UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Fiscal Year ended January 3, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________________ to _______________
Commission File Number 0-599
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THE EASTERN COMPANY
(Exact name of registrant as specified in its charter)
Connecticut 06-0330020
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(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification Number)
112 Bridge Street, Naugatuck, Connecticut 06770
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(address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (203) 729-2255
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock No Par Value
-------------------------
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [__]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K. [ X ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Exchange Act Rule 12b-2.) Yes [__] No [X]
As of June 28, 2003, 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 $42,127,812 (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 20, 2004 3,616,039 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 22, 2004 are incorporated by
reference into Part III.
The Eastern Company
Form 10-K
FOR THE FISCAL YEAR ENDED JANUARY 3, 2004
TABLE OF CONTENTS
Page
Table of Contents 2.
Safe Harbor Statement 3.
PART I
Item 1. Business 4.
Item 2. Properties 7.
Item 3. Legal Proceedings 8.
Item 4. Submission of Matters to a Vote of Security Holders 8.
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters 8.
Item 6. Selected Financial Data 10.
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 10.
Item 7A. Quantitative and Qualitative Disclosures
About Market Risk 19.
Item 8. Financial Statements and Supplementary Data 20.
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosures 43.
Item 9A. Controls and Procedures 43.
PART III
Item 10. Directors and Executive Officers of the Registrant 43.
Item 11. Executive Compensation 43.
Item 12. Security Ownership of Certain Beneficial Owners
and Management 43.
Item 13. Certain Relationships and Related Transactions 44.
Item 14. Principal Accounting Fees and Services 44.
PART IV
Item 15. Exhibits, Financial Statement Schedule and
Reports on Form 8-K 44.
Signatures 47.
Exhibit Index 48.
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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.
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PART I
Available Information
We make available, free of charge through our Internet web site at
http://www.easterncompany.com, our annual report on Form 10-K, quarterly reports
on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed
or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act
of 1934, as soon as reasonably practicable after such material is electronically
filed with or furnished to the Securities and Exchange Commission.
ITEM 1 BUSINESS
(a) General Development of Business
The Eastern Company (the Company) was incorporated under the laws of the
State of Connecticut in October, 1912, succeeding a co-partnership established
in October, 1858.
The business of the Company is the manufacture and sale of industrial
hardware, security products and metal products from four U.S. operations and
six wholly-owned foreign subsidiaries. The Company maintains nine physical
locations.
RECENT DEVELOPMENTS
The Company established Eastern Industrial Ltd. in Shanghai, China in
2003. This new facility was set-up to gain entry into the Chinese marketplace
as well as to be a supplier to other divisions and subsidiaries of the Company.
Eastern Industrial has capabilities that include stamping, tool and die making,
plastic injection molding and assembly.
Effective October 1, 2002 the Company acquired all of the issued and
outstanding common stock of Canadian Commercial Vehicles Corporation (CCV) for
cash of approximately $70,000 and the assumption of approximately $130,000 of
debt, which the Company paid upon closing. CCV was established as a Canadian
subsidiary of The Eastern Company, located in Kelowna, British Columbia,
Canada. CCV manufactures lightweight sleeper boxes used on Class 8 trailer
trucks.
Effective March 1, 2002 the Company acquired certain assets of the Big
Tag Division of Dolan Enterprises, Inc. for cash of approximately $260,000. Big
Tag was combined into the Illinois Lock/CCL division of the Company located in
Wheeling, Illinois. Big Tag provides high-visibility, custom luggage tags,
which the Company will market in conjunction with its custom logo luggage locks
to the travel, and premium incentive markets.
The above acquisitions have been accounted for using the purchase
method. The acquired businesses are included in the consolidated operating
results of the Company from their date of acquisition. The excess of the cost
of the acquired businesses over the fair market value of the net assets
acquired has been allocated to goodwill. The effects of these acquisitions on
the Company's consolidated financial position and operations are not material.
(b) Financial Information about Industry Segments
Financial information about industry segments is included in Note 12 to
the Company's financial statements, included at Item 8 of this Annual Report on
Form 10-K.
(c) Narrative Description of Business
The Company operates in three business segments: Industrial Hardware,
Security Products and Metal Products.
-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 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 and school bus door closure
hardware. The products are sold to original equipment manufacturers and
distributors through a distribution channel consisting of in-house salesmen
and outside sales representatives. Sales and customer service efforts are
concentrated through in-house sales personnel where greater representation of
our diverse product lines can be promoted across a variety of markets.
The Industrial Hardware segment sells its products to a diverse array of
markets such as the truck, bus and automotive industries as well as to the
industrial equipment, military and marine sectors. Although service, quality
and price are major criteria for servicing these markets, the continued
introduction of new or improved product designs and the acquisition of
synergistic product lines is vital for maintaining and increasing market
share.
Security Products
The Security Products segment, made up of Greenwald Industries, Illinois
Lock Company/CCL Security Products, World Lock Company Ltd. and World Security
Industries Ltd.--is a leading manufacturer of security products. This segment
manufactures electronic and mechanical locking devices, both keyed and
keyless, for the computer, electronics, vending and gaming industries. The
segment also supplies its products to the luggage, furniture, laboratory
equipment and commercial laundry industries. Greenwald manufactures and
markets coin acceptors and other coin security products used primarily in the
commercial laundry markets. In addition, the segment provides a new level of
security for the access control, municipal parking and vending markets through
the use of "smart card" technology.
Greenwald's product sales include timers, drop meters, coin chutes,
money boxes, meter cases, smart cards, value transfer stations, smart card
readers, card management software and access control units. Illinois Lock
Company/CCL Security Products sales include cabinet locks, cam locks, electric
switch locks, tubular key locks and combination padlocks. Many of the products
are sold under the names SEARCHALERT(TM), PRESTOSEAL(TM), DUO, X-STATIC(R),
EXCALIBUR(TM), WARLOCK(TM), LITE LOCK(TM), SESAMEE(R), BIG TAG(R),
PRESTOLOCK(R) and HUSKI(TM). These products are sold to original equipment
manufacturers, distributors, route operators, and locksmiths via in-house
salesmen and outside sales representatives. Sales efforts are concentrated by
national and regional sales personnel where greater representation of our
diverse product lines can be promoted across a variety of markets.
The Security Products segment continuously seeks new markets where it
can offer competitive pricing and provide customers with engineered solutions
for their security needs.
Metal Products
The Metal Products segment, based at the Company's Frazer & Jones
facility, is the largest and most efficient producer of expansion shells for
use in supporting the roofs of underground mines. This segment also
manufactures specialty malleable and ductile iron castings, which serve the
construction and electrical industries.
Typical products include mine roof support anchors, couplers for braking
systems, adjustable clamps for construction and fittings for electrical
installations. Mine roof support anchors are sold to distributors and directly
to mines, while specialty castings are sold to original equipment
manufacturers.
-5-
Although there continues to be a need for the highly engineered
proprietary mine roof support products produced by this segment of the
Company, changes in mining technology continue to decrease demand for
mechanical anchoring systems. Intense competition from foreign countries has
adversely affected our ability to compete effectively in the contract castings
market. As a result, the Company began to phase out of its low-margin contract
castings business and concentrate on its proprietary mine roof support
systems. To offset declines in the production of malleable iron castings, the
Company has invested in equipment for the production of ductile iron castings.
Raw materials and outside services were readily available from domestic
sources for all of the Company's segments during 2003 and are expected to be
readily available in 2004 and the foreseeable future. The Company expects to
experience increases in steel costs during 2004 due to a weaker U.S dollar,
higher demand and lower steel inventories worldwide, which could have a direct
impact on gross margin. 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 2003 and
does not expect any such problems in 2004.
Patent protection for the various product lines within the Company is
limited, but is sufficient to protect competitive positions. Foreign sales and
license agreements are not significant.
None of the Company's business segments are seasonal.
The Company, across all its business segments, has increased its
emphasis on sales and customer service by fulfilling the rapid delivery
requirements of our customers. As a result, investments in additional
inventories are made on a selective basis.
Customer lists for all business segments are broad-based geographically
and by markets and sales are not highly concentrated by customer. No customer
accounted for 10% or more of the Company's consolidated sales for the year
ended January 3, 2004.
The dollar amount of the level of orders in the Company is believed to
be firm as of fiscal year ended January 3, 2004 at $11,635,000, as compared to
$9,672,000 at December 28, 2002.
The Company encounters competition in all of its business segments. The
Company has been successful in dealing with this competition by offering high
quality diversified products with the flexibility of meeting customer needs on
a timely basis. This is accomplished by effectively using internal engineering
resources, cost effective manufacturing capabilities, expanding product lines
through product development and acquisitions and maintaining sufficient
inventory for fast turnaround of customer orders. However, imports from Asia
and Latin America with weak currency exchange rates have created additional
competitive pressures. The Company established Eastern Industrial Ltd. in 2003
to help combat the offshore competition.
Research and development expenditures in 2003 were $1,115,000 and
represented approximately 1% of gross revenues. In 2002 and 2001 they were
$1,041,000 and $1,006,000, respectively. The research costs are primarily
attributable to the Greenwald division, where ongoing research in both the
mechanical and smart card product lines is necessary in order to remain
competitive and to continue to provide technologically advanced smart card
systems. Other research projects include the development of the SearchAlertTM
travel lock and various 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 2003 was 547.
-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' net sales
and identifiable assets is included in Note 12 to the Company's financial
statements, included at Item 8 of this Annual Report on Form 10-K.
ITEM 2 PROPERTIES
The corporate office of the Company is located in Naugatuck, Connecticut
in a two-story 8,000 square foot administrative building on 3.2 acres of land.
All of the Company's properties are owned or leased and are adequate to
satisfy current requirements. All of the Registrant's properties have the
necessary flexibility to cover any long-term expansion requirements.
The Industrial Hardware Group includes the following:
The Eberhard Manufacturing Division in Strongsville, Ohio owns 9.6 acres
of land and a building containing 138,000 square feet, located in an
industrial park. The building is steel frame, one-story, having curtain walls
of brick, glass and insulated steel panel. The building has two high bays, one
of which houses two units of automated warehousing.
The Eberhard Hardware Manufacturing, Ltd., a wholly-owned Canadian
subsidiary in Tillsonburg, Ontario, owns 4.4 acres of land and a building
containing 31,000 square feet in an industrial park. The building is steel
frame, one-story, having curtain walls of brick, glass and insulated steel
panel. It is particularly suited for light fabrication, assembly and
warehousing and is adequate for long-term expansion requirements.
The Canadian Commercial Vehicles Corporation, a wholly-owned subsidiary
in Kelowna, British Columbia, leases 32,500 square feet of building space
located in an industrial park. The building is made from brick and concrete,
contains approximately 2,400 square feet of office space and houses a modern
paint booth for finishing our products. The building is protected by a F1
rated fire suppression system and alarmed for fire and security. The current
lease is renewable for another 3 years.
The Eastern Industrial Ltd., a wholly-owned subsidiary in Shanghai,
China leases a brick and concrete building containing 30,000 square feet,
located in an industrial area. A five-year lease was signed in 2003, which
expires on September 8, 2008 and is renewable.
The Sesamee Mexicana subsidiary is currently leasing 1,950 square feet
of a block building located in an industrial park in Lerma, Mexico on an
open-end basis.
The Security Products Group includes the following:
The Greenwald Industries Division in Chester, Connecticut owns 26 acres
of land and a building containing 120,000 square feet. The building is steel
frame, one story, having brick over concrete blocks. The Company terminated the
lease of the 5,000 square foot facility in Boynton Beach, Florida in November
2003 and consolidated operations into the Chester facility.
-7-
The Illinois Lock Company/CCL Security Products Division leases land and
a building containing 44,000 square feet in Wheeling, Illinois. The building is
brick and located in an industrial park. A five-year lease was signed in 2001,
which expires on May 31, 2006 and is renewable.
The World Lock Co. Ltd. subsidiary leases a brick and concrete building
containing 7,870 square feet and is located in Taipei, Taiwan.
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 a party to a patent infringement suit.
Although management has determined this suit is without merit, the Company
incurred approximately $115,000 of legal expenses in 2003 and expects to incur
additional expenses in 2004 to defend itself.
There are no other legal proceedings, other than ordinary routine
litigation incidental to the Company's business, or to which either the
Company or any of its subsidiaries is a party or to which any of their
property is the subject.
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
PART II
ITEM 5 MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock is traded on the American Stock Exchange
(ticker symbol EML). The approximate number of record holders of the Company
common stock on January 3, 2004 was 674.
High and low stock prices and dividends for the last two years were:
2003 2002
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Market Price Market Price
Quarter High Low Dividend Quarter High Low Dividend
------- ---- --- -------- ------- ---- --- --------
First $12.34 $11.02 $.11 First $16.25 $11.75 $.11
Second 15.70 12.14 .11 Second 16.10 14.36 .11
Third 15.70 14.00 .11 Third 14.60 12.00 .11
Fourth 15.64 14.24 .11 Fourth 12.35 11.00 .11
The Company expects to continue its policy of paying regular cash
dividends, although there is no assurance as to future dividends because they
are dependent on future earnings, capital requirements, and financial
conditions. The payment of dividends is subject to the restrictions of the
Company's loan agreement if such payment would result in an event of default.
