The balance sheet as of June 30, 2015, which has been derived from audited financial statements, and the unaudited interim financial statements as of and for the three and nine months ended March 31, 2016 and March 31, 2015,2017 have been prepared by The L.S. Starrett Company (the “Company”) in accordance with accounting principles generally accepted in the United States of America for interim financial reporting.  Accordingly, they do not include all of the information and notes required by generally accepted accounting principles for complete financial statements.  These unaudited financial statements, which, in the opinion of management, reflect all adjustments (including normal recurring adjustments) necessary for a fair presentation, should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended June 30, 2015.2016.  Operating results are not necessarily indicative of the results that may be expected for any future interim period or for the entire fiscal year.

The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America requires management to make judgments, assumptions and estimates that affect amounts reported in the consolidated financial statements and accompanying notes.  Note 2 to the Company’s Consolidated Financial Statements included in the Annual Report on Form 10-K for the year ended June 30, 20152016 describes the significant accounting policies and methods used in the preparation of the consolidated financial statements.

In May 2014, the FASB issued a new standard related to the “Revenue from Contracts with Customers” which amends the existing accounting standards for revenue recognition. The standard requires entities to recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration the entity expects to be entitled to in exchange for those goods or services. This standard is applicable for fiscal years beginning after December 15, 2017 and for interim periods within those years. Earlier application will be permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. The Company expects to adopt this standard onfor its fiscal year beginning July 1, 2018. The Company is currently evaluating the impact of the adoption of this standard on its consolidated financial statements.

Accounting Standards Update (ASU)In July 2015, the FASB issued ASU No. 2015-11, "Inventory -(Topic 330): Simplifying the Measurement of Inventory" requires companiesInventory." Previous to measure most inventory at the lowerissuance of cost or net realizable value, thereby simplifying the current guidance under which a company mustthis ASU, ASC 330 required that an entity measure inventory at the lower of cost or market. This Update eliminates the need to determine replacement cost and evaluate whether said cost is within a quantitative range. This Update also further aligns U.S. GAAP and international accounting standards. For public companies, the guidance in ASU 2015-11 specifies that “market” is defined as “net realizable value,” or the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. This ASU is effective for annual periods beginning after December 15, 2016,fiscal years, and for interim periods thereafter. Early adoption is permitted. Management does not expect ASU 2015-11 to have a material impact on the Company's financial statements and disclosures.

Accounting Standards Update 2015-17, “Balance Sheet Classification of Deferred Taxes” requires that companies classify all deferred taxes as non-current assets or liabilities. This change is applicable forwithin those fiscal years, beginning after December 15, 2016 and for interim periods within those years. There2016. Application is no impact to earningsbe applied prospectively with earlier application permitted as a result of this change; however, current assets will be reduced by the amount of the current deferred tax asset as that amount will be included with the long term deferred tax asset uponbeginning of an interim or annual reporting period. The adoption of this ASU.ASU No. 2015-11 will not have a material impact on our consolidated financial statements.

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

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

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

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

On September 5, 2012, the Board of Directors adopted The L.S. Starrett Company 2012 Long Term Incentive Plan (the “2012 Stock Plan”). The 2012 stock plan was approved by shareholders on October 17, 2012. The 2012 Stock Plan permits the granting of the following types of awards to officers, other employees and non-employee directors: stock options; restricted stock awards; unrestricted stock awards; stock appreciation rights; stock units including restricted stock units; performance awards; cash-based awards; and awards other than previously described that are convertible or otherwise based on stock. The 2012 Stock Plan provides for the issuance of up to 500,000 shares of common stock.      

Options granted vest in periods ranging from one year to three years and expire ten years after the grant date. Restricted stock units (“RSU”) granted generally vest from one year to three years. Vested restricted stock units will be settled in shares of common stock. As of March 31, 2016,2017, there were 20,000 stock options and 73,367105,634 restricted stock units outstanding. In addition, there were 391,600346,600 shares available for grant under the 2012 Stock Plan as of March 31, 2016.2017.

For stock option grants the fair value of each grant is estimated at the date of grant using the Binomial Options pricing model. The Binomial Options pricing model utilizes assumptions related to stock volatility, the risk-free interest rate, the dividend yield, and employee exercise behavior. Expected volatilities utilized in the model are based on the historic volatility of the Company’s stock price. The risk free interest rate is derived from the U.S. Treasury Yield curve in effect at the time of the grant. The expected life is determined using the average of the vesting period and contractual term of the options (Simplified Method).

No stock options were granted during the nine months ended March 31, 20162017 and 2015.2016.

The weighted average contractual term for stock options outstanding as ofMarch 31, 20162017 was 6.755.75 years.  The aggregate intrinsic value of stock options outstanding as ofMarch 31, 20162017 was $0.1 million.negligible. Stock options exercisable as ofMarch 31, 20162017 were 20,000.20,000.In recognizing stock compensation expense for the 2012 Stock Incentive Plan management has estimated that there will be no forfeitures of options.

The Company accounts for stock options and RSU awards by recognizing the expense of the grant date fair value ratably over vesting periods generally ranging from one year to three years. The related expense is included in selling, general and administrative expenses. 

There were 40,20045,000 RSU awards with a fair value of $15.11$10.86 per RSU granted during the nine months ended March 31, 2016.2017. There were 9,06712,733 RSUs settled during the nine months ended March 31, 2016.2017.  The aggregate intrinsic value of RSU awards outstanding as of March 31, 20162017 was $0.8$1.1 million. As of March 31, 20162017 all vested awards had been issued and settled.

On February 5, 2013, the Board of Directors adopted The L.S. Starrett Company 2013 Employee Stock Ownership Plan (the “2013 ESOP”). The purpose of the plan is to supplement existing Company programs through an employer funded individual account plan dedicated to investment in common stock of the Company, thereby encouraging increased ownership of the Company while providing an additional source of retirement income.  The plan is intended as an employee stock ownership plan within the meaning of Section 4975 (e) (7) of the Internal Revenue Code of 1986, as amended. U.S. employees who have completed a year of service are eligible to participate.

Compensation expense related to all stock based plans for the nine month periods ended March 31, 20162017 and 20152016 was $0.3 million and $0.2$0.3 million, respectively.  As of March 31, 2016,2017, there was $1.1$1.3 million of total unrecognized compensation costs related to outstanding stock-based compensation arrangements. Of this cost $0.7$1.1 million relates to performance based RSU grants that are not expected to be awarded. The remaining $0.4$0.2 million is expected to be recognized over a weighted average period of 2.01.4 years.

Inventories consist of the following (in thousands):

LIFO inventories were $10.7$7.2 million and $14.6$10.5 million at March 31, 20162017 and June 30, 2015,2016, respectively, such amounts being approximately $28.3$27.3 million and $28.0$28.8 million, respectively, less than if determined on a FIFO basis.  The use of LIFO, as compared to FIFO, resulted in a $0.3$1.5 million increasedecrease in cost of sales for the nine months ended March 31, 20162017 compared to a $0.2$0.3 million increase for the nine months ended March 31, 2015.2016.

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

The Company’s acquisition of Bytewise in 2011 gave rise to a goodwill asset balance.of $3,034. The Company performed a qualitative analysis in accordance with ASU 2011-08 for its October 1, 20152016 annual assessment of goodwill (commonly referred to as “Step Zero”). From a qualitative perspective, in evaluating whether it is more likely than not that the fair value of the reporting unit exceeds its respective carrying amount, relevant events and circumstances were taken into account, with greater weight assigned to events and circumstances that most affect the fair value or the carrying amounts of its assets. Items that were considered included, but were not limited to, the following: macroeconomic conditions, industry and market conditions, cost factors, overall financial performance and changes in management or key personnel. After assessing these and other factors the Company determined that it was more likely than not that the fair value of the reporting unit exceeded its carrying amount as of October 1, 2015.2016.

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

Amortizable intangible assets are being amortized on a straight-line basis over the period of expected economic benefit.

The estimated useful lives of the intangible assets subject to amortization are 14 years for trademarks and trade names, 8 years for non-compete agreements, 10 years for completed technology,  8 years for customer relationships and 5 years for software development.

The estimated aggregate amortization expense for the remainder of fiscal 20162017 and for each of the next five years and thereafter, is as follows (in thousands):

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

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

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

The Company’s pension plans use fair value as the market-related value of plan assets and recognize net actuarial gains or losses in excess of ten percent (10%) of the greater of the market-related value of plan assets or of the plans’ projected benefit obligation in net periodic (benefit) cost as of the plan measurement date, which is the same as the fiscal year end of the Company.date. Net actuarial gains or losses that are less than 10% of the thresholds noted above are accounted for as part of the accumulated other comprehensive loss.

Effective March 31, 2015, the Company terminated the eligibility of employees ages 55 - 64 years old to enter into the Post-retirement Medical Plan.

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

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

On November 22, 2011, in conjunction with the Bytewise acquisition, the Company entered into a $15.5 million term loan (the “Term Loan”) under the then existing Loan and Security Agreement.  The Term Loan is a ten year loan bearing a fixed interest rate of 4.5% and is payable in fixed monthly payments of principal and interest of $160.6 thousand.  The Term Loan had a balance of $8.1 million at March 31, 2017.

The material financial covenants of the amended Loan and Security Agreement are: 1) funded debt to EBITDA, excluding non-cash and retirement benefit expenses (“maximum leverage”), not to exceed 2.25 to 1.0 2)1.2) annual capital expenditures not to exceed $15.0 million, 3) maintain a Debt Service Coverage Rate of a minimum of 1.25 to 1.01 and 4) maintain consolidated cash plus liquid investments of not less than $10.0 million at any time.  The Company was in compliance with all debt covenants as of March 31, 2016.2017.

On November 22, 2011, in conjunction with the Bytewise acquisition, the Company entered into a $15.5 million term loan (the “Term Loan”) under the existing Loan and Security Agreement with TD Bank N.A.  The Term Loan is a ten year loan bearing a fixed interest rate of 4.5% and is payable in fixed monthly payments of principal and interest of $160,640.  The Term Loan, which had a balance of $9.6 million at March 31, 2016, is subject to the same financial covenants contained in the Loan and Security Agreement.

The effective interest rate on the Line of Credit under the Loan and Security Agreement for the nine months ended March 31, 2016 and 2015 was 2.2% and 2.0%, respectively.

The Company is subject to U.S. federal income tax and various state, local and foreign income taxes in numerous jurisdictions.  The Company’s domestic and foreign tax liabilities are subject to the allocation of revenues and expenses in different jurisdictions and the timing of recognizing revenues and expenses.  Additionally, the amount of income taxes paid is subject to the Company’s interpretation of applicable tax laws in the jurisdictions in which it files.

The Company provides for income taxes on an interim basis based on an estimate of the effective tax rate for the year. This estimate is reassessed on a quarterly basis. Discrete tax items are accounted for in the quarterly period in which they occur.

The effective tax rate for the third quarter of fiscal 20162017 was 50.2%36.8% and the effective tax rate for the third quarter of fiscal 20152016, it was 30.5%50.2%. For the first nine months of fiscal 2016,2017, the effective tax rate was 67.2%40.8% and for the first nine months of fiscal 2015,2016, it was 39.3%. The67.2%.The tax rate in fiscal 2017 is higher than the U.S. statutory rate since the benefit of earnings in foreign jurisdictions with lower effective tax rates was more than offset by discrete tax charges including the impact of a tax rate change in the U.K. applied to deferred tax assets which increased tax expense by $298,000 in the first quarter. In fiscal 2016, the tax rate is higher than the U.S. statutory rate for the year to date results in partprimarily due to losses in some foreign jurisdictions for which no tax benefit is recognized. In the third quarter of fiscal 2016, thererecognized which was a benefit of $140,000 to reflect the reversal of the valuation allowance to recognize the benefit of foreign subsidiary tax loss carryforwards. In the first nine months of fiscal 2016, there were additional discrete reductions of tax expense of $216,000 for tax return to provision adjustments. In addition, there were discrete increases of $70,000 for interest on audit exposures. In the first nine months of fiscal 2015, there werepartially offset by discrete reductions to tax expense primarily as a result of $66,000 related to use of tax loss carryforwards, $42,000 for reduction in audit exposure due to the expiration of the statute of limitations and $332,000 related to return to provision adjustments; the last item was fully booked in the third quarter which is the primary reason for the tax rate in this quarter being lower than the U.S. statutory rate.adjustments of $216,000.

U.S. Federal tax returns through fiscal 20122013 are generally no longer subject to review by tax authorities; however, tax loss carryforwards from years before fiscal 20132014 are still subject to adjustment. As of March 31, 2016,2017, the Company has substantially resolved all open income tax audits and there were no other local or federal income tax audits in progress. In international jurisdictions including Australia, Brazil, Canada, China, Germany, Mexico, New Zealand, Singapore and the UK, which comprise a significant portion of the Company’s operations, the years that may be examined vary by country. The Company’s most significant foreign subsidiary in Brazil is subject to audit for the calendar years 20102011 – 2015. The Company has identified no new uncertain tax positions during the nine month period ended March 31, 2016 for which it is currently likely that the total amount of unrecognized tax benefits will significantly increase or decrease within2016. During the next twelve months.months, it is possible that there will be a reduction in the Company’s long term tax obligations for prior year exposures of $931,000.

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

No valuation allowance has been recorded for the Company’s domestic federal net operating loss (NOL) carry forwards.deferred tax assets related to temporary differences in items included in taxable income. The Company continues to believe that due to forecasted future taxable income and certain tax planning strategies available, it is more likely than not that it will be able to utilize the tax benefit provided by those differences. In the U.S. federal NOL carryforwards., there is a valuation allowance against foreign tax credits to the extent they are limited. In certain other countries where Companycompany operations are in a loss position, the deferred tax assets for tax loss carryforwards and other temporary differences are fully offset by a valuation allowance.

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

Note 11. Segment Information

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

ITEM 2.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

RESULTS OF OPERATIONS

Three months EndedMarch 31, 20162017 andMarch 31, 20152016

Overview

The Company operates as a global business and is impacted by worldwide economic, political and industrial shifts. A slowdowncontinued to experience moderate declines in the manufacturing sector coupled with a retrenchmentdomestic market and improvement in the oil patch negatively impactedInternational sector during the quarter posting flat revenue inand lower profits. The North America, while the international markets continue to be stagnant in Europe, recessionary in Latin America andAmerican market encountered a softening in China. In addition, the strong U. S.industrial distribution market and a modest recovery in the high-end metrology sector while a weakening US dollar has negatively impacted demand for domestic products and reduced foreign subsidiary’s contribution to consolidated sales.resulted in higher International revenue, especially in Brazil.

Net sales decreased $5.8increased $0.4 million or 10%1% from $56.1 million in fiscal 2015 to $50.3 million in fiscal 2016 to $50.7 million in fiscal 2017 with North America declining $0.7 million and International accounting for $4.3 million or 75% of the shortfall.growing $1.1 million. Operating income declined $2.2$1.8 million from a profit of $0.9 million in fiscal 2016 to a loss of $0.9 million in fiscal 2017 due to $4.0a $0.3 million erosiondecline in gross margin morecoupled with a $1.5 million increase in operating expenses.

Net Sales

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

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

Gross Margin

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

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

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

Selling, General and Administrative Expenses

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

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

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

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

Other Income(Expense)

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

Income Taxes

The effective tax rates for the third quarter of fiscal 2017 and 2016 were 37% and 50%, respectively. The quarterly tax rate is lower than offset a $1.8normalized combined federal and state rate of approximately 40% due to profits in some foreign subsidiaries with lower effective tax rates. The tax rate includes negligible discrete items in fiscal 2017 and a discrete tax benefit of $0.1 million decrease in fiscal 2016.

Net Income

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

Nine Months EndedMarch 31, 2017 andMarch 31, 2016

Overview

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

Net Sales

North American sales decreased $1.5$6.9 million or 4%7% from $34.0 million in fiscal 2015 to $32.5$99.2 million in fiscal 2016 as a weakeningto $92.3 million in manufacturing activity resultedfiscal 2017 due to lower metrology tool sales through the industrial distribution channel and decreases in reduced demand for precision hand tool and saw products more than offsetting continued gains in capital equipmenthigh-end metrology products.

sales to end-user customers.

International sales declined $4.3increased $4.6 million or 19%8% from $22.1 million in fiscal 2015 to $17.8$55.8 million in fiscal 2016 as a recession in Brazil; an economic slowdown in China; the unfavorable pricing impact of a strong dollar; and $3.3to $60.4 million in currency losses all contributedfiscal 2017 with strong organic growth in Europe and a strengthening Brazilian Real relative to difficult trading overseas.the US dollar.

Gross Margin

Gross margin decreased $4.0$1.3 million or 21% from 33%3% and also declined as a % of sales in fiscal 2015 to 29% of salesfrom 30.0% in fiscal 2016 with the profit impact of lower revenues and margin decline representing $1.9 million and $2.1 million, respectively.to 29.6% in fiscal 2017.

North American gross margins decreased $2.7 million from $12.1$3.9 million or 36% of sales13% from $29.4 million in fiscal 20152016 compared to $9.4$25.5 million or 29% of sales in fiscal 2016. The reduced gross margins were the result2016 due to lower precision tool sales as well as lower sales of a revenue decline in precision hand tool and saw product lines without a comparable reduction in overhead costs more than offsetting gains in thehigher margin capital equipment gross margins.products.

International gross margins declined $1.3increased $2.6 million from $6.6 million in fiscal 2015 to $5.3 million in fiscal 2016 with volume declines and unfavorable exchange rates impacting Brazil performance by $0.4margin improvement representing $1.4 and $0.8$1.2 million, respectively

Selling, General and Administrative Expenses

Selling, general and administrative expenses decreased $1.8 million or 12% from 15.6 million in fiscal 2015 to $13.8 million in fiscal 2016.

North American expenses decreased $0.2 million from $8.4 million in fiscal 2015 to $8.2 million in fiscal 2016 as reduced salaries and incentive compensation more than offset higher employee benefits, professional fees and marketing expenses.

International expenses declinedrespectively. The stronger Brazilian Real contributed an incremental $1.6 million or 22% aswhile the strong dollarweakening British Pound resulted in a $0.8$0.9 million decrease in Brazilian expenses expressed in U. S. dollars asdecrement to the Brazilian currency declined 24% in the quarter versus the prior year. In addition to currency differences, Brazil reduced salaries, employee benefits, and professional fees $0.7 million in constant exchanges rates.

Other Income

Other income declined $0.1 million due to reduced interest income as foreign exchange and interest expense remained level in both periods

Income Taxes

The effective tax rate for the third quarter of fiscal 2016 and 2015 was 50% and 31%, respectively. The quarterly tax rate increased due to losses in some foreign subsidiaries for which no tax benefit is recognized. The tax rate was reduced by discrete benefits of $0.1 million in fiscal 2016 and $0.3 million in fiscal 2015.

Net Income

The Company recorded net income of $0.6 million or $0.08 per diluted share in the third quarter of fiscal 2016 compared to net income of $2.4 million or $0.35 per share in fiscal 2015 principally due to reduced operating income and a higher effective tax rate.

Nine months ended March 31, 2016 andMarch 31, 2015

Overview

Net sales declined $25.1 million or 14% from $180.1 million in fiscal 2015 to $155.0 million in fiscal 2016 with North America and International posting declines of $4.3 and $20.8 million, respectively. Operating income decreased $5.6 million in fiscal 2016 from $7.9 million in fiscal 2015 to $2.3 million in fiscal 2016 as lower sales and related gross margins more than offset reduced selling, general and administrative expenses.

Net Sales

North American sales decreased $4.3 million or 4% from $103.5 million in fiscal 2015 to $99.2 million in fiscal 2016 as demand for all precision hand tools declined, particularly in the oil and agricultural sectors.

International sales declined $20.8 million or 27% from $76.6 million in fiscal 2015 to $55.8 million in fiscal 2016 with unfavorable exchange rates representing $15.0 million. The impact of a recessionary economic environment was significant in Brazil as revenue declined 8% in local currency.

Gross Margin

Gross margin decreased $13.4 million or 22% from 33% of sales in fiscal 2015 to 30% of sales in fiscal 2016 with the profit impact of lower revenues and margin decline representing $8.4 and $5.0 million, respectively.

North American gross margins decreased $5.4 million or 16% in fiscal 2016 compared to fiscal 2015 as a result of reduced precision hand tool and saw product line revenues and increased costs.

International gross margins declined $8.0 million with weakening currencies representing $4.7 million. Excluding foreign exchange economic factors impacting margins, volume declines represented $1.5 and $1.1 million in Brazil and Europe, respectively.gain.

Selling, General and Administrative Expenses

Selling, general and administrative expense decreased $7.8increased $1.4 million or 15%3% from $52.1 million in fiscal 2015 to $44.3 million in fiscal 2016.2016 to $45.7 million in fiscal 2017.

North American expenses decreased $2.4$0.3 million or 9%2% due to termination of profit sharing in November of 2014 related to the Bytewise acquisition; lower incentive compensation; reduced professional fees;commissions and completion of software amortization in fiscal 2015 related to a new ERP system.travel expenses.

International expenses decreased $5.4increased $1.1 million or 22%6% principally due to a $4.9 foreign currency reduction forthe strengthening Brazilian Reals versus the US dollar.

Corporate expenses expressed in U. S. dollars, primarilyincreased $0.6 million or 13% principally due to a weakening of the Brazilian Real relative to the U. S. dollar. In addition, reduced spending for salaries, employee benefits and commissions contributed a combined $0.6 million.higher professional fees.

Other Incomeincome (expense)

Other income declined $1.3$0.8 million principally due to lower interest incomeforeign exchange translation losses and a $0.3 million cumulative loss related to an investment in a software development company. The $3.1 million gain on sale of a building is net profit realized on the devalued Chinese Yuan, which increased our Chinese subsidiary’ U. S. dollar denominated liabilities.sale of the Canadian distribution center in the first quarter of fiscal 2017.

Income Taxes

The effective tax raterates for the first nine monthsthree quarters of fiscal 2017 and 2016 was 41% and 2015 was 67% and 39%, respectively. The effective tax rateis higher than the U.S. statutory rate since the benefit of earnings in foreign jurisdictions with lower effective tax rates was more than offset by discrete tax charges including the impact of a tax rate forchange in the U.K. applied to deferred tax assets which increased tax expense by $298,000 in the first nine months ended March 31,quarter.. The effective rate in fiscal 2016 and 2015 increased as a result ofis higher due to losses in some foreign subsidiaries for which no tax benefit wasis recognized and was reduced by net discrete benefits of $0.3 million in fiscal 2016 and $0.4 million in fiscal 2015.consolidation.

Net Income

The Company recorded net income of $0.9$1.0 million or $0.12$0.15 per diluted share in the first three quarters of fiscal 20162017 compared to net income of $5.8$0.9 million or $0.83$0.13 per share in fiscal 20152016 principally due to the gain on the sale of the Canadian distribution facility and a lower effective tax rate offsetting lower operating income, reduced other income and a higher effective tax rate.income.

LIQUIDITY AND CAPITAL RESOURCES