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 years 2022 and 2021 were each 52 weeks in length. References in this Management’s Discussion and Analysis of Financial Condition and Results of Operations to results for “2022” or “fiscal year 2022” mean the fiscal year ended December 31, 2022, and references to results for “2021” or “fiscal year 2021” mean the fiscal year ended January 1, 2022. References to the “fourth quarter of 2022” or the “fourth fiscal quarter of 2022” mean the thirteen-week period from October 2, 2022 to December 31, 2022, and references to the “fourth quarter of 2021” or the “fourth fiscal quarter of 2021” mean the thirteen-week period from October 3, 2021 to January 1, 2022.
The following analysis excludes discontinued operations.
Summary
Sales for 2022 were $279.3 million compared to $246.5 million for 2021. Net income for 2022 was $11.1 million, or $1.77 per diluted share, compared to $16.2 million, or $2.58 per diluted share, for 2021. Sales for the fourth quarter of 2022 were $69.1 million compared to $59.6 million for the same period in 2021. Net income for the fourth quarter of 2022 was $0.2 million, or $0.03 per diluted share compared to $3.9 million, or $0.62 per diluted share, for the comparable 2021 period.
During 2022, the Company experienced rising material costs, supply chain disruption, labor shortages and abnormally high freight costs all having a negative impact on our gross margin. The Company’s backlog was $72.5 million on December 31, 2022, compared to $82.8 million on January 1, 2022, primarily due to a decrease of $5.0 million in backlog for locks and hardware at Eberhard, a decrease of $7.1 million in backlog at Big 3 for mold services and returnable packaging, offset by an increase of $1.8 million in backlog related to the launch of new mirror programs for Class 8 trucks being awarded to our Velvac subsidiary.
During 2022 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 have negatively impacted and could continue to 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.
Impact of COVID-19, Current Political and Economic Conditions and Supply Chain Disruptions
The COVID-19 pandemic has affected our business, including our supply chain, our operations, the labor force, costs and interest rates throughout 2021 and 2022. We continue to follow CDC guidelines, social distancing, and sanitizing work areas. During the past two years and continuing into 2023, the Company implemented a broad range of policies and procedures to ensure that employees at all our locations remain healthy. Steps that we have taken to reduce the risk of COVID-19 to our employees include, among others: protecting employee health by instructing employees to stay home if they exhibit symptoms of COVID-19. We maintain a clean work environment by frequently cleaning all touch points with products that meet EPA criteria for use against COVID-19; educating employees to clean their personal workspace at the beginning and the end of every shift; and providing hand sanitizer and disposable wipes. We encourage social distancing and continue to seek and implement additional methods to reduce the risk of COVID-19 to our employees. As a result of these measures, the COVID-19 pandemic had minimal impact on our North American capacity utilization at most of our production facilities. Many of the Company’s employees have received COVID-19 vaccinations, and we will continue to encourage our workforce to get vaccinated.
Current global economic conditions, resulting from the COVID-19 pandemic and other factors, are highly volatile. Many of the markets we serve are facing inflation and rising interest rates, which has led to and may continue to lead to contractions resulting in decreased demand for our products. Decreased demand has in turn negatively impacted, and may continue to negatively impact, our financial condition and operating results. Any further or prolonged market contractions or economic slowdowns could materially adversely affect our sales or operating margin, which would in turn reduce earnings. Volatile global economic conditions may also cause foreign exchange rate fluctuations, which could result in material increases or decreases in earnings and may adversely affect the value of the Company’s assets outside the United States. Increased pricing in response to fluctuations in foreign currency exchange rates may offset portions of the currency impacts but could also have a negative impact on demand for the Company’s products, which would affect sales and profits. Exchange rate fluctuations could also increase pricing pressure and impair the ability of the Company’s products to compete with products imported from regions with favorable exchange rates.
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In the second quarter of 2022, we experienced interruptions of our operations and supply base in China as a result of a new variant of COVID-19 and the local response to minimize its spread. A more significant resurgence of the COVID-19 pandemic or development of additional severe or highly contagious variants could cause further disruptions in our business and could adversely affect our financial condition, results of operations and cash flows. In addition, supply shortages and supply chain disruptions originally triggered by shutdowns and other restrictions imposed to slow the spread and resurgence of COVID-19 have impacted and may continue to impact the prices and availability of certain of the raw materials and components used in the production of our products.
The impact of economic contraction and supply chain disruptions has been exacerbated by the effects of tariffs, trade sanctions and global political instability. International trade policies, such as tariffs on imports from China and on aluminum imports, have increased our costs. Sanctions imposed as a result of the Ukraine conflict prohibit importation of a variety of products from Russia, which is a major global supplier of nickel, and have resulted in higher oil and other commodity prices that have increased shipping and transportation costs. Supply chain constraints and tariffs may result in cost increases that we are not able to offset with price increases, which could have a material adverse effect on our business, financial position, results of operations or cash flows. Further, trade restrictions and supply chain constraints have affected our ability to meet customer demand. If such conditions persist and we are unable to acquire necessary raw materials or components in a timely manner or at all, we may be unable to meet production requirements and may need to cancel or decline orders, which could have a material adverse effect on our reputation as well as our business and financial results.
The extent to which our operations will be further affected by COVID-19 and its lasting economic impact, including supply chain disruptions, cost inflation and rising interest rates, in fiscal year 2023 is dependent on future developments including new COVID-19 variants and governmental restrictions, the duration of the Russia–Ukraine conflict and related sanctions, actions taken by the Federal Reserve to stabilize the economy, and other factors outside our control. With the inherent uncertainty of the COVID-19 pandemic, volatile economic conditions and political instability, it is difficult to predict with any confidence the likely ultimate impact of these conditions on our future operations and the extent of actual and potential effects on our consolidated business, results of operations and financial condition. For further discussion of these risks, see Part I, Item 1A, Risk Factors, of this Form 10-K.
Critical Accounting 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 allowance for doubtful accounts; inventory accounting; the testing of goodwill and other intangible assets for impairment; and pensions and other postretirement benefits. 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.
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, considering a combination of factors that require judgment and estimates, including among others, our customers’ access to capital, customers’ willingness or ability to pay, customer payment patterns, general economic conditions and geopolitical trends, and our ongoing relationship with our customers. 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. If our estimates and assumptions as to collectability were materially incorrect, or if any of our significant customers were to develop unexpected and immediate financial problems that would prevent payment of amounts due to us, and our allowance for doubtful accounts were inadequate, this could result in an unexpected loss in profitability.
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As of December 31, 2022 and January 1, 2022, the Company’s allowance for doubtful accounts total was $677,000 and $515,000, respectively. As of December 31, 2022, and January 1, 2022, the Company’s bad debt expense was $208,000 and $48,000 respectively.
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 Eberhard while Big 3 Precision and Velvac are valued using 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, considering deterioration, obsolescence, estimated future demand, current market conditions, 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 and could vary significantly, whether favorably or unfavorably, from actual results due to, among other things, unanticipated changes in economic conditions, customer demand, or the competitive landscape.
The inventory reserve for excess or obsolete inventory reduced the Company’s inventory valuation by $1,926,000 and $1,115,000 as of December 31, 2022 and January 1, 2022, respectively.
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. The Company performs annual qualitative assessments on goodwill and other intangible assets as of the end of each fiscal year by comparing the estimated fair value of each reporting unit with its carrying amount. Additionally, the Company performs an interim analysis 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 or 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. 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, including (i) macroeconomic conditions, (ii) market and industry conditions, (iii) cost factors, (iv) overall financial performance, (v) other relevant entity-specific events, and (vi) events affecting a reporting unit. 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.
The Company performed its annual qualitative assessment as of the end of each of fiscal 2022 and 2021 on the carrying value of goodwill and determined that it is more likely than not that no impairment of goodwill existed as of such dates. See Note 3 – Accounting Policies –Goodwill, in Item 8, Financial Statements and Supplementary Data of this Form 10-K for more detail.
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 2022 and 2021. 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 $800,000 and $50,000 to our pension plans and other postretirement plan, respectively, in 2023.
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In connection with our pension and other postretirement benefits, the Company reported income of $3.3 million and $2.1 million (net of tax) on its Consolidated Statement of Comprehensive Income for fiscal years 2022 and 2021, 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
December 31, January 1,
Additional recognition due to significant event -- (71,547 )
Amortization of:
The Plan has been investing a portion of the assets in long-term bonds 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 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 2022 Compared to Fourth Quarter 2021
The following table shows, for the fourth quarter of 2022 and 2021, selected line items from the consolidated statements of income as a percentage of net sales for the Company’s operations. The Company’s continuing operations include (1) Big 3 Precision, including Big 3 Products and Big 3 Mold, Hallink Moulds, and Associated Toolmakers; (2) Eberhard Manufacturing, Eastern Industrial Ltd., World Lock Company Ltd., Dongguan Reeworld Security Products Ltd., and World Security Industries Ltd.; and (3) Velvac Holdings.
Three Months Ended
Cost of Products Sold 83.4 % 79.8 %
Product Development Expense 1.5 % 1.7 %
Selling and Administrative Expense 13.6 % 12.5 %
Restructuring Costs 1.0 % --
Operating Profit 0.5 % 6.0 %
Net sales in the fourth quarter of 2022 increased 15.8% to $69.1 million from $59.6 million in the fourth quarter of 2021. Sales increases were due to higher demand for trucks accessories, distribution products and automotive returnable packaging and improved pricing. Sales volume of existing products increased 10.5%, prices and new products contributed 5.3% in sales growth in the fourth quarter of 2022 when compared to sales in the fourth quarter of 2021. New products included various truck, mirrors, latches, and accessories.
Sales of new products contributed 1.4% to sales growth in the fourth quarter compared to 8% sales growth from new products in the fourth quarter of 2021. New products in the fourth quarter included various new truck mirrors and truck latches.
Cost of products sold in the fourth quarter of 2022 increased $10.0 million or 21% from the corresponding period in 2021. The increase in cost of products sold is primarily attributable to increased sales volume, increases in the cost of materials, increases in freight costs due to expedite fees associated with supply chain constraints, and other inventory write-offs.
Gross margin as a percentage of net sales for the fourth quarter of 2022 was 16.6% compared to 20.2% in the prior year fourth quarter. The decrease reflects the combination of higher material and freight costs and other inventory write-offs.
Product development expenses in the fourth quarter of 2022 of $1.1 million were flat when compared to the fourth quarter of 2021. As a percentage of net sales, product development costs were 1.5% and 1.7% for the fourth quarter of 2022 and 2021 respectively as part of our investment in new products at Eberhard and Velvac.
Selling and administrative expenses in the fourth quarter of 2022 increased 1.1% compared to the fourth quarter of 2021. The increase was primarily the result of increased payroll and payroll related expenses, increased travel, and other selling expenses.
Restructuring expenses of $0.7 million were recognized in the fourth quarter of 2022 due to a warehouse consolidation into Eberhard.
Net income for the fourth quarter of 2022 decreased 95% to $0.2 million, or $0.03 per diluted share, from $3.9 million, or $0.62 per diluted share, in 2021. In the fourth quarter of 2022, net income was negatively impacted by restructuring costs of $0.5 million, net of tax, related to a warehouse consolidation into Eberhard.
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Fiscal Year 2022 Compared to Fiscal Year 2021
The following table shows, for fiscal year 2022 and fiscal year 2021, selected line items from the consolidated statements of income as a percentage of net sales for the Company’s operations. The Company’s continuing operations include (1) Big 3 Precision, including Big 3 Products, Big 3 Mold, Hallink Moulds and Associated Toolmakers Ltd.; (2) Eberhard Manufacturing Company, Eberhard Hardware, 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.
Fiscal Year Ended
Cost of Products Sold 79.0 % 77.0 %
Product Development Expense 1.5 % 1.6 %
Selling and Administrative Expense 14.1 % 14.3 %
Restructuring Costs 0.3 % --
Operating Profit 5.1 % 7.1 %
Summary
Net sales for 2022 increased 13% to $279.3 million from $246.5 million in 2021. The sales increase was primarily due to higher demand for trucks accessories, distribution products and automotive returnable packaging. Sales volume of existing products increased by 7% in 2022 compared to 2021 while price increases and new products increased sales in 2022 by 6%. Sales of new products contributed 3% to sales growth in 2022 compared to 8% sales growth from new products in 2021. New products in 2022 included various new truck mirrors, truck compression latches, cable locks, and locking assemblies.
Cost of products sold increased by $30.9 million or 16% to $220.6 million in 2022 from $189.8 million in 2021. The increase in cost of products sold is primarily attributable to increased sales volume, increases in the price of materials, increases in freight costs due to expedite fees associated with supply chain constraints, and other inventory write-offs. Tariffs incurred during 2022 were $3.1 million from China-sourced products as compared to $2.9 million in 2021. Most of the tariffs were recovered through price increases.
Gross margin as a percentage of sales was 21% in 2022 compared to 23% in 2021. The decrease reflects the combination of higher material and freight costs and other inventory write-offs.
Product development expenses as a percentage of sales was 1.5% and 1.6% in 2022 and 2021, respectively, as the Company continues on-going efforts to develop new products to better serve our customers.
Restructuring expenses of $0.7 million were recognized in 2022 due to a warehouse consolidation into Eberhard.
Selling and administrative expenses increased $4.3 million or 12% to $39.5 million in 2022 from $35.2 million in 2021. The increase relates to increased payroll and payroll related costs, increased travel, and other selling expenses.
Net income for 2022 decreased 32% to $11.1 million, or $1.77 per diluted share, from $16.2 million, or $2.58 per diluted share, in 2021. In 2022, net income was negatively impacted by restructuring costs of $0.5 million, net of tax, related to a warehouse consolidation into Eberhard, and loss on sale of the Wheeling, IL building in the first quarter of 2022 of $0.2 million, net of tax, partially offset by a gain on sale of the Eastern corporate office building in the third quarter of 2022 of $0.5 million, net of tax. Net income for 2021 was positively impacted by a $1.4 million gain, net of tax, related to the sale of the Eberhard Hardware property in the first quarter, partially offset by factory relocation and start-up costs of $0.5 million, net of tax.
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Other Items
The following table shows the amount of change from the year ended January 1, 2022 to the year ended December 31, 2022 in other items (dollars in thousands):
Amount %
Interest expense $ 528 30 %
Interest expense increased in 2022 from 2021 due to increased interest rates.
Other income in 2022 decreased $0.9 million over 2021. Other income in 2022 included a favorable $1.8 million pension cost adjustment and a $0.6 million gain on the sale of the Eastern corporate office building. In 2021, other income included a favorable $1.5 million pension cost adjustment and a $1.8 million gain on the sale of the Eberhard Hardware property.
The effective tax rate for 2022 was 23% compared to the 2021 effective tax rate of 7%. The effective tax rate for 2022 was increased compared to 2021 due to the impact of foreign subsidiaries on the effective tax rate in 2021 and a greater impact from research and development tax credits in 2021. Total income taxes paid were $3.7 million in 2022 and $2.3 million in 2021.
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. The Company closely monitors inventory levels and attempts to match production to expected market demand, keeping tight control over the collection of receivables, and optimizing payment terms on its trade and other payables. The maintenance of appropriate inventory levels considering demand has been and may continue to be challenged by supply chain disruptions, which have led in some cases to a deficiency inventory that has required us to pay expedited freight fees on some of our products to timely fulfill customer orders. Coupled with increased materials costs, this has decreased our margins. If these disruptions persist and we are unable to maintain sufficient inventory on hand, we may need to cancel or decline orders, and we may be unable to offset increased material and freight costs fully by increasing prices on our products, any of which could have a material adverse impact on our liquidity.
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 2.7 2.5
Average days’ sales in accounts receivable 56 64
Inventory turnover 3.4 3.0
Ratio of working capital to sales 26.1 % 27.2 %
Total debt to shareholders’ equity 50.7 % 62.2 %
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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 $ 7.4 $ 4.3
- Held by foreign subsidiaries 2.8 2.3
Net cash (used in) provided by operating activities 7.4 (7.8 )
Net cash provided by (used in) in investing activities 5.1 13.6
Net cash used in by financing activities (11.8 ) (20.3 )
All cash held by foreign subsidiaries is readily convertible into other currencies, including the U.S. dollar.
Net cash provided by operating activities was $7.4 million in 2022 compared to $7.8 million net cash used in operating activities in 2021. In 2022, the Company contributed $0.2 million to its defined benefit retirement plan.
In 2022, cash used to support additional working capital requirements was $5.2 million, which was primarily due to management’s focus on ensuring availability of inventory to meet customer demands during the current supply chain constraints. In 2021, cash used to support additional working capital requirements was $22.9 million.
The Company provided $5.1 million and $13.6 million for investing activities in 2022 and 2021, respectively. In 2022, the company sold a business associated with its discontinued operations for $5.8 million and two of its buildings for $2.2 million. The Company also issued a note receivable of $0.4 million as part of the sale of one of its buildings. In 2021, the company sold businesses associated with its discontinued operations for $17.3 million and one of its buildings for $1.7 million, the Company also issued a note receivable of $2.5 million as part of the sale of the discontinued operations. The Company issued notes receivable of $0.4 million as part of the sale of property. These transactions are more fully discussed in Note 2 – Discontinued Operations in Item 8, Financial Statements of this Form 10-K. The Company invested in capital expenditures of $3.4 million and $3.7 million in 2022 and 2021, respectively. Capital expenditures in fiscal year 2023 are expected to be approximately $6.9 million.
In 2022, the Company made total debt payments of $17.5 million, of which $10.0 million was a repayment of the $10.0 million that had been drawn under the revolving credit facility during 2022 and used $2.8 million for payment of dividends. The Company has $20.0 million available on its revolving line of credit. See Note 6 - Debt in Item 8, Financial Statements for further discussion on the Company’s debt facilities.
In 2021, the Company made total debt payments of $17.3 million, of which $11.0 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 2021.
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 $2.7 million in 2022 and $2.3 million in 2021.
On August 30, 2019, the Company entered into the Credit Agreement with Santander Bank, N.A., for itself, M&T Bank, National Association and TD Bank, N.A. as lenders (the “Credit Agreement”), 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 M&T Bank, N.A. (approximately $19.0 million) and to acquire Big 3 Precision. The term portion of the loan required quarterly principal payments of $1.25 million for an 18-month period beginning December 31, 2019. The repayment amount then increased 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. 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.
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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 is 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 LIBOR exceeds 1.44%. On December 31, 2022, the interest rate for half ($24.0 million) of the term portion was 6.1%, using a one-month LIBOR rate, and 3.19% on the remaining balance ($40.0 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 that the transition from LIBOR to alternative benchmark rates such as SOFR. Information regarding this transition is provided below.
Central banks around the world, including the FRB, are working to implement the transition from the London Interbank Offered Rate (“LIBOR”) to replacement benchmarks including the Secured Overnight Financing Rate (“SOFR”) in the United States. The ICE Benchmark Administration (the “IBA”) ceased publication of all settings of non-US dollar LIBOR and the one-week and two-month U.S. dollar LIBOR settings on December 31, 2021, with the publication of the remaining U.S. dollar LIBOR settings scheduled to be discontinued after June 30, 2023. The Adjustable Interest Rate Act (the “LIBOR Act”), which was signed into law on March 15, 2022, provided a replacement framework for outstanding financial contracts tied to LIBOR once LIBOR ceases to be published. The LIBOR Act provides a statutory mechanism and safe harbor that applies on a nationwide basis to replace LIBOR with a benchmark rate, selected by the Federal Reserve Board based on SOFR, for certain contracts that reference LIBOR and contain no or insufficient fallback provisions. The LIBOR Act preempts and supersedes any state or local law, statute, rule, regulation, or standard relating to the selection or use of a benchmark replacement or related changes and allows parties that already have effective fallback provisions to opt out of the legislation. On December 16, 2022, the Federal Reserve adopted a final rule implementing the LIBOR Act that, among other things, identifies the applicable SOFR-based benchmark replacements under the LIBOR Act for various contact types. 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. The change from LIBOR to SOFR may adversely affect interest rates and result in higher borrowing costs. The effect of this change is still unknown and could materially and adversely affect the Company’s results of operations, cash flows and liquidity.
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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 with U.S. GAAP.
To supplement the consolidated financial statements prepared in accordance with U.S. GAAP, we have presented Adjusted Net Income from Continuing Operations, Adjusted Earnings Per Share from Continuing Operations and Adjusted EBITDA from Continuing Operations, 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 U.S. GAAP financial measures, such as net sales, net income from continuing operations, diluted earnings per share from continuing operations, or other measures prescribed by U.S. GAAP, and there are limitations to using non-GAAP financial measures.
Adjusted Net Income from Continuing Operations is defined as net income from continuing operations excluding, when incurred, gains or losses that we do not believe reflect our ongoing operations, including, for example, the impacts of impairment losses, gains/losses on the sale of subsidiaries, property and facilities, transaction expenses primarily relating to acquisitions and divestitures, factory start-up costs, factory relocation expenses and restructuring costs. Adjusted Net Income from Continuing Operations is a tool that can assist management and investors in comparing our performance on a consistent basis across periods by removing the impact of certain items that management believes do not directly reflect our underlying operating performance.
Adjusted Earnings Per Share from Continuing Operations is defined as earnings per share from continuing operations excluding, when incurred, certain per share gains or losses that we do not believe reflect our ongoing operations, including, for example, the impacts of impairment losses, gains/losses on the sale of subsidiaries, property and facilities, transaction expenses primarily relating to acquisitions and divestitures, factory start-up costs, factory relocation expenses and restructuring costs. We believe that Adjusted Earnings Per Diluted Share from Continuing Operations provides important comparability of underlying operational results, allowing investors and management to access operating performance on a consistent basis from period to period.
Adjusted EBITDA from Continuing Operations is defined as net income from continuing operations before interest expense, provision for income taxes, and depreciation and amortization and excluding, when incurred, the impacts of certain losses or gains that we do not believe reflect our ongoing operations, including, for example, impairment losses, gains/losses on sale of subsidiaries, property and facilities, transaction expenses primarily relating to acquisitions and divestitures, factory start-up costs, factory relocation expenses and restructuring expenses. Adjusted EBITDA from Continuing Operations 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.
Management uses such measures to evaluate performance period over period, to analyze the underlying trends in our business, to assess our performance relative to our competitors, and to establish operational goals and forecasts that are used in allocating resources. These financial measures should not be considered in isolation from, or as a replacement for, U.S. GAAP financial measures.
We believe that presenting non-GAAP financial measures in addition to U.S. 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.
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Reconciliation of Non-GAAP Measures
For the Three and Twelve Months ended December 31, 2022 and January 1, 2022
Three Months Ended Twelve Months Ended
Adjustments:
Gain on sale of Eberhard Hardware Ltd building, net of tax (1,353) A
Factory relocation, net of tax 105 B
Factory start-up costs, net of tax 161 C 348 C
Loss on sale of Wheeling, IL building, net of tax 202 D
Gain on sale of Eastern corporate office building, net of tax (474 ) E
Restructuring costs, net of tax 525 F 525 F
Adjusted earnings per share from continuing operations (Non-GAAP):
A) Gain on sale of Eberhard Hardware Ltd property
B) Costs incurred on relocation of ILC facility in Wheeling, IL
C) Costs incurred on start-up of Eberhard factory in Reynosa, MX
D) Loss on sale of ILC building in Wheeling, IL
E) Gain on sale of Eastern corporate office building
F) Restructuring costs associated with warehouse consolidation into Eberhard
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Reconciliation of Non-GAAP Measures
Adjusted EBITDA from Continuing Operations Calculation
For the Three and Twelve Months ended December 31, 2022 and January 1, 2022
Three Months Ended Twelve Months Ended
Gain on sale of Eberhard Hardware Ltd building (1,841) A
Factory relocation 139 B
Factory start-up costs 215 C 465 C
Loss on sale of Wheeling, IL building 269 D
Gain on sale of Eastern corporate office building (624 ) E
Restructuring costs 700 F 700 F
A) Gain on sale of Eberhard Hardware Ltd property
B) Costs incurred on relocation of ILC facility in Wheeling, IL
C) Costs incurred on start-up of Eberhard factory in Reynosa, MX
D) Loss on sale of ILC building in Wheeling, IL
E) Gain on sale of Eastern corporate office building
F) Restructuring costs associated with warehouse consolidation into Eberhard
ITEM 7AQUANTITATIVE 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
December 31, January 1,
ASSETS
Current Assets
Inventories:
Current assets held for sale - 3,521,899
Property, Plant and Equipment
Other Assets
Deferred income taxes 488,989 -
See accompanying notes.
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December 31, January 1,
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities
Current liabilities held for sale - 580,990
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
Accumulated other comprehensive loss:
Unrealized (loss) gain on interest rate swap, net of tax 1,449,754 (355,988 )
See accompanying notes.
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The Eastern Company
Consolidated Statements of Income
Year Ended
December 31, January 1,
Restructuring costs (699,868 ) -
Discontinued Operations (see note 2)
Earnings per share from continuing operations:
Gain (loss) per share from discontinued operations:
Total earnings per share:
Cash dividends per share: $ 0.44 $ 0.44
See accompanying notes.
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The Eastern Company
Consolidated Statements of Comprehensive Income
Year Ended
December 31, January 1,
Other comprehensive income:
See accompanying notes.
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The Eastern Company
Consolidated Statements of Shareholders’ Equity
Accumulated
Other
Common Common Treasury Treasury Retained Comprehensive Shareholders'
Shares Stock Shares Stock Earnings Income (Loss) Equity
Cash dividends declared,
Change in fair value of interest
Change in pension and other
postretirement benefit costs,
Issuance of Common Stock
Cash dividends declared,
Change in fair value of interest
Change in pension and other
postretirement benefit costs,
Issuance of Common Stock
See accompanying notes.
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THE EASTERN COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Consolidated Statements of Cash Flows
Year Ended
Operating Activities
Adjustments to reconcile net income to net cash provided
by (used in) operating activities:
Unrecognized pension and postretirement benefits (3,575,749 ) (4,032,917 )
Gain on sale of equipment and other assets (274,238 ) (2,470,339 )
Changes in operating assets and liabilities:
Net cash provided by (used in) operating activities 7,328,346 (7,757,423 )
Investing Activities
Marketable securities — 28,951
Business disposition — 2,325
Financing Activities
Proceeds from issuance of long-term debt and notes payable 260,793 —
Proceeds from short term borrowings (revolver) 10,000,000 —
Discontinued Operations
Cash used in investing activities — (1,022,256 )
Supplemental disclosure of cash flow information:
Non-cash investing and financing activities
1 includes cash from assets held for sale of $0.4 million as of January 1, 2022
See accompanying notes
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The Eastern Company
Notes to Consolidated Financial Statements
1. Description of Business
The Eastern Company, and its subsidiaries (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 manages the financial, operational, and strategic performance of its businesses to increase cash generation, operating earnings, and long-term shareholder value.
Eastern encompasses four operating entities within the United States, one wholly owned Canadian subsidiary located 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.
Company Operations
The Company’s operations consist of Big 3 Precision, including Big 3 Precision Products, Inc. (“Big 3 Products”) and Big 3 Mold Services, Inc. (“Big 3 Mold”), Hallink Moulds, Inc. (“Hallink Moulds”), and Associated Toolmakers Ltd. (“Associated Toolmakers”); Eberhard Manufacturing Company (“Eberhard Manufacturing”), Eberhard Hardware Manufacturing Ltd. (“Eberhard Hardware”), Eastern Industrial Ltd, World Lock Company Ltd., Dongguan Reeworld Security Products Ltd., and World Security Industries (together “Eberhard”); and Velvac Holdings Inc. (“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, and mirror-cameras.
Big 3 Products and Big 3 Mold’s turnkey returnable packaging solutions are used in the assembly processes of vehicles, aircraft, and durable goods and in the production processes of plastic packaging products, packaged consumer goods and pharmaceuticals. Big 3 Products works with original equipment manufacturers (“OEMs”) to design and produce custom returnable transport packaging to integrate with OEM assembly processes. Big 3 Mold designs and manufactures blow mold tools. Hallink Moulds is a producer of injection blow mold tooling and is a supplier of blow molds and change parts to the food, beverage, healthcare, and chemical industry. Hallink 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 Eberhard Manufacturing and Illinois Lock Company to create Eberhard, which specializes 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 OEMs and customer applications. Eberhard’s products are found in an expansive range of applications and products globally.
Velvac is a designer and manufacturer of proprietary vision technology for OEMs and aftermarket applications, and a 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.
Sales are made to customers primarily in North America.
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The Eastern Company
Notes to Consolidated Financial Statements (continued)
2. Discontinued Operations
We determined that the companies previously included in our former Diversified Products segment no longer fit with our long-term strategy and have initiated the process of selling the companies within the former Diversified Products segment. Selling these companies will allow management to focus on our core capabilities and offerings.
The former Diversified Products segment met the criteria to be held for sale and furthermore, we determined that the assets held for sale qualified for discontinued operations. As such, the financial results of the former Diversified Products segment are reflected in our condensed consolidated statements of operations as discontinued operations for all periods presented. Additionally, both current and non-current assets and liabilities of discontinued operations are reflected in the condensed consolidated balance sheets for both periods presented.
On October 19, 2022, the Company sold its Argo EMS business (“Argo”). Argo supplies printed circuit boards and other electronic assemblies to original equipment manufacturers in various industries, including measurement systems, semiconductor equipment manufacturing, and industrial control, medical, and military products.
On November 3, 2021, the Company sold its Greenwald Industries, Inc. division (“Greenwald”). Greenwald, located in Chester, CT, is an OEM manufacturer offering a range of payment solutions from coin-vending products to smart card systems and payment applications.
On November 22, 2021, the Company sold its Frazer & Jones Company division (“Frazer & Jones”). Frazer & Jones is a ductile and malleable iron foundry located in Syracuse, NY. Eastern has exited the mining business to focus on our three core businesses.
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The Eastern Company
Notes to Consolidated Financial Statements (continued)
Summarized Financial Information of Discontinued Operations
The following table represents income from discontinued operations, net of tax:
Year Ended
Gain (loss) from discontinued operations, net of tax $ 1,251,457 $ (6,833,172 )
The following table represents the assets and liabilities from discontinued operations:
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Eastern Company
Notes to Consolidated Financial Statements (continued)
Property, plant and equipment, net - 591,920
Right of use assets - 24,697
Total assets of discontinued operations $ - $ 3,521,899
Current assets of discontinued operations $ - $ 3,521,899
Non-current assets of discontinued operations - -
Total assets of discontinued operations $ - $ 3,521,899
Accrued compensation and other accrued expenses - 388,499
Current portion of lease liability - 24,697
Total liabilities of discontinued operations $ - $ 580,990
Current liabilities of discontinued operations $ - $ 580,990
Non-current liabilities of discontinued operations - -
Total liabilities of discontinued operations $ - $ 580,990
3. Accounting Policies
Fiscal Year
The Company’s year ends on the Saturday nearest to December 31. Based on this policy, fiscal years 2022 and 2021 were each comprised of 52 weeks. References in these Notes to the consolidated financial statements to “2022” or “fiscal year 2022” mean the fiscal year ended December 31, 2022, and references to “2021” or “fiscal year 2021” mean the fiscal year ended January 1, 2022. References to the “fourth quarter of 2022” or the “fourth fiscal quarter of 2022” mean the thirteen-week period from October 2, 2022 to December 31, 2022, and references to the “fourth quarter of 2021” or the “fourth fiscal quarter of 2021” mean the thirteen-week period from October 3, 2021 to January 1, 2022.
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Eastern Company
Notes to Consolidated Financial Statements (continued)
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 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.
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 27% 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. As of December 31, 2022 and January 1, 2022, the Company’s allowance for doubtful accounts total was $677,000 and $515,000, respectively. As of December 31, 2022, and January 1, 2022, the Company’s bad debt expense was $208,000 and $48,000 respectively.
Inventories
Inventories are valued at the lower of cost or net realizable value. Cost is determined by the last-in, first-out (LIFO) method at Eberhard ($23.6 million on December 31, 2022) and by the first-in, first-out (FIFO) method for inventories at Big 3 Precision, Velvac and outside the U.S. ($41.0 million on December 31, 2022).
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Eastern Company
Notes to Consolidated Financial Statements (continued)
Cost exceeds the LIFO carrying value by approximately $4.2 million on December 31, 2022 and $3.6 million on January 1, 2022. There was no material LIFO quantity liquidation in 2022 or 2021. In addition, as of the balance sheet dates, the Company has recorded reserves for excess/obsolete inventory.
Property, Plant and Equipment and Related Depreciation
Property, plant, and equipment (including equipment under capital lease) are stated at cost. Depreciation expense ($3,257,519 in 2022, $3,255,894 in 2021) is computed 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 Accounting Standards Codification (“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 that the 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 years ended December 31, 2022 and January 1, 2022.
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.
The Company performed qualitative assessments of goodwill as of the end of fiscal 2022 and determined that no impairment existed at the end of 2022.
The Company will continue to perform annual qualitative assessments as of the end of each fiscal year. Additionally, the Company will perform an interim analysis whenever conditions warrant.
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Eastern Company
Notes to Consolidated Financial Statements (continued)
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 amortized on a straight-line basis over periods ranging from 1 to 24 years. Non-compete agreements and customer relationships are amortized using the straight-line method over their useful lives. Trademarks are deemed to have indefinite lives. If 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 periods ended December 31, 2022 and January 1, 2022.
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 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 December 31, 2022 and January 1, 2022, approximate fair value because of their short-term nature and market based interest rates.
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 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 1–124 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.
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Eastern Company
Notes to Consolidated Financial Statements (continued)
Currently, the Company has 22 operating leases and two finance leases with a lease liability of $12.3 million as of December 31, 2022. 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 one real estate property to two unrelated third parties. 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. The weighted average remaining lease term is 5.7 years. The weighted average discount rate used was 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 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 $1,385,000 for the year ended December 31, 2022 and $795,000 for the year ended January 1, 2022.
Based on historical experience, product returns have been immaterial, and the Company does not accrue a reserve for product returns. For the years ended December 31, 2022 and January 1, 2022, the Company recorded sales returns of $580,000 and $395,000, respectively, as a reduction to revenue.
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 after transfer of control to the customer, are recorded as cost of sales and are expensed as incurred.
For the years ended December 31, 2022 and January 1, 2022, 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 – Geographic Information regarding the Company’s revenue disaggregated by 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.
Shipping and Handling Costs
Shipping and handling costs are included in cost of goods sold.
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Eastern Company
Notes to Consolidated Financial Statements (continued)
Product Development Costs
Product development costs, charged to expense as incurred, were $4,241,211 in 2022 and $4,101,399 in 2021 and include costs to develop new or enhance existing products to better serve our customers.
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 represent selling and administrative expenses for support functions and related overhead.
Advertising Costs
The Company expenses advertising costs as incurred. Advertising costs were $269,659 in 2022 and $200,482 in 2021.
Stock - Based Compensation
The Company accounts for its stock-based awards in accordance with ASC 718-10, Compensation, 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 awards and restricted stock awards. The Company estimates the fair value of granted stock awards using the Black-Scholes valuation model at the date of grant. 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 awards before exercising them, the estimated volatility of the Company’s common stock price and the number of awards 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 basis 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.