The following table sets forth information regarding securities
authorized for issuance under the Company's equity compensation plans as of
January 3, 2004, including the Company's 1989, 1995, 1997 and 2000 plans.
-8-
Equity Compensation Plan Information
Plan category Number of securities Weighted-average Number of securities
remaining available for
to be issued upon exercise price of future issuance under
exercise of outstanding equity compensation plans
outstanding options, options, warrants (excluding securities
warrants and rights and rights reflected in column (a))
------------------------ ------------------- -----------------------------
(a) (b) (c)
Equity compensation plans approved
by security holders
405,000 (1) $13.99 292,142 (2)
Equity compensation plans not
approved by security holders 249,000 (3) 12.49 52,500 (4)
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Total 654,000 $13.42 344,642
=========== ====== ===========
<FN>
1 Includes options outstanding under the 1989, 1995 and 2000 plans.
2 Includes shares available for future issuance under the 1989, 1995 and 2000 plans.
3 Includes options outstanding under the 1997 plan.
4 Includes shares available for future issuance under the 1997 plan.
</FN>
On September 17, 1997 the Compensation Committee of the Board of Directors
of the Company adopted The Eastern Company 1997 Directors Stock Option Plan (the
"1997 Plan") which by its terms will expire either on September 16, 2007 or upon
any earlier termination date established by the Board of Directors. The 1997
Plan authorizes the grant of non-qualified stock options to the non-employee
directors of the Company to purchase shares of common stock. The exercise price
of any options granted under the 1997 Plan is set by the Compensation Committee.
However, all options granted to date under the 1997 Plan have required an
exercise price equal to 100% of the fair market value of the shares of common
stock of the Company on the date of grant. On December 15, 1999, the Board of
Directors approved an increase in the total number of shares of common stock
which may be issued under options granted under the 1997 Plan from 225,000
shares to 325,000 shares.
Each director who is not an employee of the Company ("Outside Director")
is paid a director's fee for his services at the rate of $10,000 as well as
$1,000 for each directors' meeting and $700 for each committee meeting attended.
All annual retainer fees and meeting fees paid to non-employee members of the
Board of Directors of the Company are paid in Common Shares of the Company or
cash, in accordance with the Directors Fee Program adopted by the shareholders
on March 26, 1997 and amended on January 5, 2004. The directors make an annual
election, within a reasonable time before their first quarterly payment, to
receive their fees in the form of cash, stock or a combination thereof. The
election remains in force for one year.
-9-
ITEM 6 SELECTED FINANCIAL DATA
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
INCOME STATEMENT ITEMS (in thousands)
Net sales $ 88,307 $ 81,337 $ 82,825 $ 88,192 $ 74,678
Cost of products sold 66,719 60,637 60,783 62,192 52,460
Depreciation and amortization 3,619 3,565 4,461 3,639 2,723
Interest expense 1,303 1,716 2,259 1,786 646
Income before income taxes 5,390 4,734 6,085 10,657 9,894
Income taxes 2,028 1,442 2,172 3,602 3,356
Net income 3,362 3,292 3,913 7,055 6,538
Dividends 1,593 1,598 1,599 1,601 1,573
BALANCE SHEET ITEMS (in thousands)
Inventories $ 16,927 $ 16,345 $ 18,591 $ 17,103 $ 14,040
Working capital 24,894 25,600 27,131 26,298 24,734
Property, plant and equipment, net 24,930 25,050 26,486 27,328 16,365
Total assets 74,617 76,133 81,896 84,857 54,894
Shareholders' equity 40,508 37,903 40,056 38,538 33,400
Capital expenditures 2,763 1,560 1,895 5,065 3,690
Long-term obligations, less current portion 15,815 18,921 25,014 28,540 8,565
PER SHARE DATA
Net income per share
Basic $ .93 $ .91 $ 1.08 $ 1.95 $ 1.80
Diluted .92 .89 1.07 1.93 1.75
Dividends .44 .44 .44 .44 .43
Shareholders' equity 11.19 10.44 11.06 10.64 9.21
Average shares outstanding (Basic) 3,620,593 3,631,278 3,623,291 3,621,449 3,626,001
The per share data in the table above reflects a 3-for-2 stock split effective
May 1999.
ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Summary
While net sales for 2003 increased from 2002, net income did not show a
proportionate gain because of additional costs the Company incurred during the
year. The Company expects some of these costs to start showing a payback during
2004.
Net sales for 2003 increased 9% to $88.3 million from $81.3 million for
2002. Net income grew 2% to $3.4 million, or $.92 per diluted share, from $3.3
million, or $.89 per diluted share. Net income for 2003 grew more slowly than
sales due to several factors. One factor was a $1.8 million increase in expenses
for health insurance, liability and property insurance, legal fees associated
with a patent infringement suit, expenses incurred to launch the SearchAlertTM
product into the Travel Sentry program and pensions. During the fourth quarter
of 2003, the Company consolidated its health insurance coverage for three of its
U.S. operations to a single carrier to gain control over increasing health
insurance costs. The Company continually seeks competitive quotes within the
property and liability insurance markets. Pension costs have increased
dramatically due to the cumulative effects of depressed investment returns over
the last few years, which reduced the value of fund assets. However, in 2003 the
market began to rebound, and the Company's pension assets realized a 22.6%
return for the year. If the Company can continue to achieve returns in excess of
its 8.5% target over the next few years, this cost should begin to decline.
-10-
During 2003, the Company decided it would be more cost-effective to close
its Florida software development office and consolidate it into its Greenwald
office in Chester, Connecticut. As a result, the Company incurred a cost of
$125,000; however, it expects to recoup this expense in 2004 through greater
efficiency and shortened software development time.
In early 2003, the Company began its research on establishing a
manufacturing facility in Shanghai, China. This process generated expenses of
$250,000. The new factory, which the Company opened in late December, should be
ready for full-scale production in the second quarter of 2004.
Net sales in the fourth quarter of 2003 increased 18% to $23.3 million
from $19.7 million a year earlier. Net income declined 55% to $529,000 (or $.14
per diluted share) from $1.2 million (or $.32 per diluted share) in the 2002
fourth quarter. The decline was due to selling price reductions of $120,000;
cost increases totaling $785,000 for health care, pensions, and property and
liability insurance; and additional expenses totaling $336,000 for closing the
Company's Florida location, charges associated with the start-up of the
Company's Shanghai operation, non-capital costs associated with the
modernization of our Industrial Hardware Group's information systems, legal fees
associated with a patent infringement suit and expenses incurred to launch the
SearchAlertTM product into the Travel Sentry program.
The gross margin for the fourth quarter of 2003 was 23.8% of net sales
as compared to 26.4% for the fourth quarter of 2002. Product mix and the
higher costs and charges discussed above accounted for the reduction in the
gross margin percentage.
Selling and administrative expenses in the fourth quarter of 2003
totaled $4.2 million, an increase of 25% from the 2002 level. This increase
was mainly due to increased wages and the associated payroll charges,
advertising expenses, legal costs associated with the defense of a patent
awsuit, group insurance charges and non-capital costs associated with the
updating of information technology equipment.
In 2004, the Company anticipates significant cost increases in raw
materials, primarily in steel, with prices increasing between 10% to 40%. The
dollar impact could be in the range of $750,000 to $1 million, which the
Company will pass along through increased pricing or surcharges where
possible.
The Company incurred $115,000 in 2003 to defend against a patent
infringement suit. The Company expects to incur additional expenses in the
first quarter of 2004 of approximately $100,000 to $150,000.
The Company anticipates increased costs related to the required
compliance with Section 404 of the Sarbanes-Oxley Act in 2004. In addition,
compliance will require a significant amount of time from Company employees.
In 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities ("FIN No. 46"), which addresses when a company
should consolidate an entity based on the variable interest model of FIN No.
46. It defines a variable interest entity ("VIEs") as those entities in which
equity investors do not have the characteristics of a controlling financial
interest or in which equity investors do not bear the residual economic risks.
For all VIEs formed after February 1, 2003, FIN No. 46 is effective for fiscal
years or interim periods beginning after June 15, 2003. For all other VIEs,
FIN No. 46 is effective for periods ending after March 15, 2004. FIN No. 46
did not have any impact on the Company's financial position and results of
operations in fiscal 2003.
The Company has identified an entity, formed before February 1, 2003,
that may be a VIE. The potential VIE is a vendor of the Company, located in
China, formed solely for the benefit of the Company. The Company does not have
any ownership interest in the potential VIE but does provide all of the
financial support to the potential VIE to facilitate the production of various
materials used within the Company's production and owns the equipment used by
the potential VIE to manufacture the products. Because the Company does not
have an ownership interest in the potential VIE, the Company has been unable
to obtain reliable financial information to determine whether the entity is a
VIE, determine whether the Company is the VIE's primary beneficiary or perform
the accounting required to consolidate the VIE. Therefore, the Company is
unable at this time to estimate the potential impact the consolidation of the
potential VIE may have on its financial position or results of operations.
-11-
Critical Accounting Policies and Estimates
The preparation of the financial statements in accordance with generally
accepted accounting principles (GAAP) requires management to make judgments,
estimates and assumptions regarding uncertainties that affect the reported
amounts of assets and liabilities, the disclosure of contingent assets and
liabilities, and the reported amounts of revenues and expenses. Areas of
uncertainty that require judgments, estimates and assumptions include the
accounting for derivatives, environmental matters, the testing of goodwill and
other intangible assets for impairment, proceeds on assets to be sold,
pensions and other postretirement benefits, and tax matters. Management uses
historical experience and all available information to make its estimates and
assumptions, but actual results will inevitably differ from the estimates and
assumptions that are used to prepare the Company's financial statements at any
given time. Despite these inherent limitations, management believes that
Management's Discussion and Analysis of Financial Condition and Results of
Operations and the financial statements and related footnotes provide a
meaningful and fair presentation of the Company.
Management believes that the application of these estimates and
assumptions on a consistent basis enables the Company to provide the users of
the financial statements with useful and reliable information about the
Company's operating results and financial condition.
Allowance for Doubtful Accounts
We continuously monitor payments from our customers and maintain
allowances for doubtful accounts, that is, for estimated losses resulting from
the inability of our customers to make required payments. When we evaluate the
adequacy of our allowances for doubtful accounts, we take into account various
factors including our accounts receivable aging, customer creditworthiness,
historical bad debts and geographic risk. If the financial condition of our
customers were to deteriorate, resulting in an impairment of their ability to
make payments, additional allowances might be required.
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. (Prior to 2002,
goodwill and other indefinite-lived intangible assets were amortized over
periods ranging from 5 to 17 years.) Each year during the second quarter, the
carrying value of goodwill and other intangible assets with indefinite useful
lives is tested for impairment. During 2003, the Company used the discounted
cash flow method to calculate the fair value of goodwill associated with its
reporting units; no impairments of goodwill were deemed to exist. The
determination of discounted cash flows is based on the businesses' strategic
plans and long-range planning forecasts. The revenue growth rates included in
the plans are management's best estimates based on current and forecasted
market conditions; profit margin assumptions are projected by each business
based on the current cost structures and anticipated cost reductions. There
can be no assurance that operations will achieve the future cash flows
reflected in the projections. If different assumptions were used in these
plans, the related discounted cash flows used in measuring impairment could be
different and an impairment of assets might need to be recorded.
-12-
Pension and Other Postretirement Benefits
The amounts recognized in the consolidated financial statements related
to pension and other postretirement benefits are determined from actuarial
valuations. Inherent in these valuations are assumptions about such factors as
expected return on plan assets, discount rates at which liabilities could be
settled, rate of increase in future compensation levels, mortality rates and
trends in health insurance costs. These assumptions are reviewed annually and
updated as required. In accordance with GAAP, actual results that differ from
the assumptions are accumulated and amortized over future periods and,
therefore, affect the expense recognized and obligations recorded in future
periods.
The 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 2003 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 declines in recent years in the equity markets and interest rates
have had a negative impact on the Company's pension plan liability and the
fair value of its plan assets. As a result, the accumulated benefit obligation
exceeded the fair value of plan assets at the end of 2002 for two of the
Company's plans, which resulted in a $4.1 million charge to shareholders'
equity in the fourth quarter of that year.
The Company expects to make cash contributions to its pension plans of
approximately $1.2 million for 2004, $500,000 of which was paid in December
2003.
RESULTS OF OPERATIONS
The following table shows, for 2001-2003, each line item from the
consolidated statements of income as a percentage of net sales.
2003 2002 2001
---- ---- ----
Net sales 100.0% 100.0% 100.0%
Cost of products sold 75.6% 74.6% 73.4%
Gross margin 24.4% 25.4% 26.6%
Selling and administrative expense 17.1% 17.6% 17.6%
Interest expense 1.4% 2.1% 2.7%
Other income 0.2% 0.1% 1.0%
Income before income taxes 6.1% 5.8% 7.3%
Income taxes 2.3% 1.8% 2.6%
Net income 3.8% 4.0% 4.7%
Fiscal 2003 Compared to Fiscal 2002
Net sales for 2003 increased 9% ($7.0 million) to $88.3 million from
$81.3 million for 2002. Volume of existing products increased sales by 1%,
while new product introductions increased sales by 8%.
