STARRETT L S CO - Quarter Report: 2014 December (Form 10-Q)

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		December 31, 2014 (unaudited)				June 30, 2014
ASSETS
Current assets:
Cash		$	16,139			$	16,233
Short-term investments			7,790				8,723
Accounts receivable (less allowance for doubtful accounts of $766 and $704, respectively)			33,531				43,712
Inventories			66,418				65,582
Current deferred income tax assets			4,651				6,037
Prepaid expenses and other current assets			8,241				6,615
Total current assets			136,770				146,902
Property, plant and equipment, net			47,097				51,537
Long-term income taxes receivable			3,775				3,775
Long-term deferred income tax assets, net of current portion			16,199				16,537
Intangible assets, net			7,426				7,760
Goodwill			3,034				3,034
Other assets			2,015				1,898
Total assets		$	216,316			$	231,443
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Notes payable and current maturities of long-term debt		$	11,501			$	10,548
Accounts payable			9,210				9,980
Accrued expenses			6,718				8,516
Accrued compensation			3,824				6,642
Total current liabilities			31,253				35,686
Long-term debt, net of current portion			10,005				10,804
Other income tax obligations			4,485				3,013
Deferred income tax liabilities			2,017				2,037
Postretirement benefit and pension obligations			41,624				43,589
Total liabilities			89,384				95,129
Stockholders' equity:
Class A Common stock $1 par (20,000,000 shares authorized; 6,198,381 outstanding at December 31, 2014 and 6,165,838 outstanding at June 30, 2014)			6,199				6,166
Class B Common stock $1 par (10,000,000 shares authorized; 790,683 outstanding at December 31, 2014 and 794,990 outstanding at June 30, 2014)			791				795
Additional paid-in capital			54,468				54,063
Retained earnings			97,689				95,715
Accumulated other comprehensive loss			(32,215	)			(20,425	)
Total stockholders' equity			126,932				136,314
Total liabilities and stockholders’ equity		$	216,316			$	231,443

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		3 Months Ended								6 Months Ended
		12/31/2014				12/31/2013				12/31/2014				12/31/2013
Net sales		$	63,821			$	61,841			$	123,993			$	119,328
Cost of goods sold			41,657				41,496				82,686				81,174
Gross margin			22,164				20,345				41,307				38,154
% of Net sales			34.7	%			32.9	%			33.3	%			32.0	%
Selling, general and administrative expenses			18,461				17,917				36,538				34,990
Operating income			3,703				2,428				4,769				3,164
Other income			620				513				1,295				622
Income before income taxes			4,323				2,941				6,064				3,786
Income tax expense			1,876				1,159				2,694				1,788
Net income		$	2,447			$	1,782			$	3,370			$	1,998
Basic and diluted income per share		$	0.35			$	0.26			$	0.48			$	0.29
Weighted average outstanding shares used in per share calculations:
Basic			6,974				6,922				6,970				6,908
Diluted			7,012				6,966				7,010				6,949
Dividends per share		$	0.10			$	0.10			$	0.20			$	0.20

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		3 Months Ended								6 Months Ended
		12/31/2014				12/31/2013				12/31/2014				12/31/2013
Net income		$	2,447			$	1,782			$	3,370			$	1,998
Other comprehensive loss
Translation loss			(4,820	)			(2,120	)			(11,768	)			(945	)
Pension and postretirement plans, net of tax of $0,$0,$22 and $0 respectively			-				(15	)			(22	)			(30	)
Other comprehensive loss			(4,820	)			(2,135	)			(11,790	)			(975	)
Total comprehensive income (loss)		$	(2,373	)		$	(353	)		$	(8,420	)		$	1,023

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		Common Stock Outstanding								Addi- tional Paid-in				Retained				Accumulated Other Com- prehensive
		Class A				Class B				Capital				Earnings				Loss				Total
Balance June 30, 2014		$	6,166			$	795			$	54,063			$	95,715			$	(20,425	)		$	136,314
Total comprehensive income (loss)															3,370				(11,790	)			(8,420	)
Dividends ($0.20 per share)															(1,396	)							(1,396	)
Repurchase of shares							(2	)			(31	)											(33	)
Issuance of stock under 1984 ESOP			9								122												131
Issuance of stock under Long Term Incentive Plan			3								45												48
Issuance of stock under ESPP							14				111												125
Issuance of stock for length of service awards			5								71												76
Stock-based compensation											87												87
Conversion of class B to class A			16				(16	)															-
Balance December 31, 2014		$	6,199			$	791			$	54,468			$	97,689			$	(32,215	)		$	126,932
Accumulated balance consists of:
Translation loss																		$	(30,079	)
Pension and postretirement plans, net of taxes																			(2,136	)
																		$	(32,215	)

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		6 Months Ended
		12/31/2014				12/31/2013
Cash flows from operating activities:
Net income		$	3,370			$	1,998
Non-cash operating activities:
Depreciation			3,959				4,070
Amortization			634				578
Stock-based compensation			87				94
Stock based compensation length of service awards			76				59
Stock based compensation Long-Term Incentive Plan			48				-
Net long-term tax obligations			1,723				-
Deferred taxes			1,301				370
Unrealized transaction gain			(6	)			(13	)
Income on equity method investment			(116	)			(152	)
Working capital changes:
Accounts receivable			5,928				3,003
Inventories			(6,158	)			(4,159	)
Other current assets			(2,219	)			(313	)
Other current liabilities			(2,986	)			(1,133	)
Postretirement benefit and pension obligations			(866	)			925
Other			761				316
Net cash provided by operating activities			5,536				5,643
Cash flows from investing activities:
Additions to property, plant and equipment			(2,768	)			(4,277	)
Purchase of investments			(45	)			(52	)
Proceeds from sale of investments			201				-
Net cash used in investing activities			(2,612	)			(4,329	)
Cash flows from financing activities:
Proceeds from short-term borrowings			921				100
Short-term debt repayments			-				(25	)
Long-term debt repayments			(767	)			(3,268	)
Proceeds from common stock issued			256				270
Shares repurchased			(33	)			-
Dividends paid			(1,396	)			(1,383	)
Net cash used in financing activities			(1,019	)			(4,306	)
Effect of exchange rate changes on cash			(1,999	)			(206	)
Net decrease in cash			(94	)			(3,198	)
Cash, beginning of period			16,233				19,755
Cash, end of period		$	16,139			$	16,557
Supplemental cash flow information:
Interest paid		$	363			$	439
Income taxes paid, net			1,183				2,353
Supplemental disclosure of non-cash activities:
Issuance of stock under 2013 ESOP		$	-			$	773

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

 

The balance sheet as of June 30, 2014, which has been derived from audited financial statements, and the unaudited interim 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 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, 2014.  Operating results are not necessarily indicative of the results that may be expected for any future interim period or for the entire fiscal year.

 

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, 2014 describes the significant accounting policies and methods used in the preparation of the consolidated financial statements.

Note 2: Recent Accounting Pronouncements

 

In May 2014, the FASB issued a new standard related to the “Revenue from Contracts with Customers” which amends the existing accounting standards for revenue recognition. The standard requires entities to recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration the entity expects to be entitled to in exchange for those goods or services. This standard is applicable for fiscal years beginning after December 15, 2016 and for interim periods within those years and early adoption is not permitted. The Company expects to adopt this standard on July 1, 2017. The Company is currently evaluating the impact of the adoption of this standard on its consolidated financial statements.

 

Accounting Standards Update 2013-11, Income Taxes: Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists was approved by the FASB in July 2013 and requires that companies report their tax reserves net of the impact of tax loss and credit carryforwards for years beginning after December 15, 2013. The Company has implemented this pronouncement in the first quarter of fiscal 2015 with retrospective application as permitted by the standard. Amounts presented for prior periods have been reclassified to conform. There is no effect on tax expense and net income. On the balance sheet, there is a reduction in deferred tax assets of $7.8 million and a reduction in Other Tax Obligations of $7.8M for all periods presented.

Note 3:  Stock-based Compensation

 

On September 5, 2012, the Board of Directors adopted The L.S. Starrett Company 2012 Long Term Incentive Plan (the “2012 Stock Plan”). The 2012 stock plan was 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 December 31, 2014, there were 20,500 stock options and 42,233 restricted stock units outstanding. In addition, there were 431,800 shares available for grant under the 2012 Stock Plan as of December 31, 2014.

 

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 expected life is determined using the average of the vesting period and contractual term of the options (Short-cut method).

 

 

The fair value of stock options issued during the 6 months ended December 31, 2014 of $3.82 was estimated using the following assumptions:

 

 

The weighted average contractual term for stock options outstanding as of December 31, 2014 was 8 years.  The aggregate intrinsic value of stock options outstanding as of December 31, 2014 was $0.1 million. Stock options exercisable as of December 31, 2014 were 13,667.

 

The Company accounts for stock options and 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. 

 

There were 39,500 RSU awards issued during the six months ended December 31, 2014. There were 2,733 RSUs vested during the six months ended December 31, 2014.  The aggregate intrinsic value of RSU awards outstanding as of December 31, 2014 was $0.8 million.  RSU awards granted and vested as of December 31, 2014 were 5,466.

 

On February 5, 2013, the Board of Directors adopted The L.S. Starrett Company 2013 Employee Stock Ownership Plan (the “2013 ESOP”). 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. U.S. employees who have completed a year of service are eligible to participate.

 

Compensation expense related to all stock based plans for the six month period ended December 31, 2014 and December 31, 2013 was $0.1 million and $0.1 million, respectively.  As of December 31, 2014, there was $0.7 million of total unrecognized compensation costs related to outstanding stock-based compensation arrangements. Of this cost $0.3 million is expected to be recognized over a weighted average period of 2.5 years and $0.4 million relates to performance based RSU awards that are not expected to vest. 

 

Note 4:   Inventories

 

Inventories consist of the following (in thousands):

 

 

LIFO inventories were $15.6 million and $14.1 million at December 31, 2014 and June 30, 2014, respectively, or approximately $ 27.4 million and $ 27.3 million, respectively, less than their balances accounted for on a FIFO basis.  The use of LIFO, as compared to FIFO, resulted in a $0.1 million increase in cost of sales for the six months ended December 31, 2014 compared to a $0.4 million decrease for the six months ended December 31, 2013.

Note 5:   Goodwill and Intangible Assets

 

Goodwill is measured as the excess of the cost of acquisition over the sum of the amounts assigned to identifiable tangible and intangible assets acquired less liabilities assumed. The Company’s acquisition of Bytewise in 2011 gave rise to goodwill. The Company performs an impairment assessment on an annual basis as of the end of our October month end or more frequently if circumstances warrant. For fiscal year 2015, our impairment assessment was a two-step process. The first step requires a comparison of the implied fair value of the reporting unit to its carrying value. If the carrying value of the reporting unit is higher than its fair value, there is an indication that impairment may exist and the second step of the evaluation must be performed. In the second step, the potential impairment is calculated by comparing the implied fair value of the reporting unit’s goodwill with the carrying value of the goodwill. If the carrying value of the reporting unit’s goodwill is greater than the implied fair value of its goodwill, an impairment loss will be recognized for the excess.

 

 

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Determining the fair value of a reporting unit is subjective and requires the use of significant estimates and assumptions. With the assistance of an independent third-party appraisal firm, the Company estimates the fair value using an income approach based on the present value of future cash flows. The Company believes this approach yields the most appropriate evidence of fair value. The Company also utilizes the comparable company multiples method and market transaction fair value method to validate the fair value amount obtained using the income approach. The key assumptions utilized in the discounted cash flow model includes estimates of future cash flows from operating activities offset by estimated capital expenditures of the reporting unit, the estimated terminal value for the reporting unit, a discount rate based on a weighted average cost of capital, overall economic conditions, and an assessment of current market capitalization. Any unfavorable material changes to these key assumptions could potentially impact the Company’s fair value determinations.

 

The fair value of the 2015 goodwill assessment exceeded the carrying amount by approximately 37.4%. Therefore no goodwill impairment was recorded. If future results significantly vary from current estimates, related projections, or business assumptions in the future due to changes in industry or market conditions, the Company may be required to record impairment charges.

