UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED September 30, 2006
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM to .
Commission File Number: 0-599
THE EASTERN COMPANY
-------------------
(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
------------------ ---------- ----------- -----
(Address of principal executive offices) (Zip Code)
(203) 729-2255
--------------
(Registrant's telephone number, including area code)
Not applicable
--------------
(Former name, former address and former fiscal year,
if changed since last report)
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 a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [X]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the 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 September 30, 2006
----- ------------------------------------
Common Stock, No par value 5,478,446
PART 1 - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
THE EASTERN COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
ASSETS September 30, 2006 December 31, 2005
------ ------------------ -----------------
Current Assets
Cash and cash equivalents $ 2,312,507 $ 6,345,947
Accounts receivable, less allowances: $282,000 - 2006; $295,000 - 2005 18,933,319 14,825,014
Inventories 25,570,471 20,767,749
Prepaid expenses and other assets 2,808,906 2,391,125
Deferred income taxes 715,321 715,321
------------ ------------
Total Current Assets 50,340,524 45,045,156
Property, Plant and Equipment 46,068,983 42,468,773
Accumulated depreciation (22,632,393) (20,072,087)
------------ ------------
23,436,590 22,396,686
Goodwill 15,779,717 10,641,532
Trademarks 133,480 103,498
Patents, technology, and licenses, less accumulated amortization 1,950,696 1,946,502
Interest rate swap asset - 32,081
Intangible pension asset 732,554 732,554
Prepaid pension cost 755,481 723,826
------------ ------------
19,351,928 14,179,993
------------ ------------
TOTAL ASSETS $ 93,129,042 $ 81,621,835
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Accounts payable $ 9,574,734 $ 5,599,260
Accrued compensation 1,798,680 1,527,640
Other accrued expenses 2,787,943 3,275,159
Current portion of long-term debt 2,699,592 3,420,523
------------ ------------
Total Current Liabilities 16,860,949 13,822,582
Deferred income taxes 883,222 895,019
Long-term debt, less current portion 18,287,665 12,384,338
Accrued post-retirement benefits 2,014,004 2,078,056
Accrued pension cost 5,744,424 6,270,075
Shareholders' Equity
Preferred Stock, no par value: Authorized and unissued 2,000,000 shares
Common Stock, no par value: Authorized: 25,000,000 shares
Issued: 8,011,535 shares in 2006 and 7,992,626 shares in 2005 17,955,354 17,694,851
Treasury Stock: 2,533,089 shares (16,655,041) (16,655,041)
Retained earnings 53,082,379 50,335,658
Accumulated other comprehensive income (loss):
Foreign currency translation 998,639 818,566
Additional minimum pension liability, net of taxes (6,042,553) (6,042,553)
Derivative financial instruments, net of taxes - 20,284
------------ ------------
Accumulated other comprehensive loss (5,043,914) (5,203,703)
------------ ------------
Total Shareholders' Equity 49,338,778 46,171,765
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 93,129,042 $ 81,621,835
============ ============
See accompanying notes.
-2-
THE EASTERN COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
Nine Months Ended Three Months Ended
September 30, 2006 October 1, 2005 September 30, 2006 October 1, 2005
------------------ --------------- ------------------ ---------------
Net sales $ 88,735,730 $ 80,893,693 $ 31,206,388 $ 27,204,815
Cost of products sold (69,165,262) (62,865,242) (24,594,665) (21,098,390)
------------- ------------- ------------- -------------
Gross margin 19,570,468 18,028,451 6,611,723 6,106,425
Selling and administrative expenses (13,145,284) (12,454,214) (4,422,616) (3,906,529)
------------- ------------- ------------- -------------
Operating profit 6,425,184 5,574,237 2,189,107 2,199,896
Interest expense (732,294) (753,853) (261,193) (230,596)
Other income 132,337 45,445 84,707 21,773
------------- ------------- ------------- -------------
Income before income taxes 5,825,227 4,865,829 2,012,621 1,991,073
Income taxes 1,801,738 1,795,491 345,454 734,706
------------- ------------- ------------- -------------
Net income $ 4,023,489 $ 3,070,338 $ 1,667,167 $ 1,256,367
============= ============= ============= =============
Earnings per Share:
Basic $ .74 $ .56 $ .30 $ .23
======= ======= ======= =======
Diluted $ .69 $ .53 $ .28 $ .21
======= ======= ======= =======
Cash dividends per share: $ .23 $ .22 $ .08 $ .07
See accompanying notes.
