Attached files

file filename
EX-99 - EASTERN COex99-shareholder_letter.htm
EX-32 - CERTIFICATION CEO & CFO SEC 906 SOX - EASTERN COex32-certsox906.htm
EX-31 - CERTIFICATION OF CEO & CFO SEC 302 SOX - EASTERN COex31-certsox302.htm
EX-23 - FML CONSENT - EASTERN COex23-fml_consent.htm
EX-3.1 - RESTATED CERTIFICATE OF INCORPORATION 8-4-91 - EASTERN COex3-1cert_of_incorp8-4-1991.htm
 
 UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

(Mark One)

[X]
ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
  For the Fiscal Year ended December 30, 2017
OR
[  ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________________ to _______________

Commission File Number 001-35383

THE EASTERN COMPANY
(Exact name of registrant as specified in its charter)

Connecticut
06-0330020
(State or other jurisdiction of
(I.R.S. Employer
incorporation or organization)
Identification No.)

112 Bridge Street, Naugatuck, Connecticut
06770
(Address of principal executive offices)
(Zip Code)

Registrant's telephone number, including area code:  (203) 729-2255

Securities registered pursuant to Section 12(b) of the Act:  Common Stock No Par Value      The NASDAQ Stock Market LLC
                                                                                                    (Title of each class)                             (Name of each exchange
                                                                                                                                                                 on which registered)

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
                                                                                                                                                                      Yes [X]  No [  ]

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
                                                                                                                                                                       Yes [  ]  No [X]

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.                       Yes [X]  No [  ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).                              Yes [X]  No [  ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [  ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer [  ]
Accelerated filer [X]
Non-accelerated filer [  ] (Do not check if a smaller reporting company)
Smaller reporting company [  ]
Emerging growth company [  ]
 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  [  ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).     Yes [  ]  No [X]

As of July 1, 2017, the last day of registrant's most recently completed second fiscal quarter, the aggregate market value of the voting stock held by non-affiliates of the registrant was $155,324,724 (based on the closing sales price of the registrant's common stock on the last trading date prior to that date). Shares of the registrant's common stock held by each officer and director and shares held in trust by the pension plans of the Company have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.




As of February 27, 2018, 6,263,245 shares of the registrant's common stock, no par value per share, were issued and outstanding.

DOCUMENTS INCORPORATED BY REFERENCE
Certain information required for Part II of this report is incorporated herein by reference to the proxy statement for the 2018 annual meeting of the Company's shareholders, which will be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after December 30, 2017.

The Eastern Company
Form 10-K

FOR THE FISCAL YEAR ENDED DECEMBER 30, 2017

TABLE OF CONTENTS

   
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SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES
LITIGATION REFORM ACT OF 1995

This Annual Report on Form 10-K (this "Form 10-K") contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements reflect the Company's current expectations regarding its products, its markets and its future financial and operating performance. These statements, however, are subject to risks and uncertainties that may cause the Company's actual results in future periods to differ materially from those expected. Such risks and uncertainties include, but are not limited to, unanticipated slowdowns in the Company's major markets, changing customer preferences, lack of success of new products, loss of customers, competition, increased raw material prices, problems associated with foreign sourcing of parts and products, worldwide conditions and foreign currency fluctuations that may affect results of operations, and other factors discussed in Item 1A of this Form 10-K and, from time to time, in the Company's filings with the Securities and Exchange Commission. The Company undertakes no obligation to update, alter, or otherwise revise any forward-looking statements, whether written or oral, that may be made from time to time, whether as a result of new information, future events, or otherwise.


PART I

ITEM 1
BUSINESS

(a)  General Development of Business

The Eastern Company (the "Company," "Eastern," "we," "us," or "our") was incorporated under the laws of the State of Connecticut in October, 1912, succeeding a co-partnership established in October, 1858. The business of the Company is the design, manufacture and sale of industrial hardware, security products and metal products.

Today, the Company maintains sixteen physical locations across North America and Asia.

RECENT DEVELOPMENTS

On April 3, 2017, the Company completed a Securities Purchase Agreement (the "Securities Purchase Agreement") with Velvac Holdings, Inc., a Delaware corporation ("Velvac"), Jeffery R. Porter, W. Greg Bland, John Backovitch, Dave Otto, Bob Otto, Timothy Rintelman, Robert Brester, Dan Mcgrew, Mark Moeller, and Prospect Partners II, L.P. (collectively, the "Sellers"). Pursuant to the Securities Purchase Agreement, the Company acquired 100% of the issued and outstanding stock of Velvac from the Sellers (the "Velvac Acquisition") for $39.5 million and an earnout consideration contingent upon Velvac achieving minimum earnings performance levels and based on sales of Velvac's new proprietary Road-iQ product line (the "Earnout Consideration"). The Velvac Acquisition was financed with a $31 million term loan from People's United Bank, National Association ("People's"), a $5 million draw down on the Company's $10 million revolving credit facility with People's and $3.5 million in cash. In addition, the Company paid a working capital adjustment of $0.6 million by which working capital exceeded a pre-determined target amount. Please refer to the Company's Current Report on Form 8-K filed on April 7, 2017 and the amendment thereto filed on June 19, 2017 for further details.

 (b)  Financial Information about Industry Segments

Financial information about industry segments is included in Note 10 to the Company's financial statements, included in Item 8 of this Form 10-K.

(c)  Narrative Description of Business

The Eastern Company actively manages niche industrial divisions that focus on the design, manufacture and sale of particular products and industrial services and are leaders in their specific market sector.  We believe Eastern's divisions operate in industries with long-term macroeconomic growth opportunities, have positive and stable cash flows, face minimal threats of technological or competitive obsolescence, and have strong management teams largely in place.

Eastern focuses on proactive financial and operational management of its divisions in order to increase earnings and increase long-term shareholder value. Among other things, Eastern regularly monitors financial and operational performance, instilling consistent financial discipline and assisting management in their analysis and pursuit of prudent organic growth strategies.
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Eastern also identifies and works with division management to execute attractive external growth and acquisition opportunities.  In addition, Eastern recruits and retains talented managers to operate its divisions.

Eastern continuously reviews acquisitions of businesses that have the potential for significant long-term value creation and periodically evaluates the retention and disposition of its existing divisions and investments.  We seek to acquire businesses that produce stable and growing earnings and cash flows.  Eastern may pursue acquisitions in industries other than those in which its divisions currently operate if an acquisition presents an attractive opportunity.

The Company operates in three business segments: Industrial Hardware, Security Products and Metal Products.

Industrial Hardware

The Industrial Hardware business segment consists of Eberhard Manufacturing, Eberhard Hardware Manufacturing Ltd., Eastern Industrial Ltd, Velvac, Canadian Commercial Vehicles Corporation, Composite Panel Technologies and Sesamee Mexicana, S.A. de C.V. These divisions design, manufacture and market a diverse product line of custom and standard vehicular and industrial hardware, including passenger restraint and vehicular locks, latches, hinges, mirrors, mirror-cameras, light-weight sleeper boxes and truck bodies. These products can be found on tractor-trailer trucks, specialty commercial vehicles, recreational vehicles, fire and rescue vehicles, school buses, military vehicles and other vehicles. In addition, the segment designs and manufactures a wide selection of fasteners and other closure devices used to secure access doors on various types of industrial equipment such as metal cabinets, machinery housings and electronic instruments. The segment sells directly to original equipment manufacturers and to distributors through in-house salesmen and outside sales representatives. Sales, customer engineering and customer service are provided through in-house sales personnel and engineering staff. We believe that in order to service these markets, our divisions offer competitive engineering design, service, quality and price. In addition, we invest in the continued introduction of new or improved product designs and we expand into synergistic product lines in order to maintain and increase market share.

Security Products

The Security Products business segment consists of Illinois Lock Company/CCL Security Products, World Lock Company Ltd., Dongguan Reeworld Security Products Ltd., World Security Industries Ltd., Greenwald Industries ("Greenwald"), and Argo EMS (formerly Argo Transdata). Illinois Lock Company/CCL Security Products designs, manufactures and distributes custom engineered and standard closing and locking systems, including vehicular accessory locks, cabinet locks, cam locks, electric switch locks, tubular key locks and combination padlocks. Some of its products are sold under the names SESAMEE®, PRESTOLOCK® and SEARCHALERT™. These products are sold to original equipment manufacturers, distributors, route operators, and locksmiths through in-house salesmen and outside sales representatives. Greenwald manufactures and markets coin acceptors and other coin security products used primarily in the commercial laundry markets. Greenwald's products include timers, drop meters, coin chutes, money boxes, meter cases, smart cards, value transfer stations, smart card readers, card management software, and access control units. Argo EMS supplies printed circuit boards and other electronic assemblies to original equipment manufacturers in various industries, including measurement systems, semiconductor equipment manufacturing, and industrial controls, medical and military products. The Security Products segment continuously seeks new markets where it can offer competitive engineered solutions that meet manufacturers' security needs.

Metal Products

The Company believes that its Metal Products business segment, based at the Company's Frazer & Jones facility, is the largest and most efficient producer of expansion shells for use in supporting the roofs of underground mines. This segment also manufactures specialty malleable and ductile iron castings.
 
Typical products include mine roof support anchors, couplers for railroad braking systems, support anchoring for construction and couplers/fittings for utility (oil, water and gas) industries. Mine roof support anchors are sold to bolt manufacturers while specialty castings are sold to original equipment manufacturers or machine houses. Frazer & Jones will not be effected by the new metals tariff since all metals are purchased domestically.
 
General

The Company obtains materials from domestic, Asian affiliated and nonaffiliated sources. Raw materials and outside services were readily available for all of the Company's segments during 2017 and are expected to be readily available in 2018 and the foreseeable future. In 2017, the Company experienced price increases for many of the raw materials used in producing its products, including: scrap iron, zinc, brass and stainless steel.  In 2016, the Company experienced a price decline for many of these same materials.  At this time, the Company expects raw material prices to continue to increase as demand for raw materials increases
 
 
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as the global economy grows.  These raw material cost increases could negatively impact the Company's gross margin if raw material prices increase too rapidly for the Company to recover those cost increases through either price increases to our customers or cost reductions in other areas of the business.

Patent and trademark protection for the various product lines within the Company is limited, but believed by the Company to be sufficient to protect the Company's competitive positions.  No business segment is dependent on any patent nor would the loss of any patent have any material adverse effect on the Company's business.  Foreign sales are not significant.

None of the Company's division segments are seasonal.

Customers for all business segments are broad-based geographically and by markets, and sales are generally not highly concentrated by customer.  No one customer exceeded 10% of total consolidated sales in 2017, 2016 or 2015.

The dollar amount of the backlog of orders received by the Company is believed to be firm as of the fiscal year ended December 30, 2017. Such backlogs was $34,991,000 at December 30, 2017, as compared to $26,993,000 at December 31, 2016.  The primary reasons for the change from 2016 to 2017 were the acquisition of Velvac on April 3, 2017 and the timing of orders received from customers.

The Company encounters competition in all of its business segments. Imports from Asia and Latin America with favorable currency exchange rates and low cost labor have created additional pricing pressure. The Company competes successfully by offering high quality custom engineered products on a timely basis. To compete, the Company deploys internal engineering resources, maintains cost effective manufacturing capabilities through its wholly-owned Asian subsidiaries, expands its product lines through product development and acquisitions, and maintains sufficient inventory for fast turnaround of customer orders.

Research and development expenditures in 2017 were $3,678,000 and represented 1.8% of gross revenues.  In 2016 and 2015, such expenditures were $1,526,000 and $1,219,000, respectively.  The research and developments costs are primarily attributable to the Velvac and Eberhard Manufacturing divisions. Velvac performs ongoing research, in both the mechanical and electronic product lines, and in RoadIQ. This research is necessary for the Company to remain competitive and to continue to provide technologically advanced electronic systems. Eberhard Manufacturing develops new products for the various markets it serves based on changing customer requirements to remain competitive. Other research projects include the development of various latches and rotaries and various transportation and industrial hardware products.

The Company does not anticipate that compliance with federal, state or local environmental laws or regulations is likely to have a material effect on the Company's capital expenditures, earnings or competitive position.

The average number of employees in 2017 was 1,189.
 
The Company's ratio of working capital to sales improved in 2017 to 33.7% from 47.1% in 2016 and 41.6% in 2015. The improvement in working capital was the result of a reduction in inventory in the Metal business segment and partially the result of the Velvac acquisition.  Working capital includes cash held in various foreign subsidiaries.  With the passage of recent tax legislation cash previously held in foreign countries can be repatriated back to the United States and used for other business needs thus reducing working capital further.  Other factors affecting working capital include our average days' sales in accounts receivable, inventory turnover ratio and payment of vendor accounts payable.  In some cases, the company must hold extra inventory due to extended lead time in receiving products ordered from our foreign subsidiaries to ensure product is available for our customers.  The Company continues to monitor its working capital needs with the goal of reducing our ratio of working capital to sales to 25%.
 
(d) Financial Information about Geographic Areas

The Company includes six operating divisions located within the United States, two wholly-owned Canadian subsidiaries (one located in Tillsonburg, Ontario, Canada, and one in Kelowna, British Columbia, Canada), a wholly-owned Taiwanese subsidiary located in Taipei, Taiwan, a wholly-owned subsidiary located in Hong Kong, two wholly-owned Chinese subsidiaries (one located in Shanghai, China, and one located in Dongguan, China), a wholly-owned subsidiary located in Reynosa, Mexico, and a wholly-owned subsidiary located in Lerma, Mexico.

Individually, the Canadian, Taiwanese, Hong Kong, Chinese and Mexican subsidiaries' revenues and assets are not significant. Substantially all other revenues are derived from customers located in the United States.
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Financial information about foreign and domestic operations' revenues and identifiable assets is included in Note 10 to the Company's financial statements, included in Item 8 of this Form 10-K. Information about risks attendant to the Company's foreign operations is set forth in Item 1A of this Form 10-K.

(e) Available Information

The Company makes available, free of charge through its Internet website at http://www.easterncompany.com, its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission (the "SEC"). The public may read and copy any materials that the Company files with the SEC at the SEC's Public Reference Room, 100 F Street, N.E., Washington, DC 20549 or by calling the SEC at 1-800-SEC-0330. The Company's reports filed with, or furnished to, the SEC are also available on the SEC's website at www.sec.gov.



ITEM 1A
RISK FACTORS

In addition to the other information contained in this Form 10-K and the exhibits hereto and the Company's other filings with the SEC, the following risk factors should be considered carefully in evaluating the Company's business. The Company's business, financial condition or results of operation could be materially adversely affected by any of these risks or additional risks not presently known to the Company, or by risks the Company currently deems immaterial. which may also adversely affect its business, financial condition or results of operations, such as: changes in the economy, including changes in inflation, tax rates, interest rates and currency exchange rates; risk associated with possible disruption in the Company's operations due to terrorism, cybersecurity threats and other manmade or natural disasters; future regulatory actions, legal issues or environmental matters; loss of, or changes in, executive management; and changes in accounting standards that are adverse to the Company.  Additionally, there can be no assurance that the Company has correctly identified and appropriately assessed all factors affecting its business or that information publicly available with respect to these matters is complete and correct.

The Company's business is subject to risks associated with conducting business overseas.

International operations could be adversely affected by changes in political and economic conditions, trade protection measures, restrictions on repatriation of earnings, differing intellectual property rights and changes in regulatory requirements that restrict the sales of products or increase costs. Changes in exchange rates between the U.S. dollar and foreign currencies could result in increases or decreases in earnings and may adversely affect the value of the Company's assets outside the United States. The Company's operations are also subject to the effects of international trade agreements and regulations. These trade agreements could impose requirements that adversely affect the Company's business, such as, but not limited to, setting quotas on products that may be imported from a particular country into the Company's key markets in North America.

The Company's ability to import products in a timely and cost-effective manner may also be affected by conditions at ports or issues that otherwise affect transportation and warehousing providers, such as port and shipping capacity, labor disputes, severe weather or increased homeland security requirements in the United States or other countries. These issues could delay importation of products or require the Company to locate alternative ports or warehousing providers to avoid disruption to customers. These alternatives may not be available on short notice or could result in higher transit costs, which could have an adverse impact on the Company's business, financial conditions or results of operations.

Indebtedness may affect our business and may restrict our operating flexibility.

As of December, 31, 2017, the Company had $35,225,000 in total consolidated indebtedness. Subject to restrictions contained in our credit facility, the Company may incur additional indebtedness in the future, including indebtedness incurred to finance acquisitions. The level of indebtedness and servicing costs associated with that indebtedness could have important effects on our operation and business strategy. For example, the indebtedness could:

·
Place the Company at a competitive disadvantage relative to the Company's competitors, some of which have lower debt service obligations and greater financial resources;
·
Limit our ability to borrow additional funds;
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·
Limit our ability to complete future acquisitions;
·
Limit our ability to pay dividends;
·
Limit our ability to make capital expenditures; and
·
Increase the Company's vulnerability to general adverse economic and industry conditions.
The Company's ability to make scheduled principal payments, to pay interest on, or to refinance our indebtedness and to satisfy other debt obligations will depend upon future operating performance, which may be affected by factors beyond the Company's control. In addition, there can be no assurance that future borrowings or the issuance of equity would be available to the Company on favorable terms for the payment or refinancing of the Company's debt. If the Company is unable to service its indebtedness, the business, financial condition and results of operation would be materially adversely affected.

The Company's credit facility contains covenants requiring the Company to achieve certain financial and operations results and maintain compliance with specified financial ratios. The Company's ability to meet the financial covenants or requirements in its credit facility may be affected by events beyond our control, and the Company may not be able to satisfy such covenants and requirements. A breach of these covenants or the Company's inability to comply with the financial ratios, tests or other restrictions contained in our credit facility could result in an event of default under such credit facility. Upon the occurrence of an event of default under our credit facility and/or the expiration of any grace periods, the lenders could elect to declare all amounts outstanding under our credit facility, together with accrued interest, to be immediately due and payable. If this were to occur, the Company's assets may not be sufficient to fully repay the amounts due under our credit facility or the Company's other indebtedness.  See also "ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK" of this Form 10-K.

In addition, the Company's growth strategy involves expanding sales of its products into foreign markets. There is no guarantee that the Company's products will be accepted by foreign customers or how long it may take to develop sales of the Company's products in these foreign markets.

Increases in the price or reduced availability of raw materials.

Raw materials needed to manufacture products are obtained from numerous suppliers. Under normal market conditions, these raw materials are readily available on the open market from a variety of producers. However, from time to time, the prices and availability of these raw materials fluctuate, which could impair the Company's ability to procure the required raw materials for its operations or increase the cost of manufacturing its products. If the price of raw materials increases, the Company may be unable to pass these increases on to its customers and could experience reductions to its profit margins. Also, any decrease in the availability of raw materials could impair the Company's ability to meet production requirements in a timely manner.

If tariffs on imported steel and aluminum, such as those recently proposed by the President of the United States, are implemented, our cost of raw materials may increase, which could adversely affect our business, results of operations and financial condition.

The Company obtains raw materials, including stainless steel used in the production of its products from domestic, Asian affiliated and nonaffiliated sources.  The President of the United States recently announced a proposal to impose tariffs of 25 percent on imported steel and 10 percent on imported aluminum through the issuance of an executive order.  If implemented, such tariffs may cause an increase in costs for all domestic entities, including the Company, that purchase imported steel or aluminum.   Because steel are raw materials used in a wide-range of the Company's products, a broad-based cost increase would result in an increase in the Company's cost of goods sold, which may require us to increase prices for some of our products.  However, our inability to pass along such price increases to our customers, or an inability of our suppliers to meet our raw material requirements, may have a material adverse impact on our business, results of operations or financial condition.

Changes in competition in the markets that the Company services could impact revenues and earnings.

Any change in competition may result in lost market share or reduced prices, which could result in reduced profits and margins. This may impair the ability to grow or even maintain current levels of revenues and earnings.  While the Company has an extensive customer base, loss of certain customers could adversely affect the Company's business, financial condition or results of operations until such business is replaced, and no assurances can be made that the Company would be able to regain or replace any lost customers.
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The Company is required to evaluate its internal control over financial reporting under Section 404 of the Sarbanes-Oxley Act of 2002.

The Company is an "accelerated filer" as defined in Rule 12b-2 under the Exchange Act and is thus required to comply with Section 404 of the Sarbanes-Oxley Act of 2002. Section 404 requires the Company to include in its report management's assessment of the effectiveness of the Company's internal control over financial reporting as of the end of the fiscal period for which the Company is filing its Annual Report on Form 10-K. This report must also include disclosure of any material weaknesses in internal control over financial reporting that the Company has identified. Additionally, the Company's independent registered public accounting firm is required to issue a report on the Company's internal control over financial reporting and their evaluation of the operating effectiveness of the Company's internal control over financial reporting. The Company's assessment requires it to make subjective judgments, and the independent registered public accounting firm may not agree with the Company's assessment. If the Company or its independent registered public accounting firm were unable to complete the assessments within the period prescribed by Section 404 and thus be unable to conclude that the internal control over financial reporting is effective, investors could lose confidence in the Company's reported financial information, which could have an adverse effect on the market price of the Company's common stock or impact the Company's borrowing ability. In addition, changes in operating conditions and changes in compliance with policies and procedures currently in place may result in inadequate internal control over financial reporting in the future.

The inability to develop new products could limit growth.

Demand for new products and the inability to develop and introduce new competitive products at favorable profit margins could adversely affect the Company's performance and prospects for future growth, and the Company would not be positioned to maintain current levels of revenues and earnings. The uncertainties associated with developing and introducing new products, such as the market demands and the costs of development and production, may impede the successful development and introduction of new products. Acceptance of the new products may not meet sales expectations due to several factors, such as the Company's potential inability to accurately predict market demand or to resolve technical issues in a timely and cost effective manner. Additionally, the inability to develop new products on a timely basis could result in the loss of business to competitors.

The inability to identify or complete acquisitions could limit growth.

The Company's future growth may partly depend on its ability to acquire and successfully integrate new businesses. The Company intends to seek additional acquisition opportunities, both to expend into new markets and to enhance the Company's position in existing markets. However, there can be no assurances that the Company will be able to successfully identify suitable candidates, negotiate appropriate terms, obtain financing on acceptable terms, complete proposed acquisitions, successfully integrate acquired businesses or expand into new markets. Once acquired, operations may not achieve anticipated levels of revenues or profitability.

Acquisitions involve risk, including difficulties in the integration of the operations, technologies, services and products of the acquired companies and the diversion of management's attention from other business concerns. Although the Company's management will endeavor to evaluate the risks inherent in any particular transaction, there can be no assurances that the Company's management will properly ascertain all such risks. In addition, prior acquisitions have resulted, and future acquisitions could result in the incurrence of substantial debt and other expenses. Future acquisitions may also result in potentially dilutive issuances of equity securities. Difficulties encountered with acquisitions may have a material adverse effect on our business, financial condition and results of operations.

Environmental compliance costs and liabilities could increase the Company's expenses and adversely affect the Company's financial condition.

The Company's operations and properties are subject to laws and regulations relating to environmental protection, including air emissions, water discharges, waste management and workplace safety. These laws and regulations can result in the imposition of substantial fines and sanctions for violations and could require the installation of pollution control equipment or operational changes to limit pollution emissions and/or decrease the likelihood of accidental hazardous substance releases. The Company must conform its operations and properties to these laws and adapt to regulatory requirements in the countries in which the Company's divisions operate as these requirements change.
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The Company uses and generates hazardous substances and wastes in its operations and, as a result, could be subject to potentially material liabilities relating to the investigation and clean-up of contaminated properties and to claims alleging personal injury. The Company has experienced, and expects to continue to experience, costs relating to compliance with environmental laws and regulations. In connection with the Company's acquisitions, the Company may assume significant environmental liabilities, some of which it may not be aware of at the time of acquisition. In addition, new laws and regulations, stricter enforcement of existing laws and regulations, the discovery of previously unknown contamination or the imposition of new clean-up requirements could require the Company to incur costs or become the basis for new or increased liabilities that could have a material adverse effect on our business, financial condition and results of operations.

Our technology is important to the Company's success and the failure to protect this technology could put the Company at a competitive disadvantage.

Some of the Company's products rely on proprietary technology; therefore, the Company believes that the development and protection of intellectual property rights through patents, copyrights, trade secrets, trademarks, confidentiality agreements and other contractual provisions are important to the future success of its business. Despite the Company's efforts to protect proprietary rights, unauthorized parties or competitors may copy or otherwise obtain and use the Company's products or technology. Actions to enforce these rights may result in substantial costs and diversion of resources and the Company make no assurances that any such actions will be successful.

The Company relies on information and technology for many of its business operations, which could fail and cause disruption to the Company's business operations.

