UNITED STATES 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 2, 2005 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM to . Commission File Number 0-599 ----- THE EASTERN COMPANY ------------------- (Exact Name of Registrant as specified in its charter) Connecticut 06-0330020 ----------- ---------- (State or other jurisdiction of (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) 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 2, 2005 ----- ------------------------------ Common Stock, No par value 3,637,192 -1-
PART I FINANCIAL INFORMATION THE EASTERN COMPANY AND SUBSIDIARIES ITEM I CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED) ------ ------------------------------------------------- <TABLE> <CAPTION> ASSETS July 2, 2005 January 1, 2005 ------ ------------ --------------- <S> <C> <C> CURRENT ASSETS Cash and cash equivalents $ 4,138,342 $ 4,420,506 Accounts receivable, less allowances: 2005 - $337,000; 2004 - $332,000 14,339,511 12,528,189 Inventories 20,385,825 20,477,604 Prepaid expenses and other assets 2,034,354 2,258,642 Deferred income taxes 834,400 739,500 ------------- ------------- Total Current Assets 41,732,432 40,424,441 Property, plant and equipment 42,875,872 42,031,257 Accumulated depreciation (19,743,258) (18,124,710) ------------- ------------- 23,132,614 23,906,547 Goodwill 10,585,793 10,604,286 Trademarks 174,527 174,527 Patents, technology and licenses, less accumulated amortization 1,743,914 1,743,266 Intangible pension asset 870,064 870,064 Prepaid pension cost 332,336 348,634 ------------- ------------- TOTAL ASSETS $ 78,571,680 $ 78,071,765 ============= ============= LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES Accounts payable $ 5,758,362 $ 5,010,271 Accrued compensation 1,192,558 2,472,944 Other accrued expenses 1,954,086 2,239,668 Current portion of long-term debt 2,515,100 4,009,811 ------------- ------------- Total Current Liabilities 11,420,106 13,732,694 Deferred income taxes 1,803,473 1,452,134 Long-term debt, less current portion 14,095,972 11,804,861 Accrued post-retirement benefits 2,137,321 2,219,821 Accrued pension cost 4,170,440 4,885,160 Interest rate swap obligation -- 160,417 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: 5,325,918 shares in 2005 and 5,323,593 shares in 2004 17,634,978 17,583,561 Treasury Stock: 1,688,726 shares in 2005 and 2004 (16,655,041) (16,655,041) Retained earnings 48,582,747 47,568,571 Accumulated other comprehensive (loss)/income: Foreign currency translation 429,484 463,804 Additional minimum pension liability, net of taxes (5,047,800) (5,047,800) Derivative financial instruments, net of taxes -- (96,417) ------------- ------------- Accumulated other comprehensive loss (4,618,316) (4,680,413) ------------- ------------- TOTAL SHAREHOLDERS' EQUITY 44,944,368 43,816,678 ------------- ------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 78,571,680 $ 78,071,765 ============= ============= </TABLE> See accompanying notes. -2-
THE EASTERN COMPANY AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) <TABLE> <CAPTION> Six Months Ended Three Months Ended July 2, 2005 July 3, 2004 July 2, 2005 July 3, 2004 ------------ ------------ ------------ ------------ <S> <C> <C> <C> <C> Net sales $53,688,878 $49,863,172 $27,421,294 $25,297,964 Cost of products sold (41,766,852) (37,678,125) (20,969,162) (19,248,063) ----------- ----------- ----------- ----------- Gross margin 11,922,026 12,185,047 6,452,132 6,049,901 Selling and administrative expenses (8,547,685) (8,719,356) (4,493,691) (4,547,870) ----------- ----------- ----------- ----------- Operating profit 3,374,341 3,465,691 1,958,441 1,502,031 Interest expense (523,257) (545,568) (276,315) (269,171) Other income 23,672 9,860 16,170 2,048 ----------- ----------- ----------- ----------- INCOME BEFORE INCOME TAXES 2,874,756 2,929,983 1,698,296 1,234,908 Income taxes 1,060,785 1,092,884 614,907 474,182 ----------- ----------- ----------- ----------- NET INCOME $ 1,813,971 $ 1,837,099 $ 1,083,389 $ 760,726 =========== =========== =========== =========== Earnings per share: Basic $ 0.50 $ 0.51 $ 0.30 $ 0.21 Diluted $ 0.47 $ 0.49 $ 0.28 $ 0.20 Cash dividends per share $ 0.22 $ 0.22 $ 0.11 $ 0.11 </TABLE> See accompanying notes. THE EASTERN COMPANY AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED) <TABLE> <CAPTION> Six Months Ended Three Months Ended July 2, 2005 July 3, 2004 July 2, 2005 July 3, 2004 ------------ ------------ ------------ ------------ <S> <C> <C> <C> <C> Net income $ 1,813,971 $ 1,837,099 $ 1,083,389 $ 760,726 Other comprehensive income (loss) Currency translation (34,320) (135,464) 7,760 (166,194) Change in fair value of derivative financial instruments, net of income tax benefit: 2005 - ($64,000) and ($23,000) respectively 96,417 - 60,948 - 2004 - ($100,000) and ($59,000) respectively; - 149,367 - 88,924 ----------- ----------- ----------- ----------- Comprehensive income $ 1,876,068 $ 1,851,002 $ 1,152,097 $ 683,456 =========== =========== =========== =========== </TABLE> See accompanying notes. -3-
