The Eastern Company — Q2 2020 Form 10-Q
Business context and reporting period. The Eastern Company reported its unaudited 13-week second quarter and 26-week first half ended June 27, 2020, compared with periods ended June 29, 2019. Its three segments are Industrial Hardware, Security Products, and Metal Products. Management attributed weaker results chiefly to COVID-19-related customer closures and reduced demand, alongside structural pressures in mining and certain product markets.
Financial performance
| Metric | Q2 2020 | Q2 2019 | First half 2020 | First half 2019 |
|---|---|---|---|---|
| Net sales | $48.8 million | $61.4 million | $114.2 million | $122.3 million |
| Gross margin | $10.8 million; 22.0% | $15.0 million; 24.4% | $25.9 million; 22.6% | $28.8 million; 23.6% |
| Operating income (loss) | $(2.2) million | $3.0 million | $2.2 million | $5.3 million |
| Net income (loss) | $(1.9) million | $2.5 million | $1.0 million | $4.1 million |
| Diluted EPS | $(0.30) | $0.40 | $0.16 | $0.65 |
| Operating cash flow | Not presented for the quarter | $7.4 million | $8.7 million |
- Q2 sales fell about 21%; first-half sales fell about 7%. Q2’s $4.0 million goodwill impairment was a non-cash expense and materially affected comparability. Excluding impairment and restructuring, management reported non-GAAP adjusted diluted EPS of $0.23 for Q2 and $0.68 for the first half, versus $0.62 and $0.98, respectively, in 2019.
- Q2 segment sales were $33.9 million for Industrial Hardware, $11.1 million for Security Products, and $3.8 million for Metal Products. Year-over-year, they declined 10%, 33%, and 48%, respectively. Industrial Hardware first-half sales increased 7%, primarily reflecting the acquired Big 3 Precision business; excluding it, segment sales declined 26%.
- Metal Products’ gross margin was negative 12% in Q2 and negative 4% for the first half, reflecting under-absorption of foundry fixed costs as volumes dropped.
- Interest expense rose to $0.6 million in Q2 and $1.4 million in the first half, principally reflecting debt associated with the August 2019 Big 3 Precision acquisition. Quarterly dividends were $0.11 per share, unchanged from 2019.
Financial position and liquidity
- At June 27, 2020, cash and cash equivalents were $20.0 million, total current assets $113.4 million, and current liabilities $31.0 million. Working capital was approximately $82.3 million and the current ratio was 3.8.
- Total debt was approximately $96.1 million, comprising $5.2 million current and $91.0 million long-term, compared with approximately $98.8 million at December 28, 2019. The company had not drawn on its $20 million revolving facility. Total debt to shareholders’ equity was 93.4%.
- First-half operating cash flow of $7.4 million, investing cash inflow of $0.6 million, and financing cash outflow of $5.6 million resulted in a $2.0 million increase in cash. Financing included $2.6 million of debt principal payments, $1.4 million of dividends, and $0.4 million of treasury-stock purchases.
- The credit agreement requires a senior net leverage ratio no greater than 4.25:1 and fixed-charge coverage of at least 1.25:1. The company reported compliance at quarter-end and through the filing date. A portion of variable-rate debt was hedged with an interest-rate swap.
Changes, outlook, risks, and unusual items
- Management estimated COVID-19 reduced Q2 sales by approximately $16.1 million and operating profit by approximately $3.2 million. Facilities largely remained open at reduced levels; China-related shutdowns and supplier disruption had delayed some orders by four to six weeks. The company sources approximately 15% of its products and components from China.
- The company expects COVID-19 to adversely affect fiscal 2020 financial position, results, and cash flows, but gave no specific full-year numerical guidance. It warned that demand, operations, supply availability, customer payments, and financing could be further affected by the pandemic or resurgences.
- A $4.0 million goodwill impairment was recorded for Greenwald Industries, in the Security Products segment, due to competition and migration from legacy smart-card systems toward lower-cost mobile payment apps. Management reported no specific impairment indicators for other reporting units.
- In June, the company divested Canadian Commercial Vehicles Corporation for $1.3 million payable under a promissory note. In July, it signed an agreement to acquire Hallink RSB Inc. assets and assume liabilities for approximately $7.0 million cash; closing was expected around August 2020.
- Other risks include mining-market weakness from low natural-gas prices and growth in renewable energy, loss of certain customer contracts, variable-rate borrowing and LIBOR transition uncertainty, and the possibility that weaker earnings could pressure credit-covenant compliance or increase borrowing costs.
- The company had accrued $430,000 for remediation and monitoring of a foundry-sand landfill. Written regulatory approval was anticipated in Q3 2020, with remedial construction expected in spring 2021. Management said there were no other material pending legal proceedings.
Important facts for investors to verify
- Whether sales and operating cash flow stabilize as customer operations reopen, and how much of the downturn persists beyond Q2.
- Segment performance, especially Metal Products’ negative gross margin and Security Products’ competitive and impairment pressures.
- Debt, covenant headroom, interest expense, and terms for any borrowing under the unused revolver.
- Collection and repayment terms of the $1.3 million divestiture note, and the closing, funding, and integration of the Hallink acquisition.
- Progress on landfill remediation and any updated cost estimates or regulatory developments.