STARRETT L S CO - Quarter Report: 2018 March (Form 10-Q)

 

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		03/31/2018 (unaudited)				06/30/2017
ASSETS
Current assets:
Cash		$	15,444			$	14,607
Accounts receivable (less allowance for doubtful accounts of $1,164 and $946, respectively)			31,684				30,425
Inventories			63,799				58,097
Prepaid expenses and other current assets			7,546				6,994
Total current assets			118,473				110,123
Property, plant and equipment, net			38,659				39,345
Taxes receivable			1,888				2,627
Deferred tax assets, net			18,523				26,032
Intangible assets, net			9,452				9,868
Goodwill			4,668				4,668
Other assets			2				2
Total assets		$	191,665			$	192,665
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current maturities of long-term debt		$	4,681			$	11,514
Accounts payable			10,464				8,366
Accrued expenses			6,328				5,424
Accrued compensation			4,597				5,435
Total current liabilities			26,070				30,739
Other tax obligations			2,889				3,645
Long-term debt, net of current portion			17,736				6,095
Postretirement benefit and pension obligations			56,258				58,571
Other non-current liabilities			1,650				1,589
Total liabilities			104,603				100,639
Stockholders' equity:
Class A Common stock $1 par (20,000,000 shares authorized; 6,272,716 outstanding at March 31, 2018 and 6,267,603 outstanding at June 30, 2017)			6,273				6,268
Class B Common stock $1 par (10,000,000 shares authorized; 745,216 outstanding at March 31, 2018 and 761,588 outstanding at June 30, 2017)			745				762
Additional paid-in capital			55,562				55,579
Retained earnings			73,543				79,402
Accumulated other comprehensive loss			(49,061	)			(49,985	)
Total stockholders' equity			87,062				92,026
Total liabilities and stockholders’ equity		$	191,665			$	192,665

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		3 Months Ended								9 Months Ended
		03/31/2018				03/31/2017				03/31/2018				03/31/2017
Net sales		$	54,834			$	50,670			$	158,776			$	152,770
Cost of goods sold			36,762				36,191				108,235				107,555
Gross margin			18,072				14,479				50,541				45,215
% of Net sales			33.0	%			28.6	%			31.8	%			29.6	%
Selling, general and administrative expenses			15,859				15,326				47,435				45,689
Restructuring charges			-				6				-				400
Operating income (loss)			2,213				(853	)			3,106				(874	)
Other income (expense)			124				(391	)			968				(466	)
Gain on sale of building			-				-				-				3,089
Income (loss) before income taxes			2,337				(1,244	)			4,074				1,749
Income tax expense (benefit)			700				(458	)			8,532				713
Net income (loss)		$	1,637			$	(786	)		$	(4,458	)		$	1,036
Basic income (loss) per share		$	0.23			$	(0.11	)		$	(0.64	)		$	0.15
Diluted income (loss) per share		$	0.23			$	(0.11	)		$	(0.64	)		$	0.15
Weighted average outstanding shares used in per share calculations:
Basic			7,018				7,058				7,012				7,046
Diluted			7,036				7,058				7,012				7,078
Dividends per share		$	-			$	0.10			$	0.20			$	0.30

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		3 Months Ended								9 Months Ended
		03/31/2018				03/31/2017				03/31/2018				03/31/2017
Net income (loss)		$	1,637			$	(786	)		$	(4,458	)		$	1,036
Other comprehensive income (loss):
Currency translation gain (loss)			321				1,456				1,006				(300	)
Pension and postretirement plans, net of tax of $0, $0, $0, and $3,958, respectively			(28	)			(45	)			(82	)			6,377
Other comprehensive income (loss)			293				1,411				924				6,077
Total comprehensive income (loss)		$	1,930			$	625			$	(3,534	)		$	7,113

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		Common Stock Outstanding								Additional Paid-in				Retained				Accumulated Other Comprehensive
		Class A				Class B				Capital				Earnings				Loss				Total
Balance June 30, 2017		$	6,268			$	762			$	55,579			$	79,402			$	(49,985	)		$	92,026
Total comprehensive income (loss)			-				-				-				(4,458	)			924				(3,534	)
Dividends ($0.20 per share)			-				-				-				(1,401	)			-				(1,401	)
Repurchase of shares			(58	)			(6	)			(487	)			-				-				(551	)
Issuance of stock			21				13				244				-				-				278
Stock-based compensation			18				-				226				-				-				244
Conversion			24				(24	)			-				-				-				-
Balance March 31, 2018		$	6,273			$	745			$	55,562			$	73,543			$	(49,061	)		$	87,062
Accumulated balance consists of:
Translation loss																		$	(42,317	)
Pension and postretirement plans, net of taxes																			(6,744	)
																		$	(49,061	)

