STARRETT L S CO - Quarter Report: 2017 March (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-Q

(Mark One)

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 THE L. S. STARRETT COMPANY

CONTENTS 

PART I.               FINANCIAL INFORMATION

ITEM 1.               FINANCIAL STATEMENTS

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

For the Nine Months Ended March 31, 2017

(in thousands except per share data) (unaudited)
 

THE L. S. STARRETT COMPANY

Consolidated Statements of Cash Flows

(in thousands of dollars) (unaudited)

See Notes to Unaudited Consolidated Financial Statements

THE L. S. STARRETT COMPANY

Notes to Unaudited Consolidated Financial Statements

March 31, 2017

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

The unaudited interim financial statements as of and for the three and nine months ended March 31, 2017 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, 2016.  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, 2016 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 “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, 2017 and for interim periods within those years. Earlier application will be permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. The Company expects to adopt this standard for its fiscal year beginning July 1, 2018. The Company is currently evaluating the impact of the adoption of this standard on its consolidated financial statements. 

In July 2015, the FASB issued ASU No. 2015-11, "Inventory (Topic 330): Simplifying the Measurement of Inventory." Previous to the issuance of this ASU, ASC 330 required that an entity measure inventory at the lower of cost or market. ASU 2015-11 specifies that “market” is defined as “net realizable value,” or the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. This ASU is effective for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2016. Application is to be applied prospectively with earlier application permitted as of the beginning of an interim or annual reporting period. The adoption of ASU No. 2015-11 will not have a material impact on our consolidated financial statements.

In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842)”.  The ASU requires that organizations that lease assets recognize assets and liabilities on the balance sheet for the rights and obligations created by those leases.  The ASU will affect the presentation of lease related expenses on the income statement and statement of cash flows and will increase the required disclosures related to leases.  This ASU is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, with early adoption permitted.  The Company is currently evaluating the impact of ASU No. 2016-02 on its consolidated financial statements.  It is expected that a key change upon adoption will be the balance sheet recognition of leased assets and liabilities and that any changes in income statement recognition will not be material.

In October 2016, the FASB issued ASU No. 2016-16, "Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory," which is intended to improve the accounting for the income tax consequences of intra-entity transfers of assets other than inventory. This update removes the current exception in GAAP prohibiting entities from recognizing current and deferred income tax expenses or benefits related to transfer of assets, other than inventory, within the consolidated entity. The current exception to defer the recognition of any tax impact on the transfer of inventory within the consolidated entity until it is sold to a third party remains unaffected. The amendments in this update are effective for public entities for annual reporting periods beginning after December 15, 2017. Early adoption is permitted. The Company is currently assessing the impact of the future adoption of this update on its consolidated financial statements.

In January 2017, the FASB issued ASU No. 2017-01, "Business Combinations (Topic 805) - Clarifying the Definition of a Business," with the objective to assist entities with evaluating whether transactions should be accounted for as acquisitions ( or disposals) of assets versus businesses. The amendments in ASU 2017-01 provide a screen to determine when a set of assets and activities is not a business. The screen requires that when substantially all of the fair value of the gross assets acquired ( or disposed of) is concentrated in a single identifiable asset or a group of similar identifiable assets, the set is not a business. This screen is expected to reduce the number of transactions that need to be further evaluated. If the screen is not met, the amendments in ASU 2017-01 (i) require that to be considered a business, a set of assets and liabilities acquired must include, at a minimum, an input and a substantive process that together significantly contribute to the ability to create output; and (ii) remove the evaluation of whether a market participant could replace missing elements. The amendments in this ASU are effective for annual and interim periods beginning after December 15, 2017 and should be applied prospectively. Early adoption is permitted for transactions for which the acquisition date occurs before the issuance date of ASU 2017-01, only when the transaction has not been reported in financial statements that have been issued or made available for issuance. The Company is currently assessing the impact of the adoption of this update on its consolidated financial statements.

In January 2017, the FASB issued ASU No. 2017-04, "Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment." Under the new guidance, if a reporting unit's carrying value amount exceeds its fair value, an entity will record an impairment charge based on that difference. The impairment charge will be limited to the amount of goodwill allocated to that reporting unit. The standard eliminates today's requirement to calculate goodwill impairment using Step 2, which calculates any impairment charge by comparing the implied fair value of goodwill with its carrying amount. The standard does not change the guidance on completing Step 1 of the goodwill impairment test. The amendments in this ASU are effective for annual and interim periods beginning after December 15, 2019 and should be applied prospectively for annual and any interim goodwill impairment tests. Early adoption is permitted for entities for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company is currently evaluating the impact of the update on our consolidated financial statements.

