Item 1.
BUSINESS
Business
The A.T. Cross Company has two reportable business segments: writing instruments and accessories ("WI&A"), and optical. For certain financial information with respect to these segments, see Note K to the Company's consolidated financial statements included in Item 8 of this Annual Report on Form 10-K.
Writing Instruments and Accessories
We manufacture and market fine quality writing instruments under the Cross® brand consisting of ball-point pens, fountain pens, selectip rolling ball pens. We also manufacture and market a variety of refills for most of our product types. In addition to Cross branded writing instruments, we design and market writing instruments sold under the Penatia® and Omni® by Cross brands and a line of writing instruments sold under the licensed name of Bill Blass®. The Company is an original equipment manufacturer ("OEM") of writing instruments. In addition to writing instruments, we also design and market a variety of personal and business accessories including watches, precision reading glasses, desk sets, leather goods and key rings. The Company periodically launches new products.
Our writing instruments are offered in a variety of styles and materials at various price points. They are packaged and sold as individual units or in matching sets. The majority of the Company's writing instrument sales occur at suggested retail price points between approximately $10 and $50. We believe we are a market leader in the United States at these price points. Products in this price range include: Classic® Century®, Autocross™, Calais, Tech3 and selected Century II and ATX® writing instruments. The Cross Townsend®, Verve™, Apogee™ and Century II lines as well as selected Classic Century writing instruments provide the Company a presence in the $55 to $300 price range. Certain Classic Century, Cross Townsend and Verve writing instruments are priced over $300. The Albion, Bradbury, Cardinal, Helios, Parasol and Torpedo lines of writing instruments are currently sold exclusively to the Company's office superstore customers. The Penatia brand, which is not a "Cross" branded line of writing instruments, provides the Company a presence in the under $10 price range.
Watches are priced between $70 and $190, precision reading glasses are priced at $25 and the majority of business accessories are priced between $20 and $110.
The Company emphasizes styling, innovation, craftsmanship and quality in the design and production of all of its products. All Cross branded writing instruments carry a full warranty of unlimited duration against mechanical failure. Our watches are sold with a limited ten-year warranty, and business accessories are sold with a limited one-year warranty.
The Company's products are sold throughout the United States by our direct sales force and manufacturers' agents or representatives to approximately 5,600 retail and wholesale accounts. Retail accounts include: gift stores, department stores, jewelers, stationery, office supply and pen specialty stores, mass merchandisers and United States military post exchanges. Our wholesale accounts distribute the Company's products to retail outlets that purchase in smaller quantities. The Company's products are also sold to consumers in the United States, Canada and Hong Kong on the Company's website: www.cross.com. Advertising specialty representatives market the Company's writing instruments, accessories and watches in the United States to business accounts. Typically, such products are engraved or carry the purchaser's name or emblem and are used for gifts, sales promotions, incentive purposes or advertising.
Sales of the Company's products outside the United States during 2006 were made to foreign distributors and retailers worldwide by the Company and its wholly-owned subsidiaries.
Optical
The Company, through its wholly-owned subsidiary Costa Del Mar Sunglasses, Inc., designs, manufactures and markets premium, high-quality, polarized eyewear through its optical segment under the brand name Costa Del Mar®. Offered in more than 46 styles and 18 lens options at suggested retail price points between approximately $125 and $275, our eyewear is sold by employee representatives and manufacturer's agents to approximately 3,000 retail accounts throughout the United States. Retail accounts include optical and sunglass specialty shops, department stores and sporting goods retailers. Costa Del Mar sunglasses are sold with a lifetime warranty against defects in materials and workmanship.
Raw Materials
The Company obtains raw materials for use in writing instruments from both domestic and foreign suppliers. Items such as certain fountain pen front sections, refills, coated caps and barrels, and some lacquer coatings are obtained from Germany, Switzerland and France. Complete pencil mechanisms, certain refill components, leads, resin caps and barrels, some fountain pen front sections, cap components and certain coated shells are obtained from Japan. Some rings, screw machine parts, pen mechanisms, molded components, and cap and barrel components and assemblies are obtained from China.
The majority of component materials for the optical segment are imported from specialized manufacturers located in Europe and Asia.
To maintain the highest level of product quality, we rely on a limited number of domestic and foreign suppliers for certain raw materials and manufacturing technologies. The Company may be adversely affected in the event that these suppliers cease operations or if pricing terms become less favorable. The Company believes, but cannot be assured, that the raw materials currently supplied by these vendors could be obtained from other sources and that the manufacturing technologies could either be developed internally or that suitably similar technologies could be located.
Patents, Licenses and Trademarks
The Company, directly or through its subsidiaries, has certain writing instrument, timepiece, accessory and optical trademark registrations and/or pending trademark applications in the United States and many foreign countries, including but not limited to its principal trademark "CROSS" and the trademark "COSTA DEL MAR." The principal trademark "CROSS" is of fundamental importance to our business in general and the trademark "COSTA DEL MAR" is of fundamental importance to the optical segment. The Company, directly or through its subsidiaries, holds certain United States and foreign writing instrument patents and/or has filed United States and foreign patent applications covering products including, but not limited to, Cross Townsend, Ion and Verve as well as the Company's ball-point pen mechanism. While we pursue a practice of seeking patent protection for novel inventions or designs, our business is not dependent upon obtaining and maintaining patents.
Seasonal Business
Retail demand for our writing instrument and accessory products is highest prior to Christmas and other gift-giving occasions. The Company historically has generated approximately one third of its annual sales in its fiscal fourth quarter. However, seasonal fluctuations have not materially affected continuous production of writing instrument products.
Costa Del Mar historically has generated its strongest sales in the first half of the Company's fiscal year.
Working Capital Requirements
Writing instrument and sunglass inventory balances tend to be highest in anticipation of new product launches and before peak selling seasons. The Company offers, and may offer in the future, extended payment terms, primarily to domestic retail writing instrument customers, at certain points during the year, usually September through November. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Item 7 of this Annual Report on Form 10-K.
Customers
The Company is not dependent upon any single customer for more than 10% of its consolidated revenues. The Company is dependent, however, on three large office supply accounts, Staples, Inc., OfficeMax, Inc. and Office Depot, Inc., for a significant portion of its revenue. In 2006, sales to this group were approximately 10% of consolidated revenues. The loss of one or more of these customers could have a material adverse effect on the Company. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Item 7 of this Annual Report on Form 10-K.
Backlog of Orders
The backlog of orders is not a significant factor in the Company's business.
Competition
The writing instrument industry is competitive, in particular with respect to product quality, brand recognition and price. There are numerous manufacturers of ball-point, rolling ball and fountain pens, and mechanical pencils in the United States and abroad. Many of these manufacturers produce lower priced writing instruments than those produced by the Company. Although the Company is a major producer of ball-point, rolling ball and fountain pens, and mechanical pencils in the $10 to $50 price range, other writing instrument companies have significantly higher sales volumes from a broader product line across a wider range of prices or have greater resources as divisions of larger corporations. The Company emphasizes styling, innovation, craftsmanship and quality in the design and production of all of its products. All of the Company's Cross branded writing instruments carry a full warranty of unlimited duration against mechanical failure.
The sunglass market in the United States is estimated to be $2.1 billion at wholesale. The Company's optical segment under the brand name Costa Del Mar competes in the premium-priced ($50+ retail) sunglass market segment, which is estimated to be $1.3 billion at wholesale. Several other sunglass companies also compete in the premium segment. Costa Del Mar sunglasses are sold with a lifetime warranty against defects in materials and workmanship.
See also the "Risk Factors" in Item 1A
Item 1A.
RISK FACTORS
The following section describes certain of the more prominent risks and uncertainties inherent in our operations. The risks and uncertainties below are those that we currently consider material; however, this section does not intend to discuss all possible risks and uncertainties that a company like Cross with broad international operations could experience. We are susceptible to macroeconomic downturns in the United States or abroad that may affect the general economic climate and the performance of our customers. Similarly, the price of our securities is subject to volatility due to fluctuations in general market conditions, differences in our results of operations from estimates and projections generated by the investment community, and other factors beyond our control. Further, there could be other risks and uncertainties that are not presently known to us or that may become more significant to us. You should read these Risk Factors in conjunction with the factors discussed elsewhere in this and other of our filings with the Securities and Exchange Commission and in materials incorporated by reference in these filings. We undertake no obligation to correct or update any forward-looking statements or statements of risk related thereto for any reason.
We depend on the success of new products.
Our ability to sustain profitability and restore growth in sales depends largely on consumer acceptance of numerous new products recently introduced and planned for introduction. Further, consumer preferences are continuously changing. The markets in which we sell are highly competitive, and there is no assurance that consumer acceptance will be realized to the degree necessary to generate growth in our sales and earnings.
Our global manufacturing, sales and distribution operations make us susceptible to the risks of overseas operations.
We have sales offices and certain operations in eight countries and distributors worldwide. In 2006, approximately 47% of our revenue came from sales to locations outside the United States. Many of our products are now manufactured overseas. Operating internationally exposes us to changes in export controls and other laws or regulations, as well as the general political and economic conditions, security risks, health conditions and possible disruptions in transportation networks, of the various countries in which we operate, which could result in an adverse effect on our business and results of operations in such countries.
Incorrect forecasts of customer demand could adversely affect our results of operations.
The Company manufactures product based on forecasts of customers' demands. These forecasts are based on multiple assumptions. If we inaccurately forecast customer demand by over or underestimating that demand, we may hold inadequate, excess or obsolete inventory that would reduce our profit margins and adversely affect our results of operations and financial condition.
Our success depends on our ability to retain and recruit a sufficient number of qualified employees in a competitive environment.
Our success depends in part on our retention and recruitment of skilled personnel, including technical, distribution, sourcing, marketing, sales, management and staff personnel. There can be no assurance that we will be able to successfully retain and recruit the key personnel that we require.
Our dependence on certain suppliers may leave us temporarily without adequate access to raw materials or products.
To maintain the highest level of product quality, we rely on a limited number of domestic and foreign suppliers for certain raw materials, manufacturing technologies and certain finished products. We may be adversely affected in the event that these suppliers cease operations or if pricing terms become less favorable. We believe, but cannot guarantee, that we could obtain the raw materials currently supplied by these vendors from other sources and that we could either develop the manufacturing technologies internally or locate suitably similar technologies. If we are unable to replace a key supplier we may face delays in delivering finished products according to our customers' demands, which could have an adverse effect on our financial performance.
Overseas manufacturing makes us dependent upon the performance of our overseas partners.
As a result of our manufacturing initiative, which is now largely completed, we manufacture a significant number of finished products in China. Our manufacturing operations in China are overseen and managed by a local manufacturing partner. Should that partner not perform as expected, or should the relationship between the parties deteriorate, there could be a material adverse effect on our operations. Despite our best efforts to maintain our strict quality standards, if the quality of our products is perceived to be affected by the initiative, our reputation may be harmed and we may lose future sales.
We depend on certain accounts for a significant percentage of our sales.
The Company is dependent on three large office supply accounts, Staples, Inc., OfficeMax, Inc. and Office Depot, Inc., for approximately 10% of its consolidated revenues. The loss of one or more of these customers could have a material adverse effect on the Company. Further, there is no assurance that these accounts will maintain their current inventory levels.
Unfavorable resolution of pending or future litigation matters could prove costly to us.
We are involved from time to time in litigation matters. An unfavorable resolution of pending litigation or future litigation could have a material adverse effect on our financial condition. Litigation may result in substantial costs and expenses and significantly divert the attention of our management regardless of the outcome. There can be no assurance that we will be able to achieve a favorable settlement of pending litigation or obtain a favorable resolution of litigation if it is not settled. In addition, current and future litigation, governmental proceedings or environmental matters could lead to increased costs or interruptions of our normal business operations.
Extension of the Cross brand beyond writing instruments may fail.
Because of the maturity of the fine writing instrument industry, our ability to achieve growth is dependent, in part, on our ability to extend the Cross brand beyond writing instruments. There is no assurance that consumers will accept the Cross brand outside of writing instruments, particularly business accessories and watches, at the level necessary to generate sustainable growth for us with these products, or that consumers will accept the design and price of these products. Because we have less institutional experience with product lines outside of writing instruments, and because the complementary product lines that we enter into, such as business accessories and watches, may be extremely competitive already, these brand extensions may not prove to be successful, adversely affecting future sales growth.
Our effort to streamline operations may not generate the savings we anticipate.
We expect to generate cash from our streamlining of operations, some of which will be invested in our sales and marketing programs and other initiatives to generate growth. A significant portion of these savings is contingent on our ability to keep costs in other areas of our operations at acceptable levels. If we are unable to realize the anticipated cost savings of this streamlining, our results of operations would suffer.
The diversification of our business may not be successful.
In order to generate growth outside of writing instruments, one of our strategic initiatives is to diversify outside of our core Cross branded product. Costa Del Mar was our first foray into this area of diversification. There can be no assurance that Costa Del Mar will continue to grow at its current levels or that we will find additional suitable targets for acquisition. If we do find a suitable acquisition target, we cannot assure that we will be able to consummate a deal on terms satisfactory to us or that we will be able to successfully integrate those operations into our company. We also cannot assure that such a strategy will not divert our management's time and attention from development of our core branded products in a way that would adversely affect writing instrument or other Cross branded sales.
Item 2.
Item 2.
PROPERTIES
Up until March 2007, the Company owned and occupied approximately 269,000 square feet of manufacturing, warehouse and office space in Lincoln, Rhode Island. On March 2, 2007, the Company sold this facility at One Albion Road, Lincoln, Rhode Island to Albion Crossing LLC. The Company is leasing back approximately 154,000 square feet of space in this facility for at least 10 years and intends to keep its corporate headquarters, as well as certain manufacturing, warehouse and retail space at this location. For additional information see Note P to the Company's consolidated financial statements in Item 8 of this Annual Report on Form 10-K.
In addition, the Company leases administrative facilities and/or manufacturing and warehouse space for its WI&A segment operations in France, the United Kingdom, The Netherlands, Germany, Japan, Taiwan, Hong Kong, Singapore and China. The Company also leases retail facilities in Massachusetts and the UK.
The Company's optical segment leases an administrative and warehouse facility in Ormond Beach, Florida.
Item 3.
Item 3.
LEGAL PROCEEDINGS
The Company is named as one of approximately sixty defendants in a contribution suit brought by CCL/Unilever relating to the J.M. Mills Landfill Site, which is part of the Peterson/Puritan Superfund Site in Cumberland, Rhode Island. These complaints allege that the Company is liable under CERCLA for contribution for past and future site investigation costs incurred at the site. Past and future site investigation costs (excluding the required remedy) are currently estimated at $7 million. Based upon our investigation to date, there does not appear to be evidence to support a finding that the Company arranged for the disposal of hazardous substances at this site. No formal discovery has been taken to date. At December 30, 2006, the Company had not established a liability for any environmental remediation relating to the J.M. Mills Landfill Site, as its potential liability, if any, is currently not estimable.
The Company is involved in various other litigation and legal matters that have arisen in the ordinary course of business. To its knowledge, management believes that the ultimate resolution of any of those existing matters will not have a material adverse effect on the Company's consolidated financial position or results of operations.
Item 4.
Item 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
PART II
Item 5.
Item 5.
MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
The Company's Class A common stock is traded on the American Stock Exchange (symbol: ATX). There is no established trading market for the Company's Class B common stock. At December 30, 2006, there were 1,265 shareholders of record of the Company's Class A common stock and two shareholders of record of the Company's Class B common stock. The weighted average numbers of total shares outstanding was 14,702,827 and 14,719,251 during 2006 and 2005, respectively.
Market Price of and Dividends on the Registrant's Common Equity and Related Shareholder Matters
High and low sales prices of Class A common stock for the last two years were:
The Company has not paid dividends to its stockholders since 1998 and does not plan to pay cash dividends in the foreseeable future. The Company intends to retain earnings, if any, to finance the growth of the Company.
Performance Graph
The following graph compares the performance of the Company's Class A common stock over the Company's last five years to the American Stock Exchange Market Value Index and to the Russell Group 2000 (as the Company's peer group index), over the Company's last five years. The graph assumes that the value of the investment in the Company's Class A common stock and each index was $100 at January 1, 2002 and that all dividends were reinvested.
COMPARE 5-YEAR CUMULATIVE TOTAL RETURN
AMONG A.T. CROSS COMPANY,
AMEX MARKET INDEX AND RUSSELL 2000 INDEX
The Company has chosen the Russell Group 2000 as a meaningful peer group against which to compare its performance. The Russell Group 2000 represents a broad based group of small capitalization stocks and is generally believed to be indicative of market performance for small capitalization companies.
Issuer Purchases of Equity Securities
On October 23, 2002, the Company's Board of Directors authorized a plan to purchase up to 10% of the Company's outstanding Class A common stock. Under this plan, the Company was authorized to purchase approximately 1.4 million shares of stock on the open market, subject to regulatory considerations, from time to time, depending on market conditions. At December 30, 2006, the Company had purchased 1,173,700 shares under this plan for approximately $6.3 million at an average price per share of $5.41. No purchases were made in 2006.
Item 6.
Item 6.
SELECTED FINANCIAL DATA
Five-Year Summary
*
OPERATIONS:
(THOUSANDS OF DOLLARS)
* Sales from the optical segment, established in April of 2003 with the acquisition of Costa Del Mar Sunglasses, Inc., were $8.9 million in 2003. The increases in total assets and long-term debt in 2003 are principally due to this acquisition.
Item 7.
Item 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Results of Operations
Overview
A.T. Cross Company is a leading designer and marketer of branded personal accessories including writing instruments, watches, precision reading glasses, personal and business accessories and sunglasses. The Company has been a manufacturer and marketer of fine quality writing instruments since 1846. Sold primarily under the Cross brand, ball-point, fountain and selectip rolling ball pens and mechanical pencils are offered in a variety of styles and finishes. Also under the Cross brand, the Company offers a line of watches, reading glasses and a variety of personal and business accessories. The Company offers a lower priced line of writing instruments and after-market refills under the brand name Penatia. We also offer writing instruments under licensed brands such as Bill Blass. The Company's optical segment consists of its wholly-owned subsidiary Costa Del Mar Sunglasses, Inc., a designer, manufacturer and marketer of high-quality polarized sunglasses.
The Company has been operating in a difficult economic environment in a mature and competitive category. The Company has challenged itself to build upon its unique attributes in order to develop a vibrant, diversified and forward-looking company poised for sustainable growth and long-term profitability. Such attributes include a strong brand name, 160-year heritage, reputation for quality and craftsmanship, global distribution network and strong balance sheet. The Company established several strategic initiatives to build upon these attributes and overcome its challenges, including: becoming an innovative leader in the fine writing category, extending the Cross brand into new categories, developing avenues for diversification and streamlining its operating structure. Fiscal 2006 was the first year in which the Company's core writing instrument and accessory segment reported an increase in sales since fiscal 2000.
The Company is competing vigorously to build its position as the category leader in terms of product innovation, marketing and merchandising. In fiscal 2006 approximately 30% of writing instrument and accessory revenue was derived from new products. The Company defines new product sales as those sales generated in a product's first twenty-four months. In 2006, the Company launched its Aventura and AutoCross writing instrument product lines. Three new finishes were added to the Apogee line, which was launched in 2005. Seasonal spring and fall colors for the ATX product line were also introduced. Two new finishes, Garnet and Citrine, were added to the Townsend line. Several new fashion colors were added to the Classic Century line as well as a Breast Cancer Awareness pen, which is adorned with a pink ribbon. Several additions were added to the Century II line including Ruby and Blush colors and seasonal prints; three in the spring, the Bahia collection, and three in the fall, the Chantilly collection. A new finish, Golden Shimmer, was added to the Verve line. The Company also launched Bradbury, Cardinal, Helios, Parasol and Torpedo lines as well as new licensed Bill Blass selections, products marketed specifically for its office super store customers. The Company launched its Calais line globally. The Calais line was launched to the office superstores in 2005.
In addition to bringing new products to the market, in 2006 a number of marketing and merchandising programs were launched globally. The marketing initiative was designed to present our products as contemporary accessories for everyday life. The "Pen Wall" changed the way the Cross brand is presented at select retail locations globally. The Company also expanded on its direct to consumer mail catalog in 2006.
The Company's sales force is organized around three major geographic regions: the Americas; Asia; and Europe, Middle East and Africa ("EMEA"). Within each of these regions, the Company uses a combination of direct sales force, manufacturers' representatives and distributors that sell to carriage trade, corporate and national account customers. Corporate gift sales to business and industry reported its third consecutive year of declining sales as the demand for writing instruments for general corporate promotional purposes continued to decline. The Company is attempting to offset this trend by focusing on developing programs marketed toward higher-priced incentive award programs.
The Cross brand has strong consumer awareness and, more importantly, consumers associate the Cross name with innovation, quality and style. The strong awareness of our name and the positive attributes associated with our brand support the extension of the Cross brand into related personal accessory categories. The Company has moved into categories that allow us to further utilize our existing sourcing infrastructure and global distribution network. A priority for all of our brand extensions is to incorporate the quality, design and craftsmanship that consumers enjoy from Cross' fine writing instruments. We have done this with our Cross branded accessories. Under a licensing agreement with Sun Optics, the Company launched a line of Cross branded precision reading glasses. The Company's watch collection, expanded in 2006 with the addition of our Cross Town line, was styled to bring the Cross brand to younger fashion-forward consumers. New lines of leather desktop accessories were introduced in 2006, including matching desk pad, pencil cup, accessory and notepaper boxes and frame ensembles. In 2006, the Company expanded its line of leather accessories with offerings featuring a variety of textured and colored products including multifunctional cases, agendas, padfolios, card cases, pen cases and key fobs. Several new desk sets were introduced constructed of granite and select woods. In 2006, precision readers, watches and business accessories comprised approximately 5% of WI&A sales, up two percentage points from 2005. We have developed a foothold in these categories and look forward to further strengthening our presence in 2007.
The acquisition of Costa Del Mar has proven to be very successful. As a result of the Costa Del Mar acquisition, Cross has benefited from revenue diversification and a substantial contribution to the bottom line. In 2006, Costa Del Mar grew its business 40% through new product introductions and expanded distribution and contributed $4.2 million of the Company's $4.5 million consolidated income before income taxes. Costa Del Mar upholds our commitment to delivering exceptional product, innovation and quality to our consumers. The Company continues to look for appropriate acquisitions that will add to top and bottom line growth.
By the end of 2006 the Company essentially completed its corporate restructuring program that involved streamlining our operations and transitioning the manufacturing of certain products overseas in order to reduce our cost structure. The savings we generated were used to invest in growing our businesses and to help cover increasing fixed costs while at the same time generating an appropriate level of profitability. Our corporate reorganization program had two components: administrative and manufacturing. On the administrative side, we streamlined our North American and European non-manufacturing operations and shifted resources to our marketing and selling functions. On the manufacturing side we have adopted a very deliberate process in order to maintain our strict quality standards. The Company is satisfied that all products now manufactured overseas meet the high-quality standards that consumers expect from Cross. We believe this restructuring program was necessary to preserve Cross's ability to remain a competitive, profitable company. For an analysis of the corporate restructuring program, see Note
C to the Company's consolidated financial statements in Item 8 of this Annual Report on Form 10-K.
Comparison of Fiscal 2006 with Fiscal 2005
The following chart details net sales performance by segment and operating unit:
Writing instruments and accessories revenue in the Americas declined $0.6 million, or 1.1%. Sales to the national account and business gift channels declined from 2005. This was somewhat offset by an increase in direct-to-consumer ("DTC") sales in 2006 compared to 2005.
Sales in the Europe, Middle East and Africa region ("EMEA") increased 6.6% compared to 2005. Foreign exchange was favorable to EMEA sales results by approximately 2.1 percentage points as sales volume increased approximately 4.5% for the full year.
Asia revenue of $18.5 million increased 1.2% compared to fiscal 2005. Foreign exchange was unfavorable to Asia sales results by approximately 2.7 percentage points as sales volume increased approximately 3.8% for the full year.
The optical segment increased revenue by 40% in 2006 compared to 2005. This increase was due largely to the introduction of new products, improved sell through at key accounts and, to a lesser extent, expanded geographic distribution.
The following chart details gross profit margins for both the writing instruments and accessories segment as well as the consolidated gross profit margins:
Consolidated gross margins improved 400 basis points in 2006 compared to 2005. The improvement was due, in part, to the lower manufacturing costs resulting from our transition to manufacturing in China. Cost of goods sold in 2006 decreased by approximately $1.5 million due to the impact of a liquidation of LIFO layers and increased by approximately $0.4 million for the inflationary impact on ending inventories accounted for on a LIFO basis. In addition, lower inventory obsolescence provisions of approximately $2.0 million favorably affected margins in 2006 compared to 2005. Optical segment gross margin improved by 1.8 percentage points from 2005, primarily due to the positive effect of higher new product margins.
Consolidated selling, general and administrative ("SG&A") expenses were approximately $60.5 million, 7.9% higher than 2005. SG&A expenses were 43.4% of sales in both 2006 and 2005. SG&A expenses for the WI&A segment were approximately $50.7 million, or 45.3% of sales, compared to $48.6 million, or 44.4% of sales, in 2005. Selling and marketing expenses for the WI&A segment increased by 4.1% in support of new product introductions and the expanded direct to consumer initiatives in 2006. In addition, WI&A segment administrative expenses increased, in part, to support the commencing of operations in China. Optical segment SG&A expenses of $9.7 million were 31.7% higher than 2005. The majority of this increase was in selling expenses for sales volume related items such as sales compensation and commissions and point of sale displays and promotional spending.
Service and distribution ("S&D") expenses were approximately $4.1 million, or 2.9% of sales, in 2006 compared to $3.0 million, or 2.3% of sales in 2005. This increase was largely attributable to increased costs of servicing warranty returns in the optical segment due to the unit volume increase of the last two years.
Research and development ("R&D") expenses were approximately $2.4 million in 2006 compared to $1.8 million in 2005. This increase was due to new product development expenditures in both the WI&A and optical segments. The WI&A and optical segment R&D expenditures increased 26% and 135%, respectively.
Restructuring charges of $1.7 million were recorded in the Company's WI&A segment in fiscal 2006 compared to $1.2 million in fiscal 2005. These charges were related to the corporate restructuring program announced in July 2003. For an analysis of the corporate restructuring program, see Note C to the Company's consolidated financial statements in Item 8 of this Annual Report on Form10-K.
Interest and other (expense) income was $0.3 million of expense in fiscal 2006 compared to $0.4 million of expense in fiscal 2005. The following chart details the major components of interest and other (expense) income:
In 2006, the Company's effective tax rate was 26.5% compared to 33.0% in 2005. This change was due to a change in the mix of domestic and foreign sourced income, adjustments to deferred tax balances and the effect of an accrual to actual tax benefit upon filing the Company's 2005 Federal income tax return in the third quarter of 2006. For an analysis of income taxes see Note J to the Company's consolidated financial statements in Item 8 of this Annual Report on Form 10-K.
As a result of the foregoing, consolidated net income in fiscal 2006 was $3.3 million ($0.22 net income per share, basic and diluted) compared to fiscal 2005 net income of $0.4 million ($0.03 net income per share, basic and diluted).
Comparison of Fiscal 2005 with Fiscal 2004
The following chart details net sales performance by segment and operating unit:
Writing instruments and accessories revenue in the Americas declined $2.2 million, or 4.1 %, in 2005 compared to 2004. Sales to the national accounts in the United States, including the three office superstores, were essentially flat compared to 2004. Business gift sales in the United States, although improved in the second half of 2005, were 2.7% less than 2004 as demand for writing instruments for general corporate promotional purposes continued to decline. To offset this decline, the Company expanded into the higher priced incentive gift market. United States retail sales to carriage trade accounts declined 4% in 2005 compared to 2004. DTC sales, which include sales at the Company's retail stores and sales generated by the Company's website, toll free 800 number and direct mail catalog, increased by 30% in 2005 compared to 2004. Sales in Latin America in 2005 increased 2.8% compared to 2004.
Sales in the EMEA declined 5.2% compared to fiscal 2004. Foreign exchange was unfavorable to EMEA sales results by approximately 1.3 percentage points as sales volume decreased approximately 3.9% for the full year. Declines in sales at the Company's subsidiary markets in the UK, France and Spain of 8.6%, 17.1% and 7.8%, respectively, were somewhat offset by increased sales in the Company's Eastern Europe, Middle East and Africa distributor markets.
Asia revenue of $18.3 million decreased 1.1% compared to fiscal 2004. Foreign exchange did not have a material impact on Asian sales in 2005 compared to 2004.
The optical segment increased revenue by 29.6% in 2005 compared to 2004. This increase was due largely to a number of new product introductions made in 2005, expanded distribution on the west coast of the United States and the effect of a price increase in September 2005.
The following chart details gross profit margins for both the writing instruments and accessories segment as well as the consolidated gross profit margins:
Cost of goods sold in 2005 decreased by approximately $1.7 million due to the impact of a liquidation of LIFO layers and increased by approximately $1.2 million for the inflationary impact on ending inventories accounted for on a LIFO basis. There were no liquidations in 2004 and the impact of inflation was nominal. In addition, lower inventory obsolescence provisions of approximately $0.5 million favorably affected margins in 2005 compared to 2004. Optical segment gross margin improved by 1.5 percentage points from 2004, primarily due to the positive effect of new product margins as well as a price increase implemented in September 2005.
Consolidated SG&A expenses were approximately $56.0 million, 2.3% lower than 2004. SG&A expenses were 43.4% of net sales in 2005 compared to 44.3% of net sales in 2004. SG&A expenses for the WI&A segment were approximately $48.6 million, 4.8% less than 2004. Included in 2005 WI&A SG&A expense is $732,000 of credits related to the reversal of certain payroll tax and non-income based tax reserves established prior to 2005 that were determined to be no longer necessary. As a result of the restructuring program, the Company realized general and administrative savings, most of which have been reinvested in developing and launching new products and implementing our direct-to-consumer strategies, as well as covering the increased costs associated with employee benefits and Sarbanes-Oxley compliance. Optical segment SG&A expenses of $7.4 million were 17.8% higher than fiscal 2004. The majority of this increase was in selling expenses for sales volume related items such as sales commissions and promotional spending.
S&D expenses were approximately $3.0 million, or 2.3% of net sales, in both fiscal 2005 and 2004.
R&D expenses were approximately $1.8 million in both fiscal 2005 and 2004.
Restructuring charges of $1.2 million were recorded in the Company's WI&A segment in fiscal 2005 compared to $2.3 million in fiscal 2004. These charges were related to the corporate restructuring program announced in July 2003. For an analysis of the corporate restructuring program, see Note C to the Company's consolidated financial statements in Item 8 of this Annual Report on Form 10-K.
Interest and other (expense) income was $0.4 million of expense in fiscal 2005 compared to $0.1 million of income in fiscal 2004. Interest income in fiscal 2005 was $0.3 million compared to $0.7 million in 2004. In 2004, the Company recorded $0.4 million of interest income on a property tax settlement with the Town of Lincoln, Rhode Island. Interest expense was $0.2 million higher in 2005 due to the higher level of borrowings. The following chart details the major components of interest and other (expense) income:
In fiscal 2005, the Company's effective tax rate was 33.0% compared to 45.0% in fiscal 2004. In 2005, as a result of the American Jobs Creation Act of 2004, the Company revised its capital allocation and repatriation strategy in order to take advantage of the temporary reduction in the income tax rate for dividends. The 2005 income tax provision includes approximately $0.9 million of income taxes associated with the Company's repatriation of foreign earnings as provided for under the American Jobs Creation Act of 2004. For an analysis of income taxes see Note J to the Company's consolidated financial statements in Item 8 of this Annual Report on Form 10-K.
As a result of the foregoing, the consolidated net income in fiscal 2005 was $0.4 million ($0.03 net income per share, basic and diluted) as compared to the fiscal 2004 net loss of $0.9 million ($0.06 net loss per share, basic and diluted).
Liquidity and Capital Resources
Historically, the Company's sources of liquidity and capital resources have been its cash, cash equivalents and short-term investments ("cash"), cash generated from operations and amounts available under the Company's line of credit. These sources have been sufficient in the past to support the Company's routine operating requirements, capital projects, restructuring, contributions to the retirement plans, stock repurchase programs and debt service. The Company expects its future cash needs in 2007 will be met by these historical sources of liquidity and capital.
The Company's cash balance of $11.3 million at December 30, 2006 increased $0.2 million from December 31, 2005. The most significant factors affecting the Company's cash balance are discussed in this section.
Accounts receivable increased approximately $0.2 million from the prior year. WI&A segment accounts receivable of $28.0 million increased approximately $0.2 million from the prior year while optical segment accounts receivable of approximately $4.0 million was essentially flat with the prior year. Domestic writing instrument accounts receivable decreased by $3.0 million and foreign writing instruments accounts receivable increased by $3.2 million. The Company offers a dating program, primarily to its domestic retail writing instrument customers. Historically, this program offered customers an option whereby they may either delay payment on certain third and fourth quarter purchases until January of the next year or earn a greater discount if payment is made earlier. The program was modified in 2006 whereby the January delayed payment option was eliminated and the early payment cash discount was increased from the prior year, resulting in a lower accounts receivable balance at the end of 2006 compared to the end of 2005. The effect of this change to the dating program was somewhat offset by the higher domestic writing instrument sales volume in the month of December 2006 compared with December 2005. The increase in foreign writing instrument accounts receivable was due to the transfer of certain EMEA distributor markets from the U.S. to the UK, the stronger pound and euro, and the effect of the higher foreign writing instrument sales volume. The increased sales volume of the optical segment was offset by the effect of an increased collection effort.
Total inventory was $24.9 million at December 30, 2006, an increase of $9.9 million since December 31, 2005. WI&A inventory increased $7.7 million and Costa Del Mar sunglass inventory levels increased by $2.2 million. WI&A segment's LIFO reserve decreased by $1.1 million and WI&A FIFO inventory increased by $6.6 million. During the second quarter of 2006, the Company amended its arrangement with its Chinese contract manufacturer in order to establish enhanced control over our manufacturing equipment as well as additional financial control. Our arrangement changed from a supplier type arrangement to a management agreement, whereby our Chinese partner will continue to provide their expertise on manufacturing in China and Cross will manufacture product. As a result of the change we now own all inventory in China. WI&A inventory in China was approximately $7.4 million at December 30, 2006 and zero at December 31, 2005.
The receivable balance from our Chinese contract manufacturer decreased from $4.6 million at December 31, 2005 to zero at December 30, 2006. The decrease was due to payments received and the Company's repurchase of approximately $1.7 million of inventory.
In fiscal 2006, approximately $1.3 million was paid as a result of a corporate restructuring program initiated in 2003. This program was essentially complete at December 30, 2006. The Company incurred $7.7 million in restructuring charges over the life of this program. The amount paid since the inception of this program through the end of fiscal 2006 was approximately $7.0 million. As a result of the restructuring program, the Company realized general and administrative savings, most of which have been reinvested in developing and launching new products and implementing our direct-to-consumer strategies.
The Company's working capital was $48.2 million at the end of fiscal 2006, a decrease of $2.1 million from fiscal 2005, and its current ratio at the end of fiscal 2006 and 2005 was 2.6:1 and 3.2:1, respectively. Operating cash flow was $9.4 million in fiscal 2006 compared to $0.4 million in fiscal 2005.
Additions to property, plant and equipment were approximately $6.3 million in fiscal 2006 and $4.3 million in 2005. In fiscal 2007, the Company expects capital expenditures to be approximately $5.7 million. Depreciation expense in 2007 is expected to be approximately $5.0 million.
On October 23, 2002, the Company's Board of Directors authorized a plan to repurchase up to 10% of the outstanding Class A common stock. Under this plan, the Company plans to purchase in total approximately 1.4 million shares of stock on the open market, subject to regulatory considerations, from time to time, depending on market conditions. At December 30, 2006, the Company had repurchased 1,173,700 shares under this plan for approximately $6.3 million at an average price per share of $5.41. The Company did not repurchase any shares in 2006.
On March 30, 2006, the Company's Board of Directors voted to freeze the Company's non-contributory defined benefit pension plan effective May 20, 2006. The plan covered substantially all of the Company's domestic employees. The Board also approved enhancements to the Company's existing defined contribution retirement plan retroactive to January 1, 2006. Additionally, the Company will provide enhanced transitional benefits for a period of three years to employees close to normal retirement age. The Company made cash contributions in 2006 of approximately $0.8 million to its defined benefit pension plan, $0.7 million to its defined contribution retirement plan and $0.1 million to its excess benefit plan.
The Company maintains a $20 million secured line of credit with Bank of America, N.A.. Under this agreement, the Company has the option to borrow at various interest rates depending upon the type of borrowings made and the Company's consolidated leverage ratio. The agreement requires the Company to maintain a minimum consolidated tangible net worth, a minimum ratio of adjusted EBITDA to required debt service payments, and a maximum ratio of debt to consolidated EBITDA over any four-quarter period, each of which is calculated in accordance with the agreement. The Company is currently in compliance with these covenants. At December 30, 2006, the Company had $7.1 million outstanding on this line of credit, bearing interest at a rate of approximately 8.25% and the unused and available portion was $12.9 million. In 2006, the Company paid approximately $3.4 million on this secured line of credit.
The Company expects to contribute $1.3 million to its defined benefit pension plan, $1.2 million to its defined contribution retirement plan and $0.1 million to its excess benefit plan in 2007.
The Company expects fiscal 2007 research and development expenses to be approximately $2.3 million.
The Company believes that existing cash and funds from operations, supplemented as appropriate by the Company's borrowing arrangements, will be adequate to finance its foreseeable operating and capital requirements, the remaining requirements of the restructuring and stock repurchase plans and contributions to the retirement plans. Should operating cash flows in 2007 not materialize as projected, the Company has a number of planned alternatives to ensure that it will have sufficient cash to meet its operating needs. These alternatives include implementation of strict cost controls on discretionary spending and delaying non-critical research and development, capital projects and completion of the stock repurchase plan.
At the end of fiscal 2006, cash available for domestic operations amounted to approximately $6.7 million, and cash held offshore for international operations amounted to approximately $4.6 million.
Contractual Obligations and Commercial Commitments
An interest rate swap agreement effectively fixes the rate on a portion of the Company's line of credit at 4.15%. The Company leases office and warehouse space and certain equipment under non-cancelable operating leases that expire through 2025. Future minimum lease payments under all non-cancelable leases and other contractual obligations at December 30, 2006 were approximately:
Off Balance Sheet Arrangements
The Company has no material off balance sheet arrangements.
New Accounting Pronouncements
For a description of new accounting pronouncements that affect the Company and the status of the Company's implementation thereof, see the "New Accounting Pronouncements" section of Note A to the Company's consolidated financial statements in Item 8 of this Annual Report on Form 10-K. None are expected to have a material impact on the Company's consolidated financial position or results of operations.
Impact of Inflation and Changing Prices
The Company's operations are subject to the effects of general inflation as well as fluctuations in foreign currencies. Policies and programs are in place to manage the potential risks in these areas. The Company has generally been successful in controlling cost increases due to general inflation. The Company continues to review its number of suppliers in order to obtain lower costs and higher quality on many of its materials and purchased components. Steps taken in conjunction with restructuring efforts have reduced operating costs in its manufacturing operations.
The Company normally enters into foreign currency exchange contracts to economically hedge that portion of its net financial position exposed to foreign currency fluctuations.
Critical Accounting Policies and Estimates
Management's discussion and analysis of financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, as well as related disclosures of contingent liabilities. We evaluate our policies and estimates on an ongoing basis, including those related to tax contingencies, inventory obsolescence reserves, warranty reserves, retirement obligations, impairment of assets and revenue recognition. Management bases its estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
We have identified the following policies as critical to an understanding of our results of operations and financial condition. This is not a comprehensive list of our accounting policies. In many cases, the accounting treatment of a particular transaction is specifically dictated by generally accepted accounting principles, with no need for management's judgment in its application. There are also areas in which management's judgment in selecting any available alternative would not produce a materially different result. For a discussion of our other accounting policies, see Note A "Significant Accounting Policies" to the Company's consolidated financial statements in Item 8 of this Annual Report on Form 10-K.
Tax Contingencies.
We are subject to a variety of income and other non-income based taxes in numerous jurisdictions around the world. We are also periodically reviewed by tax authorities and positions we have taken with respect to the tax returns are subject to interpretation and negotiation. We provide for estimated tax contingencies that we believe are both probable and estimable. Our assessments are based on our understanding of the appropriate tax law, the estimated exposure and probability of a successful assessment by the taxing authorities. In 2006, net income was increased by approximately $0.4 million due to the reversal on non-income based tax reserves provided in prior years which were no longer deemed necessary due to the passing of statutes of limitation or as a result of updating our estimates. Inventory Reserves.
Our global inventories are carried at the lower of cost or market, which requires us to estimate reserves for both obsolescence and the market value we can expect to receive for our on hand inventory. Domestic WI&A segment inventories accounted for on a LIFO basis represent approximately 15% of total inventories. As a result, domestic WI&A finished goods inventories are carried significantly below their current cost and they can typically be realized at selling prices above their carrying value. Because we are required to produce our product with sufficient lead time to satisfy global distribution and expected demand during seasonal peak periods, we are subject to the risks of consumer acceptance of the products we have produced. We assess our need for obsolescence reserves based on a variety of factors including historical demand, future marketing plans and alternative uses for raw material and work-in-process. Warranty Reserves.
The Company's Cross branded writing instruments are sold with a full warranty of unlimited duration against mechanical failure. Costa Del Mar sunglasses are sold with a lifetime warranty against defects in materials and workmanship. In establishing the accrual for warranty costs, management analyzes trends, measured over a period of several years, of several factors that impact the Company's cost to service the warranty. The most significant factors include: the operating costs of the service department, unit sales, the number of units that are returned for warranty repair and the cost of product repairs. The estimates affecting the warranty reserve are updated annually. Retirement Obligations.
The Company's pension benefits are calculated using actuarial concepts, within the framework of Statement of Financial Accounting Standard ("SFAS") No. 87, "Employer's Accounting for Pensions." Two critical assumptions, the discount rate and the expected return on plan assets, are important elements of expense and liability measurement. We evaluate these critical assumptions annually. Other assumptions involve demographic factors such as retirement, mortality, turnover and rate of compensation increases. The discount rate enables us to state expected future cash flow as a present value on the measurement date. The guideline for setting this rate is a high-quality long-term corporate bond rate. A lower discount rate increases the present value of benefit obligations and increases pension expense. We increased our discount rate to 5.9% in 2006 from 5.6% in 2005 to reflect market interest rate conditions. To determine the expected long-term rate of return on the plan assets, we consider the current and expected asset allocation, as well as historical and expected returns on each plan asset class. A lower expected rate of return on pension plan assets will increase pension expense. Our long-term expected return on plan assets was 8.25% in 2006 and 2005.
Impairment Analysis.
The Company tests goodwill for impairment at least annually. The Company completed its impairment testing as of November 27, 2006 and determined that goodwill was not impaired. Management's estimates of fair values, projections of future cash flows and other factors are significant factors in testing goodwill for impairment. If these estimates or projections change in the future, the Company may be required to record an impairment charge. Revenue Recognition.
Revenue recognition requires estimates of product returns, term discounts and rebates at the time revenue is recognized. These estimates are based on customer communication and historical experience. Should these estimates change, there could be a material effect on revenue recognized. For additional information regarding management's estimates, see "Risk Factors" in Item 1A of this Annual Report on Form 10-K and "Forward-Looking Statements" below.
Forward-Looking Statements
Statements contained herein that are not historical fact are forward-looking statements that are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. In addition, words such as "believes," "anticipates," "expects," "will" and similar expressions are intended to identify forward-looking statements, including but not limited to statements related to the introduction of new writing instrument products; the new direct to consumer initiatives; the performance of Cross branded non writing instrument products, including watches, precision readers and business accessories; the availability of necessary raw materials and manufacturing technologies; the continued performance of Costa Del Mar; innovation of the Company's programs; benefits of a streamlined operation; diversification of the business beyond writing instruments; anticipated compliance with laws and regulations (including but not limited to environmental laws); and anticipated sufficiency of available working capital. The Company cautions that a number of important factors could cause the Company's actual results for fiscal 2007 and beyond to differ materially from those expressed in any forward-looking statements made by, or on behalf of, the Company. Forward-looking statements involve a number of risks and uncertainties. For a discussion of certain of those risks, see "Risk Factors" in Item 1A of this Annual Report on Form 10-K.
Item 7A.
Item 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to changes in interest rates and foreign currency exchange, primarily in its investments, line of credit and foreign currency transactions.
The Company maintains a $20 million secured line of credit with a bank. Under this agreement, the Company has the option to borrow at various interest rates depending upon the type of borrowings made and the Company's consolidated leverage ratio. The Company believes that changes in interest rates would not be material to its operations, due to its anticipated level of borrowings.
There was $7.1 million and $10.5 million outstanding under the Company's line of credit at December 30, 2006 and December 31, 2005, respectively.
The Company entered into an interest rate swap agreement that effectively fixes the interest rate on a portion of its line of credit at 4.15% per annum. At December 30, 2006, the notional value of the interest rate swap was $4.2 million.
The Company's foreign exchange exposure is generated primarily from its international operating subsidiaries. The Company seeks to minimize the impact of foreign currency fluctuations by hedging certain foreign currency denominated balance sheet positions with foreign currency forward exchange contracts. Most of these contracts are short-term, generally expire in one to three months and do not subject the Company to material market risk. The Company does not enter into foreign currency exchange transactions for speculative purposes.
Item 8.
Item 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of
A.T. Cross Company
Lincoln, Rhode Island
We have audited the accompanying consolidated balance sheets of A.T. Cross Company and subsidiaries (the "Company") as of December 30, 2006 and December 31, 2005, and the related consolidated statements of operations, comprehensive (loss) income, changes in shareholders' equity, and cash flows for each of the three years in the period ended December 30, 2006. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
As discussed in Note A to the consolidated financial statements, the Company adopted the recognition and disclosure provisions of Statement of Financial Accounting Standards ("SFAS") No. 158, Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans - an amendment of Financial Accounting Standards Board ("FASB") Statements No. 87, 88, 106 and 132(R), effective December 30, 2006.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 30, 2006 and December 31, 2005, and the results of its operations and its cash flows for each of the three years in the period ended December 30, 2006, in conformity with accounting principles generally accepted in the United States of America.
Deloitte & Touche LLP
Boston, Massachusetts
March 15, 2007
CONSOLIDATED BALANCE SHEETS
A.T. CROSS COMPANY & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
A.T. CROSS COMPANY & SUBSIDIARIES
(A)
106 incremental shares related to options or restricted stocks granted are not included due to the net loss since the effects of such shares would be anti-dilutive
CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME
A.T. CROSS COMPANY & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
A.T. CROSS COMPANY & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
A.T. CROSS COMPANY & SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A.T. CROSS COMPANY & SUBSIDIARIES
DECEMBER 30, 2006
NOTE A - SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation and Nature of Operations:
The consolidated financial statements include the accounts of A.T. Cross Company and its subsidiaries (the "Company"). Upon consolidation, all material intercompany accounts and transactions are eliminated. The Company has two reportable business segments: writing instruments and accessories ("WI&A"), and optical.
The Company's WI&A segment designs, manufactures and markets writing instruments, business accessories and watches throughout the world and is an OEM of writing instruments. Writing instrument products are sold under the Cross brand as well as the Penatia and Omni by Cross brands and under the licensed name Bill Blass. They include ball-point pens, fountain pens, selectip rolling ball pens, mechanical pencils and writing instrument accessories such as refills and desk sets. In addition to writing instrument accessories, the Company offers personal accessory products including watches, precision reading glasses and leather goods.
The Company's optical segment designs, manufactures and markets sunglasses throughout the United States under the Costa Del Mar brand.
The accounting policies of the Company's segments are described in this summary of significant accounting policies. The Company evaluates segment performance based upon the profit or loss before income taxes. The Company's reportable segments are strategic business units that offer different product lines. They are managed separately, as each unit requires different technologies and marketing strategies.
Accounting for Estimates:
The preparation of financial statements, in accordance with accounting principles generally accepted in the United States of America ("generally accepted accounting principles"), requires the Company to make assumptions that affect the estimates reported in these consolidated financial statements. Actual results may differ from these estimates. The significant estimates in the Company's consolidated financial statements include sales returns and allowances, allowance for doubtful accounts receivable, realizable value of inventory, impairment of long-lived assets and goodwill, and income taxes. Cash Equivalents:
The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. Gains or losses on trading securities, realized and unrealized, are included in interest and other (expense) income in the WI&A segment. At December 30, 2006 and December 31, 2005, approximately 55% and 53%, respectively, of the Company's cash and cash equivalents were on deposit with one financial institution. Allowance for Doubtful Accounts:
The following is a summary of the allowance for doubtful accounts for the three years ended December 30, 2006:
Inventories:
Domestic writing instrument inventories are priced at the lower of last-in, first-out ("LIFO") cost or market. The remaining inventories are priced at the lower of first-in, first-out ("FIFO") cost or market. Property, Plant and Equipment, and Related Depreciation:
Property, plant and equipment are stated on the basis of cost. Provisions for depreciation are computed using a combination of accelerated and straight-line methods, which are intended to depreciate the cost of such assets over their estimated useful lives, which are as follows:
Buildings and Building Additions
Years
Building & Land Improvements, and Furniture & Fixtures
8 to 10
Years
Machinery & Equipment
5 to 10
Years
Leasehold Improvements
4 to 20
Years
Vehicles, Tooling and Desktop PCs
3 to 4
Years
Long-Lived Assets:
In accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," the Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to undiscounted cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value, less the cost to sell. Goodwill and Other Intangible Assets:
In accordance with SFAS No. 142, "Goodwill and Other Intangible Assets," goodwill is accounted for using an impairment-only approach. Goodwill is tested for impairment annually or when an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. Patents and trademarks are amortized on a straight-line basis over five years and are evaluated for impairment using the methodology described in SFAS No. 142. The required annual impairment tests for all segments were performed on November 27, 2006 and November 28, 2005. The Company concluded for all periods that goodwill was not impaired. The Company also reviewed its indefinite lived intangible assets and concluded that under SFAS No. 142 they were unimpaired. Warranty Costs:
The Company's Cross branded writing instruments are sold with a full warranty of unlimited duration against mechanical failure. Accessories are sold with a one-year warranty against mechanical failure and defects in workmanship, and timepieces are warranted to the original owner to be free from defects in material and workmanship for a period of ten years. Costa Del Mar sunglasses are sold with a lifetime warranty against defects in materials and workmanship. Estimated warranty costs are accrued at the time of sale. The most significant factors in the estimation of warranty cost liabilities include the operating efficiency and related cost of the service department, unit sales and the number of units that are eventually returned for warranty repair. The current portions of accrued warranty costs were $429,000 and $463,000 at December 30, 2006 and December 31, 2005, respectively, and were recorded in accrued expenses and other liabilities. The following chart reflects the activity in aggregate accrued warranty costs:
Revenue Recognition:
Revenue from sales is recognized when the following criteria are met: persuasive evidence of an arrangement exists, title to the goods has passed to the customer, the sales price is fixed or determinable, and collection of the sales price is reasonably assured. Provisions are made at the time the related revenue is recognized for estimated product returns, term discounts and rebates. Marketing Support Costs:
The costs of marketing support, including advertising, are charged to expense as incurred and amounted to approximately $11.2 million, $11.1 million and $12.5 million for fiscal 2006, 2005 and 2004, respectively. Accrued marketing support expenses were approximately $2.2 million and $2.3 million at December 30, 2006 and December 31, 2005, respectively, and are included in accrued expenses and other liabilities. Derivatives:
The Company has a program in place to manage foreign currency risk. As part of that program, the Company can enter into foreign currency exchange contracts to hedge anticipated foreign currency transactions or commitments, primarily purchases of materials and products from foreign suppliers, and certain foreign currency denominated balance sheet positions. The terms of the contracts are generally less than three months. Gains and losses on other contracts that do not qualify for hedge accounting are included in SG&A expenses. The Company does not enter into foreign currency exchange transactions for speculative purposes. The Company also uses an interest rate swap to manage its exposure to changing interest rates that result from variable rate debt. This swap fixes the interest rate on a portion of the Company's line of credit at 4.15%.
Realized and unrealized gains and losses on contracts intended to hedge specific forecasted transactions or commitments, if any, that qualify for hedge accounting are deferred and recorded as a component of accumulated other comprehensive income (loss) and accounted for as part of the transaction. Contracts are recorded at fair value on the balance sheet as a component of other current assets or accrued expenses and other liabilities.
Stock-Based Compensation:
On January 1, 2006, the Company adopted SFAS No. 123(R), "Share-Based Payment" and its related implementation guidance, to account for all share-based payment transactions in which the Company acquires goods or services by issuing shares, options or other equity instruments, or incurs a liability for which the amount, at least in part, is determined based on the value of or is settled in the Company's shares or other equity instruments. Accordingly, the Company recognizes stock-based employment compensation arrangements based on the estimated fair value of stock-based awards exchanged for employee services received and recognizes compensation cost based on the fair value of the award on the date of grant, recognized ratably over the requisite service period. The service period is the period over which the employee performs the related services, which is normally the same as the vesting period. The Company adopted SFAS No. 123(R) using the modified prospective transition approach and, consequently, the Company's consolidated financial statements for prior periods have not been restated. Under this transition method, in 2006 the Company's reported stock compensation expense will include: a) expense related to the remaining unvested portion of awards granted prior to January 1, 2006, which is based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123; and b) expense related to stock compensation awards granted subsequent to January 1, 2006, which is based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123(R). As a result of the adoption of SFAS No. 123(R), the Company's results for the year ended December 30, 2006 include incremental share-based compensation expense of $55,000, which has been included in the Consolidated Statement of Operations within selling, general and administrative expenses.
Prior to January 1, 2006, the Company applied the intrinsic-value method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations in accounting for employee stock-based compensation and provides pro forma disclosures of the compensation expense determined under the fair value provisions of SFAS No. 123, "Accounting for Stock-Based Compensation," as amended by SFAS No. 148. Under the intrinsic method, the difference between the market price on the date of grant and the exercise price is charged to the results of operations over the vesting period. Accordingly, no employee stock-based compensation cost was reflected in net income (loss) related to options granted under those plans for which the exercise or purchase price was equal to the market value of the underlying common stock on the date of grant. Deferred compensation was recorded on the date of grant if the exercise or purchase price of the stock award was less than the market value of the underlying common stock on the date of grant. Deferred compensation was expensed on a straight-line basis over the vesting period of the stock award, generally three years. The following table reflects pro forma net income (loss) and net income (loss) per share had the Company elected to record expense for employee stock options under SFAS No. 123 for the years ended December 31, 2005 and January 1, 2005:
Basic and Diluted Net Income (Loss) Per Share:
Basic net income (loss) per share is computed by dividing net income (loss) by the weighted average number of total shares of Class A and Class B common stock outstanding during the year. Diluted net income (loss) per share is computed by dividing net income (loss) by diluted weighted average shares outstanding. Diluted weighted average shares reflect the dilutive effect, if any, of potential common shares. To the extent that their effect is dilutive, potential common shares include common stock options and restricted stock based on the treasury stock method. New Accounting Pronouncements:
In June 2006, the Financial Accounting Standards Board ("FASB") issued FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes" ("FIN 48"). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise's financial statements in accordance with FASB Statement No. 109, "Accounting for Income Taxes." This interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The Company is currently evaluating the impact this interpretation will have on its consolidated financial position, results of operations and cash flows. This interpretation will be effective beginning January 1, 2007.
Effective January 1, 2006, the Company adopted SFAS No. 151, "Inventory Costs," an amendment of Accounting Research Bulletin No. 43, Chapter 4. This Statement clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material. The adoption of Statement No. 151 did not have a material effect on the Company's consolidated financial position, results of operations or cash flows.
In September 2005, the Emerging Issues Task Force ("EITF") reached consensus on Issue No. 04-13, "Accounting for Purchases and Sales of Inventory with the Same Counterparty" ("EITF 04-13"). EITF 04-13 establishes criteria to be applied in determining if arrangements for the purchase and sale of inventory with the same counterparty be viewed as a single exchange transaction or separate and independent transactions within the scope of APB Opinion No. 9, "Accounting for Nonmonetary Transactions," and if the nonmonetary exchanges of inventory should be recognized at fair value or historic carrying cost. This standard is effective for all new, modified or renewed arrangements beginning in the first interim or annual reporting period beginning after March 15, 2006. The adoption of EITF No. 04-13 in the second quarter of 2006 did not have a material effect on the Company's consolidated financial position or results of operations.
In September 2006, the FASB issued SFAS No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans." This Statement requires companies to recognize a net liability or asset and an offsetting adjustment to accumulated other comprehensive income (loss) to report the funded status of defined benefit pension and other postretirement benefit plans. The Statement requires prospective application, and the recognition and disclosure requirements are effective for companies with fiscal years ending after December 15, 2006. Additionally, SFAS No. 158 requires companies to measure plan assets and obligations at their year-end balance sheet date. This requirement is effective for fiscal years ending after December 15, 2008. The following table details the impact implementing SFAS No. 158 had on the Company's December 30, 2006 consolidated balance sheet:
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements," ("SFAS No. 157") which clarifies the definition of fair value, describes methods used to appropriately measure fair value, and expands fair value disclosure requirements. SFAS No. 157 applies under other accounting pronouncements that currently require or permit fair value measurements. SFAS No. 157 is effective for the Company beginning January 1, 2008, and the Company will apply the provisions of SFAS No. 157 prospectively as of that date. The Company is in the process of determining the impact, if any, the adoption of SFAS No. 157 may have on its consolidated financial statements and related disclosures when it become effective in 2008.
In February 2007, the FASB issued SFAS 159, "The Fair Value Option for Financial Assets and Financial Liabilities, Including an amendment of SFAS 115," which permits companies to choose to measure many financial instruments and certain other items at fair value. SFAS 159 is effective for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. The Company is currently evaluating the effect SFAS 159 will have on our consolidated financial position and results of operations.
NOTE B - INVENTORIES
Domestic writing instrument inventories, approximating $3.8 million and $5.4 million at December 30, 2006 and December 31, 2005, respectively, are priced at the lower of LIFO cost or market. The remaining inventories are priced at the lower of FIFO cost or market. If the FIFO method of inventory valuation had been used for those inventories priced using the LIFO method, inventories would have been approximately $7.2 million and $8.4 million higher than reported at December 30, 2006 and December 31, 2005, respectively. During fiscal 2006, domestic writing instrument inventory quantities were reduced resulting in a liquidation of LIFO inventory quantities carried at lower costs prevailing in prior years as compared with the cost of current purchases. The effect of this liquidation was to increase net income by approximately $1.0 million, or $0.07 per share, basic and diluted. The components of inventory are as follows:
NOTE C - RESTRUCTURING CHARGES
In 2003, the Company announced a corporate restructuring program of its writing instrument and accessory segment designed to increase its competitiveness in the global marketplace by reducing operating costs and freeing additional capital for product development and diversification as well as marketing and brand development. As part of this program, a number of writing instrument manufacturing departments have been and continue to be moved offshore. As of December 30, 2006, approximately 181 manufacturing positions in Lincoln, Rhode Island had been eliminated as a result of this program. In addition, approximately 80 global non-manufacturing positions were eliminated through 2004 as part of the program to consolidate and reduce administrative expenses. This restructuring program was essentially complete as of December 30, 2006. The Company incurred $7.7 million in restructuring charges over the life of this program. Of this, approximately $5.2 million was for severance and related expenses and $2.5 million was for professional fees and other.
The following is a tabular presentation of the restructuring liabilities related to this plan:
NOTE D - GOODWILL AND OTHER INTANGIBLE ASSETS
At December 30, 2006 and December 31, 2005, the carrying value of goodwill was approximately $7.3 million. Other intangibles consisted of the following:
The Company amortizes patents and trademarks over an average five-year life. Amortization expense was approximately $723,000, $733,000 and $679,000 for fiscal years 2006, 2005 and 2004, respectively. The estimated future amortization expense for other intangibles remaining as of December 30, 2006 is as follows:
NOTE E - LINE OF CREDIT
In December 2005, the Company entered into a new secured revolving line of credit with Bank of America, N.A.. This agreement was amended as of October 26, 2006. Under the amended line of credit agreement, the bank agreed to make loans to the Company in an aggregate amount not to exceed $20 million, including up to $5 million equivalent in Eurocurrency loans denominated in pounds sterling or Euro ("Eurocurrency Loans") and up to $15 million of other committed loans to the Company ("Committed Loans") at any time. As part of the aggregate availability, the bank may also issue up to $3 million in letters of credit. Subject to the limits on availability and the other terms and conditions of the credit agreement, amounts borrowed under the facility may be borrowed, repaid without penalty and reborrowed by the Company. The amended credit facility matures and amounts outstanding must be paid on December 31, 2008.
The interest rate for the Committed Loans will be, at the Company's option, either (i) LIBOR plus an applicable margin or (ii) the higher of the federal funds rate plus 50 basis points or the bank's prime rate. The interest rate for any Eurocurrency Loans will be an interest settlement rate for deposits in pounds sterling or Euro plus an applicable margin. The applicable margin for LIBOR and Eurocurrency loans will be an amount between 1.50% and 2.25%, which amount will vary from time to time based upon the Company's consolidated leverage ratio.
Under the line of credit agreement, the Company has agreed to comply with certain affirmative and negative covenants. The most restrictive covenant restricts the Company from declaring cash dividends on its common stock. The agreement requires the Company to maintain a minimum consolidated tangible net worth, a minimum ratio of adjusted EBITDA to required debt service payments, and a maximum ratio of debt to consolidated EBITDA over any four-quarter period, each of which is calculated in accordance with the agreement. Amounts due under the credit agreement are guaranteed by certain of the domestic and foreign subsidiaries of the Company. Amounts due are also secured by a pledge of the assets of the Company and certain of its domestic subsidiaries.
At December 30, 2006, the outstanding balance of the Company's line of credit was $7.1 million, bearing an interest rate of approximately 8.25%, and the unused and available portion, according to the terms of the amended agreement, was $12.9 million. At December 31, 2005, the outstanding balance of the Company's line of credit was $10.5 million, bearing an interest rate of approximately 7.25%, and the unused and available portion, according to the terms of the amended agreement, was $9.5 million.
NOTE F - ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) ITEMS
NOTE G - FINANCIAL INSTRUMENTS
The following table details the United States dollar equivalent of foreign exchange contracts outstanding at December 30, 2006 and December 31, 2005, along with maturity dates and any unrealized gain. The net unrealized gain is recorded in SG&A in the consolidated statements of operations, since the Company did not apply hedge accounting to these contracts.
Foreign currency exchange gains (losses) that are included in SG&A expenses approximated $190,000, $(420,000) and $29,000 in fiscal 2006, 2005 and 2004, respectively.
In 2003, the Company entered into an interest rate swap agreement with an initial notional amount of $9 million and a term of five years. This swap fixes the interest rate on a portion of the Company's line of credit at 4.15%. Amounts paid or received under this swap agreement are recorded as adjustments to interest expense. The net unrealized gain (loss) is recorded in interest and other (expense) income in the consolidated statements of operations. At December 30, 2006, the notional value of the interest rate swap was $4.2 million.
The fair value of forward foreign exchange contracts, based on quoted spot exchange rates, are reported in other current assets or accrued expenses and other liabilities. The fair value of cash and cash equivalents approximates the recorded amounts, due to the short period of time to maturity. The carrying amount of long-term debt approximates fair value as a result of the variable interest rate. The fair value of the swap agreement, based upon quoted market prices, was $78,000 and $122,000 at December 30, 2006 and December 31, 2005, respectively, and was reported in other current assets.
NOTE H - EMPLOYEE BENEFIT PLANS
The Company has a non-contributory defined benefit pension plan and a defined contribution retirement plan (consisting of a savings plan and a non-contributory profit sharing plan), which cover substantially all domestic employees.
On March 30, 2006, the Company's Board of Directors voted to freeze the Company's non-contributory defined benefit pension plan effective May 20, 2006. The Board also approved enhancements to the Company's existing defined contribution retirement plan retroactive to January 1, 2006. Additionally, the Company will provide enhanced transitional benefits for a period of three years to employees close to normal retirement age.
The Company's matching contributions to the savings plan are made all in cash. In fiscal 2006, 2005 and 2004 expenses related to this plan were approximately $1,254,000, $541,000 and $395,000, respectively. There were no profit sharing plan contributions during this three-year period. The Company also maintains a deferred compensation plan that is offered to certain key executives and non-employee directors. Employees of foreign subsidiaries generally receive retirement benefits from Company sponsored defined benefit or defined contribution plans or from statutory plans administered by governmental agencies in their countries. The Company does not provide its employees with any postretirement benefits other than those described above.
Benefits under the defined benefit plans are based on the employee's years of service and compensation, as defined. While there is no requirement under any of these plans to invest in the Company's stock, the defined contribution retirement plan offers the Company's stock as an investment option. The Company's funding policy is consistent with applicable local laws and regulations.
The following chart sets forth the defined benefit plans' combined funded status and amounts recognized in the Company's consolidated balance sheet at the end of each fiscal year:
In establishing the long-term rate of return on assets assumption of 8.25%, the Company indexed its targeted allocation percentage by asset category against the long-term expected returns for those asset categories. That weighted-average return approximates 8.25%. The Company monitors investment results of its pension plan managers against benchmarks such as the Standard & Poor's 500 Index and the Russell 2000 Growth Index for the equity portion of the portfolio and the Lehman Brothers Aggregate Bond Index for fixed income investments. Meeting or exceeding those benchmarks over time would provide a reasonable expectation of achieving the 8.25% assumption.
The investment objective of the Plan is to exceed the actuarial long-term rate of return on assets assumption of 8.25%. To that end, it is the Plan's practice to invest the assets in accordance with the minimum and maximum ranges established for each asset category. These targeted asset allocation ranges have been established in accordance with the overall risk and return objectives of the portfolio. The Plan employs other risk management practices that stress diversification and liquidity. For equity investments, no more than 10% of the equity portfolio can be invested in one issuer and typically no more than 20% of equity assets can be invested in one industry. Shares must be listed on major stock exchanges to assure liquidity. Debt securities are similarly governed by risk management rules. No more than 5% of the total portfolio may be invested in one issuer (except the United States government), and no one issuer can exceed 5% of the outstanding shares of that issuer. There are also quality ratings associated with debt securities that the Plan managers must adhere to. Certain assets or transactions are prohibited in the management of Plan assets, such as commodities, real estate (except mutual funds or REITS), venture capital, private placements, purchasing securities on margin and short selling.
The Company expects to contribute $1.3 million to its defined benefit pension plan, $1.2 million to its defined contribution retirement plan and $0.1 million to its excess benefit plan in 2007.
The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid:
NOTE I - OMNIBUS INCENTIVE PLAN (THE "OI PLAN")
The Company's OI Plan permits the Compensation Committee of the Board of Directors of the Company to grant various long-term incentive awards, generally equity based, to officers and key employees from one pool of reserved shares. The OI Plan provides for grants of awards, including but not limited to, Incentive Stock Options, at not less than the full market value on the date of grant (except in the case of a shareholder possessing more than 10% of the total combined voting power of all classes of Company stock, in which case the exercise price shall not be less than 110% of the fair market value on the date of grant) and Non-Qualified Stock Options, at an exercise price determined by the Compensation Committee; Stock Appreciation Rights, which are rights to receive an amount equal to the increase, between the date of grant and the date of exercise, in the fair market value of the number of shares of common stock subject to the Stock Appreciation Right; shares of Restricted Stock, which are common shares that have certain conditions attached to them that must be satisfied in order to have unencumbered rights to the Restricted Stock; and Performance Awards, which are awards in common shares or cash. The OI Plan has no definite expiration date but may be terminated by the Board of Directors at any time. Incentive Stock Options may not be granted for a term longer than ten years from the date of grant (five years in the case of a shareholder possessing more than 10% of the total combined voting power of all classes of Company stock). At December 30, 2006, there were 460,000 shares of Restricted Stock outstanding under the OI Plan. Compensation expense recognized for Restricted Stock under the OI Plan amounted to $346,788, $283,980 and $185,185 for fiscal 2006, 2005 and 2004, respectively. At December 30, 2006, there were 2,055,347 shares reserved and 395,623 shares available to be issued under the OI Plan. At December 30, 2006 the intrinsic value of the Stock Options outstanding and exercisable was approximately $2.6 million and $2.5 million, respectively, based upon a stock price of $7.51.
Stock option activity during the three years ended December 30, 2006 was as follows:
The following chart contains summary information about the stock options outstanding at December 30, 2006:
The Company also has an Employee Stock Purchase Plan (the "ESP Plan"), allowing eligible employees, other than officers and directors, to purchase shares of the Company's Class A common stock at 10% less than the mean between the high and low prices of the stock on the date of purchase. A maximum of 320,000 shares is available under the ESP Plan, and the aggregate numbers of shares reserved and available for purchase under the ESP Plan were 91,144, 95,045 and 98,708 at December 30, 2006, December 31, 2005 and January 1, 2005, respectively.
The fair value of each stock option granted under the Company's OI Plan was estimated on the date of grant using the Black-Scholes option-pricing model. No stock options were granted in fiscal years 2006 and 2004. The weighted average fair value per share of stock options granted during fiscal 2005 was $1.74. The key assumptions used to value the options granted in 2005 were a 4.34% weighted-average risk-free rate, an average expected life of 5 years, 29.44% volatility and a 0% dividend yield. It should be noted that the option-pricing model used was designed to value readily tradable stock options with relatively short lives. The options granted to employees are not tradable and have contractual lives of up to ten years unless employment is terminated. However, management believes that the assumptions used and the model applied to value the awards yield a reasonable estimate of the fair value of the grants made under the circumstances.
NOTE J - INCOME TAXES
The provision for income taxes consists of the following:
The reconciliation of income taxes computed at the statutory Federal income tax rate to the provision (benefit) for income taxes from operations is as follows:
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 30, 2006 and December 31, 2005 are as follows:
At December 30, 2006 and December 31, 2005, undistributed earnings of foreign subsidiaries amounted to approximately $22.0 million and $17.6 million, respectively. These earnings could become subject to additional tax if they are remitted as dividends, if foreign earnings are lent to the Company or a United States affiliate or if the Company should sell its stock in the subsidiaries. The amount of additional taxes that might be payable on the undistributed foreign earnings of $22.0 million approximates $7.0 million. This amount has not been recorded because it is the Company's intention to permanently invest the remainder of the undistributed earnings of its foreign subsidiaries in the growth of business outside the United States.
The American Jobs Creation Act of 2004 created Internal Revenue Code Section 965(a), which permitted a temporary dividends-received deduction of 85% of the cash dividends received by a United States shareholder from controlled foreign corporations and invested in the United States. Taxpayers could elect to apply the deduction to either the last tax year that begins before October 22, 2004 or the taxpayer's first tax year that begins during the one-year period beginning on October 22, 2004. During 2005, the Company repatriated $20.7 million subject to the 85% dividends-received deduction. The tax effect of this repatriation was a charge to 2005 tax expense of approximately $0.9 million.
At December 30, 2006, the Company had state net operating loss carryforwards of approximately $16.1 million, which begin to expire in 2007. Net operating loss carryforwards for certain foreign subsidiaries were approximately $5.6 million for tax purposes. A portion of these losses will expire in 2007. A valuation allowance has been provided for the foreign and state net operating losses and temporary differences that are estimated to expire before they are utilized. The decrease of $0.7 million in the valuation allowance in fiscal 2006 primarily related to changes in the state deferred tax assets.
We are subject to income taxes in many jurisdictions around the world. Significant judgment is required in determining our worldwide provision for income taxes. In the ordinary course of business, there are many transactions and calculations where the ultimate tax determination is uncertain. Although we believe our tax estimates for certain tax loss contingencies are reasonable, the final determination of tax audits and any related litigation could be materially different than that which is reflected in historical income tax provisions and accruals. Additional taxes assessed as a result of an audit or litigation could have a material effect on our income tax provision and net income in the period or periods in which the determination is made. We revise our estimates of such tax loss contingencies if and when appropriate. Changes made in fiscal 2006 and 2005 reflect changes in estimates due to better information, current actions by taxing authorities and the passing of statutes of limitation in certain jurisdictions.
NOTE K - SEGMENT INFORMATION
The following chart sets forth segment information for the Company for the three fiscal years ended December 30, 2006:
(THOUSANDS OF DOLLARS)
WRITING
INSTRUMENTS
& ACCESSORIES
OPTICAL
TOTAL
Geographic Information
NOTE L - CONTINGENCIES
The Company is named as one of approximately sixty defendants in a contribution suit brought by CCL/Unilever relating to the J.M. Mills Landfill Site, which is part of the Peterson/Puritan Superfund Site in Cumberland, Rhode Island. These complaints allege that the Company is liable under CERCLA for contribution for past and future site investigation costs incurred at the Site. Past and future site investigation costs (excluding the required remedy) are currently estimated at $7 million. Based upon our investigation to date, there does not appear to be evidence to support a finding that the Company arranged for the disposal of hazardous substances at this Site. No formal discovery has been taken to date. At December 30, 2006, the Company had not established a liability for any environmental remediation relating to the J.M. Mills Landfill Site, as its potential liability, if any, is currently not estimable.
The Company is involved in various other litigation and legal matters that have arisen in the ordinary course of business. To its knowledge, management believes that the ultimate resolution of any of those existing matters will not have a material adverse effect on the Company's consolidated financial position or results of operations.
NOTE M - COMMON STOCK
Holders of Class A common stock have the right to elect one-third of the number of directors from time to time fixed by the holders of Class A and Class B common stock voting together as a single class. Holders of Class B common stock have the right to elect the remaining directors. Class A and Class B common stock vote together as a single class to reserve shares to be issued pursuant to options granted with respect to the acquisition of assets or shares of another company under certain circumstances. Except as described above or as otherwise required by law, all voting power is vested in the holders of Class B common stock.
NOTE N - RECEIVABLE FROM CHINESE CONTRACT MANUFACTURER
In 2005, the Company transferred ownership of certain raw material and work-in-process inventory to its Chinese contract manufacturer as part of the restructuring program. During the second quarter 2006, the Company amended its arrangement with its Chinese contract manufacturer from a supplier type arrangement to a management agreement, whereby our Chinese partner will continue to provide their expertise on manufacturing in China and Cross will manufacture and own the product. As a result, the receivable from Chinese contract manufacturer was zero and approximately $4.6 million at December 30, 2006 and December 31, 2005, respectively.
NOTE O - QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following is a tabulation of the unaudited quarterly results of operations for the years ended December 30, 2006 and December 31, 2005:
(A)
No incremental shares related to options or restricted stocks granted are included due to the net loss in the quarter since the effect of such shares would be anti-dilutive.
(B)
During the quarter ended December 31, 2005, net income was increased by approximately $0.6 million due to the reversal of certain payroll tax and other non-income based tax reserves no longer deemed necessary.
NOTE P - SUBSEQUENT EVENT
On March 2, 2007, the Company sold its manufacturing, warehouse and office facility at One Albion Road, Lincoln, Rhode Island to Albion Crossing, LLC for a gross sales price of $15.75 million. At the same time, the Company entered into a lease with Albion Crossing, LLC to lease back a portion of its former facility at One Albion Road, Lincoln, Rhode Island for manufacturing, warehousing and office space. The initial term of this lease is ten years with two extension options for five years each.
Item 9.
Item 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
Item 9A.
Item 9A.
CONTROLS AND PROCEDURES
A
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, which we refer to as the Exchange Act) as of the end of the period covered by this Annual Report.
In designing and evaluating our disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their desired control objectives, and our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
Based upon that evaluation, we have concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report for the information required to be disclosed in the reports we file or submit under the Exchange Act to be recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms and such information is accumulated and communicated to management as appropriate to allow timely decisions regarding required disclosure.
Remediation of prior year material weakness:
As of December 31, 2005, the Company did not maintain effective controls over accounting for taxes. With respect to this control deficiency, the following steps have been taken:
1.
Development of definitive procedures for the detailed documentation and reconciliations supporting taxes payable, deferred income tax and tax provision balances and amounts.
2.
The engagement of an outside consultant specializing in the accounting for income taxes in accordance with SFAS No. 109, "Accounting for Income Taxes."
With the implementation of the above measures and other events occurring prior to the preparation of the December 30, 2006 Consolidated Financial Statements, we have significantly improved our internal control over financial reporting and reduced to a remote likelihood the possibility of a material misstatement that would not be prevented or detected. We have therefore concluded that the above referenced material weakness in internal control over financial reporting has been fully corrected as of December 30, 2006.
B
Changes in Internal Control over Financial Reporting
Other than final changes in the remediation of the material weakness discussed above, no change in the Company's internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) occurred during the fourth quarter of 2006, that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.
Item 9B.
Item 9B.
OTHER INFORMATION
None
PART III
Item 10.
Item 10.
DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
See "Election of Directors," "Corporate Governance," "Committees of the Board of Directors" and "Section 16(a) Beneficial Ownership Reporting Compliance" in the registrant's definitive proxy statement for the 2007 annual meeting of shareholders, which sections are incorporated by reference herein. See also the "Executive Officers of the Company" section of "Business" in Item 1 of this Annual Report on Form 10-K.
We have a Code of Ethics and Business Conduct that applies to all of our employees, including our chief executive officer and senior financial and accounting officers. The text of our Code of Ethics and Business Conduct is posted in the Investor Relations section of our website, www.cross.com. Disclosure regarding any amendments to, or waivers from, provisions of our code of ethics and business conduct that apply to our chief executive officer and senior financial and accounting officers will be included in a Current Report on Form 8-K within four business days following the date of the amendment or waiver, unless website posting of such amendments or waivers is permitted by the rules of the American Stock Exchange, Inc.
Item 11.
Item 11.
EXECUTIVE COMPENSATION
See "Executive Compensation" in the registrant's definitive proxy statement for its 2007 annual meeting of shareholders, which section is incorporated by reference herein. Such incorporation by reference shall not be deemed to specifically incorporate by reference the information referred to in Item 402(a)(8) of Regulation S-K.
Item 12.
Item 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
See "Security Ownership of Certain Beneficial Owners and Management" in the registrant's definitive proxy statement for the 2007 annual meeting of shareholders, which section is incorporated by reference herein.
Equity Compensation Plan Information
The following table details the Company's equity compensation plans as of December 30, 2006:
Item 13.
Item 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
See "Election of Directors" in the registrant's definitive proxy statement for the 2007 annual meeting of shareholders, which sections are incorporated by reference herein.
Item 14.
Item 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
See "Appointment of Independent Public Accountants" and "Principal Accounting Firm Fees" in the registrant's definitive proxy statement for the 2007 annual meeting of shareholders, which sections are incorporated by reference herein.
PART IV
Item 15.
Item 15.
EXHIBITS, FINANCIAL STATEMENT SCHEDULES
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated:
SIGNATURE
TITLE
DATE
/s/RUSSELL A. BOSS__________
(Russell A. Boss)
Chairman & Director
March 15, 2007
/s/BRADFORD R. BOSS________
(Bradford R. Boss)
Chairman Emeritus & Director
March 15, 2007
/s/DAVID G. WHALEN__________
(David G. Whalen)
President & Director
(Chief Executive Officer)
March 15, 2007
/s/KEVIN F. MAHONEY_________
(Kevin F. Mahoney)
Vice President
(Chief Financial Officer)
March 15, 2007
/s/GARY S. SIMPSON__________
(Gary S. Simpson)
Corporate Controller
(Chief Accounting Officer)
March 15, 2007
/s/BERNARD V. BUONANNO, JR.
(Bernard V. Buonanno, Jr.)
Director
March 15, 2007
/s/EDWARD J. COONEY_______
(Edward J. Cooney)
Director
March 15, 2007
/s/GALAL P. DOSS____________
(Galal P. Doss)
Director
March 15, 2007
/s/TERRENCE MURRAY________
(Terrence Murray)
Director
March 15, 2007
/s/ANDREW J. PARSONS______
(Andrew J. Parsons)
Director
March 15, 2007
/s/JAMES C. TAPPAN__________
(James C. Tappan)
Director
March 15, 2007