EML US Equity☆

ITEM 7 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The Company’s fiscal year ends on the Saturday nearest to December 31. Fiscal year 2020 was 53 weeks in length and fiscal year 2019 was 52 weeks in length. References in this Management’s Discussion and Analysis of Financial Condition and Results of Operations to results for “2020” or “fiscal year 2020” mean the fiscal year ended January 2, 2021, and references to results for “2019” or “fiscal year 2019” mean the fiscal year ended December 28, 2019. References to the “fourth quarter of 2020” or the “fourth fiscal quarter of 2020” mean the thirteen-week period from October 4, 2020 to January 2, 2021, and references to the “fourth quarter of 2019” or the “fourth fiscal quarter of 2019” mean the thirteen-week period from September 29, 2019 to December 28, 2019.

Summary

Sales for 2020 were $240.4 million compared to $251.7 million for 2019. Net income for 2020 was $5.4 million, or $0.86 per diluted share, compared to $13.3 million, or $2.12 per diluted share, for 2019. Sales for the fourth quarter of 2020 were $60.4 million compared to $68.7 million for the same period in 2019. Net income for the fourth quarter of 2020 was $1.4 million, or $0.23 per diluted share compared to $5.0 million, or $0.79 per diluted share, for the comparable 2019 period. Fourth quarter 2019 operating results included three months of Big 3 Precision sales and earnings while the full fiscal year included four months of Big 3 Precision sales and earnings. Big 3 Precision was acquired on August 30, 2019.

The value of the backlog of orders received by the Company increased as of January 2, 2021, compared to December 28, 2019. The Company’s backlog was $85.0 million on January 2, 2021, as compared to $71.2 million on December 28, 2019. The primary reasons for growth from 2019 to 2020 were an increase of $4.6 million in blow mold tooling backlog at our Big 3 Mold subsidiary including $0.8 million in backlog from the acquisition of Hallink Moulds; an increase of $ 3.2 million in backlog for locks and hardware at Eberhard due to new product launches; an increase of $3.8 million in backlog related to launch of new mirror program for Class 8 trucks being awarded to our Velvac subsidiary; and new orders received by Frazer & Jones, which added $10.9 million in backlog for mining products. Backlog declined at Big 3 Products for returnable packaging by $0.8 million and at Argo EMS for printed circuit boards by $2.0 million.

During the fourth quarter of 2020 the Company experienced price increases for many of the raw materials used in producing its products, including: scrap iron, stainless steel, hot and cold rolled steel, zinc, copper, aluminum and nickel. These increases could negatively impact the Company’s gross margin if raw material prices increase too rapidly for the Company to recover those cost increases through either price increases to our customers or cost reductions in other areas of the business.

On January 15,2020 the United States and China signed the U.S.-China Phase One trade deal, which among other things rolled back tariffs on $120 billion worth of Chinese products from 15% to 7.5% effective February 14, 2020 and the U.S. agreed not to proceed with the 15% tariffs on $160 billion worth of consumer goods which was scheduled to take effect December 15, 2019. However, the 25% tariffs on $250 billion of Chinese imports will remain in effect subject to further reductions depending on the progress of future negotiations. If China does not follow through their agreed upon commitments and tariffs are reinstated on $550 billion of Chinese products at the 25% rate, it could result in a loss of business and possible reduced margins if the tariffs cannot be offset by higher selling prices.

Critical Accounting Policies and Estimates

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

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

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Allowance for Doubtful Accounts

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

Inventory

Inventories are valued at the lower of cost or net realizable value. Cost is determined by the last-in, first-out (“LIFO”) method at the Company’s U.S. facilities, with the exception of Big 3 Precision and Velvac, which are valued on a first-in, first-out (“FIFO”) method. Accordingly, a LIFO valuation reserve is calculated using the dollar value link chain method.

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

Goodwill and Other Intangible Assets

Intangible assets with finite useful lives are generally amortized on a straight-line basis over the periods benefited. Goodwill and other intangible assets with indefinite useful lives are not amortized. In December, 2020 the Company announced that the Eberhard Hardware Manufacturing Ltd. subsidiary in Ontario, Canada would be closed and all tangible assets would be moved to Eberhard Manufacturing division in Cleveland, Ohio. As a result, approximately $1.0 million of goodwill associated with Eberhard Hardware Manufacturing Ltd. was impaired and written off the books in December 2020. The Company performed its qualitative assessment as of the end of fiscal 2020 on the remainder of its companies and determined that it is more likely than not that no impairment of goodwill existed at the end of 2020 on those companies holding goodwill at the entity level. See Note 3 – Accounting Policies –Goodwill, in Item 8, Financial Statements and Supplementary Data for more detail. The Company will perform annual qualitative assessments in subsequent years as of the end of each fiscal year. Additionally, the Company will perform an interim analysis whenever conditions warrant.

Pension and Other Postretirement Benefits

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

The discount rate used is based on a single equivalent discount rate derived with the assistance of our actuaries by matching expected future benefit payments in each year to the corresponding spot rates from the FTSE Pension Liability Yield Curve, comprised of high quality (rated AA or better) corporate bonds. The Company calculates its service and interest costs in future years by applying the specific spot rates along the selected yield curve to the relevant projected cash flows.

The expected long-term rate of return on assets is also developed with input from the Company’s actuarial firms. We consider the Company’s historical experience with pension fund asset performance, the current and expected allocation of our plan assets and expected long-term rates of return. The long-term rate-of-return assumption used for determining net periodic pension expense was 7.5% for 2020 and 2019. The Company reviews the long-term rate of return each year.

Future actual pension income and expense will depend on future investment performance, changes in future discount rates and various other factors related to the population of participants in the Company’s pension plans.

The Company expects to make cash contributions of approximately $3,100,000 and $50,000 to our pension plans and other postretirement plan, respectively, in 2021.

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In connection with our pension and other postretirement benefits, the Company reported an expense of $5.7 million and $2.7 million (net of tax) on its Consolidated Statement of Comprehensive Income for fiscal years 2020 and 2019, respectively. The main factor driving this expense was the change in the discount rate during the applicable period.

Assumptions used to determine net periodic pension benefit cost for the fiscal years indicated were as follows:

Expected return on plan assets 7.5% 7.5%

Rate of compensation increase 0.0% 0.0%

Assumptions used to determine net periodic other postretirement benefit cost are the same as those assumptions used for the pension benefit cost, except that the rate of compensation is not applicable for other postretirement benefit cost.

The changes in assumptions had the following effect on the net periodic pension and other postretirement costs recorded in Other Comprehensive Income as follows:

Year ended

January 2, December 28

Additional recognition due to significant event -- (454,143 )

Amortization of:

The Plan has been investing a portion of the assets in long-term bonds in an effort to better match the impact of changes in interest rates on its assets and liabilities and thus reduce some of the volatility in Other Comprehensive Income. Please refer to Note 10 – Retirement Benefit Plans in in Item 8, Financial Statements and Supplementary Data of this Form 10-K for additional disclosures concerning the Company’s pension and other postretirement benefit plans.

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RESULTS OF OPERATIONS

Fourth Quarter 2020 Compared to Fourth Quarter 2019

The following table shows, for the fourth quarter of 2020 and 2019, selected line items from the consolidated statements of income as a percentage of net sales, by segment. The Company now reports under two segments: Engineered Solutions and Diversified Products. The Engineered Solutions segment includes (1) Big 3 Precision, including Big 3 Products and Big 3 Mold, Hallink Moulds, and Associated Toolmakers Ltd.; (2) Eberhard Manufacturing Company, Eberhard Hardware Manufacturing Ltd., Eastern Industrial Ltd., Illinois Lock Company/CCL Security Products, World Lock Company Ltd., Dongguan Reeworld Security Products Ltd., and World Security Industries Ltd.; and (3) Velvac Holdings. The Diversified Products segment consists of Frazer & Jones; Greenwald Industries; Argo EMS; and Sesamee Mexicana. In the fourth quarter of 2019, the Diversified segment includes the CCV.

Engineered Diversified

Solutions Products Total

Product Development Expense 0.7 % 3.5 % 1.2 %

Selling and Administrative Expense 13.4 % 12.3 % 13.2 %

Goodwill Impairment Loss 1.9 % — 1.6 %

Loss on Disposition of Subsidiary — 21.8 % 3.5 %

Restructuring Costs 1.3 % — 1.1 %

Operating Profit 4.9 % -19.1 % 1.0 %

Engineered Diversified

Solutions Products Total

Product Development Expense 0.8 % 2.6 % 1.1 %

Selling and Administrative Expense 16.7 % 12.0 % 15.8 %

Goodwill Impairment Loss — — —

Loss on Disposition of Subsidiary — — —

Restructuring Costs — — —

Net sales in the fourth quarter of 2020 decreased 12% to $60.4 million from $68.7 million a year earlier. Sales decreased in the Engineered Solutions segment by 8% to $50.6 million in the fourth quarter of 2020 from $54.7 million in the fourth quarter of 2019 due to lower demand for trucks accessories, distribution products and automotive returnable packaging as a result of the delay in new automotive launches, partly offset by the impact of new program launches and stronger sales of blow mold tooling and related services. Sales in the Diversified Products segment decreased 30% to $9.9 million in the fourth quarter of 2020 compared to $14.0 million in fourth quarter of 2019 as the result of the sale of Canadian Commercial Vehicles in June 2020 and lower demand for mining products, industrial castings, commercial laundry products, and printed circuit boards.

Sales of new products contributed 4% to sales growth in the fourth quarter compared to 5% of sales growth from new products in the fourth quarter of 2019. New products in the fourth quarter included various new truck mirrors, a truck compression latch, a cable lock, a mirror cam and a mobile payment app.

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Cost of products sold in the fourth quarter of 2020 decreased $3.3 million or 7% from the corresponding period in 2019. The decrease in cost of products sold is primarily attributable to the reduced sales volume. During the fourth quarter of 2020, material costs have increased substantially over the third quarter of 2020 for hot rolled steel by 81%; cold rolled steel by 53%; aluminum by 16%; copper and nickel by 23%; zinc by 17% and scrap iron by 30%.

Gross margin as a percentage of net sales for the fourth quarter of 2020 was 22% compared to 26% in the prior year fourth quarter. The decrease reflects the combination of higher raw material cost and a decline in facility utilization due to lower sales in the fourth quarter of 2020.

Product development expenses in the fourth quarter of 2020 of $0.7 million were down 11% when compared to the fourth quarter of 2019. As a percentage of net sales, product development costs were 1.2% and 1.1% for the fourth quarter of 2020 and 2019 respectively.