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 on 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, 2017, there were 20,000 stock options and 105,634 restricted stock units outstanding. In addition, there were 346,600 shares available for grant under the 2012 Stock Plan as of March 31, 2017.

For stock option grants the fair value of each grant is 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 (Simplified Method).

No stock options were granted during the nine months ended March 31, 2017 and 2016.

The weighted average contractual term for stock options outstanding as of March 31, 2017 was 5.75 years.  The aggregate intrinsic value of stock options outstanding as of March 31, 2017 was negligible. Stock options exercisable as of March 31, 2017 were 20,000. In recognizing stock compensation expense for the 2012 Stock Incentive Plan management has estimated that there will be no forfeitures of options.

The Company accounts for stock options and RSU awards by recognizing the expense of the grant date 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 45,000 RSU awards with a fair value of $10.86 per RSU granted during the nine months ended March 31, 2017. There were 12,733 RSUs settled during the nine months ended March 31, 2017.  The aggregate intrinsic value of RSU awards outstanding as of March 31, 2017 was $1.1 million. As of March 31, 2017 all vested awards had been issued and settled.

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 nine month periods ended March 31, 2017 and 2016 was $0.3 million and $0.3 million, respectively.  As of March 31, 2017, there was $1.3 million of total unrecognized compensation costs related to outstanding stock-based compensation arrangements. Of this cost $1.1 million relates to performance based RSU grants that are not expected to be awarded. The remaining $0.2 million is expected to be recognized over a weighted average period of 1.4 years.

Note 4:   Inventories

Inventories consist of the following (in thousands):

LIFO inventories were $7.2 million and $10.5 million at March 31, 2017 and June 30, 2016, respectively, such amounts being approximately $27.3 million and $28.8 million, respectively, less than if determined on a FIFO basis.  The use of LIFO, as compared to FIFO, resulted in a $1.5 million decrease in cost of sales for the nine months ended March 31, 2017 compared to a $0.3 million increase for the nine months ended March 31, 2016.

Note 5:   Business Acquisition

In fiscal 2010, the Company entered into an agreement with a private software company to invest $1.5 million in exchange for a 36% equity interest therein. In the third quarter of fiscal 2017, the Company entered into a new agreement to invest an additional $3.6 million for an additional 63% of equity in the company. The Company paid $1.8 million in cash at closing and is obligated to pay an additional $1.8 million in cash three years subsequent to closing (discounted to $1.6 million on the purchase date). In addition, the agreement provides for the former owners to receive a 30% share of operating profits of the business over the next three years so long as they remain employed by the Company.

The acquisition has been accounted for as a business combination and the financial results of the company have been included in our consolidated financial statements as of the date of acquisition. Under the acquisition method of accounting, the purchase price was allocated to net tangible and intangible assets based upon their estimated fair values as of the acquisition date. The Company expects to finalize the valuation in the fourth quarter of 2017.

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

Pro-forma financial information has not been presented for this acquisition because it is not considered material to the Company’s financial position or results of operations.

Note 6:   Goodwill and Intangible Assets

The following represents the change in the carrying amount of goodwill for the nine months ended March 31, 2017 (in thousands):

The Company’s acquisition of Bytewise in 2011 gave rise to goodwill of $3,034. The Company performed a qualitative analysis in accordance with ASU 2011-08 for its October 1, 2016 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 unit exceeds its 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 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 and changes in management or key personnel. After assessing these and other factors the Company determined that it was more likely than not that the fair value of the reporting unit exceeded its carrying amount as of October 1, 2016.

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 2017 and for each of the next five years and thereafter, is as follows (in thousands):

Note 7:   Pension and Post-retirement Benefits

The Company has two defined benefit pension plans, one for U.S. employees and another for U.K. employees.   The U.K. plan was closed to new entrants in fiscal 2009.  The Company has a postretirement medical and life insurance benefit plan for U.S. employees. The Company also has defined contribution plans.   