The Industrial Hardware segment experienced a 21% increase in sales.
Volume of existing products increased sales by 4%, internally developed new
products (for the utility truck and vehicular accessory markets) increased
sales by 6%, and sales of sleeper boxes for the Class 8 trailer truck market,
resulting from the Canadian Commercial Vehicles acquisition, increased sales
by 11%.
Sales of heavy hardware to the tractor-trailer industry increased 15%
from 2002 levels. Sales to this market had been down since the latter half of
2000. This market is expected to grow throughout 2004 and into 2005 as the
-13-
economy continues to expand. The rebound in the tractor-trailer market
utilizing heavy hardware could be adversely affected by higher steel prices
and diminishing allocation of raw materials.
Sales of industrial hardware (such as rotary locks, locking recessed
handles, multi-point paddle handles and slam latches) to original equipment
manufacturers increased 5% in 2003. This increase was due to orders from new
customers and higher demand for truck service bodies. However, sales to
distributors were down 3% from 2002, primarily because of continued softness
in this sector of our business. Sales of school bus door closures increased
10% in 2003, reflecting a greater volume of business with our primary bus
hardware customer. Sales of automotive accessories (toolbox locks, push-button
locks and rotary latches) declined 2% as a result of domestic and offshore
competition in this market. Sales at the Company's Mexican operation decreased
27% from 2002 primarily due to a lack of economic growth in Mexico.
Despite the sluggishness of the economy, the Company continued to invest
in new products and search for business acquisitions that complement its
existing operations or provide opportunities to enter new markets.
In the Security Products segment, sales were 8% higher than in 2002.
Volume of existing products increased sales by 6%, while new product
introductions increased them by 2%. Sales of locks to the computer industry
declined slightly in 2003. Sales of high-security locks for coin-operated
vending and gaming equipment were up 50% in 2003. That increase was primarily
the result of our gaining market share from our competition in an otherwise
flat market. Sales of locks to distributors servicing lower-volume accounts
decreased slightly, while sales to the industrial controls and accessories
market decreased 8%. Sales of locks for access doors, furniture, electronics
equipment and vehicular applications were up 24% from 2002 levels, mainly
through taking market share from our competition.
Sales of luggage locks for the travel industry declined 58%. Sales to
this market had been hard-hit in the wake of the September 11, 2001, terrorist
attacks, and they continued to be impacted by a Transportation Security
Administration (TSA) declaration that passengers should not lock their checked
baggage on commercial airline flights. Responding to the TSA declaration, the
CCL Security Products Division in late 2003, introduced the SearchAlertTM, a
new lock which meets all the requirements established by Travel SentryTM, the
standard setting group created to work closely with the TSA and the luggage
lock manufacturers. SearchAlertTM allows the TSA to unlock and inspect airline
passengers' bags without destroying the lock and lets the bags' owner know if
the bag has been opened via an access indicator. The Company expects this lock
to have a significant effect on luggage lock sales in 2004.
Sales of security products to the commercial laundry industry increased
8% from 2002. Sales of "smart card" products increased 10% in 2003, partially
offsetting declines that occurred in sales of two of the Company's mature
products for the laundry sector. The growth in smart card product sales
continues to be driven by greater acceptance of the technology among both
existing and new customers.
In the Metal Products segment, sales were down 13% from the previous
year. Volume of existing products decreased sales by 17%, while price
increases and new product introductions raised them by 3% and 1%,
respectively. Sales of contract castings were down 29% from 2002; the decrease
was mainly due to the Company's decision to focus more intensively on its
proprietary mine roof anchor systems in light of increased competition
from China and Mexico on contract castings. Because of lower labor and
operating costs in these countries or favorable currency exchange rates, the
price of imported castings is often below that of U.S.-produced castings.
However, the Company will continue to offer contract castings to customers
when profit margins are acceptable. In order to maintain utilization rates in
its factory, the Company has been developing capabilities for producing
castings from ductile iron (previously, it used only malleable iron in its
castings business). While the Company has filled several small orders, the
Company is still refining and perfecting its ductile iron capabilities.
Although the new capabilities will enable the Company to supply additional
products and services to its customers, further capital investments may be
required to make the casting of larger quantities possible.
Sales of mine roof support anchors decreased slightly from 2002,
reflecting lower demand for these products as a result of fairly stable
weather conditions. Demand for mine roof support anchors supplied to the coal
mining industry is dependent on demand for power, which increases during
abnormally warm summers or abnormally cold winters. The demand for power, in
turn, affects coal supplies.
-14-
The new Energy Information Administration (EIA) projects that coal will
increase its share of U.S. electricity generation from 50% in 2002 to 52% by
2025. The National Energy Policy legislation currently before Congress aims at
providing affordable coal-based electricity to business and consumers and at
providing additional incentives for the deployment of clean coal technologies.
The EIA's Annual Energy Outlook 2004 increased its projection by 5% to 112
gigawatts of new coal-fired generating capacity plants will be deployed over
the next 20 years.
Management continues to believe that coal will remain the backbone of
the U.S. energy supply. Total coal production in 2004 is projected to increase
3.5% from 2003. Although the demand for coal is influenced by the weather, the
rising price of natural gas, advances in hydrogen technology and the growing
need for fuel diversity have positioned coal usage for growth.
The total Company gross margin percentage for 2003 was 1 percentage
point below the 2002 level--24.4% versus 25.4%. The decrease was the result of
increased costs for group health insurance, property and liability insurance
and pensions.
Total selling and administrative expenses increased 5.5%, or $786,000,
from 2002. The increase was due to increased wage expense and associated
payroll charges; higher legal costs associated with the defense of a patent
lawsuit (which the Company has determined is without merit); costs associated
with the establishment of the Shanghai facilty and non-capital costs
associated with the updating of information technology equipment.
Interest expense decreased 24%, or $413,000, from 2002 due to lower
outstanding debt balances.
Corporate expenses rose 30%, or $517,000, in 2003 due to higher
post-retirement benefit costs, pension expenses and start-up costs associated
with the Shanghai facility.
Earnings before income taxes in 2003 increased 14%, or $656,000, from
2002. Pretax earnings for the Industrial Hardware segment decreased by 3%, or
$111,000. This decrease was due to increased costs for health, property and
liability insurance; non-capital costs arising from the modernization of
information technology systems; and pricing pressures from offshore
competition. The Security Products segment achieved an increase of 18%, or
$719,000, in pretax earnings. This increase was mainly due to improved sales
volume. In the Metal Products segment, pretax earnings rose 199%, or $152,000,
due to elimination of lower-margin contract casting products and cost
reductions.
The effective tax rate in 2003 was 38%, up from 31% in 2002. The
increase in the effective income tax rate in the current year is primarily due
to a change in the mix of taxable earnings in foreign jurisdictions with
higher effective tax rates and the imposition of higher state tax rates.
Fiscal 2002 Compared to Fiscal 2001
Net sales for 2002 decreased 2% ($1.5 million) to $81.3 million from
$82.8 million for 2001. Volume of existing products reduced sales by 6%, while
new product introductions raised sales by 4%.
The Industrial Hardware segment experienced a 4% increase in sales.
Volume of existing products decreased sales by 4%, while internally developed
new products (for the utility truck and vehicular accessory markets) increased
sales by 8%. Sales of heavy hardware to the tractor-trailer industry decreased
4% from 2001 levels. Sales to this market have been down since the latter half
of 2000. In the second quarter of 2002, the trailer industry began to see
signs of recovery when trailer orders rose to their highest level in nine
quarters. Despite the overall improvement in the trailer industry, several of
our customers saw their trailer sales decline from the previous year. However,
with the continued slow economy and record-high fuel costs, the trailer
industry's recovery could be weakened.
Sales of industrial hardware (such as rotary locks, locking recessed
handles, multi-point paddle handles and slam latches) to original equipment
manufacturers and distributors were down 5% from 2001. Sales of school bus
door closures increased 27% in 2002 as customers came back to our standard
door control after moving in 2001 to the linear door control design used by a
competitor; the competitor's products subsequently resulted in numerous user
complaints. Sales of automotive accessories (toolbox locks, push-button locks
and rotary latches) rose 52%; the improved demand for our hardware was due to
-15-
an increase in sales of light trucks that resulted from auto industry
promotions. Sales at the Company's Mexican operation decreased 3% from 2001
primarily due to economic conditions in Mexico.
Canadian Commercial Vehicles currently does not have a material effect
on the Company's consolidated financial position and results of operations.
However, the product it produces lends itself to the industrial,
transportation and marine industries, markets to which we presently provide
locking, latching and other hardware devices. This acquisition will open
opportunities for both Eberhard Manufacturing and Canadian Commercial Vehicles
to sell complete systems such as doors or hatches with the hardware
pre-installed. The Company intends to invest in the resources necessary to
expand Canadian Commercial Vehicles' current operations and focus it on
additional market areas such as the automotive, recreational vehicle and
marine industries. In addition, this acquisition gives the Company an
opportunity to introduce its automotive accessory hardware into the Class 8
truck market, an area where it has had little presence previously.
In the Security Products segment, sales were 2% higher than in 2001.
Volume of existing products decreased sales by 1% while new product
introductions increased sales by 2% and price increases raised sales by 1%.
Sales of locks to the computer industry grew 50% in 2002. The increase was
primarily caused by the introduction of new computer products requiring locks,
which resulted in a gain in market share from competitors. Sales of
high-security locks for coin-operated vending and gaming equipment were up 8%
in 2002. That increase was primarily the result of our gaining market share
from our competition in an otherwise flat or down market. Sales of locks to
distributors servicing lower-volume accounts increased 14%, while sales to the
industrial controls and accessories market decreased slightly. Sales of locks
for access doors, furniture, electronics equipment and vehicular applications
were down 11% from 2001 levels, mainly because of the overall softness in the
general economy. Sales of luggage locks for the travel industry declined 27%;
sales to this market were hard-hit in the wake of the September 11 terrorist
attacks, and they were further impacted by the Transportation Security
Administration (TSA) declaration that passengers should not lock their checked
baggage on commercial airline flights. As a result, the CCL Security Products
Division has introduced PrestosealTM, a device which allows the TSA access to
checked luggage and lets the owner of the bag know when someone has opened it.
In March 2002, the Company acquired certain assets of the Big Tag
Division of Dolan Enterprises, Inc. Among these assets was a high-visibility
luggage tag (The Big Tag(R)) which the Company is marketing with its
PRESTOLOCK(R) to the travel and premium markets.
Sales of security products to the commercial laundry industry increased
5% from 2001. Sales of Smart Card products continued to grow, offsetting any
declines that occurred in sales of the Company's mature products for the
laundry sector. The growth in Smart Card product sales was driven by greater
acceptance of Smart Card technology among both existing and new customers. The
successful introduction of our new coin acceptor product also contributed to
the higher sales to the laundry industry. During the year, the Company
completed its move of the CCL Security Products Division from New Britain,
Connecticut, to Wheeling, Illinois, where it was combined with the Company's
Illinois Lock Company Division.
In the Metal Products segment, sales were down 18% from the previous
year. Volume accounted for the reduction in sales. Sales of contract castings
were down 20% from 2001. This decrease was mainly due to the loss of customers
who decided to source their contract casting work from China and Mexico.
Because of lower labor and operating costs in these countries coupled with
favorable currency exchange rates, the price of imported castings is often
below that of U.S.-produced castings. Beginning in the third quarter of 2002,
the Company began to phase out its low-margin contract casting business and
concentrate instead on its proprietary mine roof anchor systems. However, the
Company will continue to offer contract castings to customers when profit
margins are acceptable. In addition, to maintain utilization rates in its
factory, the Company has developed capabilities for producing castings from
ductile iron (previously, it used only malleable iron for its castings
business). The new capabilities will enable the Company to supply additional
products and services to its customers.
Sales of mine roof support anchors decreased 16% from 2001. During 2002,
demand for these products declined as a result of an unusually warm 2001-2002
winter, which caused the demand for electric power to drop for the first time
in 10 years. Faced with a lower demand for power, utility companies reduced
their use of coal.
-16-
Total gross margin for 2002 decreased 6%, or $1.3 million, from 2001.
The decrease resulted from the combination of lower sales and increased costs
for workers compensation, insurance and pensions. The gross margin percentage
for 2002 was approximately 1 percentage point below the 2001 level--25.4%
versus 26.6%.
Total selling and administrative expenses were down 2%, or $247,000,
from 2001. The decrease was due to the elimination of the goodwill
amortization expense in 2002 as a result of the Company's adoption of
Financial Accounting Standards Board Statement No. 142, "Goodwill and Other
Intangible Assets." The elimination of this expense item was offset somewhat
by increased compensation expenses in 2002.
Interest expense decreased 24%, or $543,000, from 2001 due to lower
interest rates and lower outstanding balances resulting from payments on debt.
Earnings before income taxes in 2002 decreased 22%, or $1.4 million,
from 2001. Pretax earnings for the Industrial Hardware segment rose by 24%, or
$810,000. This increase was due to higher sales volume, increased utilization
of production facilities and sales of new products with higher margins. The
Security Products segment experienced an increase of 29%, or $904,000, in
pretax earnings. This increase was mainly due to an upturn in sales volume and
increased efficiency resulting from the consolidation of CCL Security Products
into the Company's Illinois Lock Company. In the Metal Products segment,
pretax earnings were down 103%, or $2.5 million, due to an 18% reduction in
sales volume, an underutilization of productive capacity, personnel costs
associated with the downsizing of operations, and a significant increase in
workers costs. The growth in workers compensation costs stemmed from both the
current-year premium and additional expenses associated with claims under
prior year policies. The Company reached the additional maximum expense
(approximately $200,000) in 2003. Corporate expenses were 184%, or $1.1
million, more than they were in 2001. The increase was due to higher personnel
expenses in 2002, and the fact that 2001 corporate expense included a one-time
pre-tax gain of $748,000 associated with the issuance of stock by Prudential
Financial Inc. during its demutualization and changeover to a public company.
The effective tax rate in 2002 was 31%, down from 36% in 2001. The lower
rate for 2002 was due to the Company's deriving a higher percentage of its
earnings from countries with a lower tax rate.
Liquidity and Sources of Capital
The Company's financial position remained strong throughout 2003. The
primary source of the Company's cash is earnings from operating activities
adjusted for cash generated from or used in net working capital. The most
significant recurring non-cash items included in income are depreciation and
amortization expense. Changes in working capital fluctuate with the changes in
operating activities. As sales increase there generally is an increased
requirement for working capital. Since increases in working capital reduce the
Company's cash, management attempts to keep the Company's investment in net
working capital at a reasonable level by closely monitoring inventory levels
and matching production to expected market demand, keeping tight control over
collection of receivables and optimizing payment terms on its trade and other
payables.
The Company is dependent on the continued demand for our products and
subsequent collection of accounts receivable from our customers. The Company
serves a broad base of customers and industries with a variety of products. As
a result, any fluctuations in 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
provided by the Company's operating cash flows and existing credit facility.
-17-
2003 2002 2001
---- ---- ----
Current ratio 3.5 3.5 3.7
Average days' sales in accounts receivable 48 50 52
Inventory turnover 4.1 3.7 3.3
Ratio of working capital to sales 28.2% 31.5% 33.4%
Total debt to market capitalization 31.7% 52.4% 65.8%
Total debt to shareholders' equity 44.0% 56.9% 70.9%
At January 3, 2004, December 28, 2002, and December 29, 2001, the
Company had cash and cash equivalents of $4.9 million, $5.9 million and $5.0
million respectively, and working capital of $24.9 million, $25.6 million and
$27.1 million, respectively.
Net cash provided by operating activities was $6.4 million in 2003
compared to $11.4 million in 2002 and $7.0 million in 2001. The $5.0 million
decrease from 2002 to 2003 and the $4.4 million increase from 2001 to 2002
related primarily to changes in the components of working capital. Excluding
such changes, the amount of cash provided from operations was $7.5 million,
$7.5 million and $8.2 million in 2003, 2002 and 2001, respectively. During
2003, working capital components used cash totaling $1.1 million;
substantially all of this amount was due to changes in accounts receivable,
inventories, prepaid expenses and accounts payable. The increases were a
result of higher sales volume in the fourth quarter of 2003. In 2002, working
capital components provided $3.9 million in cash resulting from a general
decrease in inventories across all segments of the business. In 2001, working
capital components used $1.2 million of cash. This use was the result of the
net changes in working capital; a decrease in accounts receivable and accounts
payable as a result of lower sales volume; an increase in inventories
resulting from the planned move of CCL Security Products from New Britain,
Connecticut, to Wheeling, Illinois; and lower-than-expected compensation
expenses.
During 2003, the Company used $1.8 million in investing activities.
Approximately $2.8 million related to the purchase of fixed assets, offset by
the sale of common stock held for investment. In 2002, the Company used $1.9
million in investing activities - $1.6 million for the purchase of fixed
assets and $300,000 for the acquisition of Canadian Commercial Vehicles
Corporation and certain assets of the Big Tag Division of Dolan Enterprises,
Inc. In 2001, the Company used $1.9 million in investing activities, all for
the purchase of fixed assets. The Company continuously upgrades and replaces
existing equipment to expand capacity, improve efficiency and satisfy safety
and environmental requirements. The Company expects capital expenditures for
2004 to be approximately $2 million to $3 million.
Net cash used by financing activities totaled $5.6 million, $8.5 million
and $4.6 million in 2003, 2002 and 2001, respectively. Of those amounts, $3.2
million, $3.4 million and $3.0 million related to the principal payments of
long-term debt in 2003, 2002 and 2001 respectively. In addition, the Company
elected to pay down $500,000 and $3.5 million on its revolving credit line in
2003 and 2002, respectively. The first $600,000 scheduled long-term debt
payment for calendar 2004 was included in fiscal 2003.
The Company leases certain equipment and buildings under cancelable and
noncancelable operating leases expiring at various dates up to 10 years. Rent
expense amounted to approximately $383,000, $306,000 and $304,000 in 2003,
2002 and 2001, respectively.
On December 27, 2002, the Company amended its unsecured loan agreement
(the Loan Agreement) with its lender. Under the amended agreement, the term
portion of the Loan Agreement ($18.6 million at the end of 2002) was paid in
quarterly installments of $600,000 during 2003, with payments increasing
annually after 2004 until maturity on January 1, 2009. During fiscal 2004, the
Company made its regular quarterly payments and also made its first scheduled
payment of $600,000 for calendar 2004. As a result, the remaining term portion
of the Loan Agreement at year-end 2003 was $15.6 million. As required, the
Company maintains an interest rate swap contract with the lender with an
original amount of $15.0 million; this amount is reduced on a quarterly basis
in accordance with the principal repayment schedule of the term portion of the
Loan Agreement ($8.4 million on January 4, 2004, and $11.2 million on December
28, 2002). The interest rate on the swap contract is fixed at 9.095%. Under
the revolving credit portion of the Loan Agreement, the Company may borrow up
to $7.5 million through July 1, 2005, and must pay a quarterly commitment fee
of 0.25% on the unused portion. As of January 3, 2004, $1.0 million was
outstanding under the revolver portion of the Loan Agreement. The Company's
loan covenants restrict it from incurring any indebtedness from any person
-18-
other than the lender in excess of the aggregate sum of $1.5 million or any
single transaction in excess of $1.0 million without express consent of the
lender or until the full payment of the current obligation has been made.
Tabular Disclosure of Contractual Obligations
The Company's known contractual obligations as of January 3, 2004, are
shown below:
Payment due by period
---------------------
Less More
than 1 1-3 3-5 than 5
Contractual Obligations (in thousands) Total Year Years Years Years
Long-term debt obligations $ 16,632 $ 1,807 $ 7,000 $ 7,200 $ 625
Capital lease obligations 1,189 200 430 475 84
Operating lease obligations 1,409 466 741 202 -
-------- -------- -------- -------- --------
Total $ 19,230 $ 2,473 $ 8,171 $ 7,877 $ 709
-------- -------- -------- -------- --------
The Company does not have any noncancelable open purchase orders.
The Company maintains a letter of credit in the amount of $900,000
related to its capital lease which reserves that amount from the Company's
revolving credit agreement under terms of the capital lease agreement.
ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's foreign manufacturing facilities account for approximately
19% of total sales and 18% of total assets. Its U.S. operations buy from and
sell to these foreign affiliates, and also make limited sales (less than 9% 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
currency exchange gains or losses have not been material and are not expected
to be material.
The Company is exposed to interest rate risk with respect to its
unsecured Loan Agreement, which provides for interest based on LIBOR plus a
spread of up to 2%. The spread is determined by a comparison of the Company's
operating performance with agreed-upon financial targets. Since the Company's
performance depends to a large extent on the overall economy, the interest
rate paid by the Company under its Loan Agreement is closely linked to the
trend in the U.S. economy. The current interest rate spread is 1.75% on the
term loan portion and 1.50% on the revolving credit line portion of the Loan
Agreement. Changes in LIBOR rates will also affect the Company's interest
expense. To hedge against future LIBOR rate increases, the Company has a swap
contract on a portion of the term loan under the Loan Agreement. The interest
rate on the swap contract is 9.095% and the swap contract expires on July 1,
2005. The notional amount of the swap contract is reduced on a quarterly basis
in accordance with the principal repayment schedule for the term portion of
the Loan Agreement. The notional amount of the swap contract was $8.4 million
as of January 3, 2004.
The remainder of the term debt is subject to the volatility of
short-term interest rates, where a 1% change in interest rates would cause an
$82,250 increase or decrease in the Company's annual interest cost. While the
Company could enter into an additional swap agreement to fix the rate, it does
not expect to do so.
-19-
ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Eastern Company
Consolidated Balance Sheets
January 3 December 28
2004 2002
--------- -----------
ASSETS
Current Assets
Cash and cash equivalents $ 4,896,816 $ 5,939,232
Investment in common stock - 807,438
Accounts receivable, less allowances of $302,000 in 2003
and $304,000 in 2002 11,036,760 10,824,807
Inventories:
Raw materials and component parts 8,687,003 7,658,722
Work in process 4,112,625 4,226,858
Finished goods 4,126,920 4,459,614
------------ ------------
16,926,548 16,345,194
Prepaid expenses and other assets 1,642,513 1,525,846
Deferred income taxes 462,700 564,000
------------ ------------
Total Current Assets 34,965,337 36,006,517
Property, Plant and Equipment
Land 701,923 701,016
Buildings 11,468,122 11,351,043
Machinery and equipment 30,649,120 28,390,569
Accumulated depreciation (17,888,740) (15,392,659)
------------ ------------
24,930,425 25,049,969
Other Assets
Goodwill and trademarks 10,687,373 10,514,047
Patents, technology, and licenses, less accumulated
amortization of $1,513,029 in 2003 and $2,382,037
in 2002 1,877,408 2,111,865
Intangible pension asset 964,592 1,112,129
Prepaid pension cost 1,192,281 1,338,010
------------ ------------
14,721,654 15,076,051
------------ ------------
$ 74,617,416 $ 76,132,537
============ ============
-20-
Consolidated Balance Sheets
January 3 December 28
2004 2002
--------- -----------
Liabilities and shareholders' equity
Current Liabilities
Accounts payable $ 4,246,633 $ 3,838,412
Accrued compensation 1,782,408 1,923,463
Other accrued expenses 2,034,918 2,015,979
Current portion of long-term debt 2,007,273 2,628,664
------------ ------------
Total Current Liabilities 10,071,232 10,406,518
Deferred income taxes 1,243,264 737,987
Long-term debt, less current portion 15,814,669 18,920,747
Accrued post-retirement benefits 2,384,770 2,578,156
Interest rate swap obligation 580,055 1,138,086
Accrued pension cost 4,015,858 4,448,197
Shareholders' Equity
Voting Preferred Stock, no par value:
Authorized and unissued: 1,000,000 shares
Nonvoting Preferred Stock, no par value:
Authorized and unissued: 1,000,000 shares
Common Stock, no par value:
Authorized: 25,000,000 shares
Issued: 3,616,039 shares in 2003 and 3,631,869 shares
in 2002; excluding shares held in treasury of
1,680,342 in 2003 and 1,657,320 in 2002 664,949 883,695
Retained earnings 44,406,855 42,638,351
Accumulated other comprehensive income (loss):
Foreign currency translation (166,295) (898,137)
Additional minimum pension liability, net of taxes (4,049,886) (4,073,870)
Derivative financial instruments, net of taxes (348,055) (683,086)
Unrealized holding gain on investment in common
stock, net of taxes - 35,893
------------ ------------
(4,564,236) (5,619,200)
------------ ------------
Total Shareholders' Equity 40,507,568 37,902,846
------------ ------------
$ 74,617,416 $ 76,132,537
============ ============
See accompanying notes.
-21-
Consolidated Statements of Income
Year ended
January 3 December 28 December 29
2004 2002 2001
---- ---- ----
Net sales $ 88,306,581 $ 81,337,207 $ 82,825,353
Cost of products sold (66,718,641) (60,637,151) (60,782,769)
------------- ------------- -------------
21,587,940 20,700,056 22,042,584
Selling and administrative expenses (15,103,624) (14,317,256) (14,563,913)
Interest expense (1,302,830) (1,716,056) (2,259,347)
Other income 209,004 67,564 866,031
------------- ------------- -------------
Income before income taxes 5,390,490 4,734,308 6,085,355
Income taxes 2,028,868 1,442,408 2,172,436
------------- ------------- -------------
Net income $ 3,361,622 $ 3,291,900 $ 3,912,919
============= ============= =============
Earnings per Share
Basic $ .93 $ .91 $ 1.08
============= ============= =============
Diluted $ .92 $ .89 $ 1.07
============= ============= =============
See accompanying notes.