Selling and administrative expenses in the fourth quarter of 2020 decreased 26% compared to the fourth quarter of 2019. The decrease was primarily the result of the Company’s initiatives to reduce payroll and payroll related expenses, reduce travel expenses, and other expense reduction initiatives.

Goodwill impairment expense of $1.0 million was incurred in the fourth quarter of 2020 as the Company announced the closure of Eberhard Hardware Manufacturing Ltd. in Ontario, Canada.

Restructuring expenses of $0.7 million for severance expenses were incurred in the fourth quarter of 2020 due to the closure of Eberhard Hardware Manufacturing Ltd.

Loss on disposal of subsidiary of $2.2 million was incurred in the fourth quarter of 2020 in recognizing the cumulative effects for foreign currency translation on Sesamee Mexicana and CCV.

Net income for the fourth quarter of 2020 decreased 72% to $1.4 million, or $0.23 per diluted share, from $5.0 million, or $0.79 per diluted share, in 2019. In the fourth quarter of 2020, net income was negatively impacted by non-cash goodwill impairment charges of $0.7 million net of tax, non-recurring restructuring, factory relocation, and transaction costs of $0.9 million net of tax, and a loss on disposition of Sesamee Mexicana and CCV of $1.6 million net of tax.

Fiscal Year 2020 Compared to Fiscal Year 2019

The following table shows, for fiscal year 2020 and fiscal year 2019, selected line items from the consolidated statements of income as a percentage of net sales, by segment. The Company now reports under two segments: Engineered Solutions and Diversified Products. The Engineered Solutions segment includes (1) Big 3 Precision, including Big 3 Products and Big 3 Mold, Hallink Moulds and Associated Toolmakers Ltd.; (2) Eberhard Manufacturing Company, Eberhard Hardware Manufacturing Ltd., Eastern Industrial Ltd., Illinois Lock Company/CCL Security Products, World Lock Company Ltd. and Dongguan Reeworld Security Products Ltd.; World Security Industries Ltd.; and (3) Velvac Holdings. The Diversified Products segment consists of Frazer & Jones ; Greenwald Industries; Argo EMS; Sesamee Mexicana; and CCV. Financial measures presented below as “excluding Big 3 Precision” are non-GAAP financial measures.

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Engineered Diversified

Solutions Products Total

Product Development Expense 0.9 % 3.1 % 1.3 %

Selling and Administrative Expense 15.3 % 12.3 % 14.7 %

Goodwill Impairment Loss 0.5 % 9.3 % 2.1 %

Loss on Disposition of Subsidiary — 5.0 % 0.9 %

Restructuring Costs 0.3 % 0.7 % 0.4 %

Operating Profit 7.4 % -17.7 % 2.9 %

Engineered Diversified

Solutions Products Total

Product Development Expense 2.5 % 2.2 % 2.4 %

Selling and Administrative Expense 15.5 % 10.5 % 14.2 %

Goodwill Impairment Loss — — —

Loss on Disposition of Subsidiary — — —

Restructuring Costs 0.9 % 1.4 % 1.1 %

Operating Profit 8.8 % 1.5 % 6.9 %

Summary

Net sales for 2020 decreased 5% to $240.4 million from $251.7 million in 2019. The sales decline is primarily due to the decision by many of our industrial and consumer goods customers to close operations as a result of the COVID-19 pandemic and the divestiture of CCV. Sales in 2020 reflect a full year of sales from the Big 3 Precision Acquisition, as compared to four months of sales in 2019. Excluding the effects of Big 3 Precision, which closed on August 30, 2019, sales would have been $186.8 million in 2020 compared to $230.4 million in 2019, a decrease of 18.9%. Sales volume of existing products decreased by 9% in 2020 compared to 2019 while price increases and new products increased sales in 2020 by 4%.

Net income for 2020 decreased 59% to $5.4 million, or $0.86 per diluted share, from $13.3 million, or $2.12 per diluted share, in 2019. In 2020, net income was negatively impacted by $6.8 million in non-recurring costs, net of tax, including goodwill impairment charges of $3.7 million net of tax, one-time restructuring, factory relocation, and transaction costs of $1.5 million net of tax, and a loss on disposition of Sesamee Mexicana and CCV of $1.6 million net of tax. Net income for 2019 was adversely affected by non-recurring restructuring costs of $3.9 million net of tax associated with the discontinuation of Road-iQ, a subsidiary of Velvac, and the consolidation of our Composite Panel Technologies facility, as well as an increase in M&A related expense incurred in 2019.

Engineered Solutions

Net sales in the Engineered Solutions segment increased 6% in 2020 to $197.6 million from $186.8 million when compared to 2019. Without Big 3 Precision sales would have been $144.0 million or a decrease of 13% from $165.4 million in 2019. Sales volume of existing products increased 1% due to the acquisition of Big 3 Precision. Excluding Big 3 Precision, sales volume of existing products decreased by 17%, partially offset by price increases and new products which contributed 5% to increased sales.

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New product sales include various new truck mirrors, a truck compression latch, a cable lock and a mirror cam.

Cost of products sold in the Engineered Solutions segment increased $14.3 million or 11% to $149.4 million from $135.1 million in 2019. In 2020 cost of products sold include twelve months of Big 3 Precision expenses whereas 2019 only included 4 months of Big 3 Precision expenses. Excluding the Big 3 Precision Acquisition, cost of products sold would have been $108.6 million in 2020 compared to $118.7 million in 2019, a decrease of $10.1 million or 9%. Freight costs are down due to lower sales but freight costs are increasing and ports backlogged in processing container ships are causing delays in meeting scheduled shipping dates. Metal prices have increased year over year for hot rolled steel by 86%; cold rolled steel by 44%; copper by 35%; nickel by 18% and zinc by 16%. Much of the increase came in the fourth quarter of 2020. Many of our supply contracts contain price adjustment clauses when material cost increase by a certain percentage. Tariffs incurred during 2020 were $2.6 million from China-sourced products as compared to $2.7 million in 2019. A majority of the tariffs were recovered through price increases. Excluding the Big 3 Precision Acquisition, costs are down primarily due to lower volume and cost initiatives in cutting payroll and payroll-related expenses by $3.6 million, freight by $2.5 million, shipping expenses by $0.7 million and other expenses by $0.3 million. However, during 2020 our factories’ productive capacity was underutilized, resulting in $2.1 million in unabsorbed overhead cost which negatively impacted our gross margin in 2020.

Gross margin as a percentage of sales was 24% in 2020 as compared to 28% in 2019. The decrease reflects the combination of higher raw material costs and a decline in facility utilization due to lower sales in 2020.

Product development expenses as a percentage of sales decreased to 1% in 2020 from 3% in 2019. The decrease relates to the closure of the Velvac Road-iQ development operations in Bellingham Washington in the second quarter of 2019 as the Company adopted a leaner approach to the development of new vision products.

Selling and administrative expenses increased $1.3 million or 5% to $30.2 million in 2020 from $28.9 million in 2019. The increase relates to the Big 3 Precision Acquisition in August 2019. Excluding Big 3 Precision, selling and administrative expenses would have decreased $3.4 million or 14% from $24.5 million in 2019 to $21.1 million in 2020.

Diversified Products

Net sales in the Diversified Products segment decreased by 22.2 million or 34% in 2020 from the 2019 level. Sales volume of existing products decreased 36% while price increases and new products contributed a 2% increase. The sales decrease is partially due to the sale of CCV in the second quarter of 2020. Sales of our mining products were down from 2019 levels by $6.9 million and industrial casting sales were down $2.9 million. Sales of commercial laundry products were also down from 2019 levels by $2.5 million while printed circuit board sales were down from 2019 levels by $0.8 million. New product sales include a mobile payment app for the commercial laundry industry and various industrial castings.

Cost of products sold in the Diversified Products segment decreased by $17.5 million or 32% in 2020 from 2019. The decrease in cost of products sold was primarily attributable to the decrease in sales volume. Cost reduction initiatives lowered factory payroll and payroll related cost by $3.8 million through various state workshare programs and layoffs where necessary. The cost of scrap iron increased year over year by 34%. The cost of scrap iron has increased another 16% in the first quarter of 2021 to $575 per ton. The Company incurred tariff costs on China-sourced products of $0.2 million in 2020 which was comparable to 2019. The majority of the tariffs have been offset by price increases.

Gross margin as a percentage of sales in the Diversified Products segment for 2020 decreased to 13% compared to the 2019 level of 16%.

Product development expenses decreased $0.1 million or 5% to $1.3 million for 2020 from $1.4 million for 2019. The Company continues to invest in the development of new products for our customers to replace legacy products being phased out.

Selling and administrative expenses in the Diversified Products segment decreased by $1.6 million or 23% in 2020 from 2019. The most significant factors resulting in changes in selling and administrative expenses were a decrease in amortization expense of $0.2 million, a decrease of $0.4 million in payroll and payroll related expenses, a decrease in travel expenses of $0.2 million, a decrease in other administrative expenses of $0.2 million and the sale of CCV, which resulted a decrease in selling and administrative expenses of $0.5 million in 2020 as compared to 2019.

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Goodwill impairmentloss of $5.0 million was incurred in 2020. In the second quarter of 2020, the Company determined that the estimated fair value of Greenwald Industries was likely below its carrying amount. The factors that led to this determination included additional competition, industry movement away from legacy products and intense competition in new mobile payment apps. This fundamental shift in lower cost payment systems away from the higher cost electronic smart card payment systems resulted in the carrying value of Greenwald exceeding its fair value. As a result, an independent valuation was conducted which estimated that the carrying value exceeded the fair value by approximately $4.0 million. During the fourth quarter of 2020 the Company announced that its subsidiary Eberhard Hardware Manufacturing Ltd. in Ontario Canada would be closed and all assets would be moved to Eberhard Manufacturing division in Cleveland, Ohio. As a result, the amount of goodwill of approximately $1.0 million at this entity level was impaired and written off in December 2020. The Company performed its qualitative assessment as of the end of fiscal 2020 on the remainder of its companies and determined that it is more likely than not that no impairment of goodwill existed at the end of 2020 on those companies holding goodwill at the entity level.

Loss on disposal of subsidiary of $2.2 million in non-cash charges were incurred in fiscal year 2020 in recognizing the cumulative effects for foreign currency translation on Sesamee Mexicana and CCV.

