10-Q 1 fy03dec10q.txt 10Q DEC 02 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended December 28, 2002 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from Commission file number 1-367 THE L. S. STARRETT COMPANY (Exact name of registrant as specified in its charter) MASSACHUSETTS 04-1866480 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 121 CRESCENT STREET, ATHOL, MASSACHUSETTS 01331-1915 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code 978-249-3551 Former name, address and fiscal year, if changed since last report. Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO Common Shares outstanding as of December 28, 2002 : Class A Common Shares 5,247,042 Class B Common Shares 1,356,199 Page 1 of 17 THE L. S. STARRETT COMPANY CONTENTS Page No. Part I. Financial Information: Item 1. Financial Statements Consolidated Statement of Operations - thirteen and twenty-six weeks ended December 28, 2002 and December 29, 2001 (unaudited) 3 Consolidated Statement of Cash Flows - thirteen and twenty-six weeks ended December 28, 2002 and December 29, 2001 (unaudited) 4 Consolidated Balance Sheets - December 28, 2002 (unaudited) and June 29, 2002 5 Consolidated Statements of Stockholders' Equity - twenty-six weeks ended December 28, 2002 and December 29, 2001 (unaudited) 6 Notes to Consolidated Financial Statements 7-8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 9-14 Item 3. Quantitative and Qualitative Disclosures About Market Risk 14 Item 4. Controls and Procedures 15 Part II. Other information: Item 6. Exhibits and reports on Form 8-K 15 SIGNATURES 15 CERTIFICATIONS 16-17 Page 2 of 17 THE L. S. STARRETT COMPANY Consolidated Statements of Operations (in thousands of dollars except per share data)(unaudited) 13 Weeks Ended 26 Weeks Ended 12/28/02 12/29/01 12/28/02 12/29/01 Net sales 44,828 44,918 90,163 91,440 Cost of goods sold (34,486) (34,819) (71,085) (68,717) Selling and general (11,106) (11,527) (23,658) (23,413) Other income (expense) (575) 10 (1,255) (382) Loss before income taxes and cumulative effect of change in accounting principle (1,339) (1,418) (5,835) (1,072) Benefit for federal, foreign and state income taxes (698) (807) (2,659) (723) Loss before cumulative effect of change in accounting principle (641) (611) (3,176) (349) Cumulative effect of change in accounting for goodwill (6,086) . Net Loss (641) (611) (9,262) (349) Basic and diluted loss per share before cumulative effect of change in accounting principle (.09) (.09) (.48) (.05) Cumulative effect of change in accounting principle (.93) . Basic and diluted loss per share (.09) (.09) (1.41) (.05) Average outstanding shares used (in thousands) 6,589 6,494 6,570 6,483 Dividends per share .20 .20 .40 .40 See Notes to Consolidated Financial Statements Page 3 of 17 THE L. S. STARRETT COMPANY Consolidated Statements of Cash Flows (in thousands of dollars)(unaudited) 13 Weeks Ended 26 Weeks Ended 12/28/02 12/29/01 12/28/02 12/29/01 Cash flows from operating activities: Net loss (641) (611) (9,262) (349) Noncash expenses (income): Cumulative effect of change in accounting principle 6,086 Depreciation and amortization 2,746 3,011 5,532 5,988 Deferred taxes (64) 372 (291) 516 Unrealized exchange losses (gains) 735 (36) 1,460 276 Retirement benefits (276) (580) (504) (1,191) Working capital changes: Receivables 3,138 4,017 2,012 6,322 Inventories 6,179 1,083 12,108 (874) Other assets and liabilities 590 272 660 745 Prepaid pension cost and other 51 (10) (107) (27) Net cash from operating 12,458 7,518 17,694 11,406 Cash flows from investing activities: Additions to plant and equipment (2,253) (2,531) (2,989) (5,042) Change in short-term investments (10,206) (3,446) (13,632) (3,144) Net cash used in investing (12,459) (5,977) (16,621) (8,186) Cash flows from financing activities: Net short-term debt repayments (1,020) (1,382) (1,578) (2,277) Long-term borrowings 2,749 2,749 Common stock issued 529 838 1,309 1,578 Treasury shares purchased (117) (333) (357) (426) Dividends (1,314) (1,295) (2,624) (2,574) Net cash from (used in)financing 827 (2,172) (501) (3,699) Exchange rate change effect on cash 6 50 (79) (32) Net increase (decrease) in cash 832 (581) 493 (511) Cash, beginning of period 1,333 2,015 1,672 1,945 Cash, end of period 2,165 1,434 2,165 1,434 See Notes to Consolidated Financial Statements Page 4 of 17 THE L. S. STARRETT COMPANY Consolidated Balance Sheets (in thousands of dollars) Dec. 28 June 29 2002 2002 ASSETS (unaudited) Current assets: Cash 2,165 1,672 Investments 23,532 10,479 Accounts receivable (less allowance for doubtful accounts of $1,539,000 and $1,790,000) 31,656 34,832 Inventories: Raw materials and supplies 14,546 17,228 Goods in process and finished parts 19,084 24,632 Finished goods 28,104 34,762 61,734 76,622 Other current assets 6,294 5,903 Total current assets 125,381 129,508 Property, plant and equipment, at cost (less accumulated depreciation of $82,435,000 and $79,005,000) 67,623 71,430 Cost in excess of net assets acquired (goodwill) (less accumulated amortization of $4,216,000 at June 29, 2002) 6,086 Prepaid pension cost 34,321 33,651 Other assets 834 863 228,159 241,538 LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Notes payable and current maturities 5,784 3,437 Accounts payable and accrued expenses 14,305 13,874 Accrued salaries and wages 3,576 4,163 Total current liabilities 23,665 21,474 Deferred income taxes 16,231 16,012 Long-term debt 5,278 7,000 Accumulated postretirement medical benefit obligation 16,825 16,711 Stockholders' equity: Class A Common $1 par (20,000,000 shrs. auth.; 5,247,042 outstanding on 12/28/02, excluding 1,349,224 in treasury; 5,147,201 outstanding on 6/29/02, excluding 1,397,659 in treasury) 5,247 5,147 Class B Common $1 par (10,000,000 shrs. auth.; 1,356,199 outstanding on 12/28/02, excluding 332,019 in treasury; 1,397,480 outstanding on 6/29/02, excluding 332,019 in treasury) 1,356 1,397 Additional paid-in capital 48,942 47,858 Retained earnings reinvested and employed in the business 137,952 150,029 Accumulated other comprehensive loss (27,337) (24,090) Total stockholders' equity 166,160 180,341 228,159 241,538 See Notes to Consolidated Financial Statements Page 5 of 17 THE L. S. STARRETT COMPANY Consolidated Statements of Stockholders' Equity For the Twenty-six Weeks Ended December 28, 2002 and December 29, 2001 (in thousands of dollars) (unaudited) Common Addi- Accumulated Stock Out- tional Other standing Paid-in Retained Comprehensive ($1 Par) Capital Earnings Loss Total Balance June 30, 2001 6,458 45,112 156,626 (23,375) 184,821 Comprehensive income: Net loss (349) (349) Unrealized net loss on investments (250) (250) Translation loss, net (1,092) (1,092) Total comprehensive income (1,691) Dividends ($.40 per share) (2,574) (2,574) Treasury shares: Purchased (21) (147) (258) (426) Issued 67 1,286 1,353 Options exercised 13 212 225 Balance Dec. 29, 2001 6,517 46,463 153,445 (24,717) 181,708 Balance June 29, 2002 6,544 47,858 150,029 (24,090) 180,341 Comprehensive income: Net loss (9,262) (9,262) Unrealized net gain on investments 11 11 Translation loss, net (3,258) (3,258) Total comprehensive income (12,509) Dividends ($.40 per share) (2,624) (2,624) Treasury shares: Purchased (18) (148) (191) (357) Issued 67 1,108 1,175 Options exercised 10 124 134 Balance Dec. 28, 2002 6,603 48,942 137,952 (27,337) 166,160 See Notes to Consolidated Financial Statements Page 6 of 17 THE L. S. STARRETT COMPANY Notes to Consolidated Financial Statements In the opinion of management, the accompanying financial statements contain all adjustments, consisting only of normal recurring adjustments, necessary to present fairly the financial position of the Company as of December 28, 2002 and June 29, 2002; the results of operations and cash flows for the thirteen weeks and twenty-six weeks ended December 28, 2002 and December 29, 2001; and changes in stockholders' equity for the twenty-six weeks ended December 28, 2002 and December 29, 2001. The Company follows the same accounting policies in the preparation of interim statements as described in the Company's annual report filed on Form 10-K for the year ended June 29, 2002, except for the treatment of goodwill as discussed below; and these financial statements should be read in conjunction with said annual report. Certain reclassifications have been made to prior period data to conform with current year presentation. In the periods presented, shares used to compute basic and diluted loss per share are the same since the inclusion of common stock equivalents would be antidilutive. Average common stock options outstanding that were not included in the calculation of diluted loss per share were as follows: quarters ended December 2002 and 2001, 20,429 and 45,220 shares, respectively; six month periods ended December 2002 and 2001, 33,902 and 58,153 shares, respectively. As discussed under Management's Discussion and Analysis of Financial Condition and Results of Operations, the Company charged pretax operations with $3.1 million ($.30 per share after tax) in the September 2002 quarter in connection with an investigation of its Coordinate Measuring Machine division, which is based in Mt. Airy, North Carolina. No assurances can be made that these charges reflect the actual costs that will ultimately be incurred by the Company or that the Company will not need to make additional charges. The Company adopted SFAS 142, Goodwill and Other Intangible Assets, as of June 30, 2002, the first day of fiscal 2003, and performed a transitional fair value based impairment test as of that date. As a result, a non-cash impairment charge of $6,086,000 ($.93 per share after taxes), relating primarily to the acquisition of the Company's Evans Rule division in 1986, was recorded as of the first day of the September 2002 quarter and related amortization of $67,000 per quarter was discontinued. The charge is reflected as the cumulative effect of a change in accounting principle in the accompanying Statements of Operations and Cash Flows. There were no income taxes associated with the charge. Had the provisions of SFAS 142 been applied in the prior year, net loss and net loss per share would have been as follows (in thousands): 13 Weeks 26 Weeks Ended 12/29/01 Ended 12/29/01 Net loss as reported (611) (349) Add