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 December 29, 2007

OR

 

o

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 No.)

 

 

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 if the registrant is a well known seasoned issuer, as defined in Rule 405 of the Securities Act.

 

Yes o No x

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

 

Yes o No x

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.                                                                                                                                Yes x No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer o

Accelerated filer x

Non-accelerated filer o (Do not check if a smaller reporting company)

Smaller reporting company o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b2 of the Act).

 

Yes o No x

 

As of June 30, 2007, 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 $144,171,193 (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 22, 2008, 5,809,599 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 18, 2008 are incorporated by reference into Part III.

 


The Eastern Company

Form 10-K

 

FOR THE FISCAL YEAR ENDED DECEMBER 29, 2007

 

TABLE OF CONTENTS

 

 

 

Page

 

Table of Contents

2.

 

 

 

 

Safe Harbor Statement

3.

 

 

 

PART I

 

 

Item 1.

Business

4.

 

 

 

Item 1A.

Risk Factors

7.

 

 

 

Item 1B.

Unresolved Staff Comments

10.

 

 

 

Item 2.

Properties

10.

 

 

 

Item 3.

Legal Proceedings

11.

 

 

 

Item 4.

Submission of Matters to a Vote of Security Holders

11.

 

 

 

PART II

 

 

Item 5.

Market for Registrant’s Common Equity, Related

 

 

Stockholder Matters and Issuer Purchases of Equity Securities

12.

 

 

 

Item 6.

Selected Financial Data

14.

 

 

 

Item 7.

Management’s Discussion and Analysis of Financial

 

 

Condition and Results of Operations

14.

 

 

 

Item 7A.

Quantitative and Qualitative Disclosures

 

 

About Market Risk

26.

 

 

 

Item 8.

Financial Statements and Supplementary Data

27.

 

 

 

Item 9.

Changes in and Disagreements with Accountants on

 

 

Accounting and Financial Disclosure

54.

 

 

 

Item 9A.

Controls and Procedures

54.

 

 

 

Item 9B.

Other Information

56.

 

 

 

PART III

 

 

Item 10.

Directors, Executive Officers and Corporate Governance

56.

 

 

 

Item 11.

Executive Compensation

56.

 

 

 

Item 12.

Security Ownership of Certain Beneficial Owners and Management

 

 

and Related Stockholder Matters

57.

 

 

 

Item 13.

Certain Relationships and Related Transactions, and Director

 

 

Independence

57.

 

 

 

Item 14.

Principal Accounting Fees and Services

57.

 

 

 

PART IV

 

 

Item 15.

Exhibits, Financial Statement Schedules

57.

 

 

 

 

Signatures

60.

 

 

 

 

Exhibit Index

61.

 

 

2

 


SAFE HARBOR STATEMENT

UNDER THE PRIVATE SECURITIES

LITIGATION REFORM ACT OF 1995

 

This Annual Report on Form 10-K contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements reflect the Company’s current expectations regarding its products, its markets and its future financial and operating performance. These statements, however, are subject to risks and uncertainties that may cause the Company’s actual results in future periods to differ materially from those expected. Such risks and uncertainties include, but are not limited to, unanticipated slowdowns in the Company’s major markets, changing customer preferences, lack of success of new products, loss of customers, competition, increased raw material prices, problems associated with foreign sourcing of parts and products, worldwide conditions and foreign currency fluctuations that may affect results of operations, and other factors discussed from time to time in the Company’s filings with the Securities and Exchange Commission. The Company is not obligated to update or revise the aforementioned statements for those new developments.

 

3

 


PART I

 

ITEM 1

BUSINESS

 

(a) General Development of Business

 

The Eastern Company (the “Company”) was incorporated under the laws of the State of Connecticut in October, 1912, succeeding a co-partnership established in October, 1858.

 

The business of the Company is the manufacture and sale of industrial hardware, security products and metal products from four U.S. operations and six wholly-owned foreign subsidiaries. The Company maintains nine physical locations.

 

RECENT DEVELOPMENTS

 

During the third quarter of 2006, the Company received orders from a military contractor for component parts used in retro-fitting Humvees as part of the military’s up-armor program to provide additional troop protection. These component parts were shipped from September 2006 through the early part of the second quarter of 2007. This program resulted in approximately $39 million in total sales for the Industrial Hardware segment of the Company during the period from September 2006 to April 2007, when the shipments were completed.

 

Effective November 8, 2006, the Company acquired certain assets of Summit Manufacturing, Inc. (“Summit”), which was integrated into the Company’s Security Products segment. Summit designs and manufactures appliance hardware and accessories, including, but not limited to, oven door latches, oven door switches and smoke eliminators and provides subcontract assembly services. The cost of the Summit acquisition was $546,000, inclusive of transaction costs and outstanding debt paid at closing, plus the assumption of $369,000 in current liabilities.

 

Effective September 25, 2006, the Company acquired certain assets of Royal Lock Corporation (“Royal”), which was also integrated into the Company’s Security Products segment. Royal is a supplier of cam locks, switch locks, padlocks, latches, handles and specialty hardware parts. The cost of the Royal acquisition was $6,991,000, inclusive of transaction costs, plus the assumption of $775,000 in current liabilities.

 

Both of the above acquisitions have been accounted for using the purchase method. The acquired businesses are included in the consolidated operating results of the Company from the date of acquisition. Neither the actual results nor the pro forma effects of these acquisitions are material to the Company’s financial statements.

 

In October 2006, the Company’s common stock was split 3-for-2.

 

Subsequent Event

 

In January, 2008, the Company acquired certain assets of the F.A. Neider Company for cash of approximately $125,000. The assets acquired were for the production of a footman loop product line and will be integrated into the Eberhard Manufacturing Division in our Industrial Hardware segment. The effect of this acquisition on the Company’s consolidated financial position and operations is 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.

 

 

4

 


Industrial Hardware

 

The Industrial Hardware segment consists of Eberhard Manufacturing, Eberhard Hardware Manufacturing Ltd., Canadian Commercial Vehicles Corporation, Eastern Industrial Ltd. and Sesamee Mexicana, S.A. de C.V. The units design, manufacture and market a diverse product line of industrial and vehicular hardware throughout North America. The segment’s locks, latches, hinges, handles, lightweight honeycomb composite structures and related hardware can be found on tractor-trailer trucks, moving vans, off-road construction and farming equipment, school buses, military vehicles and recreational boats. They are also used on pickup trucks, sport utility vehicles and fire and rescue vehicles. In addition, the segment manufactures a wide selection of fasteners and other closure devices used to secure access doors on various types of industrial equipment such as metal cabinets, machinery housings and electronic instruments. Eastern Industrial expands the range of offerings of this segment to include plastic injection molding.

 

Typical products include passenger restraint locks, slam and draw latches, dead bolt latches, compression latches, cam-type vehicular locks, hinges, tool box locks, light-weight sleeper boxes for Class 8 trucks and school bus door closure hardware. The products are sold directly to original equipment manufacturers and to distributors through a distribution channel consisting of in-house salesmen and outside sales representatives. Sales and customer service efforts are concentrated through in-house sales personnel where greater representation of our diverse product lines can be promoted across a variety of markets.

 

The Industrial Hardware segment sells its products to a diverse array of markets, such as the truck, bus and automotive industries as well as to the industrial equipment, military and marine sectors. Although service, quality and price are major criteria for servicing these markets, the continued introduction of new or improved product designs and the acquisition of synergistic product lines are vital for maintaining and increasing market share.

 

Security Products

 

The Security Products segment, made up of Greenwald Industries, Illinois Lock Company/CCL Security Products/Royal Lock, World Lock Company Ltd. and World Security Industries Ltd., is a leading manufacturer of security products. This segment manufactures electronic and mechanical locking devices, both keyed and keyless, for the computer, electronics, vending and gaming industries. The segment also supplies its products to the luggage, furniture, laboratory equipment and commercial laundry industries. Greenwald manufactures and markets coin acceptors and other coin security products used primarily in the commercial laundry markets, as well as hardware and accessories for the appliance industry. In addition, the segment provides a new level of security for the access control, municipal parking and vending markets through the use of “smart card” technology.

 

Greenwald’s products include timers, drop meters, coin chutes, money boxes, meter cases, smart cards, value transfer stations, smart card readers, card management software, access control units, oven door latches, oven door switches and smoke eliminators. Illinois Lock Company/CCL Security Products/Royal Lock sales include cabinet locks, cam locks, electric switch locks, tubular key locks and combination padlocks. Many of the products are sold under the names SEARCHALERT™, PRESTOSEAL™, DUO, X-STATIC®, EXCALIBUR™, WARLOCK™, LITE LOCK™, SESAMEE®, BIG TAG®, PRESTOLOCK® and HUSKI™. These products are sold to original equipment manufacturers, distributors, route operators, and locksmiths via in-house salesmen and outside sales representatives. Sales efforts are concentrated through national and regional sales personnel where greater representation of our diverse product lines can be promoted across a variety of markets.

 

The Security Products segment continuously seeks new markets where it can offer competitive pricing and provide customers with engineered solutions for their security needs.

 

Metal Products

 

The Metal Products segment, based at the Company’s Frazer & Jones facility, is the largest and most efficient producer of expansion shells for use in supporting the roofs of underground mines. This segment also manufactures specialty malleable and ductile iron castings.

 

Typical products include mine roof support anchors, couplers for railroad braking systems, adjustable clamps for construction and fittings for electrical installations. Mine roof support anchors are sold to distributors and directly to mines, while specialty castings are sold to original equipment manufacturers.

 

5

 


Rising oil and natural gas prices have resulted in increased demand for coal, which has led to increased demand for our highly engineered proprietary mine roof support products produced by this segment of the Company. In addition, this segment has seen an increase in demand in its contract casting business. This is directly related to the weakening U.S. dollar against the EURO and Chinese RMB, making our malleable and ductile iron contract castings more competitive against global competition.

 

General

 

Raw materials and outside services were readily available from domestic sources for all of the Company’s segments during 2007 and are expected to be readily available in 2008 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 2007 and does not expect any such problems in 2008. In 2007, the Company continued to experience price increases for zinc, brass and stainless steel, used mainly in the Industrial Hardware and Security Products segments, as well as scrap iron used in the Metal Products segment. These higher prices had a negative impact on gross margin in 2007, and will continue to negatively impact gross margin in 2008 if prices do not stabilize or the Company is not able to increase selling prices to its customers.

 

Patent protection for the various product lines within the Company is limited, but is sufficient to protect the Company’s competitive positions. Foreign sales and license agreements are not significant.

 

None of the Company’s business segments are seasonal.

 

The Company, across all its business segments, has increased its emphasis on sales and customer service by fulfilling the rapid delivery requirements of our customers. As a result, investments in additional inventories are made on a selective basis.

 

Customer lists for all business segments are broad-based geographically and by markets, and sales are generally not highly concentrated by customer. However, due to the military Humvee retro-fit contract, one customer in the Industrial Hardware Segment accounted for approximately 15% of total sales in 2006 and 14% of total sales in 2007. No other customers exceeded 10% or more of the Company’s consolidated sales for the years ended December 30, 2006 or December 29, 2007.

 

The dollar amount of the backlog of orders received by the Company is believed to be firm as of fiscal year ended December 29, 2007 at $22,802,000, as compared to $37,929,000 at December 30, 2006. The primary source of the decrease from 2006 to 2007 are orders related to the military Humvee retro-fit program that was completed in April 2007.

