EASTERN CO 10-K

ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The Eastern Company Consolidated Balance Sheets January 1, January 2, 2022 2021 ASSETS Current Assets Cash and cash equivalents $ 6,168,304 $ 15,320,776 Accounts receivable, less allowances: 2021 - $ 515,000 ;2020 - $ 487,000 43,151,500 31,804,207 Inventories: Raw materials and component parts 25,113,487 14,713,452 Work in process 9,636,009 4,465,411 Finished goods 28,112,846 23,942,873 62,862,342 43,121,736 Current portion of note receivable 1,027,125 398,414 Prepaid expenses and other assets 6,943,691 3,152,721 Current assets held for sale 3,521,899 17,937,918 Total Current Assets 123,674,861 111,735,772 Property, Plant and Equipment Land 1,292,890 1,298,850 Buildings 16,318,957 17,139,857 Machinery and equipment 39,323,233 38,550,887 Accumulated depreciation ( 28,631,329 ) ( 27,965,412 ) Property, Plant and Equipment, net 28,303,751 29,024,182 Other Assets Goodwill 72,211,873 72,219,404 Trademarks 5,409,720 5,404,284 Patents, technology and other intangibles net of accumulated amortization 22,863,497 27,089,071 Long term note receivable, less current portion 2,726,698 1,677,277 Right of Use Assets 11,138,535 12,594,663 Long-term assets held for sale - 15,783,701 Total Other Assets 114,350,323 134,768,400 TOTAL ASSETS $ 266,328,935 $ 275,528,354 See accompanying notes. 30 Table of Contents January 1, January 2, 2022 2021 LIABILITIES AND SHAREHOLDERS’ EQUITY Current Liabilities Accounts payable $ 29,633,974 $ 21,311,618 Accrued compensation 4,375,867 3,474,686 Other accrued expenses 4,808,000 3,362,032 Current portion of lease liability 2,664,895 2,827,392 Current portion of long-term debt 7,500,000 6,437,689 Current liabilities held for sale 580,990 3,252,545 Total Current Liabilities 49,563,726 40,665,962 Deferred income taxes 1,151,759 2,899,074 Other long-term liabilities 668,354 1,144,127 Lease liability 8,639,339 9,806,173 Long-term debt, less current portion 63,813,522 82,255,803 Accrued postretirement benefits 1,284,589 1,185,139 Accrued pension cost 26,605,382 33,188,623 Long-term liabilities held for sale - 76,995 Total Liabilities 151,726,671 171,221,896 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: 9,029,852 shares in 2021 and 8,996,625 shares in 2020 Outstanding: 6,265,527 shares in 2021 and 6,246,896 shares in 2020 32,620,008 31,501,041 Treasury Stock: 2,765,325 shares in 2021 and 2,749,729 shares in 2020 ( 20,907,613 ) ( 20,537,963 ) Retained earnings 129,422,625 122,840,131 Accumulated other comprehensive loss: Foreign currency translation 818,446 953,864 Unrealized (loss) gain on interest rate swap, net of tax ( 355,988 ) ( 1,391,592 ) Unrecognized net pension and postretirement benefit costs, net of tax ( 26,995,214 ) ( 29,059,023 ) Accumulated other comprehensive loss ( 26,532,756 ) ( 29,496,751 ) Total Shareholders’ Equity 114,602,264 104,306,458 TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY $ 266,328,935 $ 275,528,354 See accompanying notes. 31 Table of Contents Consolidated Statements of Income Year Ended January 1, January 2, 2022 2021 Net sales $ 246,522,823 $ 197,614,590 Cost of products sold ( 189,756,610 ) ( 149,527,553 ) Gross margin 56,766,213 48,087,037 Product development expense ( 4,101,399 ) ( 2,749,333 ) Selling and administrative expenses ( 35,218,028 ) ( 30,193,768 ) Goodwill impairment loss - ( 972,823 ) Restructuring costs - ( 665,861 ) Operating profit 17,446,786 13,505,252 Interest expense ( 1,747,723 ) ( 2,058,600 ) Other income 3,371,497 1,770,158 Income from continuing operations before income taxes 19,070,560 13,216,810 Income taxes ( 2,888,217 ) ( 2,181,891 ) Net income from continuing operations $ 16,182,343 $ 11,034,919 Discontinued Operations ( see note 3 ) Gain (loss) from operations of discontinued units $ 2,870,588 $ ( 7,191,198 ) Loss on sale of businesses ( 11,807,512 ) - Income tax benefit 2,103,752 1,561,801 Net loss on discontinued operations $ ( 6,833,172 ) $ ( 5,629,397 ) Net Income $ 9,349,171 $ 5,405,522 Earnings per Share from continuing operations: Basic $ 2.58 $ 1.77 Diluted $ 2.58 $ 1.76 Loss per Share from discontinued operations: Basic $ ( 1.09 ) $ ( 0.90 ) Diluted $ ( 1.09 ) $ ( 0.90 ) Total Earnings per Share: Basic $ 1.49 $ 0.87 Diluted $ 1.49 $ 0.86 Cash dividends per share: $ 0.44 $ 0.44 See accompanying notes. 32 Table of Contents Consolidated Statements of Comprehensive Income Year Ended January 1, January 2, 2022 2021 Net income $ 9,349,171 $ 5,405,522 Other comprehensive income: Change in foreign currency translation ( 135,418 ) 2,991,816 Change in fair value of interest rate swap, net of tax (cost) benefit of: $ 327,118 in 2021 and $ 490,234 in 2020 1,035,604 ( 1,558,610 ) Change in pension and other postretirement benefit costs, net of taxes of: $ 1,208,497 in 2021 and $ 1,776,264 in 2020 2,063,809 ( 5,695,386 ) Total other comprehensive income (loss) 2,963,995 ( 4,262,180 ) Comprehensive income $ 12,313,166 $ 1,143,342 See accompanying notes. 33 Table of Contents CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY Accumulated Other Common Common Treasury Treasury Retained Comprehensive Shareholders' Shares Stock Shares Stock Earnings Income (Loss) Equity Balances at December 28, 2019 8,975,434 $ 30,651,815 ( 2,734,729 ) $ ( 20,169,098 ) $ 120,189,111 $ ( 25,234,571 ) $ 105,437,257 Net income 5,405,522 5,405,522 Cash dividends declared, $0.44 per share ( 2,754,502 ) ( 2,754,502 ) Currency translation adjustment 2,991,816 2,991,816 Change in fair value of interest rate swap ( 1,558,610 ) ( 1,558,610 ) Change in pension and other postretirement benefit costs, net of tax ( 5,695,386 ) ( 5,695,386 ) Treasury Stock Purchase ( 15,000 ) ( 368,865 ) ( 368,865 ) Issuance of SARS 376,083 376,083 Issuance of Common Stock for directors' fees 21,191 473,143 473,143 Balances at January 2, 2021 8,996,625 $ 31,501,041 ( 2,749,729 ) $ ( 20,537,963 ) $ 122,840,131 $ ( 29,496,751 ) $ 104,306,458 Net income 9,349,171 9,349,171 Cash dividends declared, $0.44 per share ( 2,766,677 ) ( 2,766,677 ) Currency translation adjustment ( 135,418 ) ( 135,418 ) Change in fair value of interest rate swap 1,035,604 1,035,604 Change in pension and other postretirement benefit costs, net of tax 2,063,809 2,063,809 Stock Options Exercised 14,681 196,950 196,950 Treasury Stock Purchase ( 14,596 ) ( 369,650 ) ( 369,650 ) Issuance of SARS 418,000 418,000 Issuance of Common Stock for directors' fees 18,546 504,017 504,017 Balances at January 1, 2022 9,029,852 $ 32,620,008 ( 2,764,325 ) $ ( 20,907,613 ) $ 129,422,625 $ ( 26,532,756 ) $ 114,602,264 See accompanying notes. 34 Table of Contents Consolidated Statements of Cash Flows Year Ended January 1, 2022 January 2, 2021 Operating Activities Net income $ 9,349,171 $ 5,405,522 Less: Loss from discontinued operations ( 6,833,172 ) ( 5,629,397 ) Income from continuing operations $ 16,182,343 $ 11,034,919 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization 7,241,073 6,815,783 Loss on disposition of subsidiaries - ( 192,466 ) Unrecognized pension and postretirement benefits ( 4,032,917 ) ( 1,010,684 ) Goodwill impairment - 4,975,372 Gain on sale of equipment and other assets ( 2,470,339 ) ( 333,590 ) Provision for doubtful accounts 73,097 156,286 Stock compensation expense 1,118,967 849,226 Deferred taxes ( 3,010,111 ) ( 2,118,551 ) Changes in operating assets and liabilities: Accounts receivable ( 11,282,090 ) 311,887 Inventories ( 19,608,565 ) ( 836,465 ) Prepaid expenses and other ( 3,527,171 ) ( 473,615 ) Other assets ( 519,478 ) ( 4,581,818 ) Accounts payable 8,834,545 ( 295,834 ) Accrued compensation 947,171 ( 81,413 ) Other accrued expenses 2,296,052 342,794 Net cash (used in) provided by operating activities ( 7,757,423 ) 14,561,831 Investing Activities Marketable securities 28,951 5,354 Business acquisition, net of cash acquired - ( 7,172,868 ) Business disposition 2,325 2,785,657 Issuance of notes receivable ( 2,500,000 ) ( 2,172,068 ) Payments received from notes receivable 821,868 96,377 Proceeds from sale of businesses 17,030,726 - Proceeds from sale of building and equipment 1,980,729 445,212 Purchases of property, plant and equipment ( 3,719,815 ) ( 2,335,308 ) Net cash provided by (used in) investing activities 13,644,784 ( 8,347,644 ) Financing Activities Principal payments on long-term debt ( 17,274,410 ) ( 10,049,577 ) Financing leases, net 126,797 ( 10,500 ) Purchase common stock for treasury ( 369,651 ) ( 368,864 ) Dividends paid ( 2,755,686 ) ( 2,754,650 ) Net cash used in financing activities ( 20,272,950 ) ( 13,183,591 ) Discontinued Operations Cash provided by operating activities 5,733,884 6,126,931 Cash used in investing activities ( 1,022,256 ) ( 1,407,932 ) Cash provided by discontinued operations 4,711,628 4,718,999 Effect of exchange rate changes on cash 174,756 355,535 Net change in cash and cash equivalents ( 9,499,205 ) ( 1,894,870 ) Cash and cash equivalents at beginning of period 16,101,635 17,996,505 Cash and cash equivalents at end of period 1 $ 6,602,430 $ 16,101,635 Supplemental disclosure of cash flow information: Interest $ 2,271,818 $ 2,754,980 Income taxes 2,318,018 3,755,475 Non-cash investing and financing activities Right of use asset ( 1,456,128 ) 425,552 Lease liability 1,329,331 ( 464,454 ) 1 includes cash from assets held for sale of $0.4 million as of January 1, 2022 and $0.8 million as of January 2, 2021 See accompanying notes 35 Table of Contents The Eastern Company Notes to Consolidated Financial Statements 1. DESCRIPTION OF BUSINESS The Eastern Company, and its subsidiaries (the “Company,” “Eastern,” “we,” “us” or “our”) manages industrial businesses that design, manufacture and sell engineered solutions to industrial markets. Eastern’s businesses operate in industries with long-term macroeconomic growth opportunities. We look to acquire businesses that produce stable and growing earnings and cash flows. Eastern may pursue acquisitions in industries other than those in which its businesses currently operate if an acquisition presents an attractive opportunity. Eastern manages the financial, operational, and strategic performance of its businesses to increase cash generation, operating earnings, and long-term shareholder value. Eastern encompasses four operating entities within the United States, one wholly owned Canadian subsidiary located in Cambridge, Ontario, Canada, a wholly owned Taiwanese subsidiary located in Taipei, Taiwan, a wholly owned subsidiary in Hong Kong, two wholly owned Chinese subsidiaries (one located in Shanghai, China, and one located in Dongguan, China), a wholly owned subsidiary in Reynosa, Mexico and a wholly owned subsidiary