UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D. C. 20549





FORM
10-Q


(Mark
One)


QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934x
            For
      the quarterly period ended
            December
      27, 2008ORTRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934o
            For
      the transition period from
            
            toCommission
      file number
            1-367THE
      L. S. STARRETT COMPANY(Exact
      name of registrant as specified in its charter)MASSACHUSETTS
            
            04-1866480(State
      or other jurisdiction of incorporation or organization)
            
            (I.R.S.
      Employer Identification No.)121
      CRESCENT STREET, ATHOL, MASSACHUSETTS
            01331-1915(Address
      of principal executive offices)
            (Zip
      Code)Registrant's
      telephone number, including area code
            978-249-3551Former
      name, address and fiscal year, if changed since last
  reportIndicate
      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
      xNOoIndicate
      by check mark whether the registrant is a large accelerated filer, an
      accelerated filer, a non-accelerated filer, or a smaller reporting
      company. See definition of “accelerated filer,” “large accelerated filer”
      and “smaller reporting company” in Rule 12b-2 of the Exchange Act, (Check
      One):Large
      Accelerated Filer oAccelerated FilerxNon-Accelerated
      FileroSmaller Reporting Company oIndicate
      by check mark whether the registrant is a shell company (as defined in
      Rule 12b-2 of the Exchange Act).YES
      oNOxCommon
      Shares outstanding as of
            January
      31, 2009Class
      A Common Shares
            5,744,988Class
      B Common Shares
            879,135


1


THE L. S.
STARRETT COMPANY





CONTENTS





Page No.Part
      I.                      Financial
      Information:Item
      1.                      Financial
      StatementsConsolidated
      Statements of Operations –
              thirteen
      weeks and twenty-six weeks ended December 27, 2008 and December 29, 2007
      (unaudited)
            
            3Consolidated
      Statements of Cash Flows –
              thirteen
      weeks and twenty-six weeks ended December 27, 2008 and December 29, 2007
      (unaudited)
            
            4Consolidated
      Balance Sheets –
              December
      27, 2008 (unaudited) and June 28, 2008
            
            5Consolidated
      Statements of Stockholders' Equity -
              twenty-six
      weeks ended December 27, 2008 and December 29, 2007
      (unaudited)
            
            6Notes
      to Consolidated Financial Statements
            
            7-10Item
      2.                      Management's
      Discussion and Analysis of FinancialCondition and Results of
      Operations
            
            11-16Item
      3.                      Quantitative
      and Qualitative Disclosures AboutMarket Risk
            
            16Item
      4.                      Controls
      and Procedures
            
            16Part
      II.                      Other
      information:Item
      1A.                      Risk
      Factors
            
            16-18Item
      2.                      Unregistered
      Sales of Equity Securities and Use ofProceeds
            
            18Item
      4.                      Submission
      of Matters to a Vote of Security Holders
            
            19Item
      6.                      Exhibits
            
            19SIGNATURES
            
            19EXHIBIT
      INDEX
            
            20


2


Part I.
Financial Information





Item 1.
Financial Statements





THE L. S.
STARRETT COMPANY


Consolidated
Statements of Operations


(in
thousands of dollars except per share data)(unaudited)








13 Weeks Ended
                
                
                26 Weeks Ended12/27/08
                
                
                12/29/07
                
                
                12/27/08
                
                
                12/29/07Net
      sales
                
                $
                54,081
                
                
                $
                62,436
                
                
                $
                122,066
                
                
                $
                121,986Cost
      of goods sold
                
                
                (37,766
                )
                
                
                (42,892
                )
                
                
                (84,558
                )
                
                
                (83,888
                )Selling
      and general expense
                
                
                (15,493
                )
                
                
                (15,766
                )
                
                
                (32,991
                )
                
                
                (30,469
                )Other
      income (expense)
                
                
                820
                
                
                
                2,162
                
                
                
                1,355
                
                
                
                1,896Earnings
      before income taxes
                
                
                1,642
                
                
                
                5,940
                
                
                
                5,872
                
                
                
                9,525Income
      tax expense
                
                
                507
                
                
                
                2,517
                
                
                
                2,114
                
                
                
                3,772Net
      earnings
                
                $
                1,135
                
                
                $
                3,423
                
                
                $
                3,758
                
                
                $
                5,753Basic
      and diluted earnings per share
                
                $
                .17
                
                
                $
                .52
                
                
                $
                .57
                
                
                $
                .87Average
      outstanding shares used in per share calculations (in
      thousands):Basic
                
                
                6,617
                
                
                
                6,587
                
                
                
                6,617
                
                
                
                6,591Diluted
                
                
                6,620
                
                
                
                6,596
                
                
                
                6,624
                
                
                
                6,601Dividends
      per share
                
                $
                .12
                
                
                $
                .20
                
                
                $
                .24
                
                
                $
                .30


























































See Notes
to Consolidated Financial Statements


3


THE L. S.
STARRETT COMPANY


Consolidated
Statements of Cash Flows


(in
thousands of dollars)(unaudited)








13 Weeks Ended
                
                
                26 Weeks Ended12/27/08
                
                
                12/29/07
                
                
                12/27/08
                
                
                12/29/07Cash
      flows from operating activities:Net earnings
                
                $
                1,135
                
                
                $
                3,423
                
                
                $
                3,758
                
                
                $
                5,753Non-cash items
      included:Gain from sale of real
      estate
                
                
                -
                
                
                
                (1,703
                )
                
                
                -
                
                
                
                (1,703
                )Depreciation
                
                
                2,150
                
                
                
                2,465
                
                
                
                4,506
                
                
                
                4,839Impaired assets
                
                
                -
                
                
                
                95
                
                
                
                -
                
                
                
                95Amortization
                
                
                312
                
                
                
                321
                
                
                
                624
                
                
                
                616Net long-term tax
      payable
                
                
                123
                
                
                
                -
                
                
                
                224
                
                
                
                -Deferred taxes
                
                
                (639
                )
                
                
                660
                
                
                
                (562
                )
                
                
                1,107Unrealized transaction (gains)
      losses
                
                
                1,319
                
                
                
                (758
                )
                
                
                1,295
                
                
                
                (556
                )Retirement
benefits
                
                
                (479
                )
                
                
                (922
                )
                
                
                (989
                )
                
                
                (1,743
                )Cumulative effect of adopting
      FIN48
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (313
                )Working capital
      changes:Receivables
                
                
                3,231
                
                
                
                2,384
                
                
                
                1,000
                
                
                
                (730
                )Inventories
                
                
                (6,745
                )
                
                
                2,628
                
                
                
                (11,109
                )
                
                
                4,812Other current
    assets
                
                
                (144
                )
                
                
                (239
                )
                
                
                (761
                )
                
                
                668Other current
      liabilities
                
                
                (2,980
                )
                
                
                1,117
                
                
                
                (3,175
                )
                
                
                1,044Prepaid pension cost and
      other
                
                
                854
                
                
                
                303
                
                
                
                1,832
                
                
                
                648Net cash (used in) provided by
      operating activities
                
                
                (1,863
                )
                
                
                9,774
                
                
                
                (3,357
                )
                
                
                14,537Cash
      flows (used in) provided by investing activities:Additions to plant and
      equipment
                
                
                (2,457
                )
                
                
                (1,701
                )
                
                
                (5,425
                )
                
                
                (4,098
                )Proceeds from sale of real
      estate
                
                
                -
                
                
                
                2,416
                
                
                
                -
                
                
                
                2,416Decrease (increase) in
      investments
                
                
                3,384
                
                
                
                (9,090
                )
                
                
                6,683
                
                
                
                (9,850
                )Purchase of Kinemetric
      Engineering
                
                
                (270
                )
                
                
                -
                
                
                
                (270
                )
                
                
                (2,060
                )Net cash provided by (used in)
      investing activities
                
                
                657
                
                
                
                (8,375
                )
                
                
                988
                
                
                
                (13,592
                )Cash
      flows (used in) provided by financing activities:Proceeds from short-term
      borrowings
                
                
                5,610
                
                
                
                2,265
                
                
                
                9,646
                
                
                
                4,481Short-term debt
      repayments
                
                
                (3,945
                )
                
                
                (1,567
                )
                
                
                (4,365
                )
                
                
                (3,711
                )Long-term debt
      repayments
                
                
                (56
                )
                
                
                (109
                )
                
                
                (190
                )
                
                
                (224
                )Proceeds from common stock
      issued
                
                
                176
                
                
                
                157
                
                
                
                332
                
                
                
                268Treasury shares
      purchased
                
                
                (188
                )
                
                
                -
                
                
                
                (188
                )
                
                
                (317
                )Dividends
                
                
                (795
                )
                
                
                (1,318
                )
                
                
                (1,589
                )
                
                
                (1,978
                )Net cash provided by (used in)
      financing activities
                
                
                802
                
                
                
                (572
                )
                
                
                3,646
                
                
                
                (1,481
                )Effect
      of exchange rate changes on cash
                
                
                (1,146
                )
                
                
                136
                
                
                
                (1,660
                )
                
                
                166Net
      (decrease) increase in cash
                
                
                (1,550
                )
                
                
                963
                
                
                
                (383
                )
                
                
                (370
                )Cash,
      beginning of period
                
                
                7,682
                
                
                
                6,375
                
                
                
                6,515
                
                
                
                7,708Cash,
      end of period
                
                $
                6,132
                
                
                $
                7,338
                
                
                $
                6,132
                
                
                $
                7,338

















See Notes
to Consolidated Financial Statements


4


THE L. S.
STARRETT COMPANY


Consolidated
Balance Sheets


(in
thousands of dollars except share data)





Dec.
      27
                  2008
                  (unaudited)
                
                
                June
      28 2008ASSETSCurrent
      assets:Cash
                
                $
                6,132
                
                
                $
                6,515Investments
                
                
                10,295
                
                
                
                19,806Accounts receivable (less
      allowance for doubtful accounts of $664 and $701)
                
                
                30,797
                
                
                
                39,627Inventories:Raw materials and
      supplies
                
                
                19,728
                
                
                
                15,104Goods in process and finished
      parts
                
                
                17,404
                
                
                
                16,653Finished goods
                
                
                26,146
                
                
                
                29,40063,278
                
                
                
                61,157Current deferred income tax
      asset
                
                
                5,631
                
                
                
                5,996Prepaid expenses, taxes and other
      current assets
                
                
                5,397
                
                
                
                5,535Total current
    assets
                
                
                121,530
                
                
                
                138,636Property,
      plant and equipment, at cost (less accumulated depreciation of $116,522
      and $131,386)
                
                
                55,566
                
                
                
                60,945Property
      held for sale
                
                
                1,912
                
                
                
                1,912Intangible
      assets (less accumulated amortization of $3,101 and
$2,477)
                
                
                3,140
                
                
                
                3,764Goodwill
                
                
                6,302
                
                
                
                6,032Pension
      asset
                
                
                35,335
                
                
                
                34,643Other
      assets
                
                
                291
                
                
                
                1,877Long-term
      taxes receivable
                
                
                2,905
                
                
                
                2,476Total assets
                
                $
                226,981
                
                
                $
                250,285LIABILITIES
      AND STOCKHOLDERS’ EQUITYCurrent
      liabilities:Notes payable and current
      maturities
                
                $
                9,080
                
                
                $
                4,121Accounts payable and accrued
      expenses
                
                
                12,961
                
                
                
                18,041Accrued salaries and
      wages
                
                
                5,380
                
                
                
                6,907Total current
      liabilities
                
                
                27,421
                
                
                
                29,069Long-term
      taxes payable
                
                
                8,551
                
                
                
                8,522Deferred
      income taxes
                
                
                5,815
                
                
                
                6,312Long-term
      debt
                
                
                5,334
                
                
                
                5,834Postretirement
      benefit liability
                
                
                12,682
                
                
                
                13,775Total liabilities
                
                
                59,803
                
                
                
                63,512Stockholders'
      equity:Class
      A Common $1 par (20,000,000 shrs. authorized)
                  5,739,388
      outstanding on 12/27/08,
                  5,708,100
      outstanding on 6/28/08
                
                
                5,739
                
                
                
                5,708Class
      B Common $1 par (10,000,000 shrs. authorized)
                  879,135
      outstanding on 12/27/08,
                  906,065
      outstanding on 6/28/08
                
                
                879
                
                
                
                906Additional paid-in
      capital
                
                
                49,784
                
                
                
                49,613Retained earnings reinvested
      and employed in the business
                
                
                136,278
                
                
                
                134,109Accumulated other comprehensive
      loss
                
                
                (25,502
                )
                
                
                (3,563
                )Total stockholders'
      equity
                
                
                167,178
                
                
                
                186,773Total liabilities and
      stockholders’ equity
                
                $
                226,981
                
                
                $
                250,285


See Notes
to Consolidated Financial Statements


5




THE L. S.
STARRETT COMPANY
 Consolidated
Statements of Stockholders' Equity
 For the
Twenty-six Weeks Ended December 27, 2008 and December 29, 2007
 (in
thousands of dollars except per share data)
 (unaudited)
 Common
      Stock
                    Out-standing
                    ($1
      Par)Class
      A
                  
                  
                  Class
      B
                  
                  
                  Addi-
                    tional
                    Paid-in
                    Capital
                  
                  
                  Retained
                    Earnings
                  
                  
                  Accumulated
                    Other
      Com-prehensive
                    Loss
                  
                  
                  TotalBalance
      June 30, 2007
                  
                  $
                  5,632
                  
                  
                  $
                  963
                  
                  
                  $
                  49,282
                  
                  
                  $
                  127,023
                  
                  
                  $
                  (5,786
                  )
                  
                  $
                  177,114Comprehensive
      income (loss):Net earnings
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  5,753
                  
                  
                  
                  
                  
                  
                  
                  5,753Unrealized net loss on investments
      andswap agreement
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (36
                  )
                  
                  
                  (36
                  )Translation gain,
    net
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  4,243
                  
                  
                  
                  4,243Total
      comprehensive income
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  9,960Tax
      adjustment for FIN 48
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (313
                  )
                  
                  
                  
                  
                  
                  
                  (313
                  )Dividends
      ($.30 per share)
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (1,978
                  )
                  
                  
                  
                  
                  
                  
                  (1,978
                  )Treasury
      shares:Purchased
                  
                  
                  (20
                  )
                  
                  
                  
                  
                  
                  
                  (297
                  )
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (317
                  )Issued
                  
                  
                  10
                  
                  
                  
                  
                  
                  
                  
                  177
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  187Issuance
      of stock under ESPP
                  
                  
                  
                  
                  
                  
                  5
                  
                  
                  
                  99
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  104Conversion
                  
                  
                  44
                  
                  
                  
                  (44
                  )
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  -Balance
      December 29, 2007
                  
                  $
                  5,666
                  
                  
                  $
                  924
                  
                  
                  $
                  49,261
                  
                  
                  $
                  130,485
                  
                  
                  $
                  (1,579
                  )
                  
                  $
                  184,757Balance
      June 28, 2008
                  
                  $
                  5,708
                  
                  
                  $
                  906
                  
                  
                  $
                  49,613
                  
                  
                  $
                  134,109
                  
                  
                  $
                  (3,563
                  )
                  
                  $
                  186,773Comprehensive
      income (loss):Net earnings
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  3,758
                  
                  
                  
                  
                  
                  
                  
                  3,758Unrealized net gain on investments
      andswap agreement
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  229
                  
                  
                  
                  229Translation loss,
    net
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (22,168
                  )
                  
                  
                  (22,168
                  )Total
      comprehensive loss
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (18,181
                  )Dividends
      ($.24 per share)
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (1,589
                  )
                  
                  
                  
                  
                  
                  
                  (1,589
                  )Treasury
      shares:Purchased
                  
                  
                  (15
                  )
                  
                  
                  
                  
                  
                  
                  (173
                  )
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (188
                  )Issued
                  
                  
                  15
                  
                  
                  
                  
                  
                  
                  
                  268
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  283Issuance
      of stock under ESPP
                  
                  
                  
                  
                  
                  
                  4
                  
                  
                  
                  76
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  80Conversion
                  
                  
                  31
                  
                  
                  
                  (31
                  )
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  -Balance
      December 27, 2008
                  
                  $
                  5,739
                  
                  
                  $
                  879
                  
                  
                  $
                  49,784
                  
                  
                  $
                  136,278
                  
                  
                  $
                  (25,502
                  )
                  
                  $
                  167,178Cumulative
      Balance:Translation loss
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (21,562
                  )Unrealized loss on investments and
      swapagreements
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (112
                  )Amounts not recognized as a
      component of net periodic benefit cost
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (3,828
                  )$
                  (25,502
                  )
 
 
 
 
 
 
 
 
 
 See Notes
to Consolidated Financial Statements
  6






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 27, 2008 and
June 28, 2008; the results of operations and cash flows for the thirteen and
twenty-six weeks ended December 27, 2008 and December 29, 2007; and changes in
stockholders' equity for the twenty-six weeks ended December 27, 2008 and
December 29, 2007.





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 28, 2008, and these financial statements should be read in
conjunction with said Annual Report on Form 10-K. Note that significant foreign
locations are reported on a one month lag.





Included
in investments at December 27, 2008 is $1.8 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 represent
“core cash” and are part of the Company’s overall cash management and liquidity
program and, under SFAS 115, are considered “available for sale.” The
investments themselves are highly liquid, carry no early redemption penalties,
and are not designated for acquiring non-current assets. Cash and investments
held in foreign locations amounted to $11.4 million and $18.8 million at
December 27, 2008 and June 28, 2008, respectively. The other significant
component of investments at December 27, 2008 is $7.1 million of investments in
certificates of deposit which are carried at cost.





On
October 1, 2008, the Company adopted SFAS No. 157, Fair Value
Measurements (“Statement No. 157”). Statement No. 157 defines and
establishes a framework for measuring fair value and expands disclosures about
fair value instruments. In accordance with Statement No. 157, the Company
has categorized its financial assets, based on the priority of the inputs to the
valuation technique, into a three-level fair value hierarchy as set forth below.
The Company does not have any financial liabilities that are required to be
measured at fair value on a recurring basis. If the inputs used to measure the
financial instruments fall within different levels of the hierarchy, the
categorization is based on the lowest level input that is significant to the
fair value measurement of the instrument.





Financial
assets recorded on the balance sheets are categorized based on the inputs to the
valuation techniques as follows:





-
            Level
      1 – Financial assets whose values are based on unadjusted quoted prices
      for identical assets or liabilities in an active market which the company
      has the ability to access at the measurement date (examples include active
      exchange-traded equity securities and most U.S. Government and agency
      securities).





-
            Level
      2 – Financial assets whose value are based on quoted market prices in
      markets where trading occurs infrequently or whose values are based on
      quoted prices of instruments with similar attributes in active markets.
      The Company does not currently have any Level 2 financial
      assets.





-
            Level
      3 – Financial assets whose values are based on prices or valuation
      techniques that require inputs that are both unobservable and significant
      to the overall fair value measurement. These inputs reflect management’s
      own assumptions about the assumptions a market participant would use in
      pricing the asset. The Company does not currently have any Level 3
      financial assets.





As of
December 27, 2008, the Company’s Level 1 financial assets were as
follows:





Level 1Money
      Market Funds
                    
                    $
                    1,462Certificates
      of Deposits
                    
                    
                    7,082International
      Bonds
                    
                    
                    1,751$
                    10,295





The
Company has determined that a triggering event has occurred during the second
quarter of fiscal 2009 relating to the $5.3 million of goodwill on acquisition
of Tru-Stone. This event is represented by a downturn in quarterly sales and the
outlook for their markets served. In accordance with FAS 142, Goodwill and Other
Intangibles, the Company performed the step one evaluation on the carrying value
and tangible book value of Tru-Stone, using a


7


discounted
cash flow methodology, which resulted in an implied fair value greater than the
carrying value. Further, the Company’s stock price has been trading below its
book value and tangible book value for over four consecutive quarters. The
Company attributes this low stock price to both the overall market conditions
and company specific factors, including low trading volume of the Company’s
stock. On this basis, the Company did not consider it necessary to perform a
step one analysis on the other remaining reporting unit with
goodwill.





Accounts
payable and accrued expenses at December 27, 2008 and June 28, 2008 consisted
primarily of accounts payable ($5.8 million and $9.0 million), accrued benefits
($1.2 million and $1.1 million), accrued taxes other than income ($.8 million
and $2.1 million), and other accrued expenses ($5.1 million and $5.8
million).





Other
income (expense) is comprised of the following (in thousands):


Thirteen Weeks
                  Ended December
                
                
                Twenty-six Weeks
                  Ended December2008
                
                
                2007
                
                
                2008
                
                
                2007Interest income
                
                $
                224
                
                
                $
                423
                
                
                $
                541
                
                
                $
                734Interest expense and commitment
      fees
                
                
                (214
                )
                
                
                (198
                )
                
                
                (396
                )
                
                
                (453
                )Realized and unrealized exchange
      gains
                
                
                668
                
                
                
                278
                
                
                
                1,098
                
                
                
                79Gains on sale of real
      estate
                
                
                -
                
                
                
                1,703
                
                
                
                -
                
                
                
                1,703Other
                
                
                142
                
                
                
                (44
                )
                
                
                112
                
                
                
                (167
                )$
                820
                
                
                $
                2,162
                
                
                $
                1,355
                
                
                $
                1,896


The
Company adopted FASB Interpretation 48, “Accounting for Uncertainty in Income
Taxes” (“FIN No. 48”), at the beginning of fiscal year 2008. FIN No. 48
clarifies the accounting for uncertainty in income taxes recognized in an
enterprise’s financial statements in accordance with SFAS No. 109, “Accounting
for Income Taxes.” FIN No. 48 prescribes a two-step process to determine the
amount of tax benefit to be recognized. First, the tax position must be
evaluated to determine the likelihood that it will be sustained upon external
examination. If the tax position is deemed “more-likely-than-not” to be
sustained, the tax position is then assessed to determine the amount of benefit
to recognize in the financial statements. The amount of the benefit that may be
recognized is the largest amount that has a greater than 50 percent likelihood
of being realized upon ultimate settlement. As a result of implementing FIN No.
48, the Company recognized a cumulative effect adjustment of $.3 million to
decrease the July 1, 2007 retained earnings balance and increase long-term tax
payable. Also in connection with this implementation the Company has
reclassified $2.9 million of unrecognized tax benefits into a long-term taxes
receivable representing the corollary effect of transfer pricing competent
authority adjustments.


The
Company is subject to U.S. federal income tax and various state, local and
international income taxes in numerous jurisdictions. The Company’s domestic and
international 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 has substantially concluded all U.S. federal income tax matters for
years through fiscal 2003. Currently, the Company does not have any income tax
audits in progress at the Federal level, or in the numerous states, local and
international jurisdictions in which it operates. In international jurisdictions
including Argentina, Australia, Brazil, Canada, China, UK, Germany, New Zealand,
and Mexico, which comprise a significant portion of the Company’s operations,
the years that may be examined vary, with the earliest year being 2004 (except
for Brazil, which has 1997-2006 still open for examination).





The
Company recognizes interest expense related to income tax matters in income tax
expense. The Company has accrued $.1 million of interest as of June 28, 2008.
The amount did not change significantly during the six months ended December 27,
2008.





The
Company has identified no uncertain tax position for which it is reasonably
possible that the total amount of unrecognized tax benefits will significantly
increase or decrease within the next twelve months.





8


Net
periodic benefit costs (benefits) for the Company's defined benefit pension
plans consist of the following (in thousands):


Thirteen Weeks
                  Ended December
                
                
                Twenty-six Weeks
                  Ended December2008
                
                
                2007
                
                
                2008
                
                
                2007Service cost
                
                $
                556
                
                
                $
                555
                
                
                $
                1,129
                
                
                $
                1,199Interest cost
                
                
                1,710
                
                
                
                1,658
                
                
                
                3,494
                
                
                
                3,503Expected return on plan
      assets
                
                
                (2,561
                )
                
                
                (2,959
                )
                
                
                (5,197
                )
                
                
                (5,909
                )Amort. of prior service
      cost
                
                
                105
                
                
                
                112
                
                
                
                215
                
                
                
                224Amort. of unrecognized (gain)
      loss
                
                
                (3
                )
                
                
                (2
                )
                
                
                (6
                )
                
                
                (4
                )$
                (193
                )
                
                $
                (636
                )
                
                $
                (365
                )
                
                $
                (987
                )





Net
periodic benefit costs (benefits) for the Company's postretirement medical plan
consists of the following (in thousands):


Thirteen Weeks
                  Ended December
                
                
                Twenty-six Weeks
                  Ended December2008
                
                
                2007
                
                
                2008
                
                
                2007Service cost
                
                $
                88
                
                
                $
                97
                
                
                $
                176
                
                
                $
                197Interest cost
                
                
                177
                
                
                
                191
                
                
                
                354
                
                
                
                371Amort. of prior service
      cost
                
                
                (226
                )
                
                
                (226
                )
                
                
                (452
                )
                
                
                (453
                )Amort. of unrecognized
      loss
                
                
                -
                
                
                
                35
                
                
                
                -
                
                
                
                57$
                39
                
                
                $
                97
                
                
                $
                78
                
                
                $
                172


Approximately
56% of all inventories are valued on the LIFO method. LIFO inventories were
$21.6 million and $17.9 million, respectively, at December 27, 2008 and June 28,
2008, such amounts being approximately $32.3 and $27.5 million less than if
determined on a FIFO basis. The Company has not realized any material LIFO layer
liquidation profits in the periods presented.





Long-term
debt is comprised of the following (in thousands):


December
      27, 2008
                
                
                June
      28,
                  2008Reducing
    revolver
                
                $
                7,200
                
                
                $
                7,200Capitalized
      lease obligations payable in Brazilian currency due 2009-2011,
      13.3%-23.1%
                
                
                897
                
                
                
                1,569$
                8,097
                
                
                $
                8,769Less current
      portion
                
                
                2,763
                
                
                
                2,935$
                5,334
                
                
                $
                5,834





Current
notes payable, primarily in Brazilian currency, carry interest at up to 23.1%.
The average rate for the quarter ended December 27, 2008 was approximately
19.4%.





RECENT
ACCOUNTING PRONOUNCEMENTS





In
September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“FAS
157”). FAS 157 defines fair value, establishes a framework for measuring fair
value and expands disclosure of fair value measurements. FAS 157 applies under
other accounting pronouncements that require or permit fair value measurements
and accordingly, does not require any new fair value measurements. FAS 157 was
initially effective for fiscal years beginning after November 15, 2007, and
interim periods within those fiscal years. In February 2008, the FASB issued
FASB Staff Position (FSP) FAS 157-2. This FSP permits a delay in the effective
date of FAS 157 to fiscal years beginning after November 15, 2008, for
nonfinancial assets and nonfinancial liabilities, except for items that are
recognized or disclosed at fair value in the financial statements on a recurring
basis (at least annually). In October 2008, the FASB issued FSP FAS 157-3,
“Determining the Fair Value of a Financial Asset when the Market for That Asset
is Not Active,” which clarifies the application of FAS 157 for financial assets
in a market that is not active.





9


In
February 2007, the FASB issued SFAS No. 159,The Fair Value Option for Financial
Assets and Financial Liabilities(“SFAS 159”). SFAS 159 permits companies
to make a one-time election to carry eligible types of financial assets and
liabilities at fair value, even if fair value measurement is not required under
generally accepted accounting principles in the United States (“U.S. GAAP”).
SFAS 159 has been adopted by the Company beginning in the first quarter of
fiscal 2009, and the Company has determined SFAS 159 has no material impact on
its consolidated financial statements.





In
December 2007, the FASB issued SFAS No. 141 (Revised 2007),Business Combinations (“SFAS
141R”). SFAS 141R establishes principles and requirements for how the acquiror
of a business recognizes and measures in its financial statements the
identifiable assets acquired, the liabilities assumed, and any non-controlling
interest in the acquiree. SFAS 141R also provides guidance for recognizing and
measuring the goodwill acquired in the business combination and determines what
information to disclose to enable users of the financial statements to evaluate
the nature and financial effects of the business combination. This statement
applies prospectively to business combinations for which the acquisition date is
on or after the beginning of the first annual reporting period beginning
December 15, 2008, which is October 1, 2009 for the Company. The
Company is currently evaluating the impact of the provisions of SFAS 141R on its
consolidated financial statements.





In
December 2008, the FASB issued FSP FAS 132R-1 “Employers’ Disclosures about
Postretirement Benefit Plan Assets”, which amends FASB Statement 132 (revised
2003), Employers’ Disclosures
about Pensions and Other Postretirement Benefits. Beginning in fiscal
years ending after December 15, 2009, employers will be required to provide more
transparency about the assets in their postretirement benefit plans, including
defined benefit pension plans. FSP FAS 132R-1 was issued in response to users’
concerns that employers’ financial statements do not provide adequate
transparency about the types of assets and associated risks in employers’
postretirement plans. In current disclosures of the major categories of plan
assets, many employers provide information about only four asset categories:
equity, debt, real estate, and other investments. For many employers, the “other
investment” category has increased to include a significant percentage of plan
assets. Users indicate that such disclosure is not sufficiently specific to
permit evaluation of the nature and risks of assets held as
investments.





FSP FAS
132R-1’s amended disclosure requirements about plan assets are principles-based.
The objectives of the disclosures are to provide users with an understanding of
the following:


-
            How
      investment decisions are made, including factors necessary to
      understanding investment policies and
strategies


-
            The
      major categories of plan assets


-
            The
      inputs and valuation techniques used to measure the fair value of plan
      assets


-
            The
      effect of fair value measurements using significant unobservable inputs
      (Level 3 measurements in Statement 157 on changes in plan assets for the
      period)


-
            Significant
      concentrations of risk within plan
assets


Employers
are required to consider these overall disclosure objectives in providing the
detailed disclosures required by Statement 132R, as amended by FSP FAS
132R-1.





In
December 2007, the Financial Accounting Standards Board (FASB) issued SFAS No.
160, “Noncontrolling Interests in Consolidated Financial Statements – an
amendment of ARB No. 51”. This statement improves the relevance, comparability
and transparency of the financial information that a reporting entity provides
in its consolidated financial statements by establishing accounting and
reporting standards that require; the ownership interests in subsidiaries held
by parties other than the parent and the amount of consolidated net income
attributable to the parent and to the noncontrolling interest be clearly
identified and presented on the face of the consolidated statement of income,
changes in a parent’s ownership interest while the parent retains its
controlling financial interest in its subsidiary be accounted for consistently,
when a subsidiary is deconsolidated, any retained noncontrolling equity
investment in the former subsidiary be initially measured at fair value,
entities provide sufficient disclosures that clearly identify and distinguish
between the interests of the parent and the interests of the noncontrolling
owners. SFAS No. 160 affects those entities that have an outstanding
noncontrolling interest in one or more subsidiaries or that deconsolidate a
subsidiary. SFAS No. 160 is effective for fiscal years, and interim periods
within those fiscal years, beginning on or after December 15, 2008. Early
adoption is prohibited. The Company does not believe that SFAS No. 160 will have
an impact on its consolidated financial statements.








10


Item
2.





MANAGEMENT'S
DISCUSSION AND ANALYSIS OF


FINANCIAL
CONDITION AND RESULTS OF OPERATIONS





RESULTS
OF OPERATIONS





QUARTERS
ENDED DECEMBER 27, 2008 AND DECEMBER 29, 2007





Overview


The
Company experienced the severity of the global economic recession during the
quarter. Net income was $1.1 million, or $.17 per basic and diluted share, in
the second quarter of fiscal 2009 (fiscal 2009 quarter) compared to net income
of $3.4 million, or $.52 per basic and diluted share, in the second quarter of
fiscal 2008 (fiscal 2008 quarter). The quarter to quarter comparison was
negatively impacted by lower sales volume and the strengthening of the U.S.
dollar upon consolidation of international results. This represents a decrease
in net income of $2.3 million comprised of decreases in gross margin of $3.2
million and other income of $1.3 million. This was offset by a decrease of $.3
million in selling, general and administrative costs, and a decrease in income
tax expense of $2.0 million. These items are discussed in more detail
below.





Net
Sales


Net sales
for the fiscal 2009 quarter were $54.1 million, a decrease of 13% compared to
the fiscal 2008 quarter. North American sales decreased $3.9 million or 13%,
while international sales excluding North America decreased $4.4 million or 18%
(1% in local currency). The decrease in North American sales is related to the
widening of the recession to the manufacturing sector in the U.S., lower Evans
Rule sales to the construction sector, and decreased sales in Canada. It is
likely that the Company’s results will continue to be impacted by the current
global financial crises.





The
decrease in international sales is driven by the weakening of the Brazilian
Real, British Pound, and Australian Dollar against the U.S. Dollar, partially
offset by greater penetration into the Chinese markets.





Earnings before income
taxes


The
fiscal 2009 quarter's earnings before income taxes of $1.6 million represents a
decrease of earnings before income taxes of $4.3 million from the fiscal 2008
quarter’s earnings before income taxes of $5.9 million. Approximately $3.2
million of the decrease is at the gross margin line. The gross margin percentage
decreased from 31.3% in the fiscal 2008 quarter to 30.2% in the fiscal 2009
quarter. The decrease in gross margin is primarily a result of sales decreases
quarter over quarter, lower overhead absorption ($.2 million) at both domestic
and international operations due to this lower sales dollar volume.





Selling
and general expense is decreased $.3 million. However, as a percentage of sales,
selling and general expenses increased from 25.2% in the fiscal 2008 quarter to
28.6% in the fiscal 2009 quarter. The decrease in selling and general expense is
primarily a result of reduced accruals for incentives for the fiscal 2009
quarter ($.2 million), and a decrease in professional fees ($.3
million).





The
fiscal 2008 quarter includes in other income a one-time gain of $1.7 million
from the sale of the Company’s Glendale, Arizona facility on October 19, 2007
for proceeds of $2.4 million.





Income
Taxes


The
effective income tax rate is 30.9% in the fiscal 2009 quarter versus 42.4% for
the fiscal 2008 quarter. Both rates reflect a combined federal, state and
foreign rate adjusted for permanent book/tax differences, the most significant
of which is the effect of the deduction allowable for the Brazilian dividend
paid in the second quarter of fiscal 2008 and the dividend paid in the third
quarter of fiscal 2007. The change in the effective rate percentage reflects the
increased impact of the Brazilian dividend due to lower forecasted taxable
income.





No
changes in valuation allowances relating to carryforwards for foreign NOL’s,
foreign tax credits and certain state NOL’s are anticipated for fiscal 2009 at
this time other than reversals relating to realization of NOL benefits for
certain foreign subsidiaries. The Company continues to believe it is more likely
than not that it will be able to utilize its tax operating loss carryforward
assets reflected on the balance sheet.





11


Net earnings per
share


As a
result of the above factors, the Company had basic and diluted net earnings of
$.17 per share in the fiscal 2009 quarter compared to a basic and diluted net
earnings per share of $.52 in the fiscal 2008 quarter, a decrease of $.35 per
share. Included in the $.52 per share for the fiscal 2008 quarter is $.15 per
share related to the sale of the Glendale facility.





SIX MONTH
PERIODS ENDED DECEMBER 27, 2008 AND DECEMBER 29, 2007





Overview


The
Company had net income of $3.8 million, or $.57 per basic and diluted share in
the first six months of fiscal 2009, compared to net income of $5.8 million, or
$.87 per basic and diluted share in the first six months of fiscal 2008. This
represents a decrease in net income of $2.0 million comprised of a decrease in
gross margin of $.6 million, an increase in selling, general and administrative
expenses of $2.5 million and a decrease in other income of $.5 million, offset
by a decrease in income tax expense of $1.7 million.





Net
Sales


Net sales
for the first six months of fiscal 2009 were $122.1 million, up $.1 million
compared to the first six months of fiscal 2008. Domestic sales were flat, while
international sales increased 8% (7% increase in local currency). North American
sales reflect flat U.S., Canadian and Mexican demand and lower Evans Rule sales
to Sears, partially offset by the acquisition of Kinemetrics.





The
increase in international sales is driven by strong sales in the Brazilian
domestic markets and continued expansion in global markets, including Eastern
Europe, the Middle East and China, offset by the weakening of the Brazilian Real
and British Pound against the U.S. Dollar.





Earnings before income
taxes


The
earnings before income taxes for the first six months of fiscal 2009 were $5.9
million compared to $9.5 million of earnings before income taxes for the first
six months of fiscal 2008.





This
represents a decrease of earnings before income taxes of $3.6 million.
Approximately $.6 million of this decrease is at the gross margin line. The
gross margin percentage decreased from 31.2% in the first six months of fiscal
2008 to 30.7% in the first six months of fiscal 2009. The decrease in gross
margin reflects lower sales from period to period and decreases of fixed
overhead absorption at domestic manufacturing locations as a result of less
capacity utilization, partially offset by the reduction of cost of sales at the
Evans Rule Division.





This
decrease in gross margin is accompanied by an increase of $2.5 million in
selling and general expense from the first six months of fiscal 2008 to the
first six months of fiscal 2009. The increase in selling and general expense is
primarily a result of accruals for incentives for the first six months of fiscal
2009 ($.2 million), higher commissions due to higher sales ($.1 million),
increases in computer maintenance and support ($.2 million) and additional
salaries related primarily to sales and marketing ($.7 million). Finally, higher
foreign exchange gains($1.0 million) during the first six months of fiscal 2009
and a one-time gain of $1.7 million from the sale of the Company’s Glendale,
Arizona facility during the first six months of fiscal 2008, primarily
contributed to a $.5 million decrease in other income.





Income
Taxes


The
effective income tax rate is a 36.0% provision for the first six months of
fiscal 2009 versus a 39.6% tax rate for the first six months of fiscal 2008.
Both rates reflect a combined federal, state and foreign worldwide rate adjusted
for permanent book/tax differences, the most significant of which is the
deduction allowable for the Brazilian dividend paid in December 2008 and
December 2007. The change in the effective rate percentage primarily reflects
the larger impact of the Brazilian dividend on lower anticipated earnings for
fiscal 2009. No changes in valuation allowances relating to carryforwards for
foreign NOL’s, foreign tax credit carryforwards and certain state NOL’s are
anticipated for fiscal 2009 at this time other than reversals relating to
realization of NOL benefits for certain foreign subsidiaries.





The
Company continues to believe it is more likely than not that it will be able to
utilize its tax operating loss carryforward of approximately $2.5 million
reflected on the balance sheet.





12


Net earnings per
share


As a
result of the above factors, the Company had basic and diluted net earnings per
share for the first six months of fiscal 2009 of $.57 per share compared to an
earnings per share of $.87 in the first six months of fiscal 2008, a decrease of
$.30 per share. Included in the $.87 per share for the first six months of
fiscal 2008 is $.15 per share related to the sale of the Glendale
facility.








LIQUIDITY
AND CAPITAL RESOURCES





13 Weeks Ended
                
                
                26 Weeks Ended12/27/08
                
                
                12/29/07
                
                
                12/27/08
                
                
                12/29/07Cash flows (in thousands)Cash (used in) provided by
      operations
                
                
                (1,863
                )
                
                
                9,774
                
                
                
                (3,357
                )
                
                
                14,537Cash provided from (used in)
      investing activities
                
                
                657
                
                
                
                (8,375
                )
                
                
                988
                
                
                
                (13,592
                )Cash provided from (used in)
      financing activities
                
                
                802
                
                
                
                (572
                )
                
                
                3,646
                
                
                
                (1,481
                )


The
fiscal 2009 quarter showed a use of cash in operations of $1.9 million compared
to $9.8 million of cash generated in operations in the fiscal 2008 quarter. This
decrease is driven by lower net earnings, an increase in inventories and a
decrease in current liabilities, partially offset by a reduction in
receivables.





For the
first six months of fiscal 2009, there was a $3.4 million use of cash in
operations compared to $14.5 million of cash generated in the same six month
period a year ago. This decrease is driven by lower net earnings, an increase in
inventories and an decrease in current liabilities, partially offset by a
reduction in receivables.





It is
anticipated that inventory levels will decrease over the next quarter as usage
exceeds incoming receipts.





The
Company’s investing activities for the fiscal 2009 quarter and six month period
consist of expenditures for plant and equipment, the use of short-term
investments and an earnout related to the purchase of Kinemetrics. Expenditures
for plant and equipment were relatively consistent when comparing the fiscal
2009 quarter to the same period a year ago. Such expenditures for the six month
period increased compared to the same period a year ago as replacement equipment
was required at certain plant locations. The proceeds from the sale of the
Glendale distribution facility is included in the fiscal 2008 quarter and the
first six months of fiscal 2008. The purchase of Kinemetrics was completed in
the first quarter of fiscal 2008 and is included in the prior six month period.
The amount included in the fiscal 2009 quarter and six month period represents
additional purchase price relating to an earn-out provision for the Kinemetrics
acquisition.





Cash
flows related to financing activities are primarily the takedown of the line of
credit, the payment of dividends and repayments of debt.





The
Company maintains a defined benefit pension plan which as of December 27, 2008
was overfunded for accounting and for funding purposes although the amount of
this overfunding has decreased dramatically since June 28, 2008 due to a
significant decline in the U.S. stock market. Due to the continued overfunded
status however, it is not anticipated that the Company will be required to
provide any funding for this plan during fiscal 2009.





Liquidity
and credit arrangements





The
Company believes it maintains sufficient liquidity and has the resources to fund
its operations in the near term. If the Company is unable to maintain consistent
profitability, additional steps will have to be taken in order to maintain
liquidity, including plant consolidations and work force and dividend reductions
(see Strategic and Other Activities below). In addition to its cash and
investments, the Company maintains a $10 million line of credit, of which, as of
December 27, 2008, $5.0 million was taken down for short-term working capital
purposes and $1.0 million is being utilized in the form of standby letters of
credit for insurance purposes. This line of credit will terminate as of April
28, 2009. It is expected to be renewed prior to that date. As certain
investments are redeemed at maturity in January and February 2009, it is
expected that the takedown related to the line of credit will be repaid. As of
December 27, 2008, the Company is in compliance with all debt covenants related
to its Reducing Revolver and its Line of Credit Agreement. Although the credit
line is not currently collateralized, it is possible, based on the Company's
financial performance, that in the future the Company will have to provide
collateral in order to maintain the credit agreement. The Company has a working
capital ratio of 4.4 to one as of December 27, 2008 and 4.8 to one as of June
28, 2008.


13


STRATEGIC
AND OTHER ACTIVITIES


Globalization
has had a profound impact on product offerings and buying behaviors of industry
and consumers in North America and around the world, forcing the Company to
adapt to this new, highly competitive business environment. The Company
continuously evaluates most all aspects of its business, aiming for new
world-class ideas to set itself apart from its competition.





The
strategic focus has shifted from manufacturing locations to global brand
building through product portfolio and distribution channel management while
reducing costs through lean manufacturing, plant consolidations, global sourcing
and improved logistics.





The
execution of these strategic initiatives has expanded the Company’s
manufacturing and distribution in developing economies which has increased its
international sales revenues to approximately 45% of its consolidated
sales.





On
September 21, 2006, the Company sold its Alum Bank, PA level manufacturing plant
and relocated the manufacturing to the Dominican Republic, where production
began in fiscal 2005. The tape measure production of the Evans Rule Division
facilities in Puerto Rico and Charleston, SC has been transferred to the
Dominican Republic. The Company vacated and plans to sell its Evans Rule
facility in North Charleston, SC. The Company’s goal is to achieve labor savings
and maintain margins while satisfying the demands of its customers for lower
prices. The Company has closed three warehouses, the most recent being the
Glendale, AZ facility, which was sold in fiscal 2008. Also during fiscal 2006,
the Company began a lean manufacturing initiative in its Athol, MA facility,
which has reduced costs over time. This initiative has continued through fiscal
2007 and 2008 and has continued in fiscal 2009.





The
Tru-Stone acquisition in April 2006 represented a strategic acquisition for the
Company in that it provides an enhancement of the Company’s granite surface
plate capabilities. Profit margins for the Company’s standard plate business
have improved as the Company’s existing granite surface plate facility was
consolidated into Tru-Stone, where average gross margins have been higher. Along
the same line, the Kinemetric Engineering acquisition in July 2007 represented
another strategic acquisition in the field of precision video-based metrology
which, when combined with the Company’s existing optical projection line, has
provided a very comprehensive product offering.





If the
Company continues to be impacted by the worldwide recession, there will likely
be layoffs, shortened hours per week and possible temporary idling of
manufacturing plants to reduce costs in the short-term.





INFLATION





The
Company has experienced modest inflation relative to its material cost, much of
which cannot be passed on to the customer through increased prices.





OFF-BALANCE
SHEET ARRANGEMENTS





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





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 note to the Company's Consolidated Financial Statements
included in the Form 10-K for the year ended June 28, 2008 describes the
significant accounting policies and methods used in the preparation of the
consolidated financial statements.





Judgments,
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; and normal expense accruals for such things as workers
compensation and employee medical expenses.





14


Future
events and their effects cannot be determined with absolute certainty.
Therefore, the determination of estimates requires the exercise of judgment.
Actual results may differ from those estimates, and such differences may be
material to the Company’s Consolidated Financial Statements. The following
sections describe the Company’s critical accounting policies.





Sales of
merchandise and freight billed to customers are recognized when title passes and
all substantial risks of ownership change, which occurs either upon shipment or
upon delivery based upon contractual terms. Sales are net of provision for cash
discounts, returns, customer discounts (such as volume or trade discounts),
cooperative advertising and other sales related discounts.





The
allowance for doubtful accounts and sales returns of $1.0 million and $1.2
million as of December 27, 2008 and June 28, 2008, respectively, is based on the
Company’s assessment of the collectability of specific customer accounts, the
aging of the Company’s accounts receivable and trends in product returns. While
the Company believes that the allowance for doubtful accounts and sales returns
is adequate, if there is a deterioration of a major customer’s credit
worthiness, actual defaults are higher than the Company’s previous experience,
or actual future returns do not reflect historical trends, the estimates of the
recoverability of the amounts due the Company, the Company 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.





The
Company generally values property, plant and equipment (PP&E) at historical
cost less accumulated depreciation. Impairment losses are recorded when
indicators of impairment, such as plant closures, are present and the
undiscounted cash flows estimated to be generated by those assets are less than
the carrying amount. The Company continually reviews for such impairment and
believes that PP&E is being carried at its appropriate value.





The
Company assesses the fair value of its goodwill, generally based upon a
discounted cash flow methodology as of fiscal year end or when other
circumstances would indicate potential impairment. The discounted cash flows are
estimated utilizing various assumptions regarding future revenue and expenses,
working capital, terminal value, and market discount rates. If the carrying
amount of the goodwill is greater than the fair value, goodwill impairment may
be present. An impairment charge is recognized to the extent the recorded
goodwill exceeds the implied fair value of goodwill.





The
Company has determined that a triggering event has occurred during the second
quarter of fiscal 2009 relating to the $5.3 million of goodwill on acquisition
of Tru-Stone. This event is represented by a downturn in quarterly sales and the
outlook for their markets served. In accordance with FAS 142, Goodwill and Other
Intangibles, the Company performed the step one evaluation on the carrying value
and tangible book value of Tru-Stone, using a discounted cash flow methodology,
which resulted in an implied fair value greater than the carrying value.
Continued unfavorable economic conditions may continue to have an adverse impact
on the business and potentially result in goodwill impairment in the future.
Further, the Company’s stock price has been trading below its book value and
tangible book value for over four consecutive quarters. The Company attributes
this low stock price to both the overall market conditions and company specific
factors, including low trading volume of the Company’s stock. On this basis, the
Company did not consider it necessary to perform a step one analysis on the
other remaining reporting unit with goodwill.





Accounting
for income taxes requires estimates of 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. Tax
reserves are also established to cover risks associated with activities or
transactions that may be at risk for additional taxes. Should any significant
changes in the tax law or our estimate of the necessary valuation allowances or
reserves occur, we would record the impact of the change, which could have a
material effect on our financial position or results of operations.




15


Pension
and postretirement medical 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.





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 27, 2008, the
Company was party to an interest rate swap agreement, which is more fully
described in the Company’s fiscal 2008 Annual Report on Form 10-K. The Company
does engage in limited hedging activities to minimize the impact of foreign
currency fluctuations. Net foreign monetary assets are approximately $12.6
million.





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 $8.7 million and debt of $7.2 million at
December 27, 2008) or the cash flows or future earnings associated with those
financial instruments. A 10% change in interest rates would have an
insignificant impact the fair value of the Company's fixed rate investments of
approximately $6.9 million.








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 December 27,
2008, 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 that
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. There have been no changes
in internal control over financial reporting that have materially affected, or
are reasonably likely to materially affect, the Company's internal control over
financial reporting.








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 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 the Economy:
The Company’s results of operations are materially affected by the conditions in
the global economy. The current global financial crisis, which began last year,
has deteriorated further and has caused extreme volatility and disruptions in
the capital and credit markets. U.S. and foreign economies have experienced and
continue to experience significant declines in employment, household wealth and
lending. Businesses, including the Company and its customers, have faced and may
continue to face weakened demand for their products and services, difficulty
obtaining access to financing, increased funding costs, and barriers to
expanding operations. Economic and market conditions may worsen and could
negatively impact the Company’s results of operations.





16


Risks Related to
Reorganization: The Company continues to evaluate plans to consolidate
and reorganize some of its manufacturing and distribution operations. There can
be no assurance that the Company will be successful in these efforts or that any
consolidation or reorganization will result in revenue increases or cost savings
to the Company. The implementation of these reorganization measures may disrupt
the Company’s manufacturing and distribution activities, could adversely affect
operations, and could result in asset impairment charges and other costs that
will be recognized if and when reorganization or restructuring plans are
implemented or obligations are incurred. This has occurred with the Company’s
move to the Dominican Republic from South Carolina. Indeed, the relocation,
restructuring and closure of our Evans Rule Division’s Charleston, South
Carolina facility and start up of that Division’s Dominican Republic operations
was a factor contributing to the Company’s fiscal 2006 loss. If the Company is
unable to maintain consistent profitability, additional steps will have to be
taken, including further plant consolidations and workforce and dividend
reductions.





Risks Related toTechnology: 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 toForeignOperations: Approximately 50% of the Company’s sales and 40% of 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 may be difficult to
forecast.