 

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 and cost effective manufacturing capabilities, expanding product lines through product development and acquisitions, and maintaining sufficient inventory for fast turnaround of customer orders. However, imports from Asia and Latin America with favorable currency exchange rates and low cost labor have created additional competitive pressures. The Company currently utilizes three wholly-owned subsidiaries in Asia to help offset offshore competition.

 

Research and development expenditures in 2007 were $1,439,000 and represented approximately 1% of gross revenues. In 2006 and 2005 they were $1,354,000 and $1,150,000, respectively. The research costs are primarily attributable to the Greenwald Industries and Eberhard Mfg. divisions. Greenwald performs ongoing research, in both the mechanical and smart card product lines, which is necessary in order to remain competitive and to continue to provide technologically advanced smart card systems. Eberhard develops new products for the various markets they serve based on changing customer requirements to remain competitive. 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 2007 was 741.

 

 

6

 


(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’ revenues and identifiable assets is included in Note 12 to the Company’s financial statements, included at Item 8 of this Annual Report on Form 10-K. Information about risks attendant to the Company’s foreign operations is set forth at Item 1A of this Annual Report on Form 10-K.

 

(e) Available Information

 

The Company makes available, free of charge through its Internet website at http://www.easterncompany.com, its 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 public may read and copy any materials that the Company files with the SEC at the SEC’s Public Reference Room, 450 Fifth Street, N.W., Washington, DC 20549 or by calling the SEC at 1-800-SEC-0330. The Company’s reports filed with, or furnished to, the SEC are also available on the SEC’s website at www.sec.gov.

 

ITEM 1A

RISK FACTORS

 

In addition to the other information contained in this Form 10-K and the exhibits hereto and the Company’s other filings with the SEC, the following risk factors should be considered carefully in evaluating the Company’s business. The Company’s business, financial condition or results of operation could be materially adversely affected by any of these risks or additional risks not presently known to the Company, or by risks the Company currently deems immaterial which may also adversely affect its business, financial condition, or results of operations, such as: changes in the economy, including changes in inflation, tax rates and interest rates; risk associated with possible disruption in the Company’s operations due to terrorism and other manmade or natural disasters; future regulatory actions, legal issues or environmental matters; loss of, or changes in, executive management; and changes in accounting standards which are adverse to the Company. Also, there can be no assurance that the Company has correctly identified and appropriately assessed all factors affecting its business or that information publicly available with respect to these matters is complete and correct.

 

The Company’s business is subject to risks associated with conducting business overseas.

 

International operations could be adversely affected by changes in political and economic conditions, trade protection measures, restrictions on repatriation of earnings, differing intellectual property rights, and changes in regulatory requirements that restrict the sales of products or increase costs. Changes in exchange rates between the U.S. dollar and other currencies could result in increases or decreases in earnings, and may adversely affect the value of the Company’s assets outside the United States. The Company’s operations are also subject to the effects of international trade agreements and regulations. Although generally these trade agreements have positive effects, they can also impose requirements that adversely affect the Company’s business, such as setting quotas on product that may be imported from a particular country into The Company’s key markets in North America.

 

The Company’s ability to import products in a timely and cost-effective manner may also be affected by conditions at ports or issues that otherwise affect transportation and warehousing providers, such as port and shipping capacity, labor disputes, severe weather or increased homeland security requirements in the United States or other countries. These issues could delay importation of products or require the Company to locate alternative ports or warehousing providers to avoid disruption to customers. These alternatives may not be available on short notice or could result in higher transit costs, which could have an adverse impact on the Company’s business, financial conditions or results of operations.

 

7

 


See also “ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK” of this Form 10-K.

 

In addition, the Company’s growth strategy involves expanding sales of its products into foreign markets. There is no guarantee that the Company’s products will be accepted by foreign customers or how long it may take to develop sales of the Company’s products in these foreign markets.

 

Increases in the price or reduced availability of raw materials.

 

Raw materials needed to manufacture products are obtained from numerous suppliers. Under normal market conditions, these raw materials are readily available on the open market from a variety of producers. However, from time to time the prices and availability of these raw materials fluctuate, which could impair the Company’s ability to procure the required raw materials for its operations or increase the cost of manufacturing its products. If the price of raw materials increases, the Company may be unable to pass these increases on to its customers and could experience reduction to its profit margins. Also, any decrease in the availability of raw materials could impair the Company’s ability to meet production requirements in a timely manner.

 

Increased competition in the markets the Company services could impact revenues and earnings.

 

Any change in competition may result in lost market share or reduced prices, which could result in reduced profit margins. This may impair the ability to grow or even maintain current levels of revenues and earnings. While the Company has an extensive customer base, loss of certain customers could adversely affect the Company’s business, financial condition or results of operations until such business is replaced, and no assurances can be made that the Company would be able to regain or replace any lost customers.

 

The Company is required to evaluate its internal control over financial reporting under Section 404 of the Sarbanes-Oxley Act of 2002.

 

The Company is an “accelerated filer” as defined in Rule 12b-2 under the Securities Exchange Act of 1934, as amended, and is required to comply with Section 404 of the Sarbanes-Oxley Act of 2002. Section 404 requires the Company to include in its report management’s assessment of the effectiveness of the Company’s internal control over financial reporting as of the end of the fiscal period for which the Company is filing its 10-K. This report must also include disclosure of any material weaknesses in internal control over financial reporting that the Company has identified. Additionally, the Company’s independent registered public accounting firm will be required to issue a report on the Company’s internal control over financial reporting and their evaluation of the operating effectiveness of the Company’s internal control over financial reporting. The Company’s assessment requires it to make subjective judgments, and the independent registered public accounting firm may not agree with the Company’s assessment. If the Company or its independent registered public accounting firm were unable to complete the assessments within the period prescribed by Section 404 and thus be unable to conclude that the internal control over financial reporting is effective, investors could lose confidence in the Company’s reported financial information, which could have an adverse effect on the market price of the Company’s common stock or impact the Company’s borrowing ability. In addition, changes in operating conditions and changes in compliance with policies and procedures currently in place may result in inadequate internal control over financial reporting in the future.

 

The inability to identify or complete acquisitions could limit future growth.

 

As part of its growth strategy, the Company continues to pursue acquisitions of complementary products or businesses. The ability to grow through acquisitions depends upon the Company’s ability to identify, negotiate, complete and integrate suitable acquisitions. The Company makes certain assumptions based on the information provided by potential acquisition candidates and also conducts due diligence to ensure the information provided is accurate and based on reasonable assumptions. However, the Company may be unable to realize the anticipated benefits from an acquisition or predict accurately how an acquisition will ultimately affect the business, financial condition or results of operations.

 

 

8

 


Demand for new products and the inability to develop and introduce new competitive products at favorable profit margins could adversely affect the Company’s performance and prospects for future growth, and the Company would not be positioned to maintain current levels of revenues and earnings.

 

The uncertainties associated with developing and introducing new products, such as the market demands and the costs of development and production, may impede the successful development and introduction of new products. Acceptance of the new products may not meet sales expectations due to several factors, such as the Company’s failure to accurately predict market demand or its inability to resolve technical issues in a timely and cost-effective manner. Additionally, the inability to develop new products on a timely basis could result in the loss of business to competitors.

 

The Company could be subject to litigation which could have a material impact on the Company’s business, financial condition or results of operations.            

 

From time to time, the Company’s operations are parties to or targets of lawsuits, claims, investigations and proceedings, including product liability, personal injury, patent and intellectual property, commercial, contract, environmental and employment matters, which are defended and settled in the ordinary course of business. While the Company is unable to predict the outcome of any of these matters, it does not believe, based upon currently available information, that the resolution of any pending matter will have a material adverse effect on its business, financial condition or results of operations. See “ITEM 3 – LEGAL PROCEEDINGS” in this Form 10-K for a discussion of current litigation.

 

The Company could be subject to additional tax liabilities.

 

The Company is subject to income tax laws in the United States, its states and municipalities and those of other foreign jurisdictions in which the Company has business operations. These laws are complex and subject to interpretations by the taxpayer and the relevant governmental taxing authorities. Significant judgment and interpretation is required in determining the Company’s worldwide provision for income taxes. In the ordinary course of business, transactions arise where the ultimate tax determination is uncertain. Although the Company believes its tax estimates are reasonable, the final outcome of tax audits and any related litigation could be materially different from that which is reflected in historical income tax provisions and accruals. Based on the status of a given tax audit or related litigation, a material effect on the Company’s income tax provision or net income may result during the period or periods from the initial recognition of a particular matter in the Company’s reported financial results to the final closure of that tax audit or settlement of related litigation when the ultimate tax and related cash flow is known with certainty.

 

The Company’s goodwill or indefinite-lived intangible assets may become impaired which, could require a significant charge to earnings to be recognized.

 

Under accounting principles generally accepted in the United States, goodwill and indefinite-lived intangible assets are not amortized but are reviewed for impairment at least annually. Future operating results used in the assumptions, such as sales or profit forecasts, may not materialize, and the Company could be required to record a significant charge to earnings in the financial statements during the period in which any impairment is determined, resulting in an unfavorable impact on our results of operations. Numerous assumptions are used in the evaluation of impairment, and there is no guarantee that the Company’s independent registered public accounting firm would reach the same conclusion as the Company or an independent valuation firm, which could result in a disagreement between management and the independent registered public accounting firm.

 

The Company may need additional capital in the future, and it may not be available on acceptable terms, if at all.

 

From time-to-time, the Company has historically relied on outside financing to fund expanded operations, capital expenditure programs and acquisitions. The Company may require additional capital in the future to fund operations or strategic opportunities. The Company cannot be assured that additional financing will be available on favorable terms, or at all. In addition, the terms of available financing may place limits on the Company’s financial and operating flexibility. If the Company is unable to obtain sufficient capital in the future, the Company may not be able to expand or acquire complementary businesses and may not be able to continue to develop new products or otherwise respond to changing business conditions or competitive pressures.

 

9

 


The Company’s stock price is highly volatile due to low float, which is the number of shares of the Company’s common stock that are outstanding and available for trading by the public.

 

The Company’s stock price may change dramatically when buyers seeking to purchase shares of the Company’s common stock exceed the shares available on the market, or when there are no buyers to purchase shares of the Company’s common stock when shareholders are trying to sell their shares.

 

The Company may not be able to reach acceptable terms for contracts negotiated with its labor unions and be subject to work stoppages or disruption of production.

 

At December 31, 2008, a union contract covering approximately 5% of the total workforce of the Company will expire. The Company has been successful in negotiating new contracts over the years, but cannot guarantee that will continue. Failure to negotiate new union contracts could result in disruption of production, inability to deliver product or a number of unforeseen circumstances, any of which could have an unfavorable material impact on the Company’s results of operations or financial statements.

 

ITEM 1B

UNRESOLVED STAFF COMMENTS

 

None.

 

ITEM 2

PROPERTIES

 

The corporate office of the Company is located in Naugatuck, Connecticut in a two-story 8,000 square foot administrative building on 3.2 acres of land.

 

All of the Company’s properties are owned or leased and are adequate to satisfy current requirements. All of the Company’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, leases 55,415 square feet of building space located in an industrial park. The building is made from brick and concrete, contains approximately 5,400 square feet of office space on two levels and houses a modern paint booth for finishing our products. The building is protected by a F1 rated fire suppression system and alarmed for fire and security. The current lease expires December 31, 2009 and is renewable.

