The following discussion is intended to highlight significant changes in the financial position and results of operations ofThe Eastern Company (together with its consolidated subsidiaries, the "Company," "we," "us" or "our") for the quarter endedJune 27, 2020 . The interim financial statements and 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 endedDecember 28, 2019 and the related Management's Discussion and Analysis of Financial Condition and Results of Operations, both of which are contained in the Company's 2019 Form 10-K, which was filed with theSEC onMarch 5, 2020 (the "2019 Form 10-K"). The Company's fiscal year is a 52-53-week fiscal year ending on the Saturday nearest toDecember 31 . References to fiscal 2019 or the 2019 fiscal year mean the 52-week period ended onDecember 28, 2019 and references to fiscal 2020 or the 2020 fiscal year mean the 53-week period ending onJanuary 2, 2021 . In a 52-week fiscal year, each quarter is 13 weeks long. In a 53-week fiscal year, each of the first two fiscal quarters and the fourth quarter are 13 weeks long, and the third fiscal quarter is 14 weeks long. References to the second quarter of fiscal 2019, the second fiscal quarter of 2019 or the three months endedJune 29, 2019 mean the 13-week period fromMarch 31, 2019 toJune 29, 2019 . References to the second quarter of fiscal 2020, the second fiscal quarter of 2020 or the three months endedJune 27, 2020 mean the 13-week period fromMarch 29, 2020 toJune 27, 2020 . References to the six months endedJune 29, 2019 , the first six months of fiscal 2019 or the first half of fiscal 2019 mean the 26-week period fromDecember 30, 2018 toJune 29, 2019 . References to the six months endedJune 27, 2020 , the first six months of fiscal 2020 or the first half of fiscal 2020 mean the 26-week period fromDecember 29, 2019 to June
27, 2020.
Safe Harbor for Forward-Looking Statements
Statements contained in this Quarterly Report on Form 10-Q 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, but are not limited to: effects of the COVID-19 pandemic and the measures being taken to limit the spread and resurgence of COVID-19, including supply chain disruptions, 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 the Credit Agreement, and risks associated with employees working remotely or operating with reduced workforce; the scope and duration of the COVID-pandemic, including the extent of any resurgences and how quickly and to what extent normal economic activity can resume; the timing of the development and distribution of effective vaccine or treatment of COVID-19; 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, 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, commercial laundry, mining and general industrial markets; costs and liabilities associated with environmental compliance; the impact of climate change or terrorist threats and the possible responses by theU.S. and foreign governments; failure to protect our intellectual property; cyberattacks; and materially adverse or unanticipated legal judgments, fines, penalties or settlements. 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. 18 Table of Contents Overview COVID-19 Update As ofJune 2020 , there have been significant impacts to the Company's operations due to the COVID-19 pandemic and actions that have been taken to slow the spread and resurgence of COVID-19, and we expect those impacts to continue for some time. Across the Company, we have implemented a broad range of policies and procedures to ensure that employees at all of our locations remain healthy. We listened to and learned a great deal from our colleagues inChina , who began feeling the impact of COVID-19 in late 2019, and took early-on decisive action across our North American operations, accordingly. Steps that we have taken to reduce COVID-19 risk to our employees include, among others: implementing social distancing measures, staggering staff and shifts, enabling work from home for as many employees as possible, and implementing an enhanced cleaning program across all sites. We are advising our employees on the importance of wearing facemasks to reduce the spread COVID-19. As government authorities implement restrictions on commercial operations, we continue to ensure compliance with these directives in order to maintain business continuity for our essential operations. We continue to seek and implement additional methods to further reduce COVID-19 risk to our employees. The Company has operations inShanghai andDongguan China that have been impacted by COVID-19. The virus led to a chain of events that interfered with our ability, and the ability of certain suppliers of ours, to conduct business. We source approximately 15% of our products and components fromChina . As a result of government mandated shutdowns at our facilities, and those of certain suppliers, inChina , many of the products that we have ordered have been delayed by approximately four to six weeks, which has resulted in delays in our product shipments to our customers throughMay 2020 . Bymid-March 2020 , COVID-19 had begun to spread acrossthe United States , which precipitated the closure by government