THE EASTERN COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
Nine Months Ended Three Months Ended
September 30, 2006 October 1, 2005 September 30, 2006 October 1, 2005
------------------ --------------- ------------------ ---------------
Net income $ 4,023,489 $ 3,070,338 $ 1,667,167 $ 1,256,367
Other comprehensive income/(loss) -
Change in foreign currency
translation 180,073 305,513 (20,884) 339,833
Change in fair value of derivative
financial instrument, net of
income taxes of:
2006 - $14,680 and ($34,407)
respectively 26,339 - (60,218) -
2005 - $54,377 and ($9,623)
respectively - 79,963 - (16,454)
Reclassification adjustment for
termination of derivative
financial instrument net of
income taxes of ($26,477) (46,623) - (46,623) -
------------- ------------- ------------- -------------
159,789 385,476 (127,725) 323,379
------------- ------------- ------------- -------------
Comprehensive income $ 4,183,278 $ 3,455,814 $ 1,539,442 $ 1,579,746
============= ============= ============= =============
See accompanying notes.
-3-
THE EASTERN COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Nine Months Ended
September 30, 2006 October 1, 2005
------------------ ---------------
Operating Activities
Net income $ 4,023,489 $ 3,070,338
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 2,649,880 2,642,368
Provision for doubtful accounts 14,385 12,823
Deferred income taxes - 192,439
Issuance of Common Stock for directors' fees 56,803 77,628
Loss on sales of equipment and other assets - 1,284
Changes in operating assets and liabilities:
Accounts receivable (3,116,304) (1,341,425)
Inventories (3,151,149) 201,850
Prepaid expenses and other (420,103) 104,371
Prepaid pension cost (557,307) (671,931)
Other assets (117,572) (182,599)
Accounts payable 3,176,055 178,262
Accrued compensation 392,272 (900,263)
Other accrued expenses (571,254) (2,216)
------------- -------------
Net cash provided by operating activities 2,379,195 3,382,929
Investing Activities
Purchases of property, plant and equipment (3,371,840) (1,325,242)
Business acquisition (7,025,000) -
Proceeds from sale of equipment 15,035 -
------------- -------------
Net cash used in investing activities (10,381,805) (1,325,242)
Financing Activities
Principal payments on long-term debt (15,191,389) (2,256,375)
Proceeds from issuance of long-term debt 20,000,000 -
Proceeds from revolving credit loan 304,837 3,000,000
Proceeds from sales of Common Stock 203,700 -
Dividends paid (1,276,768) (1,199,886)
------------- -------------
Net cash used in financing activities 4,040,380 (456,261)
Effect of exchange rate changes on cash (71,210) 58,742
------------- -------------
Net change in cash and cash equivalents (4,033,440) 1,660,168
Cash and cash equivalents at beginning of period 6,345,947 4,420,506
------------- -------------
Cash and cash equivalents at end of period $ 2,312,507 $ 6,080,674
============= =============
See accompanying notes.
-4-
THE EASTERN COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30, 2006
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 December 31, 2005 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. All intercompany
accounts and transactions are eliminated. Operating results for interim periods
are not necessarily indicative of the results that may be expected for the full
year.
Certain prior period amounts have been reclassified to conform to the current
period presentation. These reclassifications had no effect on previously
reported net income.
The condensed consolidated balance sheet as of December 31, 2005 has been
derived from the audited consolidated balance sheet at that date.
Note B - Subsequent Event
-------------------------
On September 28, 2006, the Company announced a three-for-two stock split of the
Company's common shares. The record date was October 10, 2006, with the
additional shares being issued on October 17, 2006. Fractional shares created as
a result of this split were paid by cash. As the stock split occurred after the
close of the Company's fiscal quarter and prior to the issuance of the financial
statements, all share data and per share data in these financial statements and
notes to financial statements reflect the effects of the stock split as if it
occurred prior to the end of the fiscal quarter.
