EASTERN CO 10-Q

ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion is intended to highlight significant changes in the financial position and results of operations of The Eastern Company (together with its consolidated subsidiaries, the “Company,” “we,” “us” or “our”) for the quarter ended April 1, 2023. This Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the Consolidated Financial Statements and Notes thereto for the fiscal year ended December 31, 2022 and the related Management’s Discussion and Analysis of Financial Condition and Results of Operations, both of which are contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2022, which was filed with the Securities and Exchange Commission (the “SEC”) on March 14, 2023 (the “2022 Form 10-K”). The Company’s fiscal year is a 52-53-week fiscal year ending on the Saturday nearest to December 31. References to 2022 or the 2022 fiscal year mean the 52-week period ended on December 31, 2022, and references to 2023 or the 2023 fiscal year mean the 52-week period ending on December 30, 2023. In a 52-week fiscal year, each quarter has 13 weeks. References to the first quarter of 2022, the first fiscal quarter of 2022 or the three months ended April 2, 2022, mean the period from January 2, 2022 to April 2, 2022. References to the first quarter of 2023, the first fiscal quarter of 2023 or the three months ended April 1, 2023, mean the 13-week period from January 1, 2023 to April 1, 2023. Safe Harbor for Forward-Looking Statements Statements contained in this Quarterly Report on Form 10-Q of the Company that are not based on historical facts are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements may be identified by the use of forward-looking terminology such as “would,” “should,” “could,” “may,” “will,” “expect,” “believe,” “estimate,” “anticipate,” “intend,” “continue,” “plan,” “potential,” “opportunities,” or similar terms or variations of those terms or the negative of those terms. There are many factors that affect the Company’s business and the results of its operations and that may cause the actual results of operations in future periods to differ materially from those currently expected or anticipated. These factors include the impact of the COVID-19 pandemic and resulting economic effects, including supply chain disruptions, cost inflation, rising interest rates, delays in delivery of our products to our customers, impact on demand for our products, reductions in production levels, increased costs, including costs of raw materials, the impact on global economic conditions, the availability, terms and cost of financing, including borrowings under credit arrangements or agreements, the potential impact of bank failures on our ability to access financing or capital markets, and the impact of market conditions on pension plan funded status. Other factors include, but are not limited to: restrictions on operating flexibility imposed by the agreement governing our credit facility; the effect on interest rates of the replacement of the London Interbank Offered Rate (LIBOR) with a Secured Overnight Financing Rate (SOFR); risks associated with doing business overseas, including fluctuations in exchange rates and the inability to repatriate foreign cash, the impact on cost structure and on economic conditions as a result of actual and threatened increases in trade tariffs and the impact of political, economic and social instability; the inability to achieve the savings expected from global sourcing of materials; the impact of higher raw material and component costs, including the impact of supply chain shortages and inflation, particularly steel, plastics, scrap iron, zinc, copper and electronic components; lower-cost competition; our ability to design, introduce and sell new or updated products and related components; market acceptance of our products; the inability to attain expected benefits from acquisitions or the inability to effectively integrate such acquisitions and achieve expected synergies; domestic and international economic conditions, including the impact, length and degree of economic downturns on the customers and markets we serve and more specifically conditions in the automotive, construction, aerospace, energy, oil and gas, transportation, electronic, and general industrial markets; costs and liabilities associated with environmental compliance; the impact of climate change or terrorist threats and the possible responses by the U.S. and foreign governments; failure to protect our intellectual property; cyberattacks; materially adverse or unanticipated legal judgments, fines, penalties or settlements; and other risks identified and discussed in this Management’s Discussion and Analysis of Financial Condition and Results of Operations and Item 1A, Risk Factors , and Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations , of the 2022 Form 10-K and that may be identified from time to time in our quarterly reports on Form 10-Q, current reports on Form 8-K and other filings we make with the SEC. Although the Company believes it has an appropriate business strategy and the resources necessary for its operations, future revenue and margin trends cannot be reliably predicted and the Company may alter its business strategies to address changing conditions. Also, the Company makes estimates and assumptions that may materially affect reported amounts and disclosures. These relate to valuation allowances for accounts receivable and excess and obsolete inventories, accruals for pensions and other postretirement benefits (including forecasted future cost increases and returns on plan assets), provisions for depreciation (estimating useful lives), uncertain tax positions, and, on occasion, accruals for contingent losses. The Company undertakes no obligation to update, alter, or otherwise revise any forward-looking statements, whether written or oral, that may be made from time to time, whether as a result of new information, future events, or otherwise, except as required by law. 16 Table of Contents Overview General Overview The following analysis excludes discontinued operations. Net sales in the first quarter of 2023 increased 5% to $72.5 million from $69.0 million in the corresponding period in 2022. Sales increased in the first quarter of 2023 primarily due to increased demand for truck accessories and automotive returnable transport packaging products as well as increased demand from distributors. Our returnable transport packaging sales benefited from the increase in new automotive product launches, including several electric vehicle launches. Our backlog as of April 1, 2023 was down 16% to $72.0 million from $85.8 million as of April 2, 2022 as we optimize our supply chain to reduce past due orders and transition from old to new programs with our commercial vehicle and automotive customers and increased shipments to customers. Net sales of existing products increased 3% in the first quarter of 2023 compared to the corresponding period in 2022. Price increases and new products increased net sales by 2% in the first quarter of 2023 compared to the corresponding period in 2022. New products included various truck mirror assemblies, rotary latches, electronic latches and locks, D-rings, and mirror cams. Price increases primarily reflect our efforts to recover an increase in raw material and freight costs. Cost of products sold increased $2.6 million, or 5%, in the first quarter of 2023 compared to the corresponding period in 2022. The increase is primarily due to higher sales volume. Additionally, the Company paid tariff costs on China-sourced products of approximately $0.6 million in the first quarter of 2023, compared to $0.6 million in the first quarter of fiscal 2022. Most tariffs on China-sourced products have been recovered through price increases. Gross margin as a percentage of sales was 21% in the first quarter of fiscal 2023 compared to 21% in the first quarter of fiscal 2022. Product development expense increased $0.2 million, or 17% in the first quarter of 2023 when compared to the corresponding period in 2022 as we continue to invest in new products at Eberhard and Velvac. As a percentage of net sales, product development costs were 1.9% for the first quarter of 2023 and 1.7% for the corresponding period in 2022. Selling and administrative expense increased $2.1 million, or 21%, in the first quarter of 2023 when compared to the corresponding period in 2022 primarily due to severance and other accrued compensation expenses of $1.8 million related to the elimination of the Chief Operating Officer position and the departure of our previous Chief Executive Officer and other selling costs and payroll-related expenses. The increase in selling expenses reflects both the increase in sales as well as our investments in sales capabilities. Interest expense increased $0.3 million in the first quarter of 2023 compared to the corresponding period in 2022. Other income was down $1.1 million in the first quarter of 2023 compared to the corresponding period in 2022. The decrease in other income of $1.1 million in the first quarter was primarily driven by an unfavorable final working capital adjustment of $0.4 million related to the sale of the Greenwald business and pension cost of $0.3 million in the first quarter of 2023, while in the first quarter of 2022 the Company had a favorable pension cost adjustment of $0.4 million, partially offset by a loss on the sale of the Wheeling, IL building of $0.2 million. Net income from continuing operations for the first quarter of fiscal 2023 was $0.6 million, or $0.10 per diluted share, compared to net income from continuing operations of $2.7 million, or $0.43 per diluted share, for the comparable period in 2022. A more detailed analysis of the Company’s results of operations and financial condition follows: 17 Table of Contents Results of Operations The following table shows, for the periods indicated, selected line items from the condensed consolidated statements of operations as a percentage of net sales: Three Months Ended April 1, 2023 April 2, 2022 Net sales 100.0 % 100.0 % Cost of products sold 78.6 % 78.9 % Gross margin 21.4 % 21.1 % Product development expense 1.9 % 1.7 % Selling and administrative expense 16.5 % 14.3 % Operating Profit 3.0 % 5.1 % The following table shows the change in sales and operating profit for the first quarter of fiscal 2023 compared to the first quarter of fiscal 2022 (dollars in thousands): Three Months Ended April 1, 2023 Net Sales $ 3,481 Volume 3.3 % Price 0.8 % New products 0.9 % 5.0 % Operating Profit $ (1,355 ) Liquidity and Sources of Capital The Company generated approximately $6.9 million of cash from continuing operations during the first three months of fiscal 2023 compared to consuming approximately $3.6 million during the first three months of fiscal 2022. Cash flow from operations in the first three months of 2023 was higher when compared to the corresponding period last year primarily due to a decrease in inventory. Cash flow from operations coupled with cash at the beginning of the 2023 fiscal year were sufficient to fund capital expenditures, debt service, and dividend payments for the first three months of 2023. See Note G - Debt for further discussion on the Company’s debt facilities. Additions to property, plant and equipment for continuing operations were approximately $1.2 million for the first three months of 2023 and $0.6 million for the first three months of 2022. As of April 1, 2023, there was approximately $1.2 million of outstanding commitments for capital expenditures. The following table shows key financial ratios at the end of each specified period: First Quarter 2023 First Quarter 2022 Fiscal Year 2022 Current ratio 2.7 2.7 2.7 Average days’ sales in accounts receivable 57 63 56 Inventory turnover 4.0 3.2 3.4 Total debt to shareholders’ equity 46.6 % 63.2 % 50.7 % 18 Table of Contents The following table shows important liquidity measures as of the balance sheet date for each specified period (in millions): First First Fiscal Quarter Quarter Year 2023 2022 2022 Cash and cash equivalents - Held in the United States $ 9.7 $ 2.3 $ 7.4 - Held by a foreign subsidiary 3.4 2.9 2.8 13.1 5.2 10.2 Working capital 76.7 83.2 78.3 Net cash provided by (used in) operating activities 6.9 (3.6 ) 7.4 Change in working capital impact on net cash Provided by (used in) operating activities 3.6 (8.8 ) (5.2 ) Net cash provided by investing activities 1.1 1.0 5.1 Net cash (used in) provided by financing activities (5.1 ) 1.6 (11.8 ) Inventories of $57.7 million as of April 1, 2023, represent a decrease of 10.8% as compared to $64.6 million at the end of fiscal year 2022 and a decrease of 14.9% as compared to $67.8 million at the end of the first quarter of fiscal 2022. Accounts receivable, less allowances, were $44.5 million as of April 1, 2023, as compared to $42.9 million at 2022 fiscal year end and $47.0 million at the end of the first quarter of fiscal 2022. Cash, cash flow from operating activities and funds available under the revolving credit portion of the Credit Agreement are expected to be sufficient to cover future foreseeable working capital requirements. However, the Company cannot provide any assurances of the availability of future financing or the terms on which it might be available. In addition, the interest rate on borrowings under the Credit Agreement varies based on our senior net leverage ratio, and the Credit Agreement requires us to maintain a senior net leverage ratio not to exceed 4.25 to 1 and a fixed charge coverage ratio to be not less than 1.25 to 1. A decrease in earnings due to the impact of COVID-19 or the resulting harm to the financial condition of our customers or economic conditions generally, or an increase in indebtedness incurred to offset such a decrease in earnings, would have a negative impact on our senior net leverage ratio and our fixed charge coverage ratio, which in turn would increase the cost of borrowing under the Credit Agreement and could cause us to fail to comply with the covenants under our Credit Agreement. As of the end of the fiscal quarter ended April 1, 2023, the Company does not have any off-balance sheet arrangements that have or are reasonably likely to have a material current or future effect on the Company’s financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources. Critical Accounting Estimates The preparation of financial statements in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) requires management to make judgments, estimates and assumptions regarding uncertainties that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities and the reported amounts of revenues and expenses. For a full description of our critical accounting policies, refer to Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of the 2022 Form 10-K. While there have been no material changes to our critical accounting estimates, we continue to monitor the methodologies and assumptions underlying such critical accounting estimates. 19 Table of Contents Non-GAAP Financial Measures The non-GAAP financial measures we provide in this report should be viewed in addition to, and not as an alternative for, results prepared in accordance with U.S. GAAP. To supplement the consolidated financial statements prepared in accordance with U.S. GAAP, we have presented Adjusted Net Income from Continuing Operations, Adjusted Earnings Per Share from Continuing Operations and Adjusted EBITDA from Continuing Operations, which are considered non-GAAP financial measures. The non-GAAP financial measures presented may differ from similarly titled non-GAAP financial measures presented by other companies, and other companies may not define these non-GAAP financial measures in the same way. These measures are not substitutes for their comparable U.S. GAAP financial measures, such as net sales, net income from continuing operations, diluted earnings per share from continuing operations, or other measures prescribed by U.S. GAAP, and there are limitations to using non-GAAP financial measures. Adjusted Net Income from Continuing Operations is defined as net income from continuing operations excluding, when incurred, gains or losses that we do not believe reflect our ongoing operations, including, for example, the impacts of impairment losses, gains/losses on the sale of subsidiaries, property and facilities, transaction expenses primarily relating to acquisitions and divestitures, factory start-up costs, factory relocation expenses, executive severance, and restructuring costs. Adjusted Net Income from Continuing Operations is a tool that can assist management and investors in comparing our performance on a consistent basis across periods by removing the impact of certain items that management believes do not directly reflect our underlying operating performance. Adjusted Earnings Per Share from Continuing Operations is defined as earnings per share from continuing operations excluding, when incurred, certain per share gains or losses that we do not believe reflect our ongoing operations, including, for example, the impacts of impairment losses, gains/losses on the sale of subsidiaries, property and facilities, transaction expenses primarily relating to acquisitions and divestitures, factory start-up costs, factory relocation expenses, executive severance, and restructuring costs. We believe that Adjusted Earnings Per Diluted Share from Continuing Operations provides important comparability of underlying operational results, allowing investors and management to access operating performance on a consistent basis from period to period. Adjusted EBITDA from Continuing Operations is defined as net income from continuing operations before interest expense, provision for income taxes, and depreciation and amortization and excluding, when incurred, the impacts of certain losses or gains that we do not believe reflect our ongoing operations, including, for example, impairment losses, gains/losses on sale of subsidiaries, property and facilities, transaction expenses primarily relating to acquisitions and divestitures, factory start-up costs, factory relocation expenses, executive severance, and restructuring expenses. Adjusted EBITDA from Continuing Operations is a tool that can assist management and investors in comparing our performance on a consistent basis by removing the impact of certain items that management believes do not directly reflect our underlying operations. Management uses such measures to evaluate performance period over period, to analyze the underlying trends in our business, to assess our performance relative to our competitors, and to establish operational goals and forecasts that are used in allocating resources. These financial measures should not be considered in isolation from, or as a replacement for, U.S. GAAP financial measures. We believe that presenting non-GAAP financial measures in addition to U.S. GAAP financial measures provides investors greater transparency to the information used by our management for its financial and operational decision-making. We further believe that providing this information better enables our investors to understand our operating performance and to evaluate the methodology used by management to evaluate and measure such performance. 20 Table of Contents Reconciliation of Non-GAAP Measures Adjusted Net Income and Adjusted Earnings per Share from Continuing Operations Calculation For the Three Months ended April 1, 2023 and April 2, 2022 ($000's) Three Months Ended April 1, 2023 April 2, 2022 Net income from continuing operations as reported per generally accepted accounting principles (GAAP) $ 607 $ 2,686 Earnings per share from continuing operations as reported under generally accepted accounting principles (GAAP): Basic $ 0.10 $ 0.43 Diluted $ 0.10 $ 0.43 Adjustments: Loss on sale of Wheeling, IL building, net of tax - 202 A Severance and accrued compensation, net of tax 1,349 B - Greenwald final sale adjustment, net of tax 293 C - Total adjustments (non-GAAP) $ 1,642 $ 202 Adjusted net income from continuing operations $ 2,249 $ 2,888 Adjusted earnings per share from continuing operations (non-GAAP): Basic $ 0.36 $ 0.46 Diluted $ 0.36 $ 0.46 A) Loss on sale of ILC building in Wheeling, IL B) Severance expenses associated with accrued compensation and severance related to the elimination of the Chief Operating Officer position and the departure of the Chief Executive Officer C) Final settlement of working capital adjustment associated with Greenwald sale 21 Table of Contents Reconciliation of Non-GAAP Measures Adjusted EBITDA from Continuing Operations Calculation For the Three Months ended April 1, 2023 and April 2, 2022 ($000's) Three Months Ended April 1, 2023 April 2, 2022 Net income from continuing operations as reported per generally accepted accounting principles (GAAP) $ 607 $ 2,686 Interest expense 726 434 Provision for income taxes 195 881 Depreciation and amortization 1,815 1,830 Loss on sale of Wheeling, IL building - 269 A Severance and accrued compensation 1,799 B - Greenwald final sale adjustment 390 C - Adjusted EBITDA from continuing operations $ 5,532 $ 6,100 A) Loss on sale of ILC building in Wheeling, IL B) Severance expenses associated accrued compensation and severance related to the elimination of the Chief Operating Officer position and the departure of the Chief Executive Officer C) Final settlement of working capital adjustment associated with Greenwald sale 22 Table of Contents ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK As a result of the Company’s status as a smaller reporting company pursuant to Rule 12b-2 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), the Company is not required to provide information under this Item 3.