THE EASTERN COMPANY AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) <TABLE> <CAPTION> Six Months Ended July 2, 2005 July 3, 2004 ------------ ------------ OPERATING ACTIVITIES: <S> <C> <C> Net income $ 1,813,971 $ 1,837,099 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 1,782,112 1,796,237 Provision for doubtful accounts 5,022 5,438 Deferred income taxes 192,439 - Issuance of Common Stock for directors' fees 51,417 39,010 Gain on sales of equipment and other assets - (3,487) Changes in operating assets and liabilities: Accounts receivable (1,815,594) (2,664,889) Inventories 92,969 (396,463) Prepaid expenses and other 208,669 10,563 Prepaid pension cost (698,422) 223,825 Accounts payable 752,789 2,301,548 Accrued compensation (1,198,515) (67,866) Other accrued expenses (440,349) (662,139) Other assets (111,545) (49,651) ----------- ----------- NET CASH PROVIDED BY OPERATING ACTIVITIES 634,963 2,369,225 INVESTING ACTIVITIES: Proceeds from sale of equipment - 3,487 Purchases of property, plant, and equipment (920,031) (1,129,434) ----------- ----------- NET CASH USED BY INVESTING ACTIVITIES (920,031) (1,125,947) FINANCING ACTIVITIES: Proceeds from issuance of short-term debt 3,000,000 - Principal payments on long-term debt (2,203,599) (1,306,028) Proceeds from sale of Common Stock - 172,300 Dividends paid (799,795) (797,036) ----------- ----------- NET CASH USED BY FINANCING ACTIVITIES (3,394) (1,930,764) Effect of exchange rate changes on cash 6,298 511 ----------- ----------- NET CHANGE IN CASH AND CASH EQUIVALENTS (282,164) (686,975) Cash and Cash Equivalents at Beginning of Period 4,420,506 4,896,816 ----------- ----------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 4,138,342 $ 4,209,841 =========== =========== </TABLE> -4-
THE EASTERN COMPANY NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) JULY 2, 2005 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 1, 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. 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 balance sheet as of January 1, 2005 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: <TABLE> <CAPTION> Six Months Ended Three Months Ended July 2, 2005 July 3, 2004 July 2, 2005 July 3, 2004 ------------ ------------ ------------ ------------ <S> <C> <C> <C> <C> Denominator for basic earnings per share 3,635,546 3,622,926 3,636,100 3,628,818 ========= ========= ========= ========= Diluted: Weighted average shares outstanding 3,635,546 3,622,926 3,636,100 3,628,818 Dilutive stock options 240,690 103,095 248,959 109,488 --------- ---------- --------- --------- Denominator for diluted earnings per share 3,876,236 3,726,021 3,885,059 3,738,306 ========= ========= ========= ========= </TABLE> Note C - Inventories The components of inventories follow: July 2, 2005 January 1, 2005 ------------ --------------- Raw materials and component parts $11,232,589 $11,279,981 Work in process 3,649,063 3,670,812 Finished goods 5,504,173 5,526,811 ----------- ----------- $20,385,825 $20,477,604 =========== =========== -5-
Note D - Segment Information Segment financial information follows: <TABLE> <CAPTION> SIX MONTHS ENDED THREE MONTHS ENDED July 2, 2005 July 3, 2004 July 2, 2005 July 3, 2004 ------------ ------------ ------------ ------------ <S> <C> <C> <C> <C> Revenues: Sales to unaffiliated customers: Industrial Hardware $26,837,746 $22,155,810 $13,817,476 $11,243,606 Security Products 21,233,164 21,098,894 11,211,588 10,633,178 Metal Products 5,617,968 6,608,468 2,392,230 3,421,180 ----------- ----------- ----------- ----------- $53,688,878 $49,863,172 $27,421,294 $25,297,964 =========== =========== =========== =========== Income Before Income Taxes: Industrial Hardware $ 2,646,857 $ 2,029,078 $ 1,341,197 $ 971,760 Security Products 1,885,274 1,514,998 1,004,870 462,008 Metal Products (1,157,790) (78,385) (387,626) 68,263 ----------- ----------- ----------- ----------- Operating Profit 3,374,341 3,465,691 1,958,441 1,502,031 Interest expense (523,257) (545,568) (276,315) (269,171) Other income 23,672 9,860 16,170 2,048 ----------- ----------- ----------- ----------- $ 2,874,756 $ 2,929,983 $ 1,698,296 $ 1,234,908 =========== =========== =========== =========== </TABLE> 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. No options were granted during the first six months of 2005 or 2004. <TABLE> <CAPTION> SIX MONTHS ENDED THREE MONTHS ENDED July 2, 2005 July 3, 2004 July 2, 2005 July 3, 2004 ------------ ------------ ------------ ------------ <S> <C> <C> <C> <C> Net income, as reported $1,813,971 $1,837,099 $1,083,389 $760,726 Deduct: Total stock-based employee ------- compensation expense determined under fair value based method for all awards granted, net of related tax effects (876) (8,952) (438) (4,476) ---------- ---------- ---------- -------- Pro forma net income $1,813,095 $1,828,147 $1,082,951 $756,250 ========== ========== ========== ======== Earnings per share: Basic-as reported $ 0.50 $ 0.51 $ 0.30 $ 0.21 Basic-pro forma $ 0.50 $ 0.50 $ 0.30 $ 0.21 Diluted-as reported $ 0.47 $ 0.49 $ 0.28 $ 0.20 Diluted-pro forma $ 0.47 $ 0.49 $ 0.28 $ 0.20 </TABLE> 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 In November 2004, the FASB issued Statement of Financial Accounting Standards ("SFAS") No. 151, Inventory Costs, an amendment of ARB No. 43, Chapter 4. The amendments made by SFAS No. 151 clarify that abnormal amounts of idle facility expense, freight, handling costs, and wasted materials (spoilage) should be recognized as current-period charges and require the allocation of fixed production overheads to inventory based on the normal capacity of the production facilities. The guidance is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. It is not believed that the adoption of SFAS No. 151 will have a material impact on the consolidated financial position, results of operations or cash flows of the Company. In December 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based Payment. SFAS No. 123(R) will require that the compensation cost relating to share-based payment transactions be recognized in financial statements. That cost will be measured based on the fair value of the equity or liability instruments issued. SFAS No. 123(R) covers a wide range of share-based compensation arrangements including share options, restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans. SFAS No. 123(R) replaces FASB Statement No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees. SFAS No. 123, as originally issued in 1995, established as preferable a fair value-based method of accounting for share-based payment transactions with employees. However, that Statement permitted entities the option of continuing to apply the guidance in APB Opinion No. 25, as long as the footnotes to financial statements disclosed what net income would have been had the preferable fair value-based method been used. Public entities will be required to apply SFAS No. 123(R) as of their next fiscal year that begins after June 15, 2005. SFAS No. 123(R) permits public companies to adopt its requirements using one of two methods: 1) A "modified prospective" method in which compensation cost is recognized beginning with the effective date (a) based on the requirements of SFAS No. 123(R) for all share-based payments granted after the effective date and (b) based on requirements of SFAS No. 123 for all awards granted to employees prior to the effective date of SFAS No. 123(R) that remain unvested on the effective date. 2) A "modified retrospective" method which includes the requirements of the modified prospective method described above, but also permits entities to restate based on the amount previously recognized under SFAS No. 123 for purpose of pro forma disclosures either (a) all prior periods presented or (b) prior interim periods of the year of adoption. The impact of the adoption of Statement 123(R) cannot be predicted at this time because it will depend on levels of share-based payments granted in the future. However, had the Company adopted Statement 123(R) in prior periods, the impact of that standard would have approximated the impact of Statement 123 as described in the disclosure of pro forma net income and net income per share in the stock based compensation accounting policy note included in Note E to the consolidated financial statements. In December 2004, the FASB issued FSP No. FAS 109-2, Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004 ("AJCA"). The AJCA provides a one-time 85% dividends received deduction for certain foreign earnings that are repatriated under a plan for reinvestment in the United States, provided certain criteria are met. FSP No. 109-2 is effective immediately and provides accounting and disclosure guidance for the repatriation provision. FSP No. 109-2 allows companies additional time to evaluate the effects of the law on its unremitted earnings for the purpose of applying the "indefinite reversal criteria" under APB Opinion No. 23, Accounting for Income Taxes - Special Areas, and requires explanatory disclosures from companies that have not yet completed the evaluation. The Company is currently evaluating the effects of the repatriation provision and its impact on the consolidated financial statements. The Company does not expect to complete this evaluation before the end of 2005. The range of possible amounts of unremitted earnings that is being considered for repatriation under this provision is between zero and $500,000. The related potential range of income tax is between zero and $84,000. -7-
Note G - Goodwill The following is a roll-forward of goodwill from year-end 2004 to the end of the second quarter: Beginning balance - January 1, 2005 $ 10,604,286 Foreign exchange (18,493) ------------ Ending balance - July 2, 2005 $ 10,585,793 ============ Note H - Debt On August 1, 2005, the Company amended the Loan Agreement with its lender. The amendment renewed and extended the maturity of the Revolving Credit Loan from July 1, 2005 to August 1, 2007 and restructured and increased the existing balance of the Term Loan into a new five (5) year term loan in the amount of $15,725,000. The $4,000,000 proceeds from the term loan were used to pay down the balance on the revolving credit agreement. Repayments under the new term loan are required on a quarterly basis with $700,000 due in October 2005, $800,000 beginning in January 2006 through April 2010 and a final payment due July 1, 2010 of $625,000. The balance sheet as of July 2, 2005 has been modified to reflect the amended loan agreement. 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 2005 and 2004 follow: <TABLE> <CAPTION> Pension Benefits ---------------- Six Months Ended Three Months Ended July 2, 2005 July 3, 2004 July 2, 2005 July 3, 2004 ------------ ------------ ------------ ------------ <S> <C> <C> <C> <C> Service cost $ 673,680 $ 590,160 $ 336,840 $ 295,905 Interest cost 1,113,211 1,142,757 566,606 571,168 Expected return on plan assets (1,358,011) (1,299,371) (679,005) (649,360) Transition obligation (90,223) (102,197) (45,111) (51,098) Prior service cost 98,490 98,490 49,245 49,245 Losses recognized 185,419 176,224 92,709 87,028 ---------- ---------- ---------- ---------- Net periodic benefit cost $ 622,566 $ 606,063 $ 321,284 $ 302,888 ========== ========== ========== ========== </TABLE> <TABLE> <CAPTION> Postretirement Benefits ----------------------- Six Months Ended Three Months Ended July 2, 2005 July 3, 2004 July 2, 2005 July 3, 2004 ------------ ------------ ------------ ------------ <S> <C> <C> <C> <C> Service cost $ 43,358 $ 58,031 $ 21,679 $ 13,945 Interest cost 59,204 88,496 29,720 17,480 Expected return on plan assets (39,594) (51,920) (19,521) (10,797) Transition obligation 0 0 0 0 Prior service cost (19,953) (20,924) (9,976) (9,491) Losses recognized (18,848) (34,876) (9,088) (5,514) ---------- ---------- ---------- ---------- Net periodic benefit cost $ 24,167 $ 38,807 $ 12,814 $ 5,623 ========== ========== ========== ========== </TABLE> -8-
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 the 2004 plan year the Company was required to contribute $1,258,029 into its salaried plan and $208,159 into one of its hourly plans. The Company has paid all of the required contributions into the salaried plan as of March 31, 2005 and will make the minimum contribution into its hourly plan prior to filing its federal income tax return on September 15, 2005. For the 2005 plan year the Company is required to make quarterly contributions to one of its hourly plans. As of June 30, 2005, the Company was required to make one payment of $52,040 which was made in April 2005. An additional required payment of $52,040 was made in July 2005. On December 8, 2003, the "Medicare Prescription Drug Improvement and Modernization Act of 2003" (the "Act") was signed into law. The Act introduces a prescription drug benefit under Medicare as well as a federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that is at least "actuarially equivalent" to Medicare Part D. In the second quarter of 2004, a FASB Staff Position (FSP FAS 106-2, Accounting and Disclosure Requirements Related to the Medicare Prescription Drug Improvement and Modernization Act of 2003) was issued providing guidance on the accounting for the effects of the Act for employers that sponsor postretirement health care plans that provide prescription drug benefits. This FSP superceded FSP FAS 106-1, Accounting and Disclosure Requirements Related to the Medicare Prescription Drug Improvement and Modernization Act of 2003. The FSP is effective for the first interim or annual period beginning after June 15, 2004. The guidance in this FSP applies only to the sponsor of a single-employer defined benefit postretirement health plan for which the employer has concluded that prescription drug benefits available under the plan are actuarially equivalent and, thus, qualify for the subsidy under the Act and the expected subsidy will offset or reduce the employer's share of the costs of postretirement prescription drug coverage by the plan. The Company's actuary has estimated the impact of the Medicare Prescription Drug Improvement and Modernization Act of 2003, which resulted in a reduction in the December 31, 2004 accumulated postretirement benefit obligation ("APBO") by $52,668. This reduction has been reflected as an actuarial experience gain as of December 31, 2004, and the December 31, 2004 APBO has been reduced accordingly. The Company has a contributory savings plan under Section 401(k) of the Internal Revenue Code covering substantially all U.S. non-union employees. The plan allows participants to make voluntary contributions of up to 100% of their annual compensation on a pretax basis, subject to IRS limitations. The plan provides for contributions by the Company at its discretion. The Company made contributions of $42,313, and $82,713 in the second quarter and first six months of 2005 respectively, and $38,578 and $75,692 in the second quarter and first six months of 2004, respectively. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS ITEM 2 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 2, 2005. 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 1, 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 January 1, 2005. -9-
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 2005 the Company experienced a 8.4% increase in sales as compared to the second quarter of 2004. The Industrial Hardware and the Security Products segments experienced a 22.9% and 5.4%, respectively, increase in sales during the period while the sales of the Metal Products segment declined 30.1% from the comparable quarter of 2004. Sales for the first half of 2005 were up 7.7% compared to the same period a year ago. The Industrial Hardware and the Security Products segments experienced increases in sales of 21.1% and 0.6%, respectively, while the sales of the Metal Products segment declined 15.0% as compared to the first half of 2004. The following table shows the changes in the second quarter of 2005 compared to the second quarter of 2004 in selected results, by segment (dollars in thousands): <TABLE> <CAPTION> Industrial Security Metal Hardware Products Products Total ---------- -------- -------- ----- <S> <C> <C> <C> <C> Sales $ 2,574 $ 578 $ (1,029) $ 2,123 Volume 19.0% 3.7% -29.6% 6.0% Prices 3.0% 0.0% -0.5% 1.3% New Products 0.9% 1.7% 0.0% 1.1% ---- ---- ---- ---- 22.9% 5.4% -30.1% 8.4% Gross margin $ 534 $ 207 $ (339) $ 402 18.5% 7.1% -326.7% 6.6% Operating profit $ 369 $ 543 $ (456) $ 456 38.0% 117.5% -667.8% 30.4% </TABLE> -10-