 

The Eastern Industrial Ltd., a wholly-owned subsidiary in Shanghai, China, leases brick and concrete buildings containing approximately 45,600 square feet, located in both industrial and commercial areas. A five-year lease was signed in 2003, which expires on September 8, 2008 and is renewable.

 

The Sesamee Mexicana subsidiary is leasing 18,000 square feet located in an industrial park in Lerma, Mexico on an open-end basis. The building is steel framed with concrete block and glass curtain walls.

 

10

 


The Security Products Group includes the following:

 

The Greenwald Industries Division in Chester, Connecticut owns 26 acres of land and a building containing 120,000 square feet. The building is steel frame, one story, having brick over concrete blocks.

 

The Illinois Lock Company/CCL Security Products/Royal Lock Division owns 2.5 acres of land and a building containing 44,000 square feet in Wheeling, Illinois. The building is brick and located in an industrial park. The Company is also leasing approximately 10,000 square feet of warehouse space occupied by Royal Lock through September 2008.

 

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 is currently undergoing investigation by the U.S. Department of Environmental Protection and N.Y. Department of Environmental Conversation for various anonymous complaints regarding its metal castings facility. The Company recorded a contingency reserve of $250,000 in December 2007 for settlement of this matter. Based on current information available, the Company believes this matter will be settled for $250,000 during 2008.

 

There are no other legal proceedings, other than ordinary routine litigation incidental to the Company’s business, to which either the Company or any of its subsidiaries is a party or to which any of their property is the subject.

 

ITEM 4

SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

 

No matters were submitted to a vote of security holders during the fourth quarter ended December 29, 2007.

 

 

11

 


PART II

 

ITEM 5

MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

The Company’s common stock is traded on the American Stock Exchange (ticker symbol EML). The approximate number of record holders of the Company common stock on December 29, 2007 was 577.

 

High and low stock prices and dividends for the last two years were:

 

 

2007

 

 

2006

 

Market Price

 

 

 

Market Price

 

Quarter

High

Low

Dividend

 

Quarter

High

Low

Dividend

First

$29.30

$18.99

$.08

 

First

$14.67

$12.50

$.07

Second

33.90

24.00

.08

 

Second

15.10

13.27

.08

Third

29.28

16.00

.08

 

Third

18.83

13.70

.08

Fourth

23.77

17.28

.08

 

Fourth

19.40

16.20

.08

 

The Company increased the dividend rate by 9% in the second quarter of 2006. The Company expects to continue its policy of paying regular cash dividends, although there is no assurance as to future dividends because they are dependent on future earnings, capital requirements, and financial conditions. The payment of dividends is subject to the restrictions of the Company’s loan agreement if such payment would result in an event of default. See Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations, and Note 5 to the Company’s financial statements included at Item 8 of this Annual Report on Form 10-K.

 

The following table sets forth information regarding securities authorized for issuance under the Company’s equity compensation plans as of December 29, 2007, including the Company’s 1989, 1995, 1997 and 2000 plans.

 

Equity Compensation Plan Information

Plan category

Number of securities to be issued upon exercise of outstanding options, warrants and rights

 

Weighted-average exercise price of outstanding options, warrants and rights

 

Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))

 

(a)

 

(b)

 

(c)

Equity compensation plans approved by security holders

456,7501

 

$10.27

 

367,5002

Equity compensation plans not approved by security holders

206,2503

 

9.71

 

-

Total

663,000

 

10.10

 

367,500

 

1 Includes options outstanding under the 1989, 1995 and 2000 plans.

2 Includes shares available for future issuance under the 2000 plan.

3 Includes options outstanding under the 1997 plan.

 

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 expired on September 16, 2007. The 1997 Plan authorized 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 was set by the Compensation Committee. However, all options granted 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. While no more shares are available for grant under the plan, there are 206,250 shares reserved for issuance resulting from previous stock option grants.

Each director who is not an employee of the Company (“Outside Director”) is paid a director’s fee for his services at the annual rate of $24,600. All annual fees paid to non-employee members of the Board of Directors of the Company are paid in common stock of the Company or cash, in accordance with the Directors Fee Program adopted by the shareholders on March 26, 1997 and

 

12

 


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

 

 

 

Period

(a) Total Number of Shares Purchased

(b) Average Price Paid per Share

(c ) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs

(d) Maximum Number that May Yet Be Purchased Under the Plans or Programs

September 30 – October 27, 2007

-

-

-

-

October 28 – November 24, 2007

-

-

-

-

November 25 – December 29, 2007

4,517

$19.80

-

-

Total

4,517

$19.80

-

-

 

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.

Stock Performance Graph

The following graph sets forth the Company’s cumulative total shareholder return based upon an initial $100 investment made on December 31, 2002 (i.e., stock appreciation plus dividends during the past five fiscal years) compared to the Wilshire 5000 Index and the S&P Industrial Machinery Index.

The Company manufactures and markets a broad range of locks, latches, fasteners and other security hardware that meets the diverse security and safety needs of industrial and commercial customers. Consequently, while the S&P Industrial Machinery Index being used for comparison is the standard index most closely related to the Company, it does not completely represent the Company’s products or market applications. The Wilshire 5000 is a market index made up of 5,000 publicly-traded companies, including those having both large and small capitalization.

 


 

 

Dec. 02

Dec. 03

Dec. 04

Dec. 05

Dec. 06

Dec. 07

The Eastern Company

$100

$146

$192

$191

$292

$280

Wilshire 5000

$100

$132

$148

$158

$182

$193

S&P© Industrial Machinery

$100

$138

$163

$160

$183

$222

 

Copyright © 2008, Standard & Poor’s, a division of The McGraw-Hill Companies, Inc. All rights reserved.

 

13

 


ITEM 6

SELECTED FINANCIAL DATA

 

 

2007

2006

2005

2004

2003

INCOME STATEMENT ITEMS (in thousands)

 

 

 

 

 

Net sales

$ 156,281

$ 138,465

$ 109,107

$ 100,130

$ 88,307

Cost of products sold

120,343

103,882

84,375

74,999

66,719

Depreciation and amortization

4,370

3,746

3,460

3,461

3,619

Interest expense

1,289

1,098

1,014

1,044

1,303

Income before income taxes

14,845

14,846

7,020

6,829

5,390

Income taxes

4,765

5,187

2,653

2,071

2,028

Net income

10,081

9,659

4,367

4,758

3,362

Dividends

1,802

1,715

1,600

1,596

1,593

 

 

 

 

 

 

BALANCE SHEET ITEMS (in thousands)

 

 

 

 

 

Inventories

$ 30,491

$ 28,043

$ 20,768

$ 20,478

$ 16,927

Working capital

47,028

35,546

31,223

26,692

24,894

Property, plant and equipment, net

25,234

25,816

22,397

23,907

24,930

Total assets

108,352

103,485

81,622

78,072

74,617

Shareholders’ equity

70,817

54,391

46,172

43,817

40,508

Capital expenditures

2,868

6,722

1,750

2,062

2,763

Long-term obligations, less current portion

14,383

17,507

12,384

11,805

15,815

 

 

 

 

 

 

PER SHARE DATA

 

 

 

 

 

Net income per share

 

 

 

 

 

Basic

$ 1.79

$ 1.76

$ .80

$ .87

$ .62

Diluted

1.68

1.67

.75

.85

.61

Dividends

.32

.31

.29

.29

.29

Shareholders’ equity (Basic)

12.58

9.94

8.47

8.05

7.46

 

 

 

 

 

 

Average shares outstanding:

Basic

5,631,073

5,474,137

5,455,073

5,441,312

5,430,890

 

Diluted

5,989,754

5,768,108

5,828,837

5,618,552

5,488,448

 

The information in the table above reflects a 3-for-2 stock split effective October 2006.

 

 

ITEM 7

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Summary

 

Net sales for 2007 increased 13% to $156.3 million from $138.5 million in 2006. Net income increased 4% to $10.1 million, or $1.68 per diluted share, from $9.7 million, or $1.67 per diluted share in 2006. Net sales and net income in both 2007 and 2006 were favorably impacted by shipments of approximately $20.5 million and $18.5 million, respectively, from the Industrial Hardware segment to fulfill orders received in September 2006 to produce door latching components for a military project to up-armor existing Humvees. The military project was completed in April of 2007. The Company’s “core” business units sales in 2007 increased approximately 13% to $135.8 million from $119.9 million in 2006. Net sales in the Industrial Hardware segment increased approximately 8% in 2007. Sales increased in the Security Products segment by 21%, resulting from the combined acquisitions of Royal Lock and Summit Manufacturing. The Metal Products segment also experienced an increase in sales of 8%, resulting from increased shipments of mine roof support products.

 

 

14

 


The following table shows, for the fourth quarter of 2007 and 2006, selected line items from the consolidated statements of income as a percentage of net sales, by segment. The fourth quarter of 2006 benefited from $18.5 million in sales to fulfill orders received in September 2006 to produce door latching components for a military project to up-armor existing Humvees.

 

 

 

2007 Fourth Quarter

 

 

Industrial

Security

Metal

 

 

 

 

Hardware

Products

Products

Total

Net sales

 

100.0

%

100.0

%

100.0

%

100.0

%

Cost of products sold

 

78.6

%

76.1

%

101.5

%

79.9

%

Gross margin

 

21.4

%

23.9

%

-1.5

%

20.1

%

 

 

 

 

 

 

 

 

 

 

Selling and administrative expense

 

14.6

%

16.0

%

19.2

%

15.7

%

Operating profit

 

6.8

%

7.9

%

-20.7

%

4.4

%

 

 

 

 

 

 

 

 

 

 

 

 

2006 Fourth Quarter

 

 

Industrial

Security

Metal

 

 

 

 

Hardware

Products

Products

Total

Net sales

 

100.0

%

100.0

%

100.0

%

100.0

%

Cost of products sold

 

63.4

%

76.0

%

103.3

%

69.8

%

Gross margin

 

36.6

%

24.0

%

-3.3

%

30.2

%

 

 

 

 

 

 

 

 

 

 

Selling and administrative expense

 

9.3

%

16.7

%

8.8

%

11.3

%

Operating profit

 

27.3

%

7.3

%

-12.1

%

18.9

%

 

The following table shows the amount of change from the fourth quarter of 2006 to the fourth quarter of 2007 in sales, cost of products sold, gross margin, selling and administrative expenses and operating profit, by segment (dollars in thousands). The fourth quarter of 2006 benefited from $18.5 million in sales to fulfill orders received in September 2006 to produce door latching components for a military project to up-armor existing Humvees.

 

 

 

Industrial

 

Security

 

Metal

 

 

 

 

 

Hardware

 

Products

 

Products

 

Total

 

Net sales

 

$

(16,571

)

$

585

 

$

17

 

$

(15,969

)

Volume

 

 

-61.4

%

 

-0.3

%

 

-13.5

%

 

-40.8

%

Prices

 

 

0.2

%

 

2.5

%

 

8.9

%

 

1.5

%

New Products

 

 

9.7

%

 

2.0

%

 

5.1

%

 

7.2

%

 

 

 

-51.5

%

 

4.2

%

 

0.5

%

 

-32.1

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of products sold

 

$

(8,143

)

$

456

 

$

(45

)

$

(7,732

)

 

 

 

-39.9

%

 

4.3

%

 

-1.2

%

 

-22.3

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross margin

 

$

(8,428

)

$

129

 

$

62

 

$

(8,237

)

 

 

 

-71.7

%

 

3.8

%

 

-53.3

%

 

-54.9

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Selling and administrative expenses

 

$

(711

)

$

(4

)

$

371

 

$

(344

)

 

 

 

-23.8

%

 

-0.2

%

 

119.3

%

 

-6.1

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating profit

 

$

(7,717

)

$

133

 

$

(309

)

$

(7,893

)

 

 

 

-87.9

%

 

13.0

%

 

-72.3

%

 

-84.2

%

 

Net sales in the fourth quarter of 2007 decreased 32% to $33.8 million from $49.7 million a year earlier. Net income for the quarter decreased 84% to $887,000 (or $.15 per diluted share) from $5.6 million (or $.96 per diluted share) a year earlier. The decrease in both sales and profit from 2006 to 2007 is primarily attributable to the $18.5 million in sales in the fourth quarter of 2006 to fulfill orders received in September of that year to produce door latching components for a military project to up-armor existing Humvees.

