THE EASTERN COMPANY The Company's fiscal year ends on the Saturday nearest toDecember 31 . Fiscal year 2020 was 53 weeks in length and fiscal year 2019 was 52 weeks in length. References in this Management's Discussion and Analysis of Financial Condition and Results of Operations to results for "2020" or "fiscal year 2020" mean the fiscal year endedJanuary 2, 2021 , and references to results for "2019" or "fiscal year 2019" mean the fiscal year endedDecember 28, 2019 . References to the "fourth quarter of 2020" or the "fourth fiscal quarter of 2020" mean the thirteen-week period fromOctober 4, 2020 toJanuary 2, 2021 , and references to the "fourth quarter of 2019" or the "fourth fiscal quarter of 2019" mean the thirteen-week period fromSeptember 29, 2019 toDecember 28, 2019 . Summary
Sales for 2020 were$240.4 million compared to$251.7 million for 2019. Net income for 2020 was$5.4 million , or$0.86 per diluted share, compared to$13.3 million , or$2.12 per diluted share, for 2019. Sales for the fourth quarter of 2020 were$60.4 million compared to$68.7 million for the same period in 2019. Net income for the fourth quarter of 2020 was$1.4 million , or$0.23 per diluted share compared to$5.0 million , or$0.79 per diluted share, for the comparable 2019 period. Fourth quarter 2019 operating results included three months of Big 3 Precision sales and earnings while the full fiscal year included four months of Big 3 Precision sales and earnings. Big 3 Precision was acquired onAugust 30, 2019 .
The value of the backlog of orders received by the Company increased as ofJanuary 2, 2021 , compared toDecember 28, 2019 . The Company's backlog was$85.0 million onJanuary 2, 2021 , as compared to$71.2 million onDecember 28, 2019 . The primary reasons for growth from 2019 to 2020 were an increase of$4.6 million in blow mold tooling backlog at our Big 3 Mold subsidiary including$0.8 million in backlog from the acquisition of Hallink Moulds; an increase of$ 3.2 million in backlog for locks and hardware at Eberhard due to new product launches; an increase of$3.8 million in backlog related to launch of new mirror program for Class 8 trucks being awarded to ourVelvac subsidiary; and new orders received by Frazer & Jones, which added$10.9 million in backlog for mining products. Backlog declined at Big 3 Products for returnable packaging by$0.8 million and at Argo EMS for printed circuit boards by$2.0 million . During the fourth quarter of 2020 the Company experienced price increases for many of the raw materials used in producing its products, including: scrap iron, stainless steel, hot and cold rolled steel, zinc, copper, aluminum and nickel. These increases could negatively impact the Company's gross margin if raw material prices increase too rapidly for the Company to recover those cost increases through either price increases to our customers or cost reductions in other areas of the business.
OnJanuary 15, 2020 the United States andChina signed theU.S. -China Phase One trade deal, which among other things rolled back tariffs on$120 billion worth of Chinese products from 15% to 7.5% effectiveFebruary 14, 2020 and theU.S. agreed not to proceed with the 15% tariffs on$160 billion worth of consumer goods which was scheduled to take effectDecember 15, 2019 . However, the 25% tariffs on$250 billion of Chinese imports will remain in effect subject to further reductions depending on the progress of future negotiations. IfChina does not follow through their agreed upon commitments and tariffs are reinstated on$550 billion of Chinese products at the 25% rate, it could result in a loss of business and possible reduced margins if the tariffs cannot be offset by higher selling prices.
Critical Accounting Policies and Estimates
The preparation of financial statements in accordance with accounting principles generally accepted inthe United States ("U.S. GAAP") requires management to make judgments, estimates and assumptions regarding uncertainties that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities and the reported amounts of revenues and expenses. Areas of uncertainty that require judgments, estimates and assumptions include items such as the accounting for derivatives; environmental matters; the testing of goodwill and other intangible assets for impairment; proceeds on assets to be sold; pensions and other postretirement benefits; leases; and tax matters. Management uses historical experience and all available information to make its estimates and assumptions, but actual results will inevitably differ from the estimates and assumptions that are used to prepare the Company's financial statements at any given time. Despite these inherent limitations, management believes that Management's Discussion and Analysis of Financial Condition and Results of Operations and the financial statements and related footnotes provide a meaningful and fair presentation of the Company's financial position and results of operations. Management believes that the application of these estimates and assumptions on a consistent basis enables the Company to provide the users of the financial statements with useful and reliable information about the Company's operating results and financial condition. 21 Table of Contents
Allowance for Doubtful Accounts
The Company maintains an allowance for doubtful accounts for estimated losses
resulting from the inability of its customers to make required payments. The
Company reviews the collectability of its receivables on an ongoing basis,
taking into account a combination of factors. The Company reviews potential
problems, such as past due accounts, a bankruptcy filing or deterioration in the
customer's financial condition, to ensure that the Company has adequately
accrued for potential loss. Accounts are considered past due based on when
payment was originally due. If a customer's situation changes, such as a
bankruptcy or a change in its creditworthiness, or there is a change in the
current economic climate, the Company may modify its estimate of the allowance
for doubtful accounts. The Company will write off accounts receivable after
reasonable collection efforts have been made and the accounts are deemed
uncollectible.
Inventory
Inventories are valued at the lower of cost or net realizable value. Cost is
determined by the last-in, first-out ("LIFO") method at the Company's U.S.
facilities, with the exception of Big 3 Precision and Velvac , which are valued
on a first-in, first-out ("FIFO") method. Accordingly, a LIFO valuation reserve
is calculated using the dollar value link chain method.
We review the net realizable value of inventory in detail on an ongoing basis,
giving consideration to deterioration, obsolescence and other factors. Based on
these assessments, we provide for an inventory reserve in the period in which an
impairment is identified. The reserve fluctuates with market conditions, design
cycles and other economic factors.
Intangible assets with finite useful lives are generally amortized on a straight-line basis over the periods benefited.Goodwill and other intangible assets with indefinite useful lives are not amortized. In December, 2020 the Company announced that theEberhard Hardware Manufacturing Ltd. subsidiary inOntario, Canada would be closed and all tangible assets would be moved to Eberhard Manufacturing division inCleveland, Ohio . As a result, approximately$1.0 million of goodwill associated withEberhard Hardware Manufacturing Ltd. was impaired and written off the books inDecember 2020 . The Company performed its qualitative assessment as of the end of fiscal 2020 on the remainder of its companies and determined that it is more likely than not that no impairment of goodwill existed at the end of 2020 on those companies holding goodwill at the entity level. See Note 3 - Accounting Policies -Goodwill , in Item 8, Financial Statements and Supplementary Data for more detail. The Company will perform annual qualitative assessments in subsequent years as of the end of each fiscal year. Additionally, the Company will perform an interim analysis whenever conditions warrant.
Pension and Other Postretirement Benefits
The amounts recognized in the consolidated financial statements related to pension and other postretirement benefits are determined from actuarial valuations. Inherent in these valuations are assumptions about such factors as expected return on plan assets, discount rates at which liabilities could be settled, rate of increase in future compensation levels, mortality rates, and trends in health insurance costs. These assumptions are reviewed annually and updated as required. In accordance withU.S. GAAP, actual results that differ from the assumptions are accumulated and amortized over future periods and, therefore, affect the expense recognized and obligations recorded in future periods. The discount rate used is based on a single equivalent discount rate derived with the assistance of our actuaries by matching expected future benefit payments in each year to the corresponding spot rates from the FTSE Pension Liability Yield Curve, comprised of high quality (rated AA or better) corporate bonds. The Company calculates its service and interest costs in future years by applying the specific spot rates along the selected yield curve to the relevant projected cash flows. The expected long-term rate of return on assets is also developed with input from the Company's actuarial firms. We consider the Company's historical experience with pension fund asset performance, the current and expected allocation of our plan assets and expected long-term rates of return. The long-term rate-of-return assumption used for determining net periodic pension expense was 7.5% for 2020 and 2019. The Company reviews the long-term rate
of return each year.
Future actual pension income and expense will depend on future investment performance, changes in future discount rates and various other factors related to the population of participants in the Company's pension plans.
The Company expects to make cash contributions of approximately$3,100,000 and$50,000 to our pension plans and other postretirement plan, respectively, in 2021. 22 Table of Contents In connection with our pension and other postretirement benefits, the Company reported an expense of$5.7 million and$2.7 million (net of tax) on its Consolidated Statement of Comprehensive Income for fiscal years 2020 and 2019, respectively. The main factor driving this expense was the change in the discount rate during the applicable period.
Assumptions used to determine net periodic pension benefit cost for the fiscal years indicated were as follows:
2020 2019
Discount rate 3.18% - 3.23% 4.20% - 4.22%
Expected return on plan assets 7.5% 7.5%
Rate of compensation increase 0.0% 0.0%
Assumptions used to determine net periodic other postretirement benefit cost are
the same as those assumptions used for the pension benefit cost, except that the
rate of compensation is not applicable for other postretirement benefit cost.
The changes in assumptions had the following effect on the net periodic pension
and other postretirement costs recorded in Other Comprehensive Income as
follows:
Year ended
January 2, December 28
2021 2019
Discount rate $ (10,824,709 ) $ (12,552,989 )
Additional recognition due to significant event -- (454,143 )
Asset gain or (loss) 6,263,566 7,710,082
Amortization of:
Unrecognized gain or (loss) 1,274,625 1,114,924Unrecognized prior service cost 91,127
94,308
Other (4,276,259 )
748,512
Comprehensive income, before tax (7,741,650 ) (3,339,286 ) Income tax (1,776,264 ) (664,279 ) Comprehensive income, net of tax$ (5,695,386 ) $ (2,675,007 ) The Plan has been investing a portion of the assets in long-term bonds in an effort to better match the impact of changes in interest rates on its assets and liabilities and thus reduce some of the volatility in Other Comprehensive Income. Please refer to Note 10 - Retirement Benefit Plans in in Item 8, Financial Statements and Supplementary Data of this Form 10-K for additional disclosures concerning the Company's pension and other postretirement benefit plans. 23 Table of Contents RESULTS OF OPERATIONS
Fourth Quarter 2020 Compared to Fourth Quarter 2019
The following table shows, for the fourth quarter of 2020 and 2019, selected line items from the consolidated statements of income as a percentage of net sales, by segment. The Company now reports under two segments: Engineered Solutions and Diversified Products. The Engineered Solutions segment includes (1) Big 3 Precision, including Big 3 Products and Big 3 Mold, Hallink Moulds, andAssociated Toolmakers Ltd. ; (2)Eberhard Manufacturing Company ,Eberhard Hardware Manufacturing Ltd. ,Eastern Industrial Ltd. ,Illinois Lock Company /CCL Security Products,World Lock Company Ltd. ,Dongguan Reeworld Security Products Ltd. , andWorld Security Industries Ltd. ; and (3)Velvac Holdings . The Diversified Products segment consists of Frazer & Jones;Greenwald Industries ; Argo EMS; and Sesamee Mexicana. In the fourth quarter of 2019, the Diversified segment includes the CCV. 2020 Fourth Quarter Engineered Diversified Solutions Products Total Net Sales 100.0 % 100.0 % 100.0 % Cost of Products Sold 77.8 % 81.5 % 78.4 % Gross Margin 22.2 % 18.5 % 21.6 % Product Development Expense 0.7 % 3.5 % 1.2 %
Selling and Administrative Expense 13.4 % 12.3 % 13.2 % Goodwill Impairment Loss 1.9 % - 1.6 % Loss on Disposition of Subsidiary - 21.8 %
3.5 %
Restructuring Costs 1.3 % - 1.1 %
Operating Profit 4.9 % -19.1 % 1.0 %
2019 Fourth Quarter
Engineered Diversified
Solutions Products Total
Net Sales 100.0 % 100.0 % 100.0 %
Cost of Products Sold 71.3 % 83.1 % 73.7 %
Gross Margin 28.7 % 16.9 % 26.3 %
Product Development Expense 0.8 % 2.6 % 1.1 %Selling and Administrative Expense 16.7 % 12.0 % 15.8 % Goodwill Impairment Loss - -
-
Loss on Disposition of Subsidiary - -
- Restructuring Costs - - - Operating Profit 11.2 % 2.3 % 9.4 %
Net sales in the fourth quarter of 2020 decreased 12% to$60.4 million from$68.7 million a year earlier. Sales decreased in the Engineered Solutions segment by 8% to$50.6 million in the fourth quarter of 2020 from$54.7 million in the fourth quarter of 2019 due to lower demand for trucks accessories, distribution products and automotive returnable packaging as a result of the delay in new automotive launches, partly offset by the impact of new program launches and stronger sales of blow mold tooling and related services. Sales in the Diversified Products segment decreased 30% to$9.9 million in the fourth quarter of 2020 compared to$14.0 million in fourth quarter of 2019 as the result of the sale of Canadian Commercial Vehicles inJune 2020 and lower demand for mining products, industrial castings, commercial laundry products, and printed circuit boards. Sales of new products contributed 4% to sales growth in the fourth quarter compared to 5% of sales growth from new products in the fourth quarter of 2019. New products in the fourth quarter included various new truck mirrors, a truck compression latch, a cable lock, a mirror cam and a mobile payment app. 24 Table of Contents
Cost of products sold in the fourth quarter of 2020 decreased$3.3 million or 7% from the corresponding period in 2019. The decrease in cost of products sold is primarily attributable to the reduced sales volume. During the fourth quarter of 2020, material costs have increased substantially over the third quarter of 2020 for hot rolled steel by 81%; cold rolled steel by 53%; aluminum by 16%; copper and nickel by 23%; zinc by 17% and scrap iron by 30%. Gross margin as a percentage of net sales for the fourth quarter of 2020 was 22% compared to 26% in the prior year fourth quarter. The decrease reflects the combination of higher raw material cost and a decline in facility utilization due to lower sales in the fourth quarter of 2020. Product development expenses in the fourth quarter of 2020 of$0.7 million were down 11% when compared to the fourth quarter of 2019. As a percentage of net sales, product development costs were 1.2% and 1.1% for the fourth quarter
of 2020 and 2019 respectively.
Selling and administrative expenses in the fourth quarter of 2020 decreased 26% compared to the fourth quarter of 2019. The decrease was primarily the result of the Company's initiatives to reduce payroll and payroll related expenses, reduce travel expenses, and other expense reduction initiatives.Goodwill impairment expense of$1.0 million was incurred in the fourth quarter of 2020 as the Company announced the closure ofEberhard Hardware Manufacturing Ltd. inOntario, Canada .
Restructuring expenses of$0.7 million for severance expenses were incurred in the fourth quarter of 2020 due to the closure ofEberhard Hardware Manufacturing Ltd.
Loss on disposal of subsidiary of
Net income for the fourth quarter of 2020 decreased 72% to$1.4 million , or$0.23 per diluted share, from$5.0 million , or$0.79 per diluted share, in 2019. In the fourth quarter of 2020, net income was negatively impacted by non-cash goodwill impairment charges of$0.7 million net of tax, non-recurring restructuring, factory relocation, and transaction costs of$0.9 million net of tax, and a loss on disposition of Sesamee Mexicana and CCV of$1.6 million
net of tax.
Fiscal Year 2020 Compared to Fiscal Year 2019
The following table shows, for fiscal year 2020 and fiscal year 2019, selected line items from the consolidated statements of income as a percentage of net sales, by segment. The Company now reports under two segments: Engineered Solutions and Diversified Products. The Engineered Solutions segment includes (1) Big 3 Precision, including Big 3 Products and Big 3 Mold,Hallink Moulds and Associated Toolmakers Ltd. ; (2)Eberhard Manufacturing Company ,Eberhard Hardware Manufacturing Ltd. ,Eastern Industrial Ltd. ,Illinois Lock Company /CCL Security Products,World Lock Company Ltd. andDongguan Reeworld Security Products Ltd. ;World Security Industries Ltd. ; and (3)Velvac Holdings . The Diversified Products segment consists of Frazer & Jones ;Greenwald Industries ; Argo EMS; Sesamee Mexicana; and CCV. Financial measures presented below as "excluding Big 3 Precision" are non-GAAP financial measures. 25 Table of Contents Fiscal Year 2020 Engineered Diversified Solutions Products Total Net Sales 100.0 % 100.0 % 100.0 % Cost of Products Sold 75.6 % 87.3 % 77.7 % Gross Margin 24.4 % 12.7 % 22.3 % Product Development Expense 0.9 % 3.1 % 1.3 %
Selling and Administrative Expense 15.3 % 12.3 % 14.7 % Goodwill Impairment Loss 0.5 % 9.3 % 2.1 % Loss on Disposition of Subsidiary - 5.0 %
0.9 %
Restructuring Costs 0.3 % 0.7 % 0.4 %
Operating Profit 7.4 % -17.7 % 2.9 %
Fiscal Year 2019
Engineered Diversified
Solutions Products Total
Net Sales 100.0 % 100.0 % 100.0 %
Cost of Products Sold 72.3 % 84.4 % 75.4 %
Gross Margin 27.7 % 15.6 % 24.6 %
Product Development Expense 2.5 % 2.2 % 2.4 %Selling and Administrative Expense 15.5 % 10.5 % 14.2 % Goodwill Impairment Loss - -
-
Loss on Disposition of Subsidiary - -
- Restructuring Costs 0.9 % 1.4 % 1.1 % Operating Profit 8.8 % 1.5 % 6.9 % Summary Net sales for 2020 decreased 5% to$240.4 million from$251.7 million in 2019. The sales decline is primarily due to the decision by many of our industrial and consumer goods customers to close operations as a result of the COVID-19 pandemic and the divestiture of CCV. Sales in 2020 reflect a full year of sales from the Big 3 Precision Acquisition, as compared to four months of sales in 2019. Excluding the effects of Big 3 Precision, which closed onAugust 30, 2019 , sales would have been$186.8 million in 2020 compared to$230.4 million in 2019, a decrease of 18.9%. Sales volume of existing products decreased by 9% in 2020 compared to 2019 while price increases and new products increased sales in
2020 by 4%. Net income for 2020 decreased 59% to$5.4 million , or$0.86 per diluted share, from$13.3 million , or$2.12 per diluted share, in 2019. In 2020, net income was negatively impacted by$6.8 million in non-recurring costs, net of tax, including goodwill impairment charges of$3.7 million net of tax, one-time restructuring, factory relocation, and transaction costs of$1.5 million net of tax, and a loss on disposition of Sesamee Mexicana and CCV of$1.6 million net of tax. Net income for 2019 was adversely affected by non-recurring restructuring costs of$3.9 million net of tax associated with the discontinuation of Road-iQ, a subsidiary ofVelvac , and the consolidation of our Composite Panel Technologies facility, as well as an increase in M&A related expense incurred in 2019. Engineered Solutions Net sales in the Engineered Solutions segment increased 6% in 2020 to$197.6 million from$186.8 million when compared to 2019. Without Big 3 Precision sales would have been$144.0 million or a decrease of 13% from$165.4 million in 2019. Sales volume of existing products increased 1% due to the acquisition of Big 3 Precision. Excluding Big 3 Precision, sales volume of existing products decreased by 17%, partially offset by price increases and new products which contributed 5% to increased sales. 26 Table of Contents
New product sales include various new truck mirrors, a truck compression latch, a cable lock and a mirror cam.
Cost of products sold in the Engineered Solutions segment increased$14.3 million or 11% to$149.4 million from$135.1 million in 2019. In 2020 cost of products sold include twelve months of Big 3 Precision expenses whereas 2019 only included 4 months of Big 3 Precision expenses. Excluding the Big 3 Precision Acquisition, cost of products sold would have been$108.6 million in 2020 compared to$118.7 million in 2019, a decrease of$10.1 million or 9%. Freight costs are down due to lower sales but freight costs are increasing and ports backlogged in processing container ships are causing delays in meeting scheduled shipping dates. Metal prices have increased year over year for hot rolled steel by 86%; cold rolled steel by 44%; copper by 35%; nickel by 18% and zinc by 16%. Much of the increase came in the fourth quarter of 2020. Many of our supply contracts contain price adjustment clauses when material cost increase by a certain percentage. Tariffs incurred during 2020 were$2.6 million fromChina -sourced products as compared to$2.7 million in 2019. A majority of the tariffs were recovered through price increases. Excluding the Big 3 Precision Acquisition, costs are down primarily due to lower volume and cost initiatives in cutting payroll and payroll-related expenses by$3.6 million , freight by$2.5 million , shipping expenses by$0.7 million and other expenses by$0.3 million . However, during 2020 our factories' productive capacity was underutilized, resulting in$2.1 million in unabsorbed overhead cost which negatively impacted our gross margin in 2020.
Gross margin as a percentage of sales was 24% in 2020 as compared to 28% in 2019. The decrease reflects the combination of higher raw material costs and a decline in facility utilization due to lower sales in 2020.
Product development expenses as a percentage of sales decreased to 1% in 2020 from 3% in 2019. The decrease relates to the closure of theVelvac Road -iQ development operations inBellingham Washington in the second quarter of 2019 as the Company adopted a leaner approach to the development of new vision products. Selling and administrative expenses increased$1.3 million or 5% to$30.2 million in 2020 from$28.9 million in 2019. The increase relates to the Big 3 Precision Acquisition inAugust 2019 . Excluding Big 3 Precision, selling and administrative expenses would have decreased$3.4 million or 14% from$24.5 million in 2019 to$21.1 million in 2020. Diversified Products
Net sales in the Diversified Products segment decreased by 22.2 million or 34% in 2020 from the 2019 level. Sales volume of existing products decreased 36% while price increases and new products contributed a 2% increase. The sales decrease is partially due to the sale of CCV in the second quarter of 2020. Sales of our mining products were down from 2019 levels by$6.9 million and industrial casting sales were down$2.9 million . Sales of commercial laundry products were also down from 2019 levels by$2.5 million while printed circuit board sales were down from 2019 levels by$0.8 million . New product sales include a mobile payment app for the commercial laundry industry and various industrial castings. Cost of products sold in the Diversified Products segment decreased by$17.5 million or 32% in 2020 from 2019. The decrease in cost of products sold was primarily attributable to the decrease in sales volume. Cost reduction initiatives lowered factory payroll and payroll related cost by$3.8 million through various state workshare programs and layoffs where necessary. The cost of scrap iron increased year over year by 34%. The cost of scrap iron has increased another 16% in the first quarter of 2021 to$575 per ton. The Company incurred tariff costs onChina -sourced products of$0.2 million in 2020 which was comparable to 2019. The majority of the tariffs have been offset by price increases.
Gross margin as a percentage of sales in the Diversified Products segment for 2020 decreased to 13% compared to the 2019 level of 16%.
Product development expenses decreased$0.1 million or 5% to$1.3 million for 2020 from$1.4 million for 2019. The Company continues to invest in the development of new products for our customers to replace legacy products being phased out. Selling and administrative expenses in the Diversified Products segment decreased by$1.6 million or 23% in 2020 from 2019. The most significant factors resulting in changes in selling and administrative expenses were a decrease in amortization expense of$0.2 million , a decrease of$0.4 million in payroll and payroll related expenses, a decrease in travel expenses of$0.2 million , a decrease in other administrative expenses of$0.2 million and the sale of CCV, which resulted a decrease in selling and administrative expenses of$0.5 million in 2020 as compared to 2019. 27 Table of ContentsGoodwill impairment loss of$5.0 million was incurred in 2020. In the second quarter of 2020, the Company determined that the estimated fair value ofGreenwald Industries was likely below its carrying amount. The factors that led to this determination included additional competition, industry movement away from legacy products and intense competition in new mobile payment apps. This fundamental shift in lower cost payment systems away from the higher cost electronic smart card payment systems resulted in the carrying value of Greenwald exceeding its fair value. As a result, an independent valuation was conducted which estimated that the carrying value exceeded the fair value by approximately$4.0 million . During the fourth quarter of 2020 the Company announced that its subsidiaryEberhard Hardware Manufacturing Ltd. inOntario Canada would be closed and all assets would be moved to Eberhard Manufacturing division inCleveland, Ohio . As a result, the amount of goodwill of approximately$1.0 million at this entity level was impaired and written off inDecember 2020 . The Company performed its qualitative assessment as of the end of fiscal 2020 on the remainder of its companies and determined that it is more likely than not that no impairment of goodwill existed at the end of 2020 on those companies holding goodwill at the entity level. Loss on disposal of subsidiary of$2.2 million in non-cash charges were incurred in fiscal year 2020 in recognizing the cumulative effects for foreign currency translation on Sesamee Mexicana and CCV. Restructuring expenses of$1.0 million incurred in 2020 related to the divestiture of CCV in the second quarter of 2020 and the announced closure ofEberhard Hardware Manufacturing Ltd. InOntario, Canada in the fourth quarter of 2020. 2019 restructuring costs of$2.7 million were related to the discontinuation of our Road iQ development operations based inBellingham, Washington and the relocation costs of Composite Panels Technologies inSalisbury, North Carolina to CCV inKelowna, British Columbia . Other Items
The following table shows the amount of change from the year endedDecember 28, 2019 as compared to the year endedJanuary 2, 2021 in other items (dollars
in
thousands):
Amount %
Interest expense $ 887 48 %
Other income $ 1,164 192 %
Income taxes $ (2,320 ) -79 %
Interest expense increased in 2020 from 2019 due to the increased level of debt incurred in connection with the acquisitions of Hallink Moulds in the third quarter of 2020 and Big 3 Precision in the third quarter of 2019.
Other income in 2020 increased$1.2 million over 2019. Other income in 2020 included a favorable$1.2 million pension cost adjustment and a$0.4 million gain on a sale/leaseback transaction. In 2019, other income included a gain of$0.6 million on the sale of land at the Company headquarters location. The effective tax rate for 2020 was 10% compared to the 2019 effective tax rate of 18%. The effective tax rate for 2020 was reduced due to the expiration of statute of limitations for uncertain tax positions. Total income taxes paid were$3.8 million in 2020 and$3.2 million in 2019.
Liquidity and Sources of Capital
The primary source of the Company's cash is earnings from operating activities
adjusted for cash generated from or used for net working capital. The most
significant recurring non-cash items included in net income are depreciation and
amortization expense. Changes in working capital fluctuate with the changes in
operating activities. As sales increase, there generally is an increased need
for working capital. Since increases in working capital reduce the Company's
cash, management attempts to keep the Company's investment in net working
capital at a reasonable level by closely monitoring inventory levels and
matching production to expected market demand, keeping tight control over the
collection of receivables and optimizing payment terms on its trade and other
payables.
28
Table of Contents
The Company is dependent on continued demand for its products and subsequent
collection of accounts receivable from its customers. The Company serves a broad
base of customers and industries with a variety of products. As a result, any
fluctuations in demand or payment from a particular industry or customer should
not have a material impact on the Company's sales and collection of receivables.
Management expects that the Company's foreseeable cash needs for operations,
capital expenditures, debt service and dividend payments will continue to be met
by the Company's operating cash flows and available credit facility.
The following table shows key financial ratios at the end of each fiscal year:
2020 2019
Current ratio 2.8 3.6Average days' sales in accounts receivable 56 51 Inventory turnover
3.6 4.2
Ratio of working capital to sales 29.6 % 28.1 %
Total debt to shareholders' equity 85.1 % 93.7 %
The following table shows important liquidity measures as of the fiscal year-end balance sheet date for each of the preceding two years (in millions):
2020 2019
Cash and cash equivalents
- Held in the United States $ 10.0 $ 9.0 - Held by foreign subsidiaries 6.1
9.0
16.1 18.0
Working capital 71.1 83.0Net cash provided by operating activities 20.7
23.0
Change in working capital impact on net cash provided by (used in) operating activities
2.0 (0.3 )
Net cash used in investing activities (9.1 ) (85.8 )
Net cash (used in)/provided by financing activities (13.2 )
67.0
All cash held by foreign subsidiaries is readily convertible into other
currencies, including the
Net cash provided by operating activities was$20.7 million in 2020 compared to$23.0 million in 2019. In 2020 the Company contributed$2.7 million into its defined benefit retirement plan.
In 2020 cash provided by the net change in working capital was
The Company used$9.1 million and$85.8 million for investing activities in 2020 and 2019, respectively. In 2020 the Company invested$7.2 million to acquire Hallink Moulds, and received$3.2 million for divestures of subsidiaries and equipment. The Company issued notes receivable of$2.2 million as part of the sale of its subsidiaries. In 2019, the Company invested approximately$81.2 million to acquire Big 3 Precision. These transactions are more fully discussed in Note 2 to the 2020 Consolidated Financial Statements located in Item 8 of this Form 10-K. The balance of$3.1 million and$5.4 million in 2020 and 2019, respectively, was used to purchase fixed assets. Capital expenditures in fiscal year 2021 are expected to be approximately$5.0 million . In 2020, the Company made total debt payments of$10.0 million , of which$5.0 million was an accelerated principal payment and used$2.8 million for payment of dividends. The Company did not draw down on its$20.0 million revolving credit facility in 2020. In 2019, the Company received approximately$67.0 million from financing activities. The Company refinanced an existing note for$19.1 million and used approximately$10.8 million for debt repayments and$2.8 million for payment of dividends. The Company entered into the Credit Agreement for$120.0 million , of which the Company received$100.0 million for the term loan portion. The Company did not draw down on the$20.0 million revolving credit portion. 29 Table of Contents The Company leases certain equipment and buildings under cancelable and non-cancelable operating leases that expire at various dates up to five years. Rent expense amounted to approximately$2.1 million in 2020 and$2.2 million in 2019. OnAugust 30, 2019 , the Company entered into the Credit Agreement withSantander Bank, N.A ., for itself,People's United Bank, National Association . andTD Bank, N.A . as lenders, that included a$100.0 million term portion and a$20.0 million revolving commitment portion. Proceeds of the term loan were used to repay the Company's remaining outstanding term loan (and to terminate its existing credit facility) withPeople's United Bank, N.A. (approximately$19.0 million ) and to acquire Big 3 Precision. The term portion of the loan requires quarterly principal payments of$1.25 million for an 18-month period beginningDecember 31, 2019 . The repayment amount then increases to$1.875 million per quarter beginningSeptember 30, 2021 and continues throughJune 30, 2023 . The repayment amount then increases to$2.5 million per quarter beginningSeptember 30, 2023 and continues throughJune 30, 2024 . The term loan is a five-year loan with the remaining balance due onAugust 30, 2024 . The revolving commitment portion has an annual commitment fee of 0.25% based on the unused portion of the revolver. The revolving commitment portion has a maturity date ofAugust 30, 2024 . During 2020 and 2019, the Company did not borrow any funds on the revolving commitment portion of the facility. The interest rates on the term and revolving credit portion of the Credit Agreement vary. The interest rates may vary based on the LIBOR rate plus a margin spread of 1.25% to 2.25%. The Company's obligations under the Credit Agreement are secured by a lien on certain of the Company's and its subsidiaries' assets pursuant to a Pledge and Security Agreement, dated as ofAugust 30, 2019 withSantander Bank, N.A ., as administrative agent. The Company's loan covenants under the Credit Agreement require the Company to maintain a senior net leverage ratio not to exceed 4.25 to 1. In addition, the Company will be required to maintain a fixed charge coverage ratio to be not less than 1.25 to 1.
OnAugust 30, 2019 , the Company entered into an interest rate swap contract withSantander Bank, N.A ., with an original notional amount of$50.0 million , which was equal to 50% of the outstanding balance of the term loan on that date. The Company has a fixed interest rate of 1.44% on the swap contract and will pay the difference between the fixed rate and LIBOR when LIBOR is below 1.44% and will receive interest when the LIBOR rate exceeds 1.44%. OnJanuary 2, 2021 , the interest rate for half ($41.9 million ) of the term portion was 1.9%, using a one-month LIBOR rate, and 3.19% on the remaining balance ($46.9 million ) of the term loan based on a one-month LIBOR rate. The interest rates on the Credit Agreement, and interest rate swap contract are susceptible to changes to the method that LIBOR rates are determined and to the potential phasing out of LIBOR after 2021. Information regarding the potential phasing out of LIBOR is provided below. OnJuly 27, 2017 , theFCA (the authority that regulates LIBOR) announced that it would phase out LIBOR by the end of 2021. The IBA recently announced market consultation regarding the extension of US dollar LIBOR tenors throughJune 30, 2023 which theFCA supports. The ARRC, a financial industry group convened by theFederal Reserve Board has recommended the use of SOFR to replace LIBOR. The difference between LIBOR and SOFR is that LIBOR is a forward-looking rate which means the interest rate is set at the beginning of the period with payment due at the end. SOFR is a backward-looking overnight rate which have implications for how interest and other payments are based. Changes in the method of calculating the replacement of LIBOR with an alternative rate or benchmark are still in flux, and once an alternate rate is adopted, may adversely affect interest rates and result in higher borrowing costs. This could materially and adversely affect the Company's results of operations, cash flows and liquidity. We cannot predict the effect of the potential changes to LIBOR or the establishment and use of alternative rates or benchmarks at this time. We are working with our senior lender and may need to renegotiate our credit facilities as LIBOR phases out inJune 2023 .
Off-Balance Sheet Arrangements
As of the end of the fiscal year endedJanuary 2, 2021 , the Company does not have any material transactions, arrangements, obligations (including contingent obligations), or other relationships with unconsolidated entities or other persons, as described by Item 303(a)(4) of Regulation S-K, that have or are reasonably likely to have a material current or future impact on the Company's financial condition, results of operations, liquidity, capital expenditures, capital resources or significant components of revenues or expenses. 30 Table of Contents Non-GAAP Financial Measures
The non-GAAP financial measures we provide in this report should be viewed in addition to, and not as an alternative for, results prepared in accordance
U.S. GAAP.
To supplement the consolidated financial statements prepared in accordance withU.S. GAAP, we have presented Adjusted Earnings Per Share, Adjusted Net Income and Adjusted EBITDA, which are considered non-GAAP financial measures. The non-GAAP financial measures presented may differ from similarly titled non-GAAP financial measures presented by other companies, and other companies may not define these non-GAAP financial measures in the same way. These measures are not substitutes for their comparable GAAP financial measures, such as net sales, net income, diluted earnings per share, or other measures prescribed byU.S. GAAP, and there are limitations to using non-GAAP financial measures.
Adjusted Earnings Per Share is defined as diluted earnings per share excluding, when they occur, the impacts of impairment losses, losses on sale of subsidiaries, transaction expenses, factory relocation expenses and restructuring costs. We believe that Adjusted EPS provides important comparability of underlying operational results, allowing investors and management to access operating performance on a consistent basis.
Adjusted Net Income is defined as net income excluding, when they occur, the
impacts of impairment losses, losses on sale of subsidiaries, transaction
expenses, factory relocation expenses and restructuring costs. Adjusted Net
Income is a tool that can assist management and investors in comparing our
performance on a consistent basis by removing the impact of certain items that
management believes do not directly reflect our underlying operations.
Adjusted EBITDA is defined as net income from continuing operations before
interest expense, provision for income taxes, and depreciation and amortization.
In addition to these adjustments, we exclude, when they occur, the impacts of
impairment losses, losses on sale of subsidiaries, transaction expenses, factory
relocation expenses and restructuring expenses. Adjusted EBITDA is a tool that
can assist management and investors in comparing our performance on a consistent
basis by removing the impact of certain items that management believes do not
directly reflect our underlying operations.
We also present certain results "excluding Big 3 Precision" because we believe
this allows for more effective comparability to the corresponding prior year
period.
Management uses such measures to evaluate performance period over period, to
analyze the underlying trends in our business, including our business segments,
to assess our performance relative to that of our competitors, and to establish
operational goals and forecasts that are used in allocating resources.
31
Table of Contents
We believe that presenting non-GAAP financial measures in addition to GAAP financial measures provides investors greater transparency to the information used by our management for its financial and operational decision-making. We further believe that providing this information better enables our investors to understand our operating performance and to evaluate the methodology used by management to evaluate and measure such performance.
Reconciliation of expenses from GAAP to Non-GAAP EPS calculation
For the Three and Twelve Months ended
Three Months Ended Twelve Months Ended
December 28, December 28,
January 2, 2021 2019 January 2, 2021 2019
Net Income as
reported per
generally
accepted
accounting
principles
(GAAP) $ 1,413,813 $ 4,972,327 $ 5,405,522 $ 13,266,142
Earnings Per
Share as
reported
under
generally
accepted
accounting
principles
(GAAP):
Basic 0.23 0.80 0.87 2.13
Diluted 0.23 0.79 0.86 2.12
Adjustments
for one-time
expenses:
Goodwill
impairment
loss, net of
tax 715,026 A - 3,716,937 A -
Loss on sale
of
Subsidiary,
net of tax 1,619,147 I - 1,619,147 I -
Transaction
expenses 95,849 E 515,919 299,531 E 1,699,862 G
Factory
relocation,
net of tax 299,600 C - 475,244 C -
Restructuring
costs, net of
tax 489,408 H 144,908 D,F 714,821 B,H 2,181,550 D,F
Total
adjustments
for one-time
expenses $ 3,219,030 $ 660,827 $ 6,825,680 $ 3,881,412
Adjusted Net
Income
(related to
one time
expenses);
(Non-GAAP) $ 4,632,843 $ 5,633,154 $ 12,231,202 $ 17,147,554
Adjusted
Earnings per
share
(related to
one time
expenses);
(Non-GAAP)
Basic $ 0.74 $ 0.90 $ 1.96 $ 2.75
Diluted $ 0.74 $ 0.90 $ 1.95 $ 2.73 A)
Use of Non-GAAP Financial Measures
To supplement our consolidated financial statements presented in accordance with generally accepted accounting principles inthe United States ("GAAP"), we disclose certain non-GAAP financial measures including adjusted net income and adjusted earnings per diluted share. Adjusted net income and adjusted earnings per diluted share exclude one time related expenses. These measures are not in accordance with GAAP. 32 Table of Contents
Reconciliation of expenses from GAAP to Non-GAAP EBITDA calculation
For the Three and Twelve Months ended
Three Months Ended Twelve Months Ended
December 28, December 28,
January 2, 2021 2019 January 2, 2021 2019
Net
Income/(loss)
as reported
per generally
accepted
accounting
principles
(GAAP) $ 1,413,813 $ 4,972,327 $ 5,405,522 $ 13,266,142
Interest
expense 663,517 883,425 2,744,800 1,857,961
Provision
for/(benefit
from) income
taxes (689,205 ) 404,796 620,090 2,939,829
Depreciation
and
amortization 2,333,286 2,647,402 8,477,512 6,454,881
Goodwill
impairment
loss 972,824 A - 4,975,372 A -
Loss on Sale
of Subsidiary 2,158,863 I - 2,158,863 I -
Factory
relocation 428,000 C - 678,920 C -
Restructuring
costs 665,861 H 12,774 D,F 953,095 B,H 2,664,651 D,F
Transaction
costs 95,849 E 515,919 G 299,531 E 1,699,862 G
Adjusted
EBITDA $ 8,042,808 $ 9,436,643 $ 26,313,705 $ 28,883,326 A)
Use of Non-GAAP Financial Measures
To supplement our consolidated financial statements presented in accordance with generally accepted accounting principles inthe United States ("GAAP"), we disclose certain non-GAAP financial measures including adjusted net income and adjusted earnings per diluted share. Adjusted net income and adjusted earnings per diluted share exclude one time related expenses. These measures are not in accordance with GAAP.
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