back goodwill amortization 67 134 Proforma net loss (544) (215) Basic and diluted loss per share as reported (.09) (.05) Effect of SFAS 142 .01 .02 Proforma basic and diluted loss per share (.08) (.03) Page 7 of 17 Included in investments at December 28, 2002 is $2.3 million of AAA rated Puerto Rico debt obligations that have maturities greater than one year but carry the benefit of possibly reducing repatriation taxes. These investments are used as part of the Company's overall cash management and liquidity program and, under SFAS 115, are considered "available for sale." The investments themselves are liquid and carry no early redemption penalties and are, therefore, classified as current assets. Other income (expense) is comprised of the following (in thousands): Thirteen Weeks Twenty-six Weeks Ended December Ended December 2002 2001 2002 2001 Interest income 215 201 390 358 Interest expense and com- mitment fees (124) (144) (218) (306) Realized and unrealized exchange gains (losses) (622) 28 (1,342) (400) Other (44) (75) (85) (34) (575) 10 (1,255) (382) Approximately 70% of all inventories are valued on the LIFO method. At December 28, 2002, and June 29, 2002, total inventories are $23,978,000 and $23,835,000 less, respectively, than if determined on a FIFO basis. Although LIFO inventories have been reduced, the Company has not as yet realized any material LIFO layer liquidation profits. Long-term debt is comprised of the following (in thousands): December June 2002 2002 . Note payable due 12/03, 3.8% 4,000 4,000 Capitalized lease obligations payable in Brazilian currency due 2003 - 2007, 17%-25% 2,851 Revolving credit agreement, 1.9% 3,000 3,000 9,851 7,000 Less current portion 4,573 . 5,278 7,000 The following recently issued Statements of Financial Accounting Standards (SFAS) are either not applicable to the Company or the Company does not expect their implementation to have a material impact on the Company's financial position or results of operations: SFAS No. 143, Accounting for Asset Retirement Obligations; SFAS No. 144, Accounting for the Impairment of Long-Lived Assets; SFAS No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections; SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities; and SFAS No. 147, Acquisitions of Certain Financial Institutions. SFAS No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure, amends the disclosure requirements of SFAS No. 123, Accounting for Stock-Based Compensation, to require prominent disclosures in annual and interim financial statements about the method of accounting for stock-based compensation and the effect in measuring compensation expense. SFAS No. 148 is effective beginning with the Company's March 2003 quarter. The Company is still evaluating the impact of adopting SFAS No. 148. Page 8 of 17 THE L. S. STARRETT COMPANY MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS QUARTERS ENDED DECEMBER 28, 2002 AND DECEMBER 29, 2001 Sales Total Company sales for the December quarter are approximately the same as the corresponding quarter of a year ago, both quarters reflecting worldwide economic conditions that have been adversely affecting business for some time. Domestic sales are down 2% and foreign sales are up 5% for the quarter, although in local currency foreign sales are up 30% because Brazil's currency has devalued over the past year. Loss Before Taxes Our pretax loss for the quarter was $1.3 million, slightly better than the $1.4 million loss a year earlier, but considerably better after considering the $.7 million of unrealized exchange losses in Brazil this year compared to none last year, and the fact that most of our locations are producing at levels well below sales in order to reduce inventories. We estimate that the negative effect on pretax operating results of producing at less than our sales level is $1.5 to $2.0 million in the current quarter. Despite increased fringe benefit and insurance costs ($.5 million) and reduced production levels, cost cutting measures (primarily headcount reductions) have resulted in a slightly improved gross margin (23.1% vs 22.5%) and SG&A expense (24.8% vs 25.7%). For the quarter, domestic operations had a pretax loss of 6% of sales while foreign operations had pretax income of 4% of sales. These returns are about the same as a year ago. Income Taxes The effective income tax rate was 52% in the current quarter and 57% in the prior year's quarter. The change comes about because pretax results are so close to breakeven in both quarters that permanent book/tax differences get exaggerated when converted to percentages and the rates are relatively high compared to our normal rate of about 35% because the least profitable operations during the current year have been in the jurisdictions with the highest tax rates. Loss per share As a result of the above factors, basic and diluted loss per share for the December quarters is $(.09) in both years. SIX MONTH PERIODS ENDED DECEMBER 28, 2002 AND DECEMBER 29, 2001 Overview As more fully discussed below, results for the six months ended December 28, 2002 show the Company incurred a net loss of $9.3 million, or $1.41 per basic