The Company accounts for uncertain tax positions pursuant to the provisions of 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 2022 and 2021:
Foreign Exchange (7,531 )
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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. Amortization expense recognized in 2022 and 2021 was $3,953,838 and $3,985,179, respectively. Total amortization expense for each of the next five years is estimated to be as follows: 2023 - $4.7 million; 2024 - $3.9 million; 2025 - $3.9 million; 2026 - $3.9 million and 2027 - $3.9 million.
Weighted-Average
Amortization
Gross Amount
Patents and developed technology $ 7,412,101 4.8
Accumulated Amortization
Patents and developed technology $ 3,395,729
Gross Amount
Patents and developed technology $ 6,749,169 6.5
Accumulated Amortization
Patents and developed technology $ 2,959,782
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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, M&T Bank, National Association. and TD Bank, N.A. as lenders (the “Credit Agreement”), 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 M&T Bank, N.A. (approximately $19 million) and to acquire Big 3 Precision. The term portion of the loan required quarterly principal payments of $1,250,000 for an 18-month period beginning December 31, 2019. The repayment amount then increased 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. The Company borrowed $10,000,000 on the revolving credit facility and subsequently paid it back during 2022 and did not borrow any funds on the revolving commitment portion of the facility during 2021. 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 U.S. 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 notional 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 December 31, 2022, the interest rate for half ($24.0 million) of the term portion was 6.1%, using a one-month LIBOR rate, and 3.19% on the remaining balance ($40.0 million) of the term loan based on a one-month LIBOR rate.
The interest rates on the Credit Agreement and the interest rate swap contract are susceptible to that the transition from LIBOR to alternative benchmark rates such as SOFR. Information regarding this transition is provided below.
The ICE Benchmark Administration (the “IBA”) ceased publication of all settings of non-US dollar LIBOR and the one-week and two-month U.S. dollar LIBOR settings on December 31, 2021, with the publication of the remaining U.S. dollar LIBOR settings scheduled to be discontinued after June 30, 2023. The Adjustable Interest Rate Act (the “LIBOR Act”), which was signed into law on March 15, 2022, provided a replacement framework for outstanding financial contracts tied to LIBOR once LIBOR ceases to be published. The LIBOR Act provides a statutory mechanism and safe harbor that applies on a nationwide basis to replace LIBOR with a benchmark rate, selected by the Federal Reserve Board based on SOFR, for certain contracts that reference LIBOR and contain no or insufficient fallback provisions. The LIBOR Act preempts and supersedes any state or local law, statute, rule, regulation, or standard relating to the selection or use of a benchmark replacement or related changes and allows parties that already have effective fallback provisions to opt out of the legislation. On December 16, 2022, the Federal Reserve adopted a final rule implementing the LIBOR Act that, among other things, identifies the applicable SOFR-based benchmark replacements under the LIBOR Act for various contact types. 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.
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The Eastern Company
Notes to Consolidated Financial Statements (continued)
6. Debt(continued)
Debt consists of:
Revolving credit loan — —
Amounts are net of unamortized discounts and debt issuance costs of $113,769 as of December 31, 2022 and $186,478 as of January 1, 2022.
The Company paid interest of $2,502,883 in 2022 and $2,271,818 in 2021.
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 is required to show a senior net leverage ratio not to exceed 4.25 to 1. The Company was in compliance with all covenants as of December 31, 2022. 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 as of December 31, 2022 and January 1, 2022.
As of December 31, 2022, scheduled annual principal maturities of long-term debt for each of the next five years follow:
Thereafter —
7. Stock Options and awards
Stock Awards
As of December 31, 2022, the Company has one incentive stock award plan, The Eastern Company 2020 Stock Incentive Plan (the “2020 Plan”), for officers, other key employees, and non-employee Directors. Incentive stock awards 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 awards 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 awards granted to participants will have exercise prices determined by the Compensation Committee of the Company’s Board of Directors. The Company granted 43,300 and 27,300 awards during 2022 and 2021, respectively.
The 2020 Plan also permits the issuance of Stock Appreciation Rights (“SARs”). The SARs are in the form of an award 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 did not issue SARs in 2022 or 2021.
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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 was $504,694 for awards granted to employees during fiscal year 2022 and $418,000 for awards granted to employees during fiscal year 2021. For the 2022 fiscal year, the Company used several assumptions which included an expected term of 3 years, volatility deviation of 47.15% to 47.70% and a risk-free rate of 2.04% to 2.66%. For the 2021 fiscal year, the Company used several assumptions which included an expected term of 4 years, volatility deviation of 47.25% to 48.55% and a risk-free rate of 0.18 to 0.35%.
As of December 31, 2022, there were 808,101 shares of common stock reserved and available for future grant under 2020 Plan.
The following tables set forth the outstanding SARs for the period specified:
Units Weighted - Average Exercise Price Units Weighted - Average Exercise Price
Issued - - - -
SARs Outstanding and Exercisable
The following tables set forth the outstanding stock grants for the period specified:
Shares Shares
As of December 31, 2022, outstanding SARs and awards had an intrinsic value of $1,243,560.
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The Eastern Company
Notes to Consolidated Financial Statements (continued)
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:
Capital Loss Carry forward - (182,582 )
Net deferred income tax (assets) liabilities $ (488,989 ) $ 1,151,759
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 - 0 11,313 0
Impact of foreign subsidiaries on effective tax rate (41,404 ) 0 (282,614 ) (3 )
Impact of Research & Development tax credit (131,005 ) (1 ) (188,944 ) (3 )
A reconciliation of income taxes computed using the U.S. federal statutory rate to that reflected in operations follows for continuing operations:
Amount Percent Amount Percent
Impact on Foreign Repatriation Tax Reform - 0 11,313 0
Impact of foreign subsidiaries on effective tax rate (41,404 ) 0 (282,614 (2 )
Impact of Research & Development tax credit (131,005 ) (1 ) (188,944 (1 )
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The Eastern Company
Notes to Consolidated Financial Statements (continued)
8. Income Taxes (continued)
A reconciliation of income taxes computed using the U.S. federal statutory rate to that reflected in operations follows for discontinued operations:
Amount Percent Amount Percent
Total income taxes paid were $3,679,678 in 2022 and $2,318,018 in 2021.
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 on December 31, 2022 on approximately $12,218,919 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. The Company adopted ASU 2019-12 in the first interim period of 2021.
A reconciliation of the beginning and ending amount of unrecognized tax benefits are as follows:
Increase for positions taken during the current period 58,586 45,721
Increase (decrease) for positions taken during the prior period - -
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 2018 and non-U.S. income tax examinations by tax authorities prior to 2016.
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The Eastern Company
Notes to Consolidated Financial Statements (continued)
8. Income Taxes (continued)
Included in the balance as of December 31, 2022, are $253,655 of unrecognized tax benefits that would affect the annual effective tax rate. In 2022, the Company recognized accrued interest related to unrecognized tax benefits in income tax expense. The Company had approximately $69,245 of accrued interest as of December 31, 2022.
The total amount of unrecognized tax benefits could increase or decrease within the next twelve months for several 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 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 more than one year during each of the next five fiscal years follow:
Rent expense for all operating leases was $3,299,579 in 2022 and $2,816,258 in 2021. The weighted average lease term for all operating leases is 5.7 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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The Eastern Company
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 2.08% 1.49%
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 - -
Amortization of the net loss (8,214 ) (12,374 )
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 %
As of December 31, 2022, and January 1, 2022, the status of the Company’s pension benefit plans and other postretirement benefit plan was as follows:
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Notes to Consolidated Financial Statements (continued)
10. Retirement Benefit Plans (continued)
Pension Benefit Other Postretirement Benefit
Plan Amendment - - - 36,388
Significant Event - - - (218,103 )
Significant Event - - - (218,103 )
Pension Benefit Other Postretirement Benefit
Amounts recognized in accumulated other comprehensive income consist of:
Pension Benefit Other Postretirement Benefit
Prior service (cost) credit - (66,252 ) - -
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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
Plan Amendments - - - (36,388 )
Significant Event - - - (35,159 )
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 4.98% 2.08%
- Other postretirement plan 5.28% 2.93%
On December 31, 2022 and January 1, 2022, the accumulated benefit obligation for all qualified and nonqualified defined benefit pension plans was $80,701,715 and $107,420,338, respectively. During 2022, the pension benefit obligation decreased between 24.1% to 26.1% due to the increase in the discount rates from 2.75%-2.81% to 5.21%-5.23%.
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 $5.0 million in 2023, $5.1 million in 2024, $5.3 million in 2025, $5.5 million in 2026, $5.6 million in 2027 and a total of $29.0 million from 2028 through 2032.
Estimated future benefit payments to participants of the Company’s other postretirement plan are $46,000 in 2023, $46,000 in 2024, $49,000 in 2025, $52,000 in 2026, $53,000 in 2027 and a total of $302,000 from 2028 through 2032.
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The Eastern Company
Notes to Consolidated Financial Statements (continued)
10. Retirement Benefit Plans (continued)
The Company expects to make cash contributions to its qualified pension plans of approximately $800,000 and to its other postretirement plan of approximately $50,000 in 2023.
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 2022, as in 2021, 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.
The fair values of the Company’s pension plans assets on December 31, 2022 and January 1, 2022, utilizing the fair value hierarchy discussed in Note 4 – Accounting Policies – Fair Value of Financial Instruments, 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 $4,184,107 and $5,460,173 on December 31, 2022 and January 1, 2022, respectively. No shares were purchased in 2022 or 2021 nor were any shares sold in either period. Dividends received during 2022 and 2021 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 and going forward. 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:
As of December 31, 2022, the Company had accrued $379,090 for the non-discretionary safe harbor contribution. This amount was expensed in 2022 and was contributed to the plan in January 2023. As of January 1, 2022, the Company had accrued $323,082 for the non-discretionary safe harbor contribution. This amount was contributed to the Plan in January 2022 and was expensed in 2021.
11. Earnings per Share
The denominators used in the earnings per share computations follow:
Basic:
Diluted:
There were no anti-dilutive stock equivalents in 2022 or 2021.
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The Eastern Company
Notes to Consolidated Financial Statements (continued)
12. Geographic Information
Geographic Information:
Net Sales:
Foreign sales are primarily to customers in North America.
Identifiable Assets:
13. Recent Accounting Pronouncements
Adopted
In December 2019, FASB issued ASU 2019-12, Simplifying the Accounting for Income Tax. The changes implemented in ASU 2019-12 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. The Company adopted ASU 2019-12 as of January 3, 2021. The adoption of this guidance did not have a material impact on the consolidated financial statements of the Company.
The Company has implemented all new accounting pronouncements that are in effect and that could impact its consolidated financial statements and does not believe that there are any other new accounting pronouncements that have been issued, but are not yet effective, that might have a material impact on the consolidated financial statements of the Company.
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The Eastern Company
Notes to Consolidated Financial Statements (continued)
14. Contingencies
The Company is party to various legal proceedings from time to time related to its normal business operations. Currently, the Company is not involved in any legal proceedings.
In 2016, the Company created a plan to remediate a landfill of spent foundry sand maintained at the Company’s previously owned metal casting facility in New York. This plan was agreed to by the New York State Department of Environmental Conservation (the “NYSDEC”) on March 27, 2018. Based on estimates provided by the Company’s environmental engineers, the anticipated cost to remediate and monitor the landfill was $430,000. The Company accrued for and expensed the entire $430,000 in the first quarter of 2018 and fiscal 2017. In the fall of 2018, detailed construction drawings were prepared by an outside consultant in conjunction with informal progress reviews by the NYSDEC. Long-term groundwater monitoring commenced in April 2019. Verbal approval for the closure plan was received from the NYSDEC in May 2019, and written approval was received in October 2020. Construction of the closure remedies, including improved drainage system, regrading, and installation of a low permeability cap was completed in October 2021. A closure report and long-term maintenance plan were submitted to the NYSDEC in November 2021. The 30-year annual groundwater monitoring and site maintenance program are underway and will continue through 2048.
15. Concentration of risk