EASTERN CO - Quarter Report: 2022 July (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

OR

Commission File Number 001-35383

Securities registered pursuant to Section 12(b) of the Act:

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

As of July 2, 2022, 6,217,164 shares of the registrant’s common stock, no par value per share, were issued and outstanding.

The Eastern Company

Form 10-Q

FOR THE QUARTERLY PERIOD ENDED JULY 2, 2022

TABLE OF CONTENTS

PART 1 – FINANCIAL INFORMATION

ITEM 1 – FINANCIAL STATEMENTS

THE EASTERN COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

THE EASTERN COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

THE EASTERN COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

THE EASTERN COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

THE EASTERN COMPANY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

July 2, 2022

Note A – Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and Rule 8-03 of Regulation S-X and do not include all the information and footnotes required by generally accepted accounting principles in the United States (“GAAP”) for complete financial statements. Refer to the consolidated financial statements of The Eastern Company (together with its consolidated subsidiaries, the “Company,” “we,” “us” or our”) and the notes thereto included in the Company’s Annual Report on Form 10-K for the year ended January 1, 2022, filed with the Securities and Exchange Commission on March 17, 2022 (the “2021 Form 10-K”), for additional information.

The accompanying condensed consolidated financial statements are unaudited. However, in the opinion of management, all adjustments (consisting only of normal recurring accruals) necessary for a fair presentation of the results of operations for interim periods have been reflected therein. Operating results for interim periods are not necessarily indicative of the results that may be expected for the full year.  All intercompany accounts and transactions are eliminated.

The condensed consolidated balance sheet as of January 1, 2022 has been derived from the audited consolidated balance sheet at that date.

The Company’s fiscal year is a 52-53-week fiscal year ending on the Saturday nearest to December 31. References to 2021 or the 2021 fiscal year mean the 52-week period ended on January 1, 2022, and references to 2022 or the 2022 fiscal year mean the 52-week period ending on December 31, 2022. In a 52-week fiscal year, each quarter has 13 weeks.  References to the second quarter of 2021, the second fiscal quarter of 2021 or the three months ended July 3, 2021 mean the period from April 4, 2021 to July 3, 2021. References to the second quarter of 2022, the second fiscal quarter of 2022 or the three months ended July 2, 2022, mean the 13-week period from April 3, 2022 to July 2, 2022.

Certain amounts in the financial statements have been reclassified to conform with the current presentation with no impact or change to previously reported net income or shareholder’s equity.

Note B – Discontinued Operations

In the second quarter of 2021, the Company determined that the companies included in our former Diversified Products segment no longer fit with our long-term strategy and the Company initiated the process of selling the companies within the Diversified Products segment.  We believe that selling the companies within this segment will allow management to focus on our core capabilities and offerings.

The former Diversified Products segment met the criteria to be held for sale and furthermore, we determined that the assets held for sale qualify for discontinued operations.  As such, the financial results of the Diversified Products segment are reflected in our unaudited condensed consolidated statements of operations as discontinued operations for all periods presented.  Additionally, current and non-current assets and liabilities of discontinued operations are reflected in the unaudited condensed consolidated balance sheets for both periods presented.

On November 3, 2021, the Company sold its Greenwald Industries, Inc. division (“Greenwald”).  Greenwald, located in Chester, CT, is an OEM manufacturer offering a range of payment solutions from coin-vending products to smart card systems and payment applications.

On November 22, 2021, the Company sold its Frazer & Jones Company division (“Frazer & Jones”).  Frazer & Jones is a ductile and malleable iron foundry located in Syracuse, NY.  Eastern has exited the mining business to focus on our three core businesses.

Summarized Financial Information of Discontinued Operations

The following table represents income from discontinued operations, net of tax:

The following table represents the assets and liabilities from discontinued operations:

Note C – Earnings Per Share

The denominators used to calculate earnings per share are as follows:

Note D – Inventories

Inventories from continuing operations consist of the following components:

Note E - Goodwill

The aggregate carrying amount of goodwill from continuing operations is approximately $72.1 million as of July 2, 2022. No impairment was recognized in the second quarter of 2022.

The Company tests its reporting units for impairment annually in December, or more frequently if events or circumstances indicate it is more likely than not that the fair value of a reporting unit is less than its carrying amount.  Such events and circumstances could include, among other things, increased competition or unexpected loss of market share, significant adverse changes in the markets in which the Company operates, or unexpected business disruptions.  The Company tests reporting units for impairment by comparing the estimated fair value of each reporting unit with its carrying amount.  If the carrying amount of a reporting unit exceeds its estimated fair value, the Company records an impairment loss based on the difference between fair value and carrying amount not to exceed the associated carrying amount of goodwill.  Determining the fair value of a reporting unit involves the use of significant estimates and assumptions.  The values assigned to the key assumptions represent management’s assessment of future trends in the relevant industry and have been based on historical data from both external and internal sources.

Note F – Leases

The Company presents right-of-use (ROU) assets and lease liabilities on the balance sheet for all leases with terms longer than 12 months, in accordance with the Financial Accounting Standards Board (“FASB”) Accounting Standards Update (“ASU”) 2016-02, Leases.  The Company accounts for non-lease components as part of the lease component to which they relate.  Lease accounting involves significant judgements, including making estimates related to the lease term, lease payments, and discount rate.

The Company has operating leases for buildings, warehouses, and office equipment.  The Company determines whether an arrangement is, or contains, a lease at contract inception. An arrangement contains a lease if the Company has the right to direct the use of and obtain substantially all the economic benefits of an identified asset. ROU assets and lease liabilities are recognized at lease commencement based on the present value of lease payments over the lease term.  Leases with an initial term of 12 months or less are not recorded on the balance sheet; we recognize lease expense for these leases on a straight-line basis over the lease term.  Most leases include one or more options to renew.  The exercise of lease renewal options is at our sole discretion.  All options to extend, when it is reasonably certain the option will be exercised, have been included in the calculation of the ROU asset and lease liability. 

Currently, the Company has 25 operating leases and three finance leases with a lease liability of $13.2 million as of July 2, 2022.  The finance lease arrangements are immaterial.  The terms and conditions of the leases are determined by the individual agreements.  The leases do not contain residual value guarantees, restrictions, or covenants that could cause the Company to incur additional financial obligations.  There are no related party lease transactions.  There are no leases that have not yet commenced that could create significant rights and obligations for the Company.

Total lease expense for each of the next five fiscal years is estimated to be as follows: remainder of 2022 - $1.6 million; 2023 - $3.0 million; 2024 - $2.6 million; 2025 - $1.6 million; 2026 - $1.3 million; and $3.1 million thereafter.  The weighted average remaining lease term is 5.8 years. The implicit interest rate used was 5.0%.

Note G - Debt

On August 30, 2019, the Company entered into a credit agreement with Santander Bank, N.A., for itself, People’s United Bank, National Association and TD Bank, N.A. as lenders (the “Credit Agreement”), that included a $100 million term portion and a $20 million revolving commitment portion. Proceeds of the term loan were used to repay the Company’s remaining outstanding term loan (and to terminate its existing credit facility) with People’s United Bank, N.A. (approximately $19 million) and to acquire certain subsidiaries of Big 3 Holdings, LLC (collectively “Big 3 Precision”). The term portion of the loan required quarterly principal payments of $1,250,000 for an 18-month period beginning December 31, 2019. The repayment amount then increased to $1,875,000 per quarter beginning September 30, 2021 and continuing through June 30, 2023. The repayment amount then increases to $2,500,000 per quarter beginning September 30, 2023 and continuing through June 30, 2024. The term loan is a 5-year loan with the remaining balance due on August 30, 2024. The revolving commitment portion has an annual commitment fee of 0.25% based on the unused portion of the revolver. The revolving commitment portion has a maturity date of August 30, 2024.  As of July 2, 2022, the Company has borrowed $10,000,000 on the revolving commitment portion of the facility at an interest rate of 2.59%.  The term loan bears interest at a variable rate based on the LIBOR rate plus an applicable margin of 1.25% to 2.25%, depending on the Company’s senior net leverage ratio. Borrowings under the revolving portion bear interest at a variable rate based on, at the Company’s election, a base rate plus an applicable margin of 0.25% to 1.25% or the LIBOR rate plus an applicable margin of 1.25% to 2.25%, with such margins determined based on the Company’s senior net leverage ratio.  The Company’s obligations under the Credit Agreement are secured by a lien on certain of the Company’s and its subsidiaries’ assets pursuant to a Pledge and Security Agreement, dated August 30, 2019, with Santander Bank, N.A., as administrative agent.

The Company’s loan covenants under the Credit Agreement require the Company to maintain a senior net leverage ratio not to exceed 4.25 to 1. In addition, the Company is required to maintain a fixed charge coverage ratio to be not less than 1.25 to 1.  The Company was in compliance with all of its covenants under the Credit Agreement on July 2, 2022, and through the date of filing this Form 10-Q.

On August 30, 2019, the Company entered an interest rate swap contract with Santander Bank, N.A., with an original notional amount of $50,000,000, which was equal to 50% of the outstanding balance of the term loan on that date. The Company has a fixed interest rate of 1.44% on the swap contract and will pay the difference between the fixed rate and LIBOR when LIBOR is below 1.44% and will receive interest when the LIBOR rate exceeds 1.44%. On July 2, 2022, the interest rate for approximately half ($25.9 million) of the term portion was 2.81%, using a one-month LIBOR rate, and 3.19% on the remaining balance ($41.9 million) of the term loan based on a one-month LIBOR rate.

The interest rates under the Credit Agreement and the interest rate swap contract are susceptible to changes to the method of determining LIBOR rates and to the phasing out of LIBOR.  Information regarding the phasing out of LIBOR is provided below.

On July 27, 2017, the Financial Conduct Authority (the “FCA”) (the authority that regulates LIBOR) announced that it would phase out LIBOR by the end of 2021. In December 2020, the ICE Benchmark Administration (the “IBA”) announced a market consultation regarding the extension of US dollar LIBOR tenors through June 30, 2023, which the FCA supports.  On March 5, 2021, the IBA released its feedback statement reporting the results of the market consultation.  Pursuant to its feedback statement, the IBA ceased publication of all settings of non-US dollar LIBOR and only the one-week and two-month U.S. dollar LIBOR settings on December 31, 2021, with the publication of the remaining U.S. dollar LIBOR settings scheduled to be discontinued after June 30, 2023.  The Alternative Reference Rates Committee (ARRC), a financial industry group convened by the Federal Reserve Board, has recommended the use of a secured overnight financing rate (“SOFR”) to replace LIBOR.  In addition, on March 15, 2022, the Adjustable Interest Rate Act (the “LIBOR Act”) was signed into law, which provided a replacement framework for outstanding financial contracts tied to LIBOR once LIBOR ceases to be published. The LIBOR Act provides a statutory mechanism and safe harbor that applies on a nationwide basis to replace LIBOR with a benchmark rate, selected by the Federal Reserve Board based on SOFR, for certain contracts that reference LIBOR and contain no or insufficient fallback provisions. The LIBOR Act preempts and supersedes any state or local law, statute, rule, regulation or standard relating to the selection or use of a benchmark replacement or related changes and allows parties that already have effective fallback provisions to opt out of the legislation. The difference between LIBOR and SOFR is that LIBOR is a forward-looking rate which means the interest rate is set at the beginning of the period with payment due at the end. SOFR is a backward-looking overnight rate which has implications for how interest and other payments are based.  Changes in the method of calculating the replacement of LIBOR with an alternative rate or benchmark are still in flux, and once an alternate rate is adopted, may adversely affect interest rates and result in higher borrowing costs. This could materially and adversely affect the Company’s results of operations, cash flows and liquidity. We cannot predict the effect of the potential changes to LIBOR or the establishment and use of alternative rates or benchmarks at this time. 

Note H - Stock Options and Awards

The Eastern Company 2010 Executive Stock Incentive Plan (the “2010 Plan”), for officers, other key employees, and non-employee directors expired in February 2020.  On February 19, 2020, the Board of Directors of the Company (the “Board”) adopted the Eastern Company 2020 Stock Incentive Plan (the “2020 Plan”).   On April 29, 2020, at the Company’s 2020 Annual Meeting of Shareholders, the shareholders of the Company approved and adopted the 2020 Plan.  The 2020 Plan replaced the 2010 Plan.  The Company has no other existing plan pursuant to which equity awards may be granted.

Incentive stock options granted under the 2020 Plan must have exercise prices that are not less than 100% of the fair market value of the Company’s common stock on the dates the stock options are granted.  Restricted stock awards may also be granted to participants under the 2020 Plan with restrictions determined by the Compensation Committee of the Board.  Under the 2020 Plan, non-qualified stock options granted to participants will have exercise prices determined by the Compensation Committee of the Board. During the first six months of fiscal 2022, the Company granted 43,300 stock awards that were subject to the meeting of performance measurements.  The Company granted 27,300 stock awards in the first six months of fiscal 2021 that were subject to the meeting of performance measurements. For the first six months of fiscal 2022, the Company used assumptions which included an expected term of 4.0 years, volatility deviation between 47.15% to 47.70% and a risk-free rate between 2.04% to 2.66% for the purposes of measuring compensation under the Black Scholes Method.  For the first six months of fiscal 2021, the Company used several assumptions which included an expected term of 4.0 years, volatility deviation between 47.25% to 48.55% and a risk-free rate between 0.18% to 0.35% for the purposes of measuring compensation under the Black Scholes Method. 

The 2020 Plan also permits the issuance of Stock Appreciation Rights (“SARs”).  The SARs are in the form of an option with a cashless exercise price equal to the difference between the fair value of the Company’s common stock at the date of grant and the fair value as of the exercise date resulting in the issuance of the Company’s common stock.  During the first six months of fiscal 2022 and 2021 the Company did not issue any SARs. 

Stock-based compensation expense in connection with SARs previously granted to employees was approximately $136,000 and $100,000 in the second quarter of 2022 and the second quarter of 2021, respectively and was approximately $250,000 and $214,000 in the first six months of fiscal years 2022 and 2021, respectively.

As of July 2, 2022, there were 766,433 shares of Company common stock reserved and available for future grant under the 2020 Plan.

The following tables set forth the outstanding SARs for the period specified:

The following tables set forth the outstanding stock awards for the period specified:

As of July 2, 2022, outstanding SARs and stock awards had an intrinsic value of $1,337,000.

Note I – Share Repurchase Program

On May 2, 2018, the Company announced that the Board of Directors of the Company had authorized a new program to repurchase up to 200,000 shares of the Company’s common stock. The Company’s share repurchase program does not obligate it to acquire the Company’s common stock at any specific price per share.  Under this program, shares of common stock may be repurchased in privately negotiated and/or open market transactions, including under plans complying with Rule 10b5-1 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Below is a summary of the Company’s share repurchases during the second quarter of 2022.

Note J – Revenue Recognition

The Company’s revenues result from the sale of goods and services and reflect the consideration to which the Company expects to be entitled.  The Company records revenues in accordance with FASB Accounting Standards Codification (“ASC”) Topic 606, “Revenue from Contracts with Customers”.  The Company has defined purchase orders as contracts in accordance with ASC Topic 606. For its customer contracts, the Company identifies its performance obligations, which are delivering goods or services, determines the transaction price, allocates the contract transaction price to the performance obligations (when applicable), and recognizes the revenue when (or as) the performance obligation is transferred to the customer.  A good or service is transferred when the customer obtains control of that good or service.  The Company’s revenues are recorded at a point in time from the sale of tangible products.  Revenues are recognized when products are shipped. 

Customer volume rebates, product returns, discount and allowance are variable consideration and are recorded as a reduction of revenue in the same period that the related sales are recorded.  The Company has reviewed the overall sales transactions for variable consideration and has determined that these costs are not material. 

The Company has no future performance obligations and does not capitalize costs to obtain or fulfill contracts. 

Note K - Income Taxes

The Company files income tax returns in the U.S. federal jurisdiction, and in various states and foreign jurisdictions.  With limited exceptions, the Company is no longer subject to U.S. federal, state, and local income tax examinations by tax authorities for years before 2017 and is no longer subject to non-U.S. income tax examinations by foreign tax authorities for years prior to 2015. 

The total amount of unrecognized tax benefits could increase or decrease within the next 12 months following July 2, 2022 for several reasons, including the closure of federal, state, and foreign tax years by expiration of the statute of limitations and the recognition and measurement considerations under FASB ASC Topic 740, “Income Taxes.”  There have been no significant changes to the value of unrecognized tax benefits during the six months ended July 2, 2022.  The Company believes that it is reasonably possible that the total amount of unrecognized tax benefits will not increase or decrease significantly over the next twelve months following July 2, 2022.

Note L - Retirement Benefit Plans

The Company has four non-contributory defined benefit pension plans covering most U.S. employees.  Three of these pension plans are frozen and participants in these three plans have not accrued benefits since the date on which these plans were frozen.  A fourth pension plan does not permit new participants but existing participants in this fourth pension plan continue to accrue benefits.  Plan benefits are generally based upon age at retirement, years of service and, for the plan covering salaried employees, the level of compensation.  The Company also sponsors unfunded non-qualified supplemental retirement plans that provide certain former officers with benefits in excess of limits imposed by federal tax law. 

The Company also provides health care and life insurance for retired salaried employees in the United States who meet specific eligibility requirements.

Significant disclosures relating to these benefit plans for the first three months and first six months 2022 and 2021 are as follows:

The Company’s funding policy with respect to its qualified plans is to contribute at least the minimum amount required by applicable laws and regulations.  In 2022, the Company expects to contribute $300,000 into its pension plans and $50,000 into its postretirement plan. As of July 2, 2022, the Company has not made any contributions into its pension plans, has contributed $13,000 to its postretirement plan, and expects to make the remaining contributions as required during the remainder of the fiscal year. 

The Company has a contributory savings plan under Section 401(k) of the Internal Revenue Code (the “401(k) Plan”) covering substantially all U.S. non-union employees.  The 401(k) Plan allows participants to make voluntary contributions from their annual compensation on a pre-tax basis, subject to limitations under the Internal Revenue Code.  The 401(k) Plan provides for contributions by the Company at its discretion.

The Company made contributions to the plan as follows:

The non-discretionary contribution of $323,082 made in the six months ended July 2, 2022, was accrued for and expensed in the prior fiscal year.

Note M - Recent Accounting Pronouncements

Adopted

In December 2019, FASB issued ASU 2019-12, Simplifying the Accounting for Income Tax.  The changes implemented in ASU 2019-12 include removing exceptions to incremental intraperiod tax allocation of losses and gains from different financial statement components, exceptions to the method of recognizing income taxes on interim period losses and exceptions to deferred tax liability recognition related to foreign subsidiary investments.  In addition, ASU 2019-12 requires that entities recognize franchise tax based on an incremental method, requires an entity to evaluate the accounting for step-ups in the tax basis of goodwill as inside or outside of a business combination, and removes the requirement to allocate the current and deferred tax provision among entities in standalone financial statement reporting. The ASU also now requires that an entity reflect enacted changes in tax laws in the annual effective rate, and other codification adjustments have been made to employee stock ownership plans.  The Company adopted ASU 2019-12 as of January 3, 2021. The adoption of this guidance did not have a material impact on the consolidated financial statements of the Company.

The Company has implemented all new accounting pronouncements that are in effect and that could impact its consolidated financial statements and does not believe that there are any other new accounting pronouncements that have been issued, but are not yet effective, that might have a material impact on the consolidated financial statements of the Company.

Note N - Concentration of Risk

Credit Risk

Credit risk is the potential financial loss resulting from the failure of a customer or counterparty to settle its financial and contractual obligations to the Company, as and when they become due. The primary credit risk for the Company is its accounts receivable due from customers. The Company has established credit limits for customers and monitors their balances to mitigate the risk of loss.  As of July 2, 2022, there was one significant concentration of credit risk with a customer, who has receivables representing 11% of our total accounts receivable.  One single customer represented more than 11% of the Company’s net accounts receivable as of January 1, 2022.  The maximum exposure to credit risk is primarily represented by the carrying amount of the Company’s accounts receivable.

The Company has deposits that exceed amounts up to $250,000 that are insured by the Federal Deposit Insurance Corporation (FDIC), but the Company does not consider this a significant concentration of credit risk based on the strength of the financial institution.

Interest Rate Risk

The Company’s exposure to the risk of changes in market interest rates relates primarily to the Company’s debt, which bears interest at variable rates based on the LIBOR rate plus a margin spread of 1.25% to 2.25%. The Company has an interest rate swap with a notional amount of $41.9 million on July 2, 2022, to convert a portion of the borrowing under the Credit Agreement from variable to fixed rates. The valuation of this swap is determined using the one-month LIBOR rate index and mitigates the Company's exposure to interest rate risk.  Additionally, interest rates on the Company's debt are susceptible to changes to the method that LIBOR rates are determined and to the potential phasing out of LIBOR after 2021.  The potential phasing out of LIBOR is discussed in greater detail in Note G — Debt hereof and under the heading “The phaseout of the London Interbank Offered Rate (LIBOR), or the replacement of LIBOR with a different reference rate, may adversely affect interest rates” in Part I, Item 1A of the 2021 Form 10-K.

Currency Exchange Rate Risk

The Company’s currency exposure is concentrated in the British pound, Canadian dollar, Mexican peso, New Taiwan dollar, Chinese RMB and the Hong Kong dollar.  Because of the Company’s limited exposure to any single foreign market, any currency gains or losses have not been material and are not expected to be material in the future.  As a result, the Company does not attempt to mitigate its foreign currency exposure through the acquisition of any speculative or leveraged financial instruments.

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 July 2, 2022. 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 January 1, 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 January 1, 2022, which was filed with the Securities and Exchange Commission (the “SEC”) on March 17, 2022 (the “2021 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 2021 or the 2021 fiscal year mean the 52-week period ended on January 1, 2022, and references to 2022 or the 2022 fiscal year mean the 52-week period ending on December 31, 2022. In a 52-week fiscal year, each quarter has 13 weeks.   References to the second quarter of 2021, the second fiscal quarter of 2021 or the three months ended July 3, 2021, mean the period from April 4, 2021 to July 3, 2021. References to the second quarter of 2022, the second fiscal quarter of 2022 or the three months ended July 2, 2022, mean the 13-week period from April 3, 2022 to July 2, 2022. References to the first six months of 2021 or the six months ended July 3, 2021 mean the period from January 3, 2021 to July 3, 2021.  References to the first six months of 2022 or the six months ended July 2, 2022 mean the period from January 1, 2022 to July 2, 2022.

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 “should,” “could,” “may,” “will,” “expect,” “believe,” “estimate,” “anticipate,” “intend,” “continue,” 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 scope and duration of the COVID-19 pandemic, including timing of the distribution of  COVID-19 vaccines and rates of vaccination, the extent of resurgences,, the emergence of additional virus variants and how quickly and to what extent normal economic activity can resume, and economic effects of the COVID-19 pandemic, including supply chain disruptions, cost inflation, 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, and risks associated with employees working remotely or operating with reduced workforce. Other factors include, but are not limited to 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; restrictions on operating flexibility imposed by the agreement governing our credit facility; 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; our ability to design, introduce and sell new 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, including the impact, length and degree of economic downturns on the customers and markets we serve 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 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 2021 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.  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.

Overview

COVID-19 Update

The COVID-19 pandemic has affected our businesses, including our supply chain, our operations, the labor force, and costs throughout 2021 and into 2022.  We continue to follow CDC guidelines, including the use of proper personal protection equipment, social distancing, and sanitizing work areas.  As a result of these measures, the COVID pandemic had minimal impact on our North American capacity utilization at most of our production facilities in the second quarter of 2022. Many of the Company’s employees have received COVID-19 vaccinations, and we will continue to encourage our workforce to get vaccinated.  In the second quarter of 2022, we are experienced interruptions in China of our operations and supply base as a result of another variant of COVID-19 and the response to minimize its spread. A more significant resurgence of the COVID-19 pandemic or development of additional severe or highly contagious variants could cause further disruptions in our business and could adversely affect our financial condition, results of operations and cash flow.

During the past two years and continuing into 2022, the Company implemented a broad range of policies and procedures to ensure that employees at all our locations remain healthy. Steps that we have taken to reduce the risk of COVID-19 to our employees include, among others: protecting employee health by instructing employees to stay home if they exhibit symptoms of COVID-19; providing standard surgical masks and educating employees on hand hygiene to help stop the spread.  We maintain a clean work environment by frequently cleaning all touch points with products that meet EPA criteria for use against COVID-19; educating employees to clean their personal workspace at the beginning and the end of every shift; and providing hand sanitizer and disposable wipes.  We encourage social distancing, limit in-person meetings, reduced all non-essential workplace travel and continue to seek and implement additional methods to reduce the risk of COVID-19 to our employees.

the extent to which our operations will be further affected by COVID-19 in 2022 is dependent on future developments including new COVID variants, effectiveness of vaccines, new medication, and governmental restrictions.  All these factors could result in further supply chain shortages and resulting cost inflation, increased operating cost, difficulty in finding workers, continued port congestion, and higher shipping costs.  With the inherent uncertainty of the COVID-19 pandemic it is difficult to predict with any confidence the likely impact of the COVID-19 pandemic on our future operations and the extent of the effects it could have on our consolidated business, results of operations and financial condition. For a discussion of certain COVID-19-related risks, see Part I, Item 1A, “Risk Factors”, of the 2021 Form 10-K.

General Overview

The following analysis excludes discontinued operations.

Net sales in the second quarter of 2022 increased by 14% to $69.5 million from $61.2 million in the corresponding period in 2021. Net sales for the first six months of 2022 increased by 13% to $138.6 million from $123.0 million in the same period last year. Sales increased for both the second quarter and six-month periods due to increased demand for truck accessories and returnable transport packaging products as well as from distributors.  Our returnable transport packaging sales continue to benefit from the increase in new automotive product launches, including several electric vehicle launches. Our backlog as of July 2, 2022 decreased 0.4% to $82.8 million from $83.2 million as of July 3, 2021.

Net sales of existing products increased 9% in the second quarter of 2022 and 6% for the first six months of 2022 compared to the corresponding periods in 2021. Price increases and new products increased net sales by 5% in the second quarter and 7% in the first six months of 2022, compared to the corresponding periods in 2021. 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 increased by $6.3 million, or 13%, in the second quarter of 2022 and increased by $14.5 million, or 16% in the first six months of 2022 compared to the corresponding periods in 2021. The increases are primarily due to higher sales volume and increases in the cost of materials. The cost of several frequently used raw materials have increased significantly, year-over-year. For example, the cost of most common forms of cold-rolled steel increased 2% between the second quarter of 2021 and the second quarter of 2022; nickel increased 95%; and copper and zinc increased 5% and 41% respectively. Price increases to our customers recovered a portion of the increase in raw material costs. Finally, the Company paid tariff costs on China-sourced products of approximately $0.8 million and $1.3 million in the second quarter and first six months of 2022 respectively, compared to $0.8 million and $1.4 million in the second quarter and first six months of 2021 respectively. A significant portion of tariffs on China-sourced products have been recovered through price increases.

Gross margin as a percent of sales was 23% in the second quarter and 22% in the first six months of 2022 compared to 23% in the second quarter and 24% in the first six months of fiscal 2021. Our gross margins in the second quarter and first six months of 2022 reflect the impact of price increases to customers to recover increases in raw material costs.

Product development expense decreased $0.1 million, or 12% in the second quarter of 2022 and increased $0.1 million, or 2%, in the first six months of 2022 compared to the corresponding periods in 2021. As a percentage of net sales, product development costs were 1.4% and 1.6% for the second quarter and first six months of 2022, respectively, compared to 1.8% and 1.7% for the corresponding periods in 2021.

Selling, general and administrative expense increased $0.8 million, or 8%, in the second quarter of 2022 and increased $1.7 million, or 9% in the first six months of 2022 when compared to the corresponding periods in 2021 primarily due to increased commissions and other selling costs, payroll-related expenses, and travel costs. This increase in selling expenses reflect both the increase in sales as well as our investments in sales capabilities.

Interest expense increased $0.1 million in the second quarter of 2022 and was flat in the first six months of 2022 compared to the corresponding periods in 2021.

Other income was flat in the second quarter and decreased $2.0 million in the first six months of 2022 compared to the corresponding periods in 2021. The decrease in other income of $2.0 million in the first six months of 2022 was primarily driven by a gain on the sale of the Eberhard Hardware Ltd. building of $1.8 million in the first quarter of 2021.

Net income from continuing operations for the second quarter of fiscal 2022 was $3.7 million, or $0.59 per diluted share compared to net income of $2.8 million, or $0.44 per diluted share for the comparable period in 2021.  In the first six months of 2022 net income was $6.4 million, or $1.02 per diluted share compared to net income of $8.4 million, or $1.35 per diluted share for the comparable period in 2021.

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 the change in sales and operating profit for the second quarter and first six months of 2022 compared to the second quarter and first six months of 2021 (dollars in thousands):