authorities of non-essential businesses. The majority of our businesses are deemed essential and have accordingly remained open, but at reduced levels. Many of our customers operating in both automotive/transportation and non-automotive/transportation markets experienced varying degrees of shutdowns beginning in the last week of March, and, on a case-by-case basis, began to reopen at various dates beginning inMay 4, 2020 . We estimate the adverse financial impact of COVID-19 on our second quarter operating sales and profit to be an approximate$16.1 million and$3.2 million reduction net of tax, respectively. The broader economic fallout caused by COVID-19 may result in unfavorable operating earnings and cash flow generation in the months to follow. Although we sustained delays and disruptions in our supply chain and operations inChina , in the first quarter of 2020, the majority of our facilities returned to normal operation but at reduced levels during the second fiscal quarter of 2020. We do not anticipate further disruption in our operations unless resurgences of COVID-19 were to appear, which could cause further disruptions in our business and could adversely affect our financial condition, results of operations and cash flow. In addition, the broader economic fallout caused by COVID-19 may result in unfavorable operating earnings and cash flow generation in the months to follow, as a result of decreased consumer demand for our and our customers' products. The future extent of the COVID-19's effect on our operational and financial performance will depend in large part on developments, that cannot be predicted with confidence at this time. Future developments include the ultimate duration, scope and severity of the pandemic and any resurgences, actions that may continue to be taken to contain or mitigate the impact of the pandemic, such as the extent of restrictions on gatherings and travel, the impact on governmental programs and budgets, the development of treatments or vaccines, and the resumption of widespread economic activity. Although the inherent uncertainty of the unprecedented and rapidly evolving crisis makes it difficult to predict with any confidence the likely impact of COVID-19 on our future operations, COVID-19 could have a material adverse impact on our consolidated business, results of operations and financial condition. For a discussion of certain COVID-19-related risks, see Item 1A, Risk Factors,
of Part II of this Form 10-Q. 19 Table of Contents General Overview
The Company has accelerated the optimization of its portfolio of businesses in the second quarter of fiscal 2020. InJune 2020 , the Company completed the divestiture of its subsidiary,Canadian Commercial Vehicles Corporation , to 1252256B.C. LTD. for$1.3 million , payable pursuant to a promissory note from the buyer. Under the terms of the agreement with the buyer, 1252256B.C. LTD. acquired the stock ofCanadian Commercial Vehicles Corporation , which owns our manufacturing facility inKelowna, British Columbia at book value.
For the second fiscal quarter of 2020, the results of operations reflect a
goodwill impairment of
Net sales in the second fiscal quarter of 2020 decreased 21% to$48.8 million from$61.4 million , and nets sales in the first six months of fiscal 2020 decreased 7% to$114.2 million from$122.3 million , compared to corresponding periods in fiscal 2019. The sales decline is primarily due to the decision by many of our industrial and consumer goods customers to close operations and a precipitous decline in demand for mining related products resulting from the COVID-19 pandemic.
Sales decreased in the Industrial Hardware segment by 10% to$33.9 million in the second fiscal quarter of 2020 from$37.5 million in the second fiscal quarter of 2019 and increased by 7% to$81.1 million for the first six months of fiscal year 2020 from$75.9 million in the corresponding period of fiscal 2019. Excluding Big 3 Precision, sales decreased 42% in the Industrial Hardware segment in the second in the second quarter and decreased 26% in the first six months of fiscal 2020 compared to the comparable periods of fiscal 2019. Lower sales were primarily attributable to temporary customer closures in April and May of 2020. Many of our industrial transportation and consumer discretionary product manufactures closed their facilities for one or more weeks during the quarter. Increased sales to our distributors and aftermarket customers, as well as stronger sales to military end markets, were insufficient to offset the impact of customer closures. Sales in the Security Products segment were also impacted by COVID-19 for both the second quarter and first six months of fiscal 2020. Sales decreased 33% in the second quarter and decreased 25% in the first six months of 2020 compared to the corresponding period of fiscal 2019. Lower sales were attributable to temporary customer closures as well as lower demand across the majority of the markets we serve including distribution, industrial, vehicular accessories and commercial laundry. Impacting sales for the first six months of fiscal 2020 were the loss of supply contracts for mechatronic padlock systems and recreational vehicles door latches, that generated sales in the first six months of fiscal 2019 that did not recur in the first six months of fiscal 2020. Sales in the Metal Products segment decreased 48% in the second quarter and declined 37% for the first six months of fiscal 2020 compared to sales in the corresponding periods of 2019. Mining products decreased 56%, and sales of industrial casting products decreased 36% in the second fiscal quarter of 2020 while mining products declined 39% and industrial castings declined 35% for the first six months of fiscal 2020 compared to the corresponding period of 2019. Mining sales in the second quarter and first six months were impacted by a combination of growing renewable energy capacity and extremely low natural gas prices, which led utilities to cut back on coal usage in addition to COVID-19 which forced many mine closures resulting in further loss of sales. Sales of industrial castings in the second quarter and the first six months were negatively impacted by the loss of a customer that had temporarily sourced products from us in 2019 due to a fire at its facility in 2018, that temporarily shut down production of products that would otherwise have been sourced internally. Net sales of existing products decreased 24% in the second quarter and decreased 10% in the first six months of 2020 compared to the corresponding period of fiscal 2019. Price increases and new products affected a 3% increase in net sales in the second quarter and 2% in the first six months of fiscal 2020. New products included numerous mirror assemblies, compression latches, a handle and finger pull assembly, mount plate latch, canopy lock assembly, handle assembly and crossbar lock assembly and hospital bed frames for use in the field hospitals established due to COVID-19. Cost of products sold decreased$8.4 million , or 18%, in the second fiscal quarter of 2020, and decreased$5.2 million or 6% in the first six months of fiscal 2020 compared to the corresponding period of fiscal 2019. The primary reason for the decrease is due to the reduction in sales. Material costs decreased$10.5 million in the second fiscal quarter and decreased$10.9 million in the first six months of fiscal 2020 compared to the corresponding periods in fiscal 2019 on lower sales volume and lower material costs incurred in the production of a new Class 8 truck mirror. We have successfully transitioned all components to more favorable pricing from new suppliers. In addition, raw material costs have decreased year-over-year, hot-rolled steel decreased 7%, cold-rolled steel decreased 6%, aluminum decreased 12%, copper decreased 4%, zinc decreased 25% while scrap iron increased 5%. Also favorably impacting the second fiscal quarter and first half of fiscal 2020 were lower freight costs of$0.8 million in the second quarter of fiscal 2020, a 48% reduction over the second fiscal quarter of 2019 and lower freight costs of$1.4 million in the first six months of fiscal 2020, a 40% reduction over the first six months of fiscal 2019, due to the elimination of certain supplier quality issues and expedited shipping costs. Lower production levels resulted in the under-absorption of operating costs in the amount of$0.4 million during the second quarter and$0.3 million in the first six months of fiscal 2020 compared to the corresponding periods in fiscal 2019. 20 Table of Contents Finally, the Company paid tariff costs onChina -sourced products of approximately$0.6 million in the second quarter of fiscal 2020 compared to$0.3 million incurred in the second quarter of fiscal 2019, and$1.8 million for the first six months of fiscal 2020 compared to$0.5 million in the first six months of fiscal 2019, all of which have been recovered through price increases. Gross margin as a percent of sales was 22% in the second quarter and 23% in the first six months of fiscal 2020 compared to 24% in the second quarter and first six months of fiscal 2019. Product development expense decreased$1.4 million , or 65%, in the second quarter and decreased$2.9 million or 65% in the first six months of 2020 compared to the corresponding periods of 2019. The reduction in this expense relates to the closure of theVelvac Road -iQ development operation inBellingham, Washington , which took place in the second quarter of fiscal 2019, a strategic decision that we made to adopt a leaner approach to the development of new vision products. Selling and administrative expense decreased$0.1 million , or 1%, in the second quarter and increased$1.4 million or 8% in the first six months of fiscal 2020 compared to the corresponding periods of fiscal 2019, primarily as a result of the inclusion of Big 3 Precision in the 2020 period. The most significant factor contributing to the overall increase was payroll and payroll related expenses of$0.8 million and amortization expense related to the acquisition of$1.2 million in the first six months of fiscal 2020.
Excluding Big 3 Precision, selling and administrative expenses decreased 22% in the second quarter and decreased 12% for the first six months of the 2020 compared to the corresponding periods of 2019.
Restructuring costs of$0.3 million incurred in the second quarter of fiscal 2020 related to the divestiture ofCanadian Commercial Vehicles Corporation in the second quarter of fiscal 2020, compared to restructuring costs of$1.8 million during the second quarter of fiscal 2019, which were related to the discontinuance of our Road iQ development operations based inBellingham, Washington and the relocation costs of our Composite Panels Technologies division inSalisbury, North Carolina to the Canadian Commercial Vehicle division located inKelowna, British Columbia .Goodwill impairment loss of$4.0 million was incurred in the second quarter of 2020. The Company determined that it was more likely than not that the estimated fair value of one of its 12 reporting units (Greenwald Industries ) was below its carrying amount. The factors that led to this determination included additional competition, industry movement away from legacy products and intense competition in new mobile payment apps. This fundamental shift in lower cost payment systems away from the higher cost electronic smart card payment systems resulted in the carrying value of Greenwald exceeded its fair value. As a result, an independent valuation was conducted which estimated that the carrying value exceeded the fair value by approximately$4.0 million . Management has recognized this non-cash impairment charge in the second fiscal quarter of 2020. Interest expense increased$0.3 million in the second quarter and$0.9 million for the first six months of 2020 compared to the comparable periods of fiscal 2019 as a result of increased debt related to our acquisition of Big 3 Precision inAugust 2019 .
Other income decreased$0.2 million in the second quarter and remained the same in the first six months of fiscal 2020 compared to the corresponding periods of fiscal 2019 due to a favorable return on our pension plan assets and a onetime sale-leaseback transaction gain in the first quarter of fiscal 2020. Net income / loss for the second quarter of fiscal 2020 was as follows, the Company incurred a net loss of$1.9 million , or$0.30 per diluted share compared to income of$2.5 million , or$0.40 per diluted share, for the comparable period in fiscal 2019. In the first six months of fiscal 2020 net income was$1.0 million , or$0.16 per diluted share, compared to$4.1 million , or$0.65 per diluted share, for the comparable period in fiscal 2019. During the second quarter of fiscal 2020, the Company had a significant non-recurring goodwill impairment loss of$4.0 million .
A more detailed analysis of the Company's results of operations and financial condition follows:
21 Table of Contents Results of Operations
The following table shows, for the periods indicated, selected line items from the condensed consolidated statements of operations as a percentage of net sales, by segment for the period indicated:
Three Months Ended June 27, 2020 Industrial Security Metal Hardware Products Products Total Net sales 100.0 % 100.0 % 100.0 % 100.0 % Cost of products sold 77.0 % 69.2 % 112.2 % 78.0 % Gross margin 23.0 % 30.8 % -12.2 % 22.0 % Product development expense 0.3 % 5.9 % - 1.5 %
Selling and administrative expense 16.2 % 18.0 %
12.0 % 16.3 % Goodwill impairment loss - 36.0 % - 8.2 % Restructuring costs 0.8 % - - 0.6 % Operating profit (loss) 5.7 % -29.1 % -24.2 % -4.6 % Three Months Ended June 29, 2019 Industrial Security Metal Hardware Products Products Total Net sales 100.0 % 100.0 % 100.0 % 100.0 % Cost of products sold 76.3 % 68.3 % 88.0 % 75.6 % Gross margin 23.7 % 31.7 % 12.0 % 24.4 % Product development expense 4.2 % 3.7 % - 3.5 %
Selling and administrative expense 12.8 % 16.5 %
7.9 % 13.1 % Restructuring costs 4.7 % - - 2.9 % Operating profit 2.0 % 11.5 % 4.1 % 4.9 % The following table shows the change in sales and operating profit by segment for the second quarter of fiscal 2020 compared to the second quarter of fiscal 2019 (dollars in thousands): Industrial Security Metal Hardware Products Products Total Net sales$ (3,619 ) $ (5,389 ) $ (3,599 ) $ (12,607 ) Volume -15.3 % -34.1 % -49.0 % -24.4 % Prices 1.5 % 0.7 % 0.5 % 1.1 % New products 4.2 % 0.7 % 0.2 % 2.8 % -9.6 % -32.7 % -48.3 % -20.5 % Operating profit (loss)$ 1,180 $ (5,140 ) $ (1,242 ) $ (5,202 ) 157.9 % -270.2 % -401.4 % -175.8 % 22 Table of Contents The following table displays selected line items from the condensed consolidated statements of operations as a percentage of net sales, by segment, for the periods indicated: Six Months Ended June 27, 2020 Industrial Security Metal Hardware Products Products Total Net sales 100.0 % 100.0 % 100.0 % 100.0 % Cost of products sold 76.7 % 69.0 % 103.5 % 77.4 % Gross margin 23.3 % 31.0 % -3.5 % 22.6 %
Product development expense 0.2 % 5.7 % - 1.3 % Selling and administrative expense 15.6 % 18.0 %
10.6 % 15.6 % Goodwill impairment loss - 17.1 % 3.5 % Restructuring costs 0.3 % - - 0.3 % Operating profit (loss) 7.2 % -9.8 % -14.1 % 1.9 % Six Months Ended June 29, 2019 Industrial Security Metal Hardware Products Products Total Net sales 100.0 % 100.0 % 100.0 % 100.0 % Cost of products sold 76.6 % 69.6 % 89.7 % 76.4 % Gross margin 23.4 % 30.4 % 10.3 % 23.6 % Product development expense 4.2 % 4.0 % - 3.6 %
Selling and administrative expense 13.1 % 17.2 %
7.7 % 13.5 % Restructuring costs 3.5 % 2.2 % Operating profit 2.6 % 9.2 % 2.6 % 4.3 % The following table displays the change in net sales and operating profit by segment for the first six months of fiscal 2020 compared to the first six months of fiscal 2019 (dollars in thousands): Industrial Security Metal Hardware Products Products Total Net sales$ 5,214 $ (7,687 ) $ (5,691 ) $ (8,164 ) Volume 3.0 % -26.1 % -39.3 % -9.7 % Prices 1.3 % 0.8 % 0.6 % 1.1 % New products 2.6 % 0.6 % 1.4 % 1.9 % 6.9 % -24.7 % -37.3 % -6.7 % Operating profit (loss)$ 3,803 $ (5,169 ) $ (1,750 ) $ (3,116 ) 188.7 % -179.8 % -434.7 % -58.9 % 23 Table of Contents Industrial Hardware Segment Net sales in the Industrial Hardware segment decreased 10% in the second quarter and increased 7% in the first six months of fiscal 2020 compared to the corresponding periods of fiscal 2019. Excluding Big 3 Precision, sales would have decreased 42% in the second quarter from$34.5 million to$21.9 million and decreased 26% for the first six months of fiscal 2020 from$75.9 million to$55.9 million compared to the corresponding periods of fiscal 2019. Increased sales into the military market were not sufficient to offset a sales reduction to the distribution, Class 8 truck, and aftermarket truck parts markets in the first six months of fiscal 2020. Sales were affected in the second quarter when certain of our customers closed operations due to actions taken to help stop the spread of COVID-19. Sales of new products contributed 4.2% in the second quarter and 2.6% in the first six months of fiscal 2020. New products include numerous mirror assemblies, compression latches, a handle and finger pull assembly, a mount plate latch and hospital beds frames for use in field hospitals established due to COVID-19. Cost of products sold decreased 9% in the second quarter and increased 7% in the first six months of fiscal 2020 compared to the corresponding periods of fiscal 2019. Excluding Big 3 Precision, cost of products sold would have decreased by 38% in the second quarter from$27.8 million to$17.1 million and decreased 26% in the first six months of fiscal 2020 from$58.1 million to$42.8 million compared to the corresponding periods of fiscal 2019. Material costs decreased 29% or$5.5 million in the second quarter and 10% or$4.0 million in the first six months of fiscal 2020 due to lower sales volume and lower material costs incurred in producing a new Class 8 truck mirror that was awarded in 2018. Many of the components sourced during the first six months of fiscal 2019 were at higher than normal material cost. As of the second quarter of fiscal 2020, all components have been sourced to more favorable suppliers and costs have normalized. Also impacting the second quarter were more favorable freight costs, which were down 49% or$0.9 million in the second quarter and down 40% or$1.4 million in the first six months of fiscal 2020 compared to the corresponding periods of fiscal 2019 due to non-recurring expedited shipping costs. Finally, we experienced tariff costs onChina -sourced products of approximately$0.3 million in the second quarter of fiscal 2020 compared to$0.3 million in the second quarter of fiscal 2019 and for the first six months of fiscal 2020 we experienced$1.1 million in tariff costs compared to$0.4 million in the first six months of fiscal 2019 all of which have been recovered through price increases. Restructuring costs decreased in the second quarter of fiscal 2020 to$0.3 million related to severance pay in the sale ofCanadian Commercial Vehicles Corporation in the second quarter of fiscal 2020 compared to restructuring costs of$1.8 million during the second quarter of fiscal 2019, and for the first six months restructuring costs were$0.3 million and$2.6 million for fiscal 2020 and fiscal 2019, respectively. The costs incurred in fiscal 2019 were related to the discontinuance of our Road iQ development operations based inBellingham, Washington and the relocation cost of our Composite Panels Technologies division inSalisbury, North Carolina to the Canadian Commercial Vehicle division located inKelowna, British Columbia . Gross margin as a percentage of net sales in the second quarter and first six months of fiscal 2020 was comparable to the corresponding periods of fiscal
2019 of 23%.
Product development expense decreased by$1.5 million in the second quarter and decreased by$3.0 million for the first six months of fiscal 2020 compared to the corresponding periods of fiscal 2019 due primarily to the closure of theVelvac Road -iQ development operation inBellingham, Washington in the second quarter of fiscal 2019, as we adopted a leaner approach to the development
of new vision products.
Selling and administrative expense increased 15% in the second quarter and increased 27% for the first six months of fiscal 2020 compared to the corresponding periods of fiscal 2019 due primarily to the inclusion of Big 3 Precision. Excluding Big 3 Precision, selling and administrative expense decreased 24% in the second quarter of fiscal 2020 from$4.8 million to$3.8 million and decreased 15% for the first six months of the fiscal 2020 from$9.9 million to$8.8 million compared to the corresponding periods of fiscal 2019. Excluding Big 3 Precision, payroll and payroll-related expense decreased by$0.6 million , or 24%, in the second quarter of fiscal 2020 and decreased$0.9 million , or 16%, in the first six months of fiscal 2020 compared to the corresponding periods of fiscal 2019. 24 Table of Contents Security Products Segment Net sales in the Security Products segment decreased 33% in the second quarter and decreased 25% in the first six months of fiscal 2020 compared to the corresponding periods of fiscal 2019. The sales decline was due to lower demand across the majority of the markets we serve including distribution, industrial, vehicular accessories and commercial laundry, as well as continued business closures in the second quarter of fiscal 2020 due to the COVID-19 pandemic.
Net
sales of existing products decreased 34%, while price increases and sales of new products contributed 1% in the second quarter of fiscal 2020 period. New product sales included a canopy lock assembly, a handle assembly and a crossbar lock assembly. Cost of products sold decreased 32% in the second quarter of fiscal 2020 and decreased 25% in the first six months of fiscal 2020 compared to the corresponding periods of fiscal 2019, primarily as a result of lower sales volume and the mix of products sold. Raw materials decreased 41% or$3.2 million in the second quarter and decreased 31% or$4.5 million in the first six months of fiscal 2020 compared to the corresponding periods of fiscal 2019. Payroll and payroll related expenses decreased 17% or$0.4 million in the second quarter and decreased 16% or$0.8 million in the first six months of fiscal 2020 compared to the corresponding periods of fiscal 2019. We experienced tariff costs onChina -sourced products of approximately$0.3 million in the second quarter of fiscal 2020 compared to$0.1 million in the second quarter of fiscal 2019 and for the first six months of fiscal 2020 we experienced$0.7 million in tariff costs compared to$0.1 million in the first six months of fiscal 2019 all of which have been recovered through price increases. Gross margin as a percentage of net sales was 31% in the second quarter and for the first six months of fiscal 2020 compared to 32% in the second quarter and 30% in the first six months of fiscal 2019. Product development expense as a percentage of net sales was 6% in the second quarter and first six months of fiscal 2020 compared to 4% in the corresponding periods of fiscal 2019. This increase reflects a continuation in the development of a Bluetooth locking system, a new cable lock system, continued development of GPay, a multi-pay reader and an electronic drop. Selling and administrative expenses decreased 26% in the second quarter and decreased 21% in the first six months of fiscal 2020, compared to the corresponding periods of fiscal 2019. The most significant driver of this reduction was decreased payroll and payroll related costs, which were offset by an increase in our bad debt reserve in the amount of$152,000 related to a customer that filed for Chapter 11 bankruptcy during the first quarter of fiscal 2020.
Goodwill impairment loss of$4.0 million was incurred in the second quarter of fiscal 2020. The Company determined that it was more likely than not that the estimated fair value of one of its 12 reporting units (Greenwald Industries ) was below its carrying amount. The factors that led to this determination included additional competition, industry movement away from legacy products and intense competition in new mobile payment apps. This fundamental shift in lower cost payment systems away from the higher cost electronic smart card payment systems resulted in our belief that the carrying value of Greenwald exceeded its fair value. As a result, an independent valuation was conducted. The valuation estimated that the carrying value exceeded the fair value by approximately$4.0 million . Management has recognized this non-cash impairment charge in the second quarter of fiscal 2020. Metal Products Segment
Net sales in the Metal Products segment decreased 48% in the second quarter and decreased 37% in the first six months of fiscal 2020 compared to the corresponding periods of fiscal 2019. Sales of our mining products decreased by 56%, while sales of industrial casting products decreased by 36%, in the second quarter of fiscal 2020, and mining products declined 39% and industrial castings declined 35% for the first six months of fiscal 2020, compared to the corresponding periods of fiscal 2019. Mining sales in the second quarter and the first six months of fiscal 2020 were impacted by a combination of growing renewable energy capacity and extremely low natural gas prices which led utilities to cut back on coal usage in addition to COVID-19, which forced many mine closures resulting in further loss of sale. Sales of industrial castings in the second quarter and first six months of fiscal 2020 were negatively impacted by the loss of a customer who had temporarily sourced products from us during 2019 due to a fire at its facility in 2018 that temporarily shut down production of product that would otherwise have been sourced internally. 25 Table of Contents
Cost of products sold decreased 34% in the second quarter and decreased 28% for the first six months of fiscal 2020 compared to the corresponding periods of fiscal 2019, as a result of lower sales volume. Raw materials decreased 72% or$1.0 million in the second quarter and decreased 60% or$1.7 million in the first six months of fiscal 2020 compared to the corresponding periods of fiscal 2019. Payroll and payroll related expenses decreased 35% or$0.9 million in the second quarter and decreased 27% or$1.4 million in the first six months of fiscal 2020 compared to the corresponding periods of fiscal 2019. Gross margin as a percentage of net sales was a negative 12% in the second quarter and a negative 4% for the first six months of fiscal 2020 compared to 12% and 10% in the corresponding periods of fiscal 2019. Due to the high fixed operating cost structure of operating a foundry and the severe reduction in sales productive capacity could not be consumed resulting in the negative gross margin.
Selling and administrative expenses decreased 21% in the second quarter and decreased 13% for the first six months of fiscal 2020 compared to the corresponding periods of fiscal 2019. The most significant driver of this reduction was payroll and payroll-related costs which decreased 33% or $$0.1 million in the second quarter and decreased 25% or$0.2 million in the first six months of fiscal 2020 compared to the corresponding periods of fiscal 2019.
Liquidity and Sources of Capital
The Company generated approximately$7.4 million of cash from operations during the first six months of fiscal 2020 compared to approximately$8.7 million during the first six months of fiscal 2019. The cash flows in the first six months of the fiscal 2020 were comparable to the first six months of the fiscal 2019 period. Cash flow from operations coupled with cash at the beginning of the 2020 fiscal year was sufficient to fund capital expenditures, debt service, and dividend payments.
Additions to property, plant and equipment were approximately$1.2 million for the first six months of fiscal 2020 and$1.3 million for the first six months of fiscal 2019. As ofJune 27, 2020 , there were approximately$0.2 million of outstanding commitments for capital expenditures. The following table shows key financial ratios at the end of each specified period: Second Second Year Quarter Quarter End 2020 2019 2019 Current ratio 3.8 3.5 3.6
Average days' sales in accounts receivable 55 49
51
Inventory turnover 3.2 3.8
4.2
Total debt to shareholders' equity 93.4 % 22.3 %
93.7 %
The following table shows important liquidity measures as of the balance sheet date for each specified period (in millions):
Second Second Year Quarter Quarter End 2020 2019 2019 Cash and cash equivalents
- Held in the United States$ 13.7 $
4.9
- Held by a foreign subsidiary 6.3
8.8 9.0 20.0 13.7 18.0 Working capital 82.3 71.0 83.0 Net cash provided by operating activities 7.4 8.7 23.0 Change in working capital impact on net cash(used) in operating activities (0.9 ) (0.8 ) (0.3 ) Net cash provided (used) in investing activities 0.7 (1.3 ) (85.8 ) Net cash (used) in financing activities (5.6 ) (7.6 ) (67.0 ) 26 Table of Contents Inventories of$55.9 million represent an increase of 2% as ofJune 27, 2020 as compared to$54.6 million at the end of fiscal year 2019. Inventories increased 13% in the first six months of fiscal 2020, as compared to$49.3 at the end of the first six months of fiscal 2019. This was primarily due to the acquisition of Big 3 Precision. Accounts receivable, less allowances were$33.6 million as ofJune 27, 2020 , as compared to$37.9 million at 2019 fiscal year end and$32.1 million at the end of the first six months of fiscal 2019. 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. However, based on current macroeconomic conditions resulting from the uncertainty caused by COVID-19, 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 4.25 to 1 and a fixed charge coverage ratio to be not less than 1.25 to 1. A decrease in earnings due to responses to contain the spread of COVID-19 or the resulting harm to the financial condition of our customers or economic conditions generally, 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.
Off-Balance Sheet Arrangements
As of the end of the fiscal quarter endedJune 27, 2020 , the Company does not have any transactions, arrangements, obligations (including contingent obligations), or other relationships with unconsolidated entities or other persons, as described by Item 303(a)(4) of Regulation S-K, that have or are reasonably likely to have a material current or future impact on the Company's financial condition, results of operations, liquidity, capital expenditures, capital resources or significant components of revenues or expenses. 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
U.S. GAAP.
To supplement the consolidated financial statements prepared in accordance withU.S. GAAP, we have presented Adjusted EPS and Adjusted EBITDA, 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 GAAP financial measures, such as net sales, net income (loss), diluted earnings (loss) per common share, or other measures prescribed byU.S. GAAP, and there are limitations to using non-GAAP financial measures. We also present certain results "excluding Big 3 Precision" because we believe this allows for better comparability to the corresponding prior year period. Adjusted EPS is defined as diluted earnings (loss) per share excluding, when they occur, the impacts of impairment losses and restructuring expenses. We believe that Adjusted EPS provides important comparability of underlying operational results, allowing investors and management to access operating performance on a consistent basis. Adjusted EBITDA is defined as net income (loss) from continuing operations before interest expense, provision for (benefit from) income taxes, and depreciation and amortization. In addition to these adjustments, we exclude, when they occur, the impacts of impairment losses and restructuring expenses. Adjusted EBITDA 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.
27 Table of Contents
Reconciliation of earnings (loss) per share from GAAP to Non-GAAP financial measure
For the Three and Six Months ended
Three Months Ended
Six Months Ended
June 27, 2020 June 29, 2019 June 27, 2020 June 29, 2019 Net Income (Loss) as reported per generally accepted accounting principles (GAAP)$ (1,888,782 ) $ 2,529,773 $ 1,007,036 $ 4,100,733 Earnings (Loss) Per Share as reported under generally accepted accounting principles (GAAP): Basic $ (0.30 ) $ 0.41 $ 0.16 $ 0.66 Diluted $ (0.30 ) $ 0.40 $ 0.16 $ 0.65 Adjustments for one-time expenses Goodwill impairment loss (A)$ (3,109,980 ) $ (2,993,906 ) Restructuring costs$ (217,560 ) (B)$ (1,381,857 ) (C)$ (209,440 ) (B)$ (2,024,438 ) (C)(D)$ (3,327,540 ) $ (1,381,857 ) $ (3,203,346 ) $ (2,024,438 ) Adjusted Net Income (related to one-time expenses); (Non-GAAP)$ 1,438,758 $ 3,911,630 $ 4,210,382 $ 6,125,171 Adjusted Earnings per share (related to one-time expenses); (Non-GAAP) Basic $ 0.23 $ 0.63 $ 0.68 $ 0.98 Diluted $ 0.23 $ 0.62 $ 0.68 $ 0.98
A)
28 Table of Contents
Reconciliation of EBITDA from GAAP to Non-GAAP financial measure
For the Three and Six Months ended
Three Months Ended Six Months Ended June 27, 2020 June 29, 2019 June 27, 2020 June 29, 2019 Net Income(loss) as reported per generally accepted accounting principles (GAAP)$ (1,888,782 ) $ 2,529,773 $ 1,007,036
Interest
expense 606,553 261,618 1,434,217
554,158 Provision for (benefit from) income
taxes (543,061 ) 754,725 339,521
1,239,458
Depreciation
and
amortization 1,994,468 952,515 4,050,250
2,391,314
Goodwill impairment loss 4,002,548 (A) 4,002,548 Restructuring
2,635,987
costs 280,000 (B) 1,799,293 (C) 280,000 (C),(D) Transaction costs 17,182 17,182 Adjusted EBITDA$ 4,468,908 $ 6,297,924 $ 11,130,754
$ 10,921,650 A)Goodwill impairment
B) Cost incurred on disposition of
C) Cost incurred on closure of Road IQ in
D) Cost incurred on the relocation of Composite Panels Technology
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