and diluted share, compared to a net loss of $.3 million, or $.05 per share, in the six months ended December 29, 2001. A significant portion of the current year's loss was caused by two unusual first quarter charges: the writeoff of $6.1 million, or $.93 per share after tax, of goodwill and a $3.1 million pretax, or $.30 per share after tax, provision in connection with a government investigation of the Company's Coordinate Measuring Machine division, which is based in Mt. Airy, North Carolina. Excluding these charges, the Company incurred a net loss for the six months ended December 28, 2002 of $1.3 million, or $.18 per share, compared to a net loss of $.3 million, or $.05 per share, in the prior year. Page 9 of 17 Sales Sales for the six months ended December 28, 2002 are down 1% compared to the corresponding period a year ago. Excluding intercompany sales, domestic sales are down 4% and foreign sales are up 6%. In local currency foreign sales are up 29%. The decrease in domestic sales reflects the continued weak U.S. industrial manufacturing sector and lower first quarter shipments to a major consumer products customer as they rebalanced their inventories. Loss before taxes and cumulative effect of change in accounting principle Results for the six months, before the cumulative effect of the change in accounting principle for goodwill (adoption of SFAS 142) as previously discussed are down $4.8 million from last year. $3.1 million pretax ($.30 per share after tax) of this decrease relates to charges taken in connection with our Coordinate Measuring Machine (CMM) division as further described below. Excluding the goodwill writeoff and CMM division charges, pretax results are down $1.7 million. The major items causing the decrease are increased domestic fringe benefit and insurance costs ($.9 million), unrealized exchange losses in Brazil ($1.5 million), and the effect ($3.0 to $4.0 million), both domestic and foreign, of production levels being well below sales as the Company continues to reduce inventories. These cost increases were partially offset by cost reduction measures (primarily headcount) as well as the elimination of goodwill amortization ($.1 million). Coordinate Measuring Machine (CMM) Division The Company's CMM division is presently the subject of a federal government investigation being coordinated through the Department of Justice. The division, which is based in the Company's Mt. Airy, North Carolina facility, accounted for less than 3% of the Company's net sales during fiscal 2002. The CMM division manufactures and sells coordinate measuring machines, including the Rapid Check 2 and Rapid Check 3 machines. The Company's CMMs operate with computer measurement software sold by the Company, including software sold under the "Apogee" brand name. The Company became aware of the investigation on September 5, 2002, when federal agents conducted a search of the CMM division. The government's investigation appears to be focused on the division's Rapid Check coordinate measuring machine product line and other Starrett CMMs using the Apogee software. On September 12, 2002, the Wall Street Journal published an article in which allegations that the Company had defrauded its customers and the government were attributed to Richard Parks, a former independent contractor to the Company. The article indicated that the investigation apparently was prompted by a qui tam action filed under seal in federal court in Boston, Massachusetts by Mr. Parks. The Company has not been served with a complaint in connection with any qui tam action. In response to that article, the Company denied that it defrauded its customers or the government. The Company is fully cooperating with the government in its investigation. Beginning late in calendar 2001, the Company, on its own initiative and as part of its review of its Rapid Check product line, made certain improvements to the Rapid Check machines and incorporated these improvements in new Rapid Check machines. Beginning in March 2002, the Company informed its customers of these improvements and initiated a program to replace the affected Rapid Check machines at no cost to its customers. This replacement program continues to the present time. Page 10 of 17 As a result of the investigation and ongoing replacement program outlined above, the Company charged pretax operations with $3.1 million ($.30 per share after tax) in the September 2002 quarter. Of this, $1.5 million was charged to selling and general expense in the Statements of Operations and relates to professional fees, including legal. The remaining $1.6 million related to the Rapid Check replacement program and other CMM inventory valuation expenses and appears as part of cost of goods sold in the Statements of Operations. No assurances can be made that these charges reflect the actual costs that will ultimately be incurred by the Company or that the Company will not need to take additional charges. Total CMM division inventories were approximately $6 million as of December 28, 2002. Income Taxes The effective income tax rate was 46% for the six months ended December 28, 2002 and 67% in