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





Risks RelatedtoCompetition: The
Company’s business is subject to direct and indirect competition from both
domestic and foreign firms. In particular, low cost foreign sources have created
severe competitive pricing pressures. Under certain circumstances, including
significant changes in U.S. and foreign currency relationships, such pricing
pressures tend to reduce unit sales and/or adversely affect the Company’s
margins.





Risks Related to Customer
Concentration: Sears sales and unit volume have decreased significantly
during fiscal 2007 and 2008 and the first half of fiscal 2009 has been flat with
prior periods. This situation is problematic and if the Sears Craftsman brand we
support is no longer viable, this would have a negative effect on the Company’s
financial performance. The further loss or reduction in orders by Sears or any
of the Company’s remaining large customers, including reductions due to market,
economic or competitive conditions could adversely affect business and results
of operations. Moreover, the Company’s major customers have placed, and may
continue to place pressure on the Company to reduce its prices. This pricing
pressure may affect the Company’s margins and revenues and could adversely
affect business and results of operations.





Risks Related toInsuranceCoverage: The Company carries
liability, property damage, workers' compensation, medical, and other insurance
coverages that management considers adequate for the protection of its assets
and operations. There can be no assurance, however, that the coverage
limits of such policies will be adequate to cover all claims and losses. Such
uncovered claims and losses could have a material adverse effect on the Company.
The Company self-insures for dental benefits and retains risk in the form
of deductibles and sublimits for most coverages noted above. Depending on the
risk, deductibles can be as high as 5% of the loss or $.5 million.





Risks Related to RawMaterialand Energy Costs: Steel
is the principal raw material used in the manufacture of the Company’s products.
The price of steel has historically fluctuated on a cyclical basis and has often
depended on a variety of factors over which the Company has no control. During
fiscal 2008, the cost of steel rose


17


approximately
7%. The cost of producing the Company's products is also sensitive to the price
of energy for which the Company has recently experienced increases. The selling
prices of the Company’s products have not always increased in response to raw
material, energy or other cost increases, and the Company is unable to determine
to what extent, if any, it will be able to pass future cost increases through to
its customers. Indeed, the Company has recently experienced difficulty in
passing along the increases in steel and energy costs to its major customers.
The Company's inability to pass increased costs through to its customers could
materially and adversely affect its financial condition or results of
operations.





Risks Related to Stock Market
Performance: Although the Company's domestic defined benefit pension plan
is overfunded, another significant drop in the stock market, even if short in
duration, could cause the plan to become temporarily underfunded and require the
temporary reclassification of prepaid pension cost on the balance sheet from an
asset to a contra equity account, thus reducing stockholders' equity and book
value per share and additional funding of the plans may also be necessary. There
would be a similar risk to the Company’s UK plan, which was underfunded during
fiscal 2007 and 2008.





Risks Related to Acquisitions:Acquisitions, such as our acquisition of Tru-Stone in fiscal 2006 and
Kinemetric Engineering in fiscal 2008, involve special risks, including, the
potential assumption of unanticipated liabilities and contingencies, difficulty
in assimilating the operations and personnel of the acquired businesses,
disruption of the Company’s existing business, dissipation of the Company’s
limited management resources, and impairment of relationships with employees and
customers of the acquired business as a result of changes in ownership and
management. While the Company believes that strategic acquisitions can improve
its competitiveness and profitability, the failure to successfully integrate and
realize the expected benefits of such acquisitions could have an adverse effect
on the Company’s business, financial condition and operating
results.





Risks Related to Investor
Expectations.The Company's operating results have fluctuated from
quarter to quarter in the past, and the Company expects that they will continue
to do so in the future. The Company's earnings may not continue to grow at rates
similar to the growth rates achieved in recent years and may fall short of
either a prior quarter or investors’ expectations. If the Company fails to meet
the expectations of securities analysts or investors, the Company's share price
may decline.





Risks Related to Information Systems.The efficient operation of the Company's business is dependent on its
information systems, including its ability to operate them effectively and to
successfully implement new technologies, systems, controls and adequate disaster
recovery systems. In addition, the Company must protect the confidentiality of
data relating to its business, employees, customers and other third parties. The
failure of the Company's information systems to perform as designed or the
Company’s failure to implement and operate such systems effectively could
disrupt the Company's business or subject it to liability and thereby harm its
profitability.





Risks Related to Litigation and
Changes in Laws, Regulations and Accounting Rules.Various aspects of the
Company's operations are subject to federal, state, local or foreign laws, rules
and regulations, any of which may change from time to time. Generally accepted
accounting principles may change from time to time, as well. In addition, the
Company is regularly involved in various litigation matters that arise in the
ordinary course of business. Litigation, regulatory developments and changes in
accounting rules and principles could adversely affect the Company's business
operations and financial performance.








Item
2.                      Unregistered Sales of Equity
Securities and Use of Proceeds





A summary
of the Company's repurchases of shares of its common stock for the three months
ended December 27, 2008 is as follows:


ISSUER
      PURCHASES OF EQUITY SECURITIESPeriod
            Shares
      Purchased
            Average
      Price
            Shares
      Purchased Under Announced Programs
            Shares
      yet to be Purchased Under Announced Programs9/27/08-11/1/08
            15,000
            $12.55
            15,000
            none11/2/08-11/29/08
            none
            
            
            none11/30/08-12/27/08
            none
            
            
            none








18


Item
4.                      Submission of Matters to a
Vote of Security Holders





(a)
            The
      annual meeting of shareholders was held on October 8,
  2008.


(c)        The
following directors were elected at the annual meeting:


Votes
              For
            
            Votes
              Withheld
            
            Abstentions
              and
      Broker
              Non-votesClass
      A shares voting as separate class:Ralph G. Lawrence
            4,912,558
            
            297,084
            
            N/AClass
      A and B shares voting together:Stephen F. Walsh
            12,043,428
            
            272,364
            
            N/ASalvador de Camargo,
      Jr.
            12,123,545
            
            352,484
            
            N/A








Item
6.                      Exhibits





See the
exhibit index following the signature page to this quarterly
report.








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
      5, 2009
            
            S/R.
      J. HylekR.
      J. Hylek (Treasurer and Chief Financial Officer)Date
            February
      5, 2009
            
            S/R.
      J. SimkevichR.J.
      Simkevich (Corporate Controller)





19


EXHIBIT
INDEX








Exhibit
Number                                Description





10.1
            Change
      in Control Agreement, dated as of January 16, 2009, between the Company
      and Douglas A. Starrett.





10.2
            Form
      of Change in Control Agreements, dated as of January 16, 2009, executed
      separately by the Company and each of Randall J. Hylek and Stephen F.
      Walsh.





10.3
            Form
      of Non-Compete Agreements, dated as of January 16, 2009, executed
      separately by the Company and each of Douglas A Starrett, Randall J. Hylek
      and Stephen F. Walsh.





31.a
            Certification
      of Chief Executive Officer pursuant to Rules 13a-15(e)/15(d)-15(e) and
      13a-15(f)/15(d)-15(f).





31.b
            Certification
      of Chief Financial Officer pursuant to Rules 13a-15(e)/15(d)-15(e) and
      13a-15(f)/15(d)-15(f).





32
            Certification
      of Chief Executive Officer and Chief Financial Officer pursuant to Rule
      13a-14(b) and Section 906 of the Sarbanes-Oxley Act of 2002 (subsections
      (a) and (b) of Section 1350, Chapter 63 of Title 18, United States
      Code).


20