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Item 2. Management’s Discussion and Analysis

2023-08-08 compared with 2023-05-09 · 66 added, 50 removed, 108 unchanged (52% of the section changed)

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”).

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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.

References to the second quarter of 2022, the second fiscal quarter of 2022 or the three months ended July 2, 2022, mean the period from April 3, 2022 to July 2, 2022.

References to the first quarter of 2023, the first fiscal quarter of 2023 or the three months ended July 1, 2023, mean the 13-week period from April 2, 2023 to July 1, 2023.

References to the first six months of 2022 or the six months ended July 2, 2022 mean the period from January 2, 2022 to July 2, 2022.

References to the first six months of 2023 or the six months ended July 1, 2023 mean the period from January 1, 2023 to July 1, 2023.

Safe Harbor for Forward-Looking Statements

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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.

These factors include the impact of the COVID-19 pandemic and resulting economic effects, the impact of higher raw material and component costs and cost inflation, supply chain disruptions and shortages, particularly with respect to steel, plastics, scrap iron, zinc, copper and electronic components, rising interest rates, delays in delivery of our products to our customers, the impact of global economic conditions on demand for our products, including the impact, length and degree of economic downturns on the customers and markets we serve, reductions in production levels, 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:

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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;

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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.

Net sales in the second quarter of 2023 decreased 2% to $68.3 million from $69.5 million in the corresponding period in 2022.

Net sales for the first six months of 2023 increased by 2% to $140.8 million from $138.6 million in the corresponding period last year.

Sales decreased in the second quarter of 2023 primarily due to lower demand for returnable transport packaging products.

Sales increased for the first six months of 2023 compared to the first six months of 2022 primarily due to increased demand for truck accessories products as well as increased demand from distributors.

Our backlog as of July 1, 2023 was down 9% to $75.3 million from $82.8 million as of July 2, 2022 as we continue to 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 decreased 4% in the second quarter of 2023 and were flat for the first six months of 2023 compared to the corresponding period in 2022.

Price increases and new products increased net sales by 2% in the second quarter and 2% in the first six months of 2023, compared to the corresponding periods in 2022.

New products included various truck mirror assemblies, rotary latches, D-rings, and mirror cams.

Price increases primarily reflect our efforts to recover increases in raw material and freight costs.

Cost of products sold decreased $0.4 million, or 1%, in the second quarter of 2023 and increased by $2.2 million, or 2% in the first six months of 2023 compared to the corresponding periods in 2022.

The decrease in the second quarter of 2023 and increase for the first six months of 2023 are primarily due to lower and higher sales volumes, respectively.

Additionally, the Company paid tariff costs on China-sourced products of approximately $0.5 million and $1.1 million in the second quarter and first six months of 2023 respectively, compared to $0.8 million and $1.3 million in the second quarter and first six months of fiscal 2022 respectively.

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.

Gross margin as a percentage of sales was 22% in the second quarter and 22% in the first six months of 2023 compared to 23% in the second quarter and 22% in the first six months of 2022.

Product development expense increased $0.5 million, or 49% in the second quarter of 2023 and increased $0.7 million, or 31% in the first six months of 2023 when compared to the corresponding periods in 2022 as we continue to invest in new products at Eberhard and Velvac.

As a percentage of net sales, product development costs were 2.1% and 2.0% for the second quarter and first six months of 2023, respectively, compared to 1.4% and 1.6% for the corresponding periods in 2022.

Selling and administrative expense increased $1.1 million, or 11%, in the second quarter of 2023 when compared to the second quarter of 2022 primarily due to legal, professional, and selling costs and payroll-related expenses.

Selling and administrative expenses increased $3.2 million, or 16% in the first six months of 2023 when compared to the corresponding periods 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 during the first quarter of 2023 and legal, professional, and selling costs and payroll-related expenses during the first six months of 2023.

The increase in selling expenses reflects both the increase in sales during the first six months ended 2023 as well as our investments in sales capabilities.

Interest expense increased $0.3 million in the second quarter and $0.6 million in the first six months of 2023 compared to the corresponding periods in 2022 due to higher borrowing rates.

Other income decreased $0.3 million in the second quarter of 2023 and decreased $1.4 million in the first six months of 2023 compared to the corresponding periods in 2022.

The decrease in other income of $0.3 million in the second quarter of 2023 was primarily driven by unfavorable pension costs of $0.3 million in the second quarter of 2023, while in the second quarter of 2022 the Company had a favorable pension cost adjustment of $0.4 million, $1.4 million expense associated with the closure of Associated Toolmakers, Ltd., partially offset by a $1.6 million favorable adjustment for the final settlement of our swap agreement with Santander Bank, N.A.

(“Santander”).

The decrease in other income of $1.4 million for the first six months of 2023 when compared to the corresponding period in 2022 was primarily driven by unfavorable pension costs of $0.6 million for the first six months of 2023, while in the first six months of 2022 the Company had favorable pension cost adjustments of $0.9 million, $1.4 million expense associated with the closure of Associated Toolmakers, Ltd., an unfavorable working capital adjustment of $0.4 million in the first quarter of 2023 related to the sale of the Greenwald business, partially offset by a $1.6 million favorable adjustment for the final settlement of our swap agreement with Santander, while in the first quarter of 2022 the Company had a loss on the sale of the Wheeling, IL building of $0.3 million.

Net income from continuing operations for the second quarter of 2023 was $1.4 million, or $0.22 per diluted share, compared to net income from continuing operations of $3.7 million, or $0.59 per diluted share, for the comparable period in 2022.

In the first six months of 2023 net income was $2.0 million, or $0.32 per diluted share compared to net income of $6.4 million, or $1.02 per diluted share for the comparable period in 2022.

A more detailed analysis of the Company’s results of operations and financial condition follows:

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:

The following table shows, for the periods indicated, selected line items from the condensed consolidated statements of income as a percentage of net sales:

Three Months Ended

Six Months Ended

Cost of products sold

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Operating Profit

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):

April 1, 2023

The following table shows the change in sales and operating profit for the second quarter and first six months of 2023 compared to the second quarter and first six months of 2022 (dollars in thousands):

Operating Profit

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.

The Company generated approximately $13.6 million of cash from continuing operations during the first six months of fiscal 2023 compared to consuming approximately $2.5 million during the first six of fiscal 2022.

Cash flow from operations in the first six months of 2023 was higher when compared to the corresponding period last year primarily due to a decrease in inventory.

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.

Additions to property, plant and equipment for continuing operations were approximately $2.0 million for the first six months of 2023 and $1.1 million for the first six months of 2022.

As of July 1, 2023, there was approximately $1.1 million of outstanding commitments for capital expenditures.

The following table shows key financial ratios at the end of each specified period:

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Change in working capital impact on net cash Provided by (used in) operating activities

Net cash provided by investing activities

Net cash (used in) provided by investing activities

Net cash (used in) provided by financing activities

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.

Inventories of $57.5 million as of July 1, 2023, represent a decrease of 11.0% as compared to $64.6 million at the end of fiscal year 2022 and a decrease of 15.1% as compared to $67.7 million at the end of the second quarter of fiscal 2022.

Accounts receivable, less allowances, were $42.0 million as of July 1, 2023, as compared to $42.9 million at 2022 fiscal year end and $46.3 million at the end of the second quarter of fiscal 2022.

On June 16, 2023, the Company incurred indebtedness under the Credit Agreement in the aggregate principal amount of $60 million in the form of a term loan, the proceeds of which were used to repay the Company’s remaining outstanding term loan and to terminate its existing credit facility with Santander Bank.

See Note G for additional information regarding the terms of the Credit Agreement, including repayment terms, interest rates and applicable loan covenants.

Under the terms of the Credit Agreement, the Company is subject to restrictive covenants that limit our ability to, among other things, incur additional indebtedness, pay dividends or make other distributions, and consolidate, merge, sell or otherwise dispose of assets, as well as financial covenants that require us to maintain a fixed charge coverage ratio and a maximum senior net leverage ratio.

These covenants may limit how we conduct our business, and in the event of certain defaults, our repayment obligations may be accelerated.

We were in compliance with all our covenants as of July 1, 2023.

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.

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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.

As of the end of the second quarter of July 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

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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.

For a full description of our critical accounting estimates, 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.

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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

Adjusted Net Income and EPS from Continuing Operations Calculation

For the Three and Six Months ended July 1, 2023 and July 2, 2022

Three Months Ended

April 1, 2023

April 2, 2022

Six Months Ended

Net income from continuing operations as reported per generally accepted accounting principles (GAAP)

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Severance and accrued compensation, net of tax

Greenwald final sale adjustment, net of tax

Greenwald final sale adjustment

Associated Toolmakers, Ltd.

closure, net of tax

Total adjustments (non-GAAP)

Adjusted net income from continuing operations

Adjusted net income from continuing operations (non-GAAP)

Adjusted earnings per share from continuing operations (non-GAAP):

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

B) Severance expenses associated with accrued compensation and severance related to the elimination of the Chief Operating Officer position and the departure of the former Chief Executive Officer

C) Final settlement of working capital adjustment associated with Greenwald sale

D) Associated Toolmakers, Ltd.

closure costs

Reconciliation of Non-GAAP Measures

Adjusted EBITDA from Continuing Operations Calculation

For the Three Months ended April 1, 2023 and April 2, 2022

For the Three and Six Months ended July 1, 2023 and July 2, 2022

Three Months Ended

April 1, 2023

April 2, 2022

Six Months Ended

Net income from continuing operations as reported per generally accepted accounting principles (GAAP)

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Loss on sale of Wheeling, IL building

Severance and accrued compensation

Severance and accrued compensation, net of tax

Greenwald final sale adjustment

Associated Toolmakers, Ltd.

Adjusted EBITDA from continuing operations

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

B) Severance expenses associated with accrued compensation and severance related to the elimination of the Chief Operating Officer position and the departure of the former Chief Executive Officer

C) Final settlement of working capital adjustment associated with Greenwald sale

D) Associated Toolmakers, Ltd.

closure costs

ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis