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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Fiscal Year ended January 1, 2005
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
-------------------
(Exact name of registrant as specified in its charter)
Connecticut 06-0330020
----------- ----------
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification Number)
112 Bridge Street, Naugatuck, Connecticut 06770
----------------------------------------- -----
(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 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 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. [ X ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2.) Yes [ ] No [X]
As of July 3, 2004, 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 $48,671,598 (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 18, 2005 3,634,867 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 23, 2005 are incorporated by
reference into Part III.
The Eastern Company
Form 10-K
FOR THE FISCAL YEAR ENDED JANUARY 1, 2005
TABLE OF CONTENTS
Page
Table of Contents 2.
Safe Harbor Statement 3.
PART I
Item 1. Business 4.
Item 2. Properties 7.
Item 3. Legal Proceedings 8.
Item 4. Submission of Matters to a Vote of Security Holders 8.
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters 8.
Item 6. Selected Financial Data 10.
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 10.
Item 7A. Quantitative and Qualitative Disclosures
About Market Risk 21.
Item 8. Financial Statements and Supplementary Data 22.
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosures 45.
Item 9A. Controls and Procedures 45.
Item 9B. Other Information 45.
PART III
Item 10. Directors and Executive Officers of the Registrant 45.
Item 11. Executive Compensation 45.
Item 12. Security Ownership of Certain Beneficial Owners
and Management 45.
Item 13. Certain Relationships and Related Transactions 46.
Item 14. Principal Accounting Fees and Services 46.
PART IV
Item 15. Exhibits, Financial Statement Schedule 46.
Signatures 49.
Exhibit Index 50.
-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
The Company established Eastern Industrial Ltd. in Shanghai, China in
2003. This new facility was set-up to gain entry into the Chinese marketplace
as well as to be a supplier to other divisions and subsidiaries of the Company.
Eastern Industrial has capabilities that include stamping, tool and die making,
plastic injection molding and assembly.
Effective October 1, 2002 the Company acquired all of the issued and
outstanding common stock of Canadian Commercial Vehicles Corporation ("CCV")
for cash of approximately $70,000 and the assumption of approximately $130,000
of debt, which the Company paid upon closing. CCV was established as a Canadian
subsidiary of The Eastern Company, located in Kelowna, British Columbia,
Canada. CCV manufactures lightweight sleeper boxes used on Class 8 trailer
trucks.
Effective March 1, 2002 the Company acquired certain assets of the Big
Tag Division of Dolan Enterprises, Inc. for cash of approximately $260,000. Big
Tag was combined into the Illinois Lock/CCL division of the Company located in
Wheeling, Illinois. Big Tag provides high-visibility, custom luggage tags,
which the Company markets in conjunction with its custom logo luggage locks to
the travel, and premium incentive markets.
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 their date of acquisition. The excess of the cost
of the acquired businesses over the fair market value of the net assets
acquired has been allocated to goodwill. The effects of these acquisitions on
the Company's consolidated financial position and operations are not material.
(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
-4-
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 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 and school bus door closure
hardware. The products are sold to original equipment manufacturers and
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 is vital for maintaining and increasing market
share.
SECURITY PRODUCTS
The Security Products segment, made up of Greenwald Industries, Illinois
Lock Company/CCL Security Products, 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. 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 and access control units. Illinois Lock Company/CCL
Security Products 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 by
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, which serve the
construction and electrical industries.
Typical products include mine roof support anchors, couplers for 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 our ability to compete 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 production of malleable iron castings, the
Company has invested in equipment for the production of ductile iron castings.
-5-
Raw materials and outside services were readily available from domestic
sources for all of the Company's segments during 2004 and are expected to be
readily available in 2005 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 2004 and does not expect any such problems in 2005.
Patent protection for the various product lines within the Company is
limited, but is sufficient to protect 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 not highly concentrated by customer. No customer
accounted for 10% or more of the Company's consolidated sales for the year
ended January 1, 2005.
The dollar amount of the level of orders in the Company is believed to
be firm as of fiscal year ended January 1, 2005 at $17,124,000, as compared to
$11,635,000 at January 3, 2004.
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 established Eastern
Industrial Ltd. in 2003 to help combat the offshore competition.
Research and development expenditures in 2004 were $1,167,000 and
represented approximately 1% of gross revenues. In 2003 and 2002 they were
$1,115,000 and $1,041,000, 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 and
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 2004 was 589.
(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.
Financial information about foreign and domestic operations' net sales
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.
-6-
(e) Available Information
---------------------
We make available, free of charge through our Internet website at
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 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 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, leased an additional 5,000 square feet in its
current facility in 2004 and now leases 37,500 square feet of building space
located in an industrial park. The building is made from brick and concrete,
contains approximately 4,800 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 for another 3 years.
The Eastern Industrial Ltd., a wholly-owned subsidiary in Shanghai,
China leased an additional 15,600 square feet during 2004 and now 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 is currently leasing 13,250 square feet
of a block building located in an industrial park in Lerma, Mexico on an
open-end basis.
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 Company terminated the
lease of the 5,000 square foot facility in Boynton Beach, Florida in November
2003 and consolidated operations into the Chester facility.
The Illinois Lock Company/CCL Security Products Division leases land and
a building containing 44,000 square feet in Wheeling, Illinois. The building is
brick and located in an industrial park. A five-year lease was signed in 2001,
which expires on May 31, 2006 and is renewable.
-7-
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 $0.13 per diluted share, in 2004.
There are no other legal proceedings, other than ordinary routine
litigation incidental to the Company's business, or 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
There were no matters submitted to a vote of security holders, through
the solicitation of proxies or otherwise, during the fourth quarter ended
January 1, 2005.
PART II
ITEM 5 MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
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 January 1, 2005 was 667.
High and low stock prices and dividends for the last two years were:
2004 2003
---- ----
Market Price Market Price
Quarter High Low Dividend Quarter High Low Dividend
------- ---- --- -------- ------- ---- --- --------
First $16.37 $14.50 $.11 First $12.34 $11.02 $.11
Second 16.70 15.25 .11 Second 15.70 12.14 .11
Third 16.73 15.10 .11 Third 15.70 14.00 .11
Fourth 20.60 16.15 .11 Fourth 15.64 14.24 .11
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.
-8-
The following table sets forth information regarding securities
authorized for issuance under the Company's equity compensation plans as of
January 1, 2005, including the Company's 1989, 1995, 1997 and 2000 plans.
Equity Compensation Plan Information
Number of securities
Number of securities Weighted-average remaining available for
to be issued upon exercise price of future issuance under
exercise of outstanding equity compensation plans
outstanding options, options, warrants (excluding securities
Plan category warrants and rights and rights reflected in column (a))
------------------------ ------------------- -----------------------------
(a) (b) (c)
Equity compensation plans approved
by security holders 429,500 (1) $14.79 245,142 (2)
Equity compensation plans not
approved by security holders 249,000 (3) 12.49 52,500 (4)
------- ------ -------
Total 678,500 $13.95 297,642
======= ====== =======
1 Includes options outstanding under the 1989, 1995 and 2000 plans.
2 Includes shares available for future issuance under the 1995 and 2000 plans.
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 225,000
shares to 325,000 shares.
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 Shares 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.
Issuer Purchases of Equity Securities
(a) Total (b) Average (c) Total Number of (d) Maximum
Number of Price Shares Purchased as Part Number that May Yet
Shares Paid per of Publicly Announced Be Purchased Under
Period Purchased Share Plans or Programs the Plans or Programs
- ------ --------- ----- ----------------- ---------------------
October 3 - October 30, 2004 - - - -
November 1 - November 27, 2004 8,384 16.96 - -
November 28, 2004 - January 1, 2005 - - - -
----- ----- ----- -----
Total 8,384 16.96 - -
===== ===== ===== =====
The Company does not have any share repurchase plans or programs. The
figures shown in the table above are for shares delivered to the Company to
exercise stock options.
-9-
ITEM 6 SELECTED FINANCIAL DATA
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
INCOME STATEMENT ITEMS (in thousands)
Net sales $100,130 $ 88,307 $ 81,337 $ 82,825 $ 88,192
Cost of products sold 74,999 66,719 60,637 60,783 62,192
Depreciation and amortization 3,461 3,619 3,565 4,461 3,639
Interest expense 1,044 1,303 1,716 2,259 1,786
Income before income taxes 6,829 5,390 4,734 6,085 10,657
Income taxes 2,071 2,028 1,442 2,172 3,602
Net income 4,758 3,362 3,292 3,913 7,055
Dividends 1,596 1,593 1,598 1,599 1,601
BALANCE SHEET ITEMS (in thousands)
Inventories $ 20,478 $ 16,927 $ 16,345 $ 18,591 $ 17,103
Working capital 26,692 24,894 25,600 27,131 26,298
Property, plant and equipment, net 23,907 24,930 25,050 26,486 27,328
Total assets 78,072 74,617 76,133 81,896 84,857
Shareholders' equity 43,817 40,508 37,903 40,056 38,538
Capital expenditures 2,062 2,763 1,560 1,895 5,065
Long-term obligations, less current portion 11,805 15,815 18,921 25,014 28,540
PER SHARE DATA
Net income per share
Basic $ 1.31 $ .93 $ .91 $ 1.08 $ 1.95
Diluted 1.27 .92 .89 1.07 1.93
Dividends .44 .44 .44 .44 .44
Shareholders' equity (Basic) 12.08 11.19 10.44 11.06 10.64
Average shares outstanding: Basic 3,627,541 3,620,593 3,631,278 3,623,291 3,621,449
Diluted 3,745,701 3,658,965 3,681,084 3,667,179 3,660,923
ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Summary
Net sales for 2004 increased 13% to $100.1 million from $88.3 million
for 2003. Net income grew 42% to $4.8 million, or $1.27 per diluted share,
million, or $.92 per diluted share. Higher sales volume allowed for better
from $3.4 utilization of our manufacturing facilities, which resulted in
increased profitability. The improved profitability more than offset the
start-up costs associated with our new facility in Shanghai, China; increased
raw material prices; and the increased legal and settlement costs related to
an alleged patent infringement suit.
Net sales in the fourth quarter of 2004 increased 6% to $24.8 million
from $23.3 million a year earlier. Net income for the quarter increased 167%
to $1.4 million (or $.37 per diluted share) from $529,000 (or $.14 per diluted
share) a year earlier. The 2004 net income benefited not only from the
increased sales volume but also from the absence of certain costs that had
affected the 2003 fourth quarter results. Those costs included expenses
related to the closing of the Company's Florida location, legal fees
associated with the alleged patent infringement suit, and expenses incurred to
launch the SearchAlertTM product.
Gross margin for the fourth quarter of 2004 was 23.3% of net sales as
compared to 23.8% for the fourth quarter of 2003. Product mix plus start-up
costs and charges associated with the Shanghai operation accounted for the
decrease.
Selling and administrative expenses in the fourth quarter of 2004
totaled $4.2 million, comparable to the 2003 level. Increases resulting from
the addition of the Shanghai facility were offset by reductions at other
locations, and also by the absence of the legal costs incurred in 2003 as a
result of the alleged patent infringement suit.