On December 21, 2016, the Company amended the U.S. defined benefit pension plan to freeze benefit accruals effective December 31, 2016. Consequently, the Plan will be closed to new participants and current participants will no longer earn additional benefits after December 31, 2016.

The amendment of the defined benefit pension plan triggered a pension curtailment which required a remeasurement of the Plan's obligation as of December 31, 2016. The remeasurement resulted in a decrease in the benefit obligation of approximately $6.9 million primarily due to an increase in the discount rate from 3.77% to 4.31%, with an additional $4.2 million decrease resulting from the impact of the curtailment. These reductions in the Plan’s benefit obligation were recorded as other comprehensive income, net of taxes.  

Net periodic benefit costs for all of 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): 

For the nine-month period ended March 31, 2017, the Company contributed $3.5 million to the U.S. and $0.8 to the UK pension plans. The Company estimates that it will contribute an additional $1.1 million for the remainder of fiscal 2017.

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. 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 loss.

Note 8:   Debt

Debt is comprised of the following (in thousands):

The Company amended its Loan and Security Agreement, which includes a Line of Credit and a Term Loan, in January 2015 with changes that took effect on April 25, 2015.  Borrowings under the Line of Credit may not exceed $23.0 million.  The Line of Credit expires on April 30, 2018 and has an interest rate of LIBOR plus 1.5%.  The effective interest rate on the Line of Credit under the Loan and Security Agreement for the nine months ended March 31, 2017 and 2016 was 2.5% and 2.2%, respectively. Based upon its three year term, the Line of Credit has been classified as long term. As of March 31, 2017, $9.4 million was outstanding on the Line of Credit.

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 then existing Loan and Security Agreement.  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 $160.6 thousand.  The Term Loan had a balance of $8.1 million at March 31, 2017.

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”), 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 March 31, 2017.

Note 9:   Income Taxes

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 effective tax rate for the third quarter of fiscal 2017 was 36.8% and for the third quarter of fiscal 2016, it was 50.2%. For the first nine months of fiscal 2017, the effective tax rate was 40.8% and for the first nine months of fiscal 2016, it was 67.2%. The tax rate in fiscal 2017 is higher than the U.S. statutory rate since the benefit of earnings in foreign jurisdictions with lower effective tax rates was more than offset by discrete tax charges including the impact of a tax rate change in the U.K. applied to deferred tax assets which increased tax expense by $298,000 in the first quarter. In fiscal 2016, the tax rate is higher than the U.S. statutory rate primarily due to losses in foreign jurisdictions for which no tax benefit is recognized which was partially offset by discrete reductions to tax expense primarily as a result of return to provision adjustments of $216,000.

U.S. Federal tax returns through fiscal 2013 are generally no longer subject to review by tax authorities; however, tax loss carryforwards from years before fiscal 2014 are still subject to adjustment. As of March 31, 2017, the Company has no 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 calendar years 2011 – 2016. During the next twelve months, it is possible that there will be a reduction in the Company’s long term tax obligations for prior year exposures of $931,000.

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 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 deferred tax assets related to temporary differences in items included in taxable income. 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 tax benefit provided by those differences. In the U.S., there is a valuation allowance against foreign tax credits to the extent they are limited. 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.

In November 2015, the FASB issued Accounting Standards Update No. 2015-17 ("ASU 2015-17") regarding ASC Topic 740 "Income Taxes: Balance Sheet Classification of Deferred Taxes." The amendments in ASU 2015-17 eliminate the requirement to bifurcate Deferred Taxes between current and non-current on the balance sheet and requires that all deferred tax liabilities and assets be classified as noncurrent on the balance sheet. The amendments for ASU-2015-17 can be applied retrospectively or prospectively and early adoption is permitted. The Company has adopted the new guidance prospectively in the first quarter of fiscal 2017. Prior periods were not retrospectively adjusted.

In March 2016, the FASB issued ASU No. 2016-09, "Compensation - Stock Compensation (Topic 718), Improvements to Employee Share-Based Payment Accounting." The ASU affects the accounting for employee share-based payment transactions as it relates to accounting for income taxes, accounting for forfeitures, and statutory tax withholding requirements. This ASU is effective for annual periods beginning after December 15, 2016, and interim periods within those periods with early adoption permitted. The Company has adopted the new guidance prospectively in the first quarter of fiscal 2017.

Note 10: 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.

Note 11. Segment Information

The segment information and the accounting policies of each segment are the same as those described in the notes to the consolidated financial statements entitled “Financial Information by Segment & Geographic Area” included in our Annual Report on Form 10-K for the year ended June 30, 2016. Our business is aggregated into two reportable segments based on geography of operations: North American Operations and International Operations. Segment income is measured for internal reporting purposes by excluding corporate expenses which are included in unallocated in the table below. Other income and expense, including interest income and expense, the gain on the sale of a building and income taxes are excluded entirely from the table below. There were no significant changes in the segment operations or in the segment assets from the Annual Report. Financial results for each reportable segment are as follows (in thousands):

ITEM 2.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS 

RESULTS OF OPERATIONS

Three months Ended March 31, 2017 and March 31, 2016

Overview

The Company continued to experience moderate declines in the domestic market and improvement in the International sector during the quarter posting flat revenue and lower profits. The North American market encountered a softening in the industrial distribution market and a modest recovery in the high-end metrology sector while a weakening US dollar resulted in higher International revenue, especially in Brazil.

Net sales increased $0.4 million or 1% from $50.3 million in fiscal 2016 to $50.7 million in fiscal 2017 with North America declining $0.7 million and International growing $1.1 million. Operating income declined $1.8 million from a profit of $0.9 million in fiscal 2016 to a loss of $0.9 million in fiscal 2017 due to a $0.3 million decline in gross margin coupled with a $1.5 million increase in operating expenses.

Net Sales

North American sales decreased $0.7 million or 2% from $32.5 million in fiscal 2016 to $31.8 million in fiscal 2017 due to a decline in metrology tools sold thru the industrial distribution channel.

International sales increased $1.1 million or 6% from $17.8 million in fiscal 2016 to $18.9 million in fiscal 2017 due to 20% improvement of the Brazilian Real to the US dollar and improvement in the European sector.

Gross Margin

Gross margin decreased $0.3 million or 2% from 29.3% of sales in fiscal 2016 to 28.6% of sales in fiscal 2017.

North American gross margins decreased $0.4 million from $9.3 million or 29% of sales in fiscal 2016 to $8.9 million or 28% of sales in fiscal 2017 due to lower sales and higher cost in the industrial distribution channel.

International gross margins increased $0.1 million from $5.5 million in fiscal 2016 to $5.6 million in fiscal 2017 based upon an improved International performance with higher margins in Europe and China.

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased $1.5 million or 11% from $13.8 million in fiscal 2016 to $15.3 million in fiscal 2017. 

North American expenses increased $0.6 million from $6.7 million in fiscal 2016 to $7.3 million in fiscal 2017 as a result of increased sales and marketing expenses in the high-end metrology business.

International expenses increased $0.8 million or 14% due principally to the weakening of the US dollar to the Brazilian Real.

Corporate expenses increased $0.1 million from $1.5 million in fiscal 2016 to $1.7 million in fiscal 2017 due to higher professional fees.

Other Income (Expense)

Other expense increased $0.7 million from income of $0.3 million in fiscal 2016 to a $0.4 million loss in fiscal 2017 due to a $0.3 million cumulative loss related to an investment in a software development company and lower foreign exchange translation gains.

Income Taxes

The effective tax rates for the third quarter of fiscal 2017 and 2016 were 37% and 50%, respectively. The quarterly tax rate is lower than a normalized combined federal and state rate of approximately 40% due to profits in some foreign subsidiaries with lower effective tax rates. The tax rate includes negligible discrete items in fiscal 2017 and a discrete tax benefit of $0.1 million in fiscal 2016.

Net Income

The Company recorded net loss of $0.8 million or $0.11 per share in the third quarter of fiscal 2017 compared to net income of $0.6 million or $0.09 per share in fiscal 2016 principally due to lower Operating Income and a one-time investment write-off.

Nine Months Ended March 31, 2017 and March 31, 2016

Overview 

Net sales declined $2.3 million or 1% from $155.0 million in fiscal 2016 to $152.7 million in fiscal 2017. Operating income decreased $3.2 million in fiscal 2017 from $2.3 million profit in fiscal 2016 compared to $0.9 million loss in fiscal 2017 due to lower sales and related gross margins and higher selling, general and administrative expenses.