The following table shows the changes in the first six months of 2005 compared to the first six months of 2004 in selected results, by segment (dollars in thousands): <TABLE> <CAPTION> Industrial Security Metal Hardware Products Products Total ---------- -------- -------- ----- <S> <C> <C> <C> <C> Sales $ 4,682 $ 134 $ (990) $ 3,926 Volume 17.0% -1.0% -13.8% 5.4% Prices 3.3% 0.0% -1.2% 1.3% New Products 0.8% 1.6% 0.0% 1.0% ---- ---- ---- ---- 21.1% 0.6% -15.0% 7.7% Gross margin $ 871 $ (193) $ (941) $ (263) 15.0% -3.2% -273.3% -2.2% Operating profit $ 618 $ 370 $(1,079) $ (91) 30.4% 24.4% -1,377.1% -2.6% </TABLE> The Industrial Hardware sales increase came from both distributor and original equipment manufacturers (OEM's) as the result of a continued improvement in the economy, particularly in the manufacturing sector. Sales increased 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 sleeper boxes, particularly for Freightliner's Western Star tractor-trailer line of trucks. The sales increase in the Security Products segment came as a result of improved sales to the commercial laundry industry compared to the prior year, mainly smart card systems used in a retrofit program. Sales of lock products in total were comparable to the prior year, with increased sales of the SearchAlertTM lock to the travel industry, locks used for industrial enclosures and the automotive accessory markets being offset by decreased sales to the furniture, gaming and computer markets. Sales in the Metal Products segment were lower in both mine roof products and contract casting products for both the second quarter and first half of 2005 compared to the 2004 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 down as the result of offshore pricing competition. During 2004, the Company entered into a technical agreement with the China University of Mining and Technology for the field-testing and eventual marketing of the Company's mechanical anchor systems, which are used to secure the roofs in underground mines. Now that these tests have been substantially and successfully completed, we are actively marketing our mine roof support products to penetrate the mining market in China. Raw material prices have leveled off for the most part and the Company was successful in passing on to our customers, where possible, these increases. 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 2005 was improved over the first quarter and has tightened compared to the second quarter of 2004. The Company has experienced an increase in sales resulting in the need for additional working capital, primarily due to the timing of accounts receivable collections and payment of accounts payable. The Company's line of credit, along with controlling discretionary expenditures, should provide sufficient cash flow to meet all existing obligations. -11-
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. <TABLE> <CAPTION> Six Months Ended Three Months Ended ---------------- ------------------ July 2, 2005 July 3, 2004 July 2, 2005 July 3, 2004 ------------ ------------ ------------ ------------ <S> <C> <C> <C> <C> Net sales 100.0% 100.0% 100.0% 100.0% Cost of products sold 77.8% 75.6% 76.5% 76.1% ----- ----- ----- ----- Gross margin 22.2% 24.4% 23.5% 23.9% Selling and administrative expense 15.9% 17.4% 16.4% 17.9% Interest expense 0.9% 1.1% 1.0% 1.1% ---- ---- ---- ---- Income before income taxes 5.4% 5.9% 6.1% 4.9% Income taxes 2.0% 2.2% 2.2% 1.9% ---- ---- ---- ---- Net Income 3.4% 3.7% 3.9% 3.0% ==== ==== ==== ==== </TABLE> Net income for the second quarter of 2005 was $1.1 million or $.28 per diluted share on sales of $27.4 million compared to net income of $760,700 or $.20 per diluted share on sales of $25.3 million in the second quarter of 2004. Net income for the first six months of 2005 was $1.8 million or $.47 per diluted share on sales of $53.7 million compared to net income of $1.8 million or $.49 per diluted share on sales of $49.9 million in the 2004 period. Sales for the second quarter 2005 were up 8.4% compared to the same period a year ago. New product sales contributed 1.1%, sales volume of existing products increased 6.0% and prices increased 1.3% in the second quarter. Sales for the first half of 2005 were up 7.7% compared to the same period a year ago. Sales volume of existing products was up 5.4% and new product sales were up 1.0%, while prices increased 1.3%. The Industrial Hardware segment's second quarter sales were up 22.9% compared to the second quarter of 2004. New product sales increased 0.9%, sales volume of existing products increased 19.0% and prices were up 3.0%. New products include a push button assembly and mini rotary lock, both of which are used in the truck accessory market, a trailer ramp for the recreational vehicle market, as well as a variety of latches and handles sold through our distributor network. Sales of "sleeper boxes" for the class-8 truck market were up 73.1%. For the first half of 2005, sales were up 21.1% compared to the same period in 2004. New product sales increased 0.8%, sales volume of existing products increased 17.0% and prices were up 3.3%. The Company anticipates continued sales improvement in the Industrial Hardware segment throughout 2005. Our Eastern Industrial (Shanghai) Ltd., manufacturing facility located in Shanghai, China continues to produce 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. In addition to producing fabricated metal and plastic injection molding products, Eastern Industrial will be adding zinc die-casting capabilities in 2005. It will also serve as a sourcing center for products that do not compete directly against our North American based operations. The Security Products segment's sales were up 5.4% in the second quarter of 2005 as compared to the second quarter of 2004. New product sales increased 1.7% and sales volume of existing products increased 3.7%. Sales of new products included brackets, a sliding cover handle and a toolbox push button lock for the automotive accessory market. For the first half of 2005, sales were up 0.6% compared to the same period in 2004. New product sales increased 1.6% and sales volume of existing products decreased 1.0%. The Company anticipates continued sales improvement in the Security Products segment throughout 2005. -12-
The Metal Products segment's sales were down 30.1% in the second quarter of 2005 as compared to the second quarter of 2004. Sales volume of existing products was down 29.6% and prices declined 0.5%. Sales of our contract casting products for use in the commercial and industrial construction industry decreased 49.0% and sales of our proprietary mine roof support anchors were down 18.4% for the second quarter of 2005 as compared to the second quarter of 2004. The decrease in sales of contract castings during the second quarter was due to offshore price competition. 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. For the first half of 2005, sales were down 15.0% compared to the same period in 2004. Sales volume of existing products decreased by 13.8% and prices decreased by 1.2%. Sales of our contract casting products for use in the commercial and industrial construction industry decreased 32.5% and sales of our proprietary mine roof support anchors were down 5.4% for the first six months of 2005 as compared to the first six months of 2004. The Company is continuing its efforts to penetrate the China mining market with its mechanical anchors used in mine roof support. Several large government mines in China, where our mine roof supports have been tested successfully, have shown an interest in products and are currently evaluating their use within these mines. Barring any breakthroughs in the China mining market, sales for 2005 are expected to approximate prior year levels. Gross margin as a percentage of sales for the three and six month periods ended July 2, 2005 was 23.5% and 22.2%, respectively, compared to 23.9% and 24.4% in the comparable periods a year ago. The decrease in gross margin for both the second quarter and six months is primarily the result of product mix, decreased sales volume in the metal products segment which resulted in lower plant utilization, some price erosion due to competitive pressures, higher raw material costs that could not be passed along to customers, higher utility costs, and higher payroll and payroll related charges. Selling and administrative expenses were down 1.2% or $54,200 for the second quarter of 2005 and down 2.0% or $171,700 for the first six months of 2005 as compared to the same periods a year ago. The decrease was due to a patent infringement suit, which was settled in the second quarter of 2004, offset by higher expenses in 2005 for travel, deferred compensation, payroll and payroll related charges. Interest expense increased by $7,100 or 2.7% for the second quarter of 2005 and decreased by $22,300 or 4.1% for the first half of 2005 as compared to the same periods in 2004. This increase in interest expense for the second quarter was due to higher levels of debt resulting from a draw down of $3.0 million on the Company's revolving loan in 2005. The decrease in the six-month period was due to lower average debt over the period compared to the previous year. Earnings before income taxes for the three months ended July 2, 2005 was up $463,400 or 37.5% and for the six months ended July 2, 2005 was down $55,200 or 1.9% as