Note C - Earnings Per Share
---------------------------
The denominators used in the earnings per share computations follow:
Nine Months Ended Three Months Ended
September 30, October 1, September 30, October 1,
------------- ---------- ------------- ----------
2006 2005 2006 2005
---- ---- ---- ----
Basic:
Denominator for basic earnings per share 5,472,682 5,454,197 5,477,302 5,455,973
Diluted:
Weighted average shares outstanding 5,472,682 5,454,197 5,477,302 5,455,973
Dilutive stock options 349,526 381,417 377,868 422,178
--------- ---------- ---------- ---------
Denominator for diluted earnings per share 5,822,208 5,835,614 5,855,170 5,878,151
========= ========= ========= =========
Note D - Inventories
--------------------
The components of inventories follow:
September 30, 2006 December 31, 2005
------------------ -----------------
Raw materials and component parts $12,222,685 $ 9,917,792
Work in process 5,753,356 4,681,623
Finished Goods 7,594,430 6,168,334
----------- ----------
$25,570,471 $20,767,749
=========== ===========
-5-
Note E - Segment Information
----------------------------
Segment financial information follows:
NINE MONTHS ENDED THREE MONTHS ENDED
September 30, 2006 October 1, 2005 September 30, 2006 October 1, 2005
------------------ --------------- ------------------ ---------------
Revenues:
Sales to unaffiliated customers:
Industrial Hardware $ 43,279,116 $ 39,878,367 $ 15,930,809 $ 13,040,621
Security Products 36,034,888 32,889,979 12,529,709 11,656,815
Metal Products 9,421,726 8,125,347 2,745,870 2,507,379
------------ ------------ ------------ ------------
$ 88,735,730 $ 80,893,693 $ 31,206,388 $ 27,204,815
============ ============ ============ ============
Income Before Income Taxes:
Industrial Hardware $ 4,330,439 $ 3,784,671 $ 2,131,709 $ 1,137,813
Security Products 3,502,032 3,463,352 1,080,067 1,578,078
Metal Products (1,407,287) (1,673,786) (1,022,669) (515,995)
------------ ------------ ------------ ------------
Operating Profit 6,425,184 5,574,237 2,189,107 2,199,896
Interest expense (732,294) (753,853) (261,193) (230,596)
Other income 132,337 45,445 84,707 21,773
------------ ------------ ------------ ------------
$ 5,825,227 $ 4,865,829 $ 2,012,621 $ 1,991,073
============ ============ ============ ============
Note F - Recent Accounting Pronouncements
-----------------------------------------
The Company adopted FASB Statement of Financial Accounting Standards ("SFAS")
No. 123 (revised 2004), Share-Based Payment, using the modified prospective
method effective January 1, 2006. No stock options were granted in the first
nine months of 2006 and, as all stock options outstanding at December 31, 2005
were fully vested, the adoption of SFAS No. 123(R) had no impact on the
Company's consolidated financial statements.
The following table approximates the effect on net income and earnings per
share if the Company had applied SFAS No. 123(R) for the periods ended October
1, 2005 and had adopted this statement on January 2, 2005:
NINE MONTHS THREE MONTHS
ENDED ENDED
October 1, 2005 October 1, 2005
--------------- ---------------
Net income, as reported $3,070,338 $1,256,367
Deduct: Total stock-based employee
-------
compensation expense determined
under fair value based method for all
awards granted, net of related tax
effects (1,314) (438)
---------- ----------
Pro forma net income $3,069,024 $1,255,929
========== ==========
Earnings per share:
Basic-as reported $0.56 $0.23
Basic-pro forma $0.56 $0.23
Diluted-as reported $0.53 $0.21
Diluted-pro forma $0.53 $0.21
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.
-6-
Note F - Recent Accounting Pronouncements - continued
-----------------------------------------------------
The Company adopted SFAS No. 151, Inventory Costs, an amendment of ARB No. 43,
Chapter 4, effective January 1, 2006. The amendments made by SFAS No. 151
clarify that abnormal amounts of idle facility expense, freight, handling costs,
and wasted materials (spoilage) should be recognized as current-period charges
and require the allocation of fixed production overheads to inventory based on
the normal capacity of the production facilities. The adoption of SFAS No. 151
did not have a material impact on the consolidated financial statements of the
Company.
The Company adopted SFAS No. 154, Accounting Changes and Error Corrections--a
replacement of APB Opinion No. 20 (Accounting Changes) and FASB Statement No. 3
(Reporting Accounting Changes in Interim Financial Statements), effective
January 1, 2006. SFAS No. 154 provides guidance on accounting for and reporting
of accounting changes and error corrections. It requires retrospective
application to prior periods' financial statements, unless it is impracticable
to determine either the specific period effects or the cumulative effect of the
change. The adoption of SFAS No. 154 did not have a material impact on the
Company's consolidated financial statements.
In June 2006, the FASB issued Interpretation No. 48 ("FIN 48") Accounting for
Uncertainty in Income Taxes an interpretation of FASB Statement No. 109 ("SFAS
109"). This interpretation clarifies the accounting for uncertainty in income
taxes recognized in a company's financial statements in accordance with SFAS
109, Accounting for Income Taxes. FIN 48 details how companies should recognize,
measure, present, and disclose uncertain tax positions that have been or are
expected to be taken. As such, financial statements will reflect expected future
tax consequences of uncertain tax positions presuming the taxing authorities'
full knowledge of the position and all relevant facts. We are currently
analyzing the effect of FIN 48 on our financial statements. FIN 48 is effective
for fiscal years beginning after December 15, 2006.
In September 2006, the U.S. Securities and Exchange Commission staff issued
Staff Accounting Bulletin No. 108 ("SAB 108"), Considering the Effects of Prior
Year Misstatements when Quantifying Misstatements in Current Year Financial
Statements. SAB 108 eliminates the diversity of practice surrounding how public
companies quantify financial statement misstatements. It establishes an approach
that requires quantification of financial statement misstatements based on the
effects of the misstatements on each of the company's financial statements and
the related financial statement disclosures. We do not expect SAB 108 to have a
material impact on our financial condition or results of operations. SAB 108
must be applied to annual financial statements for their first fiscal year
ending after November 15, 2006.
In September 2006, the Financial Accounting Standards Board (FASB) issued SFAS
No. 157, Fair Value Measurements ("SFAS No. 157"). This standard clarifies the
principle that fair value should be based on the assumptions that market
participants would use when pricing an asset or liability. Additionally, it
establishes a fair value hierarchy that prioritizes the information used to
develop those assumptions. We have not yet determined the impact that the
implementation of SFAS No. 157 will have on our results of operations or
financial condition. SFAS No. 157 is effective for financial statements issued
for fiscal years beginning after November 15, 2007.
In September 2006, the FASB issued SFAS No. 158, Employers' Accounting for
Defined Benefit Pension and Other Postretirement Plans an amendment of FASB
Statements No. 87, 88, 106, and 132(R) ("SFAS No. 158"). This standard
requires employers to recognize the underfunded or overfunded status of a
defined benefit postretirement plan as an asset or liability in its statement of
financial position and to recognize changes in the funded status in the year in
which the changes occur through accumulated other comprehensive income.
Additionally, SFAS No. 158 requires employers to measure the funded status of a
plan as of the date of its year-end statement of financial position. We are
currently evaluating the impact that the implementation of SFAS No. 158 will
have on our financial statements. The new reporting requirements and related new
footnote disclosure rules of SFAS No. 158 are effective for fiscal years ending
after December 15, 2006. The new measurement date requirement applies for fiscal
years ending after December 15, 2008.
-7-
Note G - Debt
-------------
On March 8, 2006, the Company signed a capital lease in the amount of $68,948
with Citicorp Vendor Finance for the purchase of new lighting equipment at its
Greenwald facility in Chester, Connecticut. The lease has a three year term at
0% interest rate. Payments under the lease are $1,915 per month. The Company was
required to make the initial payment in March 2006, but was not required to make
another payment until the installation of the equipment was completed. As such,
no additional payments have been made. The installation was completed in October
2006 and payments will commence in the fourth quarter of 2006.
On September 22, 2006, the Company amended the unsecured loan agreement ("Loan
Agreement"), which includes a term portion and a revolving credit portion, with
its lender, Bank of America, N.A. The amendment restructures and increases the
balance of the term portion of the loan into a new seven (7) year loan in the
amount of $20,000,000. The restructured term portion is payable in quarterly
payments of $714,286 beginning January 2, 2007. The proceeds were used to repay
in full the outstanding balance of its existing term loan, $12,625,000, and for
the acquisition of Royal Lock.
In addition, the Company increased the maximum amount available under the
revolving credit portion from $7,500,000 to $12,000,000 and renewed and extended
the maturity date to September 22, 2009. The revolving credit portion has a
variable quarterly commitment fee ranging from 0.10% to 0.25% based on operating
results. As of September 30, 2006, the quarterly fee is 0.15% on the unused
portion.
The interest rates on the term and the revolving credit portions of the Loan
Agreement vary. The interest rates may vary based on the LIBOR rate plus a
margin spread of 1.0% to 1.65% for the term portion and 1.0% to 1.6% for the
revolving credit portion. The margin rate spread is based on operating results
calculated on a rolling-four-quarter basis. On September 30, 2006, the interest
rates on the term portion and the revolving credit portion of the Loan Agreement
were 6.62% and 8.25%, respectively.
Also on September 22, 2006, the Company terminated its interest rate swap
contract with the lender. At the time of termination, the notational amount was
$9,468,750, which was equal to 75% of the outstanding balance of the Term Loan
on that date. As a result of the termination, the Company received $73,100 which
was included in other income during the third quarter.
Note H - Goodwill
-----------------
The following is a roll-forward of goodwill:
Beginning balance - December 31, 2005 $ 10,641,532
Royal Lock Acquisition 5,088,828
Foreign exchange 49,357
------------
Ending balance - September 30, 2006 $ 15,779,717
============
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.
-8-
Note I - Retirement Benefit Plans - continued
---------------------------------------------
Significant disclosures relating to these benefit plans for the third quarter
and first nine months of Fiscal 2006 and 2005 follow:
Pension Benefits
----------------
Nine Months Ended Three Months Ended
--------------------------------- ----------------------------------
Sept. 30, 2006 Oct. 1, 2005 Sept. 30, 2006 Oct. 1, 2005
-------------- ------------ -------------- -------------
Service cost $ 1,200,496 $1,010,520 $ 400,164 $ 336,840
Interest cost 1,749,696 1,669,817 583,230 556,606
Expected return on plan assets (2,268,144) (2,037,016) (756,047) (679,005)
Net amortization and deferral 448,931 290,529 149,643 96,843
----------- ---------- ---------- ----------
Net periodic benefit cost $ 1,130,979 $ 933,850 $ 376,990 $ 311,284
=========== ========== ========== ==========
Post-retirement Benefits
------------------------
Nine Months Ended Three Months Ended
--------------------------------- ----------------------------------
Sept. 30, 2006 Oct. 1, 2005 Sept. 30, 2006 Oct. 1, 2005
-------------- ------------ -------------- ------------
Service cost $ 78,805 $ 65,036 $ 35,523 $ 21,678
Interest cost 92,250 88,806 40,138 29,602
Expected return on plan assets (57,452) (59,391) (14,200) (19,797)
Net amortization and deferral (33,020) (58,200) 8,738 (19,399)
----------- ---------- ---------- ----------
Net periodic benefit cost $ 80,583 $ 36,251 $ 70,199 $ 12,084
=========== ========== ========== ==========
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. For 2005, the Company was required to contribute approximately $1.4
million into its salaried plan and approximately $266,000 into one of its hourly
plans. The Company made all of the contributions prior to filing its federal
income tax return on September 15, 2006. For 2006, the Company's is required to
contribute approximately $1.8 million into its salaried plan and approximately
$273,000 into one of its hourly plans. The contributions for 2006 will be made
in 2007, prior to filing the Company's federal tax return on September 15, 2007.
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 $41,326 and $127,581 in the third quarter and first nine months
of 2006, respectively, and $39,614 and $122,327 in the third quarter and first
nine months of 2005, respectively.
Note J - Business Acquisition
-----------------------------
Effective September 25, 2006 the Company acquired certain assets of Royal Lock
Corporation ("Royal") including accounts receivable, inventories, furniture,
fixtures and equipment, intellectual property rights and rights existing under
all sales and purchase agreements. Royal is a supplier of cam locks, switch
locks, padlocks, latches, handles and specialty hardware parts. Its products are
sold to numerous OEM's in several market segments, including automotive,
recreational vehicles and furniture as well as electronics and fabricated metal
parts producers. Royal will be included in the Security Products segment of the
Company. The cost of the acquisition of Royal was $7,025,000, inclusive of
transaction costs, plus the assumption of approximately $775,000 in current
liabilities. The cost of the acquisition is subject to adjustment based on the
final closing net book value and transaction costs.
The above acquisition has been accounted for using the purchase method. The
acquired business is included in the consolidated operating results of the
Company from the date of acquisition. The excess of the cost of the acquired
business over the fair market value of the net assets acquired has been
allocated to goodwill.
Neither the actual results nor the pro forma effects of the acquisition of Royal
are material to the Company's financial statements.
-9-
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 thirty-nine weeks
ended September 30, 2006. 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 December 31, 2005 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 December 31, 2005.
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, 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 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
Net sales for the third quarter of 2006 increased 15% to $31.2 million from
$27.2 million in the third quarter of 2005. Third quarter net income increased
33% to $1.7 million, or $0.28 per diluted share, from $1.3 million, or $0.21 per
diluted share.
Net sales for the first nine months of 2006 increased 10% to $88.7 million from
$80.9 million in the first nine months of 2005. Net income increased 31% to $4.0
million, or $0.69 per diluted share, from $3.1 million, or $0.53 per diluted
share.
Approximately $1.8 million of the sales increase in both the third quarter and
nine month results was from the recent orders received from a military
contractor for door latching components to be used in a project to retro-fit
military Humvees. These orders should result in additional increased sales of
approximately $30 million over the next two quarters.
Raw material prices have increased sharply during 2006, mainly in zinc, brass
and stainless steel, which has had a negative impact on gross margins. The
Company is recovering these increases from our customers, wherever possible.
Currently, there is no indication that the Company will not be able to obtain
supplies of all the materials that it requires.
-10-
Cash flow from operations in the first nine months of 2006 has fallen-off
compared to the same period in 2005, mainly due to the working capital
requirements of the military Humvee retro-fit program. The Company's line of
credit, along with controlling discretionary expenditures, should provide
sufficient cash flow to enable the Company to meet all its existing obligations.
A more detailed analysis of the Company's results of operations and financial
condition follows:
Results of Operations
The following table shows, for the third quarter of 2006 and 2005, selected line
items from the condensed consolidated statements of income as a percentage of
net sales, by segment:
Three Months Ended September 30, 2006
-------------------------------------
Industrial Security Metal
Hardware Products Products Total
---------- -------- -------- -----
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of products sold 73.6% 75.2% 125.5% 78.8%
Gross margin 26.4% 24.8% -25.5% 21.2%
Selling and administrative expense 13.0% 16.1% 11.8% 14.2%
Operating profit 13.4% 8.7% -37.3% 7.0%
Three Months Ended October 1, 2005
----------------------------------
Industrial Security Metal
Hardware Products Products Total
---------- -------- -------- -----
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of products sold 77.1% 70.9% 110.9% 77.6%
Gross margin 22.9% 29.1% -10.9% 22.4%
Selling and administrative expense 14.2% 15.6% 9.7% 14.4%
Operating profit 8.7% 13.5% -20.6% 8.0%
The following table shows the amount of change from the third quarter of 2005 to
the third quarter of 2006 in sales, cost of products sold, gross margin, selling
and administrative expenses and operating profit, by segment (dollars in
thousands):
Industrial Security Metal
Hardware Products Products Total
---------- -------- -------- -----
Net sales $ 2,890 $ 873 $ 239 $ 4,002
Volume 2.9% 6.4% 4.8% 4.6%
Prices 0.0% -0.2% 0.3% -0.1%
New Products 19.3% 1.3% 4.4% 10.2%
---- --- --- ----
22.2% 7.5% 9.5% 14.7%
Cost of products sold $ 1,667 $ 1,164 $ 666 $ 3,497
16.6% 14.1% 24.0% 16.6%
Gross margin $ 1,223 $ (291) $ (427) $ 505
41.0% -8.6% -156.8% 8.3%
Selling and
administrativeexpenses $ 229 $ 207 $ 80 $ 516
12.4% 11.4% 32.6% 13.2%
Operating profit $ 994 $ (498) $ (507) $ (11)
87.4% -31.6% -98.2% -0.5%
-11-
The following table shows, for the first nine months of 2006 and 2005, selected
line items from the condensed consolidated statements of income as a percentage
of net sales, by segment:
Nine Months Ended September 30, 2006
------------------------------------
Industrial Security Metal
Hardware Products Products Total
---------- -------- -------- -----
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of products sold 75.9% 73.5% 104.6% 77.9%
Gross margin 24.1% 26.5% -4.6% 22.1%
Selling and administrative expense 14.1% 16.8% 10.3% 14.8%
Operating profit 10.0% 9.7% -14.9% 7.3%
Nine Months Ended October 1, 2005
---------------------------------
Industrial Security Metal
Hardware Products Products Total
---------- -------- -------- -----
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of products sold 75.7% 72.0% 110.7% 77.7%
Gross margin 24.3% 28.0% -10.7% 22.3%
Selling and administrative expense 14.8% 17.5% 9.9% 15.4%
Operating profit 9.5% 10.5% -20.6% 6.9%
The following table shows the amount of change from the first nine months of
2006 compared to the first nine months of 2005 in sales, cost of products sold,
gross margin, selling and administrative expenses and operating profit, by
segment (dollars in thousands):
Industrial Security Metal
Hardware Products Products Total
---------- -------- -------- -----
Net sales $ 3,401 $ 3,145 $ 1,296 $ 7,842
Volume -0.5% 8.6% 10.3% 4.3%
Prices 0.0% 0.1% 0.5% 0.1%
New Products 9.0% 0.9% 5.2% 5.3%
--- ---- ---- ---
8.5% 9.6% 16.0% 9.7%
Cost of products sold $ 2,625 $ 2,814 $ 861 $ 6,300
8.7% 11.9% 9.6% 10.0%
Gross margin $ 776 $ 331 $ 435 $ 1,542
8.0% 3.6% 50.1% 8.6%
Selling and
administrative expenses $ 230 $ 292 $ 169 $ 691
3.9% 5.1% 21.0% 5.5%
Operating profit $ 546 $ 39 $ 266 $ 851
14.4% 1.1% 15.9% 15.3%
-12-
Industrial Hardware Segment
Net sales in the Industrial Hardware segment were up 22% in the third quarter
and 9% in the first nine months of 2006 compared to the prior year periods. The
sales increase was mainly the result of a new product for the military market
used to retro-fit the military Humvees. Additionally, industrial hardware sales
increases were experienced in the truck accessories and service body markets and
new products. For the year to date period sales of "sleeper boxes" for the Class
8 trailer truck market decreased compared to the same period in 2005, however an
increase in sales of these units was experienced in the third quarter of 2006
compared to the prior year period. The Company expects the sales volume of
"sleeper boxes" to continue to improve during the fourth quarter. In addition,
new products developed using our lightweight honeycomb composites included a
mobile pickup mounted camper shell for emergency vehicle use and a mobile
building door for military use. Other new products included the retro-fit kit
for the military Humvee, a 3 point t-handle assembly and a star wheel rotary
assembly for the truck accessory market, a hidden hinge and a remote magnet
alarm for the service body market and an assortment of handles and latches used
in many of the markets we sell to. All of the new products were developed
internally for the variety of markets we serve.
Our Eastern Industrial (Shanghai) Ltd., manufacturing facility located in
Shanghai, China continues to produce products for our U.S. affiliates and in the
first nine months of 2006 also continued its expansion to increase its shipments
of products to non-affiliated customers. This subsidiary will be instrumental in
helping us to remain price competitive in North America and will open up the
possibility to effectively pursue global markets.
Cost of products sold for the Industrial Hardware segment increased 17% in the
third quarter and 9% in the first nine months of 2006 compared to the prior year
periods. The change in the cost of products sold is primarily the result of
sales volume increases, costs of raw materials, payroll and payroll related
charges and utilities expenses that were experienced during the periods.
Gross margin as a percent of net sales in the third quarter increased from 23%
in 2005 to 26% in 2006 and was comparable at 24% for the first nine months of
both 2005 and 2006. The increase in the third quarter gross margin is due to
higher sales volumes that resulted in more efficient utilization of production
facilities.
Selling and administrative expenses for the third quarter increased 12% and 4%
for nine months compared to the prior year periods due to increases in travel
costs and payroll and payroll related charges.
Security Products Segment
Net sales in the Security Products segment increased 8% in the third quarter and
10% in the first nine months of 2006 compared to 2005 periods. Sales volume in
the third quarter of 2006 was mainly due to increased sales of lock products
compared to the third quarter of 2005. Sales volume increases were experienced
at all of the segment's operating units during the first nine months of 2006
except for commercial laundry products when compared to the prior year. Sales
increases were experienced in many of the markets we service including:
automotive accessories, coin operated machines, gaming, electronics and
enclosures. Sales of new products focused on lock products such as the Super
SesameeTM padlock, an electric car lock set, a remote keyless lock, an L-handle
used on a vehicle roof rack, and cash drawer bill hold down and till assemblies
as well as various other items for the many markets we service. The acquisition
of Royal Lock did not have a material impact on the third quarter or nine month
financial statements because the acquisition was completed during the last week
of the quarter.
Cost of products sold for the Security Products segment was up 14% in the third
quarter and 12% in the first nine months of 2006 compared to the 2005 periods.
Most of the change in cost of products sold was the result of increased sales
volume. Additional factors affecting this segment were increases in raw material
costs, freight costs, payroll and payroll related charges and utilities.
Gross margin as a percentage of sales in the third quarter of 2006 decreased to
25% from 29% in the 2005 period and for the nine month period to 27% from 28%
due to higher manufacturing costs in the 2006 quarter.
-13-
Selling and administrative expenses increased 11% in the third quarter and 5% in
the first nine months of 2006 from 2005 levels. The increases were due to higher
payroll and payroll related charges and advertising expenses which exceeded
reductions in travel and trade show expenses resulting in the overall increase
in 2006.
Metal Products Segment
Net sales in the Metal Products segment were up 10% in the third quarter and 16%
in the first nine months of 2006 as compared to the prior year periods. Sales of
mining products were up 4% in the third quarter of 2006 compared to the third
quarter of 2005 and sales of contract castings increased 16% from the prior year
levels. Sales of both mining products and contract castings were up 16% in the
first nine months of 2006 compared to the first nine months of 2005. New product
sales were primarily a new mine roof anchor for the Canadian mining market and a
large flange nut and a tall domenut for the U.S. mining market. While the
Company expected the installation of the new automatic pouring system for
ductile iron, which was substantially completed in July, to increase efficiency
in producing ductile iron castings, debugging the new automatic pouring systems
and the learning curve associated with the installation took longer than
expected. The Company is also continuing its marketing efforts to sell mine roof
anchors to the China mining industry.
Cost of products sold increased 24% in the third quarter and 10% in the first
nine months of 2006 compared to the same periods in 2005. The change was mainly
due to increases in sales volume, raw materials and payroll and payroll related
charges. Additionally, the spike in the third quarter of 2006 was the result of
production problems during the installation and start-up of the automatic
pouring system which was installed during the quarter. The problems experienced
have been resolved and should result in lower cost of sales resulting from
anticipated improved production efficiency during the fourth quarter of 2006.
Gross margin as a percentage of net sales went from -11% to -26% in the third
quarter of 2006 compared to the 2005 period and improved from -11% in the first
nine months of 2005 to -5% for the first nine months of 2006. The decrease in
the third quarter versus the prior year period was mainly due to the production
problems experienced during the start-up of the new ductile iron automatic
pouring system. The improvement in the nine month period over the prior year is
primarily due to the increased sales volume and the mix of products produced.
Selling and administrative expenses were up 32% in the third quarter and up 21%
for the first nine months of 2006 compared to the same periods in 2005. The
increases were related to increases in payroll and payroll related charges,
advertising expenses, travel expenses and expenses associated with negotiation
of a union contract.
Other Items
Interest expense increased 13% in the third quarter and decreased 3% in the
first nine months of 2006 compared to the prior year periods. The increase in
the third quarter is due to the use of a portion of our revolving loan agreement
for working capital needs, the higher level of debt associated with the loan
agreement amendments in September 2006 and termination of the interest rate swap
agreement. The decrease for the nine month period is due to lower average debt
balances for the period compared to the first nine months of 2005.
Other income increased 289% in the third quarter and 191% from the first nine
months of 2005 to 2006 due to higher cash balances in the Company's cash
management program, which resulted in greater interest income, and termination
of the swap agreement discussed in Note G to the financial statements.
Income taxes - the effective tax rate decreased in the third quarter of 2006 to
17% from the 2005 rate of 37% and for the first nine months of 2006 to 31% from
37% in the first nine months of 2005. The decrease in the effective tax rate in
2006 is the result of favorable tax provision adjustments. Without these tax
adjustments, the effective tax rate would have approximated the prior year rate
of 37%.
-14-
Liquidity and Sources of Capital
The Company generated $2.4 million of cash from operations for the first nine
months of 2006 compared to $3.4 million for the same period in 2005. The
change in cash flows was mainly the result of timing differences for
collections of accounts receivable and payments of liabilities and changes in
inventories. Cash flow from operations coupled with cash on hand at the
beginning of the year and draw-downs on the revolving loan were sufficient to
fund capital expenditures, debt service, incentive payments, contributions to
the Company's pension plans, and dividend payments. At the end of September
2006, the draw-down on the revolving loan was approximately $305,000.
Additional borrowing under the amended loan agreement discussed in Note G to
the financial statements was used to fund the acquisition of Royal Lock.
Additions to property, plant and equipment were $3.4 million during the first
nine months of 2006 versus $1.3 million for the comparable period in the prior
year. Total capital expenditures for 2006 are expected to be in the range of
$3.5 million to $4.5 million.
Total inventories as of September 30, 2006 were $25.6 million, compared to
$20.8 million at year-end 2005. The inventory turnover ratio of 3.6 turns at
the end of the third quarter was slightly lower than both the prior year third
quarter and year-end 2005 ratio of 4.1 turns. The increase in inventory is a
result of the Royal Lock acquisition, increased business in the United States
and at our facility in Shanghai, China and ramping up production for the
Humvee retro-fit project. Accounts receivable increased by $4.1 million from
year end 2005, primarily due to the Royal Lock acquisition as well as
increased sales volume. The average days sales in accounts receivable for the
third quarter of 2006 was 55 days compared to 47 days in the third quarter of
2005 and 49 days at year end 2005.
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.
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to interest rate risk with respect to its unsecured
Loan Agreement, which was amended during the third quarter, and provides for
interest based on LIBOR plus a spread of up to 1.65%. The spread is determined
by a comparison of the Company's operating performance with agreed-upon
financial targets. Since the Company's performance depends to a large extent
on the overall economy, the interest rate paid by the Company under its Loan
Agreement is closely linked to the trend in the U.S. economy. The current
interest rate spread is 1.25% on the term loan portion and on the revolving
credit line portion of the Loan Agreement. Changes in LIBOR rates will also
affect the Company's interest expense.
The balance of the term debt is subject to the volatility of short-term
interest rates, where a 1% change in interest rates would cause a $189,000
increase or decrease in the Company's annual interest cost. The Company is
currently evaluating the establishment of a new interest rate swap as a means
of hedging future interest rate increases.
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 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
-15-
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
There are no material pending 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 1A - RISK FACTORS
There have been no material changes in risk factors from what was reported in
the 2005 Annual Report on Form 10-K.
ITEM 2 - UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
There have been no sales of unregistered securities by the Company or purchases
of registered equity securities by the Company during the period covered by this
report.
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 1, 2006.
ITEM 5 - OTHER INFORMATION
None
-16
ITEM 6 - EXHIBITS
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 December 31, 2005 is incorporated herein by reference.
99(2)) Form 8-K filed on April 26, 2006 setting forth the press
release reporting the Company's earnings for the quarter ended April
1, 2006 is incorporated herein by reference.
99(3)) Form 8-K filed on July 26, 2006 setting forth the press release
reporting the Company's earnings for the quarter ended July 1, 2006 is
incorporated herein by reference.
99(4)) Form 8-K filed on September 6, 2006 setting forth a purchase
order for approximately $15.5 million is incorporated herein by
reference.
99(5)) Form 8-K filed on September 25, 2006 setting forth the press
release reporting the Acquisition of Royal Lock Corporation and the
Amended Loan Agreement is incorporated herein by reference.
99(6)) Form 8-K filed on September 27, 2006 setting forth an addendum
to a purchase order for an additional approximate $16 million is
incorporated herein by reference.
99(7)) Form 8-K filed on September 28, 2006 setting forth the press
release announcing a three-for-two stock split of the Company's common
shares is incorporated herein by reference.
99(8)) Form 8-K filed on October 25, 2006 setting forth the press
release reporting the Company's earnings for the quarter ended
September 30, 2006 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: October 31, 2006 /s/Leonard F. Leganza
---------------- ---------------------
Leonard F. Leganza
President and Chief Executive Officer
DATE: October 31, 2006 /s/John L. Sullivan III
---------------- -----------------------
John L. Sullivan III
Vice President, Secretary and Treasurer
-17-