Restructuring expensesof $1.0 million incurred in 2020 related to the divestiture of CCV in the second quarter of 2020 and the announced closure of Eberhard Hardware Manufacturing Ltd. In Ontario, Canada in the fourth quarter of 2020. 2019 restructuring costs of $2.7 million were related to the discontinuation of our Road iQ development operations based in Bellingham, Washington and the relocation costs of Composite Panels Technologies in Salisbury, North Carolina to CCV in Kelowna, British Columbia.

Other Items

The following table shows the amount of change from the year ended December 28, 2019 as compared to the year ended January 2, 2021 in other items (dollars in thousands):

Amount %

Interest expense $ 887 48 %

Interest expense increased in 2020 from 2019 due to the increased level of debt incurred in connection with the acquisitions of Hallink Moulds in the third quarter of 2020 and Big 3 Precision in the third quarter of 2019.

Other income in 2020 increased $1.2 million over 2019. Other income in 2020 included a favorable $1.2 million pension cost adjustment and a $0.4 million gain on a sale/leaseback transaction. In 2019, other income included a gain of $0.6 million on the sale of land at the Company headquarters location.

The effective tax rate for 2020 was 10% compared to the 2019 effective tax rate of 18%. The effective tax rate for 2020 was reduced due to the expiration of statute of limitations for uncertain tax positions. Total income taxes paid were $3.8 million in 2020 and $3.2 million in 2019.

Liquidity and Sources of Capital

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

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The Company is dependent on continued demand for its products and subsequent collection of accounts receivable from its customers. The Company serves a broad base of customers and industries with a variety of products. As a result, any fluctuations in demand or payment from a particular industry or customer should not have a material impact on the Company’s sales and collection of receivables. Management expects that the Company’s foreseeable cash needs for operations, capital expenditures, debt service and dividend payments will continue to be met by the Company’s operating cash flows and available credit facility.

The following table shows key financial ratios at the end of each fiscal year:

Current ratio 2.8 3.6

Average days’ sales in accounts receivable 56 51

Inventory turnover 3.6 4.2

Ratio of working capital to sales 29.6 % 28.1 %

Total debt to shareholders’ equity 85.1 % 93.7 %

The following table shows important liquidity measures as of the fiscal year-end balance sheet date for each of the preceding two years (in millions):

Cash and cash equivalents

- Held in the United States $ 10.0 $ 9.0

- Held by foreign subsidiaries 6.1 9.0

Net cash provided by operating activities 20.7 23.0

Net cash used in investing activities (9.1 ) (85.8 )

Net cash (used in)/provided by financing activities (13.2 ) 67.0

All cash held by foreign subsidiaries is readily convertible into other currencies, including the U.S. dollar.

Net cash provided by operating activities was $20.7 million in 2020 compared to $23.0 million in 2019. In 2020 the Company contributed $2.7 million into its defined benefit retirement plan.

In 2020 cash provided by the net change in working capital was $2.0 million which was primarily due to management’s focus on reducing inventories during the pandemic. In 2019, cash used in the net change in working capital was $0.3 million.

The Company used $9.1 million and $85.8 million for investing activities in 2020 and 2019, respectively. In 2020 the Company invested $7.2 million to acquire Hallink Moulds, and received $3.2 million for divestures of subsidiaries and equipment. The Company issued notes receivable of $2.2 million as part of the sale of its subsidiaries. In 2019, the Company invested approximately $81.2 million to acquire Big 3 Precision. These transactions are more fully discussed in Note 2 to the 2020 Consolidated Financial Statements located in Item 8 of this Form 10-K. The balance of $3.1 million and $5.4 million in 2020 and 2019, respectively, was used to purchase fixed assets. Capital expenditures in fiscal year 2021 are expected to be approximately $5.0 million.

In 2020, the Company made total debt payments of $10.0 million, of which $5.0 million was an accelerated principal payment and used $2.8 million for payment of dividends. The Company did not draw down on its $20.0 million revolving credit facility in 2020.

In 2019, the Company received approximately $67.0 million from financing activities. The Company refinanced an existing note for $19.1 million and used approximately $10.8 million for debt repayments and $2.8 million for payment of dividends. The Company entered into the Credit Agreement for $120.0 million, of which the Company received $100.0 million for the term loan portion. The Company did not draw down on the $20.0 million revolving credit portion.

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The Company leases certain equipment and buildings under cancelable and non-cancelable operating leases that expire at various dates up to five years. Rent expense amounted to approximately $2.1 million in 2020 and $2.2 million in 2019.

On August 30, 2019, the Company entered into the Credit Agreement with Santander Bank, N.A., for itself, People’s United Bank, National Association. and TD Bank, N.A. as lenders, that included a $100.0 million term portion and a $20.0 million revolving commitment portion. Proceeds of the term loan were used to repay the Company’s remaining outstanding term loan (and to terminate its existing credit facility) with People’s United Bank, N.A. (approximately $19.0 million) and to acquire Big 3 Precision. The term portion of the loan requires quarterly principal payments of $1.25 million for an 18-month period beginning December 31, 2019. The repayment amount then increases to $1.875 million per quarter beginning September 30, 2021 and continues through June 30, 2023. The repayment amount then increases to $2.5 million per quarter beginning September 30, 2023 and continues through June 30, 2024. The term loan is a five-year loan with the remaining balance due on August 30, 2024. The revolving commitment portion has an annual commitment fee of 0.25% based on the unused portion of the revolver. The revolving commitment portion has a maturity date of August 30, 2024. During 2020 and 2019, the Company did not borrow any funds on the revolving commitment portion of the facility. The interest rates on the term and revolving credit portion of the Credit Agreement vary. The interest rates may vary based on the LIBOR rate plus a margin spread of 1.25% to 2.25%. The Company’s obligations under the Credit Agreement are secured by a lien on certain of the Company’s and its subsidiaries’ assets pursuant to a Pledge and Security Agreement, dated as of August 30, 2019 with Santander Bank, N.A., as administrative agent.

The Company’s loan covenants under the Credit Agreement require the Company to maintain a senior net leverage ratio not to exceed 4.25 to 1. In addition, the Company will be required to maintain a fixed charge coverage ratio to be not less than 1.25 to 1.

On August 30, 2019, the Company entered into an interest rate swap contract with Santander Bank, N.A., with an original notional amount of $50.0 million, which was equal to 50% of the outstanding balance of the term loan on that date. The Company has a fixed interest rate of 1.44% on the swap contract and will pay the difference between the fixed rate and LIBOR when LIBOR is below 1.44% and will receive interest when the LIBOR rate exceeds 1.44%. On January 2, 2021, the interest rate for half ($41.9 million) of the term portion was 1.9%, using a one-month LIBOR rate, and 3.19% on the remaining balance ($46.9 million) of the term loan based on a one-month LIBOR rate.

The interest rates on the Credit Agreement, and interest rate swap contract are susceptible to changes to the method that LIBOR rates are determined and to the potential phasing out of LIBOR after 2021. Information regarding the potential phasing out of LIBOR is provided below.

On July 27, 2017, the FCA (the authority that regulates LIBOR) announced that it would phase out LIBOR by the end of 2021. The IBA recently announced market consultation regarding the extension of US dollar LIBOR tenors through June 30, 2023 which the FCA supports. The ARRC, a financial industry group convened by the Federal Reserve Board has recommended the use of SOFR to replace LIBOR. The difference between LIBOR and SOFR is that LIBOR is a forward-looking rate which means the interest rate is set at the beginning of the period with payment due at the end. SOFR is a backward-looking overnight rate which have implications for how interest and other payments are based. Changes in the method of calculating the replacement of LIBOR with an alternative rate or benchmark are still in flux, and once an alternate rate is adopted, may adversely affect interest rates and result in higher borrowing costs. This could materially and adversely affect the Company’s results of operations, cash flows and liquidity. We cannot predict the effect of the potential changes to LIBOR or the establishment and use of alternative rates or benchmarks at this time. We are working with our senior lender and may need to renegotiate our credit facilities as LIBOR phases out in June 2023.

Off-Balance Sheet Arrangements

As of the end of the fiscal year ended January 2, 2021, the Company does not have any material transactions, arrangements, obligations (including contingent obligations), or other relationships with unconsolidated entities or other persons, as described by Item 303(a)(4) of Regulation S-K, that have or are reasonably likely to have a material current or future impact on the Company’s financial condition, results of operations, liquidity, capital expenditures, capital resources or significant components of revenues or expenses.

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Non-GAAP Financial Measures

The non-GAAP financial measures we provide in this report should be viewed in addition to, and not as an alternative for, results prepared in accordance U.S. GAAP.

To supplement the consolidated financial statements prepared in accordance with U.S. GAAP, we have presented Adjusted Earnings Per Share, Adjusted Net Income and Adjusted EBITDA, which are considered non-GAAP financial measures. The non-GAAP financial measures presented may differ from similarly titled non-GAAP financial measures presented by other companies, and other companies may not define these non-GAAP financial measures in the same way. These measures are not substitutes for their comparable GAAP financial measures, such as net sales, net income, diluted earnings per share, or other measures prescribed by U.S. GAAP, and there are limitations to using non-GAAP financial measures.

Adjusted Earnings Per Share is defined as diluted earnings per share excluding, when they occur, the impacts of impairment losses, losses on sale of subsidiaries, transaction expenses, factory relocation expenses and restructuring costs. We believe that Adjusted EPS provides important comparability of underlying operational results, allowing investors and management to access operating performance on a consistent basis.

Adjusted Net Income is defined as net income excluding, when they occur, the impacts of impairment losses, losses on sale of subsidiaries, transaction expenses, factory relocation expenses and restructuring costs. Adjusted Net Income is a tool that can assist management and investors in comparing our performance on a consistent basis by removing the impact of certain items that management believes do not directly reflect our underlying operations.

Adjusted EBITDA is defined as net income from continuing operations before interest expense, provision for income taxes, and depreciation and amortization. In addition to these adjustments, we exclude, when they occur, the impacts of impairment losses, losses on sale of subsidiaries, transaction expenses, factory relocation expenses and restructuring expenses. Adjusted EBITDA is a tool that can assist management and investors in comparing our performance on a consistent basis by removing the impact of certain items that management believes do not directly reflect our underlying operations.

We also present certain results “excluding Big 3 Precision” because we believe this allows for more effective comparability to the corresponding prior year period.

Management uses such measures to evaluate performance period over period, to analyze the underlying trends in our business, including our business segments, to assess our performance relative to that of our competitors, and to establish operational goals and forecasts that are used in allocating resources.