compared to the same periods of 2004. The Industrial Hardware segment was up 38.0% or $369,400, the Security Products segment was up $542,900 or 117.5% and the Metal Products segment was down $455,900 or 667.8% as compared to the second quarter of 2004. For the first half of 2005, the Industrial Hardware segment was up 30.4% or $617,800, the Security Products segment was up $370,300 or 24.4% and the Metal Products segment was down $1.1 million as compared to the same period of 2004. The increases in the Industrial Hardware segment reflect the continued overall improvement in the manufacturing sector economy in 2005, increased market share and the introduction of new products. The overall increase in the Security Products segment was mainly due to the non-recurring legal fees and settlement of a patent infringement suit in 2004, increases created by the general overall improvement in the economy in 2005 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 and increased offshore pricing competition. The effective tax rate of 36.9% for the first six months is lower than the 37.3% for the same period in 2004. The decrease in the effective tax rate is the result of the Company deriving a higher percentage of its earnings from countries with lower effective tax rates. -13-
Liquidity and Sources of Capital The Company provided $646,300 from operations for the first six months of 2005 compared to $2.4 million provided from operations for the same period in 2004. 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 and a draw down of $3.0 million on the Company's revolving loan were sufficient to fund capital expenditures, debt service, contributions to the Company's pension plans, and dividend payments. On August 1, 2005, the Company amended the Loan Agreement with its lender. The Company added an additional $4,000,000 to its term loan and used the proceeds to reduce the balance on the revolving credit loan. See Note H for additional details concerning this amendment. Additions to property, plant and equipment were $931,400 during the first six months of 2005 versus $1.1 million for the comparable period in 2004. Total capital expenditures for 2005 are expected to be in the range of $2.0 million to $3.0 million. Total inventories as of July 2, 2005 were $20.4 million as compared to $20.5 million at year-end 2004. The inventory turnover ratio of 4.1 turns at the end of the second quarter was slightly lower than the prior year second quarter of 4.4 turns and slightly higher than the year end 2004 ratio of 3.7 turns. Accounts receivable increased by $1.8 million from year end 2004, primarily due to increased sales volume. The average days sales in accounts receivable for the second quarter of 2005 was 48 days compared to 49 days in the second quarter of 2004 and 47 days at the end of Fiscal 2004. 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 - ------ ---------------------------------------------------------- There have been no material changes in market risk from what was reported in the 2004 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. -14-
PART II OTHER INFORMATION ITEM 1 LEGAL PROCEEDINGS - - ------ ------------------- There are no 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 UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS - ------ ----------------------------------------------------------- None 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 2, 2005. ITEM 5 OTHER INFORMATION - ------ ----------------- None 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 January 1, 2005 is incorporated herein by reference. 99(2)) Form 8-K filed on April 27, 2005 setting forth the press release reporting the Company's earnings for the quarter ended April 2, 2005 is incorporated herein by reference. 99(3)) Form 8-K filed on July 18, 2005 disclosing the change in the Company's Independent Registered Public Accounting Firm from Ernst & Young LLP to UHY LLP. 99(4)) Form 8-K filed on July 27, 2005 setting forth the press release reporting the Company's earnings for the quarter ended July 2, 2005 is incorporated herein by reference. -15-
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 3, 2005 /s/Leonard F. Leganza -------------- --------------------- Leonard F. Leganza President and Chief Executive Officer DATE: August 3, 2005 /s/John L. Sullivan, III -------------- ------------------------ John L. Sullivan, III Vice President, Secretary and Treasurer -16-