The Eastern Company (NASDAQ: EML) — Q3 2022 Form 10-Q
Business context and period: The 13-week quarter ended October 1, 2022; year-to-date figures cover the nine months ended that date. Eastern reported continuing operations, with its former Diversified Products segment presented as discontinued operations. Sales growth reflected demand for truck accessories and returnable transport packaging, including products for automotive launches, as well as distributor demand.
Key financial results
| Metric | Q3 2022 | Q3 2021 | Nine months 2022 | Nine months 2021 |
|---|---|---|---|---|
| Net sales | $71.6m | $63.9m | $210.2m | $186.9m |
| Gross margin | $16.6m; 23.1% | $15.2m; 23.8% | $47.1m; 22.4% | $44.7m; 23.9% |
| Operating profit | $5.4m | $4.8m | $13.8m | $13.9m |
| Net income from continuing operations | $4.5m | $3.8m | $10.9m | $12.3m |
| Diluted EPS from continuing operations | $0.72 | $0.61 | $1.74 | $1.96 |
| Net income, including discontinued operations | $4.9m | $6.0m | $11.9m | $7.3m |
Cash flow and liquidity: Cash used by continuing operating activities was $0.3m for the first nine months, versus $3.3m used a year earlier. Working-capital investment remained significant; inventory was $67.5m, up 7.4% from fiscal year-end, and accounts receivable was $50.9m. At October 1, cash on the balance sheet was $5.3m, working capital was $90.6m, and the current ratio was 2.9. The cash-flow statement reports ending cash of $5.7m, including cash held in assets classified as held for sale.
Debt: Current and long-term debt totaled $74.7m at October 1, including $9.0m borrowed on the revolving facility. The company reported $11.0m of revolver availability at quarter-end and compliance with its debt covenants. On October 21, it used $5.0m of proceeds from the Argo asset sale to pay down the revolver. Interest expense rose to $0.6m in Q3 and $1.6m year to date.
Material changes and management commentary
- Sales increased 12.1% in Q3 and 12.4% year to date. Management attributed growth to volume, pricing and new products; backlog rose 3% year over year to $85.7m.
- Gross margin declined year over year as product costs rose faster than sales. Management cited higher material costs and China-sourced product tariffs; price increases recovered part, but not all, of the increases.
- Q3 operating profit improved, while year-to-date operating profit was nearly flat. Higher selling costs, commissions, payroll and travel contributed to increased SG&A.
- Year-to-date continuing-operations profit fell despite sales growth, partly reflecting lower other income versus 2021. Q3 other income included a $0.6m gain on sale of the corporate office building.
- Adjusted EBITDA from continuing operations, a non-GAAP measure, was $7.7m in Q3 versus $7.1m, and $21.0m year to date versus $21.0m. Adjusted diluted EPS was $0.65 and $1.70, respectively, versus $0.64 and $1.79.
- Total net income comparisons are affected by discontinued operations: 2021 year-to-date results included a $9.3m loss related to classifying assets as held for sale. Greenwald and Frazer & Jones were sold in November 2021. Eastern subsequently closed the sale of Argo assets on October 14, 2022.
Outlook, risks and unusual items
The filing provides no specific numerical revenue or earnings guidance. Management said cash, operating cash flow and available revolver capacity were expected to cover foreseeable working-capital needs, but gave no assurance about future financing availability or terms. It also noted that future revenue and margin trends cannot be reliably predicted.
- Risks include supply-chain disruption, labor availability, inflation and higher raw-material, freight and tariff costs; management said COVID-related interruptions in China had affected operations and supply in Q2.
- Variable-rate borrowings expose the company to rising interest costs. Its debt and swap arrangements referenced LIBOR; the filing warned that transition to a replacement benchmark could increase borrowing costs.
- Debt covenants require a senior net leverage ratio no greater than 4.25:1 and fixed-charge coverage of at least 1.25:1. The company was compliant at October 1, but warned that lower earnings or higher debt could pressure compliance.
- One customer represented 15% of accounts receivable at quarter-end. The company also disclosed foreign-currency exposure and goodwill impairment sensitivity; no goodwill impairment was recorded in Q3.
- The company agreed to freeze its remaining accruing hourly pension plan effective December 31, 2022. It expected 2022 contributions of $300,000 to pension plans and $50,000 to the postretirement plan.
Important facts for investors to verify
- Whether price increases and product demand can offset material, freight and tariff inflation and restore gross margins.
- Whether inventory and receivables convert to cash, given the year-to-date operating cash outflow and elevated working capital.
- The impact of the Argo sale and $5.0m revolver paydown on debt, liquidity and ongoing earnings.
- Interest-rate exposure, benchmark transition terms and headroom under the credit covenants.
- The concentration and credit quality of the customer representing 15% of receivables, and the timing and proceeds of remaining asset-sale activity.