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We believe that presenting non-GAAP financial measures in addition to GAAP financial measures provides investors greater transparency to the information used by our management for its financial and operational decision-making. We further believe that providing this information better enables our investors to understand our operating performance and to evaluate the methodology used by management to evaluate and measure such performance.

Reconciliation of expenses from GAAP to Non-GAAP EPS calculation

For the Three and Twelve Months ended January 2, 2021 and December 28, 2019

Three Months Ended Twelve Months Ended

Net Income as reported per

Earnings Per Share as reported under generally accepted

accounting principles (GAAP):

Adjustments for one-time expenses:

Adjusted Net Income (related to one time expenses);

Adjusted Earnings per share

(related to one time expenses); (Non-GAAP)

A) Goodwill impairment

B) Cost incurred on disposition of Canadian Commercial Vehicles

C) Cost incurred on relocation of factory in Reynosa, Mexico

D) Cost incurred on the relocation of Composite Panels Technology

E) Cost incurred in the acquisition of Hallink RSB, Inc.

F) Costs incurred in the closure of Road IQ in Bellingham, WA

G) Costs incurred on the acquisition of Big 3 Precision

H) Costs incurred on announced reorganization of Eberhard Hardware Ltd

I) Loss on disposition of subsidiaries

Use of Non-GAAP Financial Measures

To supplement our consolidated financial statements presented in accordance with generally accepted accounting principles in the United States (“GAAP”), we disclose certain non-GAAP financial measures including adjusted net income and adjusted earnings per diluted share. Adjusted net income and adjusted earnings per diluted share exclude one time related expenses. These measures are not in accordance with GAAP.

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Reconciliation of expenses from GAAP to Non-GAAP EBITDA calculation

For the Three and Twelve Months ended January 2, 2021 and December 28, 2019

Three Months Ended Twelve Months Ended

A) Goodwill impairment

B) Cost incurred on disposition of Canadian Commercial Vehicles

C) Cost incurred on relocation of factory in Reynosa, Mexico

D) Cost incurred on the relocation of Composite Panels Technology

E) Cost incurred in the acquisition of Hallink RSB, Inc.

F) Costs incurred in the closure of Road IQ in Bellingham, WA

G) Costs incurred in the acquisition of Big 3 Precision

H) Costs incurred on announced reorganization of Eberhard Hardware Ltd

I) Loss on disposition of subsidiaries

Use of Non-GAAP Financial Measures

To supplement our consolidated financial statements presented in accordance with generally accepted accounting principles in the United States (“GAAP”), we disclose certain non-GAAP financial measures including adjusted net income and adjusted earnings per diluted share. Adjusted net income and adjusted earnings per diluted share exclude one time related expenses. These measures are not in accordance with GAAP.

ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

As a result of the Company’s status as a smaller reporting company pursuant to Rule 12b-2 of the Exchange Act, the Company is not required to provide information under this Item 7A.

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ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The Eastern Company

Consolidated Balance Sheets

January 2, December 28,

ASSETS

Current Assets

Inventories:

Current portion of note receivable 398,414 —

Property, Plant and Equipment

Other Assets

Long term notes receivable, less current portion 1,677,277 —

See accompanying notes.

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Consolidated Balance Sheets

LIABILITIES AND SHAREHOLDERS’ EQUITY

January 2, December 28,

Current Liabilities

Shareholders’ Equity

Voting Preferred Stock, no par value:

Authorized and unissued: 1,000,000 shares - -

Nonvoting Preferred Stock, no par value:

Authorized and unissued: 1,000,000 shares - -

Common Stock, no par value, Authorized: 50,000,000 shares

Accumulated other comprehensive loss:

Unrealized (loss) gain on interest rate swap, net of tax (1,391,592 ) 167,018

See accompanying notes.

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Consolidated Statements of Income

Year Ended

January 2, December 28,

Goodwill impairment loss (4,975,372 ) —

Loss on disposition of subsidiary (2,158,863 ) —

Earnings per Share:

See accompanying notes.

Consolidated Statements of Comprehensive Income

Year Ended

January 2, December 28,

Other comprehensive income:

Change in fair value of interest rate swap,

Change in pension and other postretirement benefit costs,

See accompanying notes.

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Consolidated Statements of Shareholders’ Equity

Change in fair value of interest rate swap 574 574

See accompanying notes.

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Consolidated Statements of Cash Flows

Year Ended

January 2, December 28,

Operating Activities

Adjustments to reconcile net income to net cash provided by

operating activities:

Loss on disposition of subsidiaries 2,148,964 —

Unrecognized pension and postretirement benefits (1,010,684 ) 1,844,814

Goodwill impairment loss 4,975,372 —

(Gain) loss on sale of equipment and other assets (219,575 ) (568,956 )

Non-cash restructuring charges — 2,641,890

Changes in operating assets and liabilities:

Investing Activities

Proceeds from business dispositions 2,785,657 —

Issuance of Note Receivable (2,172,068 ) —

Payments Received from Note Receivable 96,377 —

Financing Activities

Proceeds from long-term borrowings — 100,000,000

Lease Payments (10,500 ) —

Purchase common stock for treasury (368,864 ) —

Effect of exchange rate changes on cash (288,722 ) (85,706 )

Supplemental disclosure of cash flow information:

Cash paid during the year for:

Non-cash investing and financing activities

See accompanying notes.

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The Eastern Company

Notes to Consolidated Financial Statements

1. DESCRIPTION OF BUSINESS

The Eastern Company (the “Company,” “Eastern,” “we,” “us” or “our”) manages industrial businesses that design, manufacture and sell engineered solutions to industrial markets. Eastern’s businesses operate in industries with long-term macroeconomic growth opportunities. We look to acquire businesses that produce stable and growing earnings and cash flows. Eastern may pursue acquisitions in industries other than those in which its businesses currently operate if an acquisition presents an attractive opportunity.

Eastern focuses on proactive financial, operational, and strategic management of its businesses in order to increase cash generation, operating earnings and long-term shareholder value.

Eastern encompasses seven operating entities within the United States, two wholly-owned Canadian subsidiaries (one located in Tillsonburg, Ontario, Canada, and one in Cambridge, Ontario, Canada), a wholly-owned Taiwanese subsidiary located in Taipei, Taiwan, a wholly-owned subsidiary in Hong Kong, two wholly-owned Chinese subsidiaries (one located in Shanghai, China, and one located in Dongguan, China), a wholly-owned subsidiary in Reynosa, Mexico) and a wholly owned subsidiary in Wrexham, United Kingdom. The Company reports in two business segments: Engineered Solutions and Diversified Products.

Engineered Solutions

The Engineered Solutions segment consists of Big 3 Precision, including Big 3 Products and Big 3 Mold (each as defined below), Hallink Moulds, Inc. (“Hallink Moulds”) and Associated Toolmakers Ltd. (as defined below); Eberhard Manufacturing Company, Eberhard Hardware Manufacturing Ltd., and Eastern Industrial Ltd; Illinois Lock Company/CCL Security Products, World Lock Company Ltd., Dongguan Reeworld Security Products Ltd., and World Security Industries Ltd. (together “Eberhard”); and Velvac Holdings (“Velvac”). These businesses design, manufacture and market a diverse product line of custom and standard vehicular and industrial hardware, including turnkey returnable packaging solutions; access and security hardware; mirrors, mirror-cameras.

Big 3 Products and Big 3 Mold offer turnkey returnable packaging solutions that are used in the assembly process of vehicles, aircraft and durable goods and in the production process of plastic packaging products, packaged consumer goods and pharmaceuticals. Big 3 Products works with manufacturers to design and produce custom returnable packaging to integrate with their assembly processes. Big 3 Mold designs and manufactures blow mold tools. Hallink Moulds manufactures injection blow mold tooling and is a supplier of blow molds and change parts to the food, beverage, healthcare and chemical industry. Hallink Moulds specializes in the design, development and manufacture of 2-step stretch blow molds, and related components for the stretch blow molding industry offering integrated turnkey solutions to its customers worldwide.

In 2020, we combined all businesses associated with the Eberhard Manufacturing Company and The Illinois Lock Company to create Eberhard, a global leader in the engineering and manufacturing of access and security hardware. Eberhard offers a standard product line of rotary latches, compression latches, draw latches, hinges, camlocks, key switches, padlocks, and handles, among other products, as well as comprehensive development and program management services for custom electromechanical and mechanical systems designed for specific original equipment manufacturers (“OEMs”) and customer applications. Eberhard’s products are found in various ranges of applications and products globally.

Velvac is a designer and manufacturer of proprietary vision technology for OEMs and aftermarket applications, and a leading provider of aftermarket components to the heavy-duty truck market in North America. Velvac serves diverse, niche segments within the heavy- and medium-duty truck, motorhome, and bus markets.

Diversified Products

The Diversified Products segment consists of Frazer & Jones, Greenwald Industries (“Greenwald”); and Argo EMS (formerly Argo Transdata). Frazer & Jones designs and manufactures high quality ductile and malleable iron castings. Products include valves, torque screws, bean clamps and concrete anchors. These products are sold to a wide range of industrial markets, including oil, water and gas; truck/automotive rail, and military/aerospace. The Company believes Frazer & Jones is a producer of expansion shells for use in supporting the roofs of underground mines in North America. Greenwald designs, manufactures and markets payment systems and coin security products used primarily in the commercial laundry market. Greenwald’s products include timers, drop meters, coin chutes, money boxes, meter cases, mobile payment apps, smart cards, value transfer stations, smart card readers, card management software, and access control units. Argo EMS supplies printed circuit boards and other electronic assemblies to OEMs in various industries, including measurement systems, semiconductor equipment manufacturing, and industrial controls, medical and military products.

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The Eastern Company

Notes to Consolidated Financial Statements (continued)

Sales are made to customers primarily in North America.

2. BUSINESS ACQUISITIONS

Hallink Moulds, Inc.

Effective August 10, 2020 the Company acquired certain assets, including accounts receivable, inventories, furniture, fixtures and equipment, intellectual property rights and rights existing under all sales and purchase agreements, and assumed certain liabilities, of Hallink, RSB Inc. These assets are held in our subsidiary, Hallink Moulds. Hallink Moulds produces injection blow mold tooling and is a supplier of blow molds and change parts to the food, beverage, healthcare and chemical industry. Hallink Moulds specializes in the design, development and manufacture of 2-step stretch blow molds, and related components for the stretch blow molding industry offering integrated turnkey solutions to its customers worldwide.

Hallink Moulds is included in the Engineered Solutions segment of the Company from the date of the acquisition. The cost of the acquisition of Hallink Moulds was approximately $7,173,000.