Consolidated Statements of Comprehensive Income
Year ended
January 3 December 28 December 29
2004 2002 2001
--------- ----------- -----------
Net income $ 3,361,622 $ 3,291,900 $ 3,912,919
Other comprehensive income/(loss) -
Change in foreign currency translation 731,842 258,378 (349,897)
Cumulative effect of accounting change
for derivative financial instruments,
net of income taxes of $265,000 - - (400,756)
Change in fair value of derivative
financial instruments, net of income
taxes (benefit) of ($223,000), $33,000
and $157,000 in 2003, 2002 and 2001,
respectively 335,031 (50,666) (231,664)
Change in unrealized holding gain on
investment in common stock, net of
income taxes (benefit) of $23,900,
$17,500 and ($40,700) in 2003, 2002
and 2001, respectively (35,893) (25,079) 60,972
Change in additional minimum pension
liability net of income taxes (benefit)
of ($15,992) in 2003 and $2,715,913
in 2002 23,984 (4,073,870) -
------------- ------------- -------------
1,054,964 (3,891,237) (921,345)
------------- ------------- -------------
Comprehensive income/(loss) $ 4,416,586 $ (599,337) $ 2,991,574
============= ============= =============
See accompanying notes.
-22-
Consolidated Statements of Shareholders' Equity
Common Retained Unearned
Stock Earnings Compensation
------ -------- ------------
Balances at January 1, 2000 $ 878,024 $ 38,630,205 $ (164,063)
Net income 3,912,919
Cash dividends declared, $.44 per share (1,598,809)
Purchase of 1,594 shares of Common Stock for
treasury (23,432)
Issuance of 3,750 shares of Common Stock upon the
exercise of stock options 23,437
Issuance of 9,022 shares of Common Stock for
director fees 125,189
18,750 shares of Common Stock cancelled under
restricted stock award program (164,063) 164,063
------------- ------------- -------------
Balances at December 29, 2001 839,155 40,944,315 -
Net income 3,291,900
Cash dividends declared, $.44 per share (1,597,864)
Purchase of 5,000 shares of Common Stock for
treasury (55,855)
Issuance of 7,684 shares of Common Stock for
director fees 100,395
------------- ------------- -------------
Balances at December 28, 2002 883,695 42,638,351 -
Net income 3,361,622
Cash dividends declared, $.44 per share (1,593,118)
Purchase of 23,022 shares of Common Stock for
treasury (317,726)
Issuance of 7,192 shares of Common Stock for
director fees 98,980
------------- ------------- -------------
Balances at January 3, 2004 $ 664,949 $ 44,406,855 $ -
============= ============= =============
See accompanying notes.
-23-
Consolidated Statements of Cash Flows
Year ended
January 3 December 28 December 29
2004 2002 2001
-------- ----------- -----------
Operating Activities
Net income $ 3,361,622 $ 3,291,900 $ 3,912,919
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization 3,619,328 3,565,460 4,460,704
Common stock received - - (748,345)
Loss on sales of equipment and other assets - - 258
Provision for doubtful accounts 214,345 91,296 (4,002)
Deferred income taxes 390,788 454,200 461,200
Gain on sale of investment (166,788) - -
Issuance of Common Stock for directors' fees 98,980 100,395 125,189
Changes in operating assets and liabilities:
Accounts receivable (316,345) 259,870 2,673,430
Inventories (270,871) 2,191,677 (1,485,460)
Prepaid expenses and other (326,025) (137,673) 212,848
Prepaid pension cost (99,100) 349,385 (27,237)
Other assets (113,840) 47,536 (211,999)
Accounts payable 364,306 170,023 (1,097,265)
Accrued compensation (181,908) 1,002,865 (1,281,060)
Other accrued expenses (204,275) (19,211) (30,143)
------------ ------------ ------------
Net cash provided by operating activities 6,370,217 11,367,723 6,961,037
Investing Activities
Purchases of property, plant and equipment (2,763,130) (1,559,863) (1,894,723)
Business acquisitions, net of cash acquired - (303,746) -
Proceeds from sale of investment 915,133 - -
------------ ------------ ------------
Net cash used by investing activities (1,847,997) (1,863,609) (1,894,723)
Financing Activities
Principal payments on long-term debt (3,732,726) (6,853,694) (3,028,830)
Proceeds from sales of Common Stock - - 23,437
Purchases of Common Stock for treasury (317,726) (55,855) (23,432)
Dividends paid (1,593,118) (1,597,864) (1,598,809)
------------ ------------ ------------
Net cash used by financing activities (5,643,570) (8,507,413) (4,627,634)
Effect of exchange rate changes on cash 78,934 (12,489) (25,366)
------------ ------------ ------------
Net change in cash and cash equivalents (1,042,416) 984,212 413,314
Cash and cash equivalents at beginning of year 5,939,232 4,955,020 4,541,706
------------ ------------ ------------
Cash and cash equivalents at end of year $ 4,896,816 $ 5,939,232 $ 4,955,020
============ ============ ============
See accompanying notes.
-24-
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. The Company has historically consolidated its
subsidiaries located in Asia and Mexico as of November 30. No events have
occurred between November 30, 2003 and January 1, 2004 to materially affect the
reported amounts for the Company's Asian and Mexican subsidiaries.
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 loss - foreign currency translation". Foreign currency exchange
transaction gains and losses are not material in any year.
Cash Equivalents
Highly liquid investments purchased with a maturity of three months or less are
considered cash equivalents.
-25-
The Eastern Company
Notes to Consolidated Financial Statements (continued)
2. ACCOUNTING POLICIES (continued)
Shipping Costs
The Company records all shipping costs within cost of products sold.
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 collections of the sales proceeds. The
Company obtains written purchase authorizations from our 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 customers'
financial condition; collateral is not required. Accounts receivable are
recorded net of applicable allowances.
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.
Investment in Common Stock
The investment in common stock consists solely of shares of common stock of a
single issuer. Such shares were received as compensation during 2001 in
connection with the "demutualization" of the issuer. This investment was
classified as "available-for-sale" and, as such, was measured and reported at
fair value in the consolidated balance sheet. The cost of this investment was
$748,345 based on the fair value of the shares at the time of receipt and was
reported in "Other income". The subsequent related unrealized holding gain of
$59,093, less deferred income taxes of $23,200 to December 28, 2002 was reported
as a separate component of stockholder's equity. On July 22, 2003 the Company
sold all shares of the common stock for $915,133 with the gain on sale of stock
of $166,788 recorded within "Other income".
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. ($12,382,559 for U.S. inventories
at January 3, 2004) and by the first-in, first-out (FIFO) method for inventories
outside the U.S. ($4,543,989 for inventories outside the U.S. at January 3,
2004). Current cost exceeded the LIFO carrying value by approximately $3,677,000
at January 3, 2004 and $3,368,000 at December 28, 2002. There was no material
LIFO quantity liquidation in 2003 or 2002.
Property, Plant and Equipment and Related Depreciation
Property, plant and equipment (including equipment under capital lease) are
stated at cost. Depreciation ($3,118,885 in 2003, $3,006,994 in 2002 and
$3,173,277 in 2001) is computed generally using the straight-line method based
on the following estimated useful lives of the assets: Building 10 to 39.5
years; Machinery and equipment 3 to 10 years.
-26-
The Eastern Company
Notes to Consolidated Financial Statements (continued)
2. ACCOUNTING POLICIES (continued)
Goodwill, Intangibles and Impairment of Long-Lived Assets
Patents are recorded at cost and are amortized using the straight-line method
over the lives of the patents. Technology and licenses are recorded at cost and
are generally amortized on a straight-line basis over periods ranging from 5 to
17 years. Prior to December 30, 2001, Goodwill was being amortized over periods
ranging from 5 to 15 years. Amortization expense in 2003, 2002 and 2001 was
$500,443, $558,466 and $1,287,427 respectively. Total amortization expense for
each of the next five years is estimated to be as follows: 2004 - $345,147; 2005
- - $271,814; 2006 - $265,147; 2007 - $256,561; 2008 - $255,000.
In the event that facts and circumstances indicate that the carrying value of
long-lived assets, including definite life intangible assets, may be impaired,
an evaluation is performed to determine if a write-down is required. No events
or changes in circumstances have occurred that indicate that the carrying amount
of such long-lived assets held and used may not be recovered.
Effective December 30, 2001, the Company adopted Financial Accounting Standards
Board Statement No. 142, Goodwill and Other Intangible Assets. Under the new
standards, goodwill and trademarks are no longer amortized but are subject to
annual impairment tests; other intangible assets continue to be amortized over
their useful lives. The Company performs the required annual impairment test of
its goodwill and trademarks during the second quarter of each year. Trademarks
are not amortized as their lives are deemed to be indefinite.
If the provisions of Statement No. 142 were applied effective December 31, 2000,
the net income for the Company would have been $4,421,000 or $1.21 per share for
2001.
The following is a roll-forward of goodwill for 2003 and 2002:
2003 2002
---- ----
Beginning balance $ 10,364,140 $ 10,603,638
Additions - 50,734
Adjustment to Greenwald purchase price - (300,000)
Foreign exchange 155,626 9,768
------------ ------------
Ending balance $ 10,519,766 $ 10,364,140
============ ============
Product Development Costs
Product development costs, charged to expense as incurred, were $1,115,329 in
2003, $1,040,661 in 2002 and $1,005,555 in 2001.
Advertising Costs
The Company expenses advertising costs as incurred. Advertising costs were
$449,304 in 2003, $495,889 in 2002 and $678,479 in 2001.
-27-
The Eastern Company
Notes to Consolidated Financial Statements (continued)
2. ACCOUNTING POLICIES (continued)
Earnings Per Share
The denominators used in the earnings per share computations follow:
2003 2002 2001
---- ---- ----
Basic:
Weighted average shares outstanding 3,620,593 3,631,278 3,623,291
--------- --------- ---------
Denominator for basic earnings per share 3,620,593 3,631,278 3,623,291
========= ========= =========
Diluted:
Weighted average shares outstanding 3,620,593 3,631,278 3,623,291
Dilutive stock options 38,372 49,806 43,888
--------- --------- ---------
Denominator for diluted earnings per share 3,658,965 3,681,084 3,667,179
========= ========= =========
The Company has excluded the effect of 177,500, 547,500 and 477,500 shares in
2003, 2002 and 2001 respectively, from the above dilutive stock options, as
their inclusion would be anti-dilutive.
Derivatives
The Company entered into an interest rate swap agreement to modify the interest
characteristics of a portion of its outstanding debt. The agreement involves the
exchange of amounts based on the London Interbank Offered Rate ("LIBOR") for
amounts based on a fixed interest rate over the life of the agreement, without
an exchange of the notional amount upon which the payments are based.
The Company's interest rate swap agreement is considered `effective' through use
of the short-cut method, as defined under Statement No. 133, Accounting for
Derivative Instruments and Hedging Activities , and, as a result, changes in
fair value of the derivative are recorded in current assets or liabilities with
the offset amount recorded to accumulated other comprehensive income (loss) in
stockholders' equity. The adoption of Statement No. 133 resulted in a charge to
other comprehensive income in 2001 for the cumulative effect of an accounting
change of $400,756, net of taxes.
Stock Based Compensation
The Company accounts for stock options in accordance with Accounting Principles
Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees. As such,
it does not recognize compensation expense for stock options granted under its
stock option plans if the exercise price is at least equal to the fair market
value of the Company's common stock on the date granted. Since no options were
granted below fair market value in 2003, 2002 or 2001, no compensation expense
has been recorded.
The fair value of the stock options was estimated at the date of grant using
the Black-Scholes option pricing model with the following weighted-average
assumptions for 2003, 2002, and 2001:
2003 2002 2001
---- ---- ----
Risk free interest rate 3.18% 3.89% 4.84%
Expected volatility 0.287 0.309 0.302
Expected option life 5 years 5 years 5 years
Weighted-average dividend yield 2.9% 3.1% 3.1%
-28-
The Eastern Company
Notes to Consolidated Financial Statements (continued)
2. ACCOUNTING POLICIES (continued)
The weighted average fair market value of the shares granted under options was
$15.30 in 2003, $14.19 in 2002, and $14.40 in 2001. The weighted average fair
value of options, estimated using the Black-Scholes option pricing model based
on the assumptions in the above table, was $3.37 in 2003, $3.42 in 2002, and
$3.63 in 2001.
Pro forma information regarding net income and earnings per share, as required
by Statement No. 123 "Accounting for Stock-Based Compensation", has been
determined as if the Company had accounted for its employee stock options under
the fair value method.
(in thousands, except per share amounts) 2003 2002 2001
---------------------------------------- ---- ---- ----
Net income, as reported $3,362 $3,292 $3,913
Deduct: Total stock-based employee
compensation expense determined under fair
value based method for all awards granted
since July 19, 2000, net of related tax effects 85 138 200
------ ------ ------
Pro forma net income $3,277 $3,154 $3,713
====== ====== ======
Earnings per share:
Basic - as reported $0.93 $0.91 $1.08
Basic - pro forma $0.91 $0.87 $1.03
Diluted - as reported $0.92 $0.89 $1.07
Diluted - pro forma $0.90 $0.86 $1.01
For the purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the stock options' vesting period ranging
from 1 to 5 years. The pro forma effect on net income and related earnings per
share may not be representative of future years' impact since the terms and
conditions of new grants may vary from the current terms.
Reclassification
Certain prior year amounts have been reclassified to conform to the 2003
presentation.
