SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY
PERIOD ENDED July 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
THE EASTERN COMPANY
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(Exact Name of Registrant as specified in its charter)
Connecticut 06-0330020
----------- ----------
(State or other jurisdiction of (I.R.S. Employer incorporation or
organization) Identification No.)
112 Bridge Street, Naugatuck, Connecticut 06770
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(Address of principal executive offices) (Zip Code)
(203) 729-2255
--------------
(Registrant's Telephone Number, Including Area Code)
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 whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes-- No X .
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding as of July 3, 2004
----- ------------------------------
Common Stock, No par value 3,630,958
-1-
PART I
FINANCIAL INFORMATION
THE EASTERN COMPANY AND SUBSIDIARIES
ITEM I CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
ASSETS
July 3, 2004 January 3, 2004
------------ ---------------
CURRENT ASSETS
Cash and cash equivalents $ 4,209,841 $ 4,896,816
Accounts receivable, less allowances:
2004 - $311,000; 2003 - $302,000 13,490,143 11,036,760
Inventories 17,260,369 16,926,548
Prepaid expenses and other 1,618,047 1,642,513
Deferred income taxes 362,700 462,700
------------- -------------
Total Current Assets 36,941,100 34,965,337
--------------------
Property, plant and equipment 43,872,825 42,819,165
Accumulated depreciation (19,487,193) (17,888,740)
------------- -------------
24,385,632 24,930,425
Goodwill and trademarks 10,492,026 10,687,373
Patents, technology and licenses, less accumulated
amortization 1,922,434 1,877,408
Intangible pension asset 964,592 964,592
Prepaid pension cost 1,158,716 1,192,281
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TOTAL ASSETS $ 75,864,500 $ 74,617,416
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 6,711,069 $ 4,246,633
Accrued compensation 1,658,704 1,782,408
Other accrued expenses 1,314,056 2,034,918
Current portion of long-term debt 3,904,653 2,007,273
------------- -------------
Total Current Liabilities 13,588,482 10,071,232
-------------------------
Deferred federal income taxes 1,243,264 1,243,264
Long-term debt, less current portion 12,611,070 15,814,669
Accrued postretirement benefits 2,302,295 2,384,770
Accrued rate swap obligation 330,688 580,055
Accrued pension obligation 4,015,858 4,015,858
Shareholders' Equity
Preferred Stock, no par value
Authorized shares - 2,000,000
(No shares issued)
Common Stock, no par value:
Authorized Shares - 25,000,000
Issued and outstanding shares:
2004-3,630,958; 2003-3,616,039
excluding 1,680,342 in 2004 and 1,680,342 in
2003 shares held in treasury 876,258 664,949
Accumulated other comprehensive (loss):
Foreign currency translation (301,759) (166,295)
Additional minimum pension liability, net of taxes (4,049,886) (4,049,886)
Derivative financial instruments, net of taxes (198,688) (348,055)
------------- -------------
(4,550,333) (4,564,236)
Retained earnings 45,446,918 44,406,855
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TOTAL SHAREHOLDERS' EQUITY 41,772,843 40,507,568
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TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 75,864,500 $ 74,617,416
============= =============
See accompanying notes.
-2-
THE EASTERN COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
Six Months Ended Three Months Ended
7/3/04 6/28/03 7/3/04 6/28/03
--------- --------- --------- ---------
Net sales $49,863,172 $43,181,825 $25,297,964 $21,591,111
Cost of products sold 37,678,125 32,409,625 19,248,063 16,318,446
----------- ----------- ----------- -----------
12,185,047 10,772,200 6,049,901 5,272,665
Selling and administrative expenses 8,719,356 7,293,196 4,547,870 3,473,743
Interest expense 545,568 669,091 269,171 322,572
Other income (9,860) (25,818) (2,048) (13,249)
----------- ----------- ----------- -----------
INCOME BEFORE INCOME TAXES 2,929,983 2,835,731 1,234,908 1,489,599
Income taxes 1,092,884 945,666 474,182 552,911
----------- ----------- ----------- -----------
NET INCOME $ 1,837,099 $ 1,890,065 $ 760,726 $ 936,688
=========== =========== =========== ===========
Net income per share:
Basic $ 0.51 $ 0.52 $ 0.21 $ 0.26
Diluted $ 0.49 $ 0.52 $ 0.20 $ 0.26
Cash dividends per share $ 0.22 $ 0.22 $ 0.11 $ 0.11
See accompanying notes.
-3-
THE EASTERN COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Six Months Ended
July 3, 2004 June 28, 2003
------------ -------------
OPERATING ACTIVITIES:
Net income $ 1,837,099 $ 1,890,065
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 1,796,237 1,840,656
Gain on sales of equipment and other assets (3,487) -
Postretirement benefits other than pensions (82,475) 36,792
Provision for doubtful accounts 5,438 66,315
Issuance of Common Stock for directors' fees 39,010 49,189
Changes in operating assets and liabilities:
Accounts receivable (2,664,889) (391,352)
Inventories (396,463) (752,313)
Prepaid expenses and other 10,563 471,293
Prepaid pension cost 223,825 (24,062)
Accounts payable 2,301,548 (413,884)
Other accrued expenses (647,530) (460,712)
Other assets (49,651) (72,502)
----------- -----------
NET CASH PROVIDED BY OPERATING ACTIVITIES 2,369,225 2,239,485
INVESTING ACTIVITIES:
Purchases of property, plant, and equipment (1,129,434) (742,674)
Proceeds from sale of equipment 3,487 -
Other - 33,307
----------- -----------
NET CASH USED BY INVESTING ACTIVITIES (1,125,947) (709,367)
FINANCING ACTIVITIES:
Principal payments on long-term debt (1,306,028) (1,307,505)
Proceeds from sale of Common Stock 172,300 -
Purchases of Common Stock for treasury - (317,395)
Dividends paid (797,036) (798,185)
----------- -----------
NET CASH USED BY FINANCING ACTIVITIES (1,930,764) (2,423,085)
Effect of exchange rate changes on cash 511 12,463
----------- -----------
NET CHANGE IN CASH AND CASH EQUIVALENTS (686,975) (880,504)
Cash and Cash Equivalents at Beginning of Period 4,896,816 5,939,232
----------- -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 4,209,841 $ 5,058,728
=========== ===========
4
THE EASTERN COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
Six Months Ended Three Months Ended
July 3, 2004 June 28, 2003 July 3, 2004 June 28, 2003
------------ ------------- ------------ -------------
Net income $ 1,837,099 $ 1,890,065 $ 760,726 $ 936,688
Other comprehensive income --
Foreign currency translation (135,464) 708,602 (166,194) 531,344
Change in fair value of derivative financial
instruments, net of income tax expense:
2004 - ($100,000) and ($59,000) respectively; 149,367 88,924
2003 - ($78,000) and $(38,000) respectively; 116,396 55,829
Unrealized holding gain on investment in
common stock, net of income tax expense
2003 - ($25,700) and ($40,000) respectively; - 39,071 - 60,639
----------- ----------- --------- -----------
Comprehensive income $ 1,851,002 $ 2,754,134 $ 683,456 $ 1,584,500
=========== =========== ========= ===========
See accompanying notes.
-5-
THE EASTERN COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
JULY 3, 2004
Note A - Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with the instructions to Form 10-Q and do not include all
of the information and footnotes required by generally accepted accounting
principles in the United States for complete financial statements. Refer to the
Company's consolidated financial statements and notes thereto included in its
Form 10-K for the year ended January 3, 2004 for additional information.
The accompanying condensed consolidated financial statements are unaudited.
However, in the opinion of management, all adjustments (consisting only of
normal recurring accruals) necessary for a fair presentation of the results of
operations for interim periods have been reflected therein. Operating results
for interim periods are not necessarily indicative of the results that may be
expected for the full year.
Certain prior year amounts have been reclassified to conform to the current year
presentation. These reclassifications had no effect on previously reported net
income.
The condensed balance sheet as of January 3, 2004 has been derived from the
audited consolidated balance sheet at that date.
Note B - Earnings Per Share
The denominators used in the earnings per share computations follow:
Six Months Ended Three Months Ended
July 3, 2004 June 28, 2003 July 3, 2004 June 28, 2003
------------ ------------- ------------ --------------
Basic:
Denominator for basic earnings per share 3,622,926 3,627,807 3,628,818 3,625,310
========= ========= ========= =========
Diluted:
Weighted average shares outstanding 3,622,926 3,627,807 3,628,818 3,625,310
Dilutive stock options 103,095 2,602 109,488 5,204
--------- --------- --------- ---------
Denominator for diluted earnings per share 3,726,021 3,630,409 3,738,306 3,630,514
========= ========= ========= =========
Note C - Inventories
The components of inventories follow:
July 3, 2004 January 3, 2004
------------ ---------------
Raw materials and component parts $ 8,854,569 $ 8,687,003
Work in process 4,194,270 4,112,625
Finished goods 4,211,530 4,126,920
------------ ------------
$ 17,260,369 $ 16,926,548
============ ============
-6-
THE EASTERN COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
JULY 3, 2004
Note D - Segment Information
Segment financial information follows:
SIX MONTHS ENDED THREE MONTHS ENDED
July 3, 2004 June 28, 2003 July 3, 2004 June 28, 2003
------------ ------------- ------------ -------------
Revenues:
Sales to unaffiliated customers:
Industrial Hardware $22,155,810 $17,066,514 $11,243,606 $ 8,461,310
Security Products 21,098,894 18,861,109 10,633,178 9,379,421
Metal Products 6,608,468 7,254,202 3,421,180 3,750,380
----------- ----------- ----------- -----------
$49,863,172 $43,181,825 $25,297,964 $21,591,111
=========== =========== =========== ===========
Income Before Income Taxes:
Industrial Hardware $ 2,651,398 $ 2,197,375 $ 1,141,816 $ 1,073,507
Security Products 2,102,682 2,160,267 741,181 1,090,493
Metal Products 170,402 270,842 201,032 126,267
----------- ----------- ----------- -----------
Operating Profit 4,924,482 4,628,484 2,084,029 2,290,267
General corporate expenses (1,448,931) (1,123,662) (579,950) (478,096)
Interest expense (545,568) (669,091) (269,171) (322,572)
----------- ----------- ----------- -----------
$ 2,929,983 $ 2,835,731 $ 1,234,908 $ 1,489,599
=========== =========== =========== ===========
Note E - Stock-Based Compensation
The Company measures compensation expense related to stock-based compensation
using the intrinsic value method. Accordingly, no stock-based employee
compensation cost is reflected in net income if the exercise price of the option
equals or exceeds the fair value of the stock on the date of grant.
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. The fair value of the stock options was estimated at the
date of grant using a Black-Scholes option pricing model with the following
weighted-average assumptions:
July 3, 2004 June 28, 2003
------------ -------------
Risk free interest rate N/A 2.27
Expected volatility N/A 3.07
Expected option life N/A 5 years
Weighted-average dividend yield N/A 3.1%
Assumptions are not applicable (N/A) because no options were granted in 2004.
-7-
THE EASTERN COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
JULY 3, 2004
Note E - Stock-Based Compensation - continued
SIX MONTHS ENDED THREE MONTHS ENDED
July 3, 2004 June 28, 2003 July 3, 2004 June 28, 2003
------------ ------------- ------------ -------------
Net income, as reported $1,837,099 $1,890,065 $760,726 $936,688
Deduct: Total stock-based employee
-------
compensation expense determined
under fair value based method for all
awards granted, net of related tax
effects (8,952) (25,746) (4,476) (12,873)
---------- ---------- -------- --------
Pro forma net income $1,828,147 $1,864,319 $756,250 $923,815
========== ========== ======== ========
Earnings per share:
Basic-as reported $ 0.51 $ 0.52 $ 0.21 $ 0.26
Basic-pro forma $ 0.50 $ 0.51 $ 0.21 $ 0.25
Diluted-as reported $ 0.49 $ 0.52 $ 0.20 $ 0.26
Diluted-pro forma $ 0.49 $ 0.51 $ 0.20 $ 0.25
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.
Note F - Recent Accounting Pronouncements
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities," which was revised in December 2003 ("FIN No.
46-R"). This new rule requires that companies consolidate a variable interest
entity if the company is subject to a majority of the risk of loss from the
variable interest entity's activities and/or is entitled to receive a majority
of the entity's residual returns. The provisions of FIN No. 46-R currently were
required to be applied as of the end of the first reporting period after March
15, 2004 for the variable interest entities in which the company holds a
variable interest that it acquired on or before January 31, 2003. The adoption
of FIN No. 46-R did not have any impact to the financial position or results of
operations of the Company.
Note G - 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 $164,000 and $329,000 of
legal expenses in the second quarter and first six months of 2004, respectively,
and expects to incur additional expenses until this matter is resolved.
Subsequent to the close of the 2004 second quarter, the Company reached a
mediated potential settlement of $400,000, which was recorded as a charge to
earnings in the second quarter 2004. The legal expenses combined with the
potential settlement resulted in charges to earnings net of taxes of $348,000 or
$0.09 per diluted share in the second quarter and $457,000 or $0.12 per diluted
share in the six month period.
There are no other legal proceedings, other than ordinary routine litigation
incidental to the Company's business, to which either the Company or any of its
subsidiaries is a party or to which any of their property is the subject.
-8-
THE EASTERN COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
JULY 3, 2004
Note H - Debt
Effective January 4, 2004 the Company received approval from its financial
institution to modify the basis of calculating its debt service covenant ratios
from a rolling four-quarter test to a cumulative quarter test. The debt service
covenant test will return to a rolling four-quarter test for the fiscal years
beginning in 2005.
Note I - Retirement Benefit Plans
The Company has non-contributory defined benefit pension plans covering
certain 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 for the second quarter
and first six months of Fiscal 2004 and 2003 follow:
Pension Benefits
Six Months Ended Three Months Ended
July 3, 2004 June 28, 2003 July 3, 2004 June 28, 2003
------------ ------------- ------------ -------------
Service cost $ 590,160 $ 451,840 $ 295,905 $ 249,486
Interest cost 1,142,757 834,044 571,168 450,288
Expected return on plan assets (1,299,371) (875,456) (649,360) (477,908)
Transition obligation (102,197) (80,342) (51,098) (42,742)
Prior service cost 98,490 86,556 49,245 45,052
Losses recognized 176,224 135,732 87,028 74,357
---------- ---------- ---------- ----------
Net periodic benefit cost $ 606,063 $ 552,374 $ 302,888 $ 298,533
========== ========== ========== ==========
Postretirement Benefits
Six Months Ended Three Months Ended
July 3, 2004 June 28, 2003 July 3, 2004 June 28, 2003
------------ ------------- ------------ -------------
Service cost $ 58,031 $ 162,568 $ 13,945 $ 70,173
Interest cost 88,496 165,815 17,480 (14,353)
Expected return on plan assets (51,920) (83,649) (10,797) 7,238
Transition obligation 0 0 0 0
Prior service cost (20,924) (25,501) (9,491) 2,207
Losses recognized (34,876) (75,612) (5,514) 6,543
---------- ---------- ---------- ----------
Net periodic benefit cost $ 38,807 $ 143,621 $ 5,623 $ 71,808
========== ========== ========== ==========
-9-
THE EASTERN COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
JULY 3, 2004
Note I - Retirement Benefit Plans - continued
The Company's funding policy with respect to its qualified plans is to
contribute at least the minimum amount required by applicable laws and
regulations. The Company was required to contribute $1,007,929 into its
salaried plan and $194,123 into one of its hourly plans. The Company has paid
all of the required contributions into the salaried plan as of March 15, 2004
and will make the minimum contribution into its hourly plan prior to filing
its federal income tax return on September 15, 2004.
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
July 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 $38,578 and $75,692 in the second quarter and first six
months of 2004 respectively, and $36,897 and $71,405 in the second quarter and
first six months of 2003, respectively.
-10-
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion is intended to highlight significant changes in the
Company's financial position and results of operations for the twenty-six weeks
ended July 3, 2004. The interim financial statements and this Management's
Discussion and Analysis of Financial Condition and Results of Operations should
be read in conjunction with the Consolidated Financial Statements and Notes
thereto for the fiscal year ended January 3, 2004 and the related Management's
Discussion and Analysis of Financial Condition and Results of Operations, both
of which are contained in the Company's Annual Report on Form 10-K for the
fiscal year ended January 3, 2004.
Certain statements set forth in this discussion and analysis of financial
condition and results of operations are forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995. They use such
words as "may," "will," "expect," "believe," "plan" and other similar
terminology. These statements reflect management's current expectations
regarding future events and operating performance and speak only as of the date
of this release. These forward-looking statements involve a number of risks and
uncertainties and actual future results and trends may differ materially
depending on a variety of factors including 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, changes within our industry segments and in the overall economy,
litigation and legislation. In addition, terrorist threats and the possible
responses by the U.S. government, the effects on consumer demand, the financial
markets, the travel industry, the trucking industry, the mining industry and
other conditions increase the uncertainty inherent in forward-looking
statements. Forward-looking statements reflect the expectations of the Company
at the time they are made, and investors should rely on them only as expressions
of opinion about what may happen in the future and only at the time they are
made. The Company undertakes no obligation to update any forward-looking
statement. Although the Company believes it has an appropriate business strategy
and the resources necessary for its operations, future revenue and margin trends
cannot be reliably predicted and the Company may alter its business strategies
to address changing conditions.
In addition, the Company makes estimates and assumptions that may materially
affect reported amounts and disclosures. These relate to valuation allowances
for accounts receivable and for excess and obsolete inventories, accruals for
pensions and other postretirement benefits (including forecasted future cost
increases and returns on plan assets), provisions for depreciation (estimating
useful lives), and, on occasion, accruals for contingent losses.
Overview
During the second quarter of 2004 the Company experienced a 17.2% increase in
sales as compared to the second quarter of 2003. The Industrial Hardware and the
Security Products segments experienced a 32.9% and 13.4%, respectively, increase
in sales during the period while the sales of the Metal Products segment
declined 8.8% from the comparable quarter of 2003. Sales for the first half of
2004 were up 15.5% compared to the same period a year ago. The Industrial
Hardware and the Security Products segments experienced increases in sales of
29.8% and 11.9%, respectively, while the sales of the Metal Products segment
declined 8.9% as compared to the first half of 2003.
The Industrial Hardware sales increase came from our distributor network and
original equipment manufacturers (OEM's), as the result of a general improvement
in the manufacturing sector of the economy. Sales increased to our service body
OEM's, due to increased sales of our stainless steel paddles and our new
PowerUp(TM) system; to subcontractors for military vehicles for retrofitting the
Humvee, 1 ton and 3/4 ton trucks, with heavy duty rotary and paddle latches as
the Army increases the armor on these vehicles; and to the class 8 truck market
which is experiencing significant growth and which has increased the
requirements for our hardware and sleeper boxes, particularly for Freightliner's
Western Star tractor-trailer line of trucks.
-11-
The sales increase in the Security Products segment came as a result of
increased sales of locks to computer manufacturers such as IBM, Dell and Sun
Micro Systems as we gain more market share from our competitors; increased sales
to the travel industry as the result of the introduction of our new
SearchAlert(TM) lock which was recently introduced into the Transportation
Security Administration's program for locking checked baggage at airports;
industrial enclosures; smart card systems serving the commercial laundry market;
and increasing market share from competitors.
Sales in the Metals Products segment were lower in mine roof products and up in
contract casting products for both the second quarter and first half of 2004
compared to the 2003 periods. Our proprietary mine roof anchors declined as the
result of mining techniques where fewer of our proprietary mine roof anchors are
required, and sales of contract casting products were up as the result of
increased orders from one customer. The Company has signed a technical
development contract with China University of Mining and Technology. The
contract calls for the testing and appraisal of our proprietary mine roof
anchors for use in underground coal mining in China. The project is currently in
the testing phase.
The Company is experiencing or has been notified of cost increases affecting the
majority of material it uses such as steel, zinc and brass, with cost increases
ranging from 20% to 50%, amounting to $356,000 or $0.10 per diluted share in the
second quarter of 2004 and $550,000 or $0.15 per diluted in the six month
period. The Company intends to pass these increases on to our customers where
possible. Currently, there is no indication that the Company will not be able to
obtain all the materials that it requires.
Cash flow in the second quarter of 2004 was improved over the first quarter and
comparable to the second quarter of 2003. The Company's line of credit, along
with controlling discretionary expenditures, should provide sufficient cash flow
to meet all existing obligations.
A more detailed analysis of the Company's results of operations and financial
condition follows:
Results of Operations
The following table sets forth, for the periods indicated, selected Company
statement of operations data expressed as a percentage of net sales.
Six Months Ended Three Months Ended
---------------- ------------------
July 3, 2004 June 28, 2003 July 3, 2004 June 28, 2003
------------ ------------- ------------ -------------
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of products sold 75.6% 75.1% 76.1% 75.6%
----- ----- ----- -----
Gross margin 24.4% 24.9% 23.9% 24.4%
Selling and administrative expense 17.4% 16.9% 17.9% 16.1%
Interest expense 1.1% 1.5% 1.1% 1.5%
Other (income) expense 0.0% (0.1%) (0.0%) (0.1%)
---- ------ ------ ------
Income before income taxes 5.9% 6.6% 4.9% 6.9%
Income taxes 2.2% 2.2% 1.9% 2.6%
---- ---- ---- ----
Net Income 3.7% 4.4% 3.0% 4.3%
==== ==== ==== ====
Net income for the second quarter of 2004 was $760,726 or $.20 per diluted
share on sales of $25.3 million compared to net income of $936,688 or $.26 per
diluted share on sales of $21.6 million in the second quarter of 2003. Net
income for the first six months of 2004 was $1,837,099 or $.49 per diluted
share on sales of $49.9 million compared to net income of $1,890,065 or $.52
per diluted share on sales of $43.2 million in the 2003 period.
-12-
Sales for the second quarter 2004 were up 17.2% compared to the same period a
year ago. New product sales contributed 3.4%, sales volume of existing
products increased 13.2% and prices increased 0.6% in the second quarter. The
Company instituted selective price increases in the second quarter in order to
recover the increasing cost of material the Company is experiencing. Sales for
the first half of 2004 were up 15.5% compared to the same period a year ago.
Sales volume of existing products was up 11.7% and new product sales were up
3.7%, while prices increased 0.1%.
The Industrial Hardware segment's second quarter sales were up 32.9% compared
to the second quarter of 2003. New product sales increased 0.9%, sales volume
of existing products increased 30.5% and prices were up 1.5%. New products
include a slam latch assembly and rotary lock with a hard case, both of which
are used in the truck accessory market. Sales of "sleeper boxes" for the class
8 truck market were up 44.7%. For the first half of 2004, sales were up 29.8%
compared to the same period in 2003. New product sales increased 3.4%, sales
volume of existing products increased 26.6% and prices were down 0.2%. The
Company anticipates continued sales improvement in the Industrial Hardware
segment throughout 2004.
Our Eastern Industrial (Shanghai) Ltd., manufacturing facility located in
Shanghai, China has been very active fulfilling quotation requests from the
Company's sales networks. In addition, we have begun production of a variety
of metal and plastic products for our U.S. and Canadian affiliates. This
subsidiary will be instrumental in helping us to remain price competitive in
North America and will open up the possibility to more effectively pursue
global markets, including marketing the Company's products directly in China.
The Security Products segment's sales were up 13.4% in the second quarter of
2004 as compared to the second quarter of 2003. New product sales increased
7.1% and sales volume of existing products increased 6.3%. Sales of new
products included the SearchAlert(TM) luggage lock and a remote keyless entry
system and a snap-in lock for the automotive accessory market. For the first
half of 2004, sales were up 11.9% compared to the same period in 2003. New
product sales increased 5.3% and sales volume of existing products increased
6.5%. The Company anticipates continued sales improvement in the Security
Products segment throughout 2004.
The Metal Products segment's sales were down 8.8% in the second quarter of
2004 as compared to the second quarter of 2003, due to lower sales volume of
existing products. Sales of our contract casting products for use in the
commercial and industrial construction industry increased 9.0% and sales of
our proprietary mine roof support anchors were down 17.1% for the second
quarter of 2004 as compared to the second quarter of 2003. The increase in
sales of contract castings during the second quarter was due to increased
orders from one customer, while sales of mine roof support anchors continue to
be negatively affected by the changes in mining techniques and surface mining
requiring fewer roof support anchors. However, the demand for steel has
created an increase in demand for metallurgical coal, which is mined
underground and which may result in increased demand for our roof support
anchors. For the first half of 2004, sales were down 8.9% compared to the same
period in 2003. Sales volume of existing products decreased by 9.7% and prices
increased by 0.8%. Sales of our contract casting products for use in the
commercial and industrial construction industry increased 1.0% and sales of
our proprietary mine roof support anchors were down 13.4% for the first six
months of 2004 as compared to the first six months of 2003. Sales are expected
to remain below prior year levels throughout 2004.
Gross margin as a percentage of sales for the three and six month periods
ended July 3, 2004 was 23.9% and 24.4%, respectively, compared to 24.4% and
24.9% in the comparable periods a year ago. The decrease in gross margin in
the second quarter is primarily the result of product mix, decreased sales
volume in the metal products segment which resulted in lower plant
utilization, higher raw material prices and operating inefficiencies
experienced with the training of new workers in the Industrial Hardware
segment as it prepared for increased production activities.
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Selling and administrative expenses were up 30.9% or $1.1 million for the
second quarter of 2004 and up 19.6% or $1.4 million for the first six months
of 2004 as compared to the same periods a year ago. The increase was due in
large part to our new manufacturing facility in Shanghai which required
start-up expenses of $166,000 and $350,000 in the three and six month periods,
respectively, and a patent infringement suit which in the three and six month
periods increased the Company's legal expenses by $164,000 and $329,000,
respectively, plus a $400,000 provision to settle this suit through mediation.
Interest expense decreased by $53,400 or 16.6% for the second quarter of 2004
and decreased by $123,500 or 18.5% for the first half of 2004 as compared to
the same periods in 2003. This decrease in interest expense was due to the
lower levels of debt in the current periods.
Earnings before income taxes for the three months ended July 3, 2004 was down
$254,700 or 17.1% and for the six months ended July 3, 2004 was up $94,300 or
3.3% as compared to the same periods of 2003. The Industrial Hardware segment
was up 6.4% or $68,300, the Security Products segment was down $349,300 or
32.0% and the Metal Products segment was up $74,800 or 59.2% as compared to
the second quarter of 2003. For the first half of 2004, the Industrial
Hardware segment was up 20.7% or $454,000, the Security Products segment was
down $57,600 or 2.7% and the Metal Products segment was down $100,400 or 37.1%
as compared to the same period of 2003. The increases in the Industrial
Hardware segment reflect the general overall improvement in the economy in
2004, increased market share and the introduction of new products. The overall
decrease in the Security Products segment was mainly due to legal fees and the
proposed settlement of a patent infringement suit mentioned above, offset by
increases created by the general overall improvement in the economy in 2004,
increased market share and the introduction of new products. The Metal
Products segment decrease is the result of the continued decline in the use of
our proprietary mine roof anchors in the North American mining industry as new
mining technology continues to reduce the need for that product.
The effective tax rate of 37.3% for the first six months is higher than the
33.3% for the same period in 2003. The increase in the effective tax rate is
the result of the Company deriving a higher percentage of its earnings from
countries with higher effective tax rates.
Liquidity and Sources of Capital
The Company provided $2,369,200 from operations for the first six months of
2004 compared to $2,239,500 provided from operations for the same period in
2003. These amounts reflect the net income earned by the Company during those
periods adjusted for non-cash charges and changes in working capital which
relate, primarily, to the timing of payments or receipts of current assets and
current liabilities. Cash flow from operations coupled with cash on hand at
the beginning of the year was sufficient to fund capital expenditures, debt
service, contributions to the Company's pension plans, and dividend payments.
Additions to property, plant and equipment were $1,129,400 during the first
six months of 2004 versus $742,700 for the comparable period in 2003. Total
capital expenditures for 2004 are expected to be in the range of $2.0 million
to $3.0 million.
Total inventories as of July 3, 2004 were $17.3 million or $334,000 higher
than at the end of Fiscal 2003. The inventory turnover ratio of 4.4 turns at
the end of the second quarter was higher than both the prior year second
quarter of 3.8 turns and the year end 2003 ratio of 4.1 turns. Accounts
receivable increased by $2.5 million from year end 2003, primarily due to
increased sales volume. The average days sales in accounts receivable for the
second quarter of 2004 was 49 days compared to 48 days in the second quarter
of 2003 and 48 days at the end of Fiscal 2003.
Cash flow from operating activities and funds available under the revolving
credit portion of the Company's loan agreement are expected to be sufficient
to cover future foreseeable working capital requirements.
-14-
The Company requested and received approval from its financial institution to
modify the basis of calculating its debt service covenant ratios from a
rolling four-quarter test to a cumulative quarter test effective for the
periods beginning January 4, 2004. The debt service covenant test will return
to a rolling four-quarter test for the fiscal years beginning in 2005. This
modification to the debt service covenants will provide the Company more
flexibility within its capital expenditure programs.
ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- ------ ----------------------------------------------------------
There have been no material changes in market risk from what was reported in
the 2003 Annual Report on Form 10-K.
ITEM 4 CONTROLS AND PROCEDURES
- ------ -----------------------
Evaluation of Disclosure Controls and Procedures
An evaluation was performed under the supervision and with the participation
of the Company's management, including the Chief Executive Officer ("CEO") and
Chief Financial Officer ("CFO"), of the effectiveness of the design and
operation of the Company's disclosure controls and procedures as of the end of
the period covered by this report. Based on that evaluation, the Company's
management, including the CEO and CFO, concluded that the Company's disclosure
controls and procedures were effective as of the end of the period covered by
this report based on such evaluation.
The Company believes that a system of controls, 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.
Changes in Internal Controls
During the period covered by this report, there have been no significant
changes in the Company's internal control over financial reporting or in other
factors that have materially affected, or are reasonably likely to materially
affect, the Company's internal controls.
PART II OTHER INFORMATION
ITEM 1 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 $329,000 in the first half
of 2004, $164,000 of which was in the second quarter of 2004, and may incur
additional expenses in 2004. Subsequent to the close of the second quarter, the
Company went to mediation and reached a potential settlement of $400,000, which
was recorded as a charge to earnings in the second quarter 2004. The legal
expenses combined with the potential settlement resulted in charges to earnings
net of taxes of $348,000 or $0.09 per diluted share in the second quarter and
$457,000 or $0.12 per diluted share in the six month period.
There are no other legal proceedings, other than ordinary routine
litigation incidental to the Company's business, to which either the Company
or any of its subsidiaries is a party or to which any of their property is the
subject.
ITEM 2 CHANGES IN SECURITIES AND USE OF PROCEEDS
- ------ -----------------------------------------
None
-15-
ITEM 3 DEFAULTS UPON SENIOR SECURITIES
- ------ -------------------------------
None
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ------ ---------------------------------------------------
See the information set forth in Item 4 of the Form 10-Q of
the Company for the quarterly period ended April 3, 2004.
ITEM 5 OTHER INFORMATION
- ------ -----------------
None
ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K
- ------- --------------------------------
(a) 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(1) The Registrant's Annual Report on Form 10-K for the
fiscal year ended January 3, 2004 is incorporated herein
by reference.
(b) 99(2) Form 8-K filed on April 28, 2004 setting forth the
press release reporting the Company's earnings for the
quarter ended April 3, 2004 is incorporated herein by
reference.
99(3) Form 8-K filed on July 28, 2004 setting forth the
press release reporting the Company's earnings for the
quarter ended July 3, 2004 is incorporated herein by
reference.
SIGNATURES
Pursuant to the requirements 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.
THE EASTERN COMPANY
(Registrant)
DATE: August 4, 2004 /s/Leonard F. Leganza
-------------- ---------------------
Leonard F. Leganza
President and Chief Executive Officer
DATE: August 4, 2004 /s/John L. Sullivan III
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John L. Sullivan III
Vice President, Secretary and Treasurer
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