The above acquisition was accounted for under ASU 2014-18, Business Combinations (Topic 805). The acquired business is included in the consolidated operating results of the Company from the effective date of the acquisition. The excess of the cost of Hallink Moulds over the fair market value of the net assets acquired of $2,302,000 has been recorded as goodwill. An independent third party was utilized to establish the fair market value of net assets acquired.

In connection with the above acquisition, the Company recorded the following intangible assets:

Asset Class/Description Amount Weighted-Average Period in Years

Patents, technology, and licenses

There is no anticipated residual value relating to these intangible assets.

Big 3 Precision

On August 30, 2019, the Company and its newly-formed wholly-owned subsidiary, Eastern Engineered Systems, Inc., a Delaware corporation (“EES”) entered into a Stock Purchase Agreement (the “Stock Purchase Agreement”) with Big 3 Holdings, LLC, a Delaware limited liability company (“Seller”), Big 3 Precision Mold Services, Inc., a Delaware corporation and wholly-owned subsidiary of Seller (“Big 3 Mold”), Big 3 Precision Products, Inc., a Delaware corporation and wholly owned subsidiary of Seller (“Big 3 Products”), Industrial Design Innovations, LLC, a Delaware limited liability company and wholly-owned subsidiary of Big 3 Products (“Design Innovations”), Sur-Form, LLC, a Delaware limited liability company and wholly-owned subsidiary of Big 3 Products (“Sur-Form”), Associated Toolmakers Limited, a limited company formed under the laws of England and Wales and wholly-owned subsidiary of Big 3 Mold (“Associated” and together with Big 3 Mold, Big 3 Products, Design Innovations and Sur-Form, collectively “Big 3 Precision”), TVV Capital Partners III, L.P., a Delaware limited partnership, TVV Capital Partners III-A, L.P., a Delaware limited partnership, Alan Scheidt, Todd Riley, Clinton Hyde, and Big 3 Holdings, LLC, a Delaware limited liability company, as the initial Seller Representative. On August 30, 2019, pursuant to the Stock Purchase Agreement, the Company, through EES, acquired all of the outstanding equity interests of Big 3 Products and Big 3 Mold, and indirectly through them, all of the outstanding equity interests in Design Innovations, Sur-Form and Associated, for an adjusted purchase cash price of $81.2 million (the “Big 3 Precision Acquisition”). The Big 3 Precision Acquisition was financed with a combination of $2.1 million of cash on hand, a credit agreement (the “Credit Agreement”) with Santander Bank, N.A., for itself and, People’s United Bank, National Association and TD Bank, N.A. as lenders, providing for a $100.0 million term loan and a $20.0 million revolving credit line. In connection with the Credit Agreement, the Company also used its cash to repay the remaining balance (approximately $19.1 million) of its then outstanding term loan with People’s United Bank, National Association. Through its two divisions, Big 3 Products and Big 3 Mold, Big 3 Precision serves diverse markets including truck, automotive, plastic packaging products, packaged consumer goods and pharmaceuticals. In particular, Big 3 Products works with leading manufacturers to design and produce custom returnable packaging to integrate with their assembly processes. Big 3 Mold designs and manufactures blow mold tools.

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Notes to Consolidated Financial Statements (continued)

2. BUSINESS ACQUISITIONS (continued)

The following table summarizes the consideration paid for Big 3 Precision and the amounts of the assets acquired and liabilities assumed recognized at the acquisition date, as well as the fair value at the acquisition date. An independent third party was utilized to establish the fair market value of net assets acquired.

At August 30, 2019:

Consideration

Recognized amounts of identifiable assets acquired and liabilities assumed

Prepaid and other assets 32,268

Deferred tax liabilities (7,114,732 )

Accounts Receivable

Acquired receivables are amounts due from customers, with fair value based on net realizable value.

Inventories

The estimated fair value of inventories acquired, which are at net realizable value based upon third party valuation specialist.

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The Eastern Company

Notes to Consolidated Financial Statements (continued)

2. BUSINESS ACQUISITIONS (continued)

Property, Plant and Equipment

The property plant and equipment are estimated at fair value at the time of the acquisition based upon third party valuation specialist.

Intangible Assets

The estimated fair value of identifiable intangible assets is determined primarily using the Income Approach method which is a valuation technique that provides an estimate of the fair value of an asset based on the market participant’s expectations of the cash flows that an asset would generate over its remaining useful life. Some of the more significant assumption inherent in the development of the identifiable intangible assets valuation, from the perspective of a market participant, include the estimate net cash flows for each year for each project or product, the appropriate discount rate to select in order to measure the risk inherent in each future cash flow stream, the assessment of each asset’s life cycle, competitive trends impacting the asset and each cash flow stream as well as other factors.

Goodwill Allocation

Goodwill of $2,302,000 arising from the acquisition of Hallink Moulds consists of the difference between the consideration paid and the fair value of the assets and liabilities acquired.

Current Liabilities

Acquired current liabilities are amounts owed to vendors or accrued expenses.

Deferred Revenue

Deferred revenue is the amount of customers deposits at the time of the acquisition.

Income taxes

Income taxes are the estimated amount of state and federal taxes to settle certain tax positions prior to the acquisition.

Deferred Tax Liability

The deferred tax liability is stated at estimated tax liability due to the difference in the book basis of assets compared to the tax basis of those assets at the time of acquisition.

Acquisition Related Expenses

Included in general and administrative expenses in the consolidated statements of operations were acquisition expenses for the twelve-month period ended January 2, 2021 of $299,531.

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3. ACCOUNTING POLICIES

Fiscal Year

The Company’s year ends on the Saturday nearest to December 31. Based on this policy, fiscal year 2020 was comprised of 53 weeks and fiscal 2019 included 52 weeks. References in these Notes to the consolidated financial statements to “2020” or “fiscal year 2020” mean the fiscal year ended January 2, 2021, and references to “2019” or “fiscal year 2019” mean the fiscal year ended December 28, 2019. References to the “fourth quarter of 2020” or the “fourth fiscal quarter of 2020” mean the thirteen-week period from October 4, 2020 to January 2, 2021, and references to the “fourth quarter of 2019” or the “fourth fiscal quarter of 2019” mean the thirteen-week period from September 29, 2019 to December 28, 2019.

Principles of Consolidation

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

Reclassification

Product development expense is not necessarily a cost of product sold. Rather, these expenses are related to product development. The reclassification of these expenses does not affect the net income reported.

Certain prior year amounts have been reclassified for consistency with the current year presentation. These reclassifications had no effect on the reported results of operations. An adjustment has been made to the Consolidated Balance Sheet for fiscal year ended December 28, 2019 to reclassify customer funded projects from fixed assets to prepaid expenses and other current assets.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States (“U.S. GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. On an ongoing basis the Company evaluates its estimates, including those related to product returns, bad debts, carrying value of inventories, intangible and other long-lived assets, income taxes, pensions and other postretirement benefits. Actual results could differ from those estimates.

Foreign Currency

For foreign operations asset and liability accounts are translated with an exchange rate at the respective balance sheet dates; income statement accounts are translated at the average exchange rate for the years. Resulting translation adjustments are made directly to a separate component of shareholders’ equity – “Accumulated other comprehensive (loss) – Foreign currency translation”. Foreign currency exchange transaction gains and losses are not material in any year.

Cash Equivalents

Highly liquid investments purchased with a maturity of three months or less are considered cash equivalents. The Company has deposits that exceed amounts insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000, but the Company does not consider this a significant concentration of credit risk based on the strength of the financial institution. Approximately 38% of available cash is located outside of the United States in our foreign subsidiaries.

Accounts Receivable

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

Inventories

Inventories are valued at the lower of cost or net realizable value. Cost is determined by the last-in, first-out (LIFO) method in the U.S. ($27.9 million for U.S. inventories at January 2, 2021, excluding Big 3 Precision and Velvac) and by the first-in, first-out (FIFO) method for inventories outside the U.S. ($5.8 million for inventories outside the U.S. at January 2, 2021) and for Big 3 Precision and Velvac. Cost exceeds the LIFO carrying value by approximately $6.8 million at January 2, 2021 and $6.7 million at December 28, 2019. There was no material LIFO quantity liquidation in 2020 or 2019. In addition, as of the balance sheet dates, the Company has recorded reserves for excess/obsolete inventory.

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Property, Plant and Equipment and Related Depreciation

Property, plant and equipment (including equipment under capital lease) are stated at cost. Depreciation expense ($4,843,134 in 2020, $4,722,758 in 2019) is computed generally using the straight-line method based on the following estimated useful lives of the assets: Buildings - 10 to 39.5 years; Machinery and equipment - 3 to 10 years.

Impairment of Long-Lived Assets

In accordance with ASC 360-10, Accounting for the Impairment or Disposal of Long-Lived Assets, the Company reviews its long-lived assets and certain intangible assets for impairment whenever events or changes in circumstances indicate the that carrying amount may not be recoverable. In such an event, the carrying value of long-lived assets is reviewed by management to determine if the value may be impaired. If this review indicates that the carrying amount will not be recoverable, as determined based on the estimated expected future cash flows attributable to the asset over the remaining amortization period, management will reduce the carrying amount to recognize the impairment and recognize an impairment loss. The measurement of the impairment loss to be recognized is to be based on the difference between the fair value and the carrying amount of the asset. Fair value is defined as the amount of which the asset could be bought or sold in a current transaction between willing parties. Where quoted market prices in active markets are not available, management would estimate fair value based on the best information available in the circumstances such as the price of similar assets, a discounted cash flow analysis or other techniques. No impairment losses were recognized for the period ended January 2, 2021 and for the period December 28, 2019.

Goodwill

The Company tests its reporting units for impairment annually in December, or more frequently if events or circumstances indicate it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Such events and circumstances could include, among other things, increased competition or unexpected loss of market share, significant adverse changes in the markets in which the Company operates, or unexpected business disruptions. The Company tests reporting units for impairment by comparing the estimated fair value of each reporting unit with its carrying amount. If the carrying amount of a reporting unit exceeds its estimated fair value, the Company records an impairment loss based on the difference between fair value and carrying amount not to exceed the associated carrying amount of goodwill. Determining the fair value of a reporting unit involves the use of significant estimates and assumptions. The values assigned to the key assumptions represent management’s assessment of future trends in the relevant industry and have been based on historical data from both external and internal sources.

In the second quarter of 2020, management determined that the estimated fair value of Greenwald Industries was likely below its carrying amount. The factors that led to this determination included additional competition, industry movement away from legacy products and intense competition in new mobile payment apps. This fundamental shift in lower cost mobile payment systems away from the higher cost electronic smart card payment systems resulted in our belief that the carrying value of Greenwald exceeded its fair value. As a result, an independent valuation was conducted which estimated that the carrying value exceeded the fair value by approximately $4.0 million. Management recognized this impairment charge in the second quarter.

In December, 2020 the Company announced that the Eberhard Hardware Manufacturing Ltd. subsidiary in Ontario, Canada would be closed and all tangible assets would be moved to Eberhard Manufacturing division in Cleveland, Ohio. As a result, approximately $1.0 million of goodwill associated with Eberhard Hardware Manufacturing Ltd. was impaired and written off the books in December 2020. Management recognized this impairment charge in the fourth quarter of 2020.

The Company performed qualitative assessments of goodwill as of the end of fiscal 2019 and determined it was more likely than not that no impairment existed at the end of 2019.

The Company will perform annual qualitative assessments in subsequent years as of the end of each fiscal year. Additionally, the Company will perform interim analysis whenever conditions warrant.

Intangible Assets

Patents are recorded at cost and are amortized using the straight-line method over the lives of the patents. Technology and licenses are recorded at cost and are generally amortized on a straight-line basis over periods ranging from 5 to 17 years. Generally, non-compete agreements and customer relationships are amortized using the straight-line method over a period of 5 years. Amortization expense in 2020 and 2019 was $3,634,378 and $1,726,539, respectively. In the event that facts and circumstances indicate that the carrying value of the intangible assets, including definite life intangible assets, may be impaired, an evaluation is performed to determine if a write-down is required. No impairment losses were recognized for the period ended January 2, 2021 and for the period December 28, 2019.

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Fair Value of Financial Instruments

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The company utilizes a fair value hierarchy, which maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. The fair value hierarchy has three levels of inputs that may be used to measure fair value:

The Company’s financial instruments are primarily investments in pension assets, see Note 10, Retirement Benefit Plans, and consists of an interest rate swap.

The Company’s interest rate swap is not an exchange-traded instrument. However, it is valued based on observable inputs for similar liabilities and accordingly is classified as Level 2. The amount of the interest rate swap is included in other accrued liabilities.

The carrying amounts of other financial instruments (cash and cash equivalents, accounts receivable, accounts payable and debt) as of January 2, 2021 and December 28, 2019, approximate fair value based on the expected future cash flows of the related instruments.

Leases

The Company presents right-of-use (“ROU”) assets and lease liabilities on the balance sheet for all leases with terms longer than 12 months, in accordance with the Financial Accounting Standards Board (“FASB”) Accounting Standards Update (“ASU”) 2016-02, Leases. The Company elected to account for non-lease components as part of the lease component to which they relate. Lease accounting involves significant judgements, including making estimates related to the lease term, lease payments, and discount rate.

The Company has operating leases for buildings, warehouse and office equipment. The Company determines whether an arrangement is, or contains, a lease at contract inception. An arrangement contains a lease if the Company has the right to direct the use of and obtain substantially all of the economic benefits of an identified asset. ROU assets and lease liabilities are recognized at lease commencement based on the present value of lease payments over the lease term. Leases with an initial term of 12 months or less are not recorded on the balance sheet; we recognize lease expense for these leases on a straight-line basis over the lease term. Most leases include one or more options to renew. The exercise of lease renewal options is at our sole discretion. The Company’s option to extend certain leases ranges from 1–119 months. All options to extend, when it is reasonably certain the option will be exercised, have been included in the calculation of the ROU asset and lease liability.

Currently, the Company has 35 operating leases and three finance leases with a lease liability of $12.8 million as of January 2, 2021. The finance lease arrangements are immaterial. The basis, terms and conditions of the leases are determined by the individual agreements. The leases do not contain residual value guarantees, restrictions, or covenants that could cause the Company to incur additional financial obligations. We rent or sublease a part of one real estate property to a third party. There are no related party transactions. There are no leases that have not yet commenced that could create significant rights and obligations for the Company.

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Total lease expense for each of the next five fiscal years is estimated to be as follows: 2021 - $2,923,761; 2022 - $2,262,399; 2023 - $1,872,491; 2024 - $1,481,832; 2025 - $844,884 and $3,421,563 thereafter. The weighted average remaining lease term is 6.8 years. The interest rate used was 3.5% - 5.0%.

Revenue Recognition

The Company recognizes revenue in accordance with ASC 606 when control of the promised goods or services is transferred to the customer in an amount that reflects the consideration the Company expects to be entitled to in exchange for those goods or services.

The Company generates wholesale revenues primarily from the sale of products to original equipment manufacturers and distributers in the United States. The Company recognizes revenue upon shipment or transfer of title to the customer as that is when the customer obtains control of the promised goods. The Company typically extends credit terms to its customers based on their creditworthiness and generally does not receive advance payments. As such, the Company records accounts receivable at the time of shipment, when the Company’s right to the consideration becomes unconditional. Accounts receivable from the Company’s customers are typically due within 30 days of invoicing. An allowance for doubtful accounts is provided based on a periodic analysis of individual account balances, including an evaluation of days outstanding, payment history, recent payment trends and the Company’s assessment of the customer’s credit worthiness. As of January 2, 2021 and December 28, 2019, the Company’s allowance for doubtful accounts total was $545,000 and $556,000, respectively. As of January 2, 2021, and December 28, 2019, the Company’s bad debt expense was $253,000 and $64,000 respectively.

The Company considers several factors in determining that control transfers to the customer upon shipment of products. These factors include that legal title transfers to the customer, the Company has a present right to payment, and the customer has assumed the risk and rewards of ownership at the time of shipment.

Big 3 Mold may employ the efforts expended method for the percentage of completion for revenue recognition for certain transactions. The efforts expended method calculates the proportion of effort expended to date in comparison to the total effort expected to be expended for the contract. The amount of revenue recognized employing the percentage of completion method was $505,000 for the year ended January 2, 2021 and $576,000 for the year ended December 28, 2019.

Based on historical experience, the Company does not accrue a reserve for product returns. For the years ended January 2, 2021 and December 28, 2019, the Company recorded sales returns of $459,000 and $613,000, respectively, as a reduction of revenue.

Greenwald Industries generates subscription services revenue from access provided to customers to the division’s specific online databases. For the years ended January 2, 2021 and December 28, 2019, Greenwald Industries subscription services revenue was $441,000 and $567,000, respectively.

Sales and similar taxes that are imposed on the Company’s sales and collected from the customer are excluded from revenues.

Costs for shipping and handling activities, including those activities that occur subsequent to transfer of control to the customer, are recorded as cost of sales and are expensed as incurred.

For the years ended January 2, 2021 and December 28, 2019, the Company recorded no revenues related to performance obligations satisfied in prior periods. The Company has elected to use the practical expedient to exclude disclosure of transaction prices allocated to remaining performance obligations, and when the Company expects to recognize such revenue, for all periods prior to the date of initial application of the standard.

See Note 12 regarding the Company’s revenue disaggregated by reporting segment, intersegment sales by reporting segment and geography.

Cost of Goods Sold

Cost of goods sold reflects the cost of purchasing, manufacturing and preparing a product for sale. These costs generally represent the expenses to acquire or manufacture products for sale (including an allocation of depreciation and amortization) and are primarily comprised of direct materials, direct labor, and overhead, which includes indirect labor, facility and equipment costs, inbound freight, receiving, inspection, purchasing, warehousing and any other costs related to the purchasing, manufacturing or preparation of a product for sale.

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Shipping and Handling Costs

Shipping and handling costs are included in cost of goods sold.

Product Development Costs

Product development costs, charged to expense as incurred, were $3,131,035 in 2020 and $6,024,567 in 2019.

Selling and Administrative Expenses

Selling and administrative expenses include all operating costs of the Company that are not directly related to the cost of purchasing, manufacturing and preparing a product for sale. These expenses generally represent administrative expenses for support functions and related overhead.

Advertising Costs

The Company expenses advertising costs as incurred. Advertising costs were $303,060 in 2020 and $462,911 in 2019.

Stock Based Compensation

The Company accounts for its stock based awards in accordance with Accounting Standards Codification subtopic 718-10, Compensation (“ASC 718-10”), which requires a fair value measurement and recognition of compensation expense for all share-based payment awards made to its employees and Directors, including employee stock options and restricted stock awards. The Company estimates the fair value of granted stock options using the Black-Scholes valuation model. This model requires the Company to make estimates and assumptions including, without limitation, estimates regarding the length of time an employee will retain vested stock options before exercising them, the estimated volatility of the Company’s common stock price and the number of options that will be forfeited prior to vesting. The fair value is then amortized on a straight-line basis over the requisite service periods of the awards, which is generally the vesting period. Changes in these estimates and assumptions can materially affect the determination of the fair value of stock-based compensation and consequently, the related amount recognized in the Company’s consolidated statements of operations.

Under the terms of the Director’s Fee Program, the directors receive their Director’s fees in common shares of the Company.

Income Taxes

The Company and its U.S. subsidiaries file a consolidated federal income tax return.

Deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse.

On December, 22, 2017, SAB 118 was issued due to the complexities involved in accounting for the enacted Tax Act. SAB 118 requires the company to include in its financial statements a reasonable estimate of the impact of the Tax Act on earnings to the extent such estimate has been determined. Accordingly, the U.S. provision for income tax for 2017 was based on the reasonable estimate guidance provided by SAB 118. The company has assessed the impact from the Tax Act and recorded the impact in the fourth quarter of 2018.

The Company accounts for uncertain tax positions pursuant to the provisions of FASB Accounting Standards Codification (“ASC”) 740 which clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements. These provisions detail how companies should recognize, measure, present and disclose uncertain tax positions that have or are expected to be taken. As such, the 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. See Note 8, Income Taxes.

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The Eastern Company

Notes to Consolidated Financial Statements (continued)

4. GOODWILL

The following is a roll-forward of goodwill for 2020 and 2019:

Engineered Diversified

Solutions Products Total

Engineered Diversified

Solutions Products Total

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The Eastern Company

Notes to Consolidated Financial Statements (continued)

5. INTANGIBLES

Trademarks are not amortized as their lives are deemed to be indefinite. Total amortization expense for each of the next five years is estimated to be as follows: 2021 - $3.8 million; 2022 - $3.8 million; 2023 - $3.8 million; 2024 - $3.0 million and 2025 - $3.0 million.