in Wrexham, United Kingdom. Company Operations The Company’s operations consist of Big 3 Precision, including Big 3 Precision Products, Inc. (“Big 3 Products”) and Big 3 Mold Services, Inc. (“Big 3 Mold”), Hallink Moulds, Inc. (“Hallink Moulds”), and Associated Toolmakers Ltd. (“Associated Toolmakers”); Eberhard Manufacturing Company (“Eberhard Manufacturing”), Eberhard Hardware Manufacturing Ltd. (“Eberhard Hardware”), Eastern Industrial Ltd, World Lock Company Ltd., Dongguan Reeworld Security Products Ltd., and World Security Industries (together “Eberhard”); and Velvac Holdings Inc. (“Velvac”). These businesses design, manufacture, and market a diverse product line of custom and standard vehicular and industrial hardware, including turnkey returnable packaging solutions, access and security hardware, mirrors, and mirror-cameras. Big 3 Products and Big 3 Mold’s turnkey returnable packaging solutions are used in the assembly processes of vehicles, aircraft, and durable goods and in the production processes of plastic packaging products, packaged consumer goods and pharmaceuticals. Big 3 Products works with original equipment manufacturers (“OEMs”) to design and produce custom returnable transport packaging to integrate with OEM assembly processes. Big 3 Mold designs and manufactures blow mold tools. Hallink Moulds is a producer of injection blow mold tooling and is a supplier of blow molds and change parts to the food, beverage, healthcare, and chemical industry. Hallink specializes in the design, development and manufacture of 2-step stretch blow molds, and related components for the stretch blow molding industry offering integrated turnkey solutions to its customers worldwide. In 2020, we combined all businesses associated with Eberhard Manufacturing and Illinois Lock Company to create Eberhard, which specializes in the engineering and manufacturing of access and security hardware. Eberhard offers a standard product line of rotary latches, compression latches, draw latches, hinges, camlocks, key switches, padlocks, and handles among other products, as well as comprehensive development and program management services for custom electromechanical and mechanical systems designed for specific OEMs and customer applications. Eberhard’s products are found in an expansive range of applications and products globally. Velvac is a designer and manufacturer of proprietary vision technology for OEMs and aftermarket applications, and a provider of aftermarket components to the heavy-duty truck market in North America. Velvac serves diverse, niche segments within the heavy- and medium-duty truck, motorhome, and bus markets. Sales are made to customers primarily in North America. 36 Table of Contents The Eastern Company Notes to Consolidated Financial Statements (continued) 2. BUSINESS ACQUISITIONS Hallink Moulds, Inc. Effective August 10, 2020 the Company acquired certain assets, including accounts receivable, inventories, furniture, fixtures and equipment, intellectual property rights and rights existing under all sales and purchase agreements, and assumed certain liabilities, of Hallink, RSB Inc. These assets are held in our subsidiary, Hallink Moulds. Hallink Moulds produces injection blow mold tooling and is a supplier of blow molds and change parts to the food, beverage, healthcare and chemical industry. Hallink Moulds specializes in the design, development and manufacture of 2-step stretch blow molds, and related components for the stretch blow molding industry offering integrated turnkey solutions to its customers worldwide. The cost of the acquisition of Hallink Moulds was approximately $ 7,173,000 . The above acquisition was accounted for under ASU 2014-18, Business Combinations (Topic 805). The acquired business is included in the consolidated operating results of the Company from the effective date of the acquisition. The excess of the cost of Hallink Moulds over the fair market value of the net assets acquired of $ 2,302,000 has been recorded as goodwill. An independent third party was utilized to establish the fair market value of net assets acquired. In connection with the above acquisition, the Company recorded the following intangible assets: Asset Class/Description Amount Weighted-Average Useful Lives in Years Customer relationships $ 2,345,000 6 Intellectual property 591,000 6 Non-compete agreements 1,001,000 5 $ 3,937,000 There is no anticipated residual value relating to these intangible assets. 3. DISCONTINUED OPERATIONS We determined that the companies previously included in our former Diversified Products segment no longer fit with our long-term strategy and have initiated the process of selling the companies within the former Diversified Products segment. Selling these companies will allow management to focus on our core capabilities and offerings. The former Diversified Products segment met the criteria to be held for sale and furthermore, we determined that the assets held for sale qualified for discontinued operations. As such, the financial results of the former Diversified Products segment are reflected in our condensed consolidated statements of operations as discontinued operations for all periods presented. Additionally, current and non-current assets and liabilities of discontinued operations are reflected in the condensed consolidated balance sheets for both periods presented. On November 3, 2021, the Company sold its Greenwald Industries, Inc. division (“Greenwald”) for a sales price of $ 8.0 million, subject to a final working capital adjustment. Greenwald, located in Chester, CT, is an OEM manufacturer offering a range of payment solutions from coin-vending products to smart card systems and payment applications. On November 22, 2021, the Company sold its Frazer & Jones Company division (“Frazer & Jones”). Frazer & Jones is a ductile and malleable iron foundry located in Syracuse, NY. Eastern has exited the mining business to focus on our three core businesses. 37 Table of Contents The Eastern Company Notes to Consolidated Financial Statements (continued) Summarized Financial Information of Discontinued Operations The following table represents income from discontinued operations, net of tax: Year Ended January 1, 2022 January 2, 2021 Net sales $ 44,289,411 $ 42,788,524 Cost of products sold ( 24,873,717 ) ( 40,701,607 ) Gross margin 19,415,694 2,086,917 Selling and administrative expenses ( 15,962,532 ) ( 8,591,915 ) Restructuring costs ( 11,807,512 ) - Operating loss ( 8,354,350 ) ( 6,504,998 ) Interest expense ( 582,574 ) ( 686,200 ) Loss from discontinued operations before income taxes ( 8,936,924 ) ( 7,191,198 ) Income tax benefit 2,103,752 1,561,801 Loss from discontinued operations $ ( 6,833,172 ) $ ( 5,629,397 ) 38 Table of Contents Eastern Company Notes to Consolidated Financial Statements (continued) The following table represents the assets and liabilities from discontinued operations: January 1, 2022 January 2, 2021 Cash $ 434,126 $ 809,809 Accounts receivable 1,153,274 5,944,923 Inventory 1,258,032 9,990,656 Prepaid expenses 59,850 1,192,530 Property, plant and equipment, net 591,920 10,927,791 Patents and other intangibles net of accumulated amortization - 6,935 Goodwill - 4,675,611 Right of use assets 24,697 173,364 Total assets of discontinued operations $ 3,521,899 $ 33,721,619 Current assets of discontinued operations¹ $ 3,521,899 $ 17,937,918 Non-current assets of discontinued operations - 15,783,701 Total assets of discontinued operations $ 3,521,899 $ 33,721,619 Accounts payable $ 167,794 $ 2,196,101 Accrued compensation and other accrued expenses 388,499 937,911 Note payable, current - 22,164 Current portion of lease liability 24,697 96,369 Other long-term liabilities - 76,995 Total liabilities of discontinued operations $ 580,990 $ 3,329,540 Current liabilities of discontinued operations¹ $ 580,990 $ 3,252,545 Non-current liabilities of discontinued operations - 76,995 Total liabilities of discontinued operations $ 580,990 $ 3,329,540 ¹ The total assets and liabilities of discontinued operations are presented as current in the January 1, 2022 balance sheet as we expect to sell the discontinued operations and collect proceeds within one year. 4. ACCOUNTING POLICIES Fiscal Year The Company’s year ends on the Saturday nearest to December 31. Based on this policy, fiscal year 2021 was comprised of 52 weeks and fiscal 2020 included 53 weeks. References in these Notes to the consolidated financial statements to “2021” or “fiscal year 2021” mean the fiscal year ended January 1, 2022, and references to “2020” or “fiscal year 2020” mean the fiscal year ended January 2, 2021. References to the “fourth quarter of 2021” or the “fourth fiscal quarter of 2021” mean the thirteen-week period from October 3, 2021 to January 1, 2022, and references to the “fourth quarter of 2020” or the “fourth fiscal quarter of 2020” mean the thirteen-week period from October 4, 2020 to January 2, 2021. 39 Table of Contents Eastern Company Notes to Consolidated Financial Statements (continued) Principles of Consolidation The consolidated financial statements include the accounts of the Company and its subsidiaries, all of which are wholly owned. All intercompany accounts and transactions are eliminated. Reclassification Product development expense is not a cost of product sold. Rather, these expenses are related to product development. The reclassification of these expenses does not affect the net income reported. Certain prior year amounts have been reclassified for consistency with the current year presentation. These reclassifications had no effect on the reported results of operations. Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States (“U.S. GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. On an ongoing basis the Company evaluates its estimates, including those related to product returns, bad debts, carrying value of inventories, intangible and other long-lived assets, income taxes, pensions and other postretirement benefits. Actual results could differ from those estimates. Foreign Currency For foreign operations asset and liability accounts are translated with an exchange rate at the respective balance sheet dates; income statement accounts are translated at the average exchange rate for the years. Resulting translation adjustments are made directly to a separate component of shareholders’ equity – “Accumulated other comprehensive (loss) – Foreign currency translation”. Foreign currency exchange transaction gains and losses are not material in any year. Cash Equivalents Highly liquid investments purchased with a maturity of three months or less are considered cash equivalents. The Company has deposits that exceed amounts insured by the Federal Deposit Insurance Corporation (FDIC) up to $ 250,000 , but the Company does not consider this a significant concentration of credit risk based on the strength of the financial institution. Approximately 38 % of available cash is located outside of the United States in our foreign subsidiaries. Accounts Receivable Accounts receivable are stated at their net realizable value. The Company maintains an allowance for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. The Company reviews the collectability of its receivables on an ongoing basis considering a combination of factors. The Company reviews potential problems, such as past due accounts, a bankruptcy filing or deterioration in the customer’s financial condition, to ensure the Company is adequately accrued for potential loss. Accounts are considered past due based on when payment was originally due. If a customer’s situation changes, such as a bankruptcy or change in creditworthiness, or there is a change in the current economic climate, the Company may modify its estimate of the allowance for doubtful accounts. The Company will write off accounts receivable after reasonable collection efforts have been made and the accounts are deemed uncollectible. As of January 1, 2022 and January 2, 2021, the Company’s allowance for doubtful accounts total was $ 515,000 and $ 487,000 , respectively. As of January 1, 2022, and January 2, 2021, the Company’s bad debt expense was $ 48,000 and $ 253,000 respectively. Inventories Inventories are valued at the lower of cost or net realizable value. Cost is determined by the last-in, first-out (LIFO) method in the U.S. ($ 23.4 million for U.S. inventories at January 1, 2022, excluding Big 3 Precision and Velvac) and by the first-in, first-out (FIFO) method for inventories outside the U.S. ($ 4.5 million for inventories outside the U.S. at January 1, 2022) and for Big 3 Precision and Velvac. Cost exceeds the LIFO carrying value by approximately $ 3.6 million at January 1, 2022 and $ 2.9 million at January 2, 2021. There was no material LIFO quantity liquidation in 2021 or 2020. In addition, as of the balance sheet dates, the Company has recorded reserves for excess/obsolete inventory. 40 Table of Contents Eastern Company Notes to Consolidated Financial Statements (continued) Property, Plant and Equipment and Related Depreciation Property, plant, and equipment (including equipment under capital lease) are stated at cost. Depreciation expense ($ 3,255,894 in 2021, $ 3,208,206 in 2020) is computed using the straight-line method based on the following estimated useful lives of the assets: Buildings - 10 to 39.5 years; Machinery and equipment - 3 to 10 years. Impairment of Long-Lived Assets In accordance with ASC 360-10, Accounting for the Impairment or Disposal of Long-Lived Assets, the Company reviews its long-lived assets and certain intangible assets for impairment whenever events or changes in circumstances indicate the that carrying amount may not be recoverable. In such an event, the carrying value of long-lived assets is reviewed by management to determine if the value may be impaired. If this review indicates that the carrying amount will not be recoverable, as determined based on the estimated expected future cash flows attributable to the asset over the remaining amortization period, management will reduce the carrying amount to recognize the impairment and recognize an impairment loss. The measurement of the impairment loss to be recognized is to be based on the difference between the fair value and the carrying amount of the asset. Fair value is defined as the amount of which the asset could be bought or sold in a current transaction between willing parties. Where quoted market prices in active markets are not available, management would estimate fair value based on the best information available in the circumstances such as the price of similar assets, a discounted cash flow analysis or other techniques. No impairment losses were recognized for the years ended January 1, 2022 and January 2, 2021. Goodwill The Company tests its reporting units for impairment annually in December, or more frequently if events or circumstances indicate it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Such events and circumstances could include, among other things, increased competition or unexpected loss of market share, significant adverse changes in the markets in which the Company operates, or unexpected business disruptions. The Company tests reporting units for impairment by comparing the estimated fair value of each reporting unit with its carrying amount. If the carrying amount of a reporting unit exceeds its estimated fair value, the Company records an impairment loss based on the difference between fair value and carrying amount not to exceed the associated carrying amount of goodwill. Determining the fair value of a reporting unit involves the use of significant estimates and assumptions. The values assigned to the key assumptions represent management’s assessment of future trends in the relevant industry and have been based on historical data from both external and internal sources. The Company performed qualitative assessments of goodwill as of the end of fiscal 2021 and determined that no impairment existed at the end of 2021. In the fourth quarter of 2020 the Company announced that the Eberhard Hardware, subsidiary in Ontario, Canada would be closed, and all tangible assets would be moved to Eberhard Manufacturing division in Cleveland, Ohio. As a result, approximately $ 1.0 million of goodwill associated with Eberhard Hardware was impaired and an impairment charge was recognized in the fourth quarter of 2020. The Company will continue to perform annual qualitative assessments as of the end of each fiscal year. Additionally, the Company will perform an interim analysis whenever conditions warrant. 41 Table of Contents Eastern Company Notes to Consolidated Financial Statements (continued) Intangible Assets Patents are recorded at cost and are amortized using the straight-line method over the lives of the patents. Technology and licenses are recorded at cost and are amortized on a straight-line basis over periods ranging from 5 to 17 years. Non-compete agreements and customer relationships are amortized using the straight-line method over their useful lives. Trademarks are deemed to have indefinite lives. Amortization expense recognized in 2021 and 2020 was $ 3,985,179 and $ 3,607,577 , respectively. If facts and circumstances indicate that the carrying value of the intangible assets, including definite life intangible assets, may be impaired, an evaluation is performed to determine if a write-down is required. No impairment losses were recognized for the periods ended January 1, 2022 and January 2, 2021. Fair Value of Financial Instruments Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The company utilizes a fair value hierarchy, which maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. The fair value hierarchy has three levels of inputs that may be used to measure fair value: Level 1 Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities. Level 2 Quoted prices in markets that are not active; or other inputs that are observable, either directly or indirectly, for substantially the full term of the asset or liability. Level 3 Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable. The Company’s financial instruments are primarily investments in pension assets, see Note 10, Retirement Benefit Plans , and consists of an interest rate swap. The Company’s interest rate swap is not an exchange-traded instrument. However, it is valued based on observable inputs for similar liabilities and accordingly is classified as Level 2. The amount of the interest rate swap is included in other accrued liabilities. The carrying amounts of other financial instruments (cash and cash equivalents, accounts receivable, accounts payable and debt) as of January 1, 2022 and January 2, 2021, approximate fair value because of their short-term nature and market based interest rates. Leases The Company presents right-of-use (“ROU”) assets and lease liabilities on the balance sheet for all leases with terms longer than 12 months, in accordance with the Financial Accounting Standards Board (“FASB”) Accounting Standards Update (“ASU”) 2016-02, Leases. The Company elected to account for non-lease components as part of the lease component to which they relate. Lease accounting involves significant judgements, including making estimates related to the lease term, lease payments, and discount rate. The Company has operating leases for buildings, warehouse, and office equipment. The Company determines whether an arrangement is, or contains, a lease at contract inception. An arrangement contains a lease if the Company has the right to direct the use of and obtain substantially all of the economic benefits of an identified asset. ROU assets and lease liabilities are recognized at lease commencement based on the present value of lease payments over the lease term. Leases with an initial term of 12 months or less are not recorded on the balance sheet; we recognize lease expense for these leases on a straight-line basis over the lease term. Most leases include one or more options to renew. The exercise of lease renewal options is at our sole discretion. The Company’s option to extend certain leases ranges from 1–107 months. All options to extend, when it is reasonably certain the option will be exercised, have been included in the calculation of the ROU asset and lease liability. 42 Table of Contents Eastern Company Notes to Consolidated Financial Statements (continued) Currently, the Company has 28 operating leases and three finance leases with a lease liability of $ 11.3 million as of January 1, 2022. The finance lease arrangements are immaterial. The basis, terms and conditions of the leases are determined by the individual agreements. The leases do not contain residual value guarantees, restrictions, or covenants that could cause the Company to incur additional financial obligations. We rent or sublease a part of one real estate property to a third party. There are no related party transactions. There are no leases that have not yet commenced that could create significant rights and obligations for the Company. Total lease expense for each of the next five fiscal years is estimated to be as follows: 2022 - $ 2,664,761 ; 2023 - $ 2,186,238 ; 2024 - $ 1,700,834 ; 2025 - $ 1,081,468 ; 2026 - $ 805,722 and $ 2,865,077 thereafter. The weighted average remaining lease term is 6.4 years. The weighted average discount rate used was 5.0 %. Revenue Recognition The Company recognizes revenue in accordance with ASC 606 when control of the promised goods or services is transferred to the customer in an amount that reflects the consideration the Company expects to be entitled to in exchange for those goods or services. The Company considers several factors in determining that control transfers to the customer upon shipment of products. These factors include that legal title transfers to the customer, the Company has a present right to payment, and the customer has assumed the risk and rewards of ownership at the time of shipment. Big 3 Mold may employ the efforts expended method for the percentage of completion for revenue recognition for certain transactions. The efforts expended method calculates the proportion of effort expended to date in comparison to the total effort expected to be expended for the contract. The amount of revenue recognized employing the percentage of completion method was $ 795,000 for the year ended January 1, 2022 and $ 505,000 for the year ended January 2, 2021. Based on historical experience, the Company does not accrue a reserve for product returns. For the years ended January 1, 2022 and January 2, 2021, the Company recorded sales returns of $ 395,000 and $ 374,000 , respectively, as a reduction of revenue. Sales and similar taxes that are imposed on the Company’s sales and collected from the customer are excluded from revenues. Costs for shipping and handling activities, including those activities that occur subsequent to transfer of control to the customer, are recorded as cost of sales and are expensed as incurred. For the years ended January 1, 2022 and January 2, 2021, the Company recorded no revenues related to performance obligations satisfied in prior periods. The Company has elected to use the practical expedient to exclude disclosure of transaction prices allocated to remaining performance obligations, and when the Company expects to recognize such revenue, for all periods prior to the date of initial application of the standard. See Note 13 regarding the Company’s revenue disaggregated by geography. Cost of Goods Sold Cost of goods sold reflects the cost of purchasing, manufacturing, and preparing a product for sale. These costs generally represent the expenses to acquire or manufacture products for sale (including an allocation of depreciation and amortization) and are primarily comprised of direct materials, direct labor, and overhead, which includes indirect labor, facility and equipment costs, inbound freight, receiving, inspection, purchasing, warehousing and any other costs related to the purchasing, manufacturing or preparation of a product for sale. Shipping and Handling Costs Shipping and handling costs are included in cost of goods sold. 43 Table of Contents Eastern Company Notes to Consolidated Financial Statements (continued) Product Development Costs Product development costs, charged to expense as incurred, were $ 4,101,399 in 2021 and $ 2,749,333 in 2020. Selling and Administrative Expenses Selling and administrative expenses include all operating costs of the Company that are not directly related to the cost of purchasing, manufacturing and preparing a product for sale. These expenses represent selling and administrative expenses for support functions and related overhead. Advertising Costs The Company expenses advertising costs as incurred. Advertising costs were $ 200,482 in 2021 and $ 278,392 in 2020. Stock Based Compensation The Company accounts for its stock-based awards in accordance with Accounting Standards Codification subtopic 718-10, Compensation (“ASC 718-10”), which requires a fair value measurement and recognition of compensation expense for all share-based payment awards made to its employees and Directors, including employee stock awards and restricted stock awards. The Company estimates the fair value of granted stock awards using the Black-Scholes valuation model at the date of grant. This model requires the Company to make estimates and assumptions including, without limitation, estimates regarding the length of time an employee will retain vested stock awards before exercising them, the estimated volatility of the Company’s common stock price and the number of awards that will be forfeited prior to vesting. The fair value is then amortized on a straight-line basis over the requisite service periods of the awards, which is generally the vesting period. Changes in these estimates and assumptions can materially affect the determination of the fair value of stock-based compensation and consequently, the related amount recognized in the Company’s consolidated statements of operations. Under the terms of the Director’s Fee Program, the directors receive their director’s fees in common shares of the Company. Income Taxes The Company and its U.S. subsidiaries file a consolidated federal income tax return. Deferred tax assets and liabilities are determined based on differences between financial reporting and tax basis of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. The Company accounts for uncertain tax positions pursuant to the provisions of FASB Accounting Standards Codification (“ASC”) 740 which clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements. These provisions detail how companies should recognize, measure, present and disclose uncertain tax positions that have or are expected to be taken. As such, the financial statements will reflect expected future tax consequences of uncertain tax positions presuming the taxing authorities’ full knowledge of the position and all relevant facts. See Note 9, Income Taxes . 44 Table of Contents The Eastern Company Notes to Consolidated Financial Statements (continued) 5. GOODWILL The following is a roll-forward of goodwill for 2021 and 2020: 2021 Beginning Balance $ 72,219,404 Foreign Exchange ( 7,531 ) Ending Balance $ 72,211,873 2020 Beginning Balance $ 70,839,853 Investment in Hallink 2,302,000 Impairment Charge ( 972,824 ) Foreign Exchange 50,375 Ending Balance $ 72,219,404 45 Table of Contents The Eastern Company Notes to Consolidated Financial Statements (continued) 6. INTANGIBLES Trademarks are not amortized as their lives are deemed to be indefinite. Total amortization expense for each of the next five years is estimated to be as follows: 2022 - $ 4.7 million; 2023 - $ 4.7 million; 2024 - $ 3.9 million; 2025 - $ 3.9 million and 2026 - $ 3.9 million. Weighted-Average Amortization 2021 Period (Years) Gross Amount Patents and developed technology $ 6,749,169 6.5 Customer relationships 26,040,691 5.9 Non-compete agreements 1,111,756 3.3 Total Gross Intangibles $ 33,901,616 5.9 Accumulated Amortization Patents and developed technology $ 2,959,782 Customer relationships 7,759,667 Non-compete agreements 318,670 Accumulated Amortization $ 11,038,119 Net 2021 per Balance Sheet $ 22,863,497 2020 Gross Amount Patents and developed technology $ 7,063,510 9.3 Customer relationships 26,030,122 8.6 Non-compete agreements 1,107,243 4.3 Total Gross Intangibles $ 34,200,875 8.6 Accumulated Amortization Patents and developed technology $ 2,262,507 Customer relationships 4,742,839 Non-compete agreements 106,458 Accumulated Amortization $ 7,111,804 Net 2020 per Balance Sheet $ 27,089,071 46 Table of Contents The Eastern Company Notes to Consolidated Financial Statements (continued) 7. DEBT On August 30, 2019, the Company entered into the Credit Agreement with Santander Bank, N.A., for itself, People’s United Bank, National Association. and TD Bank, N.A. as lenders, that included a $100 million term portion and a $ 20 million revolving commitment portion. Proceeds of the term loan were used to repay the Company’s remaining outstanding term loan (and to terminate its existing credit facility) with People’s United Bank, N.A. (approximately $ 19 million) and to acquire Big 3 Precision. The term portion of the loan requires quarterly principal payments of $ 1,250,000 for an 18-month period beginning December 31, 2019. The repayment amount then increases to $ 1,875,000 per quarter beginning September 30, 2021 and continues through June 30, 2023. The repayment amount then increases to $ 2,500,000 per quarter beginning September 30, 2023 and continues through June 30, 2024. The term loan is a 5 -year loan with the remaining balance due on August 30, 2024. The revolving commitment portion has an annual commitment fee of 0.25 % based on the unused portion of the revolver. The revolving commitment portion has a maturity date of August 30, 2024. During 2020 and 2021, 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 U.S. subsidiaries’ assets pursuant to a Pledge and Security Agreement, dated August 30, 2019 with Santander Bank, N.A., as administrative agent. The Company’s loan covenants under the Credit Agreement require the Company to maintain a senior net leverage ratio not to exceed 4.25 to 1. In addition, the Company will be required to maintain a fixed charge coverage ratio to be not less than 1.25 to 1. On August 30, 2019, the Company entered into an interest rate swap contract with Santander Bank, N.A., with an original notional amount of $ 50,000,000 , which was equal to 50% of the outstanding balance of the term loan on that date. The Company has a fixed interest rate of 1.44% on the swap contract and will pay the difference between the fixed rate and LIBOR when LIBOR is below 1.44 % and will receive interest when the LIBOR rate exceeds 1.44 %. On January 1, 2022, the interest rate for half ($ 27.8 million) of the term portion was 1.6 %, using a one-month LIBOR rate, and 2.94 % one the remaining balance ($ 43.8 million) of the term loan based on a one-month LIBOR rate . The interest rates on the Credit Agreement, and interest rate swap contract are susceptible to changes to the method that LIBOR rates are determined and to the potential phasing out of LIBOR after 2021. Information regarding the potential phasing out of LIBOR is provided below. On July 27, 2017, the Financial Conduct Authority (the “FCA”) (the authority that regulates LIBOR) announced that it would phase out LIBOR by the end of 2021. The ICE Benchmark Administration (the “IBA”) recently announced market consultation regarding the extension of US dollar LIBOR tenors through June 30, 2023, which the FCA supports. The Alternative Reference Rates Committee (the “ARRC”), a financial industry group convened by the Federal Reserve Board, has recommended the use of the Secured Overnight Financing Rate (“SOFR”) to replace LIBOR. The difference between LIBOR and SOFR is that LIBOR is a forward-looking rate which means the interest rate is set at the beginning of the period with payment due at the end. SOFR is a backward-looking overnight rate, which has implications for how interest and other payments are based. 47 Table of Contents The Eastern Company Notes to Consolidated Financial Statements (continued) 7. DEBT (continued) Debt consists of: 2021 2020 Term loans $ 71,313,522 $ 88,693,492 Revolving credit loan — — 71,313,522 88,693,492 Less current portion 7,500,000 6,437,689 $ 63,813,522 $ 82,255,803 Amounts are net of unamortized discounts and debt issuance costs of $ 186,478 as of January 1, 2022 and $ 273,312 as of January 2, 2021. The Company paid interest of $ 2,271,818 in 2021, $ 2,754,980 in 2020. The Company’s loan covenants under the Credit Agreement require the Company to maintain a consolidated fixed charge coverage ratio of at least 1.25 to 1, which is to be tested quarterly on a twelve-month trailing basis. In addition, the Company will be required to show a senior net leverage ratio of 4.25 to 1. The Company was in compliance with all covenants as of January 1, 2022. In addition, the Company has restrictions on, among other things, new capital leases, purchases or redemptions of its capital stock, mergers and divestitures, and new borrowing. The Company was in compliance with all covenants in 2021 and 2020. As of January 1, 2022, scheduled annual principal maturities of long-term debt for each of the next five years follow: 2022 $ 7,500,000 2023 8,750,000 2024 55,063,522 Thereafter — $ 71,313,522 8. STOCK OPTIONS AND AWARDS Stock Awards As of January 1, 2022, the Company has one incentive stock award plan, The Eastern Company 2020 Stock Incentive Plan (the “2020 Plan”), for officers, other key employees, and non-employee Directors. The Eastern Company 2010 Executive Stock Incentive Plan expired in February 2020. Incentive stock awards granted under the 2020 Plan must have exercise prices that are not less than 100% of the fair market value of the Company’s common stock on the dates the stock awards are granted. Restricted stock awards may also be granted to participants under the 2020 Plan with restrictions determined by the Compensation Committee of the Company’s Board of Directors. Under the 2020 Plan, non-qualified stock awards granted to participants will have exercise prices determined by the Compensation Committee of the Company’s Board of Directors. The Company granted 27,300 awards during 2021. During 2020 the Company did not grant stock awards or restricted stock. The 2020 Plan also permits the issuance of Stock Appreciation Rights (“SARs”). The SARs are in the form of an award with a cashless exercise price equal to the difference between the fair value of the Company’s common stock at the date of grant and the fair value as of the exercise date resulting in the issuance of the Company’s common stock. The Company did not issue SARs during 2021 and issued 44,000 SARs during 2020. 48 Table of Contents The Eastern Company Notes to Consolidated Financial Statements (continued) 8. STOCK OPTIONS AND AWARDS (continued) Stock-based compensation expense in connection with stock awards and SARs granted to employees during fiscal year 2021 was $ 418,000 and for 2020 was $ 376,000 . For the period of 2021, the Company used several assumptions which included an expected term of 4 years, volatility deviation of 47.25 % to 48.55 % and a risk-free rate of 0.18 % to 0.35 %. For the period of 2020, the Company used several assumptions which included an expected term of 4 years, volatility deviation of 38.62 % and a risk-free rate of 0.26 %. As of January 1, 2022, there were 804,703 shares of common stock reserved and available for future grant under the above noted 2020 Plan. The following tables set forth the outstanding SARs for the period specified: Year Ended January 1, 2022 Year Ended January 2, 2021 Units Weighted - Average Exercise Price Units Weighted - Average Exercise Price Outstanding at beginning of period 244,001 $ 21.87 276,000 $ 22.30 Issued - 44,000 20.20 Exercised ( 55,668 ) 19.31 - - Forfeited ( 7,500 ) 21.20 ( 75,999 ) 22.00 Outstanding at end of period 180,833 22.88 244,001 21.87 SARs Outstanding and Exercisable Range of Exercise Prices Outstanding as of January 1, 2022 Weighted- Average Remaining Contractual Life Weighted- Average Exercise Price Exercisable as of January 1, 2022 Weighted- Average Remaining Contractual Life Weighted- Average Exercise Price $ 20.20 -$ 26.30 180,833 1.6 $ 22.88 118,335 1.12 $ 23.30 The following tables set forth the outstanding stock grants for the period specified: Year Ended January 1, 2022 Year Ended January 2, 2021 Shares Shares Outstanding at beginning of period 25,000 25,000 Issued 27,300 — Forfeited ( 25,000 ) — Outstanding at end of period 27,300 25,000 As of January 1, 2022, outstanding SARs and awards had an intrinsic value of $ 1,087,570 . 49 Table of Contents The Eastern Company Notes to Consolidated Financial Statements (continued) 9. INCOME TAXES Deferred income taxes are provided on temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and those for income tax reporting purposes. Deferred income tax (assets) liabilities relate to: 2021 2020 Property, plant and equipment $ 3,586,257 $ 4,460,316 Right of Use Asset 2,564,741 3,014,148 Intangible assets 6,364,038 8,913,638 Other 495,881 - Foreign Withholding Tax 60,462 250,432 Total deferred income tax liabilities 13,071,379 16,638,534 Other postretirement benefits ( 292,090 ) ( 279,776 ) Inventories ( 1,161,354 ) ( 1,091,887 ) Allowance for doubtful accounts ( 114,113 ) ( 120,150 ) Accrued compensation ( 390,693 ) ( 399,057 ) Lease Obligation ( 2,564,741 ) ( 3,014,148 ) Pensions ( 6,049,532 ) ( 7,761,369 ) Foreign Tax Credit ( 1,164,515 ) ( 976,000 ) Capital Loss Carry forward ( 182,582 ) - Other - ( 97,072 ) Total deferred income tax assets ( 11,919,620 ) ( 13,739,459 ) Net deferred income tax (assets) liabilities $ 1,151,759 $ 2,899,075 Income before income taxes consists of: 2021 2020 Continued Operations Discontinued Operations Total Income Statement Continued Operations Discontinued Operations Total Income Statement Domestic $ 14,574,811 $ ( 8,936,924 ) $ 5,637,887 $ 12,387,294 $ ( 7,191,198 ) $ 5,196,096 Foreign 4,495,749 - 4,495,749 829,516 - 829,516 $ 19,070,560 $ ( 8,936,924 ) $ 10,133,636 $ 13,216,810 $ ( 7,191,198 ) $ 6,025,612 50 Table of Contents The Eastern Company Notes to Consolidated Financial Statements (continued) 9. INCOME TAXES (continued) The provision for income taxes follows: 2021 2020 Continued Operations Discontinued Operations Total Income Statement Continued Operations Discontinued Operations Total Income Statement Current Federal $ 4,075,121 $ ( 1,816,413 ) $ 2,258,708 $ 993,337 $ ( 1,496,443 ) $ ( 503,106 ) Foreign 1,509,693 ( 287,339 ) 1,222,354 1,162,197 ( 65,358 ) 1,096,839 State 498,939 - 498,939 223,978 - 223,978 Deferred: Federal ( 2,292,101 ) - ( 2,292,101 ) ( 46,555 ) - ( 46,555 ) Foreign ( 189,970 ) - ( 189,970 ) ( 65,315 ) - ( 65,315 ) State ( 713,465 ) - ( 713,465 ) ( 85,751 ) - ( 85,751 ) $ 2,888,217 $ ( 2,103,752 ) $ 784,465 $ 2,181,891 $ ( 1,561,801 ) $ 620,090 A reconciliation of income taxes computed using the U.S. federal statutory rate to that reflected in operations follows: 2021 2020 Amount Percent Amount Percent Income taxes using U.S. federal statutory rate $ 2,128,063 21 % $ 1,265,378 21 % State income taxes, net of federal benefit ( 165,221 ) ( 2 ) 96,742 1 Impact on Foreign Repatriation Tax Reform 11,313 0 139,765 2 Impact of foreign subsidiaries on effective tax rate ( 282,614 ) ( 3 ) 165,210 3 Impact of Research & Development tax credit ( 188,944 ) ( 3 ) ( 188,944 ) ( 3 ) Uncertain tax positions reserve ( 417,197 ) ( 3 ) ( 926,101 ) ( 15 ) Other net ( 300,935 ) ( 3 ) 68,040 1 $ 784,465 7 % $ 620,090 10 % A reconciliation of income taxes computed using the U.S. federal statutory rate to that reflected in operations follows for continuing operations: 2021 2020 Amount Percent Amount Percent Income taxes using U.S. federal statutory rate $ 4,004,817 21 % $ 2,775,547 21 % State income taxes, net of federal benefit 61,777 1 148,374 1 Impact on Foreign Repatriation Tax Reform 11,313 0 139,765 1 Impact of foreign subsidiaries on effective tax rate ( 282,614 ) ( 2 ) 165,210 1 Impact of Research & Development tax credit ( 188,944 ) ( 1 ) ( 188,944 ) ( 1 ) Uncertain tax positions reserve ( 417,197 ) ( 2 ) ( 926,101 ) ( 7 ) Other net ( 300,935 ) ( 2 ) 68,040 0 $ 2,888,217 15 % $ 2,181,891 16 % 51 Table of Contents The Eastern Company Notes to Consolidated Financial Statements (continued) 9. INCOME TAXES (continued) A reconciliation of income taxes computed using the U.S. federal statutory rate to that reflected in operations follows for discontinued operations: 2021 2020 Amount Percent Amount Percent Income taxes using U.S. federal statutory rate $ ( 1,876,754 ) ( 21 )% $ ( 1,510,152 ) ( 21 )% State income taxes, net of federal benefit ( 226,998 ) ( 3 ) ( 51,632 ) ( 1 ) $ ( 2,103,752 ) ( 24 )% $ ( 1,561,784 ) ( 22 )% Total income taxes paid were $ 2,318,018 in 2021 and $ 3,755,475 in 2020. Under accounting standards (ASC 740), a deferred tax liability is not recorded for the excess of the financial reporting (book) basis over the tax basis of an investment in a foreign subsidiary if the indefinite reinvestment criteria are met. Effective for foreign earnings after December 30, 2017, if such earnings are distributed in the form of cash dividends, the Company would not be subject to additional U.S. income taxes but could be subject to foreign income and withholding taxes. A provision has not been made for additional U.S. federal and foreign taxes at January 1, 2022 on approximately $ 11,176,328 of undistributed earnings of foreign subsidiaries because the Company intends to reinvest these funds indefinitely. It is not practicable to estimate the unrecognized deferred tax liability for withholding taxes on these undistributed earnings. In December 2019, the FASB issued ASU 2019-12, Simplifying the Accounting for Income Taxes. The list of changes is comprehensive. The changes include removing exceptions to incremental intraperiod tax allocation of losses and gains from different financial statement components, exceptions to the method of recognizing income taxes on interim period losses and exceptions to deferred tax liability recognition related to foreign subsidiary investments. In addition, ASU 2019-12 requires that entities recognize franchise tax based on an incremental method, requires an entity to evaluate the accounting for step-ups in the tax basis of goodwill as inside or outside of a business combination, and removes the requirement to allocate the current and deferred tax provision among entities in standalone financial statement reporting. The ASU also now requires that an entity reflect enacted changes in tax laws in the annual effective rate, and other Codification adjustments have been made to employee stock ownership plans. For public business entities, the amendments in ASU 2019-12 are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. Early adoption of ASU 2019-12 is permitted, including adoption in any interim period for public business entities for periods for which financial statements have not yet been issued. An entity that elects to early adopt the amendments in an interim period should reflect any adjustments as of the beginning of the annual period that includes that interim period. Additionally, an entity that elects early adoption must adopt all the amendments in the same period. The Company adopted ASU 2019-12 in the first interim period of 2021. On March 27, 2020, the $ 2 trillion bipartisan Coronavirus Aid, Relief, and Economic Security Act (H.R. 748) (the “CARES Act”) became law. The CARES Act includes a variety of economic and tax relief measures intended to stimulate the economy, including loans for small businesses, payroll tax credits/deferrals, and corporate income tax relief. We are analyzing the following components of the CARES Act to determine their effect on our income tax provision: · Net operating losses arising in 2018, 2019, and 2020 taxable years may be carried back to each of the preceding five years, which may result in refunds of prior period corporate income tax. The Company had taxable income in 2018, 2019 and 2020, thus we did not benefit from this item of CARES Act relief. · Furthermore, for taxable years beginning before 2021, net operating loss carryforwards and carrybacks to that year may offset 100% of taxable income in the year. Previously, net operating losses generated through 2017 could offset 100% of taxable income, while losses generated after 2017 could only offset 80% of taxable income. As noted previously, the Company had taxable income in 2018, 2019 and 2020, thus we did not benefit from this item of CARES Act relief. 52 Table of Contents The Eastern Company Notes to Consolidated Financial Statements (continued) 9. INCOME TAXES (continued) · For taxable years beginning in 2019 and 2020, the interest deduction limitation is increased from 30% to 50% of “adjusted taxable income” (taxable income without interest, tax depreciation and tax amortization) plus interest income. Furthermore, the Company may choose to use the 2019 adjusted taxable income (instead of 2020) in determining the 2020 interest expense limitation. The Company was not subject to an interest limitation in 2019 nor 2020. · A technical correction to the Tax Cuts and Jobs Act permits bonus depreciation and a 15-year straight-line recovery period on qualified improvement property placed in service after December 31, 2017. Prior to this technical correction, such property placed in service after 2017 was subject to the 39-year straight-line recovery period and was ineligible for bonus depreciation. The Company will take advantage of this accelerated recovery period and bonus depreciation. To the extent the Company has eligible improvements in 2021, the Company can claim bonus depreciation which would reduce taxes payable and increase the deferred tax liability for fixed assets. · Other CARES Act corporate income tax provisions will not significantly impact the Company, including alternative minimum tax refunds and increases in the charitable contributions deduction limitation. The Company will also continue to assess the effect of state level tax relief provisions as enacted, such as state net operating loss rule changes and conformity to the federal interest, depreciation and charitable contribution deduction changes. A reconciliation of the beginning and ending amount of unrecognized tax benefits are as follows: 2021 2020 Balance at beginning of year $ 1,078,309 $ 2,407,382 Increase (decrease) for positions taken during the current period 45,721 ( 28,637 ) Increase (decrease) for positions taken during the prior period - - Increase (decrease) resulting from the expiration of the statute of limitations ( 451,932 ) ( 1,300,436 ) Balance at end of year $ 672,098 $ 1,078,309 The Company files income tax returns in the U.S. federal jurisdiction, and various states and foreign jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal, state and local income tax examinations by tax authorities for years before 2017 and non-U.S. income tax examinations by tax authorities prior to 2015. Included in the balance at January 1, 2022, are $ 243,052 of unrecognized tax benefits that would affect the annual effective tax rate. In 2021, the Company recognized accrued interest related to unrecognized tax benefits in income tax expense. The Company had approximately $ 65,836 of accrued interest at January 1, 2022. The total amount of unrecognized tax benefits could increase or decrease within the next twelve months for several reasons, including the closure of federal, state, and foreign tax years by expiration of the statute of limitations and the recognition and measurement considerations under ASC 740. The Company believes that the total amount of unrecognized tax benefits will not increase or decrease significantly over the next twelve months. 10. LEASES The Company leases certain equipment and buildings under operating lease arrangements. Most leases are for a fixed term and for a fixed amount. The Company is not a party to any leases that have capital improvement funding or payment increases based on any index or rate. 53 Table of Contents The Eastern Company Notes to Consolidated Financial Statements (continued) 10. LEASES (continued) Future minimum payments under non-cancelable operating leases with initial or remaining terms more than one year during each of the next five fiscal years follow: 2022 $ 2,664,895 2023 2,186,238 2024 1,700,834 2025 1,081,468 2026 805,722 $ 8,439,157 Rent expense for all operating leases was $ 2,816,258 in 2021 and $ 2,431,285 in 2020. The weighted average lease term for all operating leases is 6.4 years. The weighted average discount rate for all operating leases is 5 %. 11. RETIREMENT BENEFIT PLANS The Company has non-contributory defined benefit pension plans covering some U.S. employees. Plan benefits are generally based upon age at retirement, years of service and, for its salaried plan, the level of compensation. The Company also sponsors unfunded non-qualified supplemental retirement plans that provide certain former officers with benefits in excess of limits imposed by federal tax law. The Company also provides health care and life insurance for retired salaried employees in the United States who meet specific eligibility requirements. Components of the net periodic benefit cost of the Company’s pension benefit plans for the fiscal year indicated were as follows: 2021 2020 Service cost $ 1,087,333 $ 1,065,739 Interest cost 2,017,015 2,856,569 Expected return on plan assets ( 5,794,694 ) ( 5,461,044 ) Amortization of prior service cost 99,380 99,380 Amortization of the net loss 1,730,150 1,300,134 Net periodic benefit cost $ ( 860,816 ) $ ( 139,222 ) Service costs are reported in the cost of products sold and the other components of net periodic benefit costs are reported in other income in the consolidated statements of income. Assumptions used to determine net periodic benefit cost for the Company’s pension benefit plans for the fiscal year indicated were as follows: 2021 2020 Discount rate - Pension plans 2.40 % - 2.48 % 3.18 % - 3.23 % - Supplemental pension plans 1.49 % 2.61 % Expected return on plan assets 7.5 % 7.5 % Rate of compensation increase 0 % 0 % 54 Table of Contents The Eastern Company Notes to Consolidated Financial Statements (continued) 11. RETIREMENT BENEFIT PLANS (continued) Components of the net periodic benefit cost of the Company’s other postretirement benefit plan were as follows: 2021 2020 Service cost $ 54,505 $ 43,418 Interest cost 39,369 46,668 Expected return on plan assets ( 25,681 ) ( 22,355 ) Amortization of prior service cost - ( 8,253 ) Amortization of the net loss ( 12,374 ) ( 25,509 ) Net periodic benefit cost $ 55,819 $ 33,969 Assumptions used to determine net periodic benefit cost for the Company’s other postretirement plan for the fiscal year indicated were as follows: 2021 2020 Discount rate 2.66 % 3.35 % Expected return on plan assets 4.0 % 4.0 % As of January 1, 2022, and January 2, 2021, the status of the Company’s pension benefit plans and other postretirement benefit plan was as follows: Pension Benefit Other Postretirement Benefit 2021 2020 2021 2020 Benefit obligation at beginning of year $ 111,549,725 $ 102,991,053 $ 1,827,169 $ 1,566,019 Change in discount rate ( 5,316,621 ) 10,606,739 ( 96,343 ) 218,000 Service cost 1,087,333 1,065,739 54,505 43,418 Interest cost 2,017,015 2,856,569 39,369 46,668 Plan Amendment - - 36,388 - Actuarial (gain)/loss 2,340,743 ( 1,786,595 ) 110,462 32,282 Significant Event - - ( 218,103 ) - Benefits paid ( 4,257,857 ) ( 4,183,750 ) ( 28,865 ) ( 14,654 ) Benefit obligation at end of year $ 107,420,338 $ 111,549,725 $ 1,724,582 $ 1,827,169 2021 2020 2021 2020 Fair value of plan assets at beginning of year $ 78,361,102 $ 74,359,558 $ 642,030 $ 558,873 Actual return on plan assets 4,369,247 5,568,671 16,066 83,157 Employer contributions 2,342,462 2,616,623 45,243 33,343 Significant Event - - ( 218,103 ) - Benefits paid ( 4,257,855 ) ( 4,183,750 ) ( 45,243 ) ( 33,343 ) Fair value of plan assets at end of year $ 80,814,956 $ 78,361,102 $ 439,993 $ 642,030 Pension Benefit Other Postretirement Benefit Funded Status 2021 2020 2021 2020 Net amount recognized in the balance sheet $ ( 26,605,382 ) $ ( 33,188,623 ) $ ( 1,284,589 ) $ ( 1,185,139 ) 55 Table of Contents The Eastern Company Notes to Consolidated Financial Statements (continued) 11. RETIREMENT BENEFIT PLANS (continued) Amounts recognized in accumulated other comprehensive income consist of: Pension Benefit Other Postretirement Benefit 2021 2020 2021 2020 Net (loss)/gain $ ( 40,447,026 ) $ ( 43,727,607 ) $ 241,621 $ 349,276 Prior service (cost) credit ( 66,252 ) ( 165,632 ) - - $ ( 40,513,278 ) $ ( 43,893,239 ) $ 241,621 $ 349,276 Change in the components of accumulated other comprehensive income consist of: Pension Benefit Other Postretirement Benefit 2021 2020 2021 2020 Balance at beginning of period $ ( 43,893,239 ) $ ( 36,580,267 ) $ 349,276 $ 507,954 Change due to availability of final actual assets and census data - - - - Charged to net periodic benefit cost Prior service cost 99,380 99,380 - ( 8,253 ) Net loss (gain) 1,730,150 1,300,134 ( 12,374 ) ( 25,509 ) Liability (gains)/losses Discount rate 5,316,621 ( 10,606,709 ) 96,343 ( 218,000 ) Asset (gains)/losses deferred ( 771,444 ) 6,202,764 ( 9,615 ) 60,802 Plan Amendments - - ( 36,388 ) - Significant Event - - ( 35,159 ) - Other ( 2,994,746 ) ( 4,308,541 ) ( 110,462 ) 32,282 Balance at end of period $ ( 40,513,278 ) $ ( 43,893,239 ) $ 241,621 $ 349,276 Assumptions used to determine the projected benefit obligations for the Company’s pension benefit plans and other postretirement benefit plan for the fiscal year indicated were as follows: 2021 2020 Discount rate - Pension plans 2.75 % - 2.81 % 2.40 % - 2.48 % - Supplemental pension plans 2.08 % 1.49 % - Other postretirement plan 2.93 % 2.66 % At January 1, 2022 and January 2, 2021, the accumulated benefit obligation for all qualified and nonqualified defined benefit pension plans was $ 107,420,338 and $ 111,549,725 , respectively. During 2021, the pension benefit obligation decreased between 3.5% to 4.8% due to the decrease in the discount rates from 2.40 %- 2.48 % to 2.75 %- 2.81 %. 56 Table of Contents The Eastern Company Notes to Consolidated Financial Statements (continued) 11. RETIREMENT BENEFIT PLANS (continued) Information for the under-funded pension plans with a projected benefit obligation and an accumulated benefit obligation in excess of plan assets: 2021 2020 Number of plans 5 5 Projected benefit obligation $ 107,420,338 $ 111,549,725 Accumulated benefit obligation 107,420,338 111,549,725 Fair value of plan assets 80,814,956 78,361,102 Net amount recognized in accrued benefit liability $ ( 26,605,382 ) $ ( 33,188,623 ) Estimated future benefit payments to participants of the Company’s pension plans are $ 4.8 million in 2022, $ 5.0 million in 2023, $ 5.2 million in 2024, $ 5.4 million in 2025, $ 5.5 million in 2026 and a total of $ 29.2 million from 2027 through 2031. Estimated future benefit payments to participants of the Company’s other postretirement plan are $ 50,000 in 2022, $ 50,000 in 2023, $ 50,000 in 2024, $ 52,000 in 2025, $ 54,000 in 2026 and a total of $ 303,000 from 2027 through 2031. The Company expects to make cash contributions to its qualified pension plans of approximately $ 300,000 and to its other postretirement plan of approximately $ 50,000 in 2022. We consider a number of factors in determining and selecting assumptions for the overall expected long-term rate of return on plan assets. We consider the historical long-term return experience of our assets, the current and expected allocation of our plan assets, and expected long-term rates of return. We derive these expected long-term rates of return with the assistance of our investment advisors and generally base these rates on a 10-year horizon for various asset classes and consider the expected positive impact of active investment management. We base our expected allocation of plan assets on a diversified portfolio consisting of domestic and international equity securities and fixed income securities. We consider a variety of factors in determining and selecting our assumptions for the discount rate at the end of the year. In 2021, as in 2020, we developed each plan’s discount rate with the assistance of our actuaries by matching expected future benefit payments in each year to the corresponding spot rates from the FTSE Pension Liability Yield Curve, comprised of high quality (rated AA or better) corporate bonds. 57 Table of Contents The Eastern Company Notes to Consolidated Financial Statements (continued) 11. RETIREMENT BENEFIT PLANS (continued) The fair values of the company’s pension plans assets at January 1, 2022 and January 2, 2021, utilizing the fair value hierarchy discussed in Note 4 – Accounting Policies – Fair Value of Financial Instruments , follow: January 1, 2022 Level 1 Level 2 Level 3 Total Cash and Equivalents: Common/collective trust funds $ — $ 356,173 $ — $ 356,173 Equities: The Eastern Company Common Stock 5,460,173 — 5,460,173 Common/collective trust funds Russell Multi Asset Core Plus Fund (a) — 36,142,837 — 36,142,837 Fixed Income: Common/collective trust funds Target Duration LDI Fixed Income Funds (b) · Russell 25 Year LDI Fixed Income Fund — 4,320,207 — 4,320,207 · Russell 14 Year LDI Fixed Income Fund — 26,430,482 — 26,430,482 STRIPS Fixed Income Funds (c) · Russell 15 to 20 Year STRIPS Fixed Income Fund — 3,264,328 — 3,264,328 · Russell 10 to 15 Year STRIPS Fixed Income Fund — 4,840,756 — 4,840,756 Total $ 5,460,173 $ 75,354,783 $ — $ 80,814,956 58 Table of Contents The Eastern Company Notes to Consolidated Financial Statements (continued) 11. RETIREMENT BENEFIT PLANS (continued) January 2, 2021 Level 1 Level 2 Level 3 Total Cash and Equivalents: Common/collective trust funds $ — $ 347,538 $ — $ 347,538 Equities: The Eastern Company Common Stock 5,230,134 — 5,230,134 Common/collective trust funds Russell Multi Asset Core Plus Fund (a) — 35,139,260 — 35,139,260 Fixed Income: Common/collective trust funds Target Duration LDI Fixed Income Funds (b) · Russell 25 Year LDI Fixed Income Fund — 2,506,615 — 2,506,615 · Russell 14 Year LDI Fixed Income Fund — 26,452,904 — 26,452,904 STRIPS Fixed Income Funds (c) · Russell 15 to 20 Year STRIPS Fixed Income Fund — 3,500,718 — 3,500,718 · Russell 10 to 15 Year STRIPS Fixed Income Fund — 5,183,933 — 5,183,933 Total $ 5,230,134 $ 73,130,968 $ — $ 78,361,102 Equity common funds primarily hold publicly traded common stock of both U.S and international companies selected for purposes of total return and to maintain equity exposure consistent with policy allocations. The Level 1 investment is made up of shares of The Eastern Company Common Stock and is valued at market price. Level 2 investments include commingled funds valued at unit values provided by the investment managers, which are based on the fair value of the underlying publicly traded securities. 59 Table of Contents The Eastern Company Notes to Consolidated Financial Statements (continued) 11. RETIREMENT BENEFIT PLANS (continued) (a) The investment objective of the RITC (formerly Russell) Multi-Asset Core Plus Fund seeks to provide long-term growth of capital over a market cycle by offering a diversified portfolio of funds and separate accounts investing in global stock, return seeking fixed income, commodities, global real estate, and opportunistic investments. They hold a dynamic mix of underlying Russell Investments funds and/or separate accounts. Russell Investments is a strong proponent of disciplined strategic asset allocation and rebalancing strategies and believes that unstable movements in the market have the potential to create opportunities. By identifying short-term mispricing and making small tactical adjustments to the Multi-Asset Core Plus Fund, they believe there is potential to enhance returns while continuing to manage risks. (b) The Target Duration LDI Fixed Income Funds seek to outperform their respective Barclays-Russell LDI Indexes over a full market cycle. These Funds invest primarily in investment grade corporate bonds that closely match those found in discount curves used to value U.S. pension liabilities. They seek to provide additional incremental return through modest interest rate timing, security selection and tactical use of non-credit sectors. Generally, for use in combination with other bond funds to gain additional credit exposure, with the goal of reducing the mismatch between a plan’s assets and liabilities. (c) The STRIPS (Separate Trading of Registered Interest and Principal of Securities) Funds seek to provide duration and Treasury exposure by investing in an optimized subset of the STRIPS universe with a similar duration profile as the Barclays U.S. Treasury STRIPS 10-11 year, 16-16 year or 28-29 year Index. These passively managed funds are generally used with other bond funds to add additional duration to the asset portfolio. This will help reduce the mismatch between a plan’s assets and liabilities. The investment portfolio contains a diversified blend of common stocks, bonds, cash equivalents, and other investments, which may reflect varying rates of return. The investments are further diversified within each asset classification. The portfolio diversification provides protection against a single security or class of securities having a disproportionate impact on aggregate performance. The Company has elected to change its investment strategy to better match the assets with the underlying plan liabilities. Currently, the long-term target allocations for plan assets are 50% in equities and 50% in fixed income although the actual plan asset allocations may be within a range around these targets. The actual asset allocations are reviewed and rebalanced on a periodic basis to maintain the target allocations. It is expected that, as the funded status of the plans improves, more assets will be invested in long-duration fixed income instruments. The plans’ assets include 217,018 shares of the common stock of the Company having a market value of $ 5,460,173 and $ 5,230,134 on January 1, 2022 and January 2, 2021, respectively. No shares were purchased in 2021 or 2020 nor were any shares sold in either period. Dividends received during 2021 and 2020 on the common stock of the Company were $ 95,488 and $ 95,488 respectively. U.S. salaried and non-union hourly employees and most employees of the Company’s Canadian subsidiaries are covered by defined contribution plans. The Company has a contributory savings plan under Section 401(k) of the Internal Revenue Code covering substantially all U.S. non-union employees. This plan allows participants to make voluntary contributions of up to 100% of their annual compensation on a pretax basis, subject to IRS limitations. The plan provides for contributions by the Company at its discretion. 60 Table of Contents The Eastern Company Notes to Consolidated Financial Statements (continued) 11. RETIREMENT BENEFIT PLANS (continued) The Company amended the Eastern Company Savings and Investment Plan (“401(k) Plan Amendment”) effective June 1, 2016. The 401(k) Plan Amendment increased this match to 50% of the first 6% of contributions for the remainder of Fiscal 2016. The 401(k) Plan Amendment also provided for an additional non-discretionary contribution (the “transitional credit”) for certain non-union U.S. employees who were eligible to participate in the Salaried Plan. The amount of this non-discretionary contribution ranges from 0% to 4% of wages, based on the age of the individual on June 1, 2016. The 401(k) Plan Amendment increased the non-discretionary safe harbor contribution to 3% and changed the eligibility to all non-union U.S. employees. The Company made contributions to the plan as follows: 2021 2020 Regular matching contributions $ 553,619 $ 535,910 Transitional credit contributions 138,604 163,464 Non-discretionary contributions 392,865 398,908 Total contributions made for the period $ 1,085,088 $ 1,098,282 As of January 1, 2022, the Company had accrued $ 323,082 for the non-discretionary safe harbor contribution this amount was expensed in 2021 and was contributed to the plan in January 2022. As of January 2, 2021, the Company had accrued $ 332,092 for the non-discretionary safe harbor contribution. This amount was contributed to the Plan in January 2021 and was expensed in 2020. 12. EARNINGS PER SHARE The denominators used in the earnings per share computations follow: 2021 2020 Basic: Weighted average shares outstanding 6,262,378 6,237,698 Diluted: Weighted average shares outstanding 6,262,378 6,237,698 Dilutive stock awards 711 26,823 Denominator for diluted earnings per share 6,263,089 6,264,521 There were no anti-dilutive stock equivalents in 2021 or 2020. 61 Table of Contents The Eastern Company Notes to Consolidated Financial Statements (continued) 13. GEOGRAPHIC INFORMATION 2021 2020 Geographic Information: Net Sales: United States $ 234,300,461 $ 187,046,011 Foreign 12,222,362 10,568,579 $ 246,522,823 $ 197,614,590 Foreign sales are primarily to customers in North America. Identifiable Assets: United States $ 252,961,017 $ 253,689,704 Foreign 13,367,918 21,838,650 $ 266,328,935 $ 275,528,354 14. RECENT ACCOUNTING PRONOUNCEMENTS Adopted In December 2019, FASB issued ASU 2019-12, Simplifying the Accounting for Income Tax. The changes implemented in ASU 2019-12 include removing exceptions to incremental intraperiod tax allocation of losses and gains from different financial statement components, exceptions to the method of recognizing income taxes on interim period losses and exceptions to deferred tax liability recognition related to foreign subsidiary investments. In addition, ASU 2019-12 requires that entities recognize franchise tax based on an incremental method, requires an entity to evaluate the accounting for step-ups in the tax basis of goodwill as inside or outside of a business combination, and removes the requirement to allocate the current and deferred tax provision among entities in standalone financial statement reporting. The ASU also now requires that an entity reflect enacted changes in tax laws in the annual effective rate, and other codification adjustments have been made to employee stock ownership plans. The Company adopted ASU 2019-12 as of January 3, 2021. The adoption of this guidance did not have a material impact on the consolidated financial statements of the Company. The Company has implemented all new accounting pronouncements that are in effect and that could impact its consolidated financial statements and does not believe that there are any other new accounting pronouncements that have been issued, but are not yet effective, that might have a material impact on the consolidated financial statements of the Company. 62 Table of Contents The Eastern Company Notes to Consolidated Financial Statements (continued) 15. CONTINGENCIES The Company is party to various legal proceedings from time to time related to its normal business operations. Currently, the Company is not involved in any legal proceedings. In 2016, the Company created a plan to remediate a landfill of spent foundry sand maintained at the Company’s previously owned metal casting facility in New York. This plan was agreed to by the New York State Department of Environmental Conservation (the “NYSDEC”) on March 27, 2018. Based on estimates provided by the Company’s environmental engineers, the anticipated cost to remediate and monitor the landfill was $ 430,000 . The Company accrued for and expensed the entire $430,000 in the first quarter of 2018 and fiscal 2017. In the fall of 2018, detailed construction drawings were prepared by an outside consultant in conjunction with informal progress reviews by the NYSDEC. Long-term groundwater monitoring commenced in April 2019. Verbal approval for the closure plan was received from the NYSDEC in May 2019. Construction of the closure remedies, including improved drainage system, regrading, and installation of a low permeability cap was completed in October 2021. A closure report and long-term maintenance plan were submitted to the NYSDEC in November 2021. The 30-year annual groundwater monitoring and site maintenance program are underway and will continue through 2048. 16. CONCENTRATION OF RISK Credit Risk Credit risk is the potential financial loss resulting from the failure of a customer or counterparty to settle its financial and contractual obligations to the Company, as and when they become due. The primary credit risk for the Company is its accounts receivable due from customers. The Company has established credit limits for customers and monitors their balances to mitigate the risk of loss. As of January 1, 2022, and January 2, 2021, there was one significant concentration of credit risk. One customer represented 11 % of total accounts receivable for 2021 and 2020. The maximum exposure to credit risk is primarily represented by the carrying amount of the Company’s accounts receivable. Interest Rate 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 1.25 % to 2.25 %. The Company has an interest rate swap with a notional amount of $ 46,875,000 on January 2, 2021, to convert a portion of borrowings under the Credit Agreement from variable to fixed rates. The valuation of this swap is determined using the one-month LIBOR rate index and mitigates the Company’s exposure to interest rate risk. Additionally, interest rates on the Company’s debt are susceptible to changes to the method that LIBOR rates are determined and to the potential phasing out of LIBOR after 2021. More information regarding the potential phasing out of LIBOR is discussed in greater detail under Note 6, Debt to the Consolidated Financial Statements. Currency Exchange Rate Risk The Company’s currency exposure is concentrated in the Canadian dollar, Mexican peso, New Taiwan dollar, Chinese RMB, Hong Kong dollar and United Kingdom pound sterling. 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. As a result, the Company does not attempt to mitigate its foreign currency exposure through the acquisition of any speculative or leveraged financial instruments. 63 Table of Contents The Eastern Company Report of Independent Registered Public Accounting Firm To the Board of Directors and Shareholders of Naugatuck, Connecticut Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of The Eastern Company (the Company) as of January 1, 2022 and January 2, 2021, and the related consolidated statements of income, comprehensive income, stockholders’ equity, and cash flows for each of the years in the two-year period ended January 1, 2022, including the related notes and financial statement schedule appearing under Item 15(a)(2) (collectively referred to as the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of January 1, 2022 and January 2, 2021, and the results of its operations and its cash flows for each of the years in the two-year period ended January 1, 2022, in conformity with accounting principles generally accepted in the United States of America. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of January 1, 2022, based on criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 17, 2022, expressed an unqualified opinion. Basis for Opinion These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matter The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the Audit Committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of a critical audit matter does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. Impairment Assessment of Goodwill Description of the Critical Audit Matter and the Relevant Accounts and Disclosures As described in Notes 4 and 5 to the consolidated financial statements, the Company’s consolidated goodwill balance is $72.2 million as of January 1, 2022. Management tests reporting units for impairment annually in December, or more frequently if events or circumstances indicate it is more likely than not that the fair value of a reporting unit is less than its carrying amount. As disclosed by management, reporting units are tested for impairment by utilizing qualitative factors that include a) macroeconomic conditions, b) market and industry conditions, c) cost factors, d) overall financial performance, e) other relevant entity-specific events, and f) events affecting a reporting unit. Principal Considerations for the Designation of the Critical Audit Matter The principal considerations for our determination that performing procedures relating to the goodwill impairment assessments is a critical audit matter are (i) the significant judgments and assumptions used by management when developing the qualitative factors that are part of the impairment assessment; and (ii) a high degree of auditor judgment, subjectivity and effort in performing procedures and evaluating management’s significant judgments and assumptions related to the qualitative factors. 64 Table of Contents How the Critical Audit Matter was Addressed in the Audit Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to management’s goodwill impairment assessments, including controls over the valuation of the Company’s reporting units. These procedures also included, among others (i) testing management’s process for developing the qualitative factors; (ii) evaluating the appropriateness of the qualitative factors; and (iii) testing the completeness and accuracy of underlying data used in the qualitative factors by corroborating and recalculating the relevant metrics. Evaluating management’s significant judgments and assumptions related to qualitative factors involved evaluating whether those significant judgments and assumptions used by management were reasonable considering (i) the current and past performance of the reporting units; (ii) the consistency with external market and industry data; and (iii) whether these assumptions were consistent with evidence obtained in other areas of the audit. /s/Fiondella, Milone & LaSaracina LLP Fiondella, Milone & LaSaracina LLP We have served as the Company’s auditor since 2009. Glastonbury, Connecticut March 17, 2022 65 Table of Contents ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None.