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EML > SEC Filings for EML > Form 10-K on 13-Mar-2013All Recent SEC Filings

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Form 10-K for EASTERN CO


13-Mar-2013

Annual Report


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

Summary

Net sales for 2012 increased 10% to $157.5 million from $142.9 million in 2011. Net income for 2012 increased 57% to $8.6 million, or $1.38 per diluted share, from $5.5 million, or $.89 per diluted share in 2011. Net sales in the Industrial Hardware segment increased approximately 9% in 2012, resulting primarily from strong demand for lightweight composite products such as the sleeper boxes for the Class 8 truck market and panels used in the electronic white board market, in addition to new products such as the vent product line designed for the Class 8 truck market. Net sales in the Security Products segment increased approximately 5% in 2012, primarily due to increased sales of products to the commercial laundry market and the introduction of new lock products into several of the markets we serve. The Metal Products segment net sales increased approximately 22% in 2012, resulting primarily from the continued strong demand for our mine roof support products and sales of new products; a tie plate for the railroad industry and kicker clips and rail clamps for a solar panel application.


                Fourth Quarter 2012 Compared to Fourth Quarter 2011



The following table shows, for the fourth quarter of 2012 and 2011, selected
line items from the consolidated statements of income as a percentage of net
sales, by segment.

                                               2012 Fourth Quarter
                                     Industrial  Security    Metal
                                      Hardware   Products  Products   Total
Net sales                                100.0 %   100.0 %   100.0 %   100.0 %
Cost of products sold                     77.2 %    77.5 %    82.1 %    78.4 %
Gross margin                              22.8 %    22.5 %    17.9 %    21.6 %
Selling and administrative expense        14.2 %    17.0 %     6.9 %    13.5 %
Operating profit                           8.6 %     5.5 %    11.0 %     8.1 %

                                               2011 Fourth Quarter
                                     Industrial  Security    Metal
                                      Hardware   Products  Products   Total
Net sales                                100.0 %   100.0 %   100.0 %   100.0 %
Cost of products sold                     78.2 %    74.6 %    93.2 %    80.2 %
Gross margin                              21.8 %    25.4 %     6.8 %    19.8 %
Selling and administrative expense        12.4 %    18.7 %     6.8 %    13.1 %
Operating profit                           9.4 %     6.7 %     0.0 %     6.7 %

The following table shows the amount of change from the fourth quarter of 2011 to the fourth quarter of 2012 in sales, cost of products sold, gross margin, selling and administrative expenses and operating profit, by segment (dollars in thousands).

                                       Industrial     Security       Metal
                                        Hardware      Products     Products       Total
Net sales                             $     (2,845 ) $      501   $        96   $  (2,248 )
Volume                                       -19.1 %        2.4 %        -5.5 %     -10.2 %
Prices                                         0.1 %        0.9 %         0.8 %       0.5 %
New Products                                   4.4 %        1.3 %         6.0 %       3.8 %
                                             -14.6 %        4.6 %         1.3 %      -5.9 %

Cost of products sold                 $     (2,392 ) $      714   $      (768 ) $  (2,446 )
                                             -15.7 %        8.7 %       -10.8 %      -8.0 %

Gross margin                          $       (453 ) $     (213 ) $       864   $     198
                                             -10.7 %       -7.6 %       167.0 %       2.6 %

Selling and administrative expenses   $        (47 ) $     (105 ) $        14   $    (138 )
                                              -1.9 %       -5.1 %         2.7 %      -2.8 %

Operating profit                      $       (406 ) $     (108 ) $       850   $     336
                                             -22.2 %      -14.7 %   167,406.0 %      13.1 %

Net sales in the fourth quarter of 2012 decreased 6% to $35.8 million from $38.1 million a year earlier. The decrease in sales in the fourth quarter from 2011 to 2012 is primarily attributable to a drop in sales of our lightweight composite panels for use in the electronic white board industry. Net sales were favorably impacted by the introduction of new products and selective price increases to customers.


Cost of products sold in the fourth quarter decreased $2.4 million or 8% from 2011 to 2012. The most significant factors resulting in changes in cost of products sold in the fourth quarter of 2012 compared to 2011 fourth quarter included:

an increase of $0.4 million or 4% in costs for payroll and payroll related charges;

an increase of $0.2 million or 18% in costs for supplies and tools;

an increase of $0.1 million or 143% in foreign exchange;

an increase of $0.1 million or 34% from the sale of scrap;

a decrease of $2.7 million or 15% in raw materials;

a decrease of $0.3 million or 80% for miscellaneous expenses;

a decrease of $0.1 million or 10% in utilities;

and a decrease of $0.1 million or 85% for research and development.