Weighted-Average

Engineered Diversified Amortization

Solutions Products Total Period (Years)

Intellectual property - - -

2020 Accumulated Amortization

Intellectual property - - -

2019 Accumulated Amortization

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The Eastern Company

Notes to Consolidated Financial Statements (continued)

6. DEBT

On August 30, 2019, the Company entered into the Credit Agreement with Santander Bank, N.A., for itself, People’s United Bank, National Association. and TD Bank, N.A. as lenders, that included a $100 million term portion and a $20 million revolving commitment portion. Proceeds of the term loan were used to repay the Company’s remaining outstanding term loan (and to terminate its existing credit facility) with People’s United Bank, N.A. (approximately $19 million) and to acquire Big 3 Precision. The term portion of the loan requires quarterly principal payments of $1,250,000 for an 18-month period beginning December 31, 2019. The repayment amount then increases to $1,875,000 per quarter beginning September 30, 2021 and continues through June 30, 2023. The repayment amount then increases to $2,500,000 per quarter beginning September 30, 2023 and continues through June 30, 2024. The term loan is a 5-year loan with the remaining balance due on August 30, 2024. The revolving commitment portion has an annual commitment fee of 0.25% based on the unused portion of the revolver. The revolving commitment portion has a maturity date of August 30, 2024. During 2019 and 2020, the Company did not borrow any funds on the revolving commitment portion of the facility. The interest rates on the term and revolving credit portion of the Credit Agreement vary. The interest rates may vary based on the LIBOR rate plus a margin spread of 1.25% to 2.25%. The Company’s obligations under the Credit Agreement are secured by a lien on certain of the Company’s and its subsidiaries’ assets pursuant to a Pledge and Security Agreement, dated August 30, 2019 with Santander Bank, N.A., as administrative agent.

The Company’s loan covenants under the Credit Agreement require the Company to maintain a senior net leverage ratio not to exceed 4.25 to 1. In addition, the Company will be required to maintain a fixed charge coverage ratio to be not less than 1.25 to 1.

On August 30, 2019, the Company entered into an interest rate swap contract with Santander Bank, N.A., with an original notational amount of $50,000,000, which was equal to 50% of the outstanding balance of the term loan on that date. The Company has a fixed interest rate of 1.44% on the swap contract and will pay the difference between the fixed rate and LIBOR when LIBOR is below 1.44% and will receive interest when the LIBOR rate exceeds 1.44%. On January 2, 2021, the interest rate for half ($41.9 million) of the term portion was 1.9%, using a one-month LIBOR rate, and 3.19% one the remaining balance ($46.9 million) of the term loan based on a one-month LIBOR rate.

The interest rates on the Credit Agreement, and interest rate swap contract are susceptible to changes to the method that LIBOR rates are determined and to the potential phasing out of LIBOR after 2021. Information regarding the potential phasing out of LIBOR is provided below.

On July 27, 2017, the Financial Conduct Authority (the “FCA”) (the authority that regulates LIBOR) announced that it would phase out LIBOR by the end of 2021. The ICE Benchmark Administration (the “IBA”) recently announced market consultation regarding the extension of US dollar LIBOR tenors through June 30, 2023, which the FCA supports. The Alternative Reference Rates Committee (the “ARRC”), a financial industry group convened by the Federal Reserve Board, has recommended the use of the Secured Overnight Financing Rate (“SOFR”) to replace LIBOR. The difference between LIBOR and SOFR is that LIBOR is a forward-looking rate which means the interest rate is set at the beginning of the period with payment due at the end. SOFR is a backward-looking overnight rate, which has implications for how interest and other payments are based. Changes in the method of calculating the replacement of LIBOR with an alternative rate or benchmark are still in flux, and once an alternative rate is adopted, may adversely affect interest rates and result in higher borrowing costs. This could materially and adversely affect the Company’s results of operations, cash flows and liquidity. We cannot predict the effect of the potential changes to LIBOR or the establishment and use of alternative rates or benchmarks at this time. We are working with our senior lender and may need to renegotiate our credit facilities as LIBOR phases out in June 2023.

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The Eastern Company

Notes to Consolidated Financial Statements (continued)

6. DEBT (continued)

Debt consists of:

Revolving credit loan — —

1 Amounts are net of unamortized discounts and debt issuance costs of $273,312 as of January 2, 2021 and $360,146 as of December 28, 2019.

The Company paid interest of $2,754,980 in 2020, $1,857,961 in 2019.

The Company’s loan covenants under the Credit Agreement require the Company to maintain a consolidated fixed charge coverage ratio of at least 1.25 to 1, which is to be tested quarterly on a twelve-month trailing basis. In addition, the Company will be required to show a senior net leverage ratio of 4.25 to 1. The Company was in compliance with all covenants as of January 2, 2021. In addition, the Company has restrictions on, among other things, new capital leases, purchases or redemptions of its capital stock, mergers and divestitures, and new borrowing. The Company was in compliance with all covenants in 2020 and 2019.

As of January 2, 2021, scheduled annual principal maturities of long-term debt for each of the next five years follow:

Thereafter —

7. STOCK OPTIONS AND AWARDS

Stock Options

As of January 2, 2021, the Company has one stock option plan, The Eastern Company 2020 Stock Incentive Plan (the “2020 Plan”), for officers, other key employees, and non-employee Directors. The Eastern Company 2010 Executive Stock Incentive Plan expired in February 2020. Incentive stock options granted under the 2020 Plan must have exercise prices that are not less than 100% of the fair market value of the Company’s common stock on the dates the stock options are granted. Restricted stock awards may also be granted to participants under the 2020 Plan with restrictions determined by the Compensation Committee of the Company’s Board of Directors. Under the 2020 Plan, non-qualified stock options granted to participants will have exercise prices determined by the Compensation Committee of the Company’s Board of Directors. During 2020 and 2019, the Company did not grant stock options or restricted stock.

The 2020 Plan also permits the issuance of Stock Appreciation Rights (“SARs”). The SARs are in the form of an option with a cashless exercise price equal to the difference between the fair value of the Company’s common stock at the date of grant and the fair value as of the exercise date resulting in the issuance of the Company’s common stock. The Company issued 44,000 SARs during 2020 and 96,000 SARs during 2019.

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The Eastern Company

Notes to Consolidated Financial Statements (continued)

7. STOCK OPTIONS AND AWARDS (continued)

Stock-based compensation expense in connection with Stock Awards and SARs granted to employees during fiscal year 2020 was $376,000 and for 2019 was $397,000. For the period of 2020, the Company used several assumptions which included an expected term of 4 years, volatility deviation of 38.62% and a risk-free rate of 0.26%. For the period of 2019, the Company used several assumptions which included an expected term of 3.5 to 4 years, volatility deviation of 28.88% and 32.33% and a risk-free rate of 1.42% to 2.48%.

As of January 2, 2021, there were 818,864 shares of common stock reserved and available for future grant under the above noted 2020 Plan.

The following tables set forth the outstanding SARs for the period specified:

Units Weighted - Average Exercise Price Units Weighted - Average Exercise Price

SARs Outstanding and Exercisable

The following tables set forth the outstanding stock grants for the period specified:

Outstanding at beginning of period 25,000 $ — 25,000 $ —

Issued — — — —

Forfeited — — — —

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The Eastern Company

Notes to Consolidated Financial Statements (continued)

7. STOCK OPTIONS AND AWARDS (continued)

Stock Grants Outstanding and Exercisable

As of January 2, 2021, outstanding SARs and options had an intrinsic value of $1,253,140.

8. INCOME TAXES

Deferred income taxes are provided on temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and those for income tax reporting purposes. Deferred income tax (assets) liabilities relate to:

Income before income taxes consists of:

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The Eastern Company

Notes to Consolidated Financial Statements (continued)

8. INCOME TAXES (continued)

The provision for income taxes follows:

Current:

Deferred:

A reconciliation of income taxes computed using the U.S. federal statutory rate to that reflected in operations follows:

Amount Percent Amount Percent

Impact on Foreign Repatriation Tax Reform 139,765 2 -- 0

Impact of foreign subsidiaries on effective tax rate 165,210 3 (239,823 ) (2 )

Impact of Research & Development tax credit (188,944 ) (3 ) (411,090 ) (3 )

Uncertain tax positions reserve (926,101 ) (15 ) 0 0

Total income taxes paid were $3,755,475 in 2020 and $3,197,984 in 2019.

Pursuant to SAB 118, the company is allowed a measurement period of up to one year after the enactment date of the Tax Act to finalize the recording of the related tax impacts and as such has adjusted for the finalization of the tax impacts in the fourth quarter of 2018. The change primarily related to deferred taxes.

Under accounting standards (ASC 740), a deferred tax liability is not recorded for the excess of the financial reporting (book) basis over the tax basis of an investment in a foreign subsidiary if the indefinite reinvestment criteria are met. Effective for foreign earnings after December 30, 2017, if such earnings are distributed in the form of cash dividends, the Company would not be subject to additional U.S. income taxes but could be subject to foreign income and withholding taxes. A provision has not been made for additional U.S. federal and foreign taxes at January 2, 2021 on approximately $7,712,164 of undistributed earnings of foreign subsidiaries because the Company intends to reinvest these funds indefinitely. It is not practicable to estimate the unrecognized deferred tax liability for withholding taxes on these undistributed earnings.

In December 2019, the FASB issued ASU 2019-12, Simplifying the Accounting for Income Taxes. The list of changes is comprehensive. The changes include removing exceptions to incremental intraperiod tax allocation of losses and gains from different financial statement components, exceptions to the method of recognizing income taxes on interim period losses and exceptions to deferred tax liability recognition related to foreign subsidiary investments. In addition, ASU 2019-12 requires that entities recognize franchise tax based on an incremental method, requires an entity to evaluate the accounting for step-ups in the tax basis of goodwill as inside or outside of a business combination, and removes the requirement to allocate the current and deferred tax provision among entities in standalone financial statement reporting. The ASU also now requires that an entity reflect enacted changes in tax laws in the annual effective rate, and other Codification adjustments have been made to employee stock ownership plans. For public business entities, the amendments in ASU 2019-12 are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. Early adoption of ASU 2019-12 is permitted, including adoption in any interim period for public business entities for periods for which financial statements have not yet been issued. An entity that elects to early adopt the amendments in an interim period should reflect any adjustments as of the beginning of the annual period that includes that interim period. Additionally, an entity that elects early adoption must adopt all the amendments in the same period. The Company will adopt ASU 2019-12 in the first interim period of 2021.