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		9 Months Ended
		03/31/2018				03/31/2017
Cash flows from operating activities:
Net income (loss)		$	(4,458	)		$	1,036
Non-cash operating activities:
Gain on sale of building			-				(3,089	)
Depreciation			4,163				4,020
Amortization			1,490				1,280
Stock-based compensation			244				320
Net long-term tax obligations			32				(31	)
Deferred taxes			7,649				702
Postretirement benefit and pension obligations			439				1,916
(Income) loss from equity method investment			-				223
Working capital changes:
Accounts receivable			(254	)			6,200
Inventories			(4,720	)			(2,184	)
Other current assets			(474	)			(1,501	)
Other current liabilities			1,007				(1,790	)
Prepaid pension expense			(3,541	)			(4,303	)
Other			63				222
Net cash provided by (used in) operating activities			1,640				3,021
Cash flows from investing activities:
Business acquisition, net of cash acquired			-				(1,324	)
Additions to property, plant and equipment			(3,250	)			(3,478	)
Software development			(1,014	)			(750	)
Proceeds from sale of building			-				3,321
Net cash provided by (used in) investing activities			(4,264	)			(2,231	)
Cash flows from financing activities:
Proceeds from borrowings			6,845				-
Debt repayments			(2,037	)			(1,151	)
Proceeds from common stock issued			278				242
Shares repurchased			(551	)			(51	)
Dividends paid			(1,401	)			(2,113	)
Net cash provided by (used in) financing activities			3,134				(3,073	)
Effect of exchange rate changes on cash			327				(450	)
Net increase (decrease) in cash			837				(2,733	)
Cash, beginning of period			14,607				19,794
Cash, end of period		$	15,444			$	17,061
Supplemental cash flow information:
Interest paid		$	479			$	474
Income taxes paid, net			175				(213	)

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

 

The unaudited interim financial statements as of and for the nine months ended March 31, 2018 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, 2017.  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, 2017 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 Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2014-09, "Revenues from Contracts with Customers (Topic 606)," which outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The standard requires entities to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. The new guidance also includes a cohesive set of disclosure requirements intended to provide users of financial statements comprehensive information about the nature, amounts, timing and uncertainty of revenue and cash flows arising from a company's contracts with customers. ASU 2014-09 defines a five-step process to achieve this core principle and in doing so, it is possible that more judgment and estimates may be required within the revenue recognition process than are required under existing guidance, including identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to separate performance obligations, among others. The new standard will be effective for the Company beginning July 1, 2018. The FASB issued four subsequent standards in 2016 containing implementation guidance related to the new standard. These standards provide additional guidance related to principal versus agent considerations, licensing, and identifying performance obligations. Additionally, these standards provide narrow-scope improvements and practical expedients as well as technical corrections and improvements.

 

The guidance permits two methods of adoption: retrospectively to each prior reporting period presented (full retrospective method), or retrospectively with the cumulative effect of initially applying the guidance recognized at the date of initial application (the modified retrospective method). The Company will be adopting the standard using the modified retrospective method effective July 1, 2018.

 

The Company expects to complete our implementation procedures with respect to the new revenue recognition standard during the fourth quarter of fiscal year 2018. While the Company continues to assess the impact of the new standard, it should be noted that revenues are primarily generated from the sale of finished products to customers, and that sales predominantly contain a single delivery element and that revenue is recognized at a single point in time when ownership, risks and rewards transfer. The timing of revenue recognition for these product sales is not materially impacted by the new standard. However, the Company is utilizing a comprehensive approach to assess the impact of the guidance on its current contract portfolio by reviewing its current accounting policies and practices to identify potential differences that would result from applying the new requirements to the Company’s revenue contracts, including evaluation of performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price, allocating the transaction price to each separate performance obligation and accounting treatment of costs to obtain and fulfill contracts. While certain differences may arise specifically related to variable consideration and consideration payable to a customer, the Company does not expect these differences to materially impact our consolidated financial statements. In addition, the Company is currently analyzing our internal control over financial reporting framework to determine if controls should be added or modified as a result of adopting this standard, and reviewing the tax impact, if any, the adoption of the new standard may have. The Company also expects that the adoption of the new standard will result in expanded and disaggregated disclosure requirements.

 

 

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 adoption of ASU No. 2016-16 is not expected to have a material impact on the Company’s 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 adoption of ASU No. 2017-01 is not expected to have a material impact on the Company’s 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 the requirement to calculate goodwill impairment using Step 2, which calculates an 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 its consolidated financial statements.

 

In February 2018, the FASB issued ASU No. 2018-02, “Income Statement – Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income”. For deferred tax items recognized in Accumulated Other Comprehensive Income (AOCI), changes in tax rates can leave amounts “stranded” in AOCI. Under ASU 2018-02, FASB has given companies an option to reclassify the stranded tax effects resulting from the tax law and tax rate changes under the Tax Cuts and Jobs Act of 2017 from AOCI to retained earnings. This guidance is effective for fiscal years beginning after December 15, 2018 and requires companies to disclosure whether they are or are not opting to reclassify the income tax effects from the new 2017 tax act. Early adoption is permitted. The Company is currently evaluating the impact of this update on its consolidated financial statements.

 

In February 2018, the FASB issued ASU 2018-05, “Income Taxes (Topic 740): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118”. This update codified the guidance provided in SAB 118 on applying ASC 740, Income Taxes, if the accounting for certain income tax effects of the Tax Cuts and Jobs Act of 2017 is incomplete when the financial statements are issued for a reporting period. This update was effective upon issuance. Therefore, the Company has applied the guidance in this update within our consolidated financial statements for the quarter ended March 31, 2018. See Note 9: “Income Taxes”, of this Form 10-Q for more information on the adoption of this guidance.

 

 

 

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, and the material terms of its performance goals were recently re-approved by shareholders at the Company’s Annual Meeting held on October 18, 2017. 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, 2018, there were 20,000 stock options and 140,802 restricted stock units outstanding. In addition, there were 297,033 shares available for grant under the 2012 Stock Plan as of March 31, 2018.

 

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, 2018 and 2017.

 

The weighted average contractual term for stock options outstanding as of March 31, 2018 was 4.75 years.  The aggregate intrinsic value of stock options outstanding as of March 31, 2018 was less than $0.1 million. Stock options exercisable as of March 31, 2018 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 62,000 RSU awards with a fair value of $7.22 per RSU granted during the nine months ended March 31, 2018. There were 14,400 RSUs settled, and 12,433 RSUs forfeited during the nine months ended March 31, 2018.  The aggregate intrinsic value of RSU awards outstanding as of March 31, 2018 was $1.0 million. As of March 31, 2018 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, 2018 and 2017 was $0.2 million, and $0.3 million respectively.  As of March 31, 2018, there was $1.5 million of total unrecognized compensation costs related to outstanding stock-based compensation arrangements. Of this cost, $1.4 million relates to performance based RSU grants that are not expected to be awarded. The remaining $0.1 million is expected to be recognized over a weighted average period of 2.0 years.

 

 

Note 4:   Inventories

 

ASU No. 2015-11, "Inventory (Topic 330): Simplifying the Measurement of Inventory", specifies that when an entity measures inventory at the lower of cost or market 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. The adoption of ASU No. 2015-11 on July 1, 2017 did not have a material impact on our consolidated financial statements.

 

 

Inventories consist of the following (in thousands):

 

 

LIFO inventories were $8.4 million and $7.7 million at March 31, 2018 and June 30, 2017, respectively, such amounts being approximately $26.0 million and $26.2 million, respectively, less than if determined on a FIFO basis.  The use of LIFO, as compared to FIFO, resulted in a $0.2 million decrease in cost of sales for the nine months ended March 31, 2018 compared to a $1.5 million decrease in cost of sales for the nine months ended March 31, 2017.

 

 

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 64% 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 Company has accrued for such profit sharing as an expense based on results of operations since the date of acquisition.

 

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

 

 

 

 

(1)

$1,833 + 1,555 ($1.8 million discounted at 5%) = $3,388 purchase price divided by 64% = $5.294 million.

 

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 Company’s acquisition of Bytewise in 2011 and the private software company in 2017 resulted in the recognition of goodwill totaling $4.7 million. Under ASU 2011-08, the Company is required, on a set date, to annually assess its goodwill in order to determine whether or not it is more likely than not that the fair value of the reporting unit’s goodwill exceeded its carrying amount. Determining the fair value of a reporting unit is subjective and requires the use of significant estimates and assumptions.

 

 

For Bytewise, the annual assessment date was October 1, 2017. The Company performed a quantitative analysis in accordance with ASU 2011-08 for its annual assessment (commonly referred to as “Step One”). With the assistance of an independent third-party valuation specialist, the Company estimated 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 utilized 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 included 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, and an assessment of current market capitalization.

 

Under the quantitative analysis, the 2017 fair value assessment of the Bytewise goodwill exceeded the carrying amount by approximately 81.1%. Therefore no goodwill impairment was determined to exist. 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.

 

The Company performed a qualitative analysis in accordance with ASU 2011-08 for its February 1, 2018 annual assessment of goodwill (commonly referred to as “Step Zero”) associated with its purchase of the private software company. From a qualitative perspective, in evaluating whether it is more likely than not that the fair value of a reporting unit exceeds its carrying amount, relevant events and circumstances are 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 this reporting unit exceeded its carrying amount as of February 1, 2018.

 

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 range between 5 years for software development and 20 years for some trademark and trade name assets.

 

The estimated aggregate amortization expense for the remainder of fiscal 2018 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 is 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 re-measurement of the Plan's benefit obligation as of December 31, 2016. The re-measurement 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, 2018, the Company contributed $2.8 million to the U.S. and $0.8 million to the UK pension plans. The Company estimates that it will contribute an additional $1.2 million for the remainder of fiscal 2018.

 

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 2018.  Borrowings under the Line of Credit may not exceed $23.0 million.  The Line of Credit has an interest rate of LIBOR plus 1.5%, and expires on April 30, 2021.  The effective interest rate on the Line of Credit under the Loan and Security Agreement for the nine months ended March 31, 2018 and 2017 was 3.2% and 2.5%, respectively. As of March 31, 2018, $12.9 million was outstanding on the Line of Credit.

 

Availability under the Line of Credit is subject to a borrowing base comprised of accounts receivable and inventory. The Company believes that the borrowing base will consistently produce availability under the Line of Credit in excess of $23.0 million. A 0.25% commitment fee is charged on the unused portion of the Line of Credit.

 

 

The obligations under the Credit Facility are unsecured. In the event of certain triggering events, such obligations would become secured by the assets of the Company’s domestic subsidiaries. A triggering event occurs when the Company fails to achieve any of the financial covenants noted below in consecutive quarters.

 

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 1.00, 2) annual capital expenditures not to exceed $15.0 million, 3) maintain a Debt Service Coverage Rate of a minimum of 1.25 to 1.00, and 4) maintain consolidated cash plus liquid investments of not less than $10.0 million at any time.  As of March 31, 2018, the Company was in compliance with all the financial debt covenants related to its Loan and Security Agreement. The Company was not in compliance with one of its non-financial covenants related to additional borrowings made in December, but the waiver received in January 2018 was granted until June 30, 2018. The Company expects to be in compliance with this covenant prior to the waiver expiration.

 

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 $160,640.  The Term Loan had a balance of $6.5 million at March 31, 2018.

 

In December 2017, the Company’s Brazilian subsidiary entered into two short-term loans with local banks in order to support the Company’s strategic initiatives. The loans backed by the entity’s US dollar denominated export receivables were made with Santander Bank and Bradesco Bank and totaled $3.5 million. The Santander loan of $1.5 million has a term of 180 days and a rate of 4.19% and the Bradesco loan of $2.0 million has a term of 360 days and a rate of 4.75%. As of March 31, 2018, the outstanding balance on these loans was $3.0 million.

 

 

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.

 

On December 22, 2017, the Tax Cuts and Jobs Act was signed into law in the United States. This law made numerous changes to federal taxation in the U.S., including a reduction in the federal corporate tax rate to 21% and a one-time tax on historical foreign earnings that had not yet been repatriated. The effect of the tax rate change is that the Company’s federal tax rate is reduced to a blended rate of 28% from the previous rate of 34% for fiscal 2018, and then will further reduce to the enacted 21% in Fiscal 2019 and beyond. In addition, there are also a number of other changes primarily related to U.S. taxation of income earned by foreign subsidiaries and on transactions with those subsidiaries. As a result of this legislation, in the quarter ended December 31, 2017, the Company performed an initial assessment of the impact of tax reform and has taken a charge to tax expense of $7.3 million to reflect the estimated impact of the tax rate reduction on its deferred tax assets. The Company has estimated the overall federal tax impact for the one time transition tax to be zero. Further guidance from the Department of Treasury and various state taxing authorities as well as year-end financial data is required, however, before the various tax calculations can be considered complete.

 

The Company is reviewing all aspects of the tax law change and, other than the reduced tax rate on earnings going forward, which will provide a favorable benefit, the Company does not believe the other provisions will have a significant impact to tax expense. The Company will continue to measure the impact of these provisions and will record any changes in subsequent quarters when information and guidance becomes available.

 

The tax expense for the third quarter of fiscal 2018 was $0.7 million on profit before tax of $2.3 million for an effective tax rate of 30.0%. The effective tax rate for the third quarter of fiscal 2017 was 36.8%. For the first nine months of fiscal 2018, tax expense was $8.5 million on profit before tax of $4.1 million for an effective tax rate of 209%. Before the tax charge related to new tax legislation, tax expense was $1.3 million or 31.5% of pre-tax income. For the first nine months of fiscal 2017, the effective tax rate was 40.8%.

 

The tax expense in the third quarter of fiscal 2018 was increased by a nominal amount of discrete items primarily related to interest charges on tax liabilities and an increase in the valuation allowance for state tax loss carryforwards which were mostly offset by the benefit from a reduced liability for uncertain tax positions net of the reduction in the receivable for a competent authority review. In prior quarters, there were net discrete charges of $7.2 million including discrete charges for the impact of the tax law change referred to above, the impact of tax deductions on stock grants which were less than the book deductions, and interest on tax liabilities; these were partly offset by discrete tax benefits for research credits in the U.K., the use of carryforward tax losses in the U.K. and the impact of provision to return adjustments. The tax expense in the third quarter of fiscal 2017 was increased by less than $0.1 million for interest expense on uncertain tax positions and for the first nine months of fiscal 2017, it was increased by $0.3 million primarily for the impact of a tax rate change in the U.K. applied to the deferred tax asset balance.

 

 

U.S. Federal tax returns through fiscal 2014 are generally no longer subject to review by tax authorities; however, tax loss carryforwards from years before fiscal 2015 are still subject to adjustment. As of March 31, 2018, 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 calendar years 2012 - 2017. During the next twelve months, it is possible there will be a reduction of $0.2 million in long term tax obligations due to the expiration of the statute of limitations on prior year tax returns.

 

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., a partial valuation allowance has been provided for foreign tax credit carryforwards due to the uncertainty of generating sufficient foreign source income to utilize those credits in the future. 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 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.

 

In the second quarter of this year, the Company’s Brazilian subsidiary received a favorable ruling on an old tax dispute related to the Brazilian Program of Social Integration (PIS) taxes. This ruling resulted in the recognition of other income of approximately $1.0 million, and was awarded in the form of tax credits to be used to offset future tax payments.

 

 

 

 

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, 2017. The Company’s 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 in fiscal 2017, 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):

 

 

1.

Excludes $1,527 of North American segment intercompany sales to the International segment, and $3,602 of International segment intercompany sales to the North American segment.

 

2.

Excludes $1,493 of North American segment intercompany sales to the International segment, and $2,536 of International segment intercompany sales to the North American segment.

 

 

 

1.

Excludes $4,804 of North American segment intercompany sales to the International segment, and $10,290 of International segment intercompany sales to the North American segment.

 

2.

Excludes $6,189 of North American segment intercompany sales to the International segment, and $8,585 of International segment intercompany sales to the North American segment.

 

  

 

Note 12:  Facility Closure

 

This footnote was previously reported as a “subsequent event” in the fiscal 2018 second quarter 10-Q report.

 

The Company decided in January 2018 to vacate its facility in Mt. Airy, North Carolina, and move current operations to a smaller building. While no definitive date for this move has been set yet, the Company anticipates that the move will happen within the next 12 months. The Company incurred a $4.1 million impairment charge in fiscal 2016, when the majority of the plant’s operations were relocated to the Company’s Brazilian production facility. As of December 31, 2017, the carrying value of the building is $2.0 million, and the Company believes that the current fair value exceeds the carrying value. During the current quarter, the Company sold the inventory and equipment related to one of the product lines impacted by this decision. This sale resulted in a $0.1 million increase in income before tax.

 

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