-10-
The Company's research into establishing a manufacturing facility in
Shanghai began in early 2003. The new factory, Eastern Industrial, Ltd.
("EIS"), which the Company opened in late December 2003, began full-scale
production in the second quarter of 2004.
The Company experienced cost increases in 2004 that affected the
majority of material it uses in production such as steel, zinc and brass. Cost
increases ranged from 20% to 50%. The impact of the higher costs amounted to
$1.2 million, net of tax, or $0.31 per diluted share. The Company has passed
these increases in costs on to its customers where possible. Currently, there
is no indication that the Company will not be able to obtain all the materials
it requires. Additionally, there are signs that prices for materials have
leveled off or may actually decrease slightly in 2005.
The Company incurred legal expenses of $398,000 in 2004 to defend
against a patent infringement suit that it had determined to be without merit.
The Company incurred additional expense of $400,000 in the second quarter of
2004 as the result of a mediated settlement. The legal expenses combined with
the settlement resulted in charges to earnings net of taxes of $484,000, or
$0.13 per diluted share, in 2004.
For 2005 and future years, the Company anticipates increased costs
related to the required compliance with Section 404 of the Sarbanes-Oxley Act.
In addition, compliance will require a significant amount of time from Company
employees and higher audit fees for attestation by our independent registered
public accounting firm. For 2005, the fees associated with documentation
required by Section 404 will exceed $200,000. Future attestation fees are
projected to be in the range of 1.0 - 1.5 times the basic audit fee.
In January 2003, the Financial Accounting Standards Board ("FASB")
issued Interpretation No. 46, Consolidation of Variable Interest Entities,
which was revised in December 2003 ("FIN No. 46-R"). This rule requires that
companies consolidate a variable interest entity if the company is subject to
a majority of the risk of loss from the variable interest entity's activities
and/or is entitled to receive a majority of the entity's residual returns. The
provisions of FIN No. 46-R were required to be applied as of the end of the
first reporting period after March 15, 2004 for the variable interest entities
in which a company holds a variable interest that it acquired on or before
January 31, 2003. The adoption of FIN No. 46-R did not have any impact on the
financial position or results of operations of the Company.
In November 2004, the FASB issued Statement of Financial Accounting
Standards ("SFAS") No. 151, Inventory Costs, an amendment of ARB No. 43,
Chapter 4. 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 guidance is effective for inventory
costs incurred during fiscal years beginning after June 15, 2005. It is not
believed that the adoption of SFAS No. 151 will have a material impact on the
consolidated financial position, results of operations or cash flows of the
Company.
In December 2004, the FASB issued SFAS No. 123 (revised 2004),
Share-Based Payment. SFAS No. 123(R) will require that the compensation cost
relating to share-based payment transactions be recognized in financial
statements. That cost will be measured based on the fair value of the equity
or liability instruments issued. SFAS No. 123(R) covers a wide range of
share-based compensation arrangements including share options, restricted
share plans, performance-based awards, share appreciation rights, and employee
share purchase plans. SFAS No. 123(R) replaces FASB Statement No. 123,
Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25,
Accounting for Stock Issued to Employees. SFAS No. 123, as originally issued
in 1995, established as preferable a fair value-based method of accounting for
share-based payment transactions with employees. However, that Statement
permitted entities the option of continuing to apply the guidance in APB
Opinion No. 25, as long as the footnotes to financial statements disclosed
what net income would have been had the preferable fair value-based method
been used. Public entities will be required to apply SFAS No. 123(R) as of the
first interim or annual reporting period that begins after June 15, 2005. The
impact of the adoption of Statement No. 123(R) cannot be predicted at this
time because it will depend on levels of share-based payments granted in the
future. However, had the Company adopted Statement No. 123(R) in prior
periods, the impact of that standard would have approximated the impact of
Statement No. 123 as described in the disclosure of pro forma net income
(loss) and net income (loss) per share in the stock based compensation
accounting policy note included in Note 2 to the consolidated financial
statements.
-11-
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of the financial statements in accordance with generally
accepted accounting principles ("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 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 Intangibles
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 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.
-12-
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 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
bond index 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 2004 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 $1.5 million for 2005.
RESULTS OF OPERATIONS
FISCAL 2004 COMPARED TO FISCAL 2003
The following table shows, for 2004 and 2003, selected line items from
the consolidated statements of income as a percentage of net sales, by
segment.
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%
2003
----
Industrial Security Metal
Hardware Products Products Total
---------- -------- -------- -----
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of products sold 73.8% 71.5% 91.8% 75.6%
Gross margin 26.2% 28.5% 8.2% 24.4%
Selling and administrative
expense 17.1% 19.3% 10.9% 17.1%
Operating profit 9.1% 9.2% -2.7% 7.3%
-13-
The following table shows the amount of change 2003 to 2004 in selected
results, by segment (dollars in thousands):
Industrial Security Metal
Hardware Products Products Total
---------- -------- -------- -----
Sales $ 10,571 $ 3,141 $ (1,888) $ 11,824
Volume 25.7% 3.8% -13.9% 9.9%
Prices 1.6% 0.0% 0.0% 0.6%
New Products 2.5% 4.2% 0.0% 2.9%
-------- -------- -------- --------
29.8% 8.0% -13.9% 13.4%
Gross margin $ 3,392 $ 886 $ (735) $ 3,543
36.6% 7.9% -65.6% 16.4%
Operating profit $ 1,694 $ (149) $ (179) $ 1,366
52.3% -4.1% 48.3% 21.1%
Net sales for 2004 increased 13% ($11.8 million) to $100.1 million from
$88.3 million for 2003. Volume of existing products increased sales by 10%,
while new product introductions increased sales by 3%.
The Industrial Hardware segment experienced a 30% increase in sales. The
increase in volume of existing products occurred in almost every market we
service, most notably -- sales of industrial hardware (such as rotary locks,
locking recessed handles, multi-point paddle handles and slam latches) to
original equipment manufacturers up 40% and sales to distributors up 35%.
These markets experienced rapid growth throughout 2004 as the economy
improved, and they are expected to remain strong through 2005.
Sales of automotive accessories (toolbox locks, push-button locks and
rotary latches) declined 9% as a result of domestic and offshore competition
in this market. Sales at the Company's Mexican operation increased 23% from
2003 primarily due to improved economic growth in Mexico. Sales of "sleeper
boxes" for the Class 8 trailer truck market, a product resulting from the
Canadian Commercial Vehicles acquisition, increased by 41%.
New product introductions increased total segment sales by 3%. All of
the new products were internally developed, and were aimed at the utility
truck and vehicular accessory markets. Among the new products were Power UpTM,
a remote power locking system, as well as various handles and latching
systems.
The Company continued to invest in new products and its new Shanghai
facility, and to search for business acquisitions that complement its existing
operations or provide opportunities to enter new markets. The Industrial
Hardware segment is projected to continue growing through 2005.
Gross margin for the Industrial Hardware segment was 27.5% of sales for
2004 as compared to 26.2% for 2003. The improvement in the gross margin
percentage resulted from the sale of higher-margin products. Gross profit
increased $3.4 million, or 37%, from 2003 due to higher sales volume and
higher gross margin percentage.
In the Security Products segment, sales were 8% higher than in 2003. The
increase in volume of existing products was the result of sales of
high-security locks for access doors, electronics equipment and vehicular
applications, which were up 23% from 2003 levels, mainly through taking market
share from our competition. However, some of the sales increases were offset
by slight declines in the sales of locks to the furniture, coin-operated
vending and gaming equipment markets and to lock distributors servicing
lower-volume accounts. Sales to the industrial controls and accessories market
decreased 14%.
Sales of luggage locks for the travel industry increased 232% in 2004,
following the introduction of our SearchAlertTM travel lock in late 2003.
Sales to this market had been hard-hit in the wake of the September 11, 2001,
terrorist attacks. Sales were additionally impacted by a Transportation
Security Administration ("TSA") declaration that passengers should not lock
their checked baggage on commercial airline flights. Responding to the TSA
declaration, the CCL Security Products Division introduced the SearchAlertTM,
-14-
a new lock which meets all the requirements established by Travel SentryTM,
the standard-setting group created to work closely with the TSA and the
luggage lock manufacturers. SearchAlertTM allows the TSA to unlock and inspect
an airline passenger's bags without destroying the lock. The product also lets
the bags' owner know, via an access indicator, if the bag has been opened.
Sales of security products to the commercial laundry industry decreased
6% from 2003. Sales to this industry were down in most of our product lines
and in all of the markets we service. We are continuing our R&D efforts and
our search for "smart card" applications beyond the commercial laundry market.
We believe that the security characteristics of "smart cards" present us with
several potential opportunities in new markets, which we are actively
exploring.
New product introductions increased total segment sales by 4%. The new
products included the SearchAlertTM, a snap-in lock and a toolbox push-button
lock.
The Security Products segment gross margin was 28.5% for both 2004 and
2003. Gross profit increased $886,000, or 8%, from 2003, primarily due to the
8% increase in sales.
In the Metal Products segment, sales were down 14% from the previous
year. Sales of contract castings were down 15% from 2003. The primary cause of
the decrease in contract castings was the decision of two large accounts to
move their remaining casting business to lower-cost, offshore sources.
However, that decision itself resulted from our implementation of a new
strategy - begun in 2003 and completed in 2004 - to focus on mine roof anchor
systems.
Sales of mine roof support anchors decreased 13% from 2003, mainly
because one account chose to place some key business with a lower-cost,
offshore supplier. The bulk of the reduction in sales involved the proprietary
product that we had produced under contract for that customer until mid-2003.
The loss of this business was partially offset by a 25% increase in sales to
our second largest U.S. mining account. The U.S. coal mining industry grew
through 2004 and the rate of growth into 2005 is over 6%. With rising oil
prices, coal has been growing in importance as an energy source worldwide. The
growth in coal consumption should provide new opportunities for mine roof
anchor sales both in North America and Asia.
To expand our markets and counter the lower demand in the U.S. for mine
roof fasteners, resulting from changes in mining methods utilizing fewer roof
anchors per ton of coal produced, during 2004 we entered into a technical
agreement with the China University of Mining and Technology for the
field-testing and eventual marketing of the Company's mechanical anchor
systems, which are used to secure the roofs in underground mines. These tests
have been substantially and successfully completed. We will now begin our
marketing strategy to penetrate the mining market in China.
In addition, to offset reduced demand for malleable iron castings, we
have continued to develop our ductile iron casting capability. Shipments of
ductile iron castings grew to 324 tons in 2004. While that accounts for only
6% of total sales in 2004, there is significant opportunity for growth in
2005.
Gross margin for the Metal Products segment was 3.3% for 2004 as
compared to 8.2% for 2003. Gross profit for 2004 decreased $735,000, or 66%,
from 2003, primarily due to lower sales volume and the fixed costs associated
with the business.
The Company-wide gross margin percentage for 2004 was 0.7 points higher
than in 2003 -- 25.1% versus 24.4%. Gross profit increased $3.5 million, or
16%, from 2003. The increase was due to more efficient utilization of
manufacturing facilities resulting from higher sales volume; increased sales
of higher-margin products; and lower group health insurance premiums resulting
from the consolidation of several health plans in early 2004.
Total selling and administrative expenses increased 14%, or $2.2
million, from 2003. The increase was due to higher wage expense and associated
payroll charges; higher legal costs and the cost of a mediated settlement
associated with the defense of a patent lawsuit (which the Company determined
to be without merit); and costs associated with the establishment of the
Shanghai facility.
Operating profit for the Industrial Hardware segment was 10.7% of sales
for 2004 as compared to 9.1% for 2003. Operating income grew $1.7 million, or
52%, from 2003 due to higher overall sales volume and increased sales of
higher-margin products.
-15-
In the Security Products segment, operating profit was 8.2% for 2004 as
compared to 9.2% for 2003. Operating income decreased $150,000, or 4% from
2003. The decrease was primarily due to higher legal and settlement costs
associated with the aforementioned patent lawsuit, and higher raw material
costs. These higher costs were partially offset by increased sales volume in
2004 and by one-time charges in 2003 relating to the closing of the Company's
Florida location and the launch of the SearchAlertTM product.
The Metal Products segment recorded a 2004 operating loss of $548,000,
or 4.7% of sales, as compared to a loss of $370,000, or 2.7%, in 2003. The
erosion in operating profit was primarily the result of fixed costs relating
to the operation of the foundry and the reduction in sales.
Interest expense for the Company decreased 20%, or $258,000, from 2003
due to lower outstanding debt balances.
Other income decreased 89%, or $186,000, from 2003. The decrease
primarily reflected a gain in 2003 on the sale of common stock, and a drop in
the interest income the Company received during 2004. The gain in 2003 totaled
$167,000 and was from the sale of common stock received during 2001 from a
single issuer in connection with the issuer's demutualization. The decrease in
2004 interest income of $19,000 was due to lower cash balances in the Company
cash management program.
The effective tax rate in 2004 was 30%, down from 38% in 2003. The
decrease was primarily due to a change in the mix of taxable earnings in
foreign jurisdictions with lower effective tax rates.
FISCAL 2003 COMPARED TO FISCAL 2002
The following table shows, for 2002 and 2003, selected line items from
the consolidated statements of income as a percentage of net sales by segment.
2003
----
Industrial Security Metal
Hardware Products Products Total
---------- -------- -------- -----
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of products sold 73.8% 71.5% 91.8% 75.6%
Gross margin 26.2% 28.5% 8.2% 24.4%
Selling and administrative
expense 17.1% 19.3% 10.9% 17.1%
Operating profit 9.1% 9.2% -2.7% 7.3%
2002
----
Industrial Security Metal
Hardware Products Products Total
---------- -------- -------- -----
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of products sold 69.1% 71.7% 91.5% 74.6%
Gross margin 30.9% 28.3% 8.5% 25.4%
Selling and administrative
expense 17.6% 20.1% 11.7% 17.6%
Operating profit 13.3% 8.2% -3.2% 7.8%
-16-
The following table shows the amount of change in selected data by
segment during fiscal 2003 as compared to fiscal 2002 (in thousands):
Industrial Security Metal
Hardware Products Products Total
---------- -------- -------- -----
Sales $ 6,151 $ 2,893 $ (2,074) $ 6,970
Volume 4% 6% -17% 1%
Prices 0% 0% 3% 0%
New Products 17% 2% 1% 8%
-------- ------- ------- --------
21% 8% -13% 9%
Gross margin $ 206 $ 890 $ (208) $ 888
2% 9% -16% 4%
Operating income $ (666) $ 643 $ 125 $ 102
-17% 22% -25% 2%
Net sales for 2003 increased 9% ($7.0 million) to $88.3 million from
$81.3 million for 2002. Volume of existing products increased sales by 1%,
while new product introductions increased sales by 8%.
The Industrial Hardware segment experienced a 21% increase in sales. The
increase in volume of existing products is the result of an increase in sales
of heavy hardware sold to the tractor-trailer industry of 15% from 2002
levels. Sales to this market had been down since the latter half of 2000. This
market is expected to grow throughout 2004 and into 2005 as the economy
continues to expand. The rebound in the tractor-trailer market utilizing heavy
hardware could be adversely affected by higher steel prices and diminishing
allocation of raw materials.
Sales of industrial hardware (such as rotary locks, locking recessed
handles, multi-point paddle handles and slam latches) to original equipment
manufacturers increased 5% in 2003. This increase was due to orders from new
customers and higher demand for truck service bodies. However, sales to
distributors were down 3% from 2002, primarily because of continued softness
in this sector of our business. Sales of school bus door closures increased
10% in 2003, reflecting a greater volume of business with our primary bus
hardware customer. Sales of automotive accessories (toolbox locks, push-button
locks and rotary latches) declined 2% as a result of domestic and offshore
competition in this market. Sales at the Company's Mexican operation decreased
27% from 2002 primarily due to a lack of economic growth in Mexico.
New product sale increases were the result of internally developed new
products (for the utility truck and vehicular accessory markets), which
increased sales by 6%, while sales of sleeper boxes for the Class 8 trailer
truck market, resulting from the Canadian Commercial Vehicles acquisition,
increased sales by 11%.
Despite the sluggishness of the economy, the Company continued to invest
in new products and search for business acquisitions that complement its
existing operations or provide opportunities to enter new markets.
The Industrial Hardware segment gross margin was 26.2% for 2003 as
compared to 30.9% of sales for 2002. The decrease in the gross margin
percentage is the result of a greater number of lower margin products being
sold as the result of the inclusion of the Canadian Commercial Vehicle
acquisition for the full year of 2003. This company sells sleeper boxes for
the Class 8 truck market which are sold at a much lower profit margin than our
traditional transportation and industrial products. In addition, higher
material, labor and benefit costs further reduced margins since the Company
was unable to pass price increases along to our customers.
In the Security Products segment, sales were 8% higher than in 2002. The
increase in volume of existing products was the result of sales of
high-security locks for coin-operated vending and gaming equipment being up
50% in 2003. That increase was primarily the result of our gaining market
share from our competition in an otherwise flat market. Sales of locks for
access doors, furniture, electronics equipment and vehicular applications were
up 24% from 2002 levels, mainly through taking market share from our
competition. However, some of the sales increases were offset by slight
declines in sales of locks to the computer industry and to lock distributors
servicing lower-volume accounts and sales to the industrial controls and
accessories market decreased 8%.
-17-
Sales of luggage locks for the travel industry declined 58%. Sales to
this market had been hard-hit in the wake of the September 11, 2001, terrorist
attacks, and they continued to be impacted by a Transportation Security
Administration ("TSA") declaration that passengers should not lock their
checked baggage on commercial airline flights. Responding to the TSA
declaration, the CCL Security Products Division in late 2003, introduced the
SearchAlertTM, a new lock which meets all the requirements established by
Travel SentryTM, the standard setting group created to work closely with the
TSA and the luggage lock manufacturers. SearchAlertTM allows the TSA to unlock
and inspect airline passengers' bags without destroying the lock and lets the
bags' owner know if the bag has been opened via an access indicator. The
Company expects this lock to have a significant effect on luggage lock sales
in 2004.
Sales of security products to the commercial laundry industry increased
8% from 2002. Sales of "smart card" products increased 10% in 2003, partially
offsetting declines that occurred in sales of two of the Company's mature
products for the laundry sector. The growth in smart card product sales
continues to be driven by greater acceptance of the technology among both
existing and new customers.
New product introductions increased sales by 2% which included Presto
Seals, Remote Keyless Entry systems and SearchAlertTM.
The Security Products segment gross margin was 28.5% for 2003 as
compared to 28.3% of sales for 2002. The gross profit increased $890,000, or
9%, from 2002 primarily due to the aforementioned increase in sales of 8%.
In the Metal Products segment, total sales were down 13% from the
previous year. While the sale of the Company's proprietary mine roof anchor
systems decreased slightly compared to 2002, sales of contract castings were
down 29% from 2002. This decrease was caused mainly by the company's decision
to focus its efforts more intensively on its mine roof anchor systems.
Because of lower labor and operating costs in countries such as China,
Mexico and Germany, and in some cases favorable monetary exchange rates, the
price of imported castings is often well below that of U.S. produced castings.
However, the Company will continue to offer contract castings to customers
when profit margins are acceptable.
The slight decrease in the sales of mine roof anchors reflected lower
demand for these products partly as a result of fairly stable weather
conditions which reduces the demand for power which in turn reduces the demand
for coal. In addition, the increased use of mining techniques such as strip
and long well mining require none or fewer roof anchor supports than
underground mining.
The new Energy Information Administration ("EIA") projects that coal
will increase its share of U.S. electricity generation from 50% in 2002 to 52%
by 2025. The National Energy Policy legislation currently before Congress aims
at providing affordable coal-based electricity to business and consumers and
at providing additional incentives for the deployment of clean coal
technologies. The EIA's Annual Energy Outlook 2004 increased its projection by
5% to 112 gigawatts of new coal-fired generating capacity plants will be
deployed over the next 20 years.
Management continues to believe that coal will remain the backbone of
the U.S. energy supply. Total coal production in 2004 is projected to increase
3.5% from 2003. Although the demand for coal is influenced by the weather, the
rising price of natural gas, advances in hydrogen technology and the growing
need for fuel diversity have positioned coal usage for growth.
In order to maintain utilization rates in its manufacturing plant, the
Company has been developing capabilities for producing castings using ductile
iron (previously, it used only malleable iron in its casting products). While
the Company has filled several small orders, the Company is still refining and
perfecting its ductile iron capabilities. Although the new capabilities will
enable the Company to supply additional products and services to its
customers, further capital investments may be required to make the casting of
larger quantities possible.
The Metal Products Segment gross margin was 8.2% for 2003 as compared to
8.5% of sales for 2002. Gross profit decreased $208,000, or 15.7%, from 2002
primarily due to the aforementioned 13.2% decrease in sales from 2002.
-18-
The total Company gross margin percentage for 2003 was 1 percentage
point below the 2002 level--24.4% versus 25.4%. The decrease was the result of
increased costs for group health insurance, property and liability insurance
and pensions.
Total selling and administrative expenses increased 5.5%, or $786,000,
from 2002. The increase was due to increased wage expense and associated
payroll charges; higher legal costs associated with the defense and settlement
of a patent lawsuit (which the Company had determined was without merit);
costs associated with the establishment of the Shanghai manufacturing facility
and non-capital costs associated with the updating of information technology
equipment.
The Industrial Hardware segment operating profit was 9.1% for 2003 as
compared to 13.3% of sales for 2002. Operating profit decreased $666,000, or
17.1%, from 2002 due to increased wage expense and associated payroll charges,
costs associated with the establishment of the Shanghai facility and
non-capital costs associated with the updating of information technology
equipment.
The Security Products segment operating profit was 9.2% for 2003 as
compared to 8.2% of sales for 2002. Operating profit increased $643,000, or
22% from 2002 primarily due to selling and administrative expenses as a
percent of sales despite higher legal costs associated with the aforementioned
defense of a patent lawsuit.
The Metal Product segment operating loss was $370,000, or 2.7%, for 2003
as compared to a loss of $495,000, or 3.2%, of sales for 2002. The reduction
in operating losses is primarily the result of lower commission expenses as
the result of lower sales.
Interest expense decreased 24%, or $413,000, from 2002 due to lower
outstanding debt balances.
Other income increased 209%, or $141,000, from 2002 primarily due to a
gain in the sale of common stock of a single issuer received during 2001 in
connection with the demutualization of the issuer. The gain of $167,000 was
offset by a reduction of $26,000 in interest income the Company received in
its cash management program.
The effective tax rate in 2003 was 38%, up from 31% in 2002. The
increase in the effective income tax rate in the current year is primarily due
to 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 2004. The
primary source of the Company's cash is earnings from operating activities
adjusted for cash generated from or used in 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
requirement 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.
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.
-19-
2004 2003 2002
---- ---- ----
Current ratio 2.9 3.5 3.5
Average days' sales in accounts receivable 47 48 50
Inventory turnover 3.7 4.1 3.7
Ratio of working capital to sales 26.7% 28.2% 31.5%
Total debt to shareholders' equity 36.1% 44.0% 56.9%
At January 1, 2005, January 3, 2004, and December 28, 2002, the Company
had cash and cash equivalents of $4.4 million, $4.9 million and $5.9 million,
respectively, and working capital of $26.7 million, $24.9 million and $25.6
million, respectively.
Net cash provided by operating activities was $4.9 million in 2004
compared to $6.4 million in 2003 and $11.4 million in 2002. The $1.5 million
decrease from 2003 to 2004 and the $5.0 million decrease from 2002 to 2003
related primarily to changes in the components of working capital. Excluding
such changes, the net cash provided by operating activities would have been
$8.4 million, $7.5 million and $7.5 million in 2004, 2003 and 2002,
respectively. During 2004, working capital used approximately $3.6 million in
cash as a result of increased sales activity. Included in this amount was 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 a $800,000
increase in accrued compensation. In 2003, working capital components used
cash totaling $1.1 million; substantially all of this amount was due to
changes in accounts receivable, inventories, prepaid expenses and accounts
payable. The increases were a result of higher sales volume in the fourth
quarter of 2003. In 2002, working capital components provided $3.9 million in
cash; this was primarily the result of a general decrease in inventories
across all segments of the business.
During 2004, the Company used $2.0 million of cash in investing
activities, virtually all of them related to the purchase of fixed assets. In
2003, the Company used $1.8 million in investing activities - approximately
$2.8 million related to the purchase of fixed assets, offset by the proceeds
from the sale of common stock held for investment. During 2002, the Company
used $1.9 million in investing activities - $1.6 million for the purchase of
fixed assets, and $300,000 for the acquisition of Canadian Commercial Vehicles
Corporation and certain assets of the Big Tag Division of Dolan Enterprises,
Inc. The Company expects capital expenditures for 2005 to be approximately $2
million to $3 million.
Net cash used by financing activities totaled $3.4 million, $5.6 million
and $8.5 million in 2004, 2003 and 2002, respectively. Of those amounts, $2.0
million, $3.2 million and $3.4 million related to the principal payments of
long-term debt in 2004, 2003 and 2002 respectively. The first $600,000
scheduled long-term debt payment for calendar 2004 was included in fiscal
2003. In addition, the Company elected to pay down $500,000 and $3.5 million
on its revolving credit line in 2003 and 2002, 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 $642,000, $383,000 and $306,000 in 2004,
2003 and 2002, respectively.
On December 27, 2002, the Company amended its unsecured loan agreement
(the Loan Agreement) with its lender. Under the amended agreement, the term
portion of the Loan Agreement ($18.6 million at the end of 2002) was paid in
quarterly installments of $600,000 during 2003, with payments increasing
annually after 2004 until maturity on January 1, 2009. During fiscal 2003, the
Company made its regular quarterly payments and also made its first scheduled
payment of $600,000 for calendar 2004. As a result, the remaining term portion
of the Loan Agreement at year-end 2003 was $15.6 million. As required, the
Company maintains an interest rate swap contract with the lender with an
original amount of $15.0 million; this amount is reduced on a quarterly basis
in accordance with the principal repayment schedule of the term portion of the
Loan Agreement ($6.6 million on January 1, 2005, and $8.4 million on January
3, 2004). The interest rate on the swap contract is fixed at 9.095%. Under the
revolving credit portion of the Loan Agreement, the Company may borrow up to
$7.5 million through July 1, 2005, and must pay a quarterly commitment fee of
0.25% on the unused portion. As of January 1, 2005, $1.0 million was
outstanding under the revolver portion of the Loan Agreement. 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.
-20-
During the first quarter of 2005, the Company plans to borrow an
additional $3 million under its revolving credit facility to cover short-term
cash requirements.
Tabular Disclosure of Contractual Obligations
The Company's known contractual obligations as of January 1, 2005, are
shown below:
Payment due by period
---------------------
Less than More than
Contractual Obligations (in thousands) Total 1 Year 1-3 Years 3-5 Years 5 Years
Long-term debt obligations $ 14,825 $ 3,800 $ 6,800 $ 4,225 $ -
Estimated interest on long-term debt
and capital lease obligations 1,507 671 659 177 -
Capital lease obligations 990 210 452 328 -
Operating lease obligations 2,049 614 959 476 -
Estimated contributions to pension
plans 5,800 1,506 3,767 527 -
Estimated post-retirement benefits
other than pensions 1,117 152 317 316 332
-------- -------- -------- --------- --------
Total $ 26,288 $ 6,953 $ 12,954 $ 6,049 $ 332
======== ======== ======== ========= ========
The amounts shown in the above table for estimated contributions to
pension plans and estimated post-retirement 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.
The Company does not have any non-cancelable open purchase orders.
The Company maintains a letter of credit in the amount of $900,000
related to its capital lease. The 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
22% of total sales and 19% of total assets. Its U.S. operations buy from and
sell to these foreign affiliates, and also make limited sales (approximately
10% 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 January 1,
2005 for all of the listed currencies changed by 1%, the total change in
reported earnings would have been less than $25,000. 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 2004, a
10% increase/decrease in exchange rates would have resulted in a translation
increase/decrease to sales of approximately $2.0 million, and to equity of
approximately $1.3 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 2%. 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 1.75% on the
term loan portion and 1.50% on 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 a swap
contract on a portion of the term loan under the Loan Agreement. The interest
rate on the swap contract is 9.095% and the swap contract expires on July 1,
2005. 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 $6.6 million
as of January 1, 2005.
-21-
The remainder of the term debt is subject to the volatility of
short-term interest rates, where a 1% change in interest rates would cause an
$82,250 increase or decrease in the Company's annual interest cost. While the
Company could enter into an additional swap agreement to fix the rate, it does
not expect to do so.
ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Eastern Company
Consolidated Balance Sheets
January 1 January 3
2005 2004
---- ----
ASSETS
Current Assets
Cash and cash equivalents $ 4,420,506 $ 4,896,816
Accounts receivable, less allowances of $332,000
in 2004 and $302,000 in 2003 12,528,189 11,036,760
Inventories:
Raw materials and component parts 11,279,981 8,687,003
Work in process 3,670,812 4,112,625
Finished goods 5,526,811 4,126,920
------------ ------------
20,477,604 16,926,548
Prepaid expenses and other assets 2,258,642 1,642,513
Deferred income taxes 739,500 462,700
------------ ------------
Total Current Assets 40,424,441 34,965,337
Property, Plant and Equipment
Land 702,416 701,923
Buildings 11,856,933 11,468,122
Machinery and equipment 29,471,908 30,649,120
Accumulated depreciation (18,124,710) (17,888,740)
------------ ------------
23,906,547 24,930,425
Other Assets
Goodwill 10,604,286 10,519,766
Trademarks 174,527 167,607
Patents, technology, and licenses, less accumulated
amortization of $1,869,970 in 2004 and
$1,513,029 in 2003 1,743,266 1,877,408
Intangible pension asset 870,064 964,592
Prepaid pension cost 348,634 1,192,281
------------ ------------
13,740,777 14,721,654
------------ ------------
$ 78,071,765 $ 74,617,416
============ ============
-22-
Consolidated Balance Sheets
January 1 January 3
2005 2004
---- ----
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Accounts payable $ 5,010,271 $ 4,246,633
Accrued compensation 2,472,944 1,782,408
Other accrued expenses 2,239,668 2,034,918
Current portion of long-term debt 4,009,811 2,007,273
------------ ------------
Total Current Liabilities 13,732,694 10,071,232
Deferred income taxes 1,452,134 1,243,264
Long-term debt, less current portion 11,804,861 15,814,669
Accrued post-retirement benefits 2,219,821 2,384,770
Accrued pension cost 4,885,160 4,015,858
Interest rate swap obligation 160,417 580,055
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: 5,323,593 shares in 2004 and 5,296,381
shares in 2003 17,583,561 17,177,797
Treasury Stock: 1,688,726 shares in 2004 and 1,680,342
shares in 2003 (16,655,041) (16,512,848)
Retained earnings 47,568,571 44,406,855
Accumulated other comprehensive income (loss):
Foreign currency translation 463,804 (166,295)
Additional minimum pension liability, net of taxes (5,047,800) (4,049,886)
Derivative financial instruments, net of taxes (96,417) (348,055)
------------ ------------
(4,680,413) (4,564,236)
------------ ------------
Total Shareholders' Equity 43,816,678 40,507,568
------------ ------------
$ 78,071,765 $ 74,617,416
============ ============
See accompanying notes.
-23-
Consolidated Statements of Income
Year ended
January 1 January 3 December 28
2005 2004 2002
--------- --------- -----------
Net sales $ 100,130,158 $ 88,306,581 $ 81,337,207
Cost of products sold (74,999,119) (66,718,641) (60,637,151)
------------- ------------- -------------
Gross margin 25,131,039 21,587,940 20,700,056
Selling and administrative expenses (17,280,348) (15,103,624) (14,317,256)
------------- ------------- -------------
Operating profit 7,850,691 6,484,316 6,382,800
Interest expense (1,044,490) (1,302,830) (1,716,056)
Other income 22,838 209,004 67,564
------------- ------------- -------------
Income before income taxes 6,829,039 5,390,490 4,734,308
Income taxes 2,071,338 2,028,868 1,442,408
------------- ------------- -------------
Net income $ 4,757,701 $ 3,361,622 $ 3,291,900
============= ============= =============
Earnings per Share:
Basic $ 1.31 $ .93 $ .91
============= ============= =============
Diluted $ 1.27 $ .92 $ .89
============= ============= =============
See accompanying notes.
Consolidated Statements of Comprehensive Income (Loss)
Year ended
January 1 January 3 December 28
2005 2004 2002
--------- --------- -----------
Net income $ 4,757,701 $ 3,361,622 $ 3,291,900
Other comprehensive income/(loss) -
Change in foreign currency translation 630,099 731,842 258,378
Change in fair value of derivative financial
instruments, net of income taxes (benefit) of
$168,000, $223,000 and ($33,000) in 2004, 2003
and 2002, respectively 251,638 335,031 (50,666)
Unrealized gain on investment in common stock:
Unrealized holding gains, net of income taxes
(benefit) of $42,900 and ($17,500) in 2003
and 2002, respectively - 64,795 (25,079)
Less reclassification adjustment for realized
gains included in net income, net of
income tax benefit of $66,100 in 2003 - (100,688) -
Change in additional minimum pension liability net
of income taxes (benefit) of ($227,839) in 2004,
$15,992 in 2003 and ($2,715,913) in 2002 (997,914) 23,984 (4,073,870)
------------- ------------- -------------
(116,177) 1,054,964 (3,891,237)
------------- ------------- -------------
Comprehensive income/(loss) $ 4,641,524 $ 4,416,586 $ (599,337)
============= ============= =============
See accompanying notes.
-24-
Consolidated Statements of Shareholders' Equity
Common Treasury Treasury Retained
Common Shares Stock Shares Stock Earnings
------------- -------- -------- -------- --------
Balances at December 29, 2001 5,281,505 $ 16,978,422 (1,652,320) $ (16,139,267) $ 40,944,315
Net income 3,291,900
Cash dividends declared, $.44 per
share (1,597,864)
Purchase of Common Stock for
treasury (5,000) (55,855)
Issuance of Common Stock for
directors'fees 7,684 100,395
--------- ------------ ---------- ------------- ------------
Balances at December 28, 2002 5,289,189 17,078,817 (1,657,320) (16,195,122) 42,638,351
Net income 3,361,622
Cash dividends declared, $.44 per
share (1,593,118)
Purchase of Common Stock for
treasury (23,022) (317,726)
Issuance of Common Stock for
directors' fees 7,192 98,980
--------- ------------ ----------- ------------- ------------
Balances at January 3, 2004 5,296,381 17,177,797 (1,680,342) (16,512,848) 44,406,855
Net income 4,757,701
Cash dividends declared, $.44 per
share (1,595,985)
Purchase of Common Stock for
treasury (8,384) (142,193)
Issuance of Common Stock upon
the exercise of stock options 22,500 324,800
Issuance of Common Stock for
directors' fees 4,712 80,964
--------- ------------ ---------- ------------- ------------
Balances at January 1, 2005 5,323,593 $ 17,583,561 (1,688,726) $ (16,655,041) $ 47,568,571
========= ============ ========== ============= ============
See accompanying notes.
-25-
Consolidated Statements of Cash Flows
Year ended
January 1 January 3 December 28
2005 2004 2002
--------- --------- -----------
Operating Activities
Net income $ 4,757,701 $ 3,361,622 $ 3,291,900
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 3,461,411 3,619,328 3,565,460
Loss on sale of equipment and other assets 67,620 - -
Provision for doubtful accounts 112,222 220,902 91,296
Deferred income taxes (8,092) 390,788 454,200
Gain on sale of investment - (166,788) -
Issuance of Common Stock for directors' fees 80,964 98,980 100,395
Changes in operating assets and liabilities:
Accounts receivable (1,639,624) (322,902) 259,870
Inventories (3,299,948) (270,871) 2,191,677
Prepaid expenses and other (634,445) (326,025) (137,673)
Prepaid pension cost 581,724 (99,100) 349,385
Other assets (105,674) (113,840) 47,536
Accounts payable 495,218 364,306 170,023
Accrued compensation 790,492 (181,908) 1,002,865
Other accrued expenses 194,244 (204,275) (19,211)
------------ ------------- -------------
Net cash provided by operating activities 4,853,813 6,370,217 11,367,723
Investing Activities
Purchases of property, plant and equipment (2,062,313) (2,763,130) (1,559,863)
Proceeds from sale of equipment and other assets 13,367 - -
Business acquisitions, net of cash acquired - - (303,746)
Proceeds from sale of investment - 915,133 -
------------ ------------- -------------
Net cash used in investing activities (2,048,946) (1,847,997) (1,863,609)
Financing Activities
Principal payments on long-term debt (2,007,357) (3,732,726) (6,853,694)
Proceeds from sales of Common Stock 324,800 - -
Purchases of Common Stock for treasury (142,193) (317,726) (55,855)
Dividends paid (1,595,985) (1,593,118) (1,597,864)
------------ ------------- -------------
Net cash used in financing activities (3,420,735) (5,643,570) (8,507,413)
Effect of exchange rate changes on cash 139,558 78,934 (12,489)
------------ ------------- -------------
Net change in cash and cash equivalents (476,310) (1,042,416) 984,212
Cash and cash equivalents at beginning of year 4,896,816 5,939,232 4,955,020
------------ ------------- -------------
Cash and cash equivalents at end of year $ 4,420,506 $ 4,896,816 $ 5,939,232
============ ============= =============
See accompanying notes.
-26-
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. Significant
items subject to estimates and assumptions include valuation allowances for
receivables and inventories; and assets and obligations related to employee
benefit plans.
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 for 2004, all locations, including
subsidiaries in Asia and Mexico, are consolidated as of the Company's fiscal
year end of January 1, 2005. The Company has historically consolidated its
subsidiaries located in Asia and Mexico as of November 30, which has 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%.
CASH EQUIVALENTS
Highly liquid investments purchased with an original maturity of three months or
less are considered cash equivalents.
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.
-27-
The Eastern Company
Notes to Consolidated Financial Statements (continued)
2. ACCOUNTING POLICIES (continued)
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. Revenues from the sale of products to
distributors fall under the same guidelines. The Company does not offer any
special right of return, stock rotation or price protection to its distributors
or the end customers.
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. ($15,296,932 for U.S. inventories
at January 1, 2005) and by the first-in, first-out (FIFO) method for inventories
outside the U.S. ($5,180,672 for inventories outside the U.S. at January 1,
2005). Current cost exceeds the LIFO carrying value by approximately $3,922,000
at January 1, 2005 and $3,677,000 at January 3, 2004. There was no material LIFO
quantity liquidation in 2004 or 2003.
PROPERTY, PLANT AND EQUIPMENT AND RELATED DEPRECIATION
Property, plant and equipment (including equipment under capital lease) are
stated at cost. Depreciation ($3,131,483 in 2004, $3,118,885 in 2003 and
$3,006,994 in 2002) 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.
GOODWILL AND INTANGIBLES
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. Amortization expense in 2004, 2003 and 2002 was $329,927, $500,443 and
$558,466, respectively. Total amortization expense for each of the next five
years is estimated to be as follows: 2005 - $177,064; 2006 - $170,397; 2007 -
$162,768; 2008 - $160,250; and 2009 - $117,250.
Statement of Financial Accounting Standard ("SFAS") No. 142, Goodwill and Other
Intangible Assets, classifies intangible assets into three categories: (1)
intangible assets with definite lives subject to amortization; (2) intangible
assets with indefinite lives not subject to amortization; and (3) goodwill. The
Company reviews goodwill and intangible assets with indefinite lives for
impairment annually and/or if events or changes in circumstances indicate the
carrying
-28-
The Eastern Company
Notes to Consolidated Financial Statements (continued)
2. ACCOUNTING POLICIES (continued)
value of an asset may have been impaired. The Company reviews intangible assets
with definite lives for impairment whenever conditions exist that indicate the
carrying value may not be recoverable, such as economic downturn in a market or
a change in the assessment of future operations. Goodwill and intangible assets
are considered to be impaired when the net book value of a reporting unit
exceeds its estimated fair value. Fair values are primarily established using
discounted cash flow methodology. The determination of discounted cash flows is
based on the business' strategic plans and long-range forecasts. The revenue
growth rates included in the plans are management's best estimates based on
current and forecasted market conditions, and the profit margin assumptions are
projected by each segment based on the current cost structure and anticipated
cost changes.
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 2004, 2003 or 2002. Trademarks are not amortized as their lives are
deemed to be indefinite.
The following is a roll-forward of goodwill for 2004 and 2003:
2004 2003
------ ------
Beginning balance $ 10,519,766 $ 10,364,140
Foreign exchange 84,520 155,626
------------ ------------
Ending balance $ 10,604,286 $ 10,519,766
============ ============
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 $1,166,747 in
2004, $1,115,329 in 2003 and $1,040,661 in 2002.
ADVERTISING COSTS
The Company expenses advertising costs as incurred. Advertising costs were
$447,778 in 2004, $449,304 in 2003 and $495,889 in 2002.
INCOME TAXES
The Company and its 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.
-29-
The Eastern Company
Notes to Consolidated Financial Statements (continued)
2. ACCOUNTING POLICIES (continued)
EARNINGS PER SHARE
The denominators used in the earnings per share computations follow:
2004 2003 2002
---- ---- ----
Basic:
Weighted average shares outstanding 3,627,541 3,620,593 3,631,278
--------- --------- ---------
Denominator for basic earnings per share 3,627,541 3,620,593 3,631,278
========= ========= =========
Diluted:
Weighted average shares outstanding 3,627,541 3,620,593 3,631,278
Dilutive stock options 118,160 38,372 49,806
--------- --------- ---------
Denominator for diluted earnings per share 3,745,701 3,658,965 3,681,084
========= ========= =========
The Company has excluded the effect of 69,500, 177,500 and 547,500 shares in
2004, 2003 and 2002, respectively, from the above dilutive stock options, as
their inclusion would be anti-dilutive.
DERIVATIVES
The Company entered into an interest rate swap agreement to modify the interest
characteristics of a portion of its outstanding 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 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 in current assets or liabilities with the offset amount recorded to
accumulated other comprehensive income (loss) in shareholders' equity.
STOCK BASED COMPENSATION
The Company accounts for stock options in accordance with Accounting Principles
Board ("APB") Opinion No. 25, Accounting for Stock Issued to Employees. As such,
it does not recognize compensation expense for stock options granted under its
stock option plans if the exercise price is at least equal to the fair market
value of the Company's common stock on the date granted. Since no options were
granted below fair market value in 2004, 2003 or 2002, no compensation expense
has been recorded.
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, 2003, and 2002:
2004 2003 2002
---- ---- ----
Risk free interest rate 3.48% 3.18% 3.89%
Expected volatility 0.295 0.287 0.309
Expected option life 5 years 5 years 5 years
Weighted-average dividend yield 2.2% 2.9% 3.1%
-30-
The Eastern Company
Notes to Consolidated Financial Statements (continued)
2. ACCOUNTING POLICIES (continued)
The weighted average fair market value of the shares granted under options was
$20.37 in 2004, $15.30 in 2003, and $14.19 in 2002. The weighted average fair
value of options, estimated using the Black-Scholes option pricing model based
on the assumptions in the above table, was $5.15 in 2004, $3.37 in 2003, and
$3.42 in 2002.
Pro forma information regarding net income and earnings per share, as required
by Statement No. 123, Accounting for Stock-Based Compensation, has been
determined as if the Company had accounted for its employee stock options under
the fair value method.