 

15

 


Gross margin for the fourth quarter of 2007 decreased 55% from the fourth quarter of 2006. The decrease is primarily the result of lower sales volume in the 2007 fourth quarter in the Industrial Hardware segment due to completion of the contract to produce door latching components for a military project to up-armor existing Humvees, which benefited the prior year quarter.

 

Selling and administrative expenses for the fourth quarter of 2007 decreased 6.1% compared to the prior year quarter. The overall decrease was due to lower payroll and payroll related charges primarily in the Industrial Hardware segment in the current year fourth quarter. The Metal Products segment selling and administrative expenses increased due to a $250,000 environmental contingency reserve set up in the fourth quarter of 2007.

 

In 2007, the Company continued to experience increased costs related to the required compliance with Section 404 of the Sarbanes-Oxley Act. The fees paid during 2007 for assistance with the completion of documentation and testing required by Section 404 were approximately $322,000, which does not include the cost of internal personnel. The Company will continue to incur additional costs in 2008 and beyond for third party testing of its internal control procedures as required by Section 404. Fees for internal control review, for work required under Section 404 to be completed by the independent registered public accounting firm, were $392,000. The combined fees for work required to comply with Section 404 of the Sarbanes-Oxley Act were $714,000 or $0.07 per diluted share.

 

On December 30, 2006, the Company adopted the recognition and disclosure provisions of Statement of Financial Accounting Standards No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans an amendment of FASB Statements No. 87, 88, 106, and 132(R) (“SFAS No. 158”), which was issued by the Financial Accounting Standards Board (FASB) in September 2006. This standard requires employers to recognize the underfunded or overfunded status of a defined benefit postretirement plan as an asset or liability in its statement of financial position and to recognize changes in the funded status in the year in which the changes occur through accumulated other comprehensive income. Additionally, SFAS No. 158 requires employers to measure the funded status of a plan as of the date of its year-end statement of financial position. As allowed under SFAS 158, the Company did not adopt the measurement date provision in 2006. The Company will adopt the measurement date provision in 2008 as required. See also Note 10, Retirement Benefit Plans, included at Item 8 of this 10-K.

 

In June 2006, the FASB issued Interpretation No. 48 (“FIN 48”) Accounting for Uncertainty in Income Taxes an interpretation of FASB Statement No. 109 (“SFAS 109”). This interpretation clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements in accordance with SFAS 109, Accounting for Income Taxes. FIN 48 details how companies should recognize, measure, present, and disclose uncertain tax positions that have been or are expected to be taken. As such, financial statements will reflect expected future tax consequences of uncertain tax positions presuming the taxing authorities’ full knowledge of the position and all relevant facts. The Company adopted FIN 48 in the first quarter of 2007. See also Note 8, Income Taxes, included at Item 8 of this Form 10-K.

 

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (“SFAS No. 157”). This standard clarifies the principle that fair value should be based on the assumptions that market participants would use when pricing an asset or liability. Additionally, it establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. We have not yet determined the impact that the implementation of SFAS No. 157 will have on our results of operations or financial condition. The Company will adopt SFAS No. 157 in the first quarter of 2008.

 

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities – Including an Amendment of FASB Statement No. 115 (“SFAS No. 159”). SFAS No. 159, which amends SFAS No. 115, allows certain financial assets and liabilities to be recognized, at the company’s election, at fair market value, with any gains or losses for the period recorded in the statement of income. This gives a company the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. Currently, the Company records the gains or losses for the period in the statement of comprehensive income and in the equity section of the balance sheet. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. The Company has not determined the impact, if any, of the adoption of SFAS No. 159. The Company will adopt SFAS No. 159 in the first quarter of 2008.

 

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141 (revised 2007), Business Combinations—a replacement of FASB Statement No. 141 (“SFAS No. 141(R)”), which replaces SFAS No. 141. This standard significantly changes the principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any non-controlling interest in the acquiree. The statement also provides guidance for recognizing and measuring the goodwill acquired in the business combination and determines what information to

 

16

 


disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. This statement is effective prospectively, except for certain retrospective adjustments to deferred tax balances, for fiscal years beginning after December 15, 2008. The Company has not determined the impact, if any, of the adoption of SFAS No. 141(R).

 

Critical Accounting Policies and Estimates

 

The preparation of the financial statements in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) requires management to make judgments, estimates and assumptions regarding uncertainties that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported amounts of revenues and expenses. Areas of uncertainty that require judgments, estimates and assumptions include items such as the accounting for derivatives; environmental matters; the testing of goodwill and other intangible assets for impairment; proceeds on assets to be sold; pensions and other postretirement benefits; and tax matters. Management uses historical experience and all available information to make its estimates and assumptions, but actual results will inevitably differ from the estimates and assumptions that are used to prepare the Company’s financial statements at any given time. Despite these inherent limitations, management believes that Management’s Discussion and Analysis of Financial Condition and Results of Operations and the financial statements and related footnotes provide a meaningful and fair presentation of the Company.

 

Management believes that the application of these estimates and assumptions on a consistent basis enables the Company to provide the users of the financial statements with useful and reliable information about the Company’s operating results and financial condition.

 

Allowance for Doubtful Accounts

 

The Company maintains an allowance for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. The Company reviews the collectibility of its receivables on an ongoing basis taking into account a combination of factors. The Company reviews potential problems, such as past due accounts, a bankruptcy filing or deterioration in the customer’s financial condition, to ensure the Company is adequately accrued for potential loss. Accounts are considered past due based on when payment was originally due. If a customer’s situation changes, such as a bankruptcy or creditworthiness, or there is a change in the current economic climate, the Company may modify its estimate of the allowance for doubtful accounts. The Company will write off accounts receivable after reasonable collection efforts have been made and the accounts are deemed uncollectible.

 

Inventory Reserve

 

Inventories are valued at the lower of cost or market. Cost is determined by the last-in, first-out (“LIFO”) method at the Company’s U.S. facilities. Accordingly, a LIFO valuation reserve is calculated using the dollar value link chain method.

 

We review the net realizable value of inventory in detail on an ongoing basis, giving consideration to deterioration, obsolescence and other factors. Based on these assessments, we provide for an inventory reserve in the period in which an impairment is identified. The reserve fluctuates with market conditions, design cycles and other economic factors.

 

Goodwill and Other Intangible Assets

 

Intangible assets with finite useful lives are amortized generally on a straight-line basis over the periods benefited. Goodwill and other intangible assets with indefinite useful lives are not amortized. Each year during the second quarter, the carrying value of goodwill and other intangible assets with indefinite useful lives is tested for impairment. The Company uses the discounted cash flow method to calculate the fair value of goodwill associated with its reporting units. No impairments of goodwill were deemed to exist. The determination of discounted cash flows is based on the businesses’ strategic plans and long-range planning forecasts. The revenue growth rates included in the plans are management’s best estimates based on current and forecasted market conditions. Profit margin assumptions are projected by each business based on the current cost structures and anticipated cost reductions. There can be no assurance that operations will achieve the future cash flows reflected in the 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.

 

17

 


Pension and Other Postretirement Benefits

 

The amounts recognized in the consolidated financial statements related to pension and other postretirement benefits are determined from actuarial valuations. Inherent in these valuations are assumptions about such factors as expected return on plan assets, discount rates at which liabilities could be settled, rate of increase in future compensation levels, mortality rates, and trends in health insurance costs. These assumptions are reviewed annually and updated as required. In accordance with U.S. GAAP, actual results that differ from the assumptions are accumulated and amortized over future periods and, therefore, affect the expense recognized and obligations recorded in future periods.

 

The discount rate used is based on comparisons to the Moody’s Aa Corporate Bond index, as well as a hypothetical yield curve that creates a reference portfolio of high quality corporate bonds whose payments mimic the plan’s benefit payment stream. The expected long-term rate of return on assets is developed with input from the Company’s actuarial firms. Also considered is the Company’s historical experience with pension fund asset performance in comparison with expected returns. The long-term rate-of-return assumption used for determining net periodic pension expense for 2007 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 of $263,000 and $161,000 to its pension plans and postretirement plan, respectively in 2008.

 

RESULTS OF OPERATIONS

 

Fiscal 2007 Compared to Fiscal 2006

 

The following table shows, for 2007 and 2006, selected line items from the consolidated statements of income as a percentage of net sales, by segment.

 

 

 

2007

 

 

Industrial

Security

Metal

 

 

 

 

Hardware

Products

Products

Total

Net sales

 

100.0

%

100.0

%

100.0

%

100.0

%

Cost of products sold

 

72.5

%

76.8

%

104.3

%

77.0

%

Gross margin

 

27.5

%

23.2

%

-4.3

%

23.0

%

 

 

 

 

 

 

 

 

 

 

Selling and administrative expense

 

11.6

%

14.6

%

12.0

%

12.8

%

Operating profit

 

15.9

%

8.6

%

-16.3

%

10.2

%

 

 

 

 

 

 

 

 

 

 

 

 

2006

 

 

Industrial

Security

Metal

 

 

 

 

Hardware

Products

Products

Total

Net sales

 

100.0

%

100.0

%

100.0

%

100.0

%

Cost of products sold

 

70.5

%

74.2

%

104.2

%

75.0

%

Gross margin

 

29.5

%

25.8

%

-4.2

%

25.0

%

 

 

 

 

 

 

 

 

 

 

Selling and administrative expense

 

12.1

%

16.8

%

9.9

%

13.6

%

Operating profit

 

17.4

%

9.0

%

-14.1

%

11.4

%

 

 

 

 

18

 


The following table shows the amount of change from 2006 to 2007 in sales, cost of products sold, gross margin, selling and administrative expenses, and operating profit, by segment (dollars in thousands):

 

 

 

Industrial

 

Security

 

Metal

 

 

 

 

 

Hardware

 

Products

 

Products

 

Total

 

Net sales

 

$

6,165

 

$

10,677

 

$

974

 

$

17,816

 

Volume

 

 

-6.8

%

 

16.3

%

 

-0.8

%

 

2.2

%

Prices

 

 

2.9

%

 

1.2

%

 

5.8

%

 

2.5

%

New Products

 

 

12.1

%

 

3.8

%

 

2.5

%

 

8.2

%

 

 

 

8.2

%

 

21.3

%

 

7.5

%

 

12.9

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of products sold

 

$

5,909

 

$

9,526

 

$

1,027

 

$

16,462

 

 

 

 

11.1

%

 

25.6

%

 

7.6

%

 

15.8

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross margin

 

$

256

 

$

1,151

 

$

(53

)

$

1,354

 

 

 

 

1.2

%

 

8.9

%

 

-9.7

%

 

3.9

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Selling and administrative expenses

 

$

370

 

$

464

 

$

385

 

$

1,219

 

 

 

 

4.1

%

 

5.5

%

 

29.9

%

 

6.5

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating profit

 

$

(114

)

$

687

 

$

(438

)

$

135

 

 

 

 

-0.9

%

 

15.2

%

 

23.9

%

 

0.9

%

 

Industrial Hardware Segment

 

Net sales in the Industrial Hardware segment were up 8.2% in 2007 from the 2006 level. New product introductions were responsible for the increase in sales for this segment. All of the new products were internally developed and offered to the variety of markets we service, including: military, utility truck, vehicular accessories and recreational vehicles. New products included an electric door control for the bus market, a printer bed table for the electronics market, several new products for the military market including a center case kit and a variety of handles, as well as an assortment of handles and latches used in many of the markets to which we sell. Sales volume of existing products was stable in most of the markets we service, however, decreases in sales volume occurred in the truck accessory, Class 8 truck, and trailer markets. Sales at the Company’s Mexican subsidiary increased 20% from 2006, primarily due to economic growth in Mexico.

 

Cost of products sold for the Industrial Hardware segment increased 11.1% from 2006 to 2007. In addition to manufacturing costs associated with the higher volume of sales, the major factors causing the increase were higher costs of raw materials and increases in payroll and payroll related charges.

 

Gross margin as a percentage of net sales decreased from 29.5% to 27.5%, driven by higher manufacturing costs which could not be fully recovered through selling price increases due to the competitive nature of many of the products we sell.

 

Selling and administrative expenses increased 4.1% from 2006 levels due to increases in payroll and payroll related charges.

 

Security Products Segment

 

Net sales in the Security Products segment increased 21.3% from 2006 to 2007. The primary reason for the increase was an increase in sales volume resulting from the acquisitions of Royal Lock and Summit Manufacturing in the latter part of 2006. In addition to the oven latch line from the Summit Manufacturing acquisition, new products were mainly lock related, such as: a hinge for truck tonneau covers and an L-handle for a sportrack, both of which are used in the automotive accessory market, as well as a variety of other lock products for various markets.

 

19

 


Cost of products sold for the Security Products segment increased 25.6% from 2006 to 2007. Most of the increase in cost of products sold was directly proportionate to the increase in sales. The major item that outpaced the increased sales level were raw material costs, which we were not able to recover through increased prices due to the competitive nature of many of the markets to which we sell.

 

Gross margin decreased from 25.8% to 23.2% as a percentage of net sales for the Security Products segment resulting from the higher manufacturing costs, mainly raw materials, as well as a change in product mix.

 

Selling and administrative expenses increased 5.5% from the same period a year ago due to higher costs for travel expenses and the amortization of intangibles associated with the acquisitions of Royal Lock and Summit Manufacturing.

 

Metal Products Segment

 

Net sales in the Metal Products segment increased 7.5% from 2006 to 2007. Sales of mine products increased 18% in 2007 compared to 2006, while sales of contract casting products decreased 1% from 2006. In 2007, sales of mine roof supports increased in both the U.S. and Canadian markets, continuing the growth experienced in 2006. Shipments of ductile iron castings increased 9% to 1,058 tons in 2007 from 973 tons in 2006. Sales of new products in 2007 included a new cablehead and a new wall anchor for use in underground mining applications.

 

Cost of products sold for the Metal Products segment increased 7.6% from 2006 to 2007. Cost increases were experienced for raw materials, payroll and payroll related charges, utilities, outside parts and processing, supplies and tools and equipment maintenance.

 

Gross margin in the Metal Products segment was comparable for both 2006 and 2007.

 

Selling and administrative expenses in the Metal Products segment increased 29.9% from 2006 to 2007. Cost increases occurred in payroll and payroll related charges and travel and entertainment expenses, but the increase was primarily due to charges related to the environmental remediation of $250,000.

 

Other Items

 

The following table shows the amount of change from 2006 to 2007 in other items (dollars in thousands):

 

 

 

 

Total

 

Interest expense

 

$

191

 

 

 

 

17.4

%

 

 

 

 

 

Other income

 

$

56

 

 

 

 

37.4

%

 

 

 

 

 

Income taxes

 

$

(423

)

 

 

 

-8.1

%

 

Interest expense increased from 2006 to 2007 primarily due to the increased level of debt for the full year 2007 associated with the amended Loan Agreement, which is discussed in Note 5 in Item 8 of this Form 10-K.

 

Other income increased from 2006 to 2007 due to higher interest income earned on higher cash balances in the Company’s cash management program in 2007.

 

Income taxes – the effective tax rate decreased in 2007 to 32% from the 35% rate in 2006. The decrease is the result of a change in the mix of U.S and foreign income, as well as a change in the mix of U.S. earnings in states with lower income tax rates.

 

 

20

 


Fiscal 2006 Compared to Fiscal 2005

 

The following table shows, for 2006 and 2005, selected line items from the consolidated statements of income as a percentage of net sales, by segment.

 

 

 

2006

 

 

Industrial

Security

Metal

 

 

 

 

Hardware

Products

Products

Total

Net sales

 

100.0

%

100.0

%

100.0

%

100.0

%

Cost of products sold

 

70.5

%

74.2

%

104.2

%

75.0

%

Gross margin

 

29.5

%

25.8

%

-4.2

%

25.0

%

 

 

 

 

 

 

 

 

 

 

Selling and administrative expense

 

12.1

%

16.8

%

9.9

%

13.6

%

Operating profit

 

17.4

%

9.0

%

-14.1

%

11.4

%

 

 

 

 

 

 

 

 

 

 

 

 

2005

 

 

Industrial

Security

Metal

 

 

 

 

Hardware

Products

Products

Total

Net sales

 

100.0

%

100.0

%

100.0

%

100.0

%

Cost of products sold

 

75.6

%

72.1

%

107.2

%

77.3

%

Gross margin

 

24.4

%

27.8

%

-7.2

%

22.7

%

 

 

 

 

 

 

 

 

 

 

Selling and administrative expense

 

14.7

%

17.5

%

9.8

%

15.4

%

Operating profit

 

9.7

%

10.3

%

-17.0

%

7.3

%

 

 

 

The following table shows the amount of change from 2005 to 2006 in sales, cost of products sold, gross margin, selling and administrative expenses, and operating profit, by segment (dollars in thousands):

 

 

 

Industrial

 

Security

 

Metal

 

 

 

 

 

Hardware

 

Products

 

Products

 

Total

 

Net sales

 

$

21,590

 

$

5,743

 

$

2,025

 

$

29,358

 

Volume

 

 

-1.9

%

 

11.3

%

 

12.5

%

 

4.9

%

Prices

 

 

0.0

%

 

0.0

%

 

0.6

%

 

0.0

%

New Products

 

 

42.0

%

 

1.7

%

 

5.4

%

 

22.0

%

 

 

 

40.1

%

 

13.0

%

 

18.5

%

 

26.9

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of products sold

 

$

12,533

 

$

5,181

 

$

1,793

 

$

19,507

 

 

 

 

30.8

%

 

16.2

%

 

15.3

%

 

23.1

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross margin

 

$

9,057

 

$

562

 

$

232

 

$

9,851

 

 

 

 

68.8

%

 

4.5

%

 

29.7

%

 

39.8

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Selling and administrative expenses

 

$

1,178

 

$

624

 

$

211

 

$

2,013

 

 

 

 

14.9

%

 

8.0

%

 

19.6

%

 

12.0

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating profit

 

$

7,879

 

$

(62

)

$

21

 

$

7,838

 

 

 

 

150.6

%

 

-1.4

%

 

1.2

%

 

98.5

%

 

 

21

 


Industrial Hardware Segment

 

Net sales in the Industrial Hardware segment were up 40.1% in 2006 from the 2005 level. New product introductions, mainly the component parts for the Humvee retrofit program, were responsible for the increase in sales for this segment. All of the new products were internally developed and offered to the variety of markets we service, including: military, utility truck, vehicular accessories and recreational vehicles. New products included retrofit components for military Humvees, a hidden hinge used on service truck bodies, a three point handle assembly and a star wheel rotary assembly for the truck accessory market, and pick up truck camper shell used in the emergency vehicle market, as well as an assortment of handles and latches used in many of the markets to which we sell. Sales volume of existing products was up in all but two of the markets we service – truck trailers and van bodies. Sales at the Company’s Mexican subsidiary increased 12% from 2005, primarily due to economic growth in Mexico.

 

Cost of products sold for the Industrial Hardware segment increased 30.8% from 2005 to 2006. In addition to manufacturing costs associated with the higher volume of sales, the major factor causing the increase was the higher costs of raw materials.

 

Gross margin as a percentage of net sales increased from 24.4% to 29.5%, which is a direct result of the significant increase in sales volume resulting in more efficient utilization of our existing facilities.

 

Selling and administrative expenses increased 14.9% from 2005 levels due to increases in payroll and payroll related charges.

 

Security Products Segment

 

Net sales in the Security Products segment increased 13.0% from 2005 to 2006. Increased sales volume of existing products in our core lock business, coupled with the acquisitions of Royal Lock and Summit Manufacturing, more than offset declines in sales volume of our commercial laundry products. Volume decreases occurred in traditional laundry products such as drop meters and meter cases, as well as the newer “smart card” systems. Most of the 2006 decline in “smart card” systems was due to a retro-fit of card systems in 2005. In addition to the oven latch line from the Summit Manufacturing acquisition, new products were mainly lock related, such as: a car carrier clamp assembly, an L-handle for a sportrack and an electric car lock set used in the automotive accessories market, as well as a variety of other lock products for various markets.

 

Cost of products sold for the Security Products segment increased 16.2% from 2005 to 2006. Most of the increase in cost of products sold was directly proportionate to the increase in sales. The major item that outpaced the increased sales level were raw material costs, which we were not able to recover through increased prices due to the competitive nature of many of the markets to which we sell.

 

Gross margin decreased from 27.8% to 25.8% as a percentage of net sales for the Security Products segment resulting from the higher manufacturing costs, mainly raw materials, as well as a change in product mix.

 

Selling and administrative expenses increased 8.0% from the same period a year ago due to higher costs for payroll and payroll related charges, advertising expenses, and amortization of intangibles associated with the acquisitions of Royal Lock and Summit Manufacturing.

 

Metal Products Segment

 

Net sales in the Metal Products segment increased 18.5% from 2005 to 2006. Sales of mine products increased 20% in 2006 compared to 2005, while sales of contract casting products increased 16% from 2005. In 2006, sales of mine roof supports increased in both the U.S. and Canadian markets. Shipments of ductile iron castings increased 35% to 973 tons in 2006 from 723 tons in 2005. The Company continued its marketing efforts to sell mine roof anchor products in Australia and China. Sales of new products in 2006 included a new mine roof anchor for the Canadian market and a variety of dome nuts for use in underground mining applications.

 

Cost of products sold decreased as a percentage of net sales due mainly to higher sales volume. Cost increases were experienced for raw materials, payroll and payroll related charges, supplies and tools, and equipment maintenance. In order to improve the efficiency of producing ductile iron castings, the Company installed a new automatic pouring system designed specifically for

 

22

 


ductile iron in July 2006. The Company experienced higher costs than anticipated with the start-up of the equipment and did not start achieving the anticipated improvement in pouring efficiency until late in the fourth quarter of 2006.

 

Gross margin in the Metal Products segment improved slightly as a percentage of net sales mainly due to higher sales volume resulting in better utilization of production facilities and product mix.

