The Eastern Company — Q3 2023 Form 10-Q
Business context and period: The company reported unaudited results for the 13 weeks ended September 30, 2023, and nine months ended September 30, 2023. Results are from continuing operations; the former Diversified Products segment was sold, with Argo’s sale completed in October 2022.
Financial performance
| Metric | Q3 2023 | Q3 2022 | Nine months 2023 | Nine months 2022 |
|---|---|---|---|---|
| Net sales | $65.6 million | $71.6 million | $206.5 million | $210.2 million |
| Gross margin | $16.4 million; 24.9% | $16.6 million; 23.1% | $47.0 million; 22.8% | $47.1 million; 22.4% |
| Operating profit | $5.25 million | $5.45 million | $9.84 million | $13.85 million |
| Continuing-operations net income | $3.06 million | $4.50 million | $5.07 million | $10.88 million |
| Diluted EPS from continuing operations | $0.49 | $0.72 | $0.81 | $1.74 |
- Revenue fell 8% in Q3 and 2% year to date. Management attributed the declines primarily to lower demand for truck accessories and returnable transport packaging. Existing-product sales declined 14% in Q3 and 5% year to date; price increases and new products partly offset the volume declines.
- Gross margin improved year over year, which management attributed to customer price increases that recovered raw-material cost increases. Operating margin was 8.0% in Q3 versus 7.6%; year-to-date it was 4.8% versus 6.6%.
- Q3 operating profit was nearly flat, but lower other income and higher interest expense reduced continuing-operations net income. Year-to-date operating profit and net income also declined.
- Adjusted EBITDA from continuing operations, a non-GAAP measure, was $7.0 million in Q3 versus $7.7 million and $18.4 million year to date versus $21.0 million.
Cash flow, liquidity and debt
- Operating cash flow was $19.2 million for the first nine months, compared with cash use of $0.3 million in the prior-year period. Management cited lower inventory and receivables; inventory declined to $60.6 million from $64.6 million at year-end 2022.
- Capital expenditures were $4.7 million, leaving approximate operating cash flow less capital expenditures of $14.5 million. The company reported about $1.5 million of outstanding capital expenditure commitments.
- Cash was $9.5 million at September 30, 2023, versus $10.2 million at December 31, 2022. Working capital was $73.5 million and the current ratio was 2.6.
- Long-term debt, including its current portion, was $48.7 million at quarter-end, versus $64.1 million at year-end 2022. In June, the company refinanced its prior facility with a $60 million term loan and a $30 million revolving facility; no revolver funds were drawn at September 30. The term loan has variable-rate pricing tied to SOFR.
- The credit agreement requires a senior net leverage ratio no greater than 3.5:1 and fixed-charge coverage of at least 1.25:1. The company reported compliance at quarter-end and through the filing date. Management expects cash, operating cash flow and revolver availability to cover foreseeable needs in the short and long term, while noting financing availability and covenant risks.
Material changes, outlook and risks
- Product development expense rose 41% in Q3 and 34% year to date as the company invested in new products. Year-to-date SG&A increased 9%, including $1.8 million of severance and accrued compensation tied to the COO position’s elimination and the former CEO’s departure.
- Interest expense increased by $0.4 million in Q3 and $1.0 million year to date, principally due to higher borrowing rates. Other income declined sharply year over year; items included prior-year building-sale gains, pension-cost changes, 2023 closure costs for Associated Toolmakers, a Greenwald sale working-capital adjustment, and a favorable settlement of the former interest-rate swap.
- Backlog increased 4% year over year to $89.4 million. Management provided no specific revenue or earnings guidance and said future revenue and margin trends cannot be reliably predicted.
- The June 2023 acquisition of Sureflex added tractor-trailer electrical connection cable assembly capabilities; the company said its actual and pro forma effects were not material. No goodwill impairment was recorded in Q3; approximately $0.5 million of goodwill was written off following the Associated Toolmakers closure.
- Key disclosed risks include demand and economic conditions, inflation and input costs, supply-chain disruption, higher interest rates, foreign-exchange and geopolitical exposure, acquisition execution, and the possibility that weaker earnings could pressure credit covenants. One customer represented 12% of net receivables. The company reported no material pending legal proceedings and no material changes to its previously disclosed risk factors.
Investor verification points
- Assess whether improving gross margin and higher backlog can offset continued lower sales volumes and weaker year-to-date operating profit.
- Review variable-rate debt exposure, covenant headroom, refinancing terms and the availability of the undrawn $30 million revolver.
- Track cash conversion and working-capital trends, capital spending commitments, and the use of cash for dividends or share repurchases.
- Evaluate the impact and recurrence of management changes, severance, closure and sale-related adjustments, and pension costs.
- Monitor customer concentration, tariff recovery, and demand in truck accessories and returnable transport packaging.