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The Eastern Company

Notes to Consolidated Financial Statements (continued)

8. INCOME TAXES (continued)

On March 27, 2020, the $2 trillion bipartisan Coronavirus Aid, Relief, and Economic Security Act (H.R. 748) (the “CARES Act”) became law. The CARES Act includes a variety of economic and tax relief measures intended to stimulate the economy, including loans for small businesses, payroll tax credits/deferrals, and corporate income tax relief. We are analyzing the following components of the CARES Act to determine their effect on our income tax provision:

The Company will also continue to assess the effect of state level tax relief provisions as enacted, such as state net operating loss rule changes and conformity to the federal interest, depreciation and charitable contribution deduction changes.

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A reconciliation of the beginning and ending amount of unrecognized tax benefits are as follows:

Increase (decrease) for positions taken during the prior period -- 2,039,117

The Company files income tax returns in the U.S. federal jurisdiction, and various states and foreign jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal, state and local income tax examinations by tax authorities for years before 2016 and non-U.S. income tax examinations by tax authorities prior to 2014.

Included in the balance at January 2, 2021, are $653,204 of unrecognized tax benefits that would affect the annual effective tax rate. In 2020, the Company recognized accrued interest related to unrecognized tax benefits in income tax expense. The Company had approximately $56,105 of accrued interest at January 2, 2021.

The total amount of unrecognized tax benefits could increase or decrease within the next twelve months for a number of reasons, including the closure of federal, state and foreign tax years by expiration of the statute of limitations and the recognition and measurement considerations under ASC 740. The Company believes that the total amount of unrecognized tax benefits will not increase or decrease significantly over the next twelve months.

9. LEASES

The Company leases certain equipment and buildings under operating lease arrangements. Most leases are for a fixed term and for a fixed amount. The Company is not a party to any leases that have step rent provisions, escalation clauses, capital improvement funding or payment increases based on any index or rate.

Future minimum payments under non-cancelable operating leases with initial or remaining terms in excess of one year during each of the next five years follow:

Rent expense for all operating leases was $2,840,908 in 2020 and $3,106,630 in 2019. The weighted average lease term for all operating leases is 6.8 years. The weighted average discount rate for all operating leases is 5%.

10. RETIREMENT BENEFIT PLANS

The Company has non-contributory defined benefit pension plans covering some 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 non-qualified supplemental retirement plans that provide certain former officers with benefits in excess of limits imposed by federal tax law.

The Company also provides health care and life insurance for retired salaried employees in the United States who meet specific eligibility requirements.

Components of the net periodic benefit cost of the Company’s pension benefit plans for the fiscal year indicated were as follows:

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Notes to Consolidated Financial Statements (continued)

10. RETIREMENT BENEFIT PLANS (continued)

Service costs are reported in the cost of products sold and the other components of net periodic benefit costs are reported in other income in the consolidated statements of income.

Assumptions used to determine net periodic benefit cost for the Company’s pension benefit plans for the fiscal year indicated were as follows:

Discount rate

- Supplemental pension plans 2.61 % 3.81 %

Expected return on plan assets 7.5 % 7.5 %

Rate of compensation increase 0 % 0 %

Components of the net periodic benefit cost of the Company’s other postretirement benefit plan were as follows:

Amortization of prior service cost (8,253 ) (5,072 )

Assumptions used to determine net periodic benefit cost for the Company’s other postretirement plan for the fiscal year indicated were as follows:

Expected return on plan assets 4.0 % 4.0 %

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The Eastern Company

Notes to Consolidated Financial Statements (continued)

10. RETIREMENT BENEFIT PLANS (continued)

As of January 2, 2021, and December 28, 2019, the status of the Company’s pension benefit plans and other postretirement benefit plan was as follows:

Pension Benefit Other Postretirement Benefit

Significant Event - - - (902,719 )

Significant Event - - - (902,719 )

Pension Benefit Other Postretirement Benefit

Amounts recognized in accumulated other comprehensive income consist of:

Pension Benefit Other Postretirement Benefit

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The Eastern Company

Notes to Consolidated Financial Statements (continued)

10. RETIREMENT BENEFIT PLANS (continued)

Change in the components of accumulated other comprehensive income consist of:

Pension Benefit Other Postretirement Benefit

Change due to availability of final actual assets and census data - - - -

Charged to net periodic benefit cost

Liability (gains)/losses

Significant Event - - - (454,143 )

Assumptions used to determine the projected benefit obligations for the Company’s pension benefit plans and other postretirement benefit plan for the fiscal year indicated were as follows:

Discount rate

- Supplemental pension plans 1.49 % 2.61 %

- Other postretirement plan 2.66 % 3.35 %

At January 2, 2021 and December 28 2019, the accumulated benefit obligation for all qualified and nonqualified defined benefit pension plans was $111,549,725 and $102,991,053, respectively. During 2020, the pension benefit obligation increased between 10.3% to 11.3% due to the decrease in the discount rates from 3.18%-3.23% to 2.40%-2.48%.

Information for the under-funded pension plans with a projected benefit obligation and an accumulated benefit obligation in excess of plan assets:

Number of plans 5 5

Estimated future benefit payments to participants of the Company’s pension plans are $4.4 million in 2021, $4.6 million in 2022, $4.8 million in 2023, $5.0 million in 2024, $5.2 million in 2025 and a total of $28.1 million from 2026 through 2030.

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The Eastern Company

Notes to Consolidated Financial Statements (continued)

10. Retirement Benefit Plans (continued)

Estimated future benefit payments to participants of the Company’s other postretirement plan are $49,000 in 2021, $50,000 in 2022, $51,000 in 2023, $52,000 in 2024, $54,000 in 2025 and a total of $302,000 from 2026 through 2030.

The Company expects to make cash contributions to its qualified pension plans of approximately $3,100,000 and to its other postretirement plan of approximately $50,000 in 2021.

We consider a number of factors in determining and selecting assumptions for the overall expected long-term rate of return on plan assets. We consider the historical long-term return experience of our assets, the current and expected allocation of our plan assets, and expected long-term rates of return. We derive these expected long-term rates of return with the assistance of our investment advisors and generally base these rates on a 10-year horizon for various asset classes and consider the expected positive impact of active investment management. We base our expected allocation of plan assets on a diversified portfolio consisting of domestic and international equity securities and fixed income securities.

We consider a variety of factors in determining and selecting our assumptions for the discount rate at the end of the year. In 2020, as in 2019, we developed each plan’s discount rate with the assistance of our actuaries by matching expected future benefit payments in each year to the corresponding spot rates from the FTSE Pension Liability Yield Curve, comprised of high quality (rated AA or better) corporate bonds.

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The Eastern Company

Notes to Consolidated Financial Statements (continued)

10. RETIREMENT BENEFIT PLANS (continued)

The fair values of the company’s pension plans assets at January 2, 2021 and December 28, 2019, utilizing the fair value hierarchy discussed in Note 3, follow:

Level 1 Level 2 Level 3 Total

Cash and Equivalents:

Equities:

Common/collective trust funds

Fixed Income:

Common/collective trust funds

Target Duration LDI Fixed Income Funds (b)

STRIPS Fixed Income Funds (c)

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The Eastern Company

Notes to Consolidated Financial Statements (continued)

10. RETIREMENT BENEFIT PLANS (continued)

Level 1 Level 2 Level 3 Total

Cash and Equivalents:

Equities:

Common/collective trust funds

Fixed Income:

Common/collective trust funds

Target Duration LDI Fixed Income Funds (b)

STRIPS Fixed Income Funds (c)

Equity common funds primarily hold publicly traded common stock of both U.S and international companies selected for purposes of total return and to maintain equity exposure consistent with policy allocations. The Level 1 investment is made up of shares of The Eastern Company Common Stock and is valued at market price. Level 2 investments include commingled funds valued at unit values provided by the investment managers, which are based on the fair value of the underlying publicly traded securities.

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The Eastern Company

Notes to Consolidated Financial Statements (continued)

10. RETIREMENT BENEFIT PLANS (continued)

The investment portfolio contains a diversified blend of common stocks, bonds, cash equivalents, and other investments, which may reflect varying rates of return. The investments are further diversified within each asset classification. The portfolio diversification provides protection against a single security or class of securities having a disproportionate impact on aggregate performance. The Company has elected to change its investment strategy to better match the assets with the underlying plan liabilities. Currently, the long-term target allocations for plan assets are 50% in equities and 50% in fixed income although the actual plan asset allocations may be within a range around these targets. The actual asset allocations are reviewed and rebalanced on a periodic basis to maintain the target allocations. It is expected that, as the funded status of the plans improves, more assets will be invested in long-duration fixed income instruments.

The plans’ assets include 217,018 shares of the common stock of the Company having a market value of $5,230,134 and $6,625,560 at January 2, 2021 and December 28, 2019, respectively. No shares were purchased in 2020 or 2019 nor were any shares sold in either period. Dividends received during 2020 and 2019 on the common stock of the Company were $95,488 and $95,488 respectively.

U.S. salaried and non-union hourly employees and most employees of the Company’s Canadian subsidiaries are covered by defined contribution plans.

The Company has a contributory savings plan under Section 401(k) of the Internal Revenue Code covering substantially all U.S. non-union employees. This 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.

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The Eastern Company

Notes to Consolidated Financial Statements (continued)

10. RETIREMENT BENEFIT PLANS (continued)

The Company amended the Eastern Company Savings and Investment Plan (“401(k) Plan Amendment”) effective June 1, 2016. The 401(k) Plan Amendment increased this match to 50% of the first 6% of contributions for the remainder of Fiscal 2016. The 401(k) Plan Amendment also provided for an additional non-discretionary contribution (the “transitional credit”) for certain non-union U.S. employees who were eligible to participate in the Salaried Plan. The amount of this non-discretionary contribution ranges from 0% to 4% of wages, based on the age of the individual on June 1, 2016. The 401(k) Plan Amendment increased the non-discretionary safe harbor contribution to 3%, and changed the eligibility to all non-union U.S. employees.

The Company made contributions to the plan as follows:

At January 2, 2021, the Company had accrued $519,177 for the non-discretionary safe harbor contribution this amount was expensed in 2020 and was contributed to the plan in January 2021. At December 28, 2019, the Company had accrued $550,286 for the non-discretionary safe harbor contribution. This amount was contributed to the Plan in January 2020 and was expensed in 2019.

11. EARNINGS PER SHARE

The denominators used in the earnings per share computations follow:

Basic: