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 three and nine months ended September 30, 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, the 2022 fiscal year or fiscal 2022 mean the 52-week period ended on December 31, 2022, and references to 2023, the 2023 fiscal year or fiscal 2023 mean the 52-week period ending on December 30, 2023. In a 52-week fiscal year, each quarter has 13 weeks. References to the third quarter of 2022, the third fiscal quarter of 2022, the third quarter of fiscal 2022 or the three months ended October 1, 2022, mean the period from July 3, 2022 to October 1, 2022. References to the third quarter of 2023, the third fiscal quarter of 2023, the third quarter of fiscal 2023 or the three months ended September 30, 2023, mean the 13-week period from July 2, 2023 to September 30, 2023. References to the first nine months of 2022, the first nine months of fiscal 2022 or the nine months ended October 1, 2022 mean the period from January 2, 2022 to October 1, 2022. References to the first nine months of 2023, the first nine months of fiscal 2023 or the nine months ended September 30, 2023 mean the period from January 1, 2023 to September 30, 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, 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: restrictions on operating flexibility imposed by the agreement governing our credit facility; 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;; 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, 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; military conflict (including the Russia/Ukraine conflict, the conflict in Israel and surrounding areas, the possible expansion of such conflicts and geopolitical consequences) 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. -17- Table of Contents 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. General Overview The following analysis excludes discontinued operations. Net sales in the third quarter of 2023 decreased 8% to $65.6 million from $71.6 million in the corresponding period in 2022. Net sales for the first nine months of 2023 decreased 2% to $206.5 million from $210.2 million in the same period last year. Sales declined in both the third quarter of 2023 and first nine months of 2023 primarily due to lower demand for truck accessories and returnable transport packaging products. Our backlog as of September 30, 2023 increased 4% to $89.4 million from $85.7 million as of October 1, 2022. Net sales of existing products declined 14% in the third quarter of 2023 and 5% for the first nine months of 2023 compared to the corresponding periods in 2022. Price increases and new products increased net sales by 6% in the third quarter of 2023 and 3% in the first nine 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 $5.8 million, or 11%, in the third quarter of 2023 and decreased $3.6 million, or 2% in the first nine months of 2023 compared to the corresponding periods in 2022. The decreases in the third quarter and first nine months of 2023 are primarily due to lower sales volumes. Additionally, the Company paid tariff costs on China-sourced products of approximately $0.6 million and $1.7 million in the third quarter and first nine months of 2023, respectively, compared to $0.8 million and $2.5 million in the third quarter and first nine 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 25% in the third quarter and 23% in the first nine months of 2023 compared to 23% in the third quarter and 22% in the first nine months of fiscal 2022. Our gross margins in the third quarter and first nine months of 2023 reflect the impact of price increases to customers to recover increases in raw material costs. Product development expense increased $0.4 million, or 41%, in the third quarter of 2023 and increased $1.1 million, or 34%, in the first nine months of 2023 compared to the corresponding periods in 2022 as we continue to invest in new products at Eberhard, Velvac and Big 3. As a percentage of net sales, product development costs were 2.2% and 2.1% for the third quarter and first nine months of 2023, respectively, compared to 1.4% and 1.5% for the corresponding periods in 2022. Selling general and administrative expenses decreased $0.4 million, or 4%, in the third quarter of 2023 when compared to the third quarter of 2022 primarily due to lower legal, professional, and selling costs and payroll-related expenses. Selling general and administrative expenses increased $2.8 million, or 9%, in the first nine months 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 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 our investments in sales capabilities and change in management personnel. Interest expense increased $0.4 million in the third quarter and $1.0 million in the first nine months of 2023 compared to the corresponding periods in 2022 due to higher borrowing rates. Other income decreased $1.3 million in the third quarter of 2023 and decreased $2.6 million in the first nine months of 2023 compared to the corresponding periods in 2022. The decrease in other income of $1.3 million in the third quarter of 2023 was primarily driven by unfavorable pension costs of $0.3 million in the third quarter of 2023, while in the third quarter of 2022 the Company had a favorable pension cost adjustment of $0.4 million, and a $0.6 million gain on the sale of the Company’s corporate office building in the third quarter of 2022. The decrease in other income of $2.6 million for the first nine months of 2023 when compared to the corresponding period in 2022 was primarily driven by unfavorable pension costs of $0.9 million for the first nine months of 2023, while in the first nine months of 2022 the Company had favorable pension cost adjustments of $1.3 million, $1.4 million expense associated with the closure of Associated Toolmakers, Ltd. in the second quarter of 2023, 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 in the second quarter of 2023, while in the first quarter of 2022 the Company had a loss on the sale of the Wheeling, IL building of $0.3 million and a gain of $0.6 million on the sale of the Company’s corporate office building in the third quarter of 2022. -18- Table of Contents Net income from continuing operations for the third quarter of fiscal 2023 was $3.1 million, or $0.49 per diluted share compared to net income from continuing operations of $4.5 million, or $0.72 per diluted share, for the comparable period in 2022. In the first nine months of 2023 net income from continuing operations was $5.1 million, or $0.81 per diluted share, compared to net income from continuing operations of $10.9 million, or $1.74 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 income as a percentage of net sales: Three Months Ended Nine Months Ended September 30, 2023 October 1, 2022 September 30, 2023 October 1, 2022 Net sales 100.0 % 100.0 % 100.0 % 100.0 % Cost of products sold 75.1 % 76.9 % 77.2 % 77.6 % Gross margin 24.9 % 23.1 % 22.8 % 22.4 % Product development expense 2.1 % 1.4 % 2.0 % 1.5 % Selling and administrative expense 14.8 % 14.1 % 16.0 % 14.3 % Operating Profit 8.0 % 7.6 % 4.8 % 6.6 % The following table shows the change in sales and operating profit for the third quarter and first nine months of 2023 compared to the third quarter and first nine months of 2022 (dollars in thousands): Three Months Nine Months Ended Ended September 30, 2023 September 30, 2023 Net Sales $ (6,001 ) $ (3,723 ) Volume -14.0 % -4.9 % Price 4.6 % 2.1 % New products 1.0 % 1.0 % -8.4 % -1.8 % Operating Profit $ (197 ) $ (4,010 ) Liquidity and Sources of Capital The Company generated approximately $19.2 million of cash from continuing operations during the first nine months of fiscal 2022 compared to consuming approximately $0.3 million during the first nine months of fiscal 2022. Cash flow from operations in the first nine months of 2023 was higher when compared to the corresponding period in 2022 primarily due to reductions in inventory and accounts receivable. See Note G - Debt for further discussion on the Company’s debt facilities. -19- Table of Contents Additions to property, plant and equipment for continuing operations were approximately $4.7 million and $1.7 million for the first nine months of 2023 and 2022, respectively. As of September 30, 2023, there were approximately $1.5 million of outstanding commitments for capital expenditures. The following table shows key financial ratios at the end of each specified period: Third Quarter 2023 Third Quarter 2022 Fiscal Year 2022 Current ratio 2.6 2.9 2.7 Average days’ sales in accounts receivable 58 67 56 Inventory turnover 3.5 3.2 3.4 Total debt to shareholders’ equity 37.8 % 60.3 % 50.7 % The following table shows important liquidity measures as of the balance sheet date for each specified period or for the period, as applicable (in millions): Third Quarter 2023 Third Quarter 2022 Fiscal Year 2022 - Held in the United States $ 7.3 $ 3.2 7.4 - Held by a foreign subsidiary 2.2 2.5 2.8 9.5 5.7 10.2 Working capital 73.5 90.6 78.3 Net cash provided by (used in) operating activities 19.2 (0.3 ) 7.4 Change in working capital impact on net cash used in operating activities 7.7 (16.5 )) (5.2 ) Net cash (used in) provided by investing activities (3.0 ) 0.8 5.1 Net cash used in financing activities (16.9 ) (0.5 )) (11.8 ) Inventories of $60.6 million as of September 30, 2023, represent a decrease of 6.2% as compared to $64.6 million at the end of fiscal year 2022 and a decrease of 10.2% as compared to $67.5 million at the end of the third quarter of fiscal 2022. Accounts receivable, less allowances, were $42.8 million as of September 30, 2023, as compared to $42.9 million at 2022 fiscal year end and $50.9 million at the end of the third quarter of fiscal 2022. On June 16, 2023, the Company entered into a credit agreement with TD Bank, N.A., Wells Fargo Bank, Bank of America, and M&T Bank as lenders (the “Credit Agreement”), and 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 September 30, 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 in the short-term (i.e., the next 12 months from September 30, 2023) and separately in the long-term (i.e., beyond the next 12 months). 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 3.50 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 current economic conditions and inflationary pressures or the resulting harm to the financial condition of our customers, 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. -20- Table of Contents In addition to funding capital requirements, we may use available cash to pay down our indebtedness, to make investments, which may include investments in publicly traded securities, or to make acquisitions that we believe will complement or expand our existing businesses. As of the end of the third quarter of 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 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. -21- 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. -22- Table of Contents Reconciliation of Non-GAAP Measures Adjusted Net Income and EPS from Continuing Operations Calculation For the Three and Nine Months ended September 30, 2023 and October 1, 2022 ($000's) Three Months Ended Nine Months Ended September 30, 2023 October 1, 2022 September 30, 2023 October1,2022 Net income from continuing operations as reported per generally accepted accounting principles (GAAP) $ 3,062 $ 4,496 $ 5,068 $ 10,883 Earnings per share from continuing operations as reported under generally accepted accounting principles (GAAP): Basic $ 0.49 $ 0.72 $ 0.81 $ 1.75 Diluted $ 0.49 $ 0.72 $ 0.81 $ 1.74 Adjustments: Loss on sale of Wheeling, IL building, net of tax - - - 202 A Gain on sale of Eastern corporate office building, net of tax - (474) B - (474) B Severance and accrued compensation, net of tax - - 1,349 C - Greenwald final sale adjustment - 293 D - Associated Toolmakers, Ltd. closure, net of tax - 1,086 E - Total adjustments (non-GAAP) $ - $ (474 ) $ 2,728 $ (272 ) Adjusted net income from continuing operations $ 3,062 $ 4,022 $ 7,796 $ 10,611 Adjusted earnings per share from continuing operations (non-GAAP): Basic $ 0.49 $ 0.65 $ 1.25 $ 1.70 Diluted $ 0.49 $ 0.65 $ 1.24 $ 1.70 A) Loss on sale of building in Wheeling, IL B) Gain on sale of Eastern corporate office building C) 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 D) Final settlement of working capital adjustment associated with Greenwald sale E) Associated Toolmakers, Ltd. closure costs -23- Table of Contents Reconciliation of Non-GAAP Measures Adjusted EBITDA from Continuing Operations Calculation For the Three and Nine Months ended September 30, 2023 and October 1, 2022 ($000's) Three Months Ended Nine Months Ended September 30, 2023 October 1, 2022 September 30, 2023 October1,2022 Net income from continuing operations as reported per generally accepted accounting principles (GAAP) $ 3,062 $ 4,496 $ 5,068 $ 10,883 Interest expense 1,068 646 2,575 1,584 Provision for income taxes 984 1,423 1,679 3,498 Depreciation and amortization 1,851 1,756 5,472 5,389 Loss on sale of Wheeling, IL building - - - 269 A Gain on sale of Eastern corporate office building - (624 )B - (624 )B Severance and accrued compensation - - 1,799 C - Greenwald final sale adjustment - - 390 D - Associated Toolmakers, Ltd. closure, net of tax - - 1,448 E - Adjusted EBITDA from continuing operations $ 6,965 $ 7,697 $ 18,431 $ 20,999 A) Loss on sale of building in Wheeling, IL B) Gain on sale of Eastern corporate office building C) 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 D) Final settlement of working capital adjustment associated with Greenwald sale E) Associated Toolmakers, Ltd. closure costs -24- 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.