The Company's business operations are dependent upon information technology networks and systems to securely transmit, process and store electronic information and to communicate among its locations around the world and with clients and vendors. A shut-down of, or inability to access, one or more of the Company's facilities, a power outage or a failure of one or more of the Company's information technology, telecommunications or other systems could significantly impair the Company's ability to perform such functions on a timely basis. Computer viruses, cyberattacks, other external hazards and human error could result in the misappropriation of assets or sensitive information, corruption of data or operational disruption. If sustained or repeated, such a business interruption, system failure, service denial or data loss and damage could result in a deterioration of the Company's ability to write and process orders, provide customer service or perform other necessary business functions.

A breach in the security of the Company's software could harm its reputation, result in a loss of current and potential customers and subject the Company to material claims, which could materially harm our operating results and financial condition.

If the Company's security measures are breached, an unauthorized party may obtain access to the Company's data or users' or customers' data. In addition, cyber-attacks and similar acts could lead to interruptions and delays in customer processing or a loss or breach of a customer's data. Because the techniques used to obtain unauthorized access, disable or degrade service, or sabotage systems change frequently and often are not recognized until launched against a target, the Company may be unable to anticipate these techniques or to implement adequate preventative measures. The risk that these types of events could seriously harm the Company's business is likely to increase as the Company expands the number of web-based products we offer,  the services we provide, and our global operations.

Regulatory authorities around the world are considering a number of legislative and regulatory proposals concerning data protection. In addition, the interpretation and application of consumer and data protection laws in the United States and elsewhere are often uncertain and in flux. It is possible that these laws may be interpreted and applied in a manner that is inconsistent with the Company's data practices. If so, in addition to the possibility of fines, this could result in an order requiring that the Company change its data practices, which could have an adverse effect on its business and results of operations.

Any security breaches for which the Company is, or is perceived to be, responsible, in whole or in part, could subject us to legal claims or legal proceedings, including regulatory investigations, which could harm the Company's reputation and result in significant litigation costs and damage awards or settlement amounts. Any imposition of liability, particularly liability that is not covered by insurance or is in excess of insurance coverage, could materially harm our operating results and financial condition. Security breaches also could cause the Company to lose current and potential customers, which could have an adverse effect on
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our business. Moreover, the Company might be required to expend significant financial and other resources to further protect against security breaches or to rectify problems caused by any security breach.

The Company could be subject to litigation, which could have a material impact on the Company's business, financial condition or results of operations.

From time to time, the Company's operations are parties to or targets of lawsuits, claims, investigations and proceedings, including product liability, personal injury, patent and intellectual property, commercial, contract, and environmental and employment matters, which are defended and settled in the ordinary course of business. While the Company is unable to predict the outcome of any of these matters, it does not believe, based upon currently available information, that the resolution of any pending matter will have a material adverse effect on its business, financial condition or results of operations. See "ITEM 3 – LEGAL PROCEEDINGS" in this Form 10-K for a discussion of current litigation.

The Company could be subject to additional tax liabilities.

The Company is subject to income tax laws of the United States, its states and municipalities and those of other foreign jurisdictions in which the Company has business operations.  These laws are complex and subject to interpretations by the taxpayer and the relevant governmental taxing authorities. Significant judgment and interpretation is required in determining the Company's worldwide provision for income taxes. In the ordinary course of business, transactions arise where the ultimate tax determination is uncertain. Although the Company believes that our tax estimates are reasonable, the final outcome of tax audits and any related litigation could be materially different from that which is reflected in historical income tax provisions and accruals. Based on the status of a given tax audit or related litigation, a material effect on the Company's income tax provision or net income may result during the period or periods from the initial recognition of a particular matter in the Company's reported financial results to the final closure of that tax audit or settlement of related litigation when the ultimate tax and related cash flow is known with certainty.

The Company's goodwill or indefinite-lived intangible assets may become impaired, which could require a significant charge to earnings to be recognized.

Under accounting principles generally accepted in the United States, goodwill and indefinite-lived intangible assets are not amortized but are reviewed for impairment at least annually. Future operating results used in the assumptions, such as sales or profit forecasts, may not materialize, and the Company could be required to record a significant charge to earnings in the financial statements during the period in which any impairment is determined, resulting in an unfavorable impact on our results of operations. Numerous assumptions are used in the evaluation of impairment, and there is no guarantee that the Company's independent registered public accounting firm would reach the same conclusion as the Company or an independent valuation firm, which could result in a disagreement between management and the Company's independent registered public accounting firm.

The Company may need additional capital in the future, which may not be available on acceptable terms, if at all.

From time-to-time, the Company has historically relied on outside financing to fund expanded operations, capital expenditure programs and acquisitions. The Company may require additional capital in the future to fund operations or strategic opportunities. The Company cannot be assured that additional financing will be available on favorable terms, or at all. In addition, the terms of available financing may place limits on the Company's financial and operating flexibility. If the Company is unable to obtain sufficient capital in the future, the Company may not be able to expand or acquire complementary businesses and may not be able to continue to develop new products or otherwise respond to changing business conditions or competitive pressures.

The Company's stock price may become highly volatile.

The Company's stock price may change dramatically when buyers seeking to purchase shares of the Company's common stock exceed the shares available on the market, or when there are no buyers to purchase shares of the Company's common stock when shareholders are trying to sell their shares.
11


The Company may not be able to reach acceptable terms for contracts negotiated with its labor unions and be subject to work stoppages or disruption of production.

During 2018, union contracts covering approximately 9% of the Company's total workforce will expire.  The Company has been successful in negotiating new contracts over the years, but cannot guarantee that will continue. Failure to negotiate new union contracts could result in the disruption of production, inability to deliver product or a number of unforeseen circumstances, any of which could have an unfavorable material impact on the Company's results of operations or financial condition.

Deterioration in the creditworthiness of several major customers could have a material impact on the Company's business, financial condition or results of operations.

Included as a significant asset on the Company's balance sheet are accounts receivable from our customers.  If several large customers become insolvent or are otherwise unable to pay for products, or become unwilling or unable to make payments in a timely manner, it could have an unfavorable material impact on the Company's results of operations or financial condition.

Although the Company is not dependent on any one customer, deterioration in several large customers at the same time could have an unfavorable material impact on the Company's results of operations or financial condition.  No one customer exceeded 10% of total accounts receivable for 2017, 2016 or 2015.

The Company's operating results may fluctuate, which makes the results of operations difficult to predict and could cause the results to fall short of expectations.

The Company's operating results may fluctuate as a result of a number of factors, many of which are outside of our control.  As a result, comparing the Company's operating results on a period-to-period basis may not be meaningful, and past results should not be relied upon as an indication of future performance.  Quarterly, year to date and annual costs and expenses as a percentage of revenues may differ significantly from historical or projected levels.  Future operating results may fall below expectations.  These types of events could cause the price of the Company's stock to fall.

New or existing U.S. or foreign laws could subject the Company to claims or otherwise impact the Company's business, financial condition or results of operations.

The Company is subject to a variety of laws in both the U.S. and foreign countries that are costly to comply with, can result in negative publicity and diversion of management time and effort and can subject the Company to claims or other remedies.


ITEM 1B
UNRESOLVED STAFF COMMENTS

None.


ITEM 2
PROPERTIES

The corporate office of the Company is located in Naugatuck, Connecticut in a two-story, 8,000 square foot administrative building on 3.2 acres of land.

All of the Company's properties are owned or leased and are adequate to satisfy current requirements. All of the Company's properties have the necessary flexibility to cover any long-term expansion requirements.

The Industrial Hardware Group includes the following:

The Eberhard Manufacturing Division in Strongsville, Ohio owns 9.6 acres of land and a building containing 157,580 square feet, located in an industrial park. The building is steel frame, is one-story and has curtain walls of brick, glass and insulated steel panels. The building has two high bays, one of which houses two units of automated warehousing.
12



Eberhard Hardware Manufacturing, Ltd., a wholly-owned Canadian subsidiary in Tillsonburg, Ontario, owns 4.4 acres of land and a building containing 31,000 square feet in an industrial park. The building is steel frame, is one-story, and has curtain walls of brick, glass and insulated steel panels. It is particularly suited for light fabrication, assembly and warehousing and is adequate for long-term expansion requirements.

Canadian Commercial Vehicles Corporation ("CCV"), a wholly-owned subsidiary in Kelowna, British Columbia, leases 46,385 square feet of building space located in an industrial park. The building is made from brick and concrete, contains approximately 5,400 square feet of office space on two levels and houses a modern paint booth for finishing our products. The building is protected by a F1 rated fire suppression system and alarmed for fire and security. CCV's lease expires on December 31, 2018 and is renewable.

The Composite Panel Technologies Division ("CPT") in Salisbury, North Carolina, leases 70,000 square feet of building space located in an industrial park. The building is made from brick and concrete, contains approximately 6,600 square feet of office space on one level and houses a modern paint booth for finishing our products. The building is protected by a water sprinkler fire suppression system and is alarmed for fire and security. The current lease expires on October 31, 2019 and is renewable.

Eastern Industrial Ltd., a wholly-owned subsidiary in Shanghai, China, leases brick and concrete buildings containing approximately 47,500 square feet of space that are located in both industrial and commercial areas. In 2016, Eastern Industrial, Ltd. entered into a six-year lease, which expires on March 31, 2022 and is renewable.

The Sesamee Mexicana subsidiary leases 42,588 square feet in a facility located in an industrial park in Lerma, Mexico.  The current lease expires on November 30, 2020 and is renewable.  The building is steel frame with concrete block and glass curtain walls.

Velvac, Inc., a wholly-owned subsidiary in New Berlin, Wisconsin, leases a 98,000 square foot building.  The building includes 17,000 square feet of office space and 81,000 square feet of warehousing and distribution operations.  The current lease expires on May 31, 2021.

Velvac de Reynosa, S. De R.L De C.V., a maquiladora wholly-owned in Reynosa, Tamaulipas, Mexico, leases 90,000 square feet of building space located in an industrial park identified as Buildings 19, 20 and 21 and on a tract of land with an area of 165,507 square feet.  The building is one level and is made from brick and concrete.  The building is protected by a 24 hour security system and onsite security.  The current lease expires on August 31, 2021.

Velvac, Inc. also leases a 9,300 square foot building in Bellingham, Washington. The premises are used solely for software development and research and development. The current lease expires on September 30, 2021.

The Security Products Group includes the following:

The Greenwald Industries Division in Chester, Connecticut owns 26 acres of land and a building containing 120,000 square feet. The building is steel frame, is one-story, and has brick over concrete blocks.

The Illinois Lock Company/CCL Security Products Division owns 2.5 acres of land and a building containing 44,000 square feet in Wheeling, Illinois. The building is brick and is located in an industrial park.

The Argo EMS Division leases approximately 17,000 square feet of space in a building located in an industrial park in Clinton, Connecticut.  The building is a two-story steel frame structure and is situated on 2.9 acres of land.  The current lease expires on March 31, 2019.

The World Lock Co. Ltd. subsidiary leases 5,285 square feet of space in a building located in Taipei, Taiwan. The building is made from brick and concrete and is protected by a fire alarm and sprinklers.  A two-year lease was signed in 2016, which expires on July 31, 2018 and is renewable.
13


The Dongguan Reeworld Security Products Company Ltd. subsidiary was established in July 2013 to manufacture locks and hardware and leases 118,000 square feet of space in concrete buildings that are located in an industrial park in Dongguan, China.  A five-year lease was signed in 2013, which expires on June 30, 2018 and is renewable.

The Metal Products Group consists of:

The Frazer and Jones Division in Solvay, New York owns 17.9 acres of land and buildings containing 205,000 square feet constructed for foundry use. These facilities are well adapted to handle the division's current and future casting requirements.

All owned properties are free and clear of any encumbrances.


ITEM 3
LEGAL PROCEEDINGS

The Company is party to various legal proceedings and claims related to its normal business operations.  In the opinion of management, the Company has substantial and meritorious defenses for these claims and proceedings in which it is a defendant, and believes these matters will ultimately be resolved without a material adverse effect on the consolidated financial position, results of operations or liquidity of the Company.  The aggregate provision for losses related to contingencies arising in the ordinary course of business was not material to operating results for any year presented.

In 2010, the Company was contacted by the State of Illinois regarding potential ground contamination at its plant in Wheeling, Illinois. The Company entered into a voluntary remediation program in Illinois and has engaged an environmental clean-up company to perform testing and develop a remediation plan. Since 2010, the environmental company has completed a number of tests and the design of a final remediation system is currently being reviewed and is expected to be approved in the first quarter of 2018. The total estimated cost for the proposed remediation system is anticipated to be approximately $50,000.

In 2016, the Company created a plan to remediate a landfill of spent foundry sand maintained at the Company's Metal Casting facility in New York. This plan was presented to the New York Department of Environmental Conservation (the "DEC") for approval in the first quarter of 2018. The Company is in final negotiations with the DEC, and, based on estimates provided by the Company's environmental engineers, the anticipated cost to remediate and monitor the landfill is $380,000. The Company accrued for and expensed such estimated cost in the second and third quarters of 2017.

There are no other legal proceedings, other than ordinary routine litigation incidental to the Company's business, to which either the Company or any of its subsidiaries is a party or of which any property of the Company or any subsidiary is the subject.


ITEM 4
MINE SAFETY DISCLOSURES

Not applicable.
14





PART II


ITEM 5
MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

The Company's common stock is quoted on the NASDAQ Global Market under the symbol "EML". The approximate number of record holders of the Company common stock on December 30, 2017 was 354.

The following table sets forth the high and low per share sales prices of the Company's common stock, and the per share quarterly dividend declared on the Company's common stock, for each quarter of the immediately preceding two years as reported on the NASDAQ Global Market.

   
2017
       
2016
 
   
Market Price
            
Market Price
       
Quarter
 
High
   
Low
   
Dividend
 
Quarter
 
High
   
Low
   
Dividend
 
First
 
$
21.50
   
$
18.85
   
$
0.11
 
First
 
$
19.04
   
$
15.01
   
$
0.11
 
Second
   
31.50
     
21.06
     
0.11
 
Second
   
17.21
     
15.74
     
0.11
 
Third
   
31.15
     
24.35
     
0.11
 
Third
   
20.12
     
16.39
     
0.11
 
Fourth
   
30.85
     
25.10
     
0.11
 
Fourth
   
21.50
     
18.90
     
0.11
 


The Company expects to continue its policy of paying regular cash dividends, although there can be no assurance as to future dividends because they are dependent on future earnings, capital requirements and financial condition. The payment of dividends is subject to the restrictions of the Company's loan agreement if such payment would result in an event of default. See Item 7 – Management's Discussion and Analysis of Financial Condition and Results of Operations, and Note 5 to the Company's financial statements included in Item 8 of this Form 10-K.

The following table sets forth information regarding securities authorized for issuance under the Company's equity compensation plans as of December 30, 2017, consisting of the Company's 2010 Executive Stock Incentive Plan (the "2010 Plan").

Equity Compensation Plan Information
 
Plan category
 
Number of securities to be issued upon exercise of outstanding options, warrants and rights
   
Weighted-average exercise price of outstanding options, warrants and rights
   
Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
 
   
(a)
   
(b)
   
(c)
 
Equity compensation plans approved by security holders
   
56,330
     
20.36
     
333,500
1 
Equity compensation plans not approved by security holders
   
-
     
-
     
-
 
Total
   
56,330
     
20.36
     
333,500
 

1 Includes shares available for future issuance under the 2010 Plan.

Each director who is not an employee of the Company ("Outside Director") is paid a director's fee for his services at the annual rate of $30,000.  Effective August 1, 2017, the chairman of the board will receive an annual fee of $60,000 for his services and all chairs of the varying committees will receive additional compensation. All annual fees paid to non-employee members of the Board of Directors of the Company are paid in common stock of the Company or cash, in accordance with the Directors Fee Program adopted by the shareholders on March 26, 1997 and amended on January 5, 2004. The directors make an annual election, within a reasonable time before their first quarterly payment, to receive their fees in the form of cash, stock or a combination thereof. The election remains in force for one year.
15


During fiscal years 2017, 2016 or 2015, there were no sales by the Company of its securities that were not registered under the Securities Act of 1933, as amended (the "Securities Act").

The Company did not have any share repurchase plans or programs in effect during fiscal year 2017.


Stock Performance Graph
 
The following graph sets forth the Company's cumulative total shareholder return based upon an initial $100 investment made on December 31, 2012 (i.e., stock appreciation plus dividends during the past five fiscal years) compared to the Russell 2000 Index and the S&P Industrial Machinery Index.
The Company manufactures and markets a broad range of locks, latches, fasteners and other security hardware that meets the diverse security and safety needs of industrial and commercial customers. Consequently, while the S&P Industrial Machinery Index used for comparison is the standard index most closely related to the Company, it does not completely represent the Company's products or market applications. The Russell 2000 is a small cap market index of the smallest 2,000 stocks in the Russell 3000 Index.

 
 
Dec. 12
   
Dec. 13
   
Dec. 14
   
Dec. 15
   
Dec. 16
   
Dec. 17
 
The Eastern Company
 
$
100
   
$
103
   
$
114
   
$
129
   
$
147
   
$
187
 
Russell 2000
 
$
100
   
$
139
   
$
146
   
$
139
   
$
169
   
$
194
 
S&P Industrial Machinery
 
$
100
   
$
146
   
$
153
   
$
147
   
$
187
   
$
249
 
                                                 
Copyright© 2018 Standard & Poor's, a division of S&P Global. All rights reserved.
                 
Copyright© 2018 Russell Investment Group. All rights reserved.
                         




16



ITEM 6  SELECTED FINANCIAL DATA

   
2017
   
2016
   
2015
   
2014
   
2013
 
INCOME STATEMENT ITEMS (in thousands)
                             
Net sales
 
$
204,240
   
$
137,608
   
$
144,568
   
$
140,825
   
$
142,458
 
Cost of products sold
   
154,189
     
103,315
     
112,187
     
108,339
     
112,311
 
Depreciation and amortization
   
4,719
     
3,814
     
3,921
     
3,486
     
3,825
 
Interest expense
   
977
     
122
     
185
     
255
     
323
 
Income before income taxes
   
11,455
     
11,223
     
8,021
     
11,529
     
10,114
 
Income taxes
   
6,410
     
3,438
     
2,294
     
3,867
     
3,212
 
Net income
   
5,045
     
7,785
     
5,727
     
7,661
     
6,902
 
Dividends #
   
2,755
     
2,751
     
2,811
     
2,987
     
2,613
 
                                         
BALANCE SHEET ITEMS (in thousands)
                                       
Inventories
 
$
47,269
   
$
34,030
   
$
36,842
   
$
34,402
   
$
30,658
 
Working capital
   
68,751
     
64,831
     
60,105
     
57,845
     
57,379
 
Property, plant and equipment, net
   
29,192
     
26,166
     
26,801
     
28,051
     
27,392
 
Total assets
   
176,458
     
124,198
     
121,739
     
121,271
     
113,858
 
Shareholders' equity
   
86,931
     
82,468
     
79,405
     
74,975
     
81,505
 
Capital expenditures
   
2,763
     
2,863
     
2,538
     
3,633
     
5,524
 
Long-term obligations, less current portion
   
28,675
     
893
     
1,786
     
3,214
     
4,286
 
                                         
PER SHARE DATA
                                       
Net income per share
                                       
   Basic
 
$
.81
   
$
1.25
   
$
0.92
   
$
1.23
   
$
1.11
 
   Diluted
   
0.80
     
1.25
     
0.92
     
1.23
     
1.11
 
Dividends #
   
0.44
     
0.44
     
0.45
     
0.48
     
0.42
 
Shareholders' equity (Basic)
   
13.89
     
13.19
     
12.71
     
12.04
     
13.10
 
                                         
Average shares outstanding:
Basic
   
6,259,139
     
6,251,535
     
6,245,057
     
6,225,068
     
6,220,928
 
Diluted
   
6,294,773
     
6,251,535
     
6,245,057
     
6,237,914
     
6,237,758
 

# - Dividends for 2015 include a $0.01 per share redemption for the termination of the 2008 Shareholder Rights Agreement.  Dividends for 2014 include a one-time extra payment of $0.04 per share distributed on September 15, 2014.


Critical Accounting Policies and Estimates

The preparation of financial statements in accordance with accounting principles generally accepted in the United States ("U.S. GAAP") requires management to make judgments, estimates and assumptions regarding uncertainties that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities and the reported amounts of revenues and expenses. Areas of uncertainty that require judgments, estimates and assumptions include items such as the accounting for derivatives; environmental matters; the testing of goodwill and other intangible assets for impairment; proceeds on assets to be sold; pensions and other postretirement benefits; 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 collectability of its receivables on an ongoing basis, taking into account a
17


combination of factors. The Company reviews potential problems, such as past due accounts, a bankruptcy filing or deterioration in the customer's financial condition, to ensure that the Company has adequately accrued for potential loss. Accounts are considered past due based on when payment was originally due. If a customer's situation changes, such as a bankruptcy or its creditworthiness, or there is a change in the current economic climate, the Company may modify its estimate of the allowance for doubtful accounts.  The Company will write off accounts receivable after reasonable collection efforts have been made and the accounts are deemed uncollectible.

Inventory Reserve

Inventories are valued at the lower of cost or market and or net realizable value. 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 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 performed its most recent qualitative assessment as of the end of fiscal 2017 and determined that it is more likely than not that no impairment of goodwill existed at the end of 2017.  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 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.  Effective January 1, 2017, the Company elected to refine its approach for calculating 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 Company believes this method more precisely measures its obligations.

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 2017 and 8.0% for 2016. The Company reviews the long-term rate of return each year.  Effective January 1, 2017, the Company lowered the long-term rate-of-return assumption to 7.5% to better reflect the expected returns of its current investment portfolio.

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 $510,000 and $105,000 to our pension plans and other postretirement plan, respectively, in 2018. The Company may contribute $1,000,000 to $2,000,000 in 2018 to take advantage of the 34% corporate tax rate that would be applied to its 2017 federal tax return. The Company has until September 15, 2018, or until the Company files its 2017 federal tax return to make that determination and contribution.

In connection with our pension and other postretirement benefits, the Company reported a $0.6 million, ($1.1) million, and $3.5 million gain/(loss) (net of tax) on its Consolidated Statement of Comprehensive Income for Fiscal Years 2017, 2016 and 2015, respectively.  While the main factor driving this gain/(loss) was the change in the discount rate during the applicable period, the Company froze the benefits of our salaried pension plan effective May 31, 2016, resulting in an approximate $2.5 million gain for this significant event.
18



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

   
2017
   
2016
   
2015
 
Discount rate
   
4.04% - 4.08
%
   
4.24%-4.28
%
   
3.90
%
Expected return on plan assets
   
7.5
%
   
8.0
%
   
8.0
%
Rate of compensation increase
   
0.0
%
   
3.25
%
   
3.25
%

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 30
   
December 31
   
January 2
 
   
2017
   
2016
   
2016
 
Discount rate
 
$
(6,382,182
)
 
$
(2,394,216
)
 
$
4,208,918
 
Mortality table
   
--
     
--
     
--
 
Additional recognition due to significant event
   
(496,899
)
   
2,534,589
     
--
 
Asset gain or loss
   
6,043,672
     
(4,358,254
)
   
(577,892
)
Amortization of:
                       
     Unrecognized gain or loss
   
1,153,885
     
1,610,942
     
1,947,102
 
     Unrecognized prior service cost
   
157,430
     
176,678
     
194,696
 
Other
   
140,969
     
776,658
     
(415,479
)
Comprehensive income, before tax
   
616,875
     
(1,653,603
)
   
5,357,345
 
Income tax
   
62,632
     
(543,297
)
   
1,899,285
 
Comprehensive income, net of tax
 
$
554,243
   
$
(1,110,306
)
 
$
3,458,060
 


The Plan has been investing a portion of the assets in long-term bonds in an effort to better match the impact of changes in interest rates on its assets and liabilities and thus reduce some of the volatility in Other Comprehensive Income.  Please refer to Note 9 – Retirement Benefit Plans in Item 8 of this Form 10-K for additional disclosures concerning the Company's pension and other postretirement benefit plans.

Software Development Costs

Software development costs, including costs to develop software sold, leased, or otherwise marketed, that are incurred subsequent to the establishment of technological feasibility are capitalized if significant. Costs incurred during the application development stage for internal-use software are capitalized if significant. Capitalized software development costs are amortized using the straight-line amortization method over the estimated useful life of the applicable software. Such software development costs required to be capitalized have not been material to date.

Items Impacting Earnings

To supplement our consolidated financial statements presented in accordance with GAAP, we disclose certain non-GAAP financial measures, including adjusted net income and adjusted earnings per diluted share. Adjusted net income and adjusted earnings per diluted share exclude transaction-related expenses, a charge to costs of goods sold as a result of the impact of purchase accounting and environmental remediation costs. In addition, reported growth in the Industrial Hardware business segment excludes the results of the Velvac division, which was acquired on April 3, 2017. Furthermore, we show the impact of the one-time charge related to the Tax Cuts and Jobs Act of 2017. These measures are not in accordance with GAAP.

