fluctuations;

 

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limitations on foreign owned businesses; or

 

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government actions to cancel contracts, re-denominate the official currency, renounce or default on obligations, renegotiate terms unilaterally or expropriate assets.

 

In addition, political and economic changes or volatility, geopolitical regional conflicts, terrorist activity, political unrest, civil strife, acts of war, public corruption and other economic or political uncertainties could interrupt and negatively affect our business operations. All of these factors could result in increased costs or decreased revenues and could materially and adversely affect our product sales, financial condition and results of operations.

 

Failure to comply with laws, rules and regulations could negatively affect our business operations and financial performance.

 

Due to the international scope of our operations, we are subject to a complex system of federal, state, local and international laws, rules and regulations, such as state and local wage and hour laws, the U.S. Foreign Corrupt Practices Act (the “FCPA”), the False Claims Act, the Employee Retirement Income Security Act (“ERISA”), securities laws, import and export laws (including customs regulations) and many others. We may also be subject to investigations or audits by governmental authorities and regulatory agencies, which can occur in the ordinary course of business or which can result from increased scrutiny from a particular agency towards an industry, country or practice. Such investigations or audits may subject us to increased government scrutiny, investigation and civil and criminal penalties, and may limit our ability to import or export our products or to provide services outside the United States.

 

Furthermore, embargoes and sanctions imposed by the United States and other governments restricting or prohibiting sales to specific persons or countries or based on product classification may expose us to potential criminal and civil sanctions. We cannot predict the nature, scope or effect of future regulatory requirements to which our operations might be subject or in certain locations the manner in which existing laws might be administered or interpreted.

 

In addition, as a result of operating in multiple countries, we must comply with multiple foreign laws and regulations that may differ substantially from country to country and may conflict with corresponding U.S. laws and regulations. The FCPA and similar foreign anti-corruption laws generally prohibit companies and their intermediaries from making improper payments or providing anything of value to improperly influence foreign government officials for the purpose of obtaining or retaining business, or obtaining an unfair advantage. Recent years have seen a substantial increase in the global enforcement of anti-corruption laws. Our operations outside the United States, including in developing countries, expose us to the risk of such violations. If we fail to comply with laws, rules and regulations or the manner in which they are interpreted or applied, we may be subject to government enforcement action, class action litigation or other litigation, damage to our reputation, civil and criminal liability, damages, fines and penalties, and increased cost of regulatory compliance, any of which could adversely affect our results of operations and financial performance.

 

 

Costs associated with lawsuits or investigations or adverse rulings in enforcement or other legal proceedings may have an adverse effect on our results of operations.

 

From time to time, we are involved in various claims and lawsuits that arise in and outside of the ordinary course of our business. The industries in which we operate are also periodically reviewed or investigated by regulators, which could lead to enforcement actions, fines and penalties or the assertion of private litigation claims. It is not possible to predict with certainty the outcome of claims, investigations and lawsuits, and we could in the future incur judgments, fines or penalties or enter into settlements of lawsuits and claims that could have an adverse effect on our reputation, business, results of operations or financial condition in any particular period. The global and diverse nature of our operations means that legal and compliance risks will continue to exist and additional legal proceedings and other contingencies, the outcome of which cannot be predicted with certainty, may arise from time to time. In addition, subsequent developments in legal proceedings may affect our assessment and estimates of loss contingencies recorded as a reserve and require us to make payments in excess of our reserves, which could have an adverse effect on our reputation, business and results of operations or financial condition.

 

Our tax rate is dependent upon a number of factors, a change in any of which could impact our future tax rates and net income.

 

Our future tax rates may be adversely affected by a number of factors, including the enactment of certain tax legislation being considered in the United States and other countries; other changes in tax laws or the interpretation of such tax laws; changes in the estimated realization of our net deferred tax assets; the jurisdictions in which profits are determined to be earned and taxed; the repatriation of non-U.S. earnings for which we have not previously provided for U.S. income and non-U.S. withholding taxes; adjustments to estimated taxes upon finalization of various tax returns; increases in expenses that are not deductible for tax purposes, including impairment of goodwill in connection with acquisitions; changes in available tax credits; and the resolution of issues arising from tax audits with various tax authorities. Losses for which no tax benefits can be recorded could materially impact our tax rate and its volatility from one quarter to another. Any significant change in our jurisdictional earnings mix or in the tax laws in those jurisdictions could impact our future tax rates and net income in those periods.

 

 

ITEM 6.             EXHIBITS

 

  

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, 2020 are furnished herewith, formatted in XBRL (Extensible Business Reporting Language): (I) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Operations, (iii) the Consolidated Statements of Comprehensive Income (Loss), (iv) the Consolidated Statement of Stockholders' Equity, (v) the Consolidated Statements of Cash Flows, and (vi) Notes to Consolidated Financial Statements, tagged as blocks of text.

 

 

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	April 30, 2020		/S/R. Douglas A. Starrett
			Douglas A. Starrett - President and CEO (Principal Executive Officer)
Date	April 30, 2020		/S/R. John C. Tripp
			John C. Trip - Treasurer and CFO (Principal Accounting Officer)