Net Sales

North American sales decreased $6.9 million or 7% from $99.2 million in fiscal 2016 to $92.3 million in fiscal 2017 due to lower metrology tool sales through the industrial distribution channel and decreases in high-end metrology sales to end-user customers.

International sales increased $4.6 million or 8% from $55.8 million in fiscal 2016 to $60.4 million in fiscal 2017 with strong organic growth in Europe and a strengthening Brazilian Real relative to the US dollar.

Gross Margin

Gross margin decreased $1.3 million or 3% and also declined as a % of sales from 30.0% in fiscal 2016 to 29.6% in fiscal 2017.

North American gross margins decreased $3.9 million or 13% from $29.4 million in fiscal 2016 compared to $25.5 million in fiscal 2016 due to lower precision tool sales as well as lower sales of higher margin capital equipment products.

International gross margins increased $2.6 million with volume and margin improvement representing $1.4 and $1.2 million, respectively. The stronger Brazilian Real contributed an incremental $1.6 million while the weakening British Pound resulted in a $0.9 million decrement to the gross margin gain.

Selling, General and Administrative Expenses

Selling, general and administrative expense increased $1.4 million or 3% from $44.3 million in fiscal 2016 to $45.7 million in fiscal 2017.

North American expenses decreased $0.3 million or 2% due to lower commissions and travel expenses.

International expenses increased $1.1 million or 6% principally due to the strengthening Brazilian Reals versus the US dollar.

Corporate expenses increased $0.6 million or 13% principally due to higher professional fees.

Other income (expense)

Other income declined $0.8 million due to foreign exchange translation losses and a $0.3 million cumulative loss related to an investment in a software development company. The $3.1 million gain on sale of a building is net profit realized on the sale of the Canadian distribution center in the first quarter of fiscal 2017.

Income Taxes

The effective tax rates for the first three quarters of fiscal 2017 and 2016 was 41% and 67%, respectively. The effective tax rate is higher than the U.S. statutory rate since the benefit of earnings in foreign jurisdictions with lower effective tax rates was more than offset by discrete tax charges including the impact of a tax rate change in the U.K. applied to deferred tax assets which increased tax expense by $298,000 in the first quarter.. The effective rate in fiscal 2016 is higher due to losses in some foreign subsidiaries for which no tax benefit is recognized in consolidation.

Net Income

The Company recorded net income of $1.0 million or $0.15 per share in the first three quarters of fiscal 2017 compared to net income of $0.9 million or $0.13 per share in fiscal 2016 principally due to the gain on the sale of the Canadian distribution facility and a lower effective tax rate offsetting lower operating income.

LIQUIDITY AND CAPITAL RESOURCES

Fiscal 2017 net cash for the nine months ended March 31, 2017 decreased $2.7 million as cash provided from operations of $3.0 million was offset by investments of $2.2 million and debt and dividend payments of $3.1 million. In addition, exchange rates negatively impacted cash in US dollars by $0.5 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 $23 million line of credit in connection with its Loan and Security Agreement, of which, $9.4 million was outstanding as of March 31, 2017.  Availability under the agreement is further reduced by open letters of credit totaling $0.9 million. The Loan and Security Agreement was renewed in January of 2015.  The Loan and Security Agreement contains financial covenants with respect to leverage, tangible net worth, and interest coverage, and also contains customary affirmative and negative covenants, including limitations on indebtedness, liens, acquisitions, asset dispositions and fundamental corporate changes, and certain customary events of default.  As of March 31, 2017, the Company was in compliance with all debt covenants related to its Loan and Security Agreement. The Loan and Security Agreement expires on April 30, 2018 and the Company plans to negotiate an extension to the agreement.

The effective interest rate on the borrowings under the Loan and Security Agreement during the nine months ended March 31, 2017 and 2016 was 2.5% and 2.2% respectively.

OFF-BALANCE SHEET ARRANGEMENTS

The Company has no off-balance sheet arrangements 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, 2016.

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, 2017, 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, 2017, our Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective.

There have been no changes in internal control over financial reporting that materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting during the quarter ended March 31, 2017.

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, 2016. There have been no material changes from the factors disclosed in our Form 10-K for the year ended June 30, 2016.

ITEM 6.               EXHIBITS  

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.

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