Management uses such measures to evaluate performance period over period, to analyze the underlying trends in our business, including our business segments, to assess our performance relative to our competitors and to establish operational goals and
19


forecasts that are used in allocating resources. These financial measures should not be considered in isolation from, or as a replacement for, GAAP financial measures.

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




Reconciliation of expenses from GAAP to Non-GAAP financial measures
 
For the Three and Twelve Months ended December 30, 2017
 
                         
    
Three Months Ended
   
Twelve Months Ended
         
    
December 30, 2017
   
December 30, 2017
         
                         
Net Income as reported per generally accepted accounting principles (GAAP)
 
$
(168,769
)
 
$
5,045,255
             
                                 
                                 
Earnings Per Share as reported under generally accepted accounting principles (GAAP):
                               
Basic
 
$
(0.03
)
 
$
0.81
             
Diluted
 
$
(0.03
)
 
$
0.80
             
                                 
Adjustments for one-time expenses
                               
Charge to cost of goods sold relating to purchase accounting for the Velvac acquisition.
 
$
0
   
$
1,187,668
             
                                 
Transaction expenses related to the Velvac acquisition
 
$
0
   
$
869,000
           
                                 
Environmental remediation expense related to the Metal Products Segment
 
$
0
   
$
380,000
             
                                 
Personnel expenses related to the Security Products Segment
 
$
0
   
$
205,000
             
    
$
0
   
$
2,641,668
                 
                                 
Income Taxes Related to Expense Adjustment
 
$
0
   
$
887,600
                 
                                 
Income Taxes Related to Tax Cuts and Jobs Act
 
$
2,565,375
   
$
2,565,372
                 
                                 
Adjustment to Net Income (related to expenses and Tax Cuts and Jobs Act); (Non-GAAP)
 
$
2,396,606
   
$
9,364,695
             
                                 
Adjustment to Earnings per share (related to expenses and Tax Cuts and Jobs Act); (Non-GAAP)
                           
Basic
 
$
0.38
   
$
1.50
             
Diluted
 
$
0.38
   
$
1.49
             
                                 
20



Reconciliation of Industrial Hardware Segment net sales from GAAP to Non-GAAP financial measurer
 
For the Three and Twelve Months ended December 30, 2017 and December 31, 2016
 
   
Three Months Ended
   
Three Months Ended
   
Twelve Months Ended
   
Twelve Months Ended
 
   
December 30, 2017
   
December 31, 2016
   
December 30, 2017
   
December 30, 2016
 
Net sales Industrial Hardware Segment (GAAP)
 
$
31,772,577
   
$
15,369,767
   
$
115,273,233
   
$
61,058,871
 
Percent change (GAAP)
   
107
%
           
89
%
       
Net sales Velvac
 
$
15,487,191
   
$
0
   
$
47,313,216
   
$
0
 
                                 
Net sales Industrial Hardware Segment (excluding Velvac); (Non-GAAP)
 
$
16,285,386
   
$
15,369,767
   
$
67,960,017
   
$
61,058,871
 
Percent change (excluding Velvac); (Non-GAAP)
   
6
%
           
11
%
       
                                 
Use of Non-GAAP Financial Measures
                               



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

Summary

Sales for fiscal year 2017 were $204.2 million compared to $137.6 million for fiscal year 2016.  Net income for fiscal year 2017 was $5.0 million, or $0.80 per diluted share, compared to $7.8 million, or $1.25 per diluted share, for fiscal year 2016.  Sales for the fourth quarter of 2017 were $54.1 million compared to $34.1 million for the same period in 2016.  Net income for the fourth quarter of 2017 was ($0.2) million, or ($0.03) per diluted share compared to $2.6 million, or $0.42 per diluted share, for the comparable 2016 period.

The Company anticipates solid growth in sales and earnings in fiscal 2018 as a result of the acquisition of Velvac and our investments in Illinois Lock and new product development. We expect to start seeing returns on our investments in Road-iQ in the second half of the year.  We believe that sales and earnings will also benefit from strong demand in several of our core markets, including Class 8 trucks and recreational vehicles. A reduction in the Company's taxes will also contribute to earnings growth.


21


Fourth Quarter 2017 Compared to Fourth Quarter 2016

The following table shows, for the fourth quarter of 2017 and 2016, selected line items from the consolidated statements of income as a percentage of net sales, by segment.


   
2017 Fourth Quarter
 
   
Industrial
   
Security
   
Metal
       
   
Hardware
   
Products
   
Products
   
Total
 
Net sales
   
100.0
%
   
100.0
%
   
100.0
%
   
100.0
%
Cost of products sold
   
73.2
%
   
67.3
%
   
93.2
%
   
74.4
%
Gross margin
   
26.8
%
   
32.7
%
   
6.8
%
   
25.6
%
Engineering expense
   
3.1
%
   
3.1
%
   
--
%
   
2.7
%
Selling and administrative expense
   
16.6
%
   
17.3
%
   
7.8
%
   
15.5
%
Operating profit
   
7.1
%
   
12.3
%
   
-1.0
%
   
7.4
%
                                 
                                 
   
2016 Fourth Quarter
 
   
Industrial
   
Security
   
Metal
         
   
Hardware
   
Products
   
Products
   
Total
 
Net sales
   
100.0
%
   
100.0
%
   
100.0
%
   
100.0
%
Cost of products sold
   
67.3
%
   
66.2
%
   
76.0
%
   
68.2
%
Gross margin
   
32.7
%
   
33.8
%
   
24.0
%
   
31.8
%
Engineering expense
   
0.9
%
   
3.2
%
   
--
%
   
1.7
%
Selling and administrative expense
   
19.3
%
   
22.1
%
   
9.8
%
   
19.0
%
Operating profit
   
12.5
%
   
8.5
%
   
14.2
%
   
11.1
%


The following table shows the amount of change from the fourth quarter of 2016 to the fourth quarter of 2017 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
 
$
16,403
   
$
1,212
   
$
2,383
   
$
19,998
 
Volume
   
101.5
%
   
6.6
%
   
30.2
%
   
53.0
%
Prices
   
-0.7
%
   
0.3
%
   
2.4
%
   
0.2
%
New Products
   
5.9
%
   
2.0
%
   
12.9
%
   
5.4
%
     
106.7
%
   
8.9
%
   
45.5
%
   
58.6
%
                                 
Cost of products sold
 
$
12,918
   
$
969
   
$
3,127
   
$
17,014
 
     
124.8
%
   
10.8
%
   
78.5
%
   
73.1
%
                                 
Gross margin
 
$
3,485
   
$
243
   
$
(744
)
 
$
2,984
 
     
69.4
%
   
5.3
%
   
-59.0
%
   
27.5
%
                                 
Engineering expense
 
$
863
   
$
20
   
$
--
   
$
883
 
     
654.2
%
   
4.5
%
 
%
     
153.1
%
                                 
Selling and administrative expenses
 
$
2,287
   
$
(448
)
 
$
81
   
$
1,920
 
     
77.0
%
   
-15.0
%
   
16.1
%
   
29.6
%
                                 
Operating profit
 
$
335
   
$
671
   
$
(825
)
 
$
181
 
     
17.5
%
   
58.9
%
   
-110.4
%
   
4.7
%

22


Net sales in the fourth quarter of 2017 increased 59% to $54.1 million from $34.1 million a year earlier.  Sales growth reflects the acquisition of Velvac, which closed on April 3, 2017, as well as organic growth of approximately 13% in the fourth quarter of 2017, compared to the same period in 2016. Sales increased in the Industrial Hardware business segment by 107% and, excluding Velvac, increased 6% as compared to the fourth quarter sales in 2016 a result of strong sales growth to Class 8 Trucks, service bodies and bus customers.  Sales of new products contributed 6% and included tumbler paddles, handle assemblies, latch brackets and lightweight composite panels for the class 8 trucking, off highway and industrial customers.  Sales for the Security Products business segment for the fourth quarter of 2017 increased by 9% compared to the fourth quarter of 2016 as the result of increased sales volume from our investment in growth in Illinois Lock and Argo EMS.  Sales for the Metal Products business segment increased 45% from sales in the fourth quarter of 2016 as a result of a resurgence in sales to mining customers and diversification to other industrial casting markets.

Cost of products sold in the fourth quarter increased $17.0 million or 73% from 2016 to 2017.  The increase in the cost of products sold in the four quarter of 2017 when compared to the respective corresponding prior year period primarily reflects cost of products sold attributable to the Velvac Acquisition.

The most significant factors resulting in changes in cost of products sold in the fourth quarter of 2017 compared to 2016 fourth quarter included:

§
an increase of $9.0 million or 68% in costs for raw materials, with Velvac representing the increase;
§
an increase of $3.6 million or 54% in payroll and payroll related costs, with Velvac representing $1.7 million of the increase;
§
an increase of $2.8 million in freight expenses, with Velvac representing the total increase;
§
an increase of $0.9 million or 100% in supplies and tools costs;
§
an increase of $0.6 million in rent expense, with Velvac representing the total increase;
§
and an increase of $0.4 million or 107% in maintenance and repair costs.

Gross margin as a percentage of net sales for the fourth quarter of 2017 was 26% compared to 32% in the fourth quarter of 2016.  The decrease is primarily the result of product mix, material cost increases and the Velvac Acquisition noted above. 

Engineering expenses as a percentage of sales increased in the fourth quarter of 2017 to 3% from 2% in the fourth quarter of 2016.  This increase was primarily the result of the Velvac Acquisition.

Selling and administrative expenses for the fourth quarter of 2017 increased $1.9 million or 30% compared to the prior year quarter. The most significant factor resulting in changes in selling and administrative expenses in the fourth quarter of 2017 compared to 2016 fourth quarter was:

§
an increase of $1.5 million or 31% in costs for payroll and payroll related charges;
§
an increase of $0.2 million or 99% in business travel costs;
§
and a decrease of $0.2 million or 108% in commissions and royalties.

Net income (loss) for the fourth quarter of 2017 decreased to ($0.2) million or ($0.03) per diluted share from $2.6 million or $.42 per diluted share for the comparable period in 2016.  In the fourth quarter of 2017, we incurred an incremental one-time charge of $2.5 million, or $0.41 per fully diluted share, consisting of a $2.0 million charge on undistributed earnings of foreign subsidiaries as well as a charge of $0.5 million related to the impact of the tax reform on our deferred tax asset.


23



RESULTS OF OPERATIONS

Fiscal Year 2017 Compared to Fiscal Year 2016

The following table shows, for fiscal year 2017 and fiscal year 2016, selected line items from the consolidated statements of income as a percentage of net sales, by segment.

   
Industrial
   
Security
   
Metal
       
   
Hardware
   
Products
   
Products
   
Total
 
   
Fiscal Year 2017
 
Net sales
   
100.0
%
   
100.0
%
   
100.0
%
   
100.0
%
Cost of products sold
   
76.0
%
   
69.2
%
   
87.1
%
   
75.5
%
Gross margin
   
24.0
%
   
30.8
%
   
12.9
%
   
24.5
%
Engineering
   
3.3
%
   
3.0
%
   
--
%
   
2.8
%
Selling and administrative expense
   
16.3
%
   
17.8
%
   
9.1
%
   
15.7
%
Operating profit
   
4.4
%
   
10.0
%
   
3.8
%
   
6.0
%
                                 
   
Fiscal Year 2016
 
Net sales
   
100.0
%
   
100.0
%
   
100.0
%
   
100.0
%
Cost of products sold
   
72.8
%
   
68.5
%
   
91.4
%
   
73.6
%
Gross margin
   
27.2
%
   
31.5
%
   
8.6
%
   
26.4
%
Engineering
   
0.8
%
   
3.6
%
   
--
%
   
1.9
%
Selling and administrative expense
   
17.1
%
   
18.0
%
   
9.8
%
   
16.4
%
Operating profit
   
9.3
%
   
9.9
%
   
-1.2
%
   
8.1
%



The following table shows the amount of change from fiscal year 2016 to fiscal year 2017 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
 
$
54,214
   
$
3,722
   
$
8,695
   
$
66,631
 
Volume
   
83.5
%
   
4.8
%
   
29.8
%
   
43.2
%
Prices
   
-0.4
%
   
--
%
   
2.7
%
   
0.2
%
New Products
   
5.7
%
   
1.7
%
   
12.6
%
   
5.1
%
     
88.8
%
   
6.5
%
   
45.1
%
   
48.5
%
                                 
Cost of products sold
 
$
43,183
   
$
2,975
   
$
6,749
   
$
52,907
 
     
97.1
%
   
7.6
%
   
38.3
%
   
52.2
%
                                 
Gross margin
 
$
11,031
   
$
747
   
$
1,946
   
$
13,724
 
     
66.5
%
   
4.1
%
   
116.7
%
   
37.8
%
                                 
Engineering expenses
 
$
3,264
   
$
(209
)
 
$
--
   
$
3,055
 
     
633.9
%
   
-10.2
%
 
%
     
118.9
%
Selling and administrative expenses
 
$
8,325
   
$
514
   
$
670
   
$
9,509
 
     
80.0
%
   
5.0
%
   
35.4
%
   
42.0
%
                                 
Operating profit
 
$
(558
)
 
$
442
   
$
1,276
   
$
1,160
 
     
-9.8
%
   
7.8
%
   
566.8
%
   
10.4
%

24



Summary

Net sales for 2017 increased 48% to $204.2 million from $137.6 million in 2016.  Sales growth reflects the acquisition of Velvac, which closed on April 3, 2017, as well as organic growth of approximately 14% in 2017.  Net sales in the Industrial Hardware segment increased approximately 89% in 2017, and excluding Velvac, sales increased 11% as compared to the same period in 2016.  Sales of existing products increased 83% in 2017 primarily as the result of the Velvac Acquisition, as well as strong sales growth from our existing Class 8 truck, service bodies and bus customers.  Net sales in the Security Products segment increased approximately 7% in 2017 primary a result of increased sales volume from our investment in growth at our Illinois Lock and Argo EMS divisions.  The Metal Products business segment's net sales increased approximately 45% in 2017 compared to the prior year period.  Sales volume increased 34% in mine roof products sold to our customers as a result of a resurgence in the coal mining industry due to higher natural gas prices and an easing of regulatory restriction in the coal mining industry.  Net sales also increased 127% in industrial casting products through our continued efforts to diversify away from mining products.  Net income for 2017 decreased 35% to $5.0 million, or $0.80 per diluted share, from $7.8 million, or $1.25 per diluted share, in 2016. The decrease in net income was primarily the result of the recognition of one-time charges of $2.5 million related to the enactment of the Tax Cuts and Jobs Act in 2017 and $1.8 million, net of tax expenses, related to the Velvac Acquisition, environmental remediation expenses and personnel related expenses.  Excluding these one-time charges, we generated adjusted earnings of $1.49 per fully diluted share in 2017.  Adjusted earnings per share is a non-GAAP measure.


Industrial Hardware Business Segment

Net sales in the Industrial Hardware business segment increased 89% in 2017 from the 2016 level.  Sales of existing products increased 83% in 2017 as the result of the Velvac Acquisition.  Excluding Velvac, the Industrial Hardware business segment had strong organic sales growth in Class 8 trucks, service bodies and bus customers, which contributed 11%  in increased sales volume in 2017, whereas new product sales of tumbler paddles, handle assemblies, latch brackets and composite panels contributed 6% in 2017, each as compared to 2016.  From the date on which the acquisition of Velvac closed, April 3, 2017, to December 30, 2017, Velvac sales were $ 47.3 million and earnings were $(0.1) million.

Cost of products sold for the Industrial Hardware segment increased $43.2 million or 97% from 2016 to 2017. The increase in the cost of products sold in the annual period of 2017 when compared to the annual period of 2016 primarily reflects cost of products sold attributable to the Velvac Acquisition.

The most significant factors resulting in changes in cost of products sold in 2017 compared to 2016 included:

§
an increase of $30.6 million or 119% in raw materials, with Velvac representing $26.0 million of such increase;
§
an increase of $4.8 million or 38% in costs for payroll and payroll related charges, with Velvac representing $4.3 million of such increase;
§
an increase of $4.3 million in freight costs, with Velvac representing the total increase;
§
an increase of $0.9 million or 183% in rent expense, with Velvac representing the total increase;
§
an increase of $0.5 million or 205% in foreign currency translation costs;
§
an increase of $0.3 million or 127% in scrap costs, with Velvac representing the total increase;
§
an increase of $0.3 million or 29% in depreciation charges, with Velvac representing the total increase;
§
an increase of $0.3 million or 38% in supplies and tools expense, with Velvac representing $0.2 million of the increase;
§
an increase of $0.2 million or 53% for repairs and maintenance;
§
an increase of $0.2 million or 42% in utilities expenses, with Velvac representing the total increase;
§
an increase of $0.2 million in freight on supplies, with Velvac representing the total increase; and
§
an increase of $0.6 million in other expenses.

Gross margin as a percentage of sales in the Industrial Hardware business segment decreased to 24% in 2017 from 27% in 2016.  The decrease reflects the mix of products produced and the changes in cost of products sold.  Also affecting gross margin in fiscal 2017 was a one-time change to cost of goods sold, for $1.2 million, as a result of the impact of the purchase accounting in connection with the Velvac acquisition.  In addition, rising prices in raw material such as stainless steel, cold roll steel, hot rolled steel and zinc increased from 10% on stainless steel to 37% on zinc materials used in our products during 2017.  As a result of these cost increases, our margins were negatively affected and could not be fully recovered in price increases to customers or offset through operational improvements.

Engineering expenses as a percentage of sales increased in 2017 to 3% from 0.8% in 2016.  This increase was primarily the result of the Velvac Acquisition.
25



Selling and administrative expenses in the Industrial Hardware business segment increased $8.3 million or 80% in 2017 from the 2016 level.  The increase in selling and administrative expenses in the annual period of 2017 when compared to the prior year primarily reflects expenses attributable to the Velvac Acquisition.

The most significant factors resulting in changes in selling and administrative expenses in the Industrial Hardware business segment in 2017 compared to 2016 included:

§
an increase of $5.8 million or 74% in payroll and payroll related charges, with Velvac representing $3.4 million of the increase;
§
an increase of $1.0 million in commissions and royalty costs, with Velvac representing the total increase;
§
an increase of $0.6 million or 154% in business travel costs, with Velvac representing the total increase;
§
an increase of $0.7 million in depreciation and amortization expenses, with Velvac representing $0.4 million of the increase; and
§
an increase of $0.2 million in advertising expenses, with Velvac representing the total increase.


Security Products Business Segment

Net sales in the Security Products business segment increased 7% in 2017 from the 2016 level.  The increase in sales in 2017 in the Security Products segment compared to the prior year period was a result of our investment in growth in Illinois Lock and Argo EMS.  New product sales included a zinc branded puck lock, a spring return lock, a push button lock and a mini cam lock.

Cost of products sold for the Security Products business segment increased $3.0 million or 8% from 2016 to 2017.  The most significant factors resulting in changes in cost of products sold in 2017 compared to 2016 included:

§
an increase of $1.7 million or 7% in raw materials;
§
an increase of $0.4 million or 4% in payroll and payroll related charges;
§
an increase of $0.5 million in foreign exchange costs;
§
an increase of $0.2 million or 12% in other shipping expenses; and
§
an increase of $0.1 million or 11% in supplies and tools.

Gross margin as a percentage of sales in the Security Products business segment increased to 31% in 2017 from 28% in 2016.  The increase reflects the mix of products sold and higher utilization of fixed charges on increased volume. Our margins were negatively impacted by higher material costs, primarily in zinc, which was up 37%, and brass, which was up 23%, from the prior year.

Engineering expenses as a percentage of sales decreased to 3% in 2017 from 4% in 2016.

Selling and administrative expenses in the Security Products business segment increased by $0.5 million or 5% in 2017 from the 2016 level.  The most significant factors resulting in changes in selling and administrative expenses in the Security Products segment in 2017 compared to 2016 included:

§
an increase of $0.3 million or 4% in payroll and payroll related charges; and
§
an increase of $0.2 million or 12% in other administration expenses.


Metal Products Business Segment

Net sales in the Metal Products business segment increased 45% in 2017 compared to the prior year period.  Sales volume increased 34% in mine roof products sold to our customers a result of a resurgence in the coal mining industry due to higher natural gas prices and an easing of regulatory restriction in the coal mining industry.  Net sales also increased 127% in industrial casting products through our continued efforts to diversify away from mining products.

Cost of products sold for the Metal Products segment increased $6.8 million or 38% from 2016 to 2017.  The most significant factors resulting in changes in cost of products sold in 2017 compared to 2016 included:

§
an increase of $2.1 million or 33% in costs for payroll and payroll related charges;
§
an increase of $1.5 million or 29% in raw materials;
§
an increase of $1.8 million or 103% for supplies and tools;
26

§
an increase of $0.5 million or 44% for utility costs;
§
an increase of $0.2 million in other expenses; and
§
an increase of $0.1 million or 41% in other shipping expenses.
Gross margin as a percentage of sales in the Metal Products business segment increased to 13% in 2017 from 9% in 2016.  The increase reflects the mix of products produced and the utilization of productive capacity.  Our margins were negatively impacted by a 48% increase in raw material scrap iron prices.  Not all increases in the prices of raw materials could be recovered from price increases to customers.

Selling and administrative expenses in the Metal Products segment increased $0.7 million or 35% from 2016 to 2017.  The most significant factors, resulting in changes in selling and administrative expenses in the Metal Products business segment in 2017 compared to 2016 were:

§
an increase of $0.5 million or 38% in payroll and payroll related charges; and
§
a $0.4 million environmental charge.


Other Items

The following table shows the amount of change from 2016 to 2017 in other items (dollars in thousands):

   
Amount
   
%
 
Interest expense
 
$
855
     
704
%
                 
Other income
 
$
(54
)
   
-26
%
                 
Income taxes
 
$
2,972
     
86
%

Interest expense increased from 2016 in 2017 due to the increased level of debt in 2017 that was incurred in connection with the Velvac Acquisition.

Other income in 2017 decreased from the 2016 level. Other income in 2017 included the recognition of a gain on marketable securities of $72,658.  In 2016, other income included $144,231 as a result of Argo EMS not meeting the sales goals for the second year earn-out period.

The effective tax rate for 2017 was 56% compared to the 2016 effective tax rate, which was 31%.  The effective tax rate for 2017 was higher than the prior year period due to the enactment of the Tax Cuts and Jobs Act (the "Jobs Act") in 2017 and its impact on foreign repatriation tax.

Total income taxes paid were $4,104,701 in 2017, $3,493,558 in 2016 and $2,348,865 in 2015.

The Jobs Act resulted in significant changes to U.S. corporate income tax laws by, among other provisions, reducing the maximum U.S. corporate income tax rate from 35% to 21% starting in 2018, and creating a territorial tax system with a one-time mandatory tax on previously deferred foreign earnings of U.S. subsidiaries. During the year ending December 30, 2017, the Company recognized deferred income tax expense of $531,307 as a result of the re-measurement of deferred tax assets and liabilities to the new lower statutory rate of 21%.

Due to the passage of the Act, U.S. income taxes have been provided on the undistributed earnings of foreign subsidiaries ($17,153,163 at December 30, 2017), as well as the associated withholding taxes from the foreign countries.  The amount of taxes associated with the changes to the provisions of the tax law regarding foreign earnings is $2,034,065.  Foreign subsidiaries that were previously treated as corporations for U.S. income tax purposes will generally no longer be taxed on their foreign source income by the U.S. federal government.  Of the $2,034,065 in taxes associated with the new treatment of foreign earnings under the Jobs Act, $861,964 are associated with the withholding taxes assessed by the foreign countries, net of the applicable U.S. tax credits, and $1,172,101 are associated with the deemed repatriation of earnings held in foreign corporations.  The Company has made an election to pay the $1,172,101 in taxes on an installment basis over eight years with payments of $93,768 becoming due in each of the years 2018 to 2022; one payment of $175,815 becoming due in 2023; one payment of $234,420 becoming due in 2024; and a final payment of $293,026 becoming due in 2025.
27



Fiscal Year 2016 Compared to Fiscal Year 2015

The following table shows, for fiscal year 2016 and fiscal year 2015, selected line items from the consolidated statements of income as a percentage of net sales, by business segment.



   
Industrial
   
Security
   
Metal
       
   
Hardware
   
Products
   
Products
   
Total
 
   
Fiscal Year 2016
 
Net sales
   
100.0
%
   
100.0
%
   
100.0
%
   
100.0
%
Cost of products sold
   
72.8
%
   
72.0
%
   
91.4
%
   
75.1
%
Gross margin
   
27.2
%
   
28.0
%
   
8.6
%
   
24.9
%
Selling and administrative expense
   
17.9
%
   
18.1
%
   
9.8
%
   
16.8
%
Operating profit
   
9.3
%
   
9.9
%
   
-1.2
%
   
8.1
%
                                 
   
Fiscal Year 2015
 
Net sales
   
100.0
%
   
100.0
%
   
100.0
%
   
100.0
%
Cost of products sold
   
74.8
%
   
74.4
%
   
90.8
%
   
77.6
%
Gross margin
   
25.2
%
   
25.6
%
   
9.2
%
   
22.4
%
Selling and administrative expense
   
18.2
%
   
18.9
%
   
9.5
%
   
16.8
%
Operating profit
   
7.0
%
   
6.7
%
   
-0.3
%
   
5.6
%




The following table shows the amount of change from 2015 to 2016 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
 
$
(280
)
 
$
657
   
$
(7,336
)
 
$
(6,959
)
Volume
   
-8.1
%
   
0.4
%
   
-28.5
%
   
-8.5
%
Prices
   
-0.6
%
   
-0.4
%
   
0.0
%
   
-0.4
%
New Products
   
8.2
%
   
1.1
%
   
0.9
%
   
4.1
%
     
-0.5
%
   
1.2
%
   
-27.5
%
   
-4.8
%
                                 
Cost of products sold
 
$
(1,422
)
 
$
(899
)
 
$
(6,550
)
 
$
(8,871
)
     
-3.1
%
   
-2.1
%
   
-27.1
%
   
-7.9
%
                                 
Gross margin
 
$
1,142
   
$
1,556
   
$
(786
)
 
$
1,912
 
Selling and administrative expenses
 
$
(228
)
 
$
(323
)
 
$
(645
)
 
$
(1,196
)
     
2.0
%
   
-3.0
%
   
-25.4
%
   
-4.9
%
                                 
Operating profit
 
$
1,370
   
$
1,879
   
$
(141
)
 
$
3,108
 
     
31.7
%
   
49.5
%
   
-166.3
%
   
38.7
%



28

Industrial Hardware Business Segment

Net sales in the Industrial Hardware business segment decreased less than 1% in 2016 from the 2015 level.  Sales of existing product decreased 8% in 2016 as a result of a decrease in sales of our lightweight composite material for the Class 8 truck market.  This decrease was offset by an 8% increase in the new product sales of lightweight composite panels for electronic smartboards.
 
Cost of products sold for the Industrial Hardware business segment decreased $1.4 million or 3% from 2015 to 2016.  The most significant factors resulting in changes in cost of products sold in 2016 compared to 2015 included:

§
a decrease of $0.9 million or 4% in raw materials;
§
a decrease of $0.6 million or 4% in costs for payroll and payroll related charges;
§
a decrease of $0.1 million or 9% for supplies and tools;
§
a decrease of $0.1 million or 8% in depreciation charges;
§
a decrease of $0.2 million or 94% in miscellaneous income; and
§
an increase of $0.2 million or 46% in foreign exchange costs.

Gross margin of 27% for 2016 increased as compared to 25% in the 2015 period for the Industrial Hardware business segment.  The increase reflects the mix of products produced, the changes in cost of products sold discussed above and lower utilization of our production facilities in both Kelowna, British Columbia, Canada and North Carolina.

Selling and administrative expenses in the Industrial Hardware segment decreased $0.2 million or 2% from 2015 to 2016.  The most significant factors resulting in changes in selling and administrative expenses in the Industrial Hardware segment in 2016 compared to 2015 included:

§
a decrease of $0.3 million or 4% in payroll and payroll related charges; and
§
an increase of $0.1 million or 12% in administrative charges.


Security Products Business Segment

Net sales in the Security Products business segment increased 1% in 2016 from the 2015 level. The increase in sales in 2016 in the Security Products business segment when compared to the prior year period was primarily due to a combination of volume sales and new product sales in the laundry industry (which was partially offset by a decrease in the vehicle lock industry). Sales volume increased in the smart card and flash cash products sold in the international laundry market. New products included high security equipment for add value card systems in the laundry industry and new product sales in the storage, locksmith and industrial distribution and electronic locking enclosures industries.  New product sales included a zinc branded puck lock, a spring return lock, a push button lock and a mini cam lock.

Cost of products sold for the Security Products segment decreased $0.9 million or 2% from 2015 to 2016.  The most significant factors resulting in changes in cost of products sold in 2016 compared to 2015 included:

§
a decrease of $0.4 million or 2% in raw materials;
§
a decrease of $0.9 million or 11% in payroll and payroll related charges;
§
an increase of $0.2 million or 57% in foreign exchange gains;
§
an increase of $0.1 million or 12% in engineering costs;
§
an increase of $0.1 million or 8% in supplies and tools; and
§
an increase of $0.1 million or 30% in insurance costs.

Gross margin as a percentage of sales in the Security Products business segment increased to 28% in 2016 from 26% in 2015.  The increase reflects the mix of products produced and the changes in cost of products sold, as discussed above.

Selling and administrative expenses in the Security Products segment decreased $0.3 million or 3% from 2015 to 2016.  The most significant factors resulting in changes in selling and administrative expenses in the Security Products segment in 2016 compared to 2015 included:

§
a decrease of $0.3 million or 4% in payroll and payroll related charges;
§
a decrease of $0.1 million or 278% in bad debt charges;
§
a decrease of $0.1 million or 21% in commissions and royalty expenses; and
§
an increase of $0.3 million or 27% in other administrative expenses.


29

Metal Products Business Segment

Net sales in the Metal Products business segment decreased 28% in 2016 from the 2015 level.  Sales of mine products decreased 26% and industrial casting products decreased 41% in 2016 compared to 2015.  The decrease in sales of mining products was driven by lower demand for existing products compared to the prior year period primarily in the U.S. mining market where lower oil and natural gas prices, coupled with excessive coal inventories, have reduced demand for our products.    Our new products, consisting of tie plates for the rail industry and pipe fittings for the water, oil and gas industries, resulted in an increase in sales of 1%.  The Company is actively developing new customers in the industrial casting business and is close to producing several new products for the gas, water and energy industries.

Cost of products sold for the Metal Products business segment decreased $6.6 million or 27% from 2015 to 2016.  The most significant factors resulting in changes in cost of products sold in 2016 compared to 2015 included:

§
a decrease of $3.8 million or 39% in payroll and payroll related charges;
§
a decrease of $2.1 million or 61% for supplies and tools;
§
a decrease of $0.9 million or 53% in costs for maintenance and repair;
§
a decrease of $0.6 million or 34% for utility costs;
§
an increase of $0.8 million or 18% in raw materials; and
§
an increase of $0.2 million or 299% in tools and jigs costs.
Gross margin as a percentage of sales in the Metal Products business segment was approximately the same at 9% in both 2016 and 2015.

Selling and administrative expenses in the Metal Products segment decreased $0.6 million or 25% from 2015 to 2016.  The most significant factors resulting in changes in selling and administrative expenses in the Metal Products business segment in 2016 compared to 2015 were:

§
a decrease of $0.5 million or 29% in payroll and payroll related charges; and
§
a decrease of $0.1 million or 72% in commissions and royalty charges.


Other Items

The following table shows the amount of change from 2015 to 2016 in other items (dollars in thousands):

   
Amount
   
%
 
Interest expense
 
$
(64
)
   
-35
%
                 
Other income
 
$
30
     
17
%
                 
Income taxes
 
$
1,114
     
50
%

Interest expense decreased from 2015 to 2016 due to the decreased level of debt in 2016.

Other income, which is not material to the financial statements, increased from 2015 to 2016 due to the Company recognizing $144,231 in income as a result of Argo EMS not meeting the sales goals for the second year earn-out period.

The effective tax rate was 31% for 2016 compared to the 2015 rate, which was 29%.  The effective tax rate for 2016 was higher than the prior year period due to the ratio of earnings in the United States being higher than earnings from foreign entities with lower tax rates.


Liquidity and Sources of Capital

The Company's financial position strengthened in 2017.  The primary source of the Company's cash is earnings from operating activities adjusted for cash generated from or used for net working capital and the term loan from People's Bank.  The most significant recurring non-cash items included in net income are depreciation and amortization expense.  Changes in working
 
30

capital fluctuate with the changes in operating activities.  As sales increase, there generally is an increased need for working capital.  Since increases in working capital reduce the Company's cash, management attempts to keep the Company's investment in net working capital at a reasonable level by closely monitoring inventory levels and matching production to expected market demand, keeping tight control over the collection of receivables and optimizing payment terms on its trade and other payables.
 
The Company is dependent on continued demand for our products and subsequent collection of accounts receivable from our 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 year:

   
2017
   
2016
   
2015
 
Current ratio
   
3.2
     
6.0
     
5.0
 
Average days' sales in accounts receivable
   
46
     
49
     
47
 
Inventory turnover
   
3.4
     
3.0
     
3.0
 
Ratio of working capital to sales
   
33.7
%
   
47.1
%
   
41.6
%
Total debt to shareholders' equity
   
40.5
%
   
2.2
%
   
4.0
%


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

   
2017
   
2016
   
2015
 
Cash and cash equivalents
                 
    -  Held in the United States
 
$
7.9
   
$
11.2
   
$
6.9
 
    -  Held by foreign subsidiary
   
14.4
     
11.5
     
10.9
 
     
22.3
     
22.7
     
17.8
 
Working capital
   
68.8
     
64.8
     
60.1
 
Net cash provided by operating activities
   
11.2
     
12.4
     
9.1
 
Change in working capital impact on net cash
    (used)/provided by operating activities
   
2.4
     
(0.5
)
   
(2.0
)
Net cash used in investing activities
   
(44.7
)
   
(2.9
)
   
(2.5
)
Net cash (used in)/provided by financing activities
   
30.7
     
(4.2
)
   
(3.9
)


The Jobs Act resulted in significant changes U.S. corporate income tax laws by, among other provisions, reducing the maximum U.S. corporate income tax rate from 35% to 21%, starting in 2018 and creating a territorial tax system with a one-time mandatory tax on previously deferred foreign earnings of U.S. subsidiaries. During the year ending December 30, 2017, the Company recognized deferred income tax expense of $531,000 as a result of the re-measurement of deferred tax assets and liabilities to the new lower statutory rate of 21%.

Due to the enactment of the Act, U.S. income taxes have been provided on the undistributed earnings of foreign subsidiaries ($17,153,163 at December 30, 2017), as well as the associated withholding taxes from the foreign countries.  The amount of taxes associated with the changes to the provisions of the tax law regarding foreign earnings is $2,034,000.  Foreign divisions that were previously treated as corporations for U.S. income tax purposes will generally no longer be taxed on their foreign source income by the U.S. federal government.  Of the $2,034,000 in taxes associated with the new treatment of foreign earnings under the Jobs Act, $862,000 are associated with the withholding of taxes assessed by foreign countries, net of the applicable U.S. tax credits, and $1,172,000 in taxes are associated with the deemed repatriation of earnings held in foreign corporations.  See Note 7 – Income Taxes for additional information.

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

Net cash provided by operating activities was $13.1 million in 2017 compared to $12.4 million in 2016 and $9.1 million in 2015.  In 2017 and 2016, the Company was not required to, and did not, contribute anything into its salaried retirement plan.  Due to
 
31

improved benefits of the Company's 401(k) plan in 2015 and 2016 the contribution required by the Company increased by $595,000 for 2017 over the amount contributed for 2016.  See Note 9 – Retirement Benefit Plans for details of the Plan changes.

The Company, across all of its business segments, has increased its emphasis on sales and customer service by fulfilling the rapid delivery requirements of our customers.  As a result, investments in additional inventories are made on a selective basis.

In fiscal year 2017 the impact on cash from the net change in working capital was $0.2 million, which was primarily due to an increase in accounts receivable derived from increased sales activity at the end of the year.  In fiscal year 2016, inventory declined $2.5 million primarily due to inventory reduction in the Metal Products business segment in response to the slowdown in the mining industry in 2015 and 2016.  This change was offset by an increase in accounts receivable of $1.1 million due to increased sales late in the fiscal year and a reduction of accounts payable related to the previously mentioned inventory reduction.  In fiscal year 2015, cash from the net change in working capital declined by approximately $2.0 million, primarily as a result of increased inventory and accounts receivable, which were partially offset by declines in accounts payable, prepaid expenses and recoverable taxes.

The Company used $44.7 million, $2.9 million and $2.5 million for investing activities in 2017, 2016 and 2015, respectively.  Included in the 2017 figure is approximately $42.1 million used for the acquisition of the assets of Velvac.  This transaction is more fully discussed in Note 3 of the 2017 Audited Financial Statements located in Item 8 of this Form 10-K.  Almost all of the cash used in investing activities in fiscal years 2016 and 2015, and the balance of $2.6 million in fiscal year 2017, was used to purchase fixed assets.  Capital expenditures in fiscal year 2018 are expected to be in the range of $3 million.

In fiscal year 2017, the Company received approximately $30.7 million in cash from financing activities.  The Company received proceeds of $37.6 million from the issuance of new debt and used approximately $4.1 million for debt repayments and $2.8 million for the payment of dividends.  See Note 3 – Debt for additional details on the debt that was issued.

In fiscal year 2016, the Company used approximately $4.2 million in cash for financing activities.  Approximately $1.4 million was used for debt repayments and $2.8 million was paid in dividends.

In fiscal year 2015, the Company used approximately $3.9 million in cash for financing activities.  Approximately $1.1 million was used for debt repayments and $2.8 million was paid in dividends.

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 $2.2 million in 2017; $1.3 million in 2016; and $1.3 million in 2015.

On January 29, 2010, the Company signed a secured Loan Agreement (the "Loan Agreement") with People's United Bank ("People's"), which included a $5,000,000 term portion (the "Original Term Loan") and a $10,000,000 revolving credit portion.  On January 25, 2012, the Company amended the Loan Agreement by taking an additional $5,000,000 term loan (the "2012 Term Loan").  Interest on the Original Term Loan portion of the Loan Agreement is fixed at 4.98%.  Interest on the 2012 Term Loan is fixed at 3.90%.  The interest rate on the revolving credit portion of the Loan Agreement varied based on the LIBOR rate or People's Prime rate plus a margin spread of 2.25%, with a floor interest rate of 3.25% and a maturity date of January 31, 2014.  On January 23, 2014, the Company signed an amendment to the Loan Agreement with People's that extended the maturity date of the $10,000,000 revolving credit portion of the Loan Agreement to July 1, 2016 and changed the interest rate to LIBOR plus 2.25%, eliminating the floor interest rate previously in place.  On June 9, 2016, the Company signed a third amendment to its Loan Agreement, which extended the maturity date of the $10,000,000 revolving credit portion of the Loan Agreement to July 1, 2018.

On April 3, 2017, the Company signed an amended and restated loan agreement (the "Restated Loan Agreement") with People's that included a $31,000,000 term portion and a $10,000,000 revolving credit portion.  Proceeds of the loan were used to repay the remaining outstanding term loan of the Company (approximately $1,429,000) and to acquire 100% of the common stock of Velvac Holdings, Inc. (see Footnote 3).  The term portion of the Restated Loan Agreement requires quarterly principal payments of $387,500 for a two-year period beginning July 3, 2017.  The repayment amount then increases to $775,000 per quarter beginning July 1, 2019.  The term portion of the Restated Loan Agreement is a five-year loan with any remaining outstanding balance due on March 1, 2022.  The revolving credit portion has a quarterly commitment fee ranging from 0.2% to 0.375% based on operating results.  Under the terms of the Restated Loan Agreement, this quarterly commitment fee will be 0.25% for the first six months.  The revolving credit portion has a maturity date of April 1, 2022.  On April 3, 2017, the Company borrowed approximately $6.6 million on the revolving credit facility. The Company subsequently paid off $1.6 million on the revolving credit portion of the Restated Loan Agreement, leaving a balance on the revolving credit portion of the Restated Loan Agreement of $5 million as of December 30, 2017.

32

The interest rates on the term and revolving credit portion of the Restated Loan Agreement vary.  The interest rates may vary based on the LIBOR rate plus a margin spread of 1.75% to 2.50%.  The margin spread is based on operating results calculated on a rolling-four-quarter basis.  The Company may also borrow funds at the lender's Prime rate.  On December  30, 2017, the interest rate for one half ($15.1 million) of the term portion was 3.11%, using a one-month LIBOR rate and 3.33% on the remaining balance ($15.1 million) of the term portion based on a three-month LIBOR rate. The interest rate on the $5,000,000 balance on the revolving credit portion was 3.11%.

On April 4, 2017, the Company entered into an interest rate swap contract with People's with an original notional amount of $15,500,000, which is equal to 50% of the outstanding balance of the term portion of the Restated Loan Agreement on that date.  The notional amount will decrease on a quarterly basis beginning July 3, 2017 following the principal repayment schedule of the term portion of the Restated Loan Agreement.  The Company has a fixed interest rate of 1.92% on the swap contract and will pay the difference between the fixed rate and the LIBOR rate when the LIBOR rate is below 1.92% and will receive interest when the LIBOR rate exceeds 1.92%.

The quarterly payment dates as listed in the Loan Agreement and the Restated Loan Agreement are the first business day of the calendar quarter.  As a result, there were only three payment dates in fiscal year 2015.  In fiscal years 2016 and 2017, there were four scheduled payment dates.


Tabular Disclosure of Contractual Obligations

The Company's known contractual obligations as of December 30, 2017 are shown below (in thousands):

         
Payments due by period
 

 
 

Total
   
Less than 1 Year
   
1-3 Years
   
3-5 Years
   
More than 5 Years
 
Long-term debt obligations
 
$
30,225
   
$
1,550
   
$
5,425
   
$
23,250
   
$
--
 
Estimated interest on long-term debt
   
5,028
     
1,133
     
2,151
     
1,744
     
--
 
Operating lease obligations
   
5,818
     
2,178
     
2,732
     
908
     
--
 
Estimated contributions to pension plans
   
26,423
     
528
     
4,985
     
6,612
     
14,298
 
Estimated other postretirement benefits
other than pensions
   
1,106
     
105
     
213
     
219
     
569
 
Total
 
$
68,600
   
$
5,494
   
$
15,506
   
$
32,733
   
$
14,867
 

The amounts shown in the above table for estimated contributions to pension plans and for estimated postretirement benefits other than pensions are based on the assumptions set forth in Note 9 to the consolidated financial statements, as well as the assumption that participant counts will remain stable.

The Company does not have any non-cancellable open purchase obligations.

The Company believes it has sufficient cash on hand and credit resources available to it to sustain itself though the next fiscal year.




ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company's foreign manufacturing facilities account for approximately 13% of total sales and 13% of total assets.  Our U.S. operations buy from and sell to these foreign affiliates and  make limited sales (approximately 13% of total sales) to nonaffiliated foreign customers.  This trade activity could be affected by fluctuations in foreign currency exchange or by weak economic conditions.  The Company's currency exposure is concentrated in the Canadian dollar, Mexican peso, New Taiwan dollar, Chinese RMB and Hong Kong dollar.  Because of the Company's limited exposure to any single foreign market, any exchange gains or losses have not been material and are not expected to be material in the future.  Had the exchange rate as of December 30, 2017 for all of the listed currencies changed by 1%, the total change in reported earnings would have been approximately $34,000.  As a result, the Company does not attempt to mitigate its foreign currency exposure through the acquisition of any speculative or leveraged financial instruments.  In 2017, a 10% increase/decrease in exchange rates would have resulted in a translation increase/decrease of approximately $2.4 million to sales and approximately $949,000 to equity.
33


The Company has been able to recover cost increases in raw materials through either price increases to our customers or cost reductions in other areas of the business.  Therefore, the Company has not entered into any contracts to address commodity price risk.

The Company's exposure to the risk of changes in market interest rates relates primarily to the Company's debt, which bears interest at variable rates based on the LIBOR rate plus a margin spread of 1.75% to 2.50%. The Company had an interest rate swap with a notional amount of $15,112,500 on December 30, 2017 to convert the termportion of the Restated Loan Agreement from variable to fixed rates. The valuation of this swap is determined using the three month LIBOR rate index and mitigates the Company's exposure to interest rate risk.

34


ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA




The Eastern Company

Consolidated Balance Sheets


   
December 30
   
December 31
 
   
2017
   
2016
 
ASSETS
           
Current Assets
           
Cash and cash equivalents
 
$
22,275,477
   
$
22,725,376
 
Accounts receivable, less allowances of $470,000 in 2017 and $430,000 in 2016
   
27,119,910
     
18,135,792
 
                 
Inventories:
               
Raw materials and component parts
   
14,331,915
     
8,829,236
 
Work in process
   
7,718,379
     
7,118,149
 
Finished goods
   
25,218,463
     
18,082,901
 
     
47,268,757
     
34,030,286
 
                 
Prepaid expenses and other assets
   
3,401,456
     
1,858,471
 
                 
Deferred income taxes
   
     
947,001
 
Total Current Assets
   
100,065,600
     
77,696,926
 
                 
                 
Property, Plant and Equipment
               
Land
   
1,160,298
     
1,159,901
 
Buildings
   
16,426,977
     
16,303,521
 
Machinery and equipment
   
52,680,240
     
47,447,649
 
Accumulated depreciation
   
(41,075,121
)
   
(38,745,557
)
     
29,192,394
     
26,165,514
 
                 
Other Assets
               
Goodwill
   
32,228,891
     
14,819,835
 
Trademarks
   
3,686,063
     
166,312
 
Patents, technology and other intangibles net of accumulated amortization
   
9,275,158
     
1,764,449
 
Deferred income taxes
   
2,010,291
     
3,585,360
 
     
47,200,403
     
20,335,956
 
 TOTAL ASSETS
 
$
176,458,397
   
$
124,198,396
 

35








Consolidated Balance Sheets


   
December 30
   
December 31
 
   
2017
   
2016
 
LIABILITIES AND SHAREHOLDERS' EQUITY
           
Current Liabilities
           
Accounts payable
 
$
14,712,414
   
$
7,048,174
 
Accrued compensation
   
4,376,211
     
3,112,404
 
Other accrued expenses
   
3,606,057
     
1,812,647
 
      Contingent Liability     2,070,000          
Current portion of long-term debt
   
6,550,000
     
892,857
 
Total Current Liabilities
   
31,314,682
     
12,866,082
 
                 
Deferred income taxes
   
1,723,543
     
 
Other long-term liabilities
   
358,982
     
288,805
 
Long-term debt, less current portion
   
28,675,000
     
892,857
 
Accrued other postretirement benefits
   
1,032,171
     
1,051,700
 
Accrued pension cost
   
26,423,429
     
26,631,438
 
                 
Commitments and contingencies (See Note 4)
               
                 
Shareholders' Equity
               
Voting Preferred Stock, no par value:
               
Authorized and unissued: 1,000,000 shares
               
Nonvoting Preferred Stock, no par value:
               
Authorized and unissued: 1,000,000 shares
               
Common Stock, no par value:
               
Authorized: 50,000,000 shares
               
Issued: 8,957,974 shares in 2017 and 8,950,827 shares in 2016
               
Outstanding: 6,263,245 shares in 2017 and 6,256,098 shares in 2016
   
29,501,123
     
29,146,622
 
Treasury Stock: 2,694,729 shares in 2017 and 2016
   
(19,105,723
)
   
(19,105,723
)
Retained earnings
   
97,921,903
     
95,631,216
 
                 
Accumulated other comprehensive income (loss):
               
Foreign currency translation
   
(943,193
)
   
(2,165,081
)
Unrealized gain on interest rate swap, net of tax
   
41,757
     
 
Unrecognized net pension and other postretirement benefit costs, net of taxes
   
(20,485,277
)
   
(21,039,520
)
Accumulated other comprehensive loss
   
(21,386,713
)
   
(23,204,601
)
Total Shareholders' Equity
   
86,930,590
     
82,467,514
 
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY
 
$
176,458,397
   
$
124,198,396
 

See accompanying notes.
36



Consolidated Statements of Income

         
Year ended
       
   
December 30
   
December 31
   
January 2
 
   
2017
   
2016
   
2016
 
Net sales
 
$
204,239,613
   
$
137,608,258
   
$
144,567,951
 
Cost of products sold
   
(154,188,794
)
   
(101,262,048
)
   
(110,318,320
)
Gross margin
   
50,050,819
     
36,346,210
     
34,249,631
 
                         
Engineering Expenses
   
(5,622,829
)
   
(2,568,307
)
   
(2,459,062
)
Selling and administrative expenses
   
(32,151,289
)
   
(22,642,031
)
   
(23,762,841
)
Operating profit
   
12,276,701
     
11,135,872
     
8,027,728
 
                         
Interest expense
   
(976,512
)
   
(121,500
)
   
(185,475
)
Other income
   
154,753
     
209,043
     
178,722
 
Income before income taxes
   
11,454,942
     
11,223,415
     
8,020,975
 
                         
Income taxes
   
6,409,687
     
3,438,092
     
2,293,932
 
Net income
 
$
5,045,255
   
$
7,785,323
   
$
5,727,043
 
Earnings per Share:
                       
Basic
 
$
.81
   
$
1.25
   
$
.92
 
                         
Diluted
 
$
.80
   
$
1.25
   
$
.92
 

See accompanying notes.




Consolidated Statements of Comprehensive Income

         
Year ended
       
   
December 30
   
December 31
   
January 2
 
   
2017
   
2016
   
2016
 
Net income
 
$
5,045,255
   
$