 

Selling and administrative expenses in the Metal Products segment increased 19.6% from 2005 to 2006, due to increases in payroll and payroll related charges, advertising and travel expenses.

 

Other Items

 

The following table shows the amount of change from 2005 to 2006 in other items (dollars in thousands):

 

 

 

 

Total

 

Interest expense

 

$

84

 

 

 

 

8.2

%

 

 

 

 

 

Other income

 

$

72

 

 

 

 

92.0

%

 

 

 

 

 

Income taxes

 

$

2,534

 

 

 

 

95.5

%

 

Interest expense increased from 2005 to 2006 primarily due to the increased level of debt associated with the amended Loan Agreement, which is discussed in Note 5 in Item 8 of this Form 10-K.

 

Other income increased from 2005 to 2006 due to a gain on the termination of a swap agreement, which is discussed in Note 5 in Item 8 of this Form 10-K.

 

Income taxes – the effective tax rate decreased in 2006 to 35% from the 38% rate in 2005. The decrease is the result of a change in the mix of U.S and foreign income, as well as a change in the mix of U.S. earnings in states with lower income tax rates.

 

Liquidity and Sources of Capital

 

The Company’s financial position remained strong throughout 2007. The primary source of the Company’s cash is earnings from operating activities adjusted for cash generated from or used for net working capital. The most significant recurring non-cash items included in income are depreciation and amortization expense. Changes in working capital fluctuate with the changes in operating activities. As sales increase, there generally is an increased need for working capital. Since increases in working capital reduce the Company’s cash, management attempts to keep the Company’s investment in net working capital at a reasonable level by closely monitoring inventory levels (by matching production to expected market demand), keeping tight control over the collection of receivables, and optimizing payment terms on its trade and other payables.

 

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.

 

 

 

2007

 

2006

 

2005

 

Current ratio

 

3.9

 

2.5

 

3.3

 

Average days’ sales in accounts receivable

 

52

 

46

 

48

 

Inventory turnover

 

3.9

 

3.7

 

4.1

 

Ratio of working capital to sales

 

30.1

%

25.7

%

28.6

%

Total debt to shareholders’ equity

 

24.7

%

37.9

%

34.2

%

 

 

23

 


At December 29, 2007, December 30, 2006, and December 31, 2005, the Company had cash and cash equivalents of $8.2 million, $3.1 million and $6.3 million, respectively, and working capital of $47.0 million, $35.5 million and $31.2 million, respectively.

 

Net cash provided by operating activities was $8.8 million in 2007 compared to $7.9 million in 2006 and $5.2 million in 2005. The $900,000 increase from 2006 to 2007 is primarily the result of the increases in earnings, depreciation and amortization in 2007. The $2.7 million increase from 2005 to 2006 is primarily the result of the increase in earnings in 2006, as well as changes in the components of working capital. During 2007, working capital used $5.5 million in cash. Changes in inventory, recoverable taxes, accounts payable and other accrued expenses accounted for $13.3 million of cash usage, while changes in accounts receivable and other long term liabilities provided $7.7 million in cash. During 2006, working capital used $5.6 million in cash as a result of increased sales activity, primarily in the 4th quarter of the year. Increases in accounts receivable and inventory accounted for $14.4 million of cash usage, while increases in accounts payable, accrued compensation and other accrued expenses provided $8.9 million in cash. In 2005, working capital used $2.7 million in cash as a result of increased sales activity. Accounts receivable accounted for most of the increase, rising $2.2 million.

 

During 2007, 2006 and 2005 the Company used $2.8, $14.2 and $1.7 million of cash in investing activities, respectively. In 2006, the Company made two small acquisitions which used approximately $7.5 million in cash. The remaining $6.7 million in 2006 and virtually all of the amounts for 2007 and 2005 related to the purchase of fixed assets. Significant purchases in 2006 included $2.2 million of land and building for one of the Company’s Security Products segment manufacturing facilities, approximately $600,000 in new equipment purchases related to a significant contract received by the Industrial Hardware Segment, and approximately $570,000 for an automatic pouring system for ductile iron for the Metal Products Segment. The Company expects capital expenditures for 2008 to be approximately $2.5 million to $3.0 million.

 

Net cash used by financing activities in 2007 totaled approximately $1.1 million. Payments of $3.1 million in debt and $1.8 million in dividends were offset by $2.6 million received from the exercise of stock options and an additional $1.6 million related to tax benefits derived from these same stock option transactions. In 2007, 339,749 shares were issued as a result of options being exercised at an average price of approximately $7.54 per share. While there is no assurance that the Company will receive additional funds resulting from the exercise of options in 2008, options representing an additional 180,000 shares at an average price of $9.33 per share are due to expire during 2008 if they are not exercised. Net cash provided by financing activities in 2006 totaled approximately $3.2 million. This was the result of the Company’s restructuring of its outstanding debt in order to provide cash for the business and fixed asset acquisitions previously described above. See additional details concerning debt below. Net cash used by financing activities totaled $1.6 million in 2005. During 2005 the Company borrowed an additional $3.0 million on its revolving credit facility to cover short-term cash requirements. Principal payments of long-term debt amounted to $3.0 million in 2005.

 

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 $882,000, $945,000 and $826,000 in 2007, 2006 and 2005, respectively.

 

On September 22, 2006, the Company amended the unsecured loan agreement (“Loan Agreement”), which includes a term portion and a revolving credit portion, with its lender, Bank of America, N.A. The amendment restructured and increased the balance of the term portion of the loan into a new seven (7) year loan in the amount of $20,000,000. The restructured term portion is payable in quarterly payments of $714,286 which began on January 2, 2007. The proceeds were used to repay in full the outstanding balance of its existing term loan, $12,625,000, and for the acquisition of Royal Lock.

 

In addition, the Company increased the maximum amount available under the revolving credit portion from $7,500,000 to $12,000,000 and renewed and extended the maturity date to September 22, 2009. The revolving credit portion has a variable quarterly commitment fee ranging from 0.10% to 0.25% based on operating results. As of December 29, 2007, the quarterly fee is 0.25% on the unused portion. There were no borrowings against the revolving credit portion as of December 29, 2007.

 

The interest rates on the term and the revolving credit portions of the Loan Agreement vary. The interest rates may vary based on the LIBOR rate plus a margin spread of 1.0% to 1.65% for the term portion and 1.0% to 1.6% for the revolving credit portion. The margin rate spread is based on operating results calculated on a rolling-four-quarter basis. The Company may also borrow funds at the lender’s prime rate. On December 29, 2007, the interest rate on the term portion of the Loan Agreement was 6.23%.

 

Also on September 22, 2006, the Company terminated its interest rate swap contract with the lender. At the time of termination, the notional amount was $9,468,750, which was equal to 75% of the outstanding balance of the term loan on that date. As a result

 

24

 


of the termination, the Company received $73,100 of cash which was included in other income. The Company had originally entered into the interest rate swap contract with an original notional amount of $11,793,750, which was equal to 75% of the outstanding balance of the term loan on August 11, 2005. The notional amount began to decrease on a quarterly basis beginning October 3, 2005 following the principal repayment schedule of the term portion of the Loan Agreement. The Company had a fixed interest rate of 4.61% on the swap contract and paid the difference between the fixed rate and LIBOR when LIBOR was below 4.61% and received interest when the LIBOR rate exceeded 4.61%.

 

On November 2, 2006, the Company entered into an interest rate swap contract with the lender with an original notional amount of $20,000,000 (notional amount $17,142,857 on December 29, 2007), which was equal to 100% of the outstanding balance of the term loan on that date. The notional amount began decreasing on a quarterly basis on January 2, 2007 following the principal repayment schedule of the term loan. The Company has a fixed interest rate of 5.25% on the swap contract and will pay the difference between the fixed rate and LIBOR when LIBOR is below 5.25% and will receive interest when the LIBOR rate exceeds 5.25%.

 

The Company’s loan covenants restrict it from incurring any indebtedness (from any person other than the lender) that exceeds the aggregate sum of $1.5 million, or that exceeds $1.0 million in any single transaction, without the express consent of the lender or until the full payment of the current obligation has been made. The loan covenants also prohibit the Company from paying any dividends in the event the payment would result in a default under the terms of the Loan Agreement.

 

Tabular Disclosure of Contractual Obligations

 

The Company’s known contractual obligations as of December 29, 2007, are shown below (in thousands):

 

 

Payment due by period

 

 

 

Total

Less than 1 Year

 

1-3 Years

 

3-5 Years

More than 5 Years

Long-term debt obligations

$ 17,143

$ 2,857

$ 5,714

$ 5,714

$ 2,858

Estimated interest on long-term debt

and capital lease obligations

 

3,322

 

1,053

 

1,480

 

714

 

75

Capital lease obligations

364

267

97

-

-

Operating lease obligations

1,113

643

449

21

-

Estimated contributions to pension plans

1,286

311

431

259

285

Estimated post retirement benefits

other than pensions

 

1,111

 

161

 

324

 

327

 

299

Total

$ 24,339

$ 5,292

$ 8,495

$ 7,035

$ 3,517

 

Included in the estimated interest on long-term debt and capital lease obligations above are payments under the interest rate swap contract. The intent of the swap is to fix the interest rate on 100% of the Company’s bank debt.

 

The amounts shown in the above table for estimated contributions to pension plans and estimated postretirement benefits other than pensions are based on the assumptions in Note 10 to the consolidated financial statements, as well as the assumption that participant counts will remain stable.

 

The Company does not have any non-cancelable open purchase orders.

 

At December 29, 2007, the Company maintained a stand-by letter of credit in the amount of $328,000 related to one of its capital leases. This amount is declining on a monthly basis as payments on the lease are made. The stand-by letter of credit reserves that amount from the Company’s revolving credit agreement under terms of the capital lease agreement.

 

 

25

 


ITEM 7A

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

The Company’s foreign manufacturing facilities account for approximately 18% of total sales and 16% of total assets. Its U.S. operations buy from and sell to these foreign affiliates, and also make limited sales (approximately 8% of total sales) to nonaffiliated foreign customers. This trade activity could be affected by fluctuations in foreign currency exchange or by weak economic conditions. The Company’s currency exposure is concentrated in the Canadian dollar, Mexican peso, New Taiwan dollar, Chinese RMB and Hong Kong dollar. Because of the Company’s limited exposure to any single foreign market, any exchange gains or losses have not been material and are not expected to be material in the future. Had the exchange rate as of December 29, 2007 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 2007, a 10% increase/decrease in exchange rates would have resulted in a translation increase/decrease to sales of approximately $2.6 million, and to equity of approximately $1.5 million.

 

The Company is exposed to interest rate risk with respect to its unsecured Loan Agreement, which provides for interest based on LIBOR plus a spread of up to 1.65%. The spread is determined by a comparison of the Company’s operating performance with agreed-upon financial targets. Since the Company’s performance depends to a large extent on the overall economy, the interest rate paid by the Company under its Loan Agreement is closely linked to the trend in the U.S. economy. The current interest rate spread is 1.0% on both the term loan portion and the revolving credit line portion of the Loan Agreement. Changes in LIBOR rates will also affect the Company’s interest expense. To hedge against future LIBOR rate increases, the Company has an interest rate swap contract on 100% of the term loan principal amount under the Loan Agreement. The interest rate on the swap contract is 5.25% and the swap contract expires on September 22, 2013. The notional amount of the swap contract is reduced on a quarterly basis in accordance with the principal repayment schedule for the term portion of the Loan Agreement. The notional amount of the swap contract was $17.1 million as of December 29, 2007. Therefore, the term debt is not subject to the volatility of short-term interest rates because the entire amount of debt is hedged under the swap contract.