Gross margin as a percentage of net sales for the fourth quarter of 2012 was 22% compared to 20% in the fourth quarter of 2011. The increase is primarily the result of the mix of products produced, the introduction of new products and selective price increases to customers.

Selling and administrative expenses for the fourth quarter of 2012 decreased $0.1 million or 3% compared to the prior year quarter. The most significant factors resulting in changes in selling and administrative expenses in the fourth quarter of 2012 compared to 2011 fourth quarter included:

an increase of $0.1 million or 10% in other administrative expenses;

an increase of $0.1 million or 620% in bad debt expenses;

a decrease of $0.2 million or 4% in payroll and payroll related charges;

and a decrease of $0.1 million or 20% in travel expenses.

Net income for the fourth quarter of 2012 increased 18% to $1.7 million (or $.28 per diluted share) from $1.5 million (or $.24 per diluted share) a year earlier.

Authoritative Accounting Guidance

In December 2010, the FASB issued authoritative guidance which updates the guidance regarding Intangibles-Goodwill & Other. The amendments affect all entities that have recognized goodwill and have one or more reporting units whose carrying amount for purposes of performing Step 1 of the goodwill impairment test is zero or negative. The amendments modify Step 1 so that for those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that a goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that an impairment may exist. The qualitative factors are consistent with existing guidance, which requires that goodwill of a reporting unit be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The Company adopted this guidance effective January 2, 2011 and it had no impact on the consolidated financial statements of the Company.

In December 2010, the FASB issued authoritative guidance which updates the guidance regarding business combinations. The objective of this new guidance is to address diversity in practice about the interpretation of the pro forma revenue and earnings disclosure requirements for business combinations. The amendments in this guidance specify that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The amendments also expand the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. The amendments affect any public entity that enters into business combinations that are material on an individual or aggregate basis. The Company adopted this guidance effective January 2, 2011 and it had no impact on the consolidated financial statements of the Company.

In May 2011, the FASB issued authoritative guidance which clarifies the concepts related to highest and best use and valuation premise, blockage factors and other premiums and discounts, the fair value measurement of financial instruments held in a portfolio and of those instruments classified as a component of shareowners' equity. The guidance includes enhanced disclosure requirements about recurring Level 3 fair value measurements, the use of nonfinancial assets, and the level in the fair value hierarchy of assets and liabilities not recorded at fair value. This guidance became effective for the Company on January 1, 2012. This guidance did not have an impact on our consolidated financial statements or disclosures, as there are presently no recurring Level 3 fair value measurements.


In June 2011, the FASB issued authoritative guidance aimed at increasing the prominence of items reported in other comprehensive income in the financial statements. In December 2011, the FASB also issued an accounting standards update that indefinitely deferred certain financial statement presentation provisions contained in its original June 2011 guidance. The guidance requires companies to present comprehensive income in a single statement below net income or in a separate statement of comprehensive income immediately following the income statement. Companies will no longer be allowed to present comprehensive income on the statement of changes in shareholders' equity. In both options, companies must present the components of net income, total net income, the components of other comprehensive income, total other comprehensive income and total comprehensive income. This update does not change which items are reported in other comprehensive income or the requirement to report reclassifications of items from other comprehensive income to net income. This guidance became effective for the Company on January 1, 2012 and required retrospective application for all periods presented. The adoption of this guidance did not impact the presentation of the consolidated financial statements of the Company.

In September 2011, the FASB issued authoritative guidance on testing goodwill for impairment. This guidance provides an entity the option to first perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If an entity determines that the fair value of a reporting unit is less than its carrying amount, it is required to perform the currently prescribed two-step goodwill impairment test to identify potential goodwill impairment and measure the amount of goodwill impairment loss to be recognized for that reporting unit, if any. The Company adopted this guidance effective January 1, 2012 and it had no impact on the consolidated financial statements of the Company.

In July 2012, the FASB issued authoritative guidance to amend previous guidance on the annual and interim testing of indefinite-lived intangible assets for impairment. The guidance provides entities with the option of first assessing qualitative factors to determine whether it is more likely than not that the fair value of an indefinite-lived intangible asset is less than its carrying amount. If it is determined, on the basis of qualitative factors, that the fair value of the indefinite-lived intangible asset is more likely than not less than the carrying amount, a quantitative impairment test would still be required. The Company adopted this guidance effective December 30, 2012 and it had no impact on the consolidated financial statements of the Company.

In February 2013, the FASB issued authoritative guidance which adds new disclosure requirements for items reclassified out of Accumulated Other Comprehensive Income. The guidance requires that an entity present either in a single note or parenthetically on the face of the financial statements, the effect of significant amounts reclassified from each component of Accumulated Other Comprehensive Income based on its source and the income statement line items affected by the reclassification. The guidance is effective for interim and annual reporting periods beginning on or after December 15, 2012. The Company adopted this guidance effective December 30, 2012 and it had no 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.

Critical Accounting Policies and Estimates

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

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 collectibility of its receivables on an ongoing basis taking into account a combination of factors. The Company reviews potential problems, such as past due accounts, a bankruptcy filing or deterioration in the customer's financial condition, to ensure 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 creditworthiness, or there is a change in the current economic climate, the Company may modify its estimate of the allowance for doubtful accounts. The Company will write off accounts receivable after reasonable collection efforts have been made and the accounts are deemed uncollectible.

Inventory Reserve

Inventories are valued at the lower of cost or market. Cost is determined by the last-in, first-out ("LIFO") method at the Company's U.S. facilities. Accordingly, a LIFO valuation reserve is calculated using the dollar value link chain method.

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

Goodwill and Other Intangible Assets

Intangible assets with finite useful lives are amortized generally on a straight-line basis over the periods benefited. Goodwill and other intangible assets with indefinite useful lives are not amortized. During the third quarter of 2012 the Company elected to change its annual impairment testing of goodwill and trademarks from the second quarter of its fiscal year to the fourth quarter of its fiscal year. The Company discussed this change in accounting principle with its Independent Registered Public Accounting Firm and attached their Preference Letter as an exhibit to the Form 10-Q for the quarter ending September 29, 2012. The Company completed a qualitative assessment in the second quarter of 2012 and determined it is more likely than not that no impairment of goodwill existed at that time. The Company performed another qualitative assessment as of the end of fiscal 2012 and determined it is more likely than not that no impairment of goodwill existed at the end of 2012. The Company will perform annual qualitative assessments in subsequent years as of the end of each fiscal year. Additionally, the Company will perform interim analysis whenever conditions warrant.

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 Citigroup Pension Liability Yield Curve, comprised of high quality (rated AA or better) corporate bonds. 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 for 2012 was 8.0%. 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 $1.9 million and $155,000 to its pension plans and postretirement plan, respectively, in 2013.


RESULTS OF OPERATIONS

Fiscal 2012 Compared to Fiscal 2011

The following table shows, for 2012 and 2011, selected line items from the
consolidated statements of income as a percentage of net sales, by segment.

                                     Industrial  Security    Metal
                                      Hardware   Products  Products   Total
                                                      2012
Net sales                                100.0 %   100.0 %   100.0 % 100.0 %
Cost of products sold                     76.0 %    76.3 %    88.2 %  78.8 %
Gross margin                              24.0 %    23.7 %    11.8 %  21.2 %
Selling and administrative expense        13.5 %    15.5 %     6.5 %  12.6 %
Operating profit                          10.5 %     8.2 %     5.3 %   8.6 %

                                                      2011
Net sales                                100.0 %   100.0 %   100.0 % 100.0 %
Cost of products sold                     79.6 %    76.2 %    91.6 %  80.9 %
Gross margin                              20.4 %    23.8 %     8.4 %  19.1 %
Selling and administrative expense        13.0 %    16.7 %     7.0 %  13.0 %
Operating profit                           7.4 %     7.1 %     1.4 %   6.1 %

The following table shows the amount of change from 2011 to 2012 in sales, cost of products sold, gross margin, selling and administrative expenses, and operating profit, by segment (dollars in thousands):

                                       Industrial     Security      Metal
                                        Hardware      Products    Products     Total
Net sales                             $      6,149   $    2,166   $   6,338   $ 14,653
Volume                                         5.4 %        2.6 %       0.0 %      3.4 %
Prices                                         0.3 %        0.8 %       1.3 %      0.7 %
New Products                                   3.6 %        1.1 %      20.7 %      6.2 %
                                               9.3 %        4.5 %      22.0 %     10.3 %

Cost of products sold                 $      2,363   $    1,702   $   4,599   $  8,664
                                               4.5 %        4.7 %      17.4 %      7.5 %