-29-
The Eastern Company
Notes to Consolidated Financial Statements (continued)
3. BUSINESS ACQUISITIONS
Effective October 1, 2002 the Company acquired all of the issued and outstanding
stock of Canadian Commercial Vehicles Corporation (CCV) for cash of
approximately $70,000 and the assumption of approximately $130,000 of debt,
which the Company paid upon closing. CCV was established as a Canadian
Subsidiary of The Eastern Company, located in Kelowna, British Columbia, Canada.
CCV manufactures lightweight sleeper boxes used in Class 8 trailer trucks.
Effective March 1, 2002 the Company acquired certain assets of the Big Tag
Division of Dolan Enterprises, Inc. for cash of approximately $260,000. Big Tag
was merged into the CCL division of the Company located in Wheeling, Illinois.
Big Tag provides high-visibility, custom luggage tags, which the Company markets
in conjunction with its custom logo luggage locks to the travel, incentive and
premium markets.
The above acquisitions have been accounted for using the purchase method. The
acquired businesses are included in the consolidated operating results of the
Company from their date of acquisition. The excess of the cost of the acquired
businesses over the fair market value of the net assets acquired has been
allocated to goodwill. The effects of these acquisitions on the Company's
consolidated financial position and operation results are not material.
4. CONTINGENCIES
The Company is party to various legal proceedings and claims related to its
normal business operations. In the opinion of management, the Company has
substantial and meritorious defenses for these claims and proceedings in which
it is a defendant, and believes these matters will be ultimately resolved
without a material adverse effect on the consolidated financial position,
results of operations or liquidity of the Company. The aggregate provision for
losses related to contingencies arising in the ordinary course of business was
not material to operating results for any year presented. There is a nominal
aggregate liability for all contingencies as of January 3, 2004 and December 28,
2002.
5. DEBT
The Company has an unsecured loan agreement (Loan Agreement), which includes a
term portion and a revolving credit portion. The term portion of the Loan
Agreement is payable in quarterly principal payments of $600,000 in 2004 and
increases annually through maturity on January 1, 2009. The first payment of
calendar 2004 was made in fiscal 2003. The Company may borrow up to $7,500,000
through July 1, 2005 under the revolving credit portion of the Loan Agreement
with a quarterly commitment fee of 0.25% on the unused portion.
The interest rates on the term and the revolving credit portions of the Loan
Agreement may vary. The interest rates may vary based on LIBOR rate plus a
margin spread of 1.5% to 2.0% for the term portion and 1.25% to 1.75% for the
revolving credit portion. The margin rate spread is based on operating results
calculated on a rolling-four-quarter basis. On January 3, 2004 the interest rate
on the term and revolver portions of the Loan Agreement was 2.87% and 2.64%,
respectively.
The Company maintains an interest rate swap contract, as required, with the
lender, for an original notional amount of $15,000,000, (notional amount
$8,400,000 on January 3, 2004 and $11,175,000 on December 28, 2002), which is
reduced on a quarterly basis in accordance with the principal repayment schedule
of the term portion of the Loan Agreement. The interest rate on the swap
contract bears interest at a fixed rate of 9.095% and expires July 1, 2005.
-30-
The Eastern Company
Notes to Consolidated Financial Statements (continued)
5. DEBT (continued)
Debt consists of:
2003 2002
---- ----
Term loan $ 15,625,000 $ 18,625,000
Revolving credit loan 1,000,000 1,500,000
Capital lease obligation with interest at 4.99% and payable in
monthly installments of $21,203 through April 2009 1,189,290 1,379,212
Other 7,652 45,199
------------ ------------
17,821,942 21,549,411
Less current portion 2,007,273 2,628,664
------------ ------------
$ 15,814,669 $ 18,920,747
============ ============
The Company paid interest of $1,402,631 in 2003, $1,741,511 in 2002 and
$2,752,643 in 2001.
Collectively, under the covenants of the Loan Agreement and capital lease
obligation, the Company is required to maintain specified financial ratios and
amounts. In addition, the Company is restricted to, among other things, capital
leases, purchases or redemptions of its capital stock, mergers and divestitures,
and new borrowing.
As of January 3, 2004, scheduled annual principal maturities of long-term debt,
including capital lease obligations, for each of the next five years follow:
2004 $ 2,007,271
2005 4,009,811
2006 3,420,523
2007 3,831,782
2008 3,843,617
Thereafter 708,938
------------
$17,821,942
============
At January 3, 2004 and December 28, 2002, building improvements and equipment
with a cost of approximately $2,000,000 was recorded under capital leases with
accumulated depreciation of approximately $443,080 and $332,310, respectively.
The capital lease is secured by the equipment under the lease and a $900,000
letter of credit.
- -31-
The Eastern Company
Notes to Consolidated Financial Statements (continued)
6. STOCK RIGHTS
The Company has a stock rights plan. At January 3, 2004 there were 3,616,039
stock rights outstanding under the plan. Each right may be exercised to purchase
one share of the Company's Common Stock at an exercise price of $80, subject to
adjustment to prevent dilution.
The rights generally become exercisable ten days after an individual or group
acquires 10% of the Company's outstanding common shares or after commencement or
announcement of an offer for 10% or more of the Company's Common Stock. The
stock rights, which do not have voting privileges, expire on July 22, 2008, and
may be redeemed by the Company at a price of $.0067 per right at any time prior
to their expiration. In the event that the Company were acquired in a merger or
other business combination transaction, provision shall be made so that each
holder of a right shall have the right to receive, upon exercise thereof at the
then current exercise price, that number of shares of common stock of the
surviving company which at the time of such transaction would have a market
value of two times the exercise price of the right.
7. STOCK OPTIONS AND AWARDS
Stock Options
The Company has incentive stock option plans for officers, other key employees,
and non-employee directors: the 1989, 1995, 1997 and 2000 plans. Options granted
under the 1989 plans and incentive stock options granted under the 1995 and 2000
plans must have exercise prices that are not less than 100% of the fair market
value of the stock on the dates the options are granted. Restricted stock awards
may also be granted to participants under the 1995 and 2000 plans with
restrictions determined by the Compensation Committee of the Company's Board of
Directors. Under the 1995, 1997, and 2000 plans, nonqualified stock options
granted to participants will have exercise prices determined by the Compensation
Committee of the Company's Board of Directors. All options granted in 2003,
2002, and 2001 were granted at prices equal to the fair market value of the
stock on the dates granted. No restricted stock was granted in 2003, 2002 or
2001.
As of January 3, 2004, there were 344,642 shares available for future grant
under the above noted plans: 2000 - 240,891 shares, 1997 - 52,500, 1995 - 51,251
and 1989 - no shares available for grants. As of January 3, 2004, there were
998,642 shares reserved under all option plans for future issuance.
Information with respect to the Company's stock option plans is summarized
below:
Weighted Average
Shares Exercise Price
-------- ----------------
Outstanding at December 30, 2000 657,391 $13.322
Granted 44,109 14.400
Cancelled (18,750) 11.280
Exercised (3,750) 6.250
------- -------
Outstanding at December 29, 2001 679,000 13.477
Granted 35,000 14.190
Cancelled (25,000) 14.251
------- -------
Outstanding at December 28, 2002 689,000 13.475
Granted 10,000 15.300
Cancelled (45,000) 14.539
------- -------
Outstanding at January 3, 2004 654,000 $13.417
======= =======
-32-
The Eastern Company
Notes to Consolidated Financial Statements (continued)
7. STOCK OPTIONS AND AWARDS (continued)
Options Outstanding Options Exercisable
------------------- -------------------
Weighted
Average
Remaining Weighted Exercisable as of Weighted
Range of Outstanding as of Contractual Average Exercise January 3, Average Exercise
Exercise Prices January 3, 2004 Life Price 2004 Price
- --------------- ----------------- ----------- ----------------- ----------------- ----------------
$ 9.92 - $11.92 194,000 3.8 $10.461 194,000 $10.461
$14.00 - $15.30 447,500 6.1 14.556 430,009 14.556
$18.50 12,500 5.6 18.500 12,500 18.500
------- --- ------- ------- -------
654,000 5.4 $13.417 636,509 $13.392
======= === ======= ======= =======
8. INCOME TAXES
Deferred income taxes are provided on temporary differences between the carrying
amounts of assets and liabilities for financial reporting purposes and those for
income tax reporting purposes. Deferred income tax liabilities (assets) relate
to:
2003 2002 2001
---- ---- ----
Property, plant and equipment $ 3,445,288 $ 3,057,400 $ 2,801,500
Pensions - - 2,027,400
Investment in common stock - 307,500 325,800
Other 221,160 164,400 196,500
------------ ------------ ------------
Total deferred income tax liabilities 3,666,448 3,529,300 5,351,200
Other postretirement benefits (886,371) (979,700) (1,042,400)
Inventories (338,737) (316,300) (598,800)
Allowance for doubtful accounts (97,674) (82,900) (119,200)
Accrued compensation (187,393) (198,200) (257,900)
Interest rate swap obligation (232,005) (455,000) (422,000)
Pensions (809,954) (826,713) -
Other (333,750) (496,500) (424,600)
------------ ------------ ------------
Total deferred income tax assets (2,885,884) (3,355,313) (2,864,900)
------------ ------------ ------------
Net deferred income tax liabilities $ 780,564 $ 173,987 $ 2,486,300
============ ============ ============
Income before income taxes consists of:
2003 2002 2001
---- ---- ----
Domestic $ 1,778,405 $ 2,736,969 $ 4,819,818
Foreign 3,612,085 1,997,339 1,265,537
------------ ------------ ------------
$ 5,390,490 $ 4,734,308 $ 6,085,355
============ ============ =============
-33-
The Eastern Company
Notes to Financial Statements (continued)
8. INCOME TAXES (continued)
Income taxes follow:
2003 2002 2001
---- ---- ----
Current:
Federal $ 703,890 $ 458,302 $ 1,122,932
Foreign 749,390 437,506 435,304
State 184,800 92,400 153,000
Deferred 390,788 454,200 461,200
----------- ----------- -----------
$ 2,028,868 $ 1,442,408 $ 2,172,436
=========== =========== ===========
A reconciliation of income taxes computed using the U.S. federal statutory rate
to those reflected in operations follows:
2003 2002 2001
---- ---- ----
Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ -------
Income taxes using U.S.
federal statutory rate $ 1,832,665 34% $ 1,609,700 34% $ 2,069,000 34%
State income taxes, net of
federal benefit 199,062 4 73,500 2 127,000 2
Impact of foreign
subsidiaries on
effective tax rate 1,232 - (291,000) (6) (147,500) (2)
Other--net (4,091) - 50,208 1 123,936 2
------------ --- ------------ --- ------------ ---
$ 2,028,868 38% $ 1,442,408 31% $ 2,172,436 36%
============ === ============ === ============ ===
Total income taxes paid were $1,162,688 in 2003, $1,239,668 in 2002 and
$1,035,531 in 2001.
The Company's future effective tax rates could be adversely affected by earnings
being higher than anticipated in countries where statutory rates are higher.
United States income taxes have been provided on the undistributed earnings of
foreign subsidiaries ($5,950,457 at January 3, 2004) only where necessary
because such earnings are intended to be reinvested abroad indefinitely or
repatriated only when substantially free of such taxes.
9. LEASES
The Company leases certain equipment and buildings under operating lease
arrangements. Certain leases contain renewal options for periods ranging from
one to ten years.
Future minimum payments under non-cancelable operating leases with initial or
remaining terms in excess of one year during each of the next five years follow,
this table only includes leases that have been committed to and does not
recognize costs associated with anticipated renewals:
2004 $ 465,986
2005 450,939
2006 290,423
2007 111,805
2008 89,902
----------
$1,409,055
==========
-34-
The Eastern Company
Notes to Consolidated Financial Statements (continued)
9. LEASES (continued)
Rent expense for all operating leases was $383,098 in 2003, $306,293 in 2002 and
$303,784 in 2001.
10. RETIREMENT BENEFIT PLANS
The Company has non-contributory defined benefit pension plans covering most
U.S. employees. Plan benefits are generally based upon age at retirement, years
of service and, for its salaried plan, the level of compensation. The Company
also sponsors unfunded nonqualified supplemental retirement plans that provide
certain current and former officers with benefits in excess of limits imposed by
federal tax law. The measurement date for the obligations disclosed below is
September 30 of each year.
The Company also provides health care and life insurance for retired salaried
employees in the United States who meet specific eligibility requirements.
Significant disclosures relating to these benefit plans follow:
Pension Benefits Postretirement Benefits
---------------- -----------------------
2003 2002 2003 2002
---- ---- ---- ----
Change in Projected Benefit Obligation
Benefit obligation at beginning of year $ 33,737,224 $ 32,254,888 $ 1,997,724 $ 2,391,435
Change due to availability of final actual
assets and census data 132,099 136,351 75,758 (383,853)
Plan amendment (a) 145,612 358,640 - -
Service cost 1,131,435 1,073,638 70,321 73,311
Interest cost 2,274,329 2,198,127 137,124 132,966
Actuarial loss/(gain) 1,659,027 (240,287) 78,130 -
Benefits paid (2,163,871) (2,044,133) (229,148) (216,135)
------------ ------------ ------------ ------------
Benefit obligation at end of year $ 36,915,855 $ 33,737,224 $ 2,129,909 $ 1,997,724
============ ============ ============ ============
Change in Plan Assets
Fair value of plan assets at beginning
of year $ 28,816,677 $ 32,853,847 $ 796,507 $ 574,749
Change due to availability of final actual
assets and census data (1,251) 14,574 7,855 166,614
Actual return on plan assets 3,900,350 (1,995,676) 69,174 66,224
Employer contributions 1,519,683 25,527 - -
Benefits paid (2,163,871) (2,081,595) 18,892 (11,080)
------------ ------------ ------------ ------------
Fair value of plan assets at end of year $ 32,071,588 $ 28,816,677 $ 892,428 $ 796,507
============ ============ ============ ============
-35-
The Eastern Company
Notes to Consolidated Financial Statements (continued)
10. RETIREMENT BENEFIT PLANS (continued)
Pension Benefits Postretirement Benefits
---------------- -----------------------
2003 2002 2003 2002
---- ---- ---- ----
Under-funded status $ (4,844,267) $ (4,920,547) $ (1,237,481) $ (1,201,217)
Unrecognized prior service cost 1,126,515 1,137,165 (80,144) (101,233)
Unrecognized net actuarial loss (gain) 9,032,632 9,203,552 (1,067,145) (1,275,706)
Unrecognized net asset at transition (424,055) (628,445) - -
------------ ------------ ------------ ------------
Net amount recognized in the balance sheet $ 4,890,825 $ 4,791,725 $ (2,384,770) $ (2,578,156)
============ ============ ============ ============
<FN>
(a) A plan was amended in each year to increase benefits for specified retired
participants.
</FN>
Pension Benefits Postretirement Benefits
---------------- -----------------------
2003 2002 2003 2002
---- ---- ---- ----
Prepaid benefit cost $ 1,192,281 $ 1,338,010 $ - $ -
Accrued benefit liability (4,015,858) (4,448,197) (2,384,770) (2,578,156)
Intangible asset 964,592 1,112,129 - -
Accumulated other comprehensive loss 6,749,810 6,789,783 - -
------------ ------------ ------------ ------------
Net amount recognized in the balance sheet $ 4,890,825 $ 4,791,725 $ (2,384,770) $ (2,578,156)
============ ============ ============ ============
In 2003 and 2002, the accumulated benefit obligation for all qualified and
nonqualified defined benefit pension plans was $35,372,932 and $32,547,911
respectively.
Information for two of the under-funded pension plans with a projected benefit
obligation and an accumulated benefit obligation in excess of plan assets
2003 2002
---- ----
Projected benefit obligation $ 30,005,029 $ 27,377,767
Accumulated benefit obligation 29,028,413 26,658,206
Fair value of plan assets 25,458,556 22,599,696
The percentage of each asset category of the total assets held by the plans
follows:
Allocation
Parameters 2003 2002
---------- ---- ----
Equity securities 30 - 70% 60% 53%
Fixed income 30 - 60% 32 41
Cash and cash equivalents 0 - 10% 8 6
--- ---
Total 100% 100%
=== ===
The Company utilizes a diversified, strategic allocation to generate investment
returns that will meet the objectives set forth in the Company's investment
policy, while keeping periods of negative returns to a minimum. Studies of
assets and liabilities that incorporate specific plan objectives as well as
assumptions regarding long-term capital market returns and volatilities generate
the specific asset allocations for the trusts. The long-term nature of the
trusts make them well-suited
-36-
The Eastern Company
Notes to Consolidated Financial Statements (continued)
10. RETIREMENT BENEFIT PLANS (continued)
to bear the risk of added volatility associated with equity securities, and,
accordingly, the asset allocations of the trust reflect a higher allocation to
equities as compared to fixed-income securities. Non-U.S. securities are used to
diversify some of the volatility of the U.S. equity market while providing
comparable long-term returns. The investment guidelines set forth in the
Company's investment policy limit or prohibit exposure to investments in more
volatile sectors.
In selecting the expected rate of return on plan assets, the Company considers
historical returns for the types of investments that its plans hold.
The plans' assets include 430,874 shares of the Common Stock of the Company
having a market value of $6,700,091 and $4,881,802 at January 3, 2004 and
December 28, 2002, respectively. Dividends received during 2003 and 2002 on the
Common Stock of the Company were $189,585 for each year.
Pension Benefits
----------------
2003 2002 2001
---- ---- ----
Assumptions
Discount rate 6.5% 7% 7%
Expected return on plan assets 8.5% 9% 9%
Rate of compensation increase 4.25% 4.25% 4.25%
Components of Net Periodic Benefit Cost
Service cost $ 1,131,435 $ 1,073,638 $ 1,040,857
Interest cost 2,274,329 2,198,127 2,131,339
Expected return on plan assets (2,755,927) (1,577,856) (1,858,990)
Net amortization and deferral 770,747 (1,146,850) (1,314,916)
----------- ----------- -----------
Net periodic benefit cost $ 1,420,584 $ 547,059 $ (1,710)
=========== =========== ===========
Postretirement Benefits
-----------------------
2003 2002 2001
---- ---- ----
Assumptions
Discount rate 6.5% 7% 7%
Expected return on plan assets 8.5% 9% 9%
Components of Net Periodic Benefit Cost
Service cost $ 70,321 $ 73,311 $ 71,617
Interest cost 137,124 132,966 158,638
Expected return on plan assets (69,174) (66,224) (55,285)
Net amortization and deferral (83,617) (92,752) (77,066)
----------- ----------- -----------
Net periodic benefit cost $ 54,654 $ 47,301 $ 97,904
=========== =========== ===========
For measurement purposes relating to the postretirement benefit plan, the life
insurance cost trend rate is 1%. The health care cost trend rate for
participants retiring after January 1, 1991 is nil; no increase in that rate is
expected because of caps placed on benefits. The health care cost trend rate is
expected to remain at 4.5% for participants after the year 2000.
-37-
The Eastern Company
Notes to Consolidated Financial Statements (continued)
10. RETIREMENT BENEFIT PLANS (continued)
A one-percentage-point change in assumed health care cost trend rates would have
the following effects on the postretirement benefit plan:
1-Percentage Point
Increase Decrease
-------- --------
Effect on total of service and interest cost components $ 29,416 $ (13,676)
Effect on postretirement benefit obligation $ 255,030 $ (130,405)
U.S. salaried employees and most employees of the Company's Canadian subsidiary
are covered by defined contribution plans.
On December 8, 2003, the Medicare Prescription Drug, Improvement and
Modernization Act of 2003 (the Act) was signed into law. The Act introduces a
prescription drug benefit under Medicare (Medicare Part D), as well as a federal
subsidy to sponsors of retiree health care benefit plans that provide a benefit
that is at least actuarially equivalent to Medicare Part D. As of January 3,
2004, in accordance with FASB Staff Position No. FAS 106-1 any measures of the
Accumulated Postretirement Benefit Obligation (APBO) or net periodic
postretirement benefit cost in the financial statements do not reflect the
effects of the Act on the plan. More specific authoritative guidance on the
accounting of the federal subsidy is pending and, when issued, could require the
Company to change previously reported information.
The Company has a contributory savings plan under Section 401(k) of the Internal
Revenue Code covering substantially all U.S. non-union employees. The plan
allows participants to make voluntary contributions of up to 100% of their
annual compensation on a pretax basis, subject to IRS limitations. The plan
provides for contributions by the Company at its discretion. The Company made
contributions of $141,903 in 2003, $139,598 in 2002 and $149,586 in 2001.
11. FINANCIAL INSTRUMENTS
The carrying values of financial instruments (cash and cash equivalents,
accounts receivable, accounts payable, an interest rate swap obligation, and
debt) as of January 3, 2004 and December 28, 2002 approximate fair value. Fair
value was based on expected cash flows and current market conditions.
-38-
The Eastern Company
Notes to Consolidated Financial Statements (continued)
12. REPORTABLE SEGMENTS
The accounting policies of the segments are the same as those described in Note
2. Operating profit is total revenue less operating expenses, excluding interest
and general corporate expenses. Intersegment revenue, which is eliminated, is
recorded on the same basis as sales to unaffiliated customers. Identifiable
assets by reportable segment consist of those directly identified with the
segment's operations.
2003 2002 2001
---- ---- ----
Revenue:
Sales to unaffiliated customers:
Industrial Hardware $ 35,422,702 $ 29,271,624 $ 28,213,054
Security Products 39,281,707 36,388,970 35,556,863
Metal Products 13,602,172 15,676,613 19,055,436
------------- ------------- -------------
$ 88,306,581 $ 81,337,207 $ 82,825,353
============= ============= =============
Intersegment Revenue:
Industrial Hardware $ 60,598 $ 44,669 $ 65,026
Security Products 1,697,607 1,286,004 737,619
------------- ------------- -------------
$ 1,758,205 $ 1,330,673 $ 802,645
============= ============= =============
Income Before Income Taxes:
Industrial Hardware $ 4,078,257 $ 4,188,944 $ 3,378,933
Security Products 4,756,132 4,037,505 3,133,873
Metal Products 75,538 (76,586) 2,429,306
------------- ------------- -------------
Operating Profit 8,909,927 8,149,863 8,942,112
General corporate expenses (2,425,611) (1,767,062) (1,463,441)
Interest expense (1,302,830) (1,716,057) (2,259,347)
Other income 209,004 67,564 866,031
------------- ------------- -------------
$ 5,390,490 $ 4,734,308 $ 6,085,355
============= ============= =============
Geographic Information:
Net Sales:
United States $ 71,204,620 $ 70,279,299 $ 72,768,061
Foreign 17,101,961 11,057,908 10,057,292
------------- ------------- -------------
$ 88,306,581 $ 81,337,207 $ 82,825,353
============= ============= =============
Foreign Sales are primarily to North America.
-39-
The Eastern Company
Notes to Consolidated Financial Statements (continued)
12. REPORTABLE SEGMENTS (continued)
2003 2002 2001
---- ---- ----
Identifiable Assets:
United States $ 61,353,242 $ 66,135,214 $ 72,607,182
Foreign 13,264,174 9,997,323 9,288,872
------------- ------------- -------------
$ 74,617,416 $ 76,132,537 $ 81,896,054
============= ============= =============
Industrial Hardware $ 24,159,290 $ 22,457,174 $ 22,630,057
Security Products 32,811,830 31,932,295 32,428,409
Metal Products 11,969,126 13,879,715 15,652,026
------------- ------------- -------------
68,940,246 68,269,184 70,710,492
General corporate 5,677,170 7,863,353 11,185,562
------------- ------------- -------------
$ 74,617,416 $ 76,132,537 $ 81,896,054
============= ============= =============
Depreciation and Amortization
Industrial Hardware $ 1,216,015 $ 1,135,449 $ 1,176,490
Security Products 858,792 829,561 1,561,542
Metal Products 1,473,089 1,540,606 1,675,980
------------- ------------- -------------
3,547,896 3,505,616 4,414,012
General corporate 71,432 59,844 46,692
------------- ------------- -------------
$ 3,619,328 $ 3,565,460 $ 4,460,704
============= ============= =============
Capital Expenditures
Industrial Hardware $ 1,866,426 $ 519,101 $ 451,099
Security Products 627,311 404,355 527,034
Metal Products 267,978 596,388 717,951
------------- ------------- -------------
2,761,715 1,519,844 1,696,084
Currency translation adjustment (10,156) (679) (40)
General corporate 11,571 40,698 198,679
------------- ------------- -------------
$ 2,763,130 $ 1,559,863 $ 1,894,723
============= ============= =============
13. RECENT ACCOUNTING PRONOUNCEMENTS
In 2003, the FASB issued Interpretation No. 46, Consolidation of Variable
Interest Entities ("FIN No. 46"), which addresses when a company should
consolidate an entity based on the variable interest model of FIN No. 46. It
defines a variable interest entity ("VIEs") as those entities in which equity
investors do not have the characteristics of a controlling financial interest or
in which equity investors do not bear the residual economic risks. For all VIEs
formed after February 1, 2003, FIN No. 46 is effective for fiscal years or
interim periods beginning after June 15, 2003. For all other VIEs, FIN No. 46 is
effective for periods ending after March 15, 2004. FIN No. 46 did not have any
impact on the Company's financial position and results of operations in fiscal
2003.
The Company has identified an entity, formed before February 1, 2003, that may
be a VIE. The potential VIE is a vendor of the Company, located in China, formed
solely for the benefit of the Company. The Company does not have any ownership
interest in the potential VIE but does provide all of the financial support to
the potential VIE to facilitate the production of various materials used within
the Company's production and owns the equipment used by the potential VIE to
manufacture the products. Because the Company does not have an ownership
interest in the potential VIE, the Company has been unable to obtain reliable
financial information to determine whether the entity is a VIE, determine The
Eastern Company
-40-
Notes to Consolidated Financial Statements (continued)
13. RECENT ACCOUNTING PRONOUNCEMENTS (continued)
whether the Company is the VIE's primary beneficiary or perform the accounting
required to consolidate the VIE. Therefore, the Company is unable at this time
to estimate the potential impact the consolidation of the potential VIE may have
on its financial position or results of operations.