(in thousands, except per share amounts)
2004 2003 2002
---- ---- ----
Net income, as reported $4,758 $3,362 $3,292
Deduct: Total stock-based employee
compensation expense determined under fair
value-based method for all awards granted
since July 19, 2000, net of related tax effects 311 85 138
------ ------ ------
Pro forma net income $4,447 $3,277 $3,154
====== ====== ======
Earnings per share:
Basic - as reported $1.31 $0.93 $0.91
Basic - pro forma $1.23 $0.91 $0.87
Diluted - as reported $1.27 $0.92 $0.89
Diluted - pro forma $1.19 $0.90 $0.86
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.
RECLASSIFICATION
Certain prior year amounts have been reclassified to conform to the 2004
presentation.
-31-
The Eastern Company
Notes to Consolidated Financial Statements (continued)
3. BUSINESS ACQUISITIONS
Effective October 1, 2002, the Company acquired all of the issued and
outstanding stock of Canadian Commercial Vehicles Corporation ("CCV") for cash
of approximately $70,000 and the assumption of approximately $130,000 of debt,
which the Company paid upon closing. CCV was established as a Canadian
subsidiary of The Eastern Company, located in Kelowna, British Columbia, Canada.
CCV manufactures lightweight sleeper boxes used in Class 8 trailer trucks.
Effective March 1, 2002, the Company acquired certain assets of the Big Tag
Division of Dolan Enterprises, Inc. for cash of approximately $260,000. Big Tag
was merged into the CCL division of the Company located in Wheeling, Illinois.
Big Tag provides high-visibility, custom luggage tags, which the Company markets
in conjunction with its custom logo luggage locks to the travel, incentive and
premium markets.
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 their date of acquisition. The excess of the cost of the acquired
businesses over the fair market value of the net tangible and intangible assets
acquired has been allocated to goodwill. The effect of these acquisitions on the
Company's consolidated financial position and operation results is not material.
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 in 2003 and 2002.
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 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 $0.13 per diluted share, in 2004.
5. DEBT
The Company has an unsecured loan agreement ("Loan Agreement"), which includes a
term portion and a revolving credit portion. The term portion of the Loan
Agreement is payable in quarterly principal payments of $700,000 in 2005 and
increases annually through maturity on January 1, 2009. The first payment of
calendar 2004 was made in fiscal 2003. The Company may borrow up to $7,500,000
through July 1, 2005 under the revolving credit portion of the Loan Agreement,
with a quarterly commitment fee of 0.25% on the unused portion.
The interest rates on the term and the revolving credit portions of the Loan
Agreement may vary. The interest rates may vary based on the LIBOR rate plus a
margin spread of 1.5% to 2.0% for the term portion and 1.25% to 1.75% for the
revolving credit portion. The margin rate spread is based on operating results
calculated on a rolling-four-quarter basis. On January 1, 2005, the interest
rate on the term and revolving credit portions of the Loan Agreement was 3.88%
and 3.77%, respectively.
-32-
The Eastern Company
Notes to Consolidated Financial Statements (continued)
5. DEBT (continued)
The Company maintains 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 and $8,400,000 on January 3, 2004), which is
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 bears interest at a fixed rate of 9.095% and expires July 1, 2005.
Debt consists of:
2004 2003
---- ----
Term loan $ 13,825,000 $ 15,625,000
Revolving credit loan 1,000,000 1,000,000
Capital lease obligation with interest at 4.99% and payable in
monthly installments of $21,203 through April 2009 989,672 1,189,290
Other - 7,652
------------ ------------
15,814,672 17,821,942
Less current portion 4,009,811 2,007,273
------------ ------------
$ 11,804,861 $ 15,814,669
============ ============
The Company paid interest of $1,002,955 in 2004, $1,402,631 in 2003 and
$1,741,511 in 2002.
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 January 1, 2005, scheduled annual principal maturities of long-term debt,
including capital lease obligations, for each of the next five years follow:
2005 $ 4,009,811
2006 3,420,523
2007 3,831,782
2008 3,843,617
2009 708,939
Thereafter -
-----------
$15,814,672
===========
At January 1, 2005 and January 3, 2004, building improvements and equipment,
with a cost of approximately $2,000,000, were recorded under a capital lease
with accumulated amortization of approximately $554,000 and $443,000,
respectively. The capital lease is secured by the equipment under the lease and
a $900,000 letter of credit.
-33-
The Eastern Company
Notes to Consolidated Financial Statements (continued)
6. STOCK RIGHTS
The Company has a stock rights plan. At January 1, 2005, there were 3,634,867
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 $80, 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 $.0067 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 incentive 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. All options granted in 2004,
2003, and 2002 were granted at prices equal to the fair market value of the
stock on the dates granted. No restricted stock was granted in 2004, 2003 or
2002.
As of January 1, 2005, there were 297,642 shares available for future grant
under the above noted plans: 2000 - 245,000 shares; 1997 - 52,500; 1995 - 142;
and 1989 - no shares available for grant. As of January 1, 2005, there were
976,142 shares 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 December 29, 2001 679,000 $13.477
Granted 35,000 14.190
Cancelled (25,000) 14.251
------- -------
Outstanding at December 28, 2002 689,000 13.475
Granted 10,000 15.300
Cancelled (45,000) 14.539
------- -------
Outstanding at January 3, 2004 654,000 13.417
Granted 57,000 20.370
Cancelled (10,000) 14.812
Exercised (22,500) 14.436
------- -------
Outstanding at January 1, 2005 678,500 $13.948
======= =======
-34-
The Eastern Company
Notes to Consolidated Financial Statements (continued)
7. STOCK OPTIONS AND AWARDS (continued)
Options Outstanding Options Exercisable
------------------- -------------------
Weighted
Average
Remaining
Range of Exercise Outstanding as of Contractual Weighted Average Exercisable as of Weighted Average
Prices January 1, 2005 Life Exercise Price January 1, 2005 Exercise Price
- ----------------- ----------------- ----------- ---------------- ----------------- ----------------
$ 9.92 - $11.92 191,500 2.8 $10.442 191,500 $10.442
$14.00 - $15.30 417,500 5.1 14.541 415,244 14.542
$18.50 - $20.37 69,500 8.9 20.034 69,500 20.034
------- --- ------- ------- -------
678,500 4.8 $13.948 676,244 $13.945
======= === ======= ======= =======
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:
2004 2003 2002
---- ---- ----
Property, plant and equipment $ 3,521,617 $ 3,445,288 $ 3,057,400
Investment in common stock - - 307,500
Other 338,085 221,160 164,400
------------ ------------ ------------
Total deferred income tax liabilities 3,859,702 3,666,448 3,529,300
Other postretirement benefits (816,273) (886,371) (979,700)
Inventories (721,309) (338,737) (316,300)
Allowance for doubtful accounts (106,106) (97,674) (82,900)
Accrued compensation (201,280) (187,393) (198,200)
Interest rate swap obligation (58,949) (232,005) (455,000)
Pensions (724,363) (809,954) (826,713)
Tax credits (234,827) - -
Other (283,961) (333,750) (496,500)
------------ ------------ ------------
Total deferred income tax assets (3,147,068) (2,885,884) (3,355,313)
------------ ------------ ------------
Net deferred income tax liabilities $ 712,634 $ 780,564 $ 173,987
============ ============ ============
Income before income taxes consists of:
2004 2003 2002
---- ---- ----
Domestic $ 3,512,795 $ 1,778,405 $ 2,736,969
Foreign 3,316,244 3,612,085 1,997,339
------------ ------------ -----------
$ 6,829,039 $ 5,390,490 $ 4,734,308
============ ============ ===========
The provision for income taxes follows:
2004 2003 2002
---- ---- ----
Current:
Federal $ 905,843 $ 703,890 $ 458,302
Foreign 1,025,183 749,390 437,506
State 148,404 184,800 92,400
Deferred (8,092) 390,788 454,200
------------ ------------ -----------
$ 2,071,338 $ 2,028,868 $ 1,442,408
============ ============ ===========
-35-
The Eastern Company
Notes to Consolidated Financial Statements (continued)
8. INCOME TAXES (continued)
A reconciliation of income taxes computed using the U.S. federal statutory rate
to that reflected in operations follows:
2004 2003 2002
---- ---- ----
Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ -------
Income taxes using U.S. federal
statutory rate $ 2,321,873 34% $ 1,832,665 34% $ 1,609,700 34%
State income taxes, net of federal
benefit 78,463 1 199,062 4 73,500 2
Impact of foreign subsidiaries on
effective tax rate (242,163) (4) 1,232 - (291,000) (6)
Other--net (86,835) (1) (4,091) - 50,208 1
----------- --- ----------- --- ----------- ---
$ 2,071,338 30% $ 2,028,868 38% $ 1,442,408 31%
=========== === =========== === =========== ===
Total income taxes paid were $1,445,099 in 2004, $1,162,688 in 2003 and
$1,239,668 in 2002.
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 $234,827 which expire in
varying amounts through 2014. Available and prudent tax planning strategies
support this deferred tax asset at January 1, 2005.
United States income taxes have been provided on the undistributed earnings of
foreign subsidiaries ($11,146,178 at January 1, 2005) only where necessary
because such earnings are intended to be reinvested abroad indefinitely or
repatriated only when substantially free of such taxes.
In December 2004, the FASB issued FSP No. FAS 109-2, Accounting and Disclosure
Guidance for the Foreign Earnings Repatriation Provision within the American
Jobs Creation Act of 2004 ("AJCA"). The AJCA provides a one-time 85% dividends
received deduction for certain foreign earnings that are repatriated under a
plan for reinvestment in the United States, provided certain criteria are met.
FSP No. 109-2 is effective immediately and provides accounting and disclosure
guidance for the repatriation provision. FSP No. 109-2 allows companies
additional time to evaluate the effects of the law on its unremitted earnings
for the purpose of applying the "indefinite reversal criteria" under APB Opinion
No. 23, Accounting for Income Taxes - Special Areas, and requires explanatory
disclosures from companies that have not yet completed the evaluation. The
Company is currently evaluating the effects of the repatriation provision and
its impact on the consolidated financial statements. The Company does not expect
to complete this evaluation before the end of 2005. The range of possible
amounts of unremitted earnings that is being considered for repatriation under
this provision is between zero and $500,000. The related potential range of
income tax is between zero and $84,000.
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. 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.
-36-
The Eastern Company
Notes to Financial Statements (continued)
9. LEASES (continued)
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:
2005 $ 614,235
2006 614,499
2007 344,411
2008 281,698
2009 194,114
-----------
$ 2,048,957
===========
Rent expense for all operating leases was $642,000 in 2004, $383,098 in 2003 and
$306,293 in 2002.
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.
Significant disclosures relating to these benefit plans follow:
Pension Benefits Postretirement Benefits
---------------- -----------------------
2004 2003 2004 2003
---- ---- ---- ----
Change in Projected Benefit Obligation
Benefit obligation at beginning of year $ 36,915,855 $ 33,737,224 $ 2,129,909 $ 1,997,724
Change due to availability of final actual
assets and census data (98,325) 132,099 (134,531) 75,758
Plan amendment (a) - 145,612 - -
Service cost 1,198,318 1,131,435 75,488 70,321
Interest cost 2,299,608 2,274,329 123,456 137,124
Actuarial loss 534,203 1,659,027 59,421 78,130
Benefits paid (2,264,213) (2,163,871) (192,115) (229,148)
------------ ------------ ------------- -----------
Benefit obligation at end of year $ 38,585,446 $ 36,915,855 $ 2,061,628 $ 2,129,909
============ ============ ============ ===========
(a) A plan was amended in 2003 to increase benefits for specified retired
participants.
Change in Plan Assets
Fair value of plan assets at beginning of year $ 32,071,588 $ 28,816,677 $ 892,428 $ 796,507
Change due to availability of final actual
assets and census data (56,755) (1,251) (33,774) 7,855
Actual return on plan assets 2,365,233 3,900,350 73,515 69,174
Employer contributions 652,052 1,519,683 - -
Benefits paid (2,246,538) (2,163,871) 12,454 18,892
------------ ------------ ----------- ----------
Fair value of plan assets at end of year $ 32,785,580 $ 32,071,588 $ 944,623 $ 892,428
============ ============ =========== ==========
-37-
The Eastern Company
Notes to Consolidated Financial Statements (continued)
10. RETIREMENT BENEFIT PLANS (continued)
Pension Benefits Postretirement Benefits
---------------- -----------------------
2004 2003 2004 2003
---- ---- ---- ----
Reconciliation of Funded Status
Under-funded status $ (5,799,866) $ (4,844,267) $(1,117,005) $(1,237,481)
Unrecognized prior service cost 929,535 1,126,515 (320,038) (80,144)
Unrecognized net actuarial loss (gain) 9,406,330 9,032,632 (782,778) (1,067,145)
Unrecognized net asset at transition (226,898) (424,055) - -
------------ ------------ ----------- -----------
Net amount recognized in the balance sheet $ 4,309,101 $ 4,890,825 $(2,219,821) $(2,384,770)
============ ============ =========== ===========
Pension Benefits Postretirement Benefits
---------------- -----------------------
2004 2003 2004 2003
---- ---- ---- ----
Amount Recognized on Balance Sheet
Prepaid benefit cost $ 348,634 $ 1,192,281 $ - $ -
Accrued benefit liability (4,885,160) (4,015,858) (2,219,821) (2,384,770)
Intangible asset 870,064 964,592 - -
Accumulated other comprehensive loss 7,975,563 6,749,810 - -
------------ ------------ ----------- -----------
Net amount recognized in the balance sheet $ 4,309,101 $ 4,890,825 $(2,219,821) $(2,384,770)
============ ============ =========== ===========
In 2004 and 2003, the accumulated benefit obligation for all qualified and
nonqualified defined benefit pension plans was $37,038,422 and $35,372,932
respectively.
Information for three of the under-funded pension plans with a projected benefit
obligation and an accumulated benefit obligation in excess of plan assets
2004 2003
---- ----
Projected benefit obligation $ 36,507,181 $ 30,005,029
Accumulated benefit obligation 35,565,225 29,028,413
Fair value of plan assets 31,189,244 25,458,556
Estimated future benefit payments are $2.4 million in 2005, $2.4 million in
2006, $2.4 million in 2007, $2.4 million in 2008, $2.4 million in 2009 and a
total of $11.9 million from 2010 through 2014.
The percentage of each asset category of the total assets held by the plans
follows:
Allocation Parameters 2004 2003
--------------------- ---- ----
Equity securities 30 - 70% 63% 60%
Fixed income 30 - 60% 31 32
Cash and cash equivalents 0 - 10% 6 8
--- ---
Total 100% 100%
=== ===
-38-
The Eastern Company
Notes to Consolidated Financial Statements (continued)
10. RETIREMENT BENEFIT PLANS (continued)
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 410,974 shares and 430,874 of the common stock of the
Company having a market value of $8,219,480 and $6,700,091 at January 1, 2005
and January 3, 2004, respectively. The plans sold 19,900 shares of common stock
of the Company during 2004. Dividends received during 2004 and 2003 on the
common stock of the Company were $189,585 for each year.
Pension Benefits
----------------
2004 2003 2002
---- ---- ----
Assumptions
Discount rate 6% 6.5% 7%
Expected return on plan assets 8.5% 8.5% 9%
Rate of compensation increase 4.25% 4.25% 4.25%
Components of Net Periodic Benefit Cost
Service cost $ 1,198,318 $ 1,131,435 $ 1,073,638
Interest cost 2,299,608 2,274,329 2,198,127
Expected return on plan assets (2,567,814) (2,755,927) (1,577,856)
Net amortization and deferral 305,795 770,747 (1,146,850)
----------- ----------- -----------
Net periodic benefit cost $ 1,235,907 $ 1,420,584 $ 547,059
=========== =========== ===========
Postretirement Benefits
-----------------------
2004 2003 2002
---- ---- ----
Assumptions
Discount rate 6% 6.5% 7%
Expected return on plan assets 8.5% 8.5% 9%
Components of Net Periodic Benefit Cost
Service cost $ 75,488 $ 70,321 $ 73,311
Interest cost 123,456 137,124 132,966
Expected return on plan assets (73,515) (69,174) (66,224)
Net amortization and deferral (85,809) (83,617) (92,752)
----------- ----------- -----------
Net periodic benefit cost $ 39,620 $ 54,654 $ 47,301
=========== =========== ===========
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.
-39-
The Eastern Company
Notes to Consolidated Financial Statements (continued)
10. RETIREMENT BENEFIT PLANS (continued)
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 $ 31,476 $ (13,950)
Effect on postretirement benefit obligation $ 284,476 $(125,900)
U.S. salaried employees and most employees of the Company's Canadian subsidiary
are covered by defined contribution plans.
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.
In the second quarter of 2004, a FASB Staff Position (FSP FAS 106-2, Accounting
and Disclosure Requirements Related to the Medicare Prescription Drug
Improvement and Modernization Act of 2003) was issued providing guidance on the
accounting for the effects of the Act for employers that sponsor postretirement
health care plans that provide prescription drug benefits. This FSP superceded
FSP FAS 106-1, Accounting and Disclosure Requirements Related to the Medicare
Prescription Drug Improvement and Modernization Act of 2003. The FSP is
effective for the first interim or annual period beginning after June 15, 2004.
The guidance in this FSP applies only to the sponsor of a single-employer
defined benefit postretirement health plan for which the employer has concluded
that prescription drug benefits available under the plan are actuarially
equivalent and, thus, qualify for the subsidy under the Act and the expected
subsidy will offset or reduce the employer's share of the costs of
postretirement prescription drug coverage by the plan.
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.
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 $146,002 in 2004, $141,903 in 2003 and $139,598 in 2002.
11. FINANCIAL INSTRUMENTS
The carrying values of financial instruments (cash and cash equivalents,
accounts receivable, accounts payable, the interest rate swap obligation, and
debt) as of January 1, 2005 and January 3, 2004, approximate fair value. Fair
value was based on expected cash flows and current market conditions.
-40-
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.
2004 2003 2002
---- ---- ----
Sales to unaffiliated customers:
Industrial Hardware $ 45,993,489 $ 35,422,702 $ 29,271,624
Security Products 42,422,863 39,281,707 36,388,970
Metal Products 11,713,806 13,602,172 15,676,613
------------- ------------- -------------
$ 100,130,158 $ 88,306,581 $ 81,337,207
============= ============= =============
Intersegment Revenue:
Industrial Hardware $ 210,445 $ 60,598 $ 44,669
Security Products 2,619,746 1,697,607 1,286,004
------------- ------------- -------------
$ 2,830,191 $ 1,758,205 $ 1,330,673
============= ============= =============
Income Before Income Taxes:
Industrial Hardware $ 4,933,313 $ 3,238,931 $ 3,905,129
Security Products 3,465,408 3,614,913 2,972,310
Metal Products (548,030) (369,528) (494,639)
------------- ------------- -------------
Operating Profit 7,850,691 6,484,316 6,382,800
Interest expense (1,044,490) (1,302,830) (1,716,057)
Other income 22,838 209,004 67,564
------------- ------------- -------------
$ 6,829,039 $ 5,390,490 $ 4,734,308
============= ============= =============
Geographic Information:
Net Sales:
United States $ 78,119,489 $ 71,204,620 $ 70,279,299
Foreign 22,010,669 17,101,961 11,057,908
------------- ------------- -------------
$ 100,130,158 $ 88,306,581 $ 81,337,207
============= ============= =============
Foreign sales are primarily to
customers in North America.
Identifiable Assets:
United States $ 63,248,575 $ 61,353,242 $ 66,135,214
Foreign 14,823,190 13,264,174 9,997,323
------------- ------------- -------------
$ 78,071,765 $ 74,617,416 $ 76,132,537
============= ============= =============
Industrial Hardware $ 28,573,163 $ 24,159,290 $ 22,457,174
Security Products 32,664,197 32,811,830 31,932,295
Metal Products 11,703,155 11,969,126 13,879,715
------------- ------------- -------------
72,940,515 68,940,246 68,269,184
General corporate 5,131,250 5,677,170 7,863,353
------------- ------------- -------------
$ 78,071,765 $ 74,617,416 $ 76,132,537
============= ============= =============
-41-
The Eastern Company
Notes to Consolidated Financial Statements (continued)
12. REPORTABLE SEGMENTS (continued)
2004 2003 2002
---- ---- ----
Depreciation and Amortization
Industrial Hardware $ 1,311,921 $ 1,244,666 $ 1,156,987
Security Products 972,132 890,572 856,335
Metal Products 1,177,358 1,484,090 1,552,138
------------- ------------- -------------
$ 3,461,411 $ 3,619,328 $ 3,565,460
============= ============= =============
Capital Expenditures
Industrial Hardware $ 1,037,417 $ 1,866,426 $ 519,101
Security Products 782,360 627,311 404,355
Metal Products 206,443 267,978 596,388
------------- ------------- -------------
2,026,220 2,761,715 1,519,844
Currency translation adjustment (13,098) (10,156) (679)
General corporate 49,191 11,571 40,698
------------- ------------- -------------
$ 2,062,313 $ 2,763,130 $ 1,559,863
============= ============= =============
13. RECENT ACCOUNTING PRONOUNCEMENTS
In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities, which was revised in December 2003 ("FIN No. 46-R").
This new rule requires that companies consolidate a variable interest entity if
the company is subject to a majority of the risk of loss from the variable
interest entity's activities and/or is entitled to receive a majority of the
entity's residual returns. The provisions of FIN No. 46-R were required to be
applied as of the end of the first reporting period after March 15, 2004 for the
variable interest entities in which a company holds a variable interest that it
acquired on or before January 31, 2003. The adoption of FIN No. 46-R did not
have any impact on the financial position or results of operations of the
Company.
In November 2004, the FASB issued SFAS No. 151, Inventory Costs, an amendment of
ARB No. 43, Chapter 4. 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 guidance is effective for inventory
costs incurred during fiscal years beginning after June 15, 2005. It is not
believed that the adoption of SFAS No. 151 will have a material impact on the
consolidated financial position, results of operations or cash flows of the
Company.
In December 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based
Payment. SFAS No. 123(R) will require that the compensation cost relating to
share-based payment transactions be recognized in financial statements. That
cost will be measured based on the fair value of the equity or liability
instruments issued. SFAS No. 123(R) covers a wide range of share-based
compensation arrangements including share options, restricted share plans,
performance-based awards, share appreciation rights, and employee share purchase
plans. SFAS No. 123(R) replaces FASB Statement No. 123, Accounting for
Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for
Stock Issued to Employees. SFAS No. 123, as originally issued in 1995,
established as preferable a fair value-based method of accounting for
share-based payment transactions with employees. However, that Statement
permitted entities the option of continuing to apply the guidance in APB Opinion
No. 25, as long as the footnotes to financial statements disclosed what net
income would have been had the preferable fair value-based method been used.
Public entities will be required to apply SFAS No. 123(R) as of the first
interim or annual reporting period that begins after June 15, 2005. SFAS No.
123(R) permits public companies to adopt its requirements using one of two
methods:
1) A "modified prospective" method in which compensation cost is
recognized beginning with the effective date (a) based on the
requirements of SFAS No. 123(R) for all share-based payments
granted after the effective date and (b) based on requirements of
SFAS No. 123 for all awards granted to employees prior to the
effective date of SFAS No. 123(R) that remain unvested on the
effective date.
2) A "modified retrospective" method which includes the requirements
of the modified prospective method described above, but also
permits entities to restate based on the amount previously
recognized under SFAS No. 123 for purpose of pro forma disclosures
either (a) all prior periods presented or (b) prior interim
periods of the year of adoption.
-42-
The Eastern Company
Notes to Consolidated Financial Statements (continued)
13. RECENT ACCOUNTING PRONOUNCEMENTS (continued)
The impact of the adoption of Statement 123(R) cannot be predicted at this time
because it will depend on levels of share-based payments granted in the future.
However, had the Company adopted Statement 123(R) in prior periods, the impact
of that standard would have approximated the impact of Statement 123 as
described in the disclosure of pro forma net income (loss) and net income (loss)
per share in the stock based compensation accounting policy note included in
Note 2 to the consolidated financial statements.
14. SELECTED QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Selected quarterly financial information (unaudited) follows:
2004
----
First Second Third Fourth Year
----- ------ ----- ------ ----
Net sales $24,565,208 $25,297,964 $25,494,490 $24,772,496 $100,130,158
Gross margin 6,135,146 6,049,901 7,184,047 5,761,945 25,131,039
Selling and administrative
expenses 4,171,486 4,547,870 4,363,285 4,197,707 17,280,348
Net income 1,076,373 760,726 1,506,435 1,414,167 4,757,701
Net income per share:
Basic $.30 $.21 $.41 $.39 $1.31
Diluted $.29 $.20 $.40 $.37 $1.27
Weighted average shares
outstanding:
Basic 3,617,034 3,628,818 3,631,028 3,633,316 3,627,541
Diluted 3,713,736 3,738,306 3,732,969 3,797,826 3,745,701
2003
----
First Second Third Fourth Year
----- ------ ----- ------ ----
Net sales $21,590,714 $21,591,111 $21,864,105 $23,260,651 $88,306,581
Gross margin 5,499,535 5,272,665 5,287,464 5,528,276 21,587,940
Selling and administrative
expenses 3,819,453 3,473,743 3,631,127 4,179,301 15,103,624
Net income 953,377 936,688 942,759 528,798 3,361,622
Net income per share:
Basic $.26 $.26 $.26 $.15 $.93
Diluted $.26 $.26 $.26 $.14 $.92
Weighted average shares
outstanding:
Basic 3,630,303 3,625,310 3,612,748 3,614,030 3,620,593
Diluted 3,630,303 3,630,514 3,688,008 3,687,052 3,658,965
Fiscal 2004 consisted of four 13 week quarters totaling 52 weeks for the year.
Fiscal 2003 consisted of 13 weeks for the first, second and third quarters, with
the fourth quarter being 14 weeks, totaling 53 weeks for the year.
-43-
Report of Independent Registered Public Accounting Firm
THE BOARD OF DIRECTORS
THE EASTERN COMPANY
We have audited the accompanying consolidated balance sheets of The Eastern
Company as of January 1, 2005 and January 3, 2004, and the related consolidated
statements of income, comprehensive income (loss), shareholders' equity, and
cash flows for each of the three years in the period ended January 1, 2005. Our
audits 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. 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
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 Eastern
Company at January 1, 2005 and January 3, 2004, and the consolidated results of
its operations and its cash flows for each of the three years in the period
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
-44-
ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
None.
ITEM 9A CONTROLS AND PROCEDURES
As of the end of the fiscal year ended January 1, 2005, 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 AND EXECUTIVE OFFICERS OF THE REGISTRANT
There are incorporated herein by reference the portions of the
Registrant's definitive proxy statement filed with the Commission pursuant to
Regulation 14A since the close of its fiscal year, which involve the election
of Directors, the information appearing on pages 3 and 4 of said proxy
statement, being the portion captioned "Item No. 1. Election of Directors",
the information appearing on page 11 and 12 of said proxy statement, being the
portion captioned "Executive Compensation", the information appearing on page
10 of said proxy statement, being the portions captioned "Audit Committee
Financial Expert" and "Report of Audit Committee", and the information
appearing on page 8 of said proxy statement, being the portion captioned
"Section 16(a) Beneficial Ownership Reporting Compliance" and "Committees of
the Board of Directors", and the information appearing on page 22 of said
proxy statement, being the portion captioned "Exhibit B - The Eastern Company
Code of Business Conduct and Ethics." The Registrant's only Executive Officers
are Leonard F. Leganza, President and Chief Executive Officer and John L.
Sullivan III, Vice President, Secretary and Treasurer.
ITEM 11 EXECUTIVE COMPENSATION
There are incorporated herein by reference the portions of the
Registrant's definitive proxy statement filed with the Commission pursuant to
Regulation 14A since the close of its fiscal year, which involve director and
executive compensation, the information appearing on page 9 and on pages 11
through 17 of said proxy statement.
ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
(a) There are incorporated herein by reference the portions of the
Registrant's definitive proxy statement filed with the Commission pursuant to
Regulation 14A since the close of its fiscal year, which involve the security
ownership of certain beneficial shareholders, the information appearing on
pages 6 and 7 of said proxy statement.
-45-
(b) There are incorporated herein by reference the portions of the
Registrant's definitive proxy statement filed with the Commission pursuant to
Regulation 14A since the close of its fiscal year, which involve the security
ownership of management, the information appearing on pages 3 and 4, 6 and 7,
and 11 and 16 of said proxy statement.
(c) Changes in Control
None.
ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
(a) None.
(b) None.
(c) None.
(d) None.
ITEM 14 PRINCIPAL ACCOUNTING FEES AND SERVICES
The information called for by Item 14 is incorporated by reference to
the sections titled "Appointment of Independent Registered Public Accounting
Firm" located on page 5 of the Proxy Statement.
PART IV
ITEM 15 EXHIBITS, FINANCIAL STATEMENT SCHEDULE
(a) Documents filed as part of this report:
(1) Financial statements Page
Consolidated Balance Sheets - January 1, 2005 and January 3, 2004.....................22.
Consolidated Statements of Income -- Fiscal years ended January 1, 2005,
January 3, 2004 and December 28, 2002.............................................. ..24.
Consolidated Statements of Comprehensive Income (Loss) -- Fiscal years ended
January 1, 2005, January 3, 2004, and December 28, 2002...............................24.
Consolidated Statements of Shareholders' Equity -- Fiscal years ended
January 1, 2005, January 3, 2004 and December 28, 2002................................25.
Consolidated Statements of Cash Flows--Fiscal years ended January 1, 2005,
January 3, 2004, and December 28, 2002................................................26.
Notes to Consolidated Financial Statements............................................27.
Report of Ernst & Young LLP, Independent Registered Public Accounting Firm............44.
(2) Financial Statement Schedule
Schedule II -- Valuation and qualifying accounts......................................48.
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.
-46-
(3) Exhibits
Exhibits are as set forth in the "Exhibit Index" which
appears on pages 50 through 51.
(b) Exhibits Required by Item 601 of Regulation S-K
Form 8-K filed on April 28, 2004 setting forth the press release
reporting the Company's earnings for the quarter ended April 3, 2004.
Form 8-K filed on July 28, 2004 setting forth the press release
reporting the Company's earnings for the quarter ended July 3, 2004.
Form 8-K filed on October 27, 2004 setting forth the press release
reporting the Company's earnings for the quarter ended October 2,
2004.
Form 8-K filed on February 10, 2005 setting forth the press release
reporting the Company's earnings for the quarter and fiscal year ended
January 1, 2005.
Form 8-K filed on February 24, 2005 setting forth the Employment
Agreement for Leonard F. Leganza.
Form 8-K filed on February 25, 2005 setting forth the 2005 Executive
Incentive Program.
(c) None.
-47-
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 January 1, 2005:
Deducted from asset accounts:
Allowance for doubtful accounts $302,000 $112,222 $ 82,222 (a) $332,000
======== ======== ======== ========
Fiscal year ended January 3, 2004:
Deducted from asset accounts:
Allowance for doubtful accounts $304,000 $220,902 $222,902 (a) $302,000
======== ======== ======== ========
Fiscal year ended December 28, 2002:
Deducted from asset accounts:
Allowance for doubtful accounts $344,000 $ 91,296 $131,296 (a) $304,000
======== ======== ======== ========
(a) Uncollectible accounts written off, net of recoveries.
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: March 23, 2005 THE EASTERN COMPANY
--------------
By /s/ John L. Sullivan III
---------------------------
John L. Sullivan III
Vice President, Secretary and Treasurer
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 March 23, 2005
-------------------------
Leonard F. Leganza
Director, President
and Chief Executive Officer
/s/ John W. Everets March 23, 2005
-------------------------
John W. Everets
Director
/s/ Charles W. Henry March 23, 2005
-------------------------
Charles W. Henry
Director
/s/ David C. Robinson March 23, 2005
-------------------------
David C. Robinson
Director
/s/ Donald S. Tuttle, III March 23, 2005
-------------------------
Donald S. Tuttle III
Director
-49-
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 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.
(14) The Eastern Company Code of Business Conduct and Ethics incorporated
by reference to Exhibit B of the Registrant's proxy statement filed
with the Commission pursuant to Regulation 14A for the annual meeting
to be held on April 27, 2005. The Eastern Company Code of Business
Conduct and Ethics is also available free of charge on the Company's
Internet website at http://www.easterncompany.com under the section
labeled "Corporate Governance".
-50-
(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) Consent of independent registered public accounting firm attached
hereto on page 52.
(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 2004 is attached on
page 56.
-51-