Gross margin                          $      3,786   $      464   $   1,739   $  5,989
                                              28.0 %        4.1 %      72.5 %     21.9 %

Selling and administrative expenses   $      1,132   $     (242 ) $     260   $  1,150
                                              13.1 %       -3.0 %      12.9 %      6.2 %

Operating profit                      $      2,654   $      706   $   1,479   $  4,839
                                              54.0 %       20.7 %     377.8 %     55.5 %

Industrial Hardware Segment

Net sales in the Industrial Hardware segment increased 9% in 2012 from the 2011 level. The higher sales in 2012 reflected an increase in sales of existing products to the distribution, service body, truck accessory, military and Class 8 truck markets compared to the same period in 2011, selective price increases to customers and the introduction of new products. All of the new products were developed internally and included rotary latches and a venting line of products for the Class 8 truck market; an escape hatch for the military market; a door latch for the recreational vehicle market; as well as a variety of locking and latching products for the many markets we serve.


Cost of products sold for the Industrial Hardware segment increased $2.4 million or 5% from 2011 to 2012. The most significant factors resulting in changes in cost of products sold in 2012 compared to 2011 included:

an increase of $1.1 million or 3% in raw materials;

an increase of $1.0 million or 7% in costs for payroll and payroll related charges;

an increase of $0.2 million or 18% in costs for supplies and tools;

an increase of $0.2 million or 28% from the sale of scrap;

an increase of $0.1 million or 22% related to costs for maintenance and repairs;

an increase of $0.1 million or 72% in engineering expenses;

an increase of $0.1 million or 24% for fire and liability insurance;

a decrease of $0.4 million or 209% in foreign exchange;

and a decrease of $0.1 million or 67% for research and development.

Gross margin as a percentage of net sales for the Industrial Hardware segment increased from 20% in 2011 to 24% in 2012. The increase in gross margin for the 2012 period reflects the higher volume of sales in 2012, the mix of products produced and the changes in cost of products sold discussed above.

Selling and administrative expenses in the Industrial Hardware segment increased $1.1 million or 13% from 2011 to 2012. The most significant factors resulting in changes in selling and administrative expenses in the Industrial Hardware segment in 2012 compared to 2011 included:

an increase of $1.1 million or 18% in payroll and payroll related charges;

a increase of $0.1 million or 99% in commission payments;

and a decrease of $0.1 million or 19% in travel expenses.

Security Products Segment

Net sales in the Security Products segment increased 5% from 2011 to 2012. The increase in sales in 2012 in the Security Products segment is a combination of increased sales of existing products, selective price increases to customers and sales of new products. The increase in sales of existing products in 2012 in the Security Products segment resulted from sales to the many markets served by this segment, including: storage, cash management and commercial laundry. Sales of new products included new lock products for the storage, original equipment manufacturer, locksmith, cash management and commercial laundry markets. The new products included locker locks and end brackets for the electronic enclosure market; a mailbox lock and a mini "D" ring handle assembly for the storage market; a puck lock for the OEM market; as well as a variety of other lock products for various markets. Sales of new products for the commercial laundry industry included the new "Flash Cash" advanced, contactless and wireless cash payment system, Pinmate and Digicoin.

Cost of products sold for the Security Products segment increased $1.7 million or 5% from 2011 to 2012. The most significant factors resulting in changes in cost of products sold in 2012 compared to 2011 included:

an increase of $1.4 million or 5% in raw materials;

an increase of $0.2 million or 178% in foreign exchange;

an increase of $0.1 million or 14% in costs for supplies and tools;

an increase of $0.l million or 8% for engineering expenses;

and a decrease of $0.1 million or 49% for outbound freight.

Gross margin for 2012 of 24% was comparable to the 2011 period as a percentage of net sales for the Security Products segment.

Selling and administrative expenses in the Security Products segment decreased $0.2 million or 3% from 2011 to 2012. The most significant factors resulting in changes in selling and administrative expenses in the Security Products segment in 2012 compared to 2011 included:

an increase of $0.2 million or 34% in other administrative expenses;

an increase of $0.1 million or 1% in payroll and payroll related charges;

an increase of $0.1 million or 283% in bad debt expenses;

a decrease of $0.3 million or 83% in amortization expense;

a decrease of $0.1 million or 10% in commission payments;

a decrease of $0.1 million or 27% in advertising expenses;

and a decrease of $0.1 million or 15% in travel expenses.


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