the prior six month period. The change comes about because pretax results are so close to breakeven in both periods that permanent book/tax differences get exaggerated when converted to percentages and the rates are relatively high compared to our normal rate of about 35% because the least profitable operations during the current year have been in the jurisdictions with the highest tax rates. Loss per share before change in accounting principle As a result of the above factors and before the change in accounting principle (adoption of SFAS 142), the Company incurred a basic and diluted loss per share for the six months ended December 28, 2002 of $.48 ($.18 before the CMM division charges discussed above) compared to a loss of $.05 per share a year ago. Net loss per share after change in accounting principle Basic and diluted net loss per share was $1.41 for the six months ended December 28, 2002. Excluding the $.30 related to the CMM division charges discussed above and the $.93 related to the writeoff of goodwill discussed in the notes to the financial statements, the net loss was $.18 per share compared to a net loss of $.05 per share for the six months ended December 29, 2001. LIQUIDITY AND CAPITAL RESOURCES 13 Weeks Ended 26 Weeks Ended 12/28/02 12/29/01 12/28/02 12/29/01 Cash provided by operations 12,458 7,518 17,694 11,406 Cash used in investing activities (12,459) (5,977) (16,621) (8,186) Cash used in financing activities 827 (2,172) (501) (3,699) Despite small operating losses in all quarters plus the additional $3.1 million charge taken in the first quarter of fiscal 2003, cash provided by operations has been positive and increasing period to period. By far the biggest factor contributing to the increase has been the reduction in inventories during this year's first and second quarters (approximately $6 million in both quarters). "Retirement benefits" under noncash expenses in the detailed cash flow statement shows the effect on operating cash flow of the Company's pension and retiree medical plans. Primarily because the Company's domestic defined benefit plan is overfunded, retirement benefits in total are currently generating approximately $.2 million of noncash income per quarter ($.6 million per quarter in the prior year). On an accrual basis, retirement benefits (expense) are approximately $(.2) million per quarter in the current year and $.1 million in the prior year. Page 11 of 17 The Company's investing activities consist of expenditures for plant and equipment and the investment of cash not immediately needed for operations. Increased short-term investments partially offset by less capital expenditures in the first quarter of fiscal 2003 accounts for the increase in investing activities. Cash flows from financing activities are primarily the payment of dividends, which tend to be steady from year to year. The Company entered into a lease financing arrangement in Brazil in the December quarter worth approximately $2.7 million that reduced the quarter and year to date cash required for financing activities. The proceeds from the sale of stock under the various stock plans has historically been used to purchase treasury shares, although such treasury share purchases have been curtailed during the past 12 months. The Company maintains sufficient liquidity and has the resources to fund its operations in the near term. If economic conditions do not improve and the Company continues to sustain losses, additional steps will have to be taken in order to maintain liquidity, including further workforce reductions and/or reducing or eliminating dividends. The Company maintains a $25 million line of credit but has not made significant borrowings under it. The Company has a working capital ratio of 5.3 to 1 as of December 28, 2002 and 6.0 to 1 as of June 29, 2002. ACCOUNTING PRONOUNCEMENTS The following recently issued Statements of Financial Accounting Standards (SFAS) are either not applicable to the Company or the Company does not expect their implementation to have a material impact on the Company's financial position or results of operations: SFAS No. 143, Accounting for Asset Retirement Obligations; SFAS No. 144, Accounting for the Impairment of Long-Lived Assets; SFAS No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections; SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities; and SFAS No. 147, Acquisitions of Certain Financial Institutions. SFAS No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure, amends the disclosure requirements of SFAS No. 123, Accounting for Stock-Based Compensation, to require prominent disclosures in annual and interim financial statements about the method of accounting for stock-based compensation and the effect in measuring compensation expense. SFAS No. 148 is effective beginning with the Company's March 2003 quarter. The Company is still evaluating the impact of adopting SFAS No. 148. CRITICAL ACCOUNTING POLICIES 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 the amounts reported in the consolidated financial statements and accompanying notes. The first footnote to the consolidated financial statements in the Annual Report on Form 10-K for the fiscal year ended June 29, 2002 describes the significant accounting policies and methods used in the preparation of the consolidated financial statements. Judgements, assumptions, and estimates are used for, but not limited to, the allowance for doubtful accounts receivable and returned goods; inventory allowances; income tax reserves; employee turnover, discount, and return rates used to calculate pension obligations; normal expense accruals for such things as workers compensation and employee medical expenses; and of particular importance this fiscal year the previously discussed charges connected with the government investigation of our CMM division. Actual results could differ from these estimates. Page 12 of 17 The allowance for doubtful accounts and sales returns is based on our assessment of the collectibility of specific customer accounts, the aging of our accounts receivable and trends in product returns. While we believe that our allowance for doubtful accounts and sales returns is adequate and that the judgment applied is appropriate, if there is a deterioration of a major customer's credit worthiness, actual defaults are higher than our previous experience, or actual future returns do not reflect historical trends, our estimates of the recoverability of the amounts due us and our sales could be adversely affected. Inventory purchases and commitments are based upon future demand forecasts. If there is a sudden and significant decrease in demand for our products or there is a higher risk of inventory obsolescence because of rapidly changing technology and requirements, we may be required to increase our inventory reserve and, as a result, our gross profit margin could be adversely affected. Accounting for income taxes requires us to estimate our future tax liabilities. Due to timing differences in the 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, we assess the likelihood that the asset will be realized. If realization is in doubt because of uncertainty regarding future profitability or enacted tax rates, we provide a valuation allowance related to the asset. Should any significant changes in the tax law or our estimate of the necessary valuation allowance occur, we would record the impact of the change, which could have a material effect on our financial position or results of operations. Pension and postretirement medical benefit costs and obligations are dependent on assumptions used by our actuaries in calculating such amounts. These assumptions include discount rates, healthcare cost trends, inflation, salary growth, long-term return on plan assets, retirement rates, mortality rates, and other factors. These assumptions are made based on a combination of external market factors, actual historical experience, long-term trend analysis, and an analysis of the assumptions being used by other companies with similar plans. Actual results that differ from our assumptions are accumulated and amortized over future periods. Significant differences in actual experience or significant changes in assumptions would affect our pension and other postretirement benefit costs and obligations. SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1996 This Quarterly Report on Form 10-Q as well as the 2002 Annual Report, including the President's letter to stockholders, and the quarterly shareholder earnings announcement include forward-looking statements about the Company's business, sales, expenditures, environmental regulatory compliance, foreign operations, interest rate sensitivity, debt service, liquidity and capital resources, other operating and capital requirements, and the pending government investigation. In addition, forward-looking statements may be included in future Company documents and in oral statements by Company representatives to security analysts and investors. The Company is subject to risks that could cause actual events to vary materially from such forward- looking statements, including the following risk factors: Risks Related to Government Investigation: As discussed above, the Government is currently investigating the Company's CMM division. There can be no assurance as to how long this investigation will last and what the outcome of the investigation will be and what effect, if any, the outcome of the investigation will have on the Company, its sales of CMMs and other products or its stock price. Page 13 of 17 Risks Related to Technology: Although the Company's strategy includes investment in research and development of new and innovative products to meet technology advances, there can be no assurance that the Company will be successful in competing against new technologies developed by competitors. Risks Related to the Euro: The United Kingdom has not adopted the euro and the Company's Scottish subsidiary transacts a significant amount of business with euro countries. There can be no assurance that this situation will not result in unforseen economic conditions that affect the Company's business. Indeed, the historic weakness of the euro as compared to the British pound has had an adverse impact on the Company's sales and margins on business done with euro countries. Risks Related to Foreign Operations: Approximately a third of the Company's sales and net assets relate to foreign operations. Foreign operations are subject to special risks that can materially affect the sales, profits, cash flows, and financial position of the Company, including taxes and other restrictions on distributions and payments, currency exchange rate fluctuations, political and economic instability, inflation, minimum capital requirements, and exchange controls. In particular, the Company's Brazilian operations, which constitute over half of the Company's revenues from foreign operations, can be very volatile, changing from year to year due to the political situation and economy. As a result, the future performance of the Brazilian operations is inherently unpredictable. Risks Related to Cyclical Nature of the Industry: The market for most of the Company's products is subject to economic conditions affecting the industrial manufacturing sector, including the level of capital spending by industrial companies. Accordingly, economic weakness in the industrial manufacturing sector will result in decreased demand for the Company's products and will adversely affect performance. Economic weakness in the consumer market also impacts the Company's performance. Risks Related to Competition: The Company's business is subject to direct and indirect competition from both domestic and foreign firms. In particular, low-wage foreign sources have created severe competitive pricing pressures. Under certain circumstances, including significant changes in U.S. and foreign currency relationships, such pricing pressures might reduce unit sales and/or adversely affect the Company's margins. Item 3. Quantitative and Qualitative Disclosure About Market Risk Market risk is the potential change in a financial instrument's value caused by fluctuations in interest and currency exchange rates, and equity and commodity prices. The Company's operating activities expose it to risks that are continually monitored, evaluated, and managed. Proper management of these risks helps reduce the likelihood of earnings volatility. At December 2002 and June 2002, the Company was not a party to any derivative arrangement and the Company does not engage in trading, market-making or other speculative activities in the derivatives markets. The Company does not enter into long-term supply contracts with either fixed prices or quantities. The Company does not engage in regular hedging activities to minimize the impact of foreign currency fluctuations. Net foreign monetary assets total approximately $5 million as of December 28, 2002. A 10% change in interest rates would not have a significant impact on the aggregate net fair value of the Company's interest rate sensitive financial instruments (primarily variable rate investments of $23 million and debt of $11 million at December 28, 2002) or the cash flows or future earnings associated with those financial instruments. A 10% change in interest rates would impact the fair value of the Company's fixed rate investments of $2.3 million by approximately $40,000. Page 14 of 17 Item 4. Controls and Procedures Within the 90 days prior to the date of this Form 10-Q, the Company carried out an evaluation, under the supervision and with the participation of the Company's management, including the Company's Chief Executive Officer along with the Company's Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, the Company's Chief Executive Officer along with the Company's Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company's periodic Securities and Exchange Commission filings. There have been no significant changes in the Company's internal controls or in other factors that could significantly affect internal controls subsequent to the date the Company carried out its evaluation. PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits 99a Certification of Douglas A. Starrett pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 99b Certification of Roger U. Wellington, Jr. pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (b) Reports on Form 8-K None SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. THE L. S. STARRETT COMPANY (Registrant) Date February 7, 2003 S/R.U.WELLINGTON, JR. R. U. Wellington, Jr. (Vice President, Treasurer and Chief Financial Officer) Date February 7, 2003 S/S.G.THOMSON S. G. Thomson (Chief Accounting Officer) Page 15 of 17 CERTIFICATION OF CHIEF EXECUTIVE OFFICER I, Douglas A. Starrett, certify that: 1. I have reviewed this quarterly report on Form 10-Q of The L.S.Starrett Company; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: February 7, 2003 S/DOUGLAS A. STARRETT Douglas A. Starrett President and Chief Executive Officer Page 16 of 17 CERTIFICATION OF CHIEF FINANCIAL OFFICER I, Roger U. Wellington, Jr., certify that: 1. I have reviewed this quarterly report on Form 10-Q of The L.S.Starrett Company; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: February 7, 2003 S/ROGER U. WELLINGTON, JR. Roger U. Wellington, Jr. Vice President, Treasurer and Chief Financial Officer Page 17 of 17