UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A
(Amendment No. 1)
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Fiscal Year ended December 30, 2006
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________________ to _______________
Commission File Number 0-599
THE EASTERN COMPANY
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(Exact name of registrant as specified in its charter)
Connecticut 06-0330020
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(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
112 Bridge Street, Naugatuck, Connecticut 06770
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (203) 729-2255
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock No Par Value
-------------------------
(Title of Class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. Yes [ ] No [X]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [X]
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (ss.229.405 of this chapter) is not contained herein, and will
not be contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. [X]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [X]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act). Yes [ ] No [X]
As of July 1, 2006, the last day of registrant's most recently completed second
fiscal quarter, the aggregate market value of the voting stock held by
non-affiliates of the registrant was $63,152,194 (based on the closing sales
price of the registrant's common stock on the last trading date prior to that
date). Shares of the registrant's common stock held by each officer and director
and shares held in trust by the pension plans of the Company have been excluded
in that such persons may be deemed to be affiliates. This determination of
affiliate status is not necessarily a conclusive determination for other
purposes.
As of February 23, 2007, 5,503,211 shares of the registrant's common stock, no
par value per share, were issued and outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the annual proxy statement dated March 19, 2007 are incorporated by
reference into Part III.
The Eastern Company
Form 10-K/A
Amendment No.1
EXPLANATORY NOTE
We are amending our annual report on Form 10-K for the year ended December 30,
2006 to include an Exhibit 23 that was omitted from the EDGAR conversion of Form
10-K on March 19, 2007. Exhibit 23, the consent of UHY LLP, the Company's
independent registered public accounting firm was not included in the original
filing of Form 10-K on March 19, 2007. This amendment also corrects the
pagination to include the Exhibit.
Except as discussed above, we have not modified or updated the disclosures
presented in the original annual report on Form 10-K. Accordingly, this Form
10-K/A does not reflect events occurring after the filing of our original Form
10-K. Information not affected by the correction is unchanged and reflects the
disclosures made at the time of the original filing of the Form 10-K on March
19, 2007.
FOR THE FISCAL YEAR ENDED DECEMBER 30, 2006
TABLE OF CONTENTS
Page
Table of Contents 2.
Safe Harbor Statement 3.
PART I
Item 1. Business 4.
Item 1A. Risk Factors 7.
Item 1B. Unresolved Staff Comments 10.
Item 2. Properties 10.
Item 3. Legal Proceedings 11.
Item 4. Submission of Matters to a Vote of Security Holders 11.
PART II
Item 5. Market for Registrant's Common Equity, Related
Stockholder Matters and Issuer Purchases of Equity Securities 12.
Item 6. Selected Financial Data 14.
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 14.
Item 7A. Quantitative and Qualitative Disclosures
About Market Risk 26.
Item 8. Financial Statements and Supplementary Data 27.
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 56.
Item 9A. Controls and Procedures 56.
Item 9B. Other Information 56.
PART III
Item 10. Directors, Executive Officers and Corporate Governance 56.
Item 11. Executive Compensation 57.
Item 12. Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters 57.
Item 13. Certain Relationships and Related Transactions, and Director
Independence 57.
Item 14. Principal Accounting Fees and Services 57.
PART IV
Item 15. Exhibits, Financial Statement Schedules 58.
Signatures 61.
Exhibit Index 62.
-2-
SAFE HARBOR STATEMENT
UNDER THE PRIVATE SECURITIES
LITIGATION REFORM ACT OF 1995
This Annual Report on Form 10-K contains forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995. Such statements
reflect the Company's current expectations regarding its products, its markets
and its future financial and operating performance. These statements, however,
are subject to risks and uncertainties that may cause the Company's actual
results in future periods to differ materially from those expected. Such risks
and uncertainties include, but are not limited to, unanticipated slowdowns in
the Company's major markets, changing customer preferences, lack of success of
new products, loss of customers, competition, increased raw material prices,
problems associated with foreign sourcing of parts and products, worldwide
conditions and foreign currency fluctuations that may affect results of
operations, and other factors discussed from time to time in the Company's
filings with the Securities and Exchange Commission. The Company is not
obligated to update or revise the aforementioned statements for those new
developments.
-3-
PART I
ITEM 1 BUSINESS
(a) General Development of Business
-------------------------------
The Eastern Company (the "Company") was incorporated under the laws of the State
of Connecticut in October, 1912, succeeding a co-partnership established in
October, 1858.
The business of the Company is the manufacture and sale of industrial hardware,
security products and metal products from four U.S. operations and six
wholly-owned foreign subsidiaries. The Company maintains nine physical
locations.
RECENT DEVELOPMENTS
During the third quarter of 2006, the Company received orders from a military
contractor for component parts used in retro-fitting Humvees as part of the
military's up-armor program to provide additional troop protection. These
component parts began to be shipped in September 2006 and are scheduled to
continue to be shipped into the early part of the second quarter of 2007. This
program will result in approximately $31 million in total sales for the
Industrial Hardware segment of the Company during the period from September 2006
to April 2007.
Effective November 8, 2006, the Company acquired certain assets of Summit
Manufacturing, Inc. ("Summit"), which was integrated into the Company's Security
Products segment. Summit designs and manufactures appliance hardware and
accessories, including, but not limited to, oven door latches, oven door
switches and smoke eliminators and provides subcontract assembly services. The
cost of the Summit acquisition was $546,000, inclusive of transaction costs and
outstanding debt paid at closing, plus the assumption of $369,000 in current
liabilities.
Effective September 25, 2006, the Company acquired certain assets of Royal Lock
Corporation ("Royal"), which was also integrated into the Company's Security
Products segment. Royal is a supplier of cam locks, switch locks, padlocks,
latches, handles and specialty hardware parts. The cost of the Royal acquisition
was $6,991,000, inclusive of transaction costs, plus the assumption of $775,000
in current liabilities.
Both of the above acquisitions have been accounted for using the purchase
method. The acquired businesses are included in the consolidated operating
results of the Company from the date of acquisition. Neither the actual results
nor the pro forma effects of these acquisitions are material to the Company's
financial statements.
In October 2006, the Company's common stock was split 3-for-2. The effect of
this stock split is reflected in all applicable share data and per share data in
this Annual Report on Form 10-K.
(b) Financial Information about Industry Segments
---------------------------------------------
Financial information about industry segments is included in Note 12 to the
Company's financial statements, included at Item 8 of this Annual Report on Form
10-K.
(c) Narrative Description of Business
---------------------------------
The Company operates in three business segments: Industrial Hardware, Security
Products and Metal Products.
Industrial Hardware
The Industrial Hardware segment consists of Eberhard Manufacturing, Eberhard
Hardware Manufacturing Ltd., Canadian Commercial Vehicles Corporation, Eastern
Industrial Ltd. and Sesamee Mexicana, S.A. de C.V. The units design, manufacture
and market a diverse product line of industrial and vehicular hardware
throughout North America. The segment's locks, latches, hinges, handles,
lightweight honeycomb composite structures and related hardware can be found on
tractor-trailer trucks, moving vans, off-road construction and farming
equipment, school buses, military vehicles and recreational boats. They are also
used on pickup trucks, sport utility vehicles and fire and rescue vehicles. In
addition, the segment manufactures a wide selection of fasteners and other
closure devices used to secure access doors on various types of industrial
equipment such as metal cabinets, machinery housings and electronic instruments.
Eastern Industrial expands the range of offerings of this segment to include
-4-
plastic injection molding. Typical products include passenger restraint locks,
slam and draw latches, dead bolt latches, compression latches, cam-type
vehicular locks, hinges, tool box locks, light-weight sleeper boxes for Class 8
trucks and school bus door closure hardware. The products are sold directly to
original equipment manufacturers and to distributors through a distribution
channel consisting of in-house salesmen and outside sales representatives. Sales
and customer service efforts are concentrated through in-house sales personnel
where greater representation of our diverse product lines can be promoted across
a variety of markets.
The Industrial Hardware segment sells its products to a diverse array of markets
such as the truck, bus and automotive industries as well as to the industrial
equipment, military and marine sectors. Although service, quality and price are
major criteria for servicing these markets, the continued introduction of new or
improved product designs and the acquisition of synergistic product lines are
vital for maintaining and increasing market share.
Security Products
The Security Products segment, made up of Greenwald Industries, Illinois Lock
Company/CCL Security Products/Royal Lock, World Lock Company Ltd. and World
Security Industries Ltd.--is a leading manufacturer of security products. This
segment manufactures electronic and mechanical locking devices, both keyed and
keyless, for the computer, electronics, vending and gaming industries. The
segment also supplies its products to the luggage, furniture, laboratory
equipment and commercial laundry industries. Greenwald manufactures and markets
coin acceptors and other coin security products used primarily in the commercial
laundry markets, as well as hardware and accessories for the appliance industry.
In addition, the segment provides a new level of security for the access
control, municipal parking and vending markets through the use of "smart card"
technology.
Greenwald's products include timers, drop meters, coin chutes, money boxes,
meter cases, smart cards, value transfer stations, smart card readers, card
management software, access control units, oven door latches, oven door switches
and smoke eliminators. Illinois Lock Company/CCL Security Products/Royal Lock
sales include cabinet locks, cam locks, electric switch locks, tubular key locks
and combination padlocks. Many of the products are sold under the names
SEARCHALERT(TM), PRESTOSEAL(TM), DUO, X-STATIC(R), EXCALIBUR(TM), WARLOCK(TM),
LITE LOCK(TM), SESAMEE(R), BIG TAG(R), PRESTOLOCK(R) and HUSKI(TM). These
products are sold to original equipment manufacturers, distributors, route
operators, and locksmiths via in-house salesmen and outside sales
representatives. Sales efforts are concentrated through national and regional
sales personnel where greater representation of our diverse product lines can be
promoted across a variety of markets.
The Security Products segment continuously seeks new markets where it can offer
competitive pricing and provide customers with engineered solutions for their
security needs.
Metal Products
The Metal Products segment, based at the Company's Frazer & Jones facility, is
the largest and most efficient producer of expansion shells for use in
supporting the roofs of underground mines. This segment also manufactures
specialty malleable and ductile iron castings.
Typical products include mine roof support anchors, couplers for railroad
braking systems, adjustable clamps for construction and fittings for electrical
installations. Mine roof support anchors are sold to distributors and directly
to mines, while specialty castings are sold to original equipment manufacturers.
Although there continues to be a need for the highly engineered proprietary mine
roof support products produced by this segment of the Company, changes in mining
technology continue to decrease demand for mechanical anchoring systems. Intense
competition from foreign countries has adversely affected competing effectively
in the contract castings market. As a result, the Company began to phase out of
its low-margin contract castings business and concentrate on its proprietary
mine roof support systems. To offset declines in the demand for malleable iron
castings, the Company has invested in equipment for the production and marketing
of ductile iron castings.
-5-
General
Raw materials and outside services were readily available from domestic sources
for all of the Company's segments during 2006 and are expected to be readily
available in 2007 and the foreseeable future. The Company also obtains materials
from Asian affiliated and nonaffiliated sources. The Company has not experienced
any significant problems obtaining material from its Asian sources in 2006 and
does not expect any such problems in 2007. In 2006, the Company experienced
significant price increases for zinc, brass and stainless steel, used mainly in
the Industrial Hardware and Security Products segments, as well as scrap iron
used in the Metal Products segment. These higher prices had a negative impact on
gross margin in 2006, and will continue to negatively impact gross margin in
2007, if prices do not stabilize.
Patent protection for the various product lines within the Company is limited,
but is sufficient to protect the Company's competitive positions. Foreign sales
and license agreements are not significant.
None of the Company's business segments are seasonal.
The Company, across all its business segments, has increased its emphasis on
sales and customer service by fulfilling the rapid delivery requirements of our
customers. As a result, investments in additional inventories are made on a
selective basis.
Customer lists for all business segments are broad-based geographically and by
markets and sales are generally not highly concentrated by customer. However,
due to the military Humvee retro-fit contract, one customer in the Industrial
Hardware Segment accounted for approximately 15% of total sales in 2006. No
other customers exceeded 10% or more of the Company's consolidated sales for the
year ended December 30, 2006. Following the completion of the Humvee retro-fit
contract in April 2007, if additional military orders are not received, the
Company anticipates sales in the second quarter of 2007 would be in the range of
10% - 20% above the second quarter of 2006.
The dollar amount of the backlog of orders received by the Company is believed
to be firm as of fiscal year ended December 30, 2006 at $37,929,000, as compared
to $17,219,000 at December 31, 2005. The primary source of the increase from
2005 to 2006 are orders related to the military Humvee retro-fit program.
The Company encounters competition in all of its business segments. The Company
has been successful in dealing with this competition by offering high quality
diversified products with the flexibility of meeting customer needs on a timely
basis. This is accomplished by effectively using internal engineering resources,
cost effective manufacturing capabilities, expanding product lines through
product development and acquisitions and maintaining sufficient inventory for
fast turnaround of customer orders. However, imports from Asia and Latin America
with favorable currency exchange rates and low cost labor have created
additional competitive pressures. The Company currently utilizes three
wholly-owned subsidiaries in Asia to help offset offshore competition.
Research and development expenditures in 2006 were $1,354,000 and represented
approximately 1% of gross revenues. In 2005 and 2004 they were $1,150,000 and
$1,167,000, respectively. The research costs are primarily attributable to the
Greenwald division, where ongoing research, in both the mechanical and smart
card product lines, is necessary in order to remain competitive and to continue
to provide technologically advanced smart card systems. Other research projects
include the development of various locks, transportation and industrial hardware
products.
The Company does not anticipate that compliance with federal, state or local
environmental laws or regulations will have a material effect on the Company's
capital expenditures, earnings or competitive position.
The average number of employees in 2006 was 695.
(d) Financial Information about Geographic Areas
--------------------------------------------
The Company includes four separate operating divisions located within the United
States, two wholly-owned Canadian subsidiaries, one located in Tillsonburg,
Ontario, Canada, and one in Kelowna, British Columbia, Canada, a wholly-owned
Taiwanese subsidiary located in Taipei, Taiwan, a wholly-owned subsidiary in
Hong Kong, a wholly-owned subsidiary in Shanghai, China and a wholly-owned
subsidiary in Mexico.
Individually, the Canadian, Taiwanese, Hong Kong, Chinese and Mexican
subsidiaries' revenue and assets are not significant. Substantially all other
revenues are derived from customers located in the United States.
-6-
Financial information about foreign and domestic operations' revenues and
identifiable assets is included in Note 12 to the Company's financial
statements, included at Item 8 of this Annual Report on Form 10-K. Information
about risks attendant to the Company's foreign operations is set forth at Item
1A of this Annual Report on Form 10-K.
(e) Available Information
---------------------
We make available, free of charge through our Internet website at
http://www.easterncompany.com, our annual report on Form 10-K, quarterly reports
on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed
or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act
of 1934, as soon as reasonably practicable after such material is electronically
filed with or furnished to the Securities and Exchange Commission. The Company's
reports filed with, or furnished to, the SEC are also available on the SEC's
website at www.sec.gov.
ITEM 1A RISK FACTORS
In addition to the other information contained in this Form 10-K and the
exhibits hereto and the Company's other filings with the SEC, the following risk
factors should be considered carefully in evaluating the Company's business. The
Company's business, financial condition or results of operation could be
materially adversely affected by any of these risks or additional risks not
presently known to the Company, or by risks the Company currently deems
immaterial which may also adversely affect its business, financial condition, or
results of operations, such as: changes in the economy, including changes in
inflation, tax rates and interest rates, risk associated with possible
disruption in the Company's operations due to terrorism and other manmade or
natural disasters, future regulatory actions, legal issues or environmental
matters, loss of, or changes in, executive management and changes in accounting
standards which are adverse to the Company. Also, there can be no assurance that
the Company has correctly identified and appropriately assessed all factors
affecting our business or that information publicly available with respect to
these matters is complete and correct.
OUR BUSINESS IS SUBJECT TO RISKS ASSOCIATED WITH CONDUCTING BUSINESS OVERSEAS.
International operations could be adversely affected by changes in political and
economic conditions, trade protection measures, restrictions on repatriation of
earnings, differing intellectual property rights and changes in regulatory
requirements that restrict the sales of products or increase costs. Changes in
exchange rates between the U.S. dollar and other currencies could result in
increases or decreases in earnings and may adversely affect the value of the
Company's assets outside the United States. Our operations are also subject to
the effects of international trade agreements and regulations. Although
generally these trade agreements have positive effects, they can also impose
requirements that adversely affect our business, such as setting quotas on
product that may be imported from a particular country into our key markets in
North America.
Our ability to import products in a timely and cost-effective manner may also be
affected by conditions at ports or issues that otherwise affect transportation
and warehousing providers, such as port and shipping capacity, labor disputes,
severe weather or increased homeland security requirements in the United States
or other countries. These issues could delay importation of products or require
us to locate alternative ports or warehousing providers to avoid disruption to
our customers. These alternatives may not be available on short notice or could
result in higher transit costs, which could have an adverse impact on our
business, financial conditions or results of operations.
See also "ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK"
of this Form 10-K.
In addition, the Company's growth strategy involves expanding sales of its
products into foreign markets. There is no guarantee that our products will be
accepted by foreign customers or how long it may take to develop sales of our
products in these foreign markets.
-7-
INCREASES IN THE PRICE OR REDUCED AVAILABILITY OF RAW MATERIALS.
Raw materials needed to manufacture products are obtained from numerous
suppliers. Under normal market conditions, these raw materials are readily
available on the open market from a variety of producers. However, from time to
time the prices and availability of these raw materials fluctuate, which could
impair the Company's ability to procure the required raw materials for our
operations or increase the cost of manufacturing our products. If the price of
raw materials increases, the Company may be unable to pass these increases on to
its customers and could experience reduction to its profit margins. Also, any
decrease in the availability of raw materials could impair our ability to meet
production requirements in a timely manner.
INCREASED COMPETITION IN THE MARKETS THE COMPANY SERVICES COULD IMPACT REVENUES
AND EARNINGS.
Any change in competition may result in lost market share or reduced prices,
which could result in reduced profit margins. This may impair the ability to
grow or even maintain current levels of revenues and earnings. While the Company
has an extensive customer base, loss of certain customers could adversely affect
the Company's business, financial condition or results of operations until such
business is replaced, and no assurances can be made that the Company would be
able to regain or replace any lost customers.
THE COMPANY WILL BE REQUIRED TO EVALUATE ITS INTERNAL CONTROL OVER FINANCIAL
REPORTING UNDER SECTION 404 OF THE SARBANES-OXLEY ACT OF 2002.
As of December 31, 2006, the Company is a "non-accelerated filer" as defined in
Rule 12b-2 under the Securities Exchange Act of 1934, as amended. Pursuant to
current reporting requirements, the Company expects to be an "accelerated
filer", as defined in Rule 12b-2 under the Securities Exchange Act of 1934, as
amended, and will be required to comply with Section 404 of the Sarbanes-Oxley
Act of 2002 beginning with our Annual Report on Form 10-K for fiscal year end
2007. Section 404 will require the Company to include in its report management's
assessment of the effectiveness of the Company's internal control over financial
reporting as of the end of the fiscal period for which the Company is filing its
10-K. This report must also include disclosure of any material weaknesses in
internal control over financial reporting that the Company has identified.
Additionally, the Company's independent registered public accounting firm will
be required to issue an attestation report on management's assessment of its
internal control over financial reporting and their evaluation of the operating
effectiveness of the Company's internal control over financial reporting. The
Company's assessment requires it to make subjective judgments and the
independent registered public accounting firm may not agree with the Company's
assessment. If the Company or its independent registered public accounting firm
were unable to complete the assessments within the period prescribed by Section
404 and thus be unable to conclude that the internal control over financial
reporting is effective, investors could lose confidence in our reported
financial information, which could have an adverse effect on the market price of
the Company's common stock or impact the Company's borrowing ability.
THE INABILITY TO IDENTIFY OR COMPLETE ACQUISITIONS COULD LIMIT FUTURE GROWTH.
As part of its growth strategy, the Company continues to pursue acquisitions of
complementary products or businesses. The ability to grow through acquisitions
depends upon the Company's ability to identify, negotiate, complete and
integrate suitable acquisitions. The Company makes certain assumptions based on
the information provided by potential acquisition candidates and also conducts
due diligence to ensure the information provided is accurate and based on
reasonable assumptions, but the Company may be unable to realize the anticipated
benefits from an acquisition or predict accurately how an acquisition will
ultimately affect the business, financial condition or results of operations.
DEMAND FOR NEW PRODUCTS AND THE INABILITY TO DEVELOP AND INTRODUCE NEW
COMPETITIVE PRODUCTS AT FAVORABLE PROFIT MARGINS COULD ADVERSELY AFFECT THE
COMPANY'S PERFORMANCE AND PROSPECTS FOR FUTURE GROWTH AND THE COMPANY WOULD NOT
BE POSITIONED TO MAINTAIN CURRENT LEVELS OF REVENUES AND EARNINGS.
The uncertainties associated with developing and introducing new products, such
as the market demands and the costs of development and production, may impede
the successful development and introduction of new products successfully.
Acceptance of the new products may not meet sales expectations due to several
factors, such as the Company's failure to accurately predict market demand or
its inability to resolve technical issues in a timely and cost-effective manner.
Additionally, the inability to develop new products on a timely basis could
result in the loss of business to competitors.
-8-
THE COMPANY COULD BE SUBJECT TO LITIGATION WHICH COULD HAVE A MATERIAL IMPACT ON
THE COMPANY'S BUSINESS, FINANCIAL CONDITION OR RESULTS OF OPERATIONS.
From time to time, the Company's operations are parties to or targets of
lawsuits, claims, investigations and proceedings, including product liability,
personal injury, patent and intellectual property, commercial, contract,
environmental and employment matters, which are defended and settled in the
ordinary course of business. While the Company is unable to predict the outcome
of any of these matters, it does not believe, based upon currently available
information, that the resolution of any pending matter will have a material
adverse effect on its business, financial condition or results of operations.
See "ITEM 3 - LEGAL PROCEEDINGS" in this Form 10-K for a discussion of current
litigation.
THE COMPANY COULD BE SUBJECT TO ADDITIONAL TAX LIABILITIES.
The Company is subject to income tax laws in the United States, its states and
municipalities and those of other foreign jurisdictions in which the Company has
business operations. These laws are complex and subject to interpretations by
the taxpayer and the relevant governmental taxing authorities. Significant
judgment and interpretation is required in determining the Company's worldwide
provision for income taxes. In the ordinary course of business, transactions
arise where the ultimate tax determination is uncertain. Although we believe the
Company's tax estimates are reasonable, the final outcome of tax audits and any
related litigation could be materially different from that which is reflected in
historical income tax provisions and accruals. Based on the status of a given
tax audit or related litigation, a material effect on our income tax provision
or net income may result during the period or periods from the initial
recognition of a particular matter in our reported financial results to the
final closure of that tax audit or settlement of related litigation when the
ultimate tax and related cash flow is known with certainty.
THE COMPANY'S GOODWILL OR INDEFINITE-LIVED INTANGIBLE ASSETS MAY BECOME IMPAIRED
WHICH COULD REQUIRE A SIGNIFICANT CHARGE TO EARNINGS TO BE RECOGNIZED.
Under accounting principles generally accepted in the United States, goodwill
and indefinite-lived intangible assets are not amortized but are reviewed for
impairment at least annually. Numerous assumptions are used in the evaluation of
impairment and there is no guarantee that the Company's independent registered
public accounting firm would reach the same conclusion as the Company or an
independent valuation firm, which could result in a disagreement between
management and the independent registered public accounting firm. Future
operating results used in the assumptions, such as sales or profit forecasts,
may not materialize and the Company could be required to record a significant
charge to earnings in the financial statements during the period in which any
impairment is determined, resulting in an unfavorable impact on our results of
operations.
THE COMPANY MAY NEED ADDITIONAL CAPITAL IN THE FUTURE, AND IT MAY NOT BE
AVAILABLE ON ACCEPTABLE TERMS, IF AT ALL.
From time-to-time, the Company has historically relied on outside financing to
fund expanded operations, capital expenditure programs and acquisitions. The
Company may require additional capital in the future to fund operations or
strategic opportunities. The Company cannot be assured that additional financing
will be available on favorable terms, or at all. In addition, the terms of
available financing may place limits on the Company's financial and operating
flexibility. If the Company is unable to obtain sufficient capital in the
future, the Company may not be able to expand or acquire complementary
businesses and may not be able to continue to develop new products or otherwise
respond to changing business conditions or competitive pressures.
THE COMPANY'S STOCK PRICE IS HIGHLY VOLATILE DUE TO LOW FLOAT, WHICH IS THE
NUMBER OF SHARES OF THE COMPANY'S COMMON STOCK THAT ARE OUTSTANDING AND
AVAILABLE FOR TRADING BY THE PUBLIC.
The Company's stock price may change dramatically when buyers seeking to
purchase shares of the Company's common stock exceed the shares available on the
market or when there are no buyers to purchase shares of the Company's common
stock when shareholders are trying to sell their shares.
-9-
THE COMPANY MAY NOT BE ABLE TO REACH ACCEPTABLE TERMS FOR CONTRACTS NEGOTIATED
WITH ITS LABOR UNIONS AND BE SUBJECT TO WORK STOPPAGES OR DISRUPTION OF
PRODUCTION.
During 2007, union contracts covering 32% of the total workforce of the Company
will expire. The Company has been successful in negotiating new contracts over
the years, but cannot guarantee that will continue. Failure to negotiate new
union contracts could result in disruption of production, inability to deliver
product or a number of unforeseen circumstances, any of which could have an
unfavorable material impact on the Company's results of operations or financial
statements.
ITEM 1B UNRESOLVED STAFF COMMENTS
None.
ITEM 2 PROPERTIES
The corporate office of the Company is located in Naugatuck, Connecticut in a
two-story 8,000 square foot administrative building on 3.2 acres of land.
All of the Company's properties are owned or leased and are adequate to satisfy
current requirements. All of the Registrant's properties have the necessary
flexibility to cover any long-term expansion requirements.
THE INDUSTRIAL HARDWARE GROUP INCLUDES THE FOLLOWING:
The Eberhard Manufacturing Division in Strongsville, Ohio owns 9.6 acres of land
and a building containing 138,000 square feet, located in an industrial park.
The building is steel frame, one-story, having curtain walls of brick, glass and
insulated steel panel. The building has two high bays, one of which houses two
units of automated warehousing. The Company has rented additional space in an
adjacent building to fulfill space requirements for the current military
contracts.
The Eberhard Hardware Manufacturing, Ltd., a wholly-owned Canadian subsidiary in
Tillsonburg, Ontario, owns 4.4 acres of land and a building containing 31,000
square feet in an industrial park. The building is steel frame, one-story,
having curtain walls of brick, glass and insulated steel panel. It is
particularly suited for light fabrication, assembly and warehousing and is
adequate for long-term expansion requirements.
The Canadian Commercial Vehicles Corporation, a wholly-owned subsidiary in
Kelowna, British Columbia, leases 46,500 square feet of building space located
in an industrial park. The building is made from brick and concrete, contains
approximately 5,400 square feet of office space on two levels and houses a
modern paint booth for finishing our products. The building is protected by a F1
rated fire suppression system and alarmed for fire and security. The current
lease is renewable annually on January 1st.
The Eastern Industrial Ltd., a wholly-owned subsidiary in Shanghai, China leases
brick and concrete buildings containing approximately 45,600 square feet,
located in both industrial and commercial areas. A five-year lease was signed in
2003, which expires on September 8, 2008 and is renewable.
The Sesamee Mexicana subsidiary moved into a new facility during 2006 and is
leasing 18,000 square feet located in an industrial park in Lerma, Mexico on an
open-end basis. The building is steel framed with concrete block and glass
curtain walls.
-10-
THE SECURITY PRODUCTS GROUP INCLUDES THE FOLLOWING:
The Greenwald Industries Division in Chester, Connecticut owns 26 acres of land
and a building containing 120,000 square feet. The building is steel frame, one
story, having brick over concrete blocks.
The Illinois Lock Company/CCL Security Products/Royal Lock Division occupies a
building containing 44,000 square feet in Wheeling, Illinois. The building is
brick and located in an industrial park. In December 2006, the Company purchased
this building and land for $2.2 million. This facility had been leased prior to
December 2006. The Company is also leasing approximately 10,000 square feet of
warehouse space occupied by Royal Lock during the transition into our existing
facility.
The World Lock Co. Ltd. subsidiary leases 5,285 square feet located in Taipei,
Taiwan. The building is made from brick and concrete and is protected by a fire
alarm and sprinklers.
THE METAL PRODUCTS GROUP CONSISTS OF:
The Frazer and Jones Division in Solvay, New York, which owns 17.9 acres of land
and buildings containing 205,000 square feet constructed for foundry use. These
facilities are well adapted to handle the division's current and future casting
requirements.
All owned properties are free and clear of any encumbrances.
ITEM 3 LEGAL PROCEEDINGS
The Company was a party to a patent infringement suit filed on December 23, 2002
in the U.S. District Court for the Eastern District of Texas, Marshall Division,
Civil Action Number 2-03-CV005-TJW. Imonex Services, Inc. (the "Plaintiff")
alleged the Company infringed on two of its patents. The Plaintiff was seeking a
permanent injunction against the Company's direct and inducing infringement of
its patents. The Plaintiff was also seeking an unspecified amount of damages,
treble damages for willful infringement, interest on the damages, reimbursement
of legal expenses and other such relief as the court deemed just and proper.
Although management determined that the suit was without merit, the Company
agreed to a mediated settlement of $400,000, which was recorded as a charge to
earnings in the second quarter of 2004. In addition to the settlement, the
Company incurred approximately $115,000 of legal expenses in 2003 and $398,000
of legal expenses in 2004 relating to this suit. The legal expenses combined
with the settlement resulted in charges to earnings, net of taxes, of $484,000,
or $0.09 per diluted share, in 2004.
There are no other legal proceedings, other than ordinary routine litigation
incidental to the Company's business, to which either the Company or any of its
subsidiaries is a party or to which any of their property is the subject.
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter ended December 30, 2006.
-11-
PART II
ITEM 5 MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS
AND ISSUER PURCHASES OF EQUITY SECURITIES
The Company's common stock is traded on the American Stock Exchange (ticker
symbol EML). The approximate number of record holders of the Company common
stock on December 30, 2006 was 595.
High and low stock prices and dividends for the last two years were:
2006 2005
--------------------------------------------------- ---------------------------------------------------
Market Price Market Price
Quarter High Low Dividend Quarter High Low Dividend
--------------------------------------------------- ---------------------------------------------------
First $14.67 $12.50 $.07 First $15.97 $12.87 $.07
Second 15.10 13.27 .08 Second 15.70 13.33 .07
Third 18.83 13.70 .08 Third 17.50 14.17 .07
Fourth 19.40 16.20 .08 Fourth 15.63 12.97 .07
The Company increased the dividend rate by 9% in the second quarter of 2006. The
Company expects to continue its policy of paying regular cash dividends,
although there is no assurance as to future dividends because they are dependent
on future earnings, capital requirements, and financial conditions. The payment
of dividends is subject to the restrictions of the Company's loan agreement if
such payment would result in an event of default. See Item 7 - Management's
Discussion and Analysis of Financial Condition and Results of Operations, and
Note 5 to the Company's financial statements included at Item 8 of this Annual
Report on Form 10-K.
The following table sets forth information regarding securities authorized for
issuance under the Company's equity compensation plans as of December 30, 2006,
including the Company's 1989, 1995, 1997 and 2000 plans.
Equity Compensation Plan Information
-----------------------------------------------------------------------------------------------------------------------------------
Number of securities Number of securities remaining
to be issued upon available for future issuance
exercise of Weighted-average exercise under equity compensation plans
outstanding options, price of outstanding (excluding securities reflected
Plan category warrants and rights options, warrants and rights in column (a))
-------------------- ---------------------------- -------------------------------
(a) (b) (c)
Equity compensation plans
approved by security holders 629,250(1) $9.77 367,500(2)
Equity compensation plans not
approved by security holders 373,500(3) 8.32 78,750(4)
--------- ----- -------
Total 1,002,750 $9.23 446,250
========= ===== =======
(1) Includes options outstanding under the 1989, 1995 and 2000 plans.
(2) Includes shares available for future issuance under the 2000 plan.
(3) Includes options outstanding under the 1997 plan.
(4) Includes shares available for future issuance under the 1997 plan.
On September 17, 1997 the Compensation Committee of the Board of Directors of
the Company adopted The Eastern Company 1997 Directors Stock Option Plan (the
"1997 Plan") which by its terms will expire either on September 16, 2007 or upon
any earlier termination date established by the Board of Directors. The 1997
Plan authorizes the grant of non-qualified stock options to the non-employee
directors of the Company to purchase shares of common stock. The exercise price
of any options granted under the 1997 Plan is set by the Compensation Committee.
However, all options granted to date under the 1997 Plan have required an
exercise price equal to 100% of the fair market value of the shares of common
stock of the Company on the date of grant. On December 15, 1999, the Board of
Directors approved an increase in the total number of shares of common stock
which may be issued under options granted under the 1997 Plan from 337,500
shares to 487,500 shares.
-12-
Each director who is not an employee of the Company ("Outside Director") is paid
a director's fee for his services at the annual rate of $24,600. All annual fees
paid to non-employee members of the Board of Directors of the Company are paid
in common stock of the Company or cash, in accordance with the Directors Fee
Program adopted by the shareholders on March 26, 1997 and amended on January 5,
2004. The directors make an annual election, within a reasonable time before
their first quarterly payment, to receive their fees in the form of cash, stock
or a combination thereof. The election remains in force for one year.
There were no issuer purchases of equity securities in 2006. The Company does
not have any share repurchase plans or programs.
STOCK PERFORMANCE GRAPH
The following graph sets forth the Company's cumulative total shareholder return
based upon an initial $100 investment made on December 31, 2001 (i.e., stock
appreciation plus dividends during the past five fiscal years) compared to the
Wilshire 5000 Index and the S&P Industrial Machinery Index.
The Company manufactures and markets a broad range of locks, latches, fasteners
and other security hardware that meets the diverse security and safety needs of
industrial and commercial customers. Consequently, while the S&P Industrial
Machinery Index being used for comparison is the standard index most closely
related to the Company, it does not completely represent the Company's products
or market applications. The Wilshire 5000 is a market index made up of 5,000
publicly-traded companies, including those having both large and small
capitalization.
[CHART OF CUMULATIVE TOTAL RETURN APPEARS HERE]
Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Dec-06
Eastern Co. $100 $ 95 $139 $183 $182 $277
Wilshire 5000 $100 $ 79 $104 $117 $125 $144
S&P (C) Industrial Machinery $100 $ 99 $137 $162 $159 $181
Copyright (C) 2007, Standard & Poor's, a division of The McGraw-Hill Companies,
Inc. All rights reserved.
-13-
ITEM 6 SELECTED FINANCIAL DATA
2006 2005 2004 2003 2002
-----------------------------------------------------------------
INCOME STATEMENT ITEMS (in thousands)
Net sales $138,465 $109,107 $100,130 $ 88,307 $ 81,337
Cost of products sold 103,882 84,375 74,999 66,719 60,637
Depreciation and amortization 3,746 3,460 3,461 3,619 3,565
Interest expense 1,098 1,014 1,044 1,303 1,716
Income before income taxes 14,846 7,020 6,829 5,390 4,734
Income taxes 5,187 2,653 2,071 2,028 1,442
Net income 9,659 4,367 4,758 3,362 3,292
Dividends 1,715 1,600 1,596 1,593 1,598
BALANCE SHEET ITEMS (in thousands)
Inventories $ 28,043 $ 20,768 $ 20,478 $ 16,927 $ 16,345
Working capital 35,546 31,223 26,692 24,894 25,600
Property, plant and equipment, net 25,816 22,397 23,907 24,930 25,050
Total assets 103,485 81,622 78,072 74,617 76,133
Shareholders' equity 54,391 46,172 43,817 40,508 37,903
Capital expenditures 6,722 1,750 2,062 2,763 1,560
Long-term obligations, less current portion 17,507 12,384 11,805 15,815 18,921
PER SHARE DATA
Net income per share
Basic $ 1.76 $ .80 $ .87 $ .62 $ .60
Diluted 1.67 .75 .85 .61 .60
Dividends .31 .29 .29 .29 .29
Shareholders' equity (Basic) 9.94 8.47 8.05 7.46 6.96
Average shares outstanding: Basic 5,474,137 5,455,073 5,441,312 5,430,890 5,446,917
Diluted 5,768,108 5,828,837 5,618,552 5,488,448 5,521,626
The information in the table above reflects a 3-for-2 stock split effective
October 2006.
ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Summary
Net sales for 2006 increased 27% to $138.5 million from $109.1 million in 2005.
Net income increased 121% to $9.7 million, or $1.67 per diluted share, from $4.4
million, or $0.75 per diluted share in 2005. Net sales and net income were
favorably impacted by shipments of approximately $19 million from the Industrial
Hardware segment to fulfill orders received in September 2006 to produce door
latching components for a military project to up-armor existing Humvees.
Shipments toward fulfillment of that military project are expected to continue
through April of 2007. Net sales in the Industrial Hardware segment increased
approximately 40% in 2006. Sales increased in the Security Products segment by
13%, resulting from the combined acquisitions of Royal Lock and Summit
Manufacturing which contributed 5% of the increases and increases in existing
operations of 8%. The Metal Products segment also experienced an increase in
sales of 19%, resulting from increased shipments of both malleable and ductile
iron products.
-14-
The following table shows, for the fourth quarter of 2006 and 2005, selected
line items from the consolidated statements of income as a percentage of net
sales, by segment.
2006 Fourth Quarter
-----------------------------------------------------
Industrial Security Metal
Hardware Products Products Total
-----------------------------------------------------
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of products sold 63.4% 76.0% 103.3% 69.8%
Gross margin 36.6% 24.0% -3.3% 30.2%
Selling and administrative expense 9.3% 16.7% 8.8% 11.3%
Operating profit 27.3% 7.3% -12.1% 18.9%
2005 Fourth Quarter
-----------------------------------------------------
Industrial Security Metal
Hardware Products Products Total
-----------------------------------------------------
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of products sold 75.1% 72.6% 96.9% 76.2%
Gross margin 24.9% 27.4% 3.1% 23.8%
Selling and administrative expense 14.6% 17.6% 9.6% 15.3%
Operating profit 10.3% 9.8% -6.5% 8.5%
The following table shows the amount of change from the fourth quarter of 2005
to the fourth quarter of 2006 in sales, cost of products sold, gross margin,
selling and administrative expenses and operating profit, by segment (dollars in
thousands):
Industrial Security Metal
Hardware Products Products Total
------------------------------------------------------------------
Net sales $ 18,189 $ 2,598 $ 729 $ 21,516
Volume -6.0% 19.3% 19.2% 6.8%
Prices 0.0% -0.4% 0.6% -0.1%
New Products 136.2% 3.8% 6.1% 69.6%
----- ---- ---- ------
130.2% 22.7% 25.9% 76.3%
Cost of products sold $ 9,909 $ 2,366 $ 932 $ 13,207
94.5% 28.5% 34.2% 61.4%
Gross margin $ 8,280 $ 232 $ (203) $ 8,309
237.8% 7.4% -234.4% 123.9%
Selling and administrative
expenses $ 947 $ 333 $ 42 $ 1,322
46.5% 16.5% 15.7% 30.6%
Operating profit $ 7,333 $ (101) $ (245) $ 6,987
507.3% -9.0% -134.3% 293.3%
Net sales in the fourth quarter of 2006 increased 76% to $49.7 million from
$28.2 million a year earlier. Net income for the quarter increased 335% to $5.6
million (or $.96 per diluted share) from $1.3 million (or $.23 per diluted
share) a year earlier.
Gross margin for the fourth quarter of 2006 improved 124% from the fourth
quarter of 2005. Higher sales volume which resulted in better utilization of
production capacity mainly in the Industrial Hardware segment was the main
reason for the improvement. Gross margin was negatively impacted by cost
increases for raw materials and increased payroll and payroll related charges in
all three of our business segments.
-15-
Selling and administrative expenses for the fourth quarter of 2006 increased
30.6% compared to the prior year quarter due to higher payroll and payroll
related charges for all business segments and increased amortization of
intangibles associated with the Royal Lock and Summit Manufacturing
acquisitions.
In 2006, the Company continued to experience increased costs related to the
required compliance with Section 404 of the Sarbanes-Oxley Act. The fees paid
during 2006 for assistance with the documentation required by Section 404 were
approximately $145,000, which does not include the cost of internal personnel.
The Company has completed the documentation phase of its process and will incur
additional costs in 2007 for third party testing of its internal control
procedures. Based on the Company's current public float and current regulations,
the Company will be required to report on its internal controls in the 2007 Form
10-K, which will be filed in March 2008. Future attestation fees, for work to be
completed by the independent registered public accounting firm, are projected to
be in the range of $230,000 - $350,000.
The Company adopted SFAS 123R, Share Based Payment (as Amended) effective
January 1, 2006. SFAS 123R eliminates the alternative to use the intrinsic value
method of accounting that was provided for in SFAS 123, which generally resulted
in no compensation expense recorded in the financial statements related to the
issuance of equity awards to employees and directors to the extent issued at
fair market value. SFAS 123R requires that the cost resulting from all
share-based payment transactions be recognized in the financial statements. SFAS
123R establishes fair value as the measurement objective in accounting for
share-based payment arrangements and requires all companies to apply a
fair-value-based measurement method in accounting generally for all share-based
payment transactions with employees. SFAS 123R does not require the recording of
compensation expense in periods prior to the date of adoption. As no stock
options were granted in 2006 and, as all options granted prior to January 1,
2006 were fully vested, there was no impact on the current year financial
statements.
The Company adopted SFAS No. 151, Inventory Costs, an amendment of ARB No. 43,
Chapter 4, effective January 1, 2006. The amendments made by SFAS No. 151
clarify that abnormal amounts of idle facility expense, freight, handling costs,
and wasted materials (spoilage) should be recognized as current-period charges
and require the allocation of fixed production overheads to inventory based on
the normal capacity of the production facilities. The adoption of SFAS No. 151
did not have a material impact on the consolidated financial statements of the
Company.
The Company adopted SFAS No. 154, Accounting Changes and Error Corrections--a
replacement of APB Opinion No. 20 (Accounting Changes) and FASB Statement No. 3
(Reporting Accounting Changes in Interim Financial Statements), effective
January 1, 2006. SFAS No. 154 provides guidance on accounting for and reporting
of accounting changes and error corrections. It requires retrospective
application to prior periods' financial statements, unless it is impracticable
to determine either the specific period effects or the cumulative effect of the
change. The adoption of SFAS No. 154 did not have a material impact on the
Company's consolidated financial statements.
On December 30, 2006, the Company adopted the recognition and disclosure
provisions of SFAS No. 158, Employers' Accounting for Defined Benefit Pension
and Other Postretirement Plans an amendment of FASB Statements No. 87, 88, 106,
and 132(R) ("SFAS No. 158"), which was issued by the FASB in September 2006.
This standard requires employers to recognize the underfunded or overfunded
status of a defined benefit postretirement plan as an asset or liability in its
statement of financial position and to recognize changes in the funded status in
the year in which the changes occur through accumulated other comprehensive
income. Additionally, SFAS No. 158 requires employers to measure the funded
status of a plan as of the date of its year-end statement of financial position.
As allowed under SFAS 158, the Company did not adopt the measurement date
provision in 2006. The Company will adopt the measurement date provision by 2008
as required.
In June 2006, the FASB issued Interpretation No. 48 ("FIN 48") Accounting for
Uncertainty in Income Taxes an interpretation of FASB Statement No. 109 ("SFAS
109"). This interpretation clarifies the accounting for uncertainty in income
taxes recognized in a company's financial statements in accordance with SFAS
109, Accounting for Income Taxes. FIN 48 details how companies should recognize,
measure, present, and disclose uncertain tax positions that have been or are
expected to be taken. As such, financial statements will reflect expected future
tax consequences of uncertain tax positions presuming the taxing authorities'
full knowledge of the position and all relevant facts. We are currently
analyzing the effect of FIN 48 on our financial statements. The Company will
adopt FIN 48 in the first quarter of 2007.
In September 2006, the U.S. Securities and Exchange Commission staff issued
Staff Accounting Bulletin No. 108 ("SAB 108"), Considering the Effects of Prior
Year Misstatements when Quantifying Misstatements in Current Year Financial
Statements. SAB 108 eliminates the diversity of practice surrounding how public
companies quantify financial statement misstatements. It establishes an approach
that requires quantification of financial statement misstatements based on the
effects of the misstatements on each of the company's financial statements and
the related financial statement disclosures. SAB 108 must be applied to annual
-16-
financial statements for their first fiscal year ending after November 15, 2006.
The application of SAB 108 did not have a material impact on our financial
condition or results of operations.
In September 2006, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 157, Fair Value Measurements ("SFAS No. 157"). This standard clarifies the
principle that fair value should be based on the assumptions that market
participants would use when pricing an asset or liability. Additionally, it
establishes a fair value hierarchy that prioritizes the information used to
develop those assumptions. We have not yet determined the impact that the
implementation of SFAS No. 157 will have on our results of operations or
financial condition. SFAS No. 157 is effective for financial statements issued
for fiscal years beginning after November 15, 2007.
Critical Accounting Policies and Estimates
The preparation of the financial statements in accordance with accounting
principles generally accepted in the United States ("U.S. GAAP") requires
management to make judgments, estimates and assumptions regarding uncertainties
that affect the reported amounts of assets and liabilities, the disclosure of
contingent assets and liabilities, and the reported amounts of revenues and
expenses. Areas of uncertainty that require judgments, estimates and assumptions
include items such as the accounting for derivatives; environmental matters; the
testing of goodwill and other intangible assets for impairment; proceeds on
assets to be sold; pensions and other postretirement benefits; and tax matters.
Management uses historical experience and all available information to make its
estimates and assumptions, but actual results will inevitably differ from the
estimates and assumptions that are used to prepare the Company's financial
statements at any given time. Despite these inherent limitations, management
believes that Management's Discussion and Analysis of Financial Condition and
Results of Operations and the financial statements and related footnotes provide
a meaningful and fair presentation of the Company.
Management believes that the application of these estimates and assumptions on a
consistent basis enables the Company to provide the users of the financial
statements with useful and reliable information about the Company's operating
results and financial condition.
Allowance for Doubtful Accounts
The Company maintains an allowance for doubtful accounts for estimated losses
resulting from the inability of its customers to make required payments. The
Company reviews the collectibility of its receivables on an ongoing basis taking
into account a combination of factors. The Company reviews potential problems,
such as past due accounts, a bankruptcy filing or deterioration in the
customer's financial condition, to ensure the Company is adequately accrued for
potential loss. Accounts are considered past due based on when payment was
originally due. If a customer's situation changes, such as a bankruptcy or
creditworthiness, or there is a change in the current economic climate, the
Company may modify its estimate of the allowance for doubtful accounts. The
Company will write off accounts receivable after reasonable collection efforts
have been made and the accounts are deemed uncollectible.
Inventory Reserve
Inventories are valued at the lower of cost or market. Cost is determined by the
last-in, first-out ("LIFO") method at the Company's U.S. facilities.
Accordingly, a LIFO valuation reserve is calculated using the dollar value link
chain method.
We review the net realizable value of inventory in detail on an ongoing basis,
giving consideration to deterioration, obsolescence and other factors. Based on
these assessments, we provide for an inventory reserve in the period in which an
impairment is identified. The reserve fluctuates with market conditions, design
cycles and other economic factors.
Goodwill and Other Intangible Assets
Intangible assets with finite useful lives are amortized generally on a
straight-line basis over the periods benefited. Goodwill and other intangible
assets with indefinite useful lives are not amortized. Each year during the
second quarter, the carrying value of goodwill and other intangible assets with
indefinite useful lives is tested for impairment. The Company uses the
discounted cash flow method to calculate the fair value of goodwill associated
with its reporting units; no impairments of goodwill were deemed to exist. The
determination of discounted cash flows is based on the businesses' strategic
plans and long-range planning forecasts. The revenue growth rates included in
the plans are management's best estimates based on current and forecasted market
conditions; profit margin assumptions are projected by each business based on
the current cost structures and anticipated cost reductions. There can be no
assurance that operations will achieve the future cash flows reflected in the
-17-
projections. If different assumptions were used in these plans, the related
discounted cash flows used in measuring impairment could be different and an
impairment of assets might need to be recorded.
Pension and Other Postretirement Benefits
The amounts recognized in the consolidated financial statements related to
pension and other postretirement benefits are determined from actuarial
valuations. Inherent in these valuations are assumptions about such factors as
expected return on plan assets, discount rates at which liabilities could be
settled, rate of increase in future compensation levels, mortality rates and
trends in health insurance costs. These assumptions are reviewed annually and
updated as required. In accordance with U.S. GAAP, actual results that differ
from the assumptions are accumulated and amortized over future periods and,
therefore, affect the expense recognized and obligations recorded in future
periods.
The discount rate used is based on comparisons to the Moody's Aa Corporate Bond
index, as well as a hypothetical yield curve that creates a reference portfolio
of high quality corporate bonds whose payments mimic the plan's benefit payment
stream. The expected long-term rate of return on assets is developed with input
from the Company's actuarial firms. Also considered is the Company's historical
experience with pension fund asset performance in comparison with expected
returns. The long-term rate-of-return assumption used for determining net
periodic pension expense for 2006 was 8.5%. The Company reviews the long-term
rate of return each year. Future actual pension income and expense will depend
on future investment performance, changes in future discount rates and various
other factors related to the population of participants in the Company's pension
plans.
The Company expects to make cash contributions to its pension plans of
approximately $2.1 million in 2007.
RESULTS OF OPERATIONS
Fiscal 2006 Compared to Fiscal 2005
The following table shows, for 2006 and 2005, selected line items from the
consolidated statements of income as a percentage of net sales, by segment.
2006
--------------------------------------------------------
Industrial Security Metal
Hardware Products Products Total
--------------------------------------------------------
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of products sold 70.5% 74.2% 104.2% 75.0%
Gross margin 29.5% 25.8% -4.2% 25.0%
Selling and administrative expense 12.1% 16.8% 9.9% 13.6%
Operating profit 17.4% 9.0% -14.1% 11.4%
2005
--------------------------------------------------------
Industrial Security Metal
Hardware Products Products Total
--------------------------------------------------------
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of products sold 75.6% 72.1% 107.2% 77.3%
Gross margin 24.4% 27.8% -7.2% 22.7%
Selling and administrative expense 14.7% 17.5% 9.8% 15.4%
Operating profit 9.7% 10.3% -17.0% 7.3%
-18-
The following table shows the amount of change from 2005 to 2006 in sales, cost
of products sold, gross margin, selling and administrative expenses and
operating profit, by segment (dollars in thousands):
Industrial Security Metal
Hardware Products Products Total
-----------------------------------------------------------------
Net sales $ 21,590 $ 5,743 $ 2,025 $ 29,358
Volume -1.9% 11.3% 12.5% 4.9%
Prices 0.0% 0.0% 0.6% 0.0%
New Products 42.0% 1.7% 5.4% 22.0%
---- ---- ---- ----
40.1% 13.0% 18.5% 26.9%
Cost of products sold $ 12,533 $ 5,181 $ 1,793 $ 19,507
30.8% 16.2% 15.3% 23.1%
Gross margin $ 9,057 $ 562 $ 232 $ 9,851
68.8% 4.5% 29.7% 39.8%
Selling and
administrative expenses $ 1,178 $ 624 $ 211 $ 2,013
14.9% 8.0% 19.6% 12.0%
Operating profit $ 7,879 $ (62) $ 21 $ 7,838
150.6% -1.4% 1.2% 98.5%
INDUSTRIAL HARDWARE SEGMENT
Net sales in the Industrial Hardware segment were up 40.1% in 2006 from the 2005
level. New product introductions, mainly the component parts for the Humvee
retrofit program, were responsible for the increase in sales for this segment.
All of the new products were internally developed and offered to the variety of
markets we service including: military, utility truck, vehicular accessories and
recreational vehicles. New products included retrofit components for military
Humvees, a hidden hinge used on service truck bodies, a three point handle
assembly and a star wheel rotary assembly for the truck accessory market and
pickup truck camper shell used in the emergency vehicle market as well as an
assortment of handles and latches used in many of the markets we sell to. Sales
volume of existing products was up in all but two of the markets we service -
truck trailers and van bodies. Sales at the Company's Mexican subsidiary
increased 12% from 2005 primarily due to economic growth in Mexico.
Cost of products sold for the Industrial Hardware segment increased 30.8% from
2005 to 2006. In addition to manufacturing costs associated with the higher
volume of sales, the major factor causing the increase was the higher costs of
raw materials.
Gross margin as a percentage of net sales increased from 24.4% to 29.5%, which
is a direct result of the significant increase in sales volume resulting in more
efficient utilization of our existing facilities.
Selling and administrative expenses increased 14.9% from 2005 levels due to
increases in payroll and payroll related charges.
SECURITY PRODUCTS SEGMENT
Net sales in the Security Products segment increased 13.0% from 2005 to 2006.
Increased sales volume of existing products in our core lock business coupled
with the acquisitions of Royal Lock and Summit Manufacturing, more than offset
declines in sales volume of our commercial laundry products. Volume decreases
occurred in traditional laundry products such as drop meters and meter cases as
well as the newer "smart card" systems. Most of the 2006 decline in "smart card"
systems was due to a retro-fit of card systems in 2005. In addition to the oven
latch line from the Summit Manufacturing acquisition, new products were mainly
lock related, such as: a car carrier clamp assembly, an L-handle for a sportrack
and an electric car lock set used in the automotive accessories market as well
as a variety of other lock products for various markets.
Cost of products sold for the Security Products segment increased 16.2% from
2005 to 2006. Most of the increase in cost of products sold was directly
proportionate to the increase in sales. The major item that outpaced the
-19-
increased sales level were raw material costs, which we were not able to be
recover through increased prices due to the competitive nature of many of the
markets we sell to.
Gross margin decreased from 27.8% to 25.8% as a percentage of net sales for the
Security Products segment resulting from the higher manufacturing costs, mainly
raw materials, as well as a change in product mix.
Selling and administrative expenses increased 8.0% from the same period a year
ago due to higher costs for payroll and payroll related charges, advertising
expenses and amortization of intangibles associated with the acquisitions of
Royal Lock and Summit Manufacturing.
METAL PRODUCTS SEGMENT
Net sales in the Metal Products segment increased 18.5% from 2005 to 2006. Sales
of mine products increased 20% in 2006 compared to 2005, while sales of contract
casting products increased 16% from 2005. In 2006, sales of mine roof supports
increased in both the U.S. and Canadian markets. Shipments of ductile iron
castings increased 35% to 973 tons in 2006 from 723 tons in 2005. The Company
continued its marketing efforts to sell mine roof anchor products in Australia
and China. Sales of new products in 2006 included a new mine roof anchor for the
Canadian market and a variety of dome nuts for use in underground mining
applications.
Cost of products sold decreased as a percentage of net sales due mainly to
higher sales volume. Cost increases were experienced for raw materials, payroll
and payroll related charges, supplies and tools and equipment maintenance. In
order to improve the efficiency of producing ductile iron castings, the Company
installed a new automatic pouring system designed specifically for ductile iron
in July 2006. The Company experienced higher costs than anticipated with the
start-up of the equipment and did not start achieving the anticipated
improvement in pouring efficiency until late in the fourth quarter of 2006.
Gross margin in the Metal Products segment improved slightly as a percentage of
net sales mainly due to higher sales volume resulting in better utilization of
production facilities and product mix.
Selling and administrative expenses in the Metal Products segment increased
19.6% from 2005 to 2006, due to increases in payroll and payroll related
charges, advertising and travel expenses.
Other Items
The following table shows the amount of change from 2005 to 2006 in other items
(dollars in thousands):
Total
-------
Interest expense $ 84
8.2%
Other income $ 72
92.0%
Income taxes $ 2,534
95.5%
Interest expense increased from 2005 to 2006 primarily due to the increased
level of debt associated with the amended Loan Agreement, which is discussed in
Note 5 in Item 8 of this Form 10-K.
Other income increased from 2005 to 2006 due to a gain on the termination of a
swap agreement, which is discussed in Note 5 in Item 8 of this Form 10-K.
Income taxes - the effective tax rate decreased in 2006 to 35% from the 38% rate
in 2005. The decrease is the result of a change in the mix of U.S and foreign
income, as well as a change in the mix of U.S. earnings in states with lower
income tax rates.
-20-
FISCAL 2005 COMPARED TO FISCAL 2004
The following table shows, for 2005 and 2004, selected line items from the
consolidated statements of income as a percentage of net sales, by segment.
2005
--------------------------------------------------------
Industrial Security Metal
Hardware Products Products Total
--------------------------------------------------------
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of products sold 75.6% 72.1% 107.2% 77.3%
Gross margin 24.4% 27.8% -7.2% 22.7%
Selling and administrative expense 14.7% 17.5% 9.8% 15.4%
Operating profit 9.7% 10.3% -17.0% 7.3%
2004
--------------------------------------------------------
Industrial Security Metal
Hardware Products Products Total
--------------------------------------------------------
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of products sold 72.5% 71.5% 96.7% 74.9%
Gross margin 27.5% 28.5% 3.3% 25.1%
Selling and administrative expense 16.8% 20.3% 8.0% 17.3%
Operating profit 10.7% 8.2% -4.7% 7.8%
The following table shows the amount of change from 2004 to 2005 in sales, cost
of products sold, gross margin, selling and administrative expenses and
operating profit, by segment (dollars in thousands):
Industrial Security Metal
Hardware Products Products Total
------------------------------------------------------------------
Net sales $ 7,853 $ 1,901 $ (777) $ 8,977
Volume 4.3% 1.8% -6.4% 2.0%
Prices 3.2% 1.1% -0.3% 1.9%
New Products 9.6% 1.6% 0.1% 5.1%
---- ---- ---- ----
17.1% 4.5% -6.6% 9.0%
Cost of products sold $ 7,352 $ 1,631 $ 392 $ 9,375
22.1% 5.4% 3.5% 12.5%
Gross margin $ 501 $ 270 $ (1,169) $ (398)
4.0% 2.2% -302.8% -1.6%
Selling and administrative
expenses $ 204 $ (847) $ 139 $ (504)
2.6% -9.8% 14.9% -2.9%
Operating profit $ 297 $ 1,117 $ (1,308) $ 106
6.0% 32.2% -238.7% 1.3%
-21-
INDUSTRIAL HARDWARE SEGMENT
Net sales in the Industrial Hardware segment were up 17.1% in 2005 from the 2004
level. New product introductions were responsible for over half of the increase
in sales for this segment. All of the new products were internally developed and
aimed at a variety of the markets we service including: military, utility truck,
vehicular accessories and recreational vehicles. New products included a
retro-fit kit for the military Humvee, a remote power lock kit for utility truck
bodies, a trailer ramp and pickup truck camper for the recreational vehicle
markets and an assortment of handles and latches used in many of the markets we
sell to. Sales volume of existing products was up in all but two of the markets
we service - truck accessories and van bodies. Sales volume increased 37% for
"sleeper boxes" for the Class 8 trailer truck market, a product resulting from
the Canadian Commercial Vehicles acquisition in 2002. Sales at the Company's
Mexican subsidiary increased 17% from 2004 primarily due to economic growth in
Mexico. Price increases generally offset higher raw material and production
costs and did not result in an increase in gross margins.
Cost of products sold for the Industrial Hardware segment increased 22.1% from
2004 to 2005. In addition to manufacturing costs associated with the higher
volume of sales, higher costs were experienced in utilities, raw materials, and
expediting the introduction of new products, all of which contributed to the
increase.
Gross margin as a percentage of net sales decreased from 27.5% to 24.4% due to
the higher manufacturing costs, price reductions in select product lines to
remain competitive and a change in product mix.
Selling and administrative expenses increased 2.6% from 2004 levels due to
increases in payroll and payroll related charges, advertising and travel
expenses.
SECURITY PRODUCTS SEGMENT
Net sales in the Security Products segment increased 4.5% from 2004 to 2005.
Increased sales volume of existing products was primarily related to the
commercial laundry industry. Volume increases occurred in traditional products
such as drop meters and meter cases as well as the newer "smart card" systems.
New products were mainly lock related, such as: a toolbox push button lock, car
carrier clamp assembly, electric car lock set, and brackets used in the
automotive accessories market as well as a variety of other items for various
markets. Price increases generally offset higher raw material and production
costs and did not result in an increase in gross margins.
Cost of products sold for the Security Products segment increased 5.4% from 2004
to 2005. Most of the increase in cost of products sold was directly
proportionate to the increase in sales. Several items which outpaced the
increased sales level included payroll, freight on sales due to higher fuel
costs and utilities, which contributed to the increase in cost of products sold.
Gross margin decreased from 28.5% to 27.8% as a percentage of net sales for the
Security Products segment resulting from the higher sales volume offset by
higher manufacturing costs, price reductions in select product lines to remain
competitive and a change in product mix.
Selling and administrative expenses decreased 9.8% from the same period a year
ago due to fees and costs incurred in 2004 for defending against and settlement
of a patent infringement suit.
METAL PRODUCTS SEGMENT
Net sales in the Metal Products segment were down 6.6% from 2004 to 2005. Sales
of mine products were comparable for both years. Although sales of contract
casting products declined 19% in 2005, shipments of ductile iron castings more
than doubled from 324 tons in 2004 to 723 tons in 2005. In 2005, the Company
added a salesman in Canada to focus on the Canadian mining business which
resulted in increased business in 2006. We also expanded our marketing efforts
for our mine roof anchor products into Australia and China. Late in the second
quarter of 2005, we completed our testing at a technology and authentication
meeting in Changzhi, China which was sponsored by the China University of Mining
and Technology. The China mining association approved our products for use in
the China mining industry, stating that our products represented superior
technology.
-22-
Cost of products sold increased as a percentage of net sales mainly due to the
fixed costs associated with the Metal Products segment. While costs related to
volume declined, such as payroll and payroll related charges, supplies and tools
and maintenance and repairs, increases were experienced in insurance costs and
utilities. Rates for both natural gas and electricity increased 47% and 14%,
respectively. The division also was negatively impacted by the higher labor cost
of manually pouring ductile iron. As part of the Company's longer term strategy
of reducing the dependence on only pouring malleable iron, the Company
determined that it can also produce quality ductile iron castings. In order to
improve the efficiency of producing ductile iron castings, the Company installed
a new automatic pouring system designed specifically for ductile iron in July of
2006.
Gross margin in the Metal Products segment decreased as a percentage of net
sales mainly due to lower sales volume, producing ductile iron castings and a
change in product mix.
Selling and administrative expenses in the Metal Products segment increased
14.9% from 2004 to 2005, primarily due to the addition of sales personnel in
Canada and increased travel expenses associated with testing and marketing mine
roof anchors in China.
Other Items
The following table shows the amount of change from 2004 to 2005 in other items
(dollars in thousands):
Total
-------
Interest expense $ (30)
-2.9%
Other income $ 55
240.8%
Income taxes $ 582
28.1%
Interest expense decreased from 2004 to 2005 primarily due to the new interest
rate swap contract associated with the amended Loan Agreement, which is
discussed in Note 4 in Item 8 of the 2005 Form 10-K. This swap contract fixed
the rate at 4.61% compared to the old swap contract rate of 9.095%.
Other income increased from 2004 to 2005 due to higher cash balances in the
Company cash management program which resulted in higher interest income.
Income taxes increased from 2004 to 2005 due to a higher effective tax rate, 38%
in 2005 versus 30% in 2004, resulting primarily from a change in the mix of
taxable earnings in foreign jurisdictions with higher effective tax rates and
the imposition of higher state tax rates.
LIQUIDITY AND SOURCES OF CAPITAL
The Company's financial position remained strong throughout 2006. The primary
source of the Company's cash is earnings from operating activities adjusted for
cash generated from or used for net working capital. The most significant
recurring non-cash items included in income are depreciation and amortization
expense. Changes in working capital fluctuate with the changes in operating
activities. As sales increase, there generally is an increased need for working
capital. Since increases in working capital reduce the Company's cash,
management attempts to keep the Company's investment in net working capital at a
reasonable level by closely monitoring inventory levels (by matching production
to expected market demand), keeping tight control over the collection of
receivables, and optimizing payment terms on its trade and other payables.
-23-
The Company is dependent on the continued demand for its products and subsequent
collection of accounts receivable from its customers. The Company serves a broad
base of customers and industries with a variety of products. As a result, any
fluctuations in demand or payment from a particular industry or customer will
not have a material impact on the Company's sales and collection of receivables.
Management expects that the Company's foreseeable cash needs for operations,
capital expenditures, debt service and dividend payments will continue to be met
by the Company's operating cash flows and existing credit facility.
2006 2005 2004
----------------------------------
Current ratio 2.5 3.3 2.9
Average days' sales in accounts receivable 46 48 47
Inventory turnover 3.7 4.1 3.7
Ratio of working capital to sales 25.7% 28.6% 26.7%
Total debt to shareholders' equity 37.9% 34.2% 36.1%
At December 30, 2006, December 31, 2005, and January 1, 2005, the Company had
cash and cash equivalents of $3.1 million, $6.3 million and $4.4 million,
respectively, and working capital of $35.5 million, $31.2 million and $26.7
million, respectively.
Net cash provided by operating activities was $7.9 million in 2006 compared to
$5.2 million in 2005 and $4.9 million in 2004. The $2.7 million increase from
2005 to 2006 is primarily the result of the increase in earnings in 2006, as
well as changes in the components of working capital. The $0.3 million increase
from 2004 to 2005 related primarily to changes in the components of working
capital. During 2006, working capital used $5.6 million in cash as a result of
increased sales activity, primarily in the 4th quarter of the year. Increases in
accounts receivable and inventory accounted for $14.4 million of cash usage
while increases in accounts payable, accrued compensation and other accrued
expenses provided $8.9 million in cash. In 2005, working capital used $2.7
million in cash as a result of increased sales activity. Accounts receivable
accounted for most of the increase, rising $2.2 million. In 2004, working
capital used approximately $3.6 million in cash as a result of increased sales
activity. Included in this amount were a $3.3 million increase in inventories
and a $1.6 million increase in accounts receivable, offset by a $500,000
increase in accounts payable and an $800,000 increase in accrued compensation.
During 2006, 2005 and 2004 the Company used $14.2, $1.7 and $2.0 million of cash
in investing activities, respectively. In 2006, the Company made two small
acquisitions which used approximately $7.5 million in cash. The remaining $6.7
million in 2006 and virtually all of the amounts for 2005 and 2004 related to
the purchase of fixed assets. Significant purchases in 2006 included $2.2
million of land and building for one of the Company's Security Products Segment
manufacturing facilities, approximately $600,000 in new equipment purchases
related to a significant contract received by the Industrial Hardware Segment,
and approximately $570,000 for an automatic pouring system for ductile iron for
the Metal Products Segment. The Company expects capital expenditures for 2007 to
be approximately $4.5 million to $5.5 million.
Net cash provided by financing activities in 2006 totaled approximately $3.2
million. This was the result of the Company's restructuring of its outstanding
debt in order to provide cash for the business and fixed asset acquisitions
previously described above. See additional details concerning debt below. Net
cash used by financing activities totaled $1.6 million and $3.4 million in 2005
and 2004, respectively. During 2005, the Company borrowed an additional $3.0
million on its revolving credit facility to cover short-term cash requirements.
Principal payments of long-term debt amounted to $3.0 million and $2.0 million
in 2005 and 2004, respectively.
The Company leases certain equipment and buildings under cancelable and
non-cancelable operating leases expiring at various dates up to 10 years. Rent
expense amounted to approximately $945,000, $826,000 and $642,000 in 2006, 2005
and 2004, respectively.
On September 22, 2006, the Company amended the unsecured loan agreement ("Loan
Agreement"), which includes a term portion and a revolving credit portion, with
its lender, Bank of America, N.A. The amendment restructures and increases the
balance of the term portion of the loan into a new seven (7) year loan in the
amount of $20,000,000. The restructured term portion is payable in quarterly
payments of $714,286 beginning January 2, 2007. The proceeds were used to repay
in full the outstanding balance of its existing term loan, $12,625,000, and for
the acquisition of Royal Lock.
In addition, the Company increased the maximum amount available under the
revolving credit portion from $7,500,000 to $12,000,000 and renewed and extended
the maturity date to September 22, 2009. The revolving credit portion has a
variable quarterly commitment fee ranging from 0.10% to 0.25% based on operating
results. As of December 30, 2006, the quarterly fee is 0.15% on the unused
portion.
-24-
The interest rates on the term and the revolving credit portions of the Loan
Agreement vary. The interest rates may vary based on the LIBOR rate plus a
margin spread of 1.0% to 1.65% for the term portion and 1.0% to 1.6% for the
revolving credit portion. The margin rate spread is based on operating results
calculated on a rolling-four-quarter basis. The Company may also borrow funds at
the lender's prime rate. On December 30, 2006, the interest rate on the term
portion of the Loan Agreement was 6.62%.
Also on September 22, 2006, the Company terminated its interest rate swap
contract with the lender. At the time of termination, the notional amount was
$9,468,750, which was equal to 75% of the outstanding balance of the term loan
on that date. As a result of the termination, the Company received $73,100 of
cash which was included in other income. The Company had originally entered into
the interest rate swap contract with an original notional amount of $11,793,750
which was equal to 75% of the outstanding balance of the term loan on August 11,
2005. The notional amount began to decrease on a quarterly basis beginning
October 3, 2005 following the principal repayment schedule of the term portion
of the Loan Agreement. The Company had a fixed interest rate of 4.61% on the
swap contract and paid the difference between the fixed rate and LIBOR when
LIBOR was below 4.61% and received interest when the LIBOR rate exceeded 4.61%.
On November 2, 2006, the Company entered into an interest rate swap contract
with the lender with an original notional amount of $20,000,000 (notional amount
$20,000,000 on December 30, 2006), which was equal to 100% of the outstanding
balance of the term loan on that date. The notional amount will decrease on a
quarterly basis beginning January 2, 2007 following the principal repayment
schedule of the term loan. The Company has a fixed interest rate of 5.25% on the
swap contract and will pay the difference between the fixed rate and LIBOR when
LIBOR is below 5.25% and will receive interest when the LIBOR rate exceeds
5.25%.
On August 1, 2005, the Company had also amended the Loan Agreement. The
amendment renewed and extended the maturity of the revolving credit loan from
July 1, 2005 to August 1, 2007 and restructured and increased the existing
balance of the term loan into a new five (5) year term loan. The additional
$4,000,000 proceeds from the term loan were used to pay down the balance on the
revolving credit agreement at that time.
Previously, the Company maintained an interest rate swap contract, as required,
with the lender for an original notional amount of $15,000,000 (notional amount
$6,600,000 on January 1, 2005), which was reduced on a quarterly basis in
accordance with the principal repayment schedule of the term portion of the Loan
Agreement. The interest rate on the swap contract was at a fixed rate of 9.095%
and expired on July 1, 2005.
The Company's loan covenants restrict it from incurring any indebtedness (from
any person other than the lender) that exceeds the aggregate sum of $1.5
million, or that exceeds $1.0 million in any single transaction, without the
express consent of the lender or until the full payment of the current
obligation has been made. The loan covenants also prohibit the Company from
paying any dividends in the event the payment would result in a default under
the terms of the Loan Agreement.
Tabular Disclosure of Contractual Obligations
The Company's known contractual obligations as of December 30, 2006, are shown
below:
Payment due by period
Less than More than 5
Contractual Obligations (in thousands) Total 1 Year 1-3 Years 3-5 Years Years
------- -------- --------- --------- -------
Long-term debt obligations $ 20,000 $ 2,857 $ 5,714 $ 5,714 $ 5,715
Estimated interest on long-term debt
and capital lease obligations 4,531 1,300 1,856 1,049 326
Capital lease obligations 619 255 364 - -
Operating lease obligations 1,762 595 1,060 107 -
Estimated contributions to pension plans 5,324 2,102 2,721 259 242
Estimated postretirement benefits
other than pensions 1,221 165 323 325 408
-------- -------- -------- -------- --------
Total $ 33,457 $ 7,274 $ 12,038 $ 7,454 $ 6,691
======== ======== ======== ======== ========
The amounts shown in the above table for estimated contributions to pension
plans and estimated postretirement benefits other than pensions are based on the
assumptions in Note 10 to the consolidated financial statements as well as the
assumption that participant counts will remain stable.
-25-
The Company does not have any non-cancelable open purchase orders.
At December 30, 2006, the Company maintained a stand-by letter of credit in the
amount of $559,000 related to one of its capital leases. This amount is
declining on a monthly basis as payments on the lease are made. The stand-by
letter of credit reserves that amount from the Company's revolving credit
agreement under terms of the capital lease agreement.
ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's foreign manufacturing facilities account for approximately 20% of
total sales and 14% of total assets. Its U.S. operations buy from and sell to
these foreign affiliates, and also make limited sales (approximately 7% of total
sales) to nonaffiliated foreign customers. This trade activity could be affected
by fluctuations in foreign currency exchange or by weak economic conditions. The
Company's currency exposure is concentrated in the Canadian dollar, Mexican
peso, New Taiwan dollar, Chinese RMB and Hong Kong dollar. Because of the
Company's limited exposure to any single foreign market, any exchange gains or
losses have not been material and are not expected to be material in the future.
Had the exchange rate as of December 30, 2006 for all of the listed currencies
changed by 1%, the total change in reported earnings would have been less than
$20,000. As a result, the Company does not attempt to mitigate its foreign
currency exposure through the acquisition of any speculative or leveraged
financial instruments. In 2006, a 10% increase/decrease in exchange rates would
have resulted in a translation increase/decrease to sales of approximately $2.6
million, and to equity of approximately $1.6 million.
The Company is exposed to interest rate risk with respect to its unsecured Loan
Agreement, which provides for interest based on LIBOR plus a spread of up to
1.65%. The spread is determined by a comparison of the Company's operating
performance with agreed-upon financial targets. Since the Company's performance
depends to a large extent on the overall economy, the interest rate paid by the
Company under its Loan Agreement is closely linked to the trend in the U.S.
economy. The current interest rate spread is 1.25% on both the term loan portion
and the revolving credit line portion of the Loan Agreement. Changes in LIBOR
rates will also affect the Company's interest expense. To hedge against future
LIBOR rate increases, the Company has an interest rate swap contract on 100% of
the term loan principal amount under the Loan Agreement. The interest rate on
the swap contract is 5.25% and the swap contract expires on September 22, 2013.
The notional amount of the swap contract is reduced on a quarterly basis in
accordance with the principal repayment schedule for the term portion of the
Loan Agreement. The notional amount of the swap contract was $20.0 million as of
December 30, 2006. Therefore, the term debt is not subject to the volatility of
short-term interest rates because the entire amount of debt is hedged under the
swap contract.
-26-
ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Eastern Company
Consolidated Balance Sheets
December 30 December 31
2006 2005
----------- -----------
ASSETS
Current Assets
Cash and cash equivalents $ 3,101,458 $ 6,345,947
Accounts receivable, less allowances of $319,000 in 2006 and
$295,000 in 2005 24,859,152 14,825,014
Inventories:
Raw materials and component parts 8,008,603 9,917,792
Work in process 6,366,354 4,681,623
Finished goods 13,667,609 6,168,334
------------- -------------
28,042,566 20,767,749
Prepaid expenses and other assets 2,391,425 2,391,125
Deferred income taxes 931,641 715,321
------------- -------------
Total Current Assets 59,326,242 45,045,156
Property, Plant and Equipment
Land 1,102,628 702,633
Buildings 13,687,524 11,802,519
Machinery and equipment 32,068,499 29,963,621
Accumulated depreciation (21,042,934) (20,072,087)
------------- -------------
25,815,717 22,396,686
Other Assets
Goodwill 13,742,160 10,641,532
Trademarks 117,959 103,498
Patents, technology and other intangibles net of accumulated
amortization 4,216,508 1,946,502
Interest rate swap asset - 32,081
Intangible pension asset - 732,554
Prepaid pension cost 266,358 723,826
------------- -------------
18,342,985 14,179,993
------------- -------------
$ 103,484,944 $ 81,621,835
============= =============
-27-
Consolidated Balance Sheets
December 30 December 31
2006 2005
----------- -----------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Accounts payable $ 13,170,491 $ 5,599,260
Accrued compensation 3,098,525 1,527,640
Other accrued expenses 4,399,358 3,275,159
Current portion of long-term debt 3,111,908 3,420,523
------------- ------------
Total Current Liabilities 23,780,282 13,822,582
Deferred income taxes 1,123,537 895,019
Long-term debt, less current portion 17,506,802 12,384,338
Accrued postretirement benefits 1,221,156 2,078,056
Accrued pension cost 5,323,550 6,270,075
Interest rate swap obligation 138,412 -
Shareholders' Equity
Voting Preferred Stock, no par value:
Authorized and unissued: 1,000,000 shares
Nonvoting Preferred Stock, no par value:
Authorized and unissued: 1,000,000 shares
Common Stock, no par value:
Authorized: 25,000,000 shares
Issued: 8,012,550 shares in 2006 and 7,992,626 shares in 2005 17,974,115 17,694,851
Treasury Stock: 2,533,089 shares in 2006 and 2005 (16,655,041) (16,655,041)
Retained earnings 58,279,371 50,335,658
Accumulated other comprehensive income (loss):
Foreign currency translation 756,452 818,566
Unrecognized net pension and postretirement benefit costs, net
of taxes (5,875,261) -
Additional minimum pension liability, net of taxes - (6,042,553)
Derivative financial instruments, net of taxes (88,431) 20,284
------------- ------------
(5,207,240) (5,203,703)
------------- ------------
Total Shareholders' Equity 54,391,205 46,171,765
------------- ------------
$ 103,484,944 $ 81,621,835
============= ============
See accompanying notes.
-28-
Consolidated Statements of Income
Year ended
-----------------------------------------------------
December 30 December 31 January 1
2006 2005 2005
------------- ------------- -----------
Net sales $ 138,465,411 $ 109,107,290 $ 100,130,158
Cost of products sold (103,881,660) (84,374,501) (74,999,119)
--------------- --------------- --------------
Gross margin 34,583,751 24,732,789 25,131,039
Selling and administrative expenses (18,789,514) (16,776,253) (17,280,348)
--------------- --------------- --------------
Operating profit 15,794,237 7,956,536 7,850,691
Interest expense (1,097,640) (1,014,052) (1,044,490)
Other income 149,451 77,823 22,838
--------------- --------------- --------------
Income before income taxes 14,846,048 7,020,307 6,829,039
Income taxes 5,187,300 2,653,120 2,071,338
--------------- --------------- --------------
Net income $ 9,658,748 $ 4,367,187 $ 4,757,701
=============== =============== ==============
Earnings per Share:
Basic $ 1.76 $ .80 $ .87
=============== =============== ==============
Diluted $ 1.67 $ .75 $ .85
=============== =============== ==============
See accompanying notes.
Consolidated Statements of Comprehensive Income
Year ended
------------------------------------------------------
December 30 December 31 January 1
2006 2005 2005
------------- ------------- -----------
Net income $ 9,658,748 $ 4,367,187 $ 4,757,701
Other comprehensive income/(loss) -
Change in foreign currency translation (62,114) 354,762 630,099
Change in fair value of derivative financial
instruments, net of income taxes (benefit)
of ($35,301) in 2006, $75,797 in 2005 and
$168,000 in 2004 (62,092) 116,701 251,638
Reclassification adjustment for termination of
derivative financial instrument, net of
income tax benefit of $26,477 (46,623) - -
Change in additional minimum pension liability
net of income taxes (benefit) of $927,837 in
2006, ($584,440) in 2005 and ($227,839) in
2004 1,466,438 (994,753) (997,914)
Effect on net pension and postretirement
benefit costs related to the adoption of FAS
158, net of income tax benefit of $734,263
in 2006 (1,299,146) - -
--------------- ---------------- ---------------
(3,537) (523,290) (116,177)
--------------- ---------------- ---------------
Comprehensive income $ 9,655,211 $ 3,843,897 $ 4,641,524
=============== ================ ===============
See accompanying notes.
-29-
Consolidated Statements of Shareholders' Equity
Common Common Treasury Treasury Retained
Shares Stock Shares Stock Earnings
------ ------ -------- -------- --------
Balances at January 3, 2004 7,944,572 $17,177,797 (2,520,513) $(16,512,848) $44,406,855
Net income 4,757,701
Cash dividends declared, $.29 per share (1,595,985)
Purchase of Common Stock for treasury (12,576) (142,193)
Issuance of Common Stock upon the exercise of
stock options 33,750 324,800
Issuance of Common Stock for directors' fees 7,068 80,964
--------- ----------- --------- ------------ ------------
Balances at January 1, 2005 7,985,390 17,583,561 (2,533,089) (16,655,041) 47,568,571
Net income 4,367,187
Cash dividends declared, $.29 per share (1,600,100)
Tax benefit from disqualifying disposition of
incentive stock options 6,403
Issuance of Common Stock for directors' fees 7,236 104,887
--------- ----------- --------- ------------ ------------
Balances at December 31, 2005 7,992,626 17,694,851 (2,533,089) (16,655,041) 50,335,658
Net income 9,658,748
Cash dividends declared, $.31 per share (1,715,035)
Issuance of Common Stock upon the exercise of
stock options 15,000 203,700
Cash payment for fractional shares resulting from
3-for-2 stock split effective October 2006 (94) (1,633)
Issuance of Common Stock for directors' fees 5,018 77,197
--------- ----------- --------- ------------ ------------
Balances at December 30, 2006 8,012,550 $17,974,115 (2,533,089) $(16,655,041) $58,279,371
========= =========== ========== ============ ===========
See accompanying notes.
-30-
Consolidated Statements of Cash Flows
Year ended
-----------------------------------------------------
December 30 December 31 January 1
2006 2005 2005
------------- ------------ -----------
Operating Activities
Net income $ 9,658,748 $ 4,367,187 $ 4,757,701
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 3,745,693 3,459,747 3,461,411
Loss on sale of equipment and other assets 2,574 3,314 67,620
Provision for doubtful accounts 58,424 6,433 112,222
Deferred income taxes (119,413) (27,293) (8,092)
Issuance of Common Stock for directors' fees 77,197 104,887 80,964
Changes in operating assets and liabilities:
Accounts receivable (8,844,177) (2,155,923) (1,639,624)
Inventories (5,601,588) (88,147) (3,299,948)
Prepaid expenses and other 4,413 (147,867) (634,445)
Prepaid pension cost 97,106 (428,959) 581,724
Other assets (142,673) (218,801) (105,674)
Accounts payable 6,516,275 524,078 495,218
Accrued compensation 1,313,076 (800,582) 790,492
Other accrued expenses 1,097,299 600,331 194,244
------------- ------------- -------------
Net cash provided by operating activities 7,862,954 5,198,405 4,853,813
Investing Activities
Purchases of property, plant and equipment (6,721,581) (1,750,252) (2,062,313)
Proceeds from sale of equipment and other assets 19,374 750 13,367
Business acquisitions (7,536,916) - -
------------- ------------- -------------
Net cash used in investing activities (14,239,123) (1,749,502) (2,048,946)
Financing Activities
Principal payments on long-term debt (15,255,099) (3,009,811) (2,007,357)
Proceeds from issuance of long-term debt 20,000,000 - -
Proceeds from revolving credit loan - 3,000,000 -
Proceeds from sales of Common Stock 203,700 - 324,800
Tax benefit from disqualifying disposition of incentive
stock options - 6,403 -
Purchases of Common Stock for treasury - - (142,193)
Cash payment for fractional shares resulting from
3-for-2 stock split (1,633) - -
Dividends paid (1,715,035) (1,600,100) (1,595,985)
------------- ------------- -------------
Net cash provided by (used in) financing activities 3,231,933 (1,603,508) (3,420,735)
Effect of exchange rate changes on cash (100,253) 80,046 139,558
------------- ------------- -------------
Net change in cash and cash equivalents (3,244,489) 1,925,441 (476,310)
Cash and cash equivalents at beginning of year 6,345,947 4,420,506 4,896,816
------------- ------------- -------------
Cash and cash equivalents at end of year $ 3,101,458 $ 6,345,947 $ 4,420,506
============= ============= =============
See accompanying notes.
-31-
The Eastern Company
Notes to Consolidated Financial Statements
1. OPERATIONS
The operations of The Eastern Company (the "Company") consist of three business
segments: industrial hardware, security products, and metal products. The
industrial hardware segment produces latching devices for use on industrial
equipment and instrumentation as well as a broad line of proprietary hardware
designed for truck bodies and other vehicular type equipment. The security
products segment manufactures and markets a broad range of locks for traditional
general purpose security applications as well as specialized locks for soft
luggage, coin-operated vending and gaming equipment, and electric and computer
peripheral components. This segment also manufactures and markets coin acceptors
and metering systems to secure cash used in the commercial laundry industry and
produces cashless payment systems utilizing advanced smart card technology. The
metal products segment produces anchoring devices used in supporting the roofs
of underground coal mines and specialty products, which serve the construction,
automotive and electrical industries.
Sales are made to customers primarily in North America.
2. ACCOUNTING POLICIES
Estimates and Assumptions
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
the disclosure of contingent assets and liabilities at the date of the financial
statements, as well as the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Fiscal Year
The Company's year ends on the Saturday nearest to December 31.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and
its subsidiaries, all of which are wholly-owned. All intercompany accounts and
transactions are eliminated. Effective beginning in 2004, all locations,
including subsidiaries in Asia and Mexico, are consolidated as of the Company's
fiscal year end. The Company had historically consolidated its subsidiaries
located in Asia and Mexico as of November 30, which resulted in a thirteenth
period being included in the 2004 year end consolidation. The inclusion of the
additional period increased revenue by less than 0.5% and increased net income
approximately 3% for 2004.
Cash Equivalents and Concentrations of Credit Risk
Highly liquid investments purchased with a maturity of three months or less are
considered cash equivalents. The Company has deposits that exceed amounts
insured by the Federal Deposit Insurance Corporation (FDIC) up to $100,000, but
the Company does not consider this a significant concentration of credit risk
based on the strength of the financial institution.
-32-
The Eastern Company
Notes to Consolidated Financial Statements (continued)
2. ACCOUNTING POLICIES (continued)
Foreign Currency Translation
For foreign operations, balance sheet accounts are translated at the current
year-end exchange rate; income statement accounts are translated at the average
exchange rate for the year. Resulting translation adjustments are made directly
to a separate component of shareholders' equity - "Accumulated other
comprehensive income (loss) - Foreign currency translation". Foreign currency
exchange transaction gains and losses are not material in any year.
Recognition of Revenue and Accounts Receivable
Revenue and accounts receivable are recognized when persuasive evidence of an
arrangement exists, the price is fixed and determinable, delivery has occurred,
and there is a reasonable assurance of collection of the sales proceeds. The
Company obtains written purchase authorizations from its customers for a
specified amount of product at a specified price and delivery occurs at the time
of shipment. Credit is extended based on an evaluation of each customer's
financial condition; collateral is not required. Accounts receivable are
recorded net of applicable allowances. At year end 2006, one customer accounted
for approximately 29% of total accounts receivable.
Allowance for Doubtful Accounts
The Company maintains an allowance for doubtful accounts for estimated losses
resulting from the inability of its customers to make required payments. The
Company reviews the collectibility of its receivables on an ongoing basis taking
into account a combination of factors. The Company reviews potential problems,
such as past due accounts, a bankruptcy filing or deterioration in the
customer's financial condition, to ensure the Company is adequately accrued for
potential loss. Accounts are considered past due based on when payment was
originally due. If a customer's situation changes, such as a bankruptcy or
creditworthiness, or there is a change in the current economic climate, the
Company may modify its estimate of the allowance for doubtful accounts. The
Company will write off accounts receivable after reasonable collection efforts
have been made and the accounts are deemed uncollectible.
Inventories
Inventories are valued at the lower of cost or market. Cost is determined by the
last-in, first-out (LIFO) method in the U.S. ($22,200,222 for U.S. inventories
at December 30, 2006) and by the first-in, first-out (FIFO) method for
inventories outside the U.S. ($5,842,344 for inventories outside the U.S. at
December 30, 2006). Current cost exceeds the LIFO carrying value by
approximately $4,665,000 at December 30, 2006 and $4,033,000 at December 31,
2005. There was no material LIFO quantity liquidation in 2006, 2005 or 2004.
Property, Plant and Equipment and Related Depreciation
Property, plant and equipment (including equipment under capital lease) are
stated at cost. Depreciation ($3,443,351 in 2006, $3,322,891 in 2005 and
$3,131,483 in 2004) is computed generally using the straight-line method based
on the following estimated useful lives of the assets: Buildings 10 to 39.5
years; Machinery and equipment 3 to 10 years.
-33-
The Eastern Company
Notes to Consolidated Financial Statements (continued)
2. ACCOUNTING POLICIES (continued)
Goodwill, Intangibles and Impairment of Long-Lived Assets
Patents are recorded at cost and are amortized using the straight-line method
over the lives of the patents. Technology and licenses are recorded at cost and
are generally amortized on a straight-line basis over periods ranging from 5 to
17 years. Non-compete agreements and customer relationships are being amortized
using the straight-line method over a period of 5 years. Amortization expense in
2006, 2005 and 2004 was $302,342, $136,856 and $329,927, respectively. Total
amortization expense for each of the next five years is estimated to be as
follows: 2007 - $644,000; 2008 - $637,000; 2009 - $636,000; 2010 - $630,000; and
2011 - $536,000. Trademarks are not amortized as their lives are deemed to be
indefinite.
The gross carrying amount and accumulated amortization of amortizable intangible
assets:
Industrial Security Metal Weighted-Average
Hardware Products Products Amortization
Segment Segment Segment Total Period (Years)
------- ------- ------- ----- --------------
2006 Gross Amount:
Patents and developed $ 2,411,468 $ 1,005,390 $ 82,747 $ 3,499,605 16.1
technology
Customer relationships - 1,921,811 - 1,921,811 5.0
Non-compete agreements - 90,735 - 90,735 5.0
Other - 3,941 - 3,941 -
------------ ------------ ----------- ------------ ----
Total Gross Intangibles $ 2,411,468 $ 3,021,877 $ 82,747 $ 5,516,092 11.5
============ ============ =========== ============ ====
2006 Accumulated
Amortization:
Patents and developed $ 902,854 $ 192,250 $ 62,553 $ 1,151,657
technology
Customer relationships - 93,133 - 93,133
Non-compete agreements - 48,794 - 48,794
------------ ------------ ----------- ------------
Total Gross Amortization $ 902,854 $ 334,177 $ 62,553 $ 1,299,584
============ ============ =========== ============
------------ ------------ ----------- ------------
Net 2006 per Balance Sheet $ 1,508,614 $ 2,687,700 $ 20,194 $ 4,216,508
============ ============ =========== ============
2005 Gross Amount:
Patents and developed $ 2,602,120 $ 467,201 $ 82,747 $ 3,152,068 16.4
technology
Non-compete agreements - 50,735 - 50,735 5.0
Other - 3,941 - 3,941 -
------------ ------------ ----------- ------------ ----
Total Gross Intangibles $ 2,602,120 $ 521,877 $ 82,747 $ 3,206,744 16.2
============ ============ =========== ============ ====
2005 Accumulated
Amortization:
Patents and developed $ 1,021,206 $ 143,362 $ 57,604 $ 1,222,172
technology
Non-compete agreements - 38,070 - 38,070
------------ ------------ ----------- ------------
Total Gross Amortization $ 1,021,206 $ 181,432 $ 57,604 $ 1,260,242
============ ============ =========== ============
------------ ------------ ----------- ------------
Net 2005 per Balance Sheet $ 1,580,914 $ 340,445 $ 25,143 $ 1,946,502
============ ============ =========== ============
-34-
The Eastern Company
Notes to Consolidated Financial Statements (continued)
2. ACCOUNTING POLICIES (continued)
In the event that facts and circumstances indicate that the carrying value of
long-lived assets, including definite life intangible assets, may be impaired,
an evaluation is performed to determine if a write-down is required. No events
or changes in circumstances have occurred to indicate that the carrying amount
of such long-lived assets held and used may not be recovered.
The Company performs an annual impairment test of its goodwill and trademarks
during the second quarter of each year. Goodwill and trademarks were not
impaired in 2006, 2005 or 2004.
The following is a roll-forward of goodwill for 2006 and 2005:
Industrial Security Metal
Hardware Products Products
Segment Segment Segment Total
------- ------- ------- -----
2006
Beginning balance $ 1,909,126 $ 8,732,406 $ - $ 10,641,532
Acquisition of Royal Lock - 3,101,410 - 3,101,410
Foreign exchange (782) - - (782)
---------- ------------ ----- ------------
Ending balance $ 1,908,344 $ 11,833,816 $ - $ 13,742,160
=========== ============ ===== ============
2005
Beginning balance $ 1,871,880 $ 8,732,406 $ - $ 10,604,286
Foreign exchange 37,246 - - 37,246
---------- ------------ ----- ------------
Ending balance $ 1,909,126 $ 8,732,406 $ - $ 10,641,532
=========== ============ ===== ============
The goodwill for Royal Lock will be amortized over a 15 year period for tax
purposes.
Cost of Products Sold
The Company includes the cost of inventory sold and related costs for the
acquisition and distribution of its product in cost of products sold. These
costs include inbound freight charges, receiving, inspection, purchasing and
warehousing related costs.
Selling and Administrative Expenses
All advertising, selling, general consulting, executive salaries, regulatory
compliance, audit, legal and professional fees are included in selling and
administrative expenses.
Product Development Costs
Product development costs, charged to expense as incurred, were $1,354,224 in
2006, $1,150,378 in 2005 and $1,166,747 in 2004.
Advertising Costs
The Company expenses advertising costs as incurred. Advertising costs were
$525,632 in 2006, $606,330 in 2005 and $447,778 in 2004.
-35-
The Eastern Company
Notes to Consolidated Financial Statements (continued)
2. ACCOUNTING POLICIES (continued)
Income Taxes
The Company and its U.S. subsidiaries file a consolidated federal income tax
return.
Deferred tax assets and liabilities are determined based on differences between
financial reporting and tax bases of assets and liabilities and are measured
using the enacted tax rates and laws that will be in effect when the differences
are expected to reverse.
Stock Split and Earnings Per Share
On September 28, 2006, the Company announced a three-for-two stock split of the
Company's common shares. The record date was October 10, 2006, with the
additional shares being issued on October 17, 2006. Fractional shares created as
a result of this split were paid by cash. In connection therewith the Company's
Common Stock purchase rights (see Note 6) have also been adjusted to reflect the
stock split. The effect of this stock split has been applied retroactively and
all applicable share data and per share data in these financial statements and
notes to financial statements have been restated.
The denominators used in the earnings per share computations follow:
2006 2005 2004
---- ---- ----
Basic:
Weighted average shares outstanding 5,474,137 5,455,073 5,441,312
========= ========= =========
Diluted:
Weighted average shares outstanding 5,474,137 5,455,073 5,441,312
Dilutive stock options 293,971 373,764 177,240
--------- --------- ---------
Denominator for diluted earnings per share 5,768,108 5,828,837 5,618,552
========= ========= =========
The Company has excluded the effect of 104,250 stock options in 2004 from the
above dilutive stock options, as their inclusion would be anti-dilutive. There
were no anti-dilutive stock options in 2006 or 2005.
Derivatives
The Company maintains an interest rate swap agreement to minimize the risk of
fluctuations of interest rates on the Company's variable rate term debt. The
agreement involves the exchange of amounts based on the London Interbank Offered
Rate ("LIBOR") for amounts based on a fixed interest rate over the life of the
agreement, without an exchange of the notional amount upon which the payments
are based.
The Company's interest rate swap agreement, which is accounted for as a cashflow
hedge, is considered "effective" through use of the short-cut method, as defined
under Financial Accounting Standards Board ("FASB") Statement No. 133,
Accounting for Derivative Instruments and Hedging Activities, and, as a result,
changes in the fair value of the derivative are recorded as an asset or
liability with the offset amount recorded to accumulated other comprehensive
income (loss) in shareholders' equity.
-36-
The Eastern Company
Notes to Consolidated Financial Statements (continued)
2. ACCOUNTING POLICIES (continued)
Stock Based Compensation
In December 2004, the FASB issued Statement of Financial Standards ("SFAS") No.
123R, Share Based Payment (as amended). SFAS 123R eliminates the alternative to
use the intrinsic value method of accounting that was provided for in SFAS 123,
which generally resulted in no compensation expense recorded in the financial
statements related to the issuance of equity awards to employees and directors
to the extent issued at fair market value. SFAS 123R requires that the cost
resulting from all share-based payment transactions be recognized in the
financial statements. SFAS 123R establishes fair value as the measurement
objective in accounting for share-based payment arrangements and requires all
companies to apply a fair-value-based measurement method in accounting generally
for all share-based payment transactions with employees. SFAS 123R does not
require the recording of compensation expense in periods prior to the date of
adoption.
On January 1, 2006, the Company adopted the fair value recognition provisions of
SFAS 123R using the modified prospective method. As no stock options were
granted in 2006 and, as all options granted prior to January 1, 2006 were fully
vested, there was no impact on the current year financial statements.
Prior to the adoption of SFAS 123R, the Company accounted for stock options in
accordance with Accounting Principles Board Opinion No. 25 ("APB 25"),
Accounting for Stock Issued to Employees. Under APB 25 because the exercise
price of stock options equaled the market price of the underlying stock on the
date of grant, no compensation expense was recognized.
The fair value of stock options was estimated at the date of grant using the
Black-Scholes option pricing model with the following weighted-average
assumptions for 2004 (2006 and 2005 are not applicable (N/A) because no options
were granted during either year):
2006 2005 2004
------------------------------
Risk free interest rate N/A N/A 3.48%
Expected volatility N/A N/A 0.295
Expected option life N/A N/A 5 years
Weighted-average dividend yield N/A N/A 2.2%
The weighted average fair market value of the shares granted under options was
$13.58 in 2004. The weighted average fair value of options, estimated using the
Black-Scholes option pricing model based on the assumptions in the above table,
was $3.43 in 2004.
-37-
The Eastern Company
Notes to Consolidated Financial Statements (continued)
2. ACCOUNTING POLICIES (continued)
Stock Based Compensation (continued)
Had the Company used the fair value based accounting method for share-based
compensation expense in 2005 and 2004, the Company's consolidated pro forma
information regarding net income and earnings per share would have been as
follows:
(in thousands, except
per share amounts)
---------------------
2005 2004
------ ------
Net income, as reported $4,367 $4,758
Deduct: Total stock-based employee
compensation expense determined under
fair value-based method, net of related tax
effects 2 311
------ ------
Pro forma net income $4,365 $4,447
====== ======
Earnings per share:
Basic - as reported $0.80 $0.87
Basic - pro forma $0.80 $0.82
Diluted - as reported $0.75 $0.85
Diluted - pro forma $0.75 $0.79
For the purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the stock options' vesting period ranging
from 1 to 5 years. The pro forma effect on net income and related earnings per
share may not be representative of future years' impact since the terms and
conditions of new grants may vary from the current terms.
3. BUSINESS ACQUISITIONS
Effective November 8, 2006 the Company acquired certain assets of Summit
Manufacturing, Inc. ("Summit") including accounts receivable, inventory,
fixtures and equipment, intellectual property rights and all rights existing
under all sales and purchase agreements. Summit designs and manufactures
appliance hardware and accessories, including, but not limited to, oven door
latches, oven door switches and smoke eliminators and engaging in subcontract
assembly services, including, but not limited to, subcontract assembly services
for products known as "Mosquito Magnets". Its products will be sold into the
appliance industry and is included in the Security Products segment of the
Company from the date of acquisition. The cost of the acquisition was $546,000,
inclusive of transaction costs and debt paid at closing, plus the assumption of
$369,000 in current liabilities.
Effective September 25, 2006 the Company acquired certain assets of Royal Lock
Corporation ("Royal") including accounts receivable, inventories, furniture,
fixtures and equipment, intellectual property rights and rights existing under
all sales and purchase agreements. Royal is a supplier of cam locks, switch
locks, padlocks, latches, handles and specialty hardware parts. Its products are
sold to numerous OEM's in several market segments, including automotive,
recreational vehicles and furniture as well as electronics and fabricated metal
parts producers. Royal is included in the Security Products segment of the
Company from the date of the acquisition. The cost of the acquisition of Royal
was $6,991,000, inclusive of transaction costs, plus the assumption of $775,000
in current liabilities.
-38-
The Eastern Company
Notes to Consolidated Financial Statements (continued)
3. BUSINESS ACQUISITIONS (continued)
Both of the above acquisitions have been accounted for using the purchase
method. The acquired businesses are included in the consolidated operating
results of the Company from the date of acquisition. The excess of the cost of
Royal Lock over the fair market value of the net assets acquired of $3,101,410
has been recorded as goodwill. There was no goodwill attributable to the Summit
Manufacturing acquisition.
In connection with the above acquisitions, the Company recorded the following
intangible assets:
Weighted-average Amortization
Asset Class/Description Amount Period in Years
-----------------------------------------------------------------------------------------------
Patents, technology, and licenses
Customer relationships $ 1,921,811 5.0
Patents and developed technology 473,828 12.9
Non-compete agreements 40,000 5.0
------------
$ 2,435,639 6.5
============
There is no anticipated residual value relating to these intangible assets.
Neither the actual results nor the pro forma effects of the acquisition of
Summit and Royal, individually or in total, are material to the Company's
financial statements.
4. CONTINGENCIES
The Company is party to various legal proceedings and claims related to its
normal business operations. In the opinion of management, the Company has
substantial and meritorious defenses for these claims and proceedings in which
it is a defendant, and believes these matters will be ultimately resolved
without a material adverse effect on the consolidated financial position,
results of operations or liquidity of the Company. The aggregate provision for
losses related to contingencies arising in the ordinary course of business was
not material to operating results for any year presented.
Approximately 36% of the total workforce is subject to negotiated union
contracts and 32% of the total workforce is covered by such agreements which
expire during 2007.
5. DEBT
On September 22, 2006, the Company amended the unsecured loan agreement ("Loan
Agreement"), which includes a term portion and a revolving credit portion, with
its lender, Bank of America, N.A. The amendment restructures and increases the
balance of the term portion of the loan into a new seven (7) year loan in the
amount of $20,000,000. The restructured term portion is payable in quarterly
payments of $714,286 beginning January 2, 2007. The proceeds were used to repay
in full the outstanding balance of its existing term loan, $12,625,000, and for
the acquisition of Royal Lock.
In addition, the Company increased the maximum amount available under the
revolving credit portion from $7,500,000 to $12,000,000 and renewed and extended
the maturity date to September 22, 2009. The revolving credit portion has a
variable quarterly commitment fee ranging from 0.10% to 0.25% based on operating
results. As of December 30, 2006, the quarterly fee is 0.15% on the unused
portion.
-39-
The Eastern Company
Notes to Consolidated Financial Statements (continued)
5. DEBT (continued)
The interest rates on the term and the revolving credit portions of the Loan
Agreement vary. The interest rates may vary based on the LIBOR rate plus a
margin spread of 1.0% to 1.65% for the term portion and 1.0% to 1.6% for the
revolving credit portion. The margin rate spread is based on operating results
calculated on a rolling-four-quarter basis. The Company may also borrow funds at
the lender's prime rate. On December 30, 2006, the interest rate on the term
portion of the Loan Agreement was 6.62%.
Also on September 22, 2006, the Company terminated its interest rate swap
contract with the lender. At the time of termination, the notional amount was
$9,468,750, which was equal to 75% of the outstanding balance of the term loan
on that date. As a result of the termination, the Company received $73,100 of
cash which was included in other income. The Company had originally entered into
the interest rate swap contract with an original notional amount of $11,793,750
which was equal to 75% of the outstanding balance of the term loan on August 11,
2005. The notional amount began to decrease on a quarterly basis beginning
October 3, 2005 following the principal repayment schedule of the term portion
of the Loan Agreement. The Company had a fixed interest rate of 4.61% on the
swap contract and paid the difference between the fixed rate and LIBOR when
LIBOR was below 4.61% and received interest when the LIBOR rate exceeded 4.61%.
On November 2, 2006, the Company entered into an interest rate swap contract
with the lender with an original notional amount of $20,000,000 (notional amount
$20,000,000 on December 30, 2006), which was equal to 100% of the outstanding
balance of the term loan on that date. The notional amount will decrease on a
quarterly basis beginning January 2, 2007 following the principal repayment
schedule of the term loan. The Company has a fixed interest rate of 5.25% on the
swap contract and will pay the difference between the fixed rate and LIBOR when
LIBOR is below 5.25% and will receive interest when the LIBOR rate exceeds
5.25%.
On March 8, 2006, the Company signed a capital lease in the amount of $68,948
with Citicorp Vendor Finance for the purchase of new lighting equipment at its
Greenwald facility in Chester, Connecticut. The lease has a three year term at
0% interest rate. Payments under the lease are $1,915 per month. The Company was
required to make the initial payment in March 2006, but was not required to make
another payment until the installation of the equipment was completed in October
2006.
On August 1, 2005, the Company had also amended the Loan Agreement. The
amendment renewed and extended the maturity of the revolving credit loan from
July 1, 2005 to August 1, 2007 and restructured and increased the existing
balance of the term loan into a new five (5) year term loan. The additional
$4,000,000 proceeds from the term loan were used to pay down the balance on the
revolving credit agreement.
Previously, the Company maintained an interest rate swap contract, as required,
with the lender for an original notional amount of $15,000,000 (notional amount
$6,600,000 on January 1, 2005), which was reduced on a quarterly basis in
accordance with the principal repayment schedule of the term portion of the Loan
Agreement. The interest rate on the swap contract was at a fixed rate of 9.095%
and expired on July 1, 2005.
-40-
The Eastern Company
Notes to Consolidated Financial Statements (continued)
5. DEBT (continued)
Debt consists of:
2006 2005
------------------------------
Term loan $ 20,000,000 $ 15,025,000
Revolving credit loan - -
Capital lease obligation with interest at 4.99% and payable in
monthly installments of $21,203 through April 2009 559,338 779,861
Capital lease obligation with interest at 0% and payable in
monthly installments of $1,915 through September 2009 59,372 -
------------ ------------
20,618,710 15,804,861
Less current portion 3,111,908 3,420,523
------------ ------------
$ 17,506,802 $ 12,384,338
============ ============
The Company paid interest of $903,759 in 2006, $929,756 in 2005 and $1,002,955
in 2004.
Collectively, under the covenants of the Loan Agreement and capital lease
obligation, the Company is required to maintain specified financial ratios and
amounts. In addition, the Company is restricted to, among other things, capital
leases, purchases or redemptions of its capital stock, mergers and divestitures,
and new borrowing.
As of December 30, 2006, scheduled annual principal maturities of long-term
debt, including capital lease obligations, for each of the next five years
follow:
2007 $ 3,111,908
2008 3,123,742
2009 2,954,488
2010 2,857,143
2011 2,857,143
Thereafter 5,714,286
-----------
$20,618,710
===========
At December 30, 2006 and December 31, 2005, building improvements and equipment,
with a cost of approximately $2,069,000, were recorded under capital leases with
accumulated amortization of approximately $751,000 and $640,000, respectively.
One capital lease is secured by the equipment under the lease and a $559,000
letter of credit.
-41-
The Eastern Company
Notes to Consolidated Financial Statements (continued)
6. STOCK RIGHTS
The Company has a stock rights plan. At December 30, 2006, there were 5,479,461
stock rights outstanding under the plan. Each right may be exercised to purchase
one share of the Company's common stock at an exercise price of $53.33, subject
to adjustment to prevent dilution.
The rights generally become exercisable ten days after an individual or group
acquires 10% of the Company's outstanding common stock or after commencement or
announcement of an offer for 10% or more of the Company's common stock. The
stock rights, which do not have voting privileges, expire on July 22, 2008, and
may be redeemed by the Company at a price of $0.0045 per right at any time prior
to their expiration. In the event that the Company were acquired in a merger or
other business combination transaction, provision shall be made so that each
holder of a right shall have the right to receive, upon exercise thereof at the
then current exercise price, that number of shares of common stock of the
surviving company which at the time of such transaction would have a market
value of two times the exercise price of the right.
7. STOCK OPTIONS AND AWARDS
Stock Options
The Company has stock option plans for officers, other key employees, and
non-employee directors: the 1989, 1995, 1997 and 2000 plans. Options granted
under the 1989 plan and incentive stock options granted under the 1995 and 2000
plans must have exercise prices that are not less than 100% of the fair market
value of the stock on the dates the options are granted. Restricted stock awards
may also be granted to participants under the 1995 and 2000 plans with
restrictions determined by the Compensation Committee of the Company's Board of
Directors. Under the 1995, 1997, and 2000 plans, nonqualified stock options
granted to participants will have exercise prices determined by the Compensation
Committee of the Company's Board of Directors. No options were granted in 2006
or 2005. All options granted in 2004 were granted at prices equal to the fair
market value of the stock on the dates granted. No restricted stock was granted
in 2006, 2005 or 2004.
As of December 30, 2006, there were 446,250 shares available for future grant
under the above noted plans: 2000 - 367,500 shares; 1997 - 78,750; 1995 and 1989
- no shares available for grant. As of December 30, 2006, there were 1,449,000
shares of common stock reserved under all option plans for future issuance.
Information with respect to the Company's stock option plans is summarized
below:
Weighted Average
Shares Exercise Price
-------- -----------------
Outstanding at January 3, 2004 981,000 $ 8.944
Granted 85,500 13.580
Cancelled (15,000) 9.876
Exercised (33,750) 9.624
--------- --------
Outstanding at January 1, 2005 1,017,750 9.297
No activity in 2005 - -
--------- --------
Outstanding at December 31, 2005 1,017,750 9.297
Exercised (15,000) 13.580
--------- --------
Outstanding at December 30, 2006 1,002,750 $ 9.233
========= ========
-42-
The Eastern Company
Notes to Consolidated Financial Statements (continued)
7. STOCK OPTIONS AND AWARDS (continued)
Options Outstanding and Exercisable
---------------------------------------------------------------------------------
Weighted
Average
Remaining
Range of Exercise Outstanding as of Contractual Weighted Average
Prices December 30, 2006 Life Exercise Price
---------------------------------------------------------------------------------
$ 6.61 - $ 7.95 287,250 0.8 $ 6.960
$ 9.33 - $10.20 626,250 3.1 9.694
$ 12.33 - $13.58 89,250 6.8 13.317
---------
1,002,750 2.7 9.233
=========
At December 30, 2006, outstanding and exercisable options had an intrinsic value
of $10,234,785 with a weighted average remaining contractual life of 2.7 years.
The total intrinsic value of stock options exercised in 2006 was $7,350.
8. INCOME TAXES
Deferred income taxes are provided on temporary differences between the carrying
amounts of assets and liabilities for financial reporting purposes and those for
income tax reporting purposes. Deferred income tax liabilities (assets) relate
to:
2006 2005 2004
--------------------------------------------------
Property, plant and equipment $ 3,311,478 $ 3,363,679 $ 3,521,617
Interest rate swap asset - 11,797 -
Other 335,273 195,034 338,085
------------ ------------ ------------
Total deferred income tax liabilities 3,646,751 3,570,510 3,859,702
Other postretirement benefits (440,984) (764,143) (816,273)
Inventories (867,042) (562,881) (721,309)
Allowance for doubtful accounts (87,484) (89,668) (106,106)
Accrued compensation (301,232) (236,776) (201,280)
Interest rate swap obligation (49,983) - (58,949)
Pensions (1,160,893) (1,156,476) (724,363)
Tax credits (375,439) (362,143) (234,827)
Other (171,797) (218,725) (283,961)
------------ ------------ ------------
Total deferred income tax assets (3,454,854) (3,390,812) (3,147,068)
------------ ------------ ------------
Net deferred income tax liabilities $ 191,897 $ 179,698 $ 712,634
============ ============ ============
Income before income taxes consists of:
2006 2005 2004
--------------------------------------------------
Domestic $ 11,954,924 $ 4,266,725 $ 3,512,795
Foreign 2,891,124 2,753,582 3,316,244
------------ ------------- ------------
$ 14,846,048 $ 7,020,307 $ 6,829,039
============ ============= ============
-43-
The Eastern Company
Notes to Consolidated Financial Statements (continued)
8. INCOME TAXES (continued)
The provision for income taxes follows:
2006 2005 2004
------------------------------------------------
Current:
Federal $ 3,741,551 $ 1,505,934 $ 905,843
Foreign 1,030,902 902,145 1,025,183
State 534,260 272,334 148,404
Deferred:
Federal (6,460) (39,294) 21,428
Foreign - - -
State (112,953) 12,001 (29,520)
------------ ------------ ------------
$ 5,187,300 $ 2,653,120 $ 2,071,338
============ ============ ============
A reconciliation of income taxes computed using the U.S. federal statutory rate
to that reflected in operations follows:
2006 2005 2004
-------------------------------------------------------------------------------
Amount Percent Amount Percent Amount Percent
-------------------------------------------------------------------------------
Income taxes using U.S. federal statutory
rate $ 5,047,655 34% $ 2,387,578 34% $ 2,321,873 34%
State income taxes, net of federal benefit 277,999 2 187,661 3 78,463 1
Impact of foreign subsidiaries on effective
tax rate 63,536 - 127,634 2 (242,163) (4)
Other--net (201,890) (1) (49,753) (1) (86,835) (1)
----------- --- ----------- --- ----------- ---
$ 5,187,300 35% $ 2,653,120 38% $ 2,071,338 30%
=========== === =========== === =========== ===
Total income taxes paid were $4,358,944 in 2006, $2,105,690 in 2005 and
$1,445,099 in 2004.
The Company's future effective tax rates could be adversely affected by earnings
being lower than anticipated in countries where statutory rates are lower.
The Company has foreign tax credit carryforwards of $375,439 which expire in
varying amounts through 2013. Available and prudent tax planning strategies
support this deferred tax asset at December 30, 2006.
United States income taxes have been provided on the undistributed earnings of
foreign subsidiaries ($12,353,999 at December 30, 2006) only where necessary
because such earnings are intended to be reinvested abroad indefinitely or
repatriated only when substantially free of such taxes.
During 2005, a former employee sold shares of Company stock, which he had
acquired through the exercise of stock options in late 2004, that resulted in
the disqualification of those incentive stock options. As a result of the
disqualification, the Company received a tax benefit of $6,403 in 2005.
-44-
The Eastern Company
Notes to Consolidated Financial Statements (continued)
9. LEASES
The Company leases certain equipment and buildings under operating lease
arrangements. Most leases are for a fixed term and for a fixed amount;
additionally, the Company leases certain buildings under operating leases on a
month-to-month basis. The Company is not a party to any leases that have step
rent provisions, escalation clauses, capital improvement funding or payment
increases based on any index or rate.
Future minimum payments under non-cancelable operating leases with initial or
remaining terms in excess of one year during each of the next five years follow:
2007 $ 594,547
2008 553,032
2009 506,797
2010 101,289
2011 5,689
-----------
$ 1,761,354
===========
Rent expense for all operating leases was $944,610 in 2006, $826,396 in 2005 and
$642,000 in 2004. The Company expects future rent expense, including
non-cancelable operating leases, leases that are expected to be renewed and
buildings leased on a month-to-month basis, for each of the next five years to
be in the range of $750,000 to $850,000.
10. RETIREMENT BENEFIT PLANS
The Company has non-contributory defined benefit pension plans covering most
U.S. employees. Plan benefits are generally based upon age at retirement, years
of service and, for its salaried plan, the level of compensation. The Company
also sponsors unfunded nonqualified supplemental retirement plans that provide
certain current and former officers with benefits in excess of limits imposed by
federal tax law. The measurement date for the obligations disclosed below is
September 30 of each year.
The Company also provides health care and life insurance for retired salaried
employees in the United States who meet specific eligibility requirements.
On December 30, 2006, the Company adopted the recognition and disclosure
provisions of SFAS No. 158, Employers' Accounting for Defined Benefit Pension
and Other Postretirement Plans an amendment of FASB Statements No. 87, 88, 106,
and 132(R) ("SFAS No. 158"), which was issued by the FASB in September 2006.
This standard requires employers to recognize the underfunded or overfunded
status of a defined benefit postretirement plan as an asset or liability in its
statement of financial position and to recognize changes in the funded status in
the year in which the changes occur through accumulated other comprehensive
income. Additionally, SFAS No. 158 requires employers to measure the funded
status of a plan as of the date of its year-end statement of financial position.
As allowed under SFAS 158, the Company did not adopt the measurement date
provision in 2006. The Company will adopt the measurement date provision by 2008
as required.
-45-
The Eastern Company
Notes to Consolidated Financial Statements (continued)
10. RETIREMENT BENEFIT PLANS (continued)
Incremental effect of applying FASB Statement No. 158 on individual line items
in the balance sheet as of December 30, 2006 follow:
Before After
Application Application of
of Statement 158 Adjustments Statement 158
-------------------------------------------------------------
Intangible pension asset $ 655,077 $ (655,077) $ -
Prepaid pension cost 766,034 (499,676) 266,358
Deferred income tax liabilities (389,274) (734,263) (1,123,537)
Accrued postretirement benefits (2,014,820) 793,664 (1,221,156)
Accrued pension cost (3,651,230) (1,672,320) (5,323,550)
Unrecognized net pension and postretirement benefit
costs, net of tax - (5,875,261) (5,875,261)
Additional minimum pension liability, net of tax (4,576,115) 4,576,115 -
Total Shareholders' Equity 55,690,351 (1,299,146) 54,391,205
Components of the net periodic benefit cost of the Company's pension benefit
plans were as follows:
2006 2005 2004
------------------------------------------------------
Service cost $ 1,560,654 $ 1,382,535 $ 1,198,318
Interest cost 2,335,814 2,226,422 2,299,608
Expected return on plan assets (3,113,089) (3,127,392) (2,567,814)
Amortization of prior service cost 152,250 196,981 196,980
Amortization of the transition obligation (34,607) (180,444) (204,391)
Amortization of the net (gain) loss 602,381 782,208 313,206
------------ ------------ ------------
Net periodic benefit cost $ 1,503,403 $ 1,280,310 $ 1,235,907
============ ============ ============
Assumptions used to determine net periodic benefit cost for the Company's
pension benefit plans for the fiscal year indicated were as follows:
2006 2005 2004
------------------------------------------------------
Discount rate 5.5% 6.0% 6.5%
Expected return on plan assets 8.5% 8.5% 8.5%
Rate of compensation increase 4.25% 4.25% 4.25%
Components of the net periodic benefit cost of the Company's postretirement
benefit plan were as follows:
2006 2005 2004
------------------------------------------------------
Service cost $ 105,073 $ 86,714 $ 75,488
Interest cost 123,000 118,407 123,456
Expected return on plan assets (84,453) (79,188) (73,515)
Amortization of prior service cost (40,758) (37,694) (39,905)
Amortization of the net (gain) loss 4,582 (39,905) (45,904)
------------ ------------ -----------
Net periodic benefit cost $ 107,444 $ 48,334 $ 39,620
============ ============ ===========
-46-
The Eastern Company
Notes to Consolidated Financial Statements (continued)
10. RETIREMENT BENEFIT PLANS (continued)
Assumptions used to determine net periodic benefit cost for the Company's
postretirement plan for the fiscal year indicated were as follows:
2006 2005 2004
----------------------------------------
Discount rate 5.5% 6.0% 6.5%
Expected return on plan assets 8.5% 8.5% 8.5%
As of the measurement date, the status of the Company's pension benefit plans
and postretirement benefit plan was as follows:
Pension Benefit Postretirement Benefit
------------------------------------------------------------------------
2006 2005 2006 2005
------------------------------------------------------------------------
Benefit obligation at beginning of year $ 43,992,192 $ 38,585,446 $ 1,964,984 $ 2,061,628
Change due to availability of final actual
assets and census data - - 363,616 -
Plan amendment 74,773 - - (296,068)
Service cost 1,560,654 1,382,534 105,073 86,714
Interest cost 2,335,814 2,226,422 123,000 118,407
Actuarial (gain)/loss (1,320,458) 4,124,907 (80,070) 170,663
Benefits paid (2,255,541) (2,327,117) (184,456) (176,360)
------------- ------------- ------------- -------------
Benefit obligation at end of year $ 44,387,434 $ 43,992,192 $ 2,292,147 $ 1,964,984
============= ============= ============= =============
Pension Benefit Postretirement Benefit
------------------------------------------------------------------------
2006 2005 2006 2005
------------------------------------------------------------------------
Fair value of plan assets at beginning of year $ 36,386,203 $ 32,785,580 $ 1,017,679 $ 944,623
Change due to availability of final actual
assets and census data - - (17,365) (19,871)
Actual return on plan assets 3,506,876 4,213,460 84,453 79,188
Employer contributions 1,692,704 1,714,280 170,680 190,099
Benefits paid (2,255,541) (2,327,117) (184,456) (176,360)
------------- ------------- ------------- -------------
Fair value of plan assets at end of year $ 39,330,242 $ 36,386,203 $ 1,070,991 $ 1,017,679
============= ============= ============= =============
Pension Benefits Postretirement Benefits
------------------------------------------------------------------------
Reconciliation of Funded Status: 2006 2005 2006 2005
------------------------------------------------------------------------
Under-funded status $ (5,057,192) $ (7,605,989) $ (1,221,156) $ (947,305)
Unrecognized prior service cost - 732,554 - (554,550)
Unrecognized net actuarial loss (gain) - 11,662,961 - (576,201)
Unrecognized net asset at transition - (46,454) - -
-------------- ------------- ------------- -------------
Net amount recognized in the balance sheet $ (5,057,192) $ 4,743,072 $ (1,221,156) $ (2,078,056)
============== ============= ============= =============
-47-
The Eastern Company
Notes to Consolidated Financial Statements (continued)
10. RETIREMENT BENEFIT PLANS (continued)
Pension Benefit Postretirement Benefit
------------------------------------------------------------------------
2006 2005 2006 2005
------------------------------------------------------------------------
Prepaid benefit cost $ 266,358 $ 723,826 $ - $ -
Accrued benefit liability (5,323,550) (6,270,075) (1,221,156) (2,078,056)
Intangible asset - 732,554 - -
Accumulated other comprehensive loss - 9,556,767 - -
-------------- ------------- ------------- -------------
Net amount recognized in the balance sheet $ (5,057,192) $ 4,743,072 $ (1,221,156) $ (2,078,056)
============== ============= ============= =============
Amounts recognized in accumulated other comprehensive income consist of:
Pension Benefit Postretirement Benefit
------------------------------------------------------------------------
2006 2005 2006 2005
------------------------------------------------------------------------
Net (loss) gain $ (9,346,335) $ - $ 278,702 $ -
Prior service (cost) credit (655,077) - 514,962 -
Transition asset 11,847
Additional minimum pension liability - (9,556,767) - -
--------------- ------------- ------------- -------------
$ (9,989,565) $ (9,556,767) $ 793,664 $ -
=============== ============= ============= =============
In 2007, the net periodic pension benefit cost will include $357,064 of net loss
and $81,791 of prior service cost and the net periodic post retirement benefit
cost will include $19,050 of net gain and $23,886 of prior service credit.
Assumptions used to determine the projected benefit obligations for the
Company's pension benefit plans and postretirement benefit plan for the fiscal
year indicated were as follows:
2006 2005
--------------------
Discount rate 5.8% 5.5%
Expected return on plan assets 8.5% 8.5%
Rate of compensation increase 4.25% 4.25%
In 2006 and 2005, the accumulated benefit obligation for all qualified and
nonqualified defined benefit pension plans was $42,124,458 and $42,047,559
respectively.
Information for the under-funded pension plans with a projected benefit
obligation and an accumulated benefit obligation in excess of plan assets
-----------------------------------------------------------------------------------------
2006 2005
-----------------------------------------------------------------------------------------
Number of plans 5 5
Projected benefit obligation $ 38,084,799 $ 38,033,899
Accumulated benefit obligation 37,084,799 37,010,899
Fair value of plan assets 33,454,176 30,763,467
Net amount recognized in accrued benefit liability (5,323,550) (6,270,075)
Estimated future benefit payments are $2.5 million in 2007, $2.6 million in
2008, $2.6 million in 2009, $2.7 million in 2010, $2.8 million in 2011 and a
total of $15.1 million from 2012 through 2016.
-48-
The Eastern Company
Notes to Consolidated Financial Statements (continued)
10. RETIREMENT BENEFIT PLANS (continued)
The Company expects to make cash contributions to its pension plans of
approximately $2.1 million in 2007.
The percentage of each asset category of the total assets held by the plans
follows:
Allocation
Parameters 2006 2005
-----------------------------------
Equity securities 30 - 70% 59% 57%
Fixed income 30 - 60% 26 30
Cash and cash equivalents 0 - 10% 12 10
Cash surrender value of life insurance policies for
the Salaried Retirement Plan 3 3
---- ----
Total 100% 100%
==== ====
The Company utilizes a diversified, strategic allocation to generate investment
returns that will meet the objectives set forth in the Company's investment
policy, while keeping periods of negative returns to a minimum. Studies of
assets and liabilities that incorporate specific plan objectives, as well as
assumptions regarding long-term capital market returns and volatilities,
generate the specific asset allocations for the trusts. The long-term nature of
the trusts make them well-suited to bear the risk of added volatility associated
with equity securities and, accordingly, the asset allocations of the trust
reflect a higher allocation to equities as compared to fixed-income securities.
Non-U.S. securities are used to diversify some of the volatility of the U.S.
equity market while providing comparable long-term returns. The investment
guidelines set forth in the Company's investment policy limit or prohibit
exposure to investments in more volatile sectors.
In selecting the expected rate of return on plan assets, the Company considers
historical returns for the types of investments that its plans hold.
The plans' assets include 440,061 shares and 494,811 shares of the common stock
of the Company having a market value of $8,554,786 and $6,439,140 at December
30, 2006 and December 31, 2005, respectively. The plans sold 54,750 and 81,100
shares of common stock of the Company during 2006 and 2005, respectively. During
the first quarter of 2007, the plans sold an additional 82,700 shares of common
stock of the Company as of February 23, 2007. Dividends received during 2006 and
2005 on the common stock of the Company were $150,661 and $153,065 respectively.
For measurement purposes relating to the postretirement benefit plan, the life
insurance cost trend rate is 1%. The health care cost trend rate for
participants retiring after January 1, 1991 is nil; no increase in that rate is
expected because of caps placed on benefits. The health care cost trend rate is
expected to remain at 4.5% for participants after the year 2000.
A one-percentage-point change in assumed health care cost trend rates would have
the following effects on the postretirement benefit plan:
1-Percentage Point
Increase Decrease
-----------------------------
Effect on total of service and interest cost components $ 20,741 $ (8,049)
Effect on postretirement benefit obligation $ 327,657 $ (161,393)
On December 8, 2003, the "Medicare Prescription Drug Improvement and
Modernization Act of 2003" (the "Act") was signed into law. The Act introduces a
prescription drug benefit under Medicare as well as a federal subsidy to
sponsors of retiree health care benefit plans that provide a benefit that is at
least "actuarially equivalent" to Medicare Part D.
-49-
The Eastern Company
Notes to Consolidated Financial Statements (continued)
10. RETIREMENT BENEFIT PLANS (continued)
The Company's actuary has estimated the impact of the Medicare Prescription Drug
Improvement and Modernization Act of 2003, which resulted in a reduction in the
December 31, 2004 accumulated postretirement benefit obligation ("APBO") by
$52,668. This reduction has been reflected as an actuarial experience gain as of
December 31, 2004, and the December 31, 2004 APBO has been reduced accordingly.
Effective January 1, 2006, the retirement health benefit plan was amended to
exclude prescription drug coverage. This amendment resulted in a decrease in the
benefit obligation as of December 31, 2005 of $296,068.
U.S. salaried employees and most employees of the Company's Canadian
subsidiaries are covered by defined contribution plans.
The Company has a contributory savings plan under Section 401(k) of the Internal
Revenue Code covering substantially all U.S. non-union employees. The plan
allows participants to make voluntary contributions of up to 100% of their
annual compensation on a pretax basis, subject to IRS limitations. The plan
provides for contributions by the Company at its discretion. The Company made
contributions of $169,675 in 2006, $162,668 in 2005 and $146,002 in 2004.
11. FINANCIAL INSTRUMENTS
The carrying amounts of financial instruments (cash and cash equivalents,
accounts receivable, accounts payable, the interest rate swap agreement, and
debt) as of December 30, 2006 and December 31, 2005, approximate fair value.
Fair value was based on expected cash flows and current market conditions.
12. REPORTABLE SEGMENTS
The accounting policies of the segments are the same as those described in Note
2. Operating profit is total revenue less operating expenses, excluding interest
and miscellaneous non-operating income and expenses. Intersegment revenue, which
is eliminated, is recorded on the same basis as sales to unaffiliated customers.
Identifiable assets by reportable segment consist of those directly identified
with the segment's operations.
During 2006, one customer accounted for approximately 27% of the revenue of the
Industrial Hardware segment and approximately 15% of total revenue. No other
customers exceeded 10% of total revenue in 2006, 2005 or 2004.
2006 2005 2004
-----------------------------------------------------
Revenue:
Sales to unaffiliated customers:
Industrial Hardware $ 75,436,663 $ 53,846,834 $ 45,993,489
Security Products 50,067,145 44,323,782 42,422,863
Metal Products 12,961,603 10,936,674 11,713,806
------------- ------------- -------------
$ 138,465,411 $ 109,107,290 $ 100,130,158
============= ============= =============
Intersegment Revenue:
Industrial Hardware $ 741,201 $ 403,081 $ 210,445
Security Products 3,573,382 2,548,533 2,619,746
Metal Products 227,667 5,926 -
------------- ------------- -------------
$ 4,542,250 $ 2,957,540 $ 2,830,191
============= ============= =============
-50-
The Eastern Company
Notes to Consolidated Financial Statements (continued)
12. REPORTABLE SEGMENTS (continued)
2006 2005 2004
Income Before Income Taxes:
Industrial Hardware $ 13,108,681 $ 5,230,136 $ 4,933,313
Security Products 4,520,233 4,582,567 3,465,408
Metal Products (1,834,677) (1,856,167) (548,030)
------------- ------------- -------------
Operating Profit 15,794,237 7,956,536 7,850,691
Interest expense (1,097,640) (1,014,052) (1,044,490)
Other income 149,451 77,823 22,838
------------- ------------- -------------
$ 14,846,048 $ 7,020,307 $ 6,829,039
============= ============= =============
Geographic Information:
Net Sales:
United States $ 110,379,622 $ 83,541,509 $ 78,119,489
Foreign 28,085,789 25,565,781 22,010,669
------------- ------------- -------------
$ 138,465,411 $ 109,107,290 $ 100,130,158
============= ============= =============
Foreign sales are primarily to customers in North America.
Identifiable Assets:
United States $ 88,505,118 $ 66,136,432 $ 63,248,575
Foreign 14,979,826 15,485,403 14,823,190
------------- ------------- -------------
$ 103,484,944 $ 81,621,835 $ 78,071,765
============= ============= =============
Industrial Hardware $ 41,620,127 $ 29,728,833 $ 28,573,163
Security Products 38,340,163 34,018,271 32,664,197
Metal Products 14,627,858 11,471,545 11,703,155
------------- ------------- -------------
94,588,148 75,218,649 72,940,515
General corporate 8,896,796 6,403,186 5,131,250
------------- ------------- -------------
$ 103,484,944 $ 81,621,835 $ 78,071,765
============= ============= =============
Depreciation and Amortization:
Industrial Hardware $ 1,599,906 $ 1,283,491 $ 1,311,921
Security Products 1,204,981 1,087,645 972,132
Metal Products 941,806 1,088,611 1,177,358
------------- ------------- -------------
$ 3,745,693 $ 3,459,747 $ 3,461,411
============= ============= =============
Capital Expenditures:
Industrial Hardware $ 2,900,529 $ 1,015,368 $ 1,037,417
Security Products 2,698,141 475,206 782,360
Metal Products 1,116,857 215,962 206,443
------------- ------------- -------------
6,715,527 1,706,536 2,026,220
Currency translation adjustment (355) 2,646 (13,098)
General corporate 6,409 41,070 49,191
------------- ------------- -------------
$ 6,721,581 $ 1,750,252 $ 2,062,313
============= ============= =============
-51-
The Eastern Company
Notes to Consolidated Financial Statements (continued)
13. RECENT ACCOUNTING PRONOUNCEMENTS
The Company adopted SFAS No. 151, Inventory Costs, an amendment of ARB No. 43,
Chapter 4, effective January 1, 2006. The amendments made by SFAS No. 151
clarify that abnormal amounts of idle facility expense, freight, handling costs,
and wasted materials (spoilage) should be recognized as current-period charges
and require the allocation of fixed production overheads to inventory based on
the normal capacity of the production facilities. The adoption of SFAS No. 151
did not have a material impact on the consolidated financial statements of the
Company.
The Company adopted SFAS No. 154, Accounting Changes and Error Corrections-a
replacement of APB Opinion No. 20 (Accounting Changes) and FASB Statement No. 3
(Reporting Accounting Changes in Interim Financial Statements), effective
January 1, 2006. SFAS No. 154 provides guidance on accounting for and reporting
of accounting changes and error corrections. It requires retrospective
application to prior periods' financial statements, unless it is impracticable
to determine either the specific period effects or the cumulative effect of the
change. The adoption of SFAS No. 154 did not have a material impact on the
Company's consolidated financial statements.
In June 2006, the FASB issued Interpretation No. 48 ("FIN 48") Accounting for
Uncertainty in Income Taxes an interpretation of FASB Statement No. 109 ("SFAS
109"). This interpretation clarifies the accounting for uncertainty in income
taxes recognized in a company's financial statements in accordance with SFAS
109, Accounting for Income Taxes. FIN 48 details how companies should recognize,
measure, present, and disclose uncertain tax positions that have been or are
expected to be taken. As such, financial statements will reflect expected future
tax consequences of uncertain tax positions presuming the taxing authorities'
full knowledge of the position and all relevant facts. We are currently
analyzing the effect of FIN 48 on our financial statements. The Company will
adopt FIN 48 in the first quarter of 2007.
In September 2006, the U.S. Securities and Exchange Commission staff issued
Staff Accounting Bulletin No. 108 ("SAB 108"), Considering the Effects of Prior
Year Misstatements when Quantifying Misstatements in Current Year Financial
Statements. SAB 108 eliminates the diversity of practice surrounding how public
companies quantify financial statement misstatements. It establishes an approach
that requires quantification of financial statement misstatements based on the
effects of the misstatements on each of the company's financial statements and
the related financial statement disclosures. SAB 108 must be applied to annual
financial statements for their first fiscal year ending after November 15, 2006.
The application of SAB 108 did not have a material impact on our financial
condition or results of operations.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements ("SFAS
No. 157"). This standard clarifies the principle that fair value should be based
on the assumptions that market participants would use when pricing an asset or
liability. Additionally, it establishes a fair value hierarchy that prioritizes
the information used to develop those assumptions. We have not yet determined
the impact that the implementation of SFAS No. 157 will have on our results of
operations or financial condition. SFAS No. 157 is effective for financial
statements issued for fiscal years beginning after November 15, 2007.
-52-
The Eastern Company
Notes to Consolidated Financial Statements (continued)
14. SELECTED QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Selected quarterly financial information (unaudited) follows:
2006
---------------------------------------------------------------------------------------------
First Second Third Fourth Year
---------------------------------------------------------------------------------------------
Net sales $27,860,183 $29,669,159 $31,206,388 $49,729,681 $138,465,411
Gross margin 6,483,744 6,475,001 6,611,723 15,013,283 34,583,751
Selling and administrative
expenses 4,461,468 4,261,200 4,422,616 5,644,230 18,789,514
Net income 1,143,765 1,212,557 1,667,167 5,635,259 9,658,748
Net income per share:
Basic $.21 $.22 $.30 $1.03 $1.76
Diluted $.20 $.21 $.29 * $ .96 $1.67
Weighted average shares
outstanding:
Basic 5,464,691 5,476,055 5,477,302 5,478,592 5,474,137
Diluted 5,711,137 * 5,740,326 * 5,766,147 * 5,854,147 5,768,108
* Restated to reflect tax benefit which would result from the exercise of
nonqualified stock options.
2005
-----------------------------------------------------------------------------------------------
First Second Third Fourth Year
-----------------------------------------------------------------------------------------------
Net sales $26,267,584 $27,421,294 $27,204,815 $28,213,597 $109,107,290
Gross margin 5,469,894 6,452,132 6,106,425 6,704,338 24,732,789
Selling and administrative
expenses 4,053,994 4,493,691 3,906,529 4,322,039 16,776,253
Net income 730,582 1,083,389 1,256,367 1,296,849 4,367,187
Net income per share:
Basic $.13 $.20 $.23 $.24 $.80
Diluted $.13 $.19 $.21 $.23 $.75
Weighted average shares
outstanding:
Basic 5,452,487 5,454,150 5,455,973 5,457,690 5,455,073
Diluted 5,801,120 5,827,589 5,892,311 5,794,337 5,828,837
-53-
REPORT OF UHY LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors
The Eastern Company
We have audited the accompanying consolidated balance sheets of The Eastern
Company (the Company) as of December 30, 2006 and December 31, 2005 and the
related consolidated statements of income, comprehensive income, shareholders'
equity, and cash flows for the years then ended. Our audit also included the
financial statement schedule listed in the Index at Item 15(a)(2). These
financial statements and schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of the Company at
December 30, 2006 and December 31, 2005 and the consolidated results of its
operations and its cash flows for the years then ended in conformity with
accounting principles generally accepted in the United States of America. Also,
in our opinion, the related financial statement schedule, when considered in
relation to the basic financial statements taken as a whole, presents fairly in
material respects the information set forth therein.
As discussed in Note 10 to the consolidated financial statements, the Company
changed its method of accounting for its pension and postretirement benefit
plans as of December 30, 2006.
/s/ UHY LLP
Hartford, Connecticut
March 9, 2007
-54-
REPORT OF ERNST & YOUNG LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors
The Eastern Company
We have audited the accompanying consolidated statements of income,
comprehensive income, shareholders' equity, and cash flows of The Eastern
Company for the year ended January 1, 2005. Our audit also included the
financial statement schedule listed in the Index at Item 15(a)(2). These
financial statements and schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedule based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. We were not engaged to perform an
audit of the Company's internal control over financial reporting. Our audit
included consideration of internal control over financial reporting as a basis
for designing audit procedures that are appropriate in the circumstances, but
not for the purpose of expressing an opinion on the effectiveness of the
Company's internal control over financial reporting. Accordingly, we express no
such opinion. An audit also includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated results of operations and cash flows of
The Eastern Company for the year ended January 1, 2005, in conformity with U.S.
generally accepted accounting principles. Also, in our opinion, the related
financial statement schedule, when considered in relation to the basic financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.
/s/ Ernst & Young LLP
Hartford, Connecticut
February 8, 2005
-55-
ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
For information regarding the change in the Company's independent registered
public accounting firm, see the Form 8-K filed on July 18, 2005.
ITEM 9A CONTROLS AND PROCEDURES
As of the end of the fiscal year ended December 30, 2006, the Company carried
out an evaluation, under the supervision and with the participation of the
Company's management, including the Chief Executive Officer (the "CEO") and
Chief Financial Officer (the "CFO"), of the effectiveness of the design and
operation of the Company's disclosure controls and procedures pursuant to
Exchange Act Rule 240.13a-15. Based upon that evaluation, the CEO and CFO
concluded that the Company's current disclosure controls and procedures are
effective in timely alerting them to material information relating to the
Company and its subsidiaries required to be included in the Company's periodic
SEC filings. There were no significant changes in the Company's internal control
over financial reporting during the period covered by this report that
materially affected, or are reasonably likely to materially affect, the
Company's internal control over financial reporting.
The Company believes that a controls system, no matter how well designed and
operated, cannot provide absolute assurance that the objectives of the controls
system are met, and no evaluation of controls can provide absolute assurance
that all control issues and instances of fraud, if any, within a company have
been detected. The Company's disclosure controls and procedures are designed to
provide reasonable assurance of achieving their objectives, and the CEO and CFO
have concluded that these controls and procedures are effective at the
"reasonable assurance" level.
ITEM 9B OTHER INFORMATION
None.
PART III
ITEM 10 DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The Registrant's definitive proxy statement ("Proxy Statement") for the 2007
Annual Meeting of Shareholders which is incorporated herein by reference will be
filed with the SEC pursuant to Regulation 14A not later than 120 days after
December 30, 2006.
The information concerning directors is incorporated herein by reference to our
Proxy Statement under the caption "Item No. 1 - Election of Director".
The information concerning our executive officers is incorporated herein by
reference to our Proxy Statement under the captions "Compensation Discussion and
Analysis" and "Executive Compensation". The Registrant's only Executive Officers
are Leonard F. Leganza, Chairman, President and Chief Executive Officer, and
John L. Sullivan III, Vice President and Chief Financial Officer.
The information concerning our Audit Committee is incorporated herein by
reference to our Proxy Statement under the captions "Audit Committee Financial
Expert", "Report of the Audit Committee", "Committees of the Board of Directors"
and "Exhibit `A' - The Eastern Company Audit Committee Charter". The Audit
Committee Charter is also available on the Company's website at
http://www.easterncompany.com by clicking on Corporate Governance.
The information concerning compliance with Section 16(a) of the Securities
Exchange Act is incorporated herein by reference to our Proxy Statement under
the caption "Section 16(a) Beneficial Ownership Reporting Compliance".
The Company's Board of Directors has adopted a Code of Business Conduct and
Ethics that applies to our Chief Executive Officer, Chief Financial Officer,
Chief Accounting Officer and the Company's other financial professionals. The
Code of Business Conduct and Ethics is available on the Company's website at
http://www.easterncompany.com by clicking on Corporate Governance.
-56-
ITEM 11 EXECUTIVE COMPENSATION
Information concerning director and executive compensation is incorporated
herein by reference to portions of the Company's Proxy Statement to be filed
with the SEC pursuant to Regulation 14A not later than 120 days after December
30, 2006, under the captions "Director Compensation", "Compensation Discussion
and Analysis", "Compensation Committee Report", "Compensation Committee
Interlocks and Insider Participation", "Executive Compensation", "Stock
Options", "Outstanding Equity Awards at Fiscal Year End" and "Termination of
Employment and Change in Control Arrangements". The Compensation Committee of
the Board of Directors operates under the Compensation Committee Charter, which
can be found on the Company's website at http://www.easterncompany.com by
clicking on Corporate Governance. .
ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
Security ownership of certain beneficial owners and management:
(a) Information concerning security ownership of certain beneficial owners is
incorporated herein by reference to the Proxy Statement to be filed with
the SEC pursuant to Regulation 14A not later than 120 days after December
30, 2006, under the caption "Security Ownership of Certain Beneficial
Shareholders".
(b) Information concerning security ownership of management is incorporated
herein by reference to the Proxy Statement to be filed with the SEC
pursuant to Regulation 14A not later than 120 days after December 30, 2006,
under the captions "Item No. 1 - Election of Director", "Security Ownership
of Certain Beneficial Shareholders", "Executive Compensation", "Stock
Options" and "Outstanding Equity Awards at Fiscal Year-End". See also the
equity compensation plan information in Item 5 of this Annual Report on
Form 10-K.
(c) Changes in Control
None.
Related stockholder matters:
The information required by Item 201(d) of Regulation S-K is included in Item 5
of this Annual Report on Form 10-K.
ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE
Information regarding certain relationships and related transactions is
incorporated herein by reference to our Proxy Statement to be filed with the SEC
pursuant to Regulation 14A not later than 120 days after December 30, 2006 under
the caption "Policies and Procedures Concerning Related Persons Transactions".
Information regarding director independence is incorporated herein by reference
to our Proxy Statement to be filed with the SEC pursuant to Regulation 14A not
later than 120 days after December 30, 2006 under the captions "Item No.1 -
Election of Director" and "Committees of the Board of Directors".
ITEM 14 PRINCIPAL ACCOUNTING FEES AND SERVICES
Information concerning principal accountant fees and services are incorporated
herein by reference to our Proxy Statement to be filed with the SEC pursuant to
Regulation 14A not later than 120 days after December 30, 2006 under the caption
"Item No. 3 - Appointment of the Independent Registered Public Accounting Firm".
-57-
PART IV
ITEM 15 EXHIBITS, FINANCIAL STATEMENT SCHEDULE
(a) Documents filed as part of this report:
(1) Financial statements Page
Consolidated Balance Sheets - December 30, 2006 and December 31, 2005............................27.
Consolidated Statements of Income -- Fiscal years ended December 30, 2006,
December 31, 2005 and January 1, 2005............................................................29.
Consolidated Statements of Comprehensive Income -- Fiscal years ended
December 30, 2006, December 31, 2005, and January 1, 2005........................................29.
Consolidated Statements of Shareholders' Equity -- Fiscal years ended
December 30, 2006, December 31, 2005 and January 1, 2005.........................................30.
Consolidated Statements of Cash Flows--Fiscal years ended December 30, 2006,
December 31, 2005, and January 1, 2005...........................................................31.
Notes to Consolidated Financial Statements.......................................................32.
Report of UHY LLP, Independent Registered Public Accounting Firm.................................54.
Report of Ernst & Young LLP, Independent Registered Public Accounting Firm.......................55.
(2) Financial Statement Schedule
Schedule II -- Valuation and qualifying accounts.................................................60.
Schedules other than that listed above have been omitted because
the required information is contained in the financial statements
and notes thereto, or because such schedules are not required or
applicable.
(3) Exhibits
Exhibits are as set forth in the "Exhibit Index" which appears
on pages 62 through 63.
(b) Exhibits Required by Item 601 of Regulation S-K
Exhibits are as set forth in the "Exhibit Index" which appears on
pages 62 through 63. Also refer to the following Form 8-K's filed
by the Company.
Form 8-K filed on April 26, 2006 setting forth the press release
reporting the Company's earnings for the quarter ended April 1,
2006.
From 8-K filed on April 26, 2006 setting forth the press release
reporting a 9% increase in the quarterly dividend.
Form 8-K filed on July 26, 2006 setting forth the press release
reporting the Company's earnings for the quarter ended July 1,
2006.
Form 8-K filed on September 6, 2006 setting forth reporting the
Company's receipt of purchase orders for latching system
components approximating $15.5 million.
Form 8-K filed on September 25, 2006 setting forth the press
release reporting the Company's acquisition of Royal Lock
Corporation and amended loan agreement.
Form 8-K filed on September 27, 2006 setting forth reporting the
Company's receipt of additional purchase orders for latching
system components increasing original order to approximately
$31.5 million.
-58-
Form 8-K filed on September 28, 2006 setting forth a 3-for-2
stock split of the Company's common stock.
Form 8-K filed on October 25, 2006 setting forth the press
release reporting the Company's earnings for the quarter ended
September 30, 2006.
Form 8-K filed on November 8, 2006 setting forth the Company's
purchase of the assets of Summit Manufacturing, Inc.
Form 8-K filed on December 14, 2006 setting forth the appointment
of principal officers.
Form 8-K filed on December 18, 2006 setting forth a sales
estimate for 2006.
Form 8-K filed on February 7, 2007 setting forth the press
release reporting the Company's earnings for the quarter and
fiscal year ended December 30, 2006.
Form 8-K filed on February 7, 2007 setting forth the 2007
Executive Incentive Program.
(c) None.
-59-
The Eastern Company and Subsidiaries
Schedule II - Valuation and Qualifying accounts
COL. A COL. B COL. C COL. D COL. E
-----------------------------------------------------------------------------------------------------------------------------------
ADDITIONS
-------------------------------------
(1) (2)
Balance at Beginning Charged to Costs Charged to Other Deductions - Balance at End
Description of Period and Expenses Accounts-Describe Describe of Period
---------------------------------- ------------------- ---------------- ------------------ ------------ --------------
Fiscal year ended December 30, 2006:
Deducted from asset accounts:
Allowance for doubtful accounts $295,000 $ 58,424 - $34,424 (a) $319,000
======== ======== ======= ========
Fiscal year ended December 31, 2005:
Deducted from asset accounts:
Allowance for doubtful accounts $332,000 $ 6,433 - $43,433 (a) $295,000
======== ======== ======= ========
Fiscal year ended January 1, 2005:
Deducted from asset accounts:
Allowance for doubtful accounts $302,000 $112,222 - $82,222 (a) $332,000
======== ======== ======= ========
(a) Uncollectible accounts written off, net of recoveries.
-60-
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
Dated: April 18, 2007 THE EASTERN COMPANY
--------------
By /s/ John L. Sullivan III
---------------------------
John L. Sullivan III
Vice President and Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
/s/ Leonard F. Leganza April 18, 2007
------------------------
Leonard F. Leganza
Chairman, President
and Chief Executive Officer
/s/ John L. Sullivan III April 18, 2007
------------------------
John L. Sullivan III
Vice President and Chief Financial Officer
/s/ Kenneth R. Sapack April 18, 2007
------------------------
Kenneth R. Sapack
Chief Accounting Officer
/s/ John W. Everets April 18, 2007
------------------------
John W. Everets
Director
/s/ Charles W. Henry April 18, 2007
------------------------
Charles W. Henry
Director
/s/ David C. Robinson April 18, 2007
------------------------
David C. Robinson
Director
/s/ Donald S. Tuttle III April 18, 2007
------------------------
Donald S. Tuttle III
Director
-61-
EXHIBIT INDEX
(3) Restated Certificate of Incorporation dated August 14, 1991 is
incorporated by reference to the Registrant's Annual Report on Form
10-K for the fiscal year ended December 28, 1991 and the Registrant's
Form 8-K filed on February 13, 1991. Amended and restated bylaws dated
July 29, 1996 is incorporated by reference to the Registrant's Form
8-K filed on July 29, 1996.
(4) Rights Agreement entered into between the Registrant and BankBoston
N.A. dated as of August 6, 1998 and Letter to all shareholders of the
Registrant, dated July 22, 1998 together with Press Release dated July
22, 1998 describing the Registrant's redemption of shareholders
Purchase Rights dated September 16, 1991 and the issuance of a new
Purchase Rights dividend distribution are incorporated by reference to
the Registrant's Form 8-K filed on August 6, 1998.
(10)(a) Amendment to the Deferred Compensation Agreement with Russell G.
McMillen dated May 1, 1988 is incorporated by reference to
Registrant's Annual Report on Form 10-K for the fiscal year ended
December 31, 1988. The Deferred Compensation Agreement with Russell G.
McMillen dated October 28, 1980 and amended on March 27, 1986 is
incorporated by reference to the Registrant's Annual Report on Form
10-K for the fiscal year ended January 3, 1987.
(b) The Eastern Company 1995 Executive Stock Incentive Plan effective as
of April 26, 1995 incorporated by reference to the Registrant's Form
S-8 filed on February 7, 1997.
(c) The Eastern Company Directors Fee Program effective as of October 1,
1996 incorporated by reference to the Registrant's Form S-8 filed on
February 7, 1997, as amended by Amendment No.1 and Amendment No. 2 are
incorporated by reference to the Registrant's Form 10-K filed on March
29, 2000 and Amendment No. 3 is incorporated by reference to the
Registrant's Form 10-K filed on March 22, 2004.
(d) The Eastern Company 1997 Directors Stock Option Plan effective as of
September 17, 1997 incorporated by reference to the Registrant's Form
S-8 filed on May 3, 2004.
(e) Supplemental Retirement Plan dated September 9, 1998 with Leonard F.
Leganza is incorporated by reference to the Registrant's Annual Report
on Form 10-K for the fiscal year ended January 2, 1999.
(f) The Eastern Company 2000 Executive Stock Incentive Plan effective July
2000 is incorporated by reference to the Registrant's Annual Report on
Form 10-K for the fiscal year ended December 30, 2000.
(g) Employment Agreement dated February 22, 2005 with Leonard F. Leganza
is incorporated by reference to the Registrant's Current Report on
Form 8-K dated February 22, 2005.
(h) The Eastern Company 2007 Executive Incentive Program is incorporated
by reference to the Registrant's Current Report on Form 8-K dated
February 7, 2007.
(14) The Eastern Company Code of Business Conduct and Ethics incorporated
by reference. The Eastern Company Code of Business Conduct and Ethics
is available free of charge on the Company's Internet website at
http://www.easterncompany.com under the section labeled "Corporate
Governance".
-62-
(16) Letter from Ernst & Young, LLP regarding Change in Certifying
Accountant is incorporated by reference to Exhibit 16 to the
Registrant's Current Report on Form 8-K dated July 18, 2005.
(21) List of subsidiaries as follows:
Eberhard Hardware Mfg. Ltd., a private corporation organized
under the laws of the Province of Ontario, Canada.
Canadian Commercial Vehicles Corporation, a private corporation
organized under the laws of the Province of British Columbia,
Canada.
Eastern Industrial Ltd., a private corporation organized under
the laws of the Peoples Republic of China.
World Lock Co. Ltd., a private corporation organized under the
laws of Taiwan (The Republic of China).
Sesamee Mexicana, Subsidiary, a private corporation organized
under the laws of Mexico.
World Security Industries Co. Ltd., a private corporation
organized under the laws of Hong Kong.
(23) Consents of independent registered public accounting firms attached
hereto on page 64 and 65.
(31) Certifications required by Rule 13a-14(a) of the Securities Exchange
Act of 1934, as amended, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
(32) Certifications pursuant to Rule 13a-14(b) and 18 USC 1350 as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(99) Letter to our shareholders from the Annual Report 2007 is attached on
page 69.
-63-