During 2003, 2002 and 2001, the Company purchased $4,908,689, $3,804,033 and
$3,288,223 of product from the vendor.
14. SELECTED QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Selected quarterly financial information (unaudited) follows:
2003
----
First Second Third Fourth Year
----- ------ ----- ------ ----
Net sales $21,590,714 $21,591,111 $21,864,105 $23,260,651 $88,306,581
Gross profit 5,499,535 5,272,665 5,287,464 5,528,276 21,587,940
Selling and administrative expenses
3,819,453 3,473,743 3,631,127 4,179,301 15,103,624
Net income 953,377 936,688 942,759 528,798 3,361,622
Net income per share:
Basic $.26 $.26 $.26 $.15 $.93
Diluted $.26 $.26 $.26 $.14 $.92
2002
----
First Second Third Fourth Year
----- ------ ----- ------ ----
Net sales $20,320,517 $21,291,745 $20,040,682 $19,684,263 $81,337,207
Gross profit 5,109,559 4,813,198 5,576,655 5,200,644 20,700,056
Selling and administrative expenses
3,641,780 3,269,684 4,054,823 3,350,969 14,317,256
Net income 677,107 758,518 678,043 1,178,232 3,291,900
Net income per share:
Basic $.19 $.21 $.19 $.32 $.91
Diluted $.18 $.20 $.19 $.32 $.89
-41-
Report of Ernst & Young LLP, Independent Auditors
THE Board of Directors
The Eastern Company
We have audited the accompanying consolidated balance sheets of The Eastern
Company as of January 3, 2004 and December 28, 2002, and the related
consolidated statements of income, comprehensive income, shareholders' equity,
and cash flows for each of the three years in the period ended January 3, 2004.
Our audits also included the financial statement schedule listed in the Index at
Item 15(a). 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 auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of The Eastern
Company at January 3, 2004 and December 28, 2002, and the consolidated results
of its operations and its cash flows for each of the three years in the period
ended January 3, 2004, in conformity with accounting principles generally
accepted in the United States. 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 2 to the Consolidated Financial Statements, effective
December 30, 2001, the Company adopted Statement of Financial Standards No. 142,
"Goodwill and Other Intangible Assets".
/s/ Ernst & Young LLP
Hartford, Connecticut
February 4, 2004
-42-
ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A CONTROLS AND PROCEDURES
As of the end of the fiscal year ended January 3, 2004, the Company
carried out an evaluation, under the supervision and with the participation of
the Company's management, including the Chief Executive Officer (the "CEO")
and Chief Financial Officer (the "CFO"), of the effectiveness of the design
and operation of the Company's disclosure controls and procedures pursuant to
Exchange Act Rule 240.13a-15. Based upon that evaluation, the CEO and CFO
concluded that the Company's current disclosure controls and procedures are
effective in timely alerting them to material information relating to the
Company and its subsidiaries required to be included in the Company's periodic
SEC filings. There were no significant changes in the Company's internal
control over financial reporting during the period covered by this report that
materially affected, or are reasonably likely to materially affect, the
Company's internal control over financial reporting.
The Company believes that a controls system, no matter how well designed
and operated, cannot provide absolute assurance that the objectives of the
controls system are met, and no evaluation of controls can provide absolute
assurance that all control issues and instances of fraud, if any, within a
company have been detected. The Company's disclosure controls and procedures
are designed to provide reasonable assurance of achieving their objectives,
and the CEO and CFO have concluded that these controls and procedures are
effective at the "reasonable assurance" level.
PART III
ITEM 10 DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
There are incorporated herein by reference the portions of the
Registrant's definitive proxy statement filed with the Commission pursuant to
Regulation 14A since the close of its fiscal year, which involve the election
of Directors, the information appearing on pages 3 and 4 of said proxy
statement, being the portion captioned "Item No. 1. Election of Directors",
the information appearing on page 11 and 12 of said proxy statement, being the
portion captioned "Executive Compensation", the information appearing on page
10 of said proxy statement, being the portions captioned "Audit Committee
Financial Expert" and "Report of Audit Committee", and the information
appearing on page 8 of said proxy statement, being the portion captioned
"Section 16(a) Beneficial Ownership Reporting Compliance" and "Committees of
the Board of Directors", and the information appearing on page 22 of said
proxy statement, being the portion captioned "Exhibit B - The Eastern Company
Code of Business Conduct and Ethics." The Registrant's only Executive Officers
are Leonard F. Leganza, President and Chief Executive Officer and John L.
Sullivan III, Vice President, Secretary and Treasurer.
ITEM 11 EXECUTIVE COMPENSATION
There are incorporated herein by reference the portions of the
Registrant's definitive proxy statement filed with the Commission pursuant to
Regulation 14A since the close of its fiscal year, which involve executive
compensation, the information appearing on pages 11 through 16 of said proxy
statement.
ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
(a) There are incorporated herein by reference the portions of the
Registrant's definitive proxy statement filed with the Commission pursuant to
Regulation 14A since the close of its fiscal year, which involve the security
ownership of certain beneficial shareholders, the information appearing on
pages 6 and 7 of said proxy statement.
-43-
(b) There are incorporated herein by reference the portions of the
Registrant's definitive proxy statement filed with the Commission pursuant to
Regulation 14A since the close of its fiscal year, which involve the security
ownership of management, the information appearing on pages 3 and 4, 6 and 7,
and 11 and 15 of said proxy statement.
(c) Changes in Control
None.
(d) The information relating to the securities authorized for issuance
under the Registrant's equity compensation plans is set forth in Part II, Item
5 of this Form 10-K Annual Report.
ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
(a) None.
(b) None.
(c) None.
(d) None.
ITEM 14 PRINCIPAL ACCOUNTING FEES AND SERVICES
The information called for by Item 14 is incorporated by reference to
the sections titled "Appointment of Independent Auditors" located on page 5 of
the Proxy Statement.
PART IV
ITEM 15 EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Documents filed as part of this report:
(1) Financial statements Page
Consolidated Balance Sheets -- January 3, 2004 and December 28, 2002..................20.
Consolidated Statements of Income -- Fiscal years ended January 3, 2004,
December 28, 2002 and December 29, 2001...............................................22.
Consolidated Statements of Comprehensive Income -- Fiscal years ended
January 3, 2004, December 28, 2002, and December 29, 2001.............................22.
Consolidated Statements of Shareholders' Equity -- Fiscal years ended
January 3, 2004, December 28, 2002 and December 29, 2001..............................23.
Consolidated Statements of Cash Flows -- Fiscal years ended January 3, 2004,
December 28, 2002, and December 29, 2001..............................................24.
Notes to Consolidated Financial Statements............................................25.
Report of Ernst & Young LLP, Independent Auditors.....................................42.
(2) Financial Statement Schedule
Schedule II -- Valuation and qualifying accounts.....................................46.
-44-
Schedules other than that listed above have been omitted
because the required information is contained in the financial
statements and notes thereto, or because such schedules are not
required or applicable.
(3) Exhibits
Exhibits are as set forth in the "Exhibit Index" which
appears on pages 48 through 49.
(b) Reports on Form 8-K
Form 8-K filed on April 25, 2003 setting forth the press
release reporting the Company's earnings for the quarter ended
March 29, 2003.
Form 8-K filed on July 30, 2003 setting forth the press
release reporting the Company's earnings for the quarter ended
June 28, 2003.
Form 8-K filed on October 29, 2003 setting forth the press
release reporting the Company's earnings for the quarter ended
September 27, 2003.
Form 8-K filed on February 4, 2004 setting forth the press
release reporting the Company's earnings for the quarter and
fiscal year ended January 3, 2004.
-45-
The Eastern Company and Subsidiaries
Schedule II - Valuation and Qualifying accounts
COL. A COL. B COL. C COL. D COL. E
ADDITIONS
(1) (2)
Balance at Beginning Charged to Costs Charged to Other Deductions - Balance at End
Description of Period and Expenses Accounts-Describe Describe of Period
- ----------------------------------- -------------------- ---------------- ----------------- ------------ --------------
Fiscal year ended January 3, 2004:
Deducted from asset accounts:
Allowance for doubtful accounts $304,000 $224,987 $226,987 (a) $302,000
======== ======== ======== ========
Fiscal year ended December 28, 2002:
Deducted from asset accounts:
Allowance for doubtful accounts $344,000 $91,563 $131,563 (a) $304,000
======== ======= ======== ========
Fiscal year ended December 29, 2001:
Deducted from asset accounts:
Allowance for doubtful accounts $362,000 ($5,126) $12,874 (a) $344,000
======== ======= ======= ========
<FN>
(a) Uncollectible accounts written off, net of recoveries
</FN>
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
Dated: March 22, 2004 THE EASTERN COMPANY
--------------
By /s/ John L. Sullivan III
------------------------
John L. Sullivan III
Vice President, Secretary and Treasurer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
/s/ Leonard F. Leganza March 22, 2004
-------------------------
Leonard F. Leganza
Director, President
and Chief Executive Officer
/s/ John W. Everets March 22, 2004
-------------------------
John W. Everets
Director
/s/ Charles W. Henry March 22, 2004
-------------------------
Charles W. Henry
Director
/s/ David C. Robinson March 22, 2004
-------------------------
David C. Robinson
Director
/s/ Donald S. Tuttle, III March 22, 2004
-------------------------
Donald S. Tuttle III
Director
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EXHIBIT INDEX
(3) Restated Certificate of Incorporation dated August 14, 1991 is
incorporated by reference to the Registrant's Annual Report on
Form 10-K for the fiscal year ended December 28, 1991 and the
Registrant's Form 8-K filed on February 13, 1991. Amended and
restated bylaws dated July 29, 1996 is incorporated by
reference to the Registrant's Form 8-K filed on July 29, 1996.
(4) Rights Agreement entered into between the Registrant and
BankBoston N.A. dated as of August 6, 1998 and Letter to all
shareholders of the Registrant, dated July 22, 1998 together
with Press Release dated July 22, 1998 describing the
Registrant's redemption of shareholders Purchase Rights dated
September 16, 1991 and the issuance of a new Purchase Rights
dividend distribution are incorporated by reference to the
Registrant's Form 8-K filed on August 6, 1998.
(10)(a) Amendment to the Deferred Compensation Agreement with Russell
G. McMillen dated May 1, 1988 is incorporated by reference to
Registrant's Annual Report on Form 10-K for the fiscal year
ended December 31, 1988. The Deferred Compensation Agreement
with Russell G. McMillen dated October 28, 1980 and amended on
March 27, 1986 is incorporated by reference to the
Registrant's Annual Report on Form 10-K for the fiscal year
ended January 3, 1987.
(b) The Eastern Company 1995 Executive Stock Incentive Plan
effective as of April 26, 1995 incorporated by reference to
the Registrant's Form S-8 filed on February 7, 1997.
(c) The Eastern Company Directors Fee Program effective as of
October 1, 1996 incorporated by reference to the Registrant's
Form S-8 filed on February 7, 1997, as amended by Amendment
No.1 and Amendment No. 2 are incorporated by reference to the
Registrant's Form 10-K filed on March 29, 2000. A copy of
Amendment No. 3 to the Directors Fee Program, adopted on
January 5, 2004, is attached hereto.
(d) The Eastern Company 1997 Directors Stock Option Plan effective
as of September 17, 1997 incorporated by reference to the
Registrant's Form S-8 filed on January 30, 1998, and
Post-Effective Amendment No. 1 to the Registrant's Form S-8
filed on March 2, 2000.
(e) Supplemental Retirement Plan dated September 9, 1998 with
Leonard F. Leganza is incorporated by reference to the
Registrant's Annual Report on Form 10-K for the fiscal year
ended January 2, 1999.
(f) Severance Agreement dated February 21, 2001 with Leonard F.
Leganza is incorporated by reference to the Registrant's
Annual Report on Form 10-K for fiscal year ended December 30,
2000.
(g) The Eastern Company 2000 Executive Stock Incentive Plan
effective July 2000 is incorporated by reference to the
Registrant's Annual Report on Form 10-K for fiscal year ended
December 30, 2000.
(14) The Eastern Company Code of Business Conduct and Ethics
incorporated by reference to Exhibit B of the Registrant's
proxy statement filed with the Commission pursuant to
Regulation 14A for the annual meeting to be held on April 28,
2004.
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(21) List of subsidiaries as follows:
Eberhard Hardware Mfg. Ltd., a private corporation
organized under the laws of the Province of
Ontario, Canada.
Canadian Commercial Vehicles Corporation, a private
corporation organized under the laws of the Province of
British Columbia, Canada.
Eastern Industrial Ltd., a private corporation
organized under the laws of the Peoples
Republic of China.
World Lock Co. Ltd., a private corporation organized
under the laws of Taiwan (The Republic of
China).
Sesamee Mexicana, Subsidiary, a private corporation
organized under the laws of Mexico.
World Security Industries Co. Ltd., a private
corporation organized under the laws of Hong Kong.
(23) Consent of independent auditors attached hereto on page 52.
(31) Certifications required by Rule 13a-14(a) of the Securities
Exchange Act of 1934, as amended, as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
(32) Certifications pursuant to Rule 13a-14(b) and 18 USC 1350 as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
(99) Letter to our shareholders from the Annual Report 2003 is
attached on page 56.
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