 

26

 


ITEM 8

FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

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 (the Company) as of December 29, 2007 and December 30, 2006, and the related consolidated statements of income, comprehensive income, shareholders’ equity, and cash flows for each of the years in the three-year period ended December 29, 2007. Our audit also included the financial statement schedule listed in the Index at Item 15(a)(2). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company as of December 29, 2007 and December 30, 2006, and the consolidated results of its operations and its cash flows for each of the years in the three-year period ended December 29, 2007 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

 

As discussed in Note 10 to the consolidated financial statements, effective December 30, 2006, the Company adopted the recognition and disclosure provisions of Statement of Financial Accounting Standards No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans an amendment of FASB Statements No. 87, 88, 106, and 132(R). Further, as discussed in Note 8, the Company adopted Financial Accounting Standards Board Interpretation 48, Accounting for Uncertainty in Income Taxes, effective December 31, 2006.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 29, 2007, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 5, 2008, expressed an unqualified opinion thereon.

 

/s/ UHY LLP

 

Hartford, Connecticut

March 5, 2008

 

27

 


The Eastern Company

 

Consolidated Balance Sheets

 

 

 

 

December 29

 

December 30

 

 

 

2007

 

2006

 

ASSETS

 

 

 

 

 

 

 

Current Assets

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

8,209,722

 

$

3,101,458

 

Accounts receivable, less allowances of $342,000 in 2007 and $319,000 in 2006

 

 

18,993,934

 

 

24,859,152

 

 

 

 

 

 

 

 

 

Inventories:

 

 

 

 

 

 

 

Raw materials and component parts

 

 

8,435,858

 

 

8,008,603

 

Work in process

 

 

8,482,427

 

 

6,366,354

 

Finished goods

 

 

13,572,411

 

 

13,667,609

 

 

 

 

30,490,696

 

 

28,042,566

 

 

 

 

 

 

 

 

 

Prepaid expenses and other assets

 

 

2,872,910

 

 

2,391,425

 

Recoverable taxes receivable

 

 

1,428,569

 

 

 

Deferred income taxes

 

 

1,256,780

 

 

931,641

 

Total Current Assets

 

 

63,252,611

 

 

59,326,242

 

 

 

 

 

 

 

 

 

Property, Plant and Equipment

 

 

 

 

 

 

 

Land

 

 

1,103,872

 

 

1,102,628

 

Buildings

 

 

13,822,209

 

 

13,687,524

 

Machinery and equipment

 

 

33,057,484

 

 

32,068,499

 

Accumulated depreciation

 

 

(22,749,351

)

 

(21,042,934

)

 

 

 

25,234,214

 

 

25,815,717

 

 

 

 

 

 

 

 

 

Other Assets

 

 

 

 

 

 

 

Goodwill

 

 

13,955,608

 

 

13,742,160

 

Trademarks

 

 

135,473

 

 

117,959

 

Patents, technology and other intangibles net of accumulated amortization

 

 

3,981,338

 

 

4,216,508

 

Prepaid pension cost

 

 

1,792,657

 

 

266,358

 

 

 

 

19,865,076

 

 

18,342,985

 

 

 

$

108,351,901

 

$

103,484,944

 

 

 

28

 


Consolidated Balance Sheets

 

 

 

 

December 29

 

December 30

 

 

 

2007

 

2006

 

Liabilities and shareholders’ equity

 

 

 

 

 

 

 

Current Liabilities

 

 

 

 

 

 

 

Accounts payable

 

$

8,183,408

 

$

13,170,491

 

Accrued compensation

 

 

2,571,970

 

 

3,098,525

 

Other accrued expenses

 

 

2,345,091

 

 

4,399,358

 

Current portion of long-term debt

 

 

3,123,742

 

 

3,111,908

 

Total Current Liabilities

 

 

16,224,211

 

 

23,780,282

 

 

 

 

 

 

 

 

 

Deferred income taxes

 

 

2,390,882

 

 

1,123,537

 

Other long-term liabilities

 

 

1,620,311

 

 

 

Long-term debt, less current portion

 

 

14,383,060

 

 

17,506,802

 

Accrued postretirement benefits

 

 

1,111,234

 

 

1,221,156

 

Accrued pension cost

 

 

1,226,994

 

 

5,323,550

 

Interest rate swap obligation

 

 

577,941

 

 

138,412

 

 

 

 

 

 

 

 

 

Shareholders’ Equity

 

 

 

 

 

 

 

Voting Preferred Stock, no par value:

 

 

 

 

 

 

 

Authorized and unissued: 1,000,000 shares

 

 

 

 

 

 

 

Nonvoting Preferred Stock, no par value:

 

 

 

 

 

 

 

Authorized and unissued: 1,000,000 shares

 

 

 

 

 

 

 

Common Stock, no par value:

 

 

 

 

 

 

 

Authorized: 50,000,000 shares

 

 

 

 

 

 

 

Issued: 8,354,978 shares in 2007 and 8,012,550 shares in 2006

 

 

22,173,795

 

 

17,974,115

 

Treasury Stock: 2,545,379 shares in 2007 and 2,533,089 shares in 2006

 

 

(16,967,562

)

 

(16,655,041

)

Retained earnings

 

 

66,262,566

 

 

58,279,371

 

 

 

 

 

 

 

 

 

Accumulated other comprehensive income (loss):

 

 

 

 

 

 

 

Foreign currency translation

 

 

2,400,268

 

 

756,452

 

Unrecognized net pension and postretirement benefit costs, net of taxes

 

 

(2,682,183

)

 

(5,875,261

)

Derivative financial instruments, net of taxes

 

 

(369,616

)

 

(88,431

)

 

 

 

(651,531

)

 

(5,207,240

)

Total Shareholders’ Equity

 

 

70,817,268

 

 

54,391,205

 

 

 

$

108,351,901

 

$

103,484,944

 

 

See accompanying notes.

 

29

 


Consolidated Statements of Income

 

 

 

 

 

Year ended

 

 

 

 

 

December 29

 

December 30

 

December 31

 

 

 

2007

 

2006

 

2005

 

Net sales

 

$

156,281,083

 

$

138,465,411

 

$

109,107,290

 

Cost of products sold

 

 

(120,343,196

)

 

(103,881,660

)

 

(84,374,501

)

Gross margin

 

 

35,937,887

 

 

34,583,751

 

 

24,732,789

 

 

 

 

 

 

 

 

 

 

 

 

Selling and administrative expenses

 

 

(20,008,851

)

 

(18,789,514

)

 

(16,776,253

)

Operating profit

 

 

15,929,036

 

 

15,794,237

 

 

7,956,536

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

(1,288,952

)

 

(1,097,640

)

 

(1,014,052

)

Other income

 

 

205,379

 

 

149,451

 

 

77,823

 

Income before income taxes

 

 

14,845,463

 

 

14,846,048

 

 

7,020,307

 

 

 

 

 

 

 

 

 

 

 

 

Income taxes

 

 

4,764,770

 

 

5,187,300

 

 

2,653,120

 

Net income

 

$

10,080,693

 

$

9,658,748

 

$

4,367,187

 

Earnings per Share:

 

 

 

 

 

 

 

 

 

 

Basic

 

$

1.79

 

$

1.76

 

$

.80

 

 

 

 

 

 

 

 

 

 

 

 

Diluted

 

$

1.68

 

$

1.67

 

$

.75

 

 

See accompanying notes.

 

Consolidated Statements of Comprehensive Income

 

 

 

 

 

Year ended

 

 

 

 

 

December 29

 

December 30

 

December 31

 

 

 

2007

 

2006 (restated)

 

2005

 

Net income

 

$

10,080,693

 

$

9,658,748

 

$

4,367,187

 

Other comprehensive income/(loss) -

 

 

 

 

 

 

 

 

 

 

Change in foreign currency translation

 

 

1,643,816

 

 

(62,114

)

 

354,762

 

Change in fair value of derivative financial instruments, net of income taxes (benefit) of ($158,343) in 2007, ($35,301) in 2006 and $75,797 in 2005

 

 

(281,185

)

 

(62,092

)

 

116,701

 

Reclassification adjustment for termination of derivative financial instrument, net of income tax benefit of $26,477

 

 

 

 

(46,623

)

 

 

Change in pension and postretirement benefit costs, net of income taxes of $1,808,898

 

 

3,193,078

 

 

 

 

 

Change in additional minimum pension liability, net of income taxes (benefit) of $927,837 in 2006 and ($584,440) in 2005

 

 

 

 

1,466,438

 

 

(994,753

)

 

 

 

4,555,709

 

 

1,295,609

 

 

(523,290

)

Comprehensive income

 

$

14,636,402

 

$

10,954,357

 

$

3,843,897

 

 

See accompanying notes.

 

30

 


Consolidated Statements of Shareholders’ Equity

 

 

 

Common Shares

 

Common
Stock

 

Treasury
Shares

 

Treasury
Stock

 

Retained
Earnings

 

Accumulated
Other
Comprehensive
Income (Loss)

 

Shareholders’
Equity

 

Balances at January 1, 2005

 

7,985,390

 

$

17,583,561

 

(2,533,089

)

$

(16,655,041

)

$

47,568,571

 

$

(4,680,413

)

$

43,816,678

 

Net income

 

 

 

 

 

 

 

 

 

 

 

 

4,367,187

 

 

 

 

 

4,367,187

 

Currency translation adjustment

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

354,762

 

 

354,762

 

Change in minimum pension liability, net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(994,753

)

 

(994,753

)

Change in derivative financial instrument, net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

116,701

 

 

116,701

 

Cash dividends declared, $.29 per share

 

 

 

 

 

 

 

 

 

 

 

 

(1,600,100

)

 

 

 

 

(1,600,100

)

Tax benefit from disqualifying disposition of incentive stock options

 

 

 

 

6,403

 

 

 

 

 

 

 

 

 

 

 

 

 

6,403

 

Issuance of Common Stock for directors’ fees

 

7,236

 

 

104,887

 

 

 

 

 

 

 

 

 

 

 

 

 

104,887

 

Balances at December 31, 2005

 

7,992,626

 

 

17,694,851

 

(2,533,089

)

 

(16,655,041

)

 

50,335,658

 

 

(5,203,703

)

 

46,171,765

 

Net income

 

 

 

 

 

 

 

 

 

 

 

 

9,658,748

 

 

 

 

 

9,658,748

 

Currency translation adjustment

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(62,114

)

 

(62,114

)

Change in minimum pension liability, net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1,466,438

 

 

1,466,438

 

Change in derivative financial instrument, net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(62,092

)

 

(62,092

)

Change in accounting for pension and postretirement benefit costs, net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(1,299,146

)

 

(1,299,146

)

Reclassification adjustment for termination of derivative financial instrument, net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(46,623

)

 

(46,623

)

Cash dividends declared, $.31 per share

 

 

 

 

 

 

 

 

 

 

 

 

(1,715,035

)

 

 

 

 

(1,715,035

)

Issuance of Common Stock upon the exercise of stock options

 

15,000

 

 

203,700

 

 

 

 

 

 

 

 

 

 

 

 

 

203,700

 

 

 

31

 


Consolidated Statements of Shareholders’ Equity (continued)

 

 

Common Shares

 

Common
Stock

 

Treasury
Shares

 

Treasury
Stock

 

Retained
Earnings

 

Accumulated
Other
Comprehensive
Income (Loss)

 

Shareholders’
Equity

 

Cash payment for fractional shares resulting from 3-for-2 stock split effective October 2006

 


(94

)

 


(1,633

)

 

 

 

 

 

 

 

 

 

 

 

 

(1,633

)

Issuance of Common Stock for directors’ fees

 

5,018

 

 

77,197

 

 

 

 

 

 

 

 

 

 

 

 

 

77,197

 

Balances at December 30, 2006

 

8,012,550

 

 

17,974,115

 

(2,533,089

)

 

(16,655,041

)

 

58,279,371

 

 

(5,207,240

)

 

54,391,205

 

Net income

 

 

 

 

 

 

 

 

 

 

 

 

10,080,693

 

 

 

 

 

10,080,693

 

Cash dividends declared, $.32 per share

 

 

 

 

 

 

 

 

 

 

 

 

(1,801,570

)

 

 

 

 

(1,801,570

)

Currency translation adjustment

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1,643,816

 

 

1,643,816

 

Change in pension and postretirement benefit costs, net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

3,193,078

 

 

3,193,078

 

Change in derivative financial instrument, net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(281,185

)

 

(281,185

)

Change in accounting for uncertain tax positions

 

 

 

 

 

 

 

 

 

 

 

 

(295,928

)

 

 

 

 

(295,928

)

Purchase of Common Stock for treasury

 

 

 

 

 

 

(12,290

)

 

(312,521

)

 

 

 

 

 

 

 

(312,521

)

Issuance of Common Stock upon the exercise of stock options

 


339,749

 

 


2,562,997

 

 

 

 

 

 

 

 

 

 

 

 

 


2,562,997

 

Tax benefit from exercise of non-qualified stock options and disqualifying dispositions of incentive stock options

 

 

 

 

1,575,500

 

 

 

 

 

 

 

 

 

 

 

 

 

1,575,500

 

Cash payment for fractional shares resulting from exercise of stock options

 

 

 

 

(20

)

 

 

 

 

 

 

 

 

 

 

 

 

(20

)

Issuance of Common Stock for directors’ fees

 

2,679

 

 

61,203

 

 

 

 

 

 

 

 

 

 

 

 

 

61,203

 

Balances at December 29, 2007

 

8,354,978

 

$

22,173,795

 

(2,545,379

)

$

(16,967,562

)

$

66,262,566

 

$

(651,531

)

$

70,817,268

 

 

See accompanying notes.

 

32

 


Consolidated Statements of Cash Flows

 

 

 

 

 

Year ended

 

 

 

 

 

December 29

 

December 30

 

December 31

 

 

 

2007

 

2006

 

2005

 

Operating Activities

 

 

 

 

 

 

 

 

 

 

Net income

 

$

10,080,693

 

$

9,658,748

 

$

4,367,187

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

4,369,998

 

 

3,745,693

 

 

3,459,747

 

Loss on sale of equipment and other assets

 

 

65,182

 

 

2,574

 

 

3,314

 

Provision for doubtful accounts

 

 

45,740

 

 

58,424

 

 

6,433

 

Deferred income taxes

 

 

(404,618

)

 

(119,413

)

 

(27,293

)

Issuance of Common Stock for directors’ fees

 

 

61,203

 

 

77,197

 

 

104,887

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

 

 

 

Accounts receivable

 

 

6,133,976

 

 

(8,844,177

)

 

(2,155,923

)

Inventories

 

 

(1,923,947

)

 

(5,601,588

)

 

(88,147

)

Prepaid expenses and other

 

 

(462,604

)

 

4,413

 

 

(147,867

)

Prepaid pension cost

 

 

(684,514

)

 

97,106

 

 

(428,959

)

Recoverable taxes receivable

 

 

(1,411,477

)

 

 

 

 

Other assets

 

 

(229,858

)

 

(142,673

)

 

(218,801

)

Accounts payable

 

 

(5,190,868

)

 

6,516,275

 

 

524,078

 

Accrued compensation

 

 

(549,639

)

 

1,313,076

 

 

(800,582

)

Other accrued expenses

 

 

(1,139,189

)

 

1,097,299

 

 

600,331

 

Net cash provided by operating activities

 

 

8,760,078

 

 

7,862,954

 

 

5,198,405

 

 

 

 

 

 

 

 

 

 

 

 

Investing Activities

 

 

 

 

 

 

 

 

 

 

Purchases of property, plant and equipment

 

 

(2,867,829

)

 

(6,721,581

)

 

(1,750,252

)

Proceeds from sale of equipment and other assets

 

 

25,120

 

 

19,374

 

 

750

 

Business acquisitions

 

 

 

 

(7,536,916

)

 

 

Net cash used in investing activities

 

 

(2,842,709

)

 

(14,239,123

)

 

(1,749,502

)

 

 

 

 

 

 

 

 

 

 

 

Financing Activities

 

 

 

 

 

 

 

 

 

 

Principal payments on long-term debt

 

 

(3,111,907

)

 

(15,255,099

)

 

(3,009,811

)

Proceeds from issuance of long-term debt

 

 

 

 

20,000,000

 

 

 

Proceeds from revolving credit loan

 

 

 

 

 

 

3,000,000

 

Proceeds from sales of Common Stock

 

 

2,562,997

 

 

203,700

 

 

 

Tax benefit from disqualifying disposition of incentive stock options and exercise of non-qualified stock options

 

 

1,575,500

 

 

 

 

6,403

 

Purchases of Common Stock for treasury

 

 

(312,521

)

 

 

 

 

Cash payment for fractional shares resulting from exercise of stock options

 

 

(20

)

 

 

 

 

Cash payment for fractional shares resulting from 3-for-2 stock split

 

 

 

 

(1,633

)

 

 

Dividends paid

 

 

(1,801,570

)

 

(1,715,035

)

 

(1,600,100

)

Net cash (used in) provided by financing activities

 

 

(1,087,521

)

 

3,231,933

 

 

(1,603,508

)

Effect of exchange rate changes on cash

 

 

278,416

 

 

(100,253

)

 

80,046

 

Net change in cash and cash equivalents

 

 

5,108,264

 

 

(3,244,489

)

 

1,925,441

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents at beginning of year

 

 

3,101,458

 

 

6,345,947

 

 

4,420,506

 

Cash and cash equivalents at end of year

 

$

8,209,722

 

$

3,101,458

 

$

6,345,947

 

 

See accompanying notes.

 

33

 


The Eastern Company

 

Notes to Consolidated Financial Statements

 

1. OPERATIONS

 

The operations of The Eastern Company (the “Company”) consist of three business segments: industrial hardware, security products, and metal products. The industrial hardware segment produces latching devices for use on industrial equipment and instrumentation as well as a broad line of proprietary hardware designed for truck bodies and other vehicular type equipment. The security products segment manufactures and markets a broad range of locks for traditional general purpose security applications as well as specialized locks for soft luggage, coin-operated vending and gaming equipment, and electric and computer peripheral components. This segment also manufactures and markets coin acceptors and metering systems to secure cash used in the commercial laundry industry and produces cashless payment systems utilizing advanced smart card technology. The metal products segment produces anchoring devices used in supporting the roofs of underground coal mines and specialty products, which serve the construction, automotive and electrical industries.

 

Sales are made to customers primarily in North America.

 

2. ACCOUNTING POLICIES

 

Estimates and Assumptions

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

Fiscal Year

 

The Company’s year ends on the Saturday nearest to December 31.

 

Principles of Consolidation

 

The consolidated financial statements include the accounts of the Company and its subsidiaries, all of which are wholly-owned. All intercompany accounts and transactions are eliminated.

 

Cash Equivalents and Concentrations of Credit Risk

 

Highly liquid investments purchased with a maturity of three months or less are considered cash equivalents. The Company has deposits that exceed amounts insured by the Federal Deposit Insurance Corporation (FDIC) up to $100,000, but the Company does not consider this a significant concentration of credit risk based on the strength of the financial institution.

 

Restatement

 

The Company restated the Other Comprehensive Income for 2006 to exclude the $1,299,146 impact, net of taxes, resulting from the adoption of Statement of Financial Accounting Standards No. 158. There was no effect on previously reported net income for 2006.

 

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.

 

34

 


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. At year end 2006, one customer accounted for approximately 29% of total accounts receivable. No customers exceeded 10% of total accounts receivable at year end 2007 or 2005.

 

 

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. Write-offs have been within management’s estimates.

 

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. ($23,212,313 for U.S. inventories at December 29, 2007) and by the first-in, first-out (FIFO) method for inventories outside the U.S. ($7,278,383 for inventories outside the U.S. at December 29, 2007). Current cost exceeds the LIFO carrying value by approximately $5,098,000 at December 29, 2007 and $4,665,000 at December 30, 2006. There was no material LIFO quantity liquidation in 2007, 2006 or 2005.

 

Property, Plant and Equipment and Related Depreciation

 

Property, plant and equipment (including equipment under capital lease) are stated at cost. Depreciation ($3,770,280 in 2007, $3,443,351 in 2006 and $3,322,891 in 2005) 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, Intangibles and Impairment of Long-Lived Assets

 

Patents are recorded at cost and are amortized using the straight-line method over the lives of the patents. Technology and licenses are recorded at cost and are generally amortized on a straight-line basis over periods ranging from 5 to 17 years. Non-compete agreements and customer relationships are being amortized using the straight-line method over a period of 5 years. Amortization expense in 2007, 2006 and 2005 was $599,718, $302,342 and $136,856, respectively. Total amortization expense for each of the next five years is estimated to be as follows: 2008 - $602,000; 2009 - $602,000; 2010 - $602,000; 2011 - $499,000; and 2012 - $187,000. Trademarks are not amortized as their lives are deemed to be indefinite.

 

 

 

35

 


The Eastern Company

 

Notes to Consolidated Financial Statements (continued)

 

2. ACCOUNTING POLICIES (continued)

 

The gross carrying amount and accumulated amortization of amortizable intangible assets:

 

 

 


Industrial
Hardware
Segment

 


Security
Products
Segment

 


Metal
Products
Segment

 




Total

 

Weighted-Average
Amortization Period (Years)

 

2007 Gross Amount:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Patents and developed
technology

 

$

2,738,893

 

$

1,088,592

 

$

82,747

 

$

3,910,232

 

15.7

 

Customer relationships

 

 

 

 

1,921,811

 

 

 

 

1,921,811

 

5.0

 

Non-compete agreements

 

 

 

 

90,735

 

 

 

 

90,735

 

5.0

 

Other

 

 

 

 

3,941

 

 

 

 

3,941

 

 

Total Gross Intangibles

 

$

2,738,893

 

$

3,105,079

 

$

82,747

 

$

5,926,719

 

11.8

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2007 Accumulated
Amortization:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Patents and developed
technology

 

$

1,077,608

 

$

263,255

 

$

67,501

 

$

1,408,364

 

 

 

Customer relationships

 

 

 

 

477,495

 

 

 

 

477,495

 

 

 

Non-compete agreements

 

 

 

 

59,522

 

 

 

 

59,522

 

 

 

Total Gross Amortization

 

$

1,077,608

 

$

800,272

 

$

67,501

 

$

1,945,381

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net 2007 per Balance Sheet

 

$

1,661,285

 

$

2,304,807

 

$

15,246

 

$

3,981,338

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2006 Gross Amount:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Patents and developed
technology

 

$

2,411,468

 

$

1,005,390

 

$

82,747

 

$

3,499,605

 

16.1

 

Customer relationships

 

 

 

 

1,921,811