 

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

 

 

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 2015 and for each of the next five years and thereafter, is as follows (in thousands):

 

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):

 

 

 

 

Net periodic benefit costs for the Company's Postretirement Medical Plan consists of the following (in thousands): 

 

  

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).

 

Effective December 31, 2013, the Company terminated the eligibility of employees ages 55 -64 years old to enter into the Postretirement Medical Plan.

Note 7:   Debt

 

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

 

 

The Company executed an amendment to its Loan and Security Agreement (Line of Credit) as of April 25, 2012.  The Line of Credit is effective for three years commencing April 25, 2012 and was due to expire on April 30, 2015.  The agreement continued the previous line of $23.0 million, of which $12.2 million is available as of December 31, 2014, with an interest rate of LIBOR plus 1.5%.

 

As of December 31, 2014 the material financial covenants of the amended Loan and Security Agreement were: 1) funded debt to EBITDA, excluding non-cash and retirement benefit expenses (“maximum leverage”), not to exceed 2.25 to 1, 2) annual capital expenditures not to 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 Company was in compliance with all debt covenants as of December 31, 2014.

 

The effective interest rate on the Line of Credit under the Loan and Security Agreement for the six months ended December 31, 2014 and 2013 was 2.0% and 2.0%, respectively.

 

On January 26, 2015 the Line of Credit was amended based on the current debt limits and financial covenants and will expire on April 30, 2018.

 

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 $11.4 million at December 31, 2014, is subject to the same financial covenants as the Loan and Security Agreement. 

Note 8:   Income Taxes

 

The Company is subject to U.S. federal income taxes 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 effective tax rate for the second quarter of fiscal 2015 was 43.4%. The effective tax rate for the second quarter of fiscal 2014 was 39.4%. For the first half of fiscal 2015, the effective tax rate was 44.4% and for the first half of fiscal 2014, it was 47.2%. The tax rate is higher than the U.S. federal and state statutory rate in part due to losses in some foreign jurisdictions for which no tax benefit is recognized. In the first half of fiscal 2015, there was a discrete reduction to tax expense of $108,000 related to use of tax loss carryforwards and the reduction of the tax liability for audits related to the expiration of the statute of limitations; $33,000 of this was recorded in the second quarter. In the first half of fiscal 2014 there was a discrete tax expense of $278,000 for the effect of a tax rate change in the UK applied to the net deferred tax assets in that jurisdiction.

 

U.S. Federal tax returns through fiscal 2010 are generally no longer subject to review by tax authorities; however, tax loss carryforwards from years before fiscal 2011 are still subject to adjustment. As of December 31, 2014, the Company has substantially resolved all open income tax audits and there were no other local or federal income tax audits in progress. In international jurisdictions including Australia, Brazil, Canada, China, Germany, Mexico, New Zealand, Singapore and the UK, 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 2009 – 2014. The Company has identified no new uncertain tax positions during the six month period ended December 31, 2014 for which it is currently likely that the total amount of unrecognized tax benefits will significantly increase or decrease within the next twelve months.

 

Accounting for income taxes requires estimates of future benefits and tax liabilities. Due to the temporary differences in the timing of recognition of items included in income for accounting and tax purposes, deferred tax assets or liabilities are recorded to reflect the impact arising from these differences on future tax payments. With respect to recorded deferred tax assets, the Company assesses the likelihood that the asset will be realized by addressing the positive and negative evidence to determine whether realization is more likely than not to occur. If realization is in doubt because of uncertainty regarding future profitability, the Company provides a valuation allowance related to the asset to the extent that it is more likely than not that the deferred tax asset will not be realized. Should any significant changes in the tax law or the estimate of the necessary valuation allowance occur, the Company would record the impact of the change, which could have a material effect on the Company’s financial position.

 

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 U.S. federal NOL carryforwards. In certain other countries where Company operations are in a loss position, the deferred tax assets for tax loss carryforwards and other temporary differences are fully offset by a valuation allowance.

Note 9:  Contingencies

 

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

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