Business Overview
We are a leading manufacturer of engineered components utilized in a variety of applications and industries. Through our Security Products segment we manufacture mechanical and electronic cabinet locks and other locking mechanisms used in recreational transportation, postal, office and institutional furniture, cabinetry, tool storage and healthcare applications. We also manufacture stainless steel exhaust systems, gauges, throttle controls, wake enhancement systems and trim tabs for the recreational marine and other industries through our Marine Components segment.
General
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, as amended. Statements in this Quarterly Report that are not historical facts are forward-looking in nature and represent management's beliefs and assumptions based on currently available information. In some cases, you can identify forward-looking statements by the use of words such as "believes," "intends," "may," "should," "could," "anticipates," "expects" or comparable terminology, or by discussions of strategies or trends. Although we believe that the expectations reflected in such forward-looking statements are reasonable, we do not know if these expectations will be correct. Such statements by their nature involve substantial risks and uncertainties that could significantly impact expected results. Actual future results could differ materially from those predicted. The factors that could cause actual future results to differ materially from those described herein are the risks and uncertainties discussed in this Quarterly Report and those described from time to time in our other filings with theSEC and include, but are not limited to, the following:
• Future demand for our products,
• Changes in our raw material and other operating costs (such as zinc, brass, aluminum, steel and energy costs) and our ability to pass those costs on to our customers or offset them with reductions in other operating costs,
• Price and product competition from low-cost manufacturing sources (such as
China ), • The impact of pricing and production decisions, • Customer and competitor strategies including substitute products,
• Uncertainties associated with the development of new products and product
features, • Future litigation, • Our ability to protect or defend our intellectual property rights, • Potential difficulties in integrating future acquisitions,
• Decisions to sell operating assets other than in the ordinary course of
business,
• Environmental matters (such as those requiring emission and discharge
standards for existing and new facilities),
• The ultimate outcome of income tax audits, tax settlement initiatives or
other tax matters, including future tax reform,
• The impact of current or future government regulations (including employee
healthcare benefit related regulations),
• General global economic and political conditions that disrupt or introduce
instability into our supply chain, impact our customers' level of demand or our customers' perception regarding demand or impair our ability to
operate our facilities (including changes in the level of gross domestic
product in various regions of the world, natural disasters, terrorist
acts, global conflicts and public health crises such as COVID-19),
• Operating interruptions (including, but not limited to labor disputes,
hazardous chemical leaks, natural disasters, fires, explosions, unscheduled or unplanned downtime, transportation interruptions, cyber-attacks and public health crises such as COVID-19); and
• Possible disruption of our business or increases in the cost of doing
business resulting from terrorist activities or global conflicts.
Should one or more of these risks materialize or if the consequences worsen, or if the underlying assumptions prove incorrect, actual results could differ materially from those currently forecasted or expected. We disclaim any intention or obligation to update or revise any forward-looking statement whether as a result of changes in information, future events or otherwise.
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Operating Income Overview
We reported operating income of$5.0 million in the first quarter of 2020 compared to$4.3 million in the same period of 2019. The increase in operating income from 2019 to 2020 primarily resulted from higher Security Products sales volumes to existing government security customers and to a lesser extent higher Marine Components sales to the towboat and center console boat markets. We sell a large number of products that have a wide variation in selling price and manufacturing cost, which results in certain practical limitations on our ability to quantify the impact of changes in individual product sales quantities and selling prices on our net sales, cost of goods sold and gross profit. In addition, small variations in period-to-period net sales, cost of goods sold and gross profit can result from changes in the relative mix of our products sold. Results of Operations Three months ended March 31, 2019 % 2020 % (Dollars in thousands) Net sales$ 31,176 100.0 %$ 32,311 100.0 % Cost of sales 21,552 69.1 21,880 67.7 Gross margin 9,624 30.9 10,431 32.3 Operating costs and expenses 5,334 17.1 5,411 16.8 Operating income$ 4,290 13.8 %$ 5,020 15.5 % Net sales. Net sales increased$1.1 million in the first quarter of 2020 compared to the same period in 2019 primarily due to higher Security Products sales and to a lesser extent higher Marine Components sales. Relative changes in selling prices did not have a material impact on net sales comparisons. Cost of sales and gross margin. Cost of sales as a percentage of sales decreased 1.4% in the first quarter of 2020 compared to the same period in 2019 due to the favorable effects of customer and product mix, partially offset by increased medical costs for both Security Products and Marine Components. As a result, gross margin as a percentage of sales increased over the same period. Gross margin dollars increased due to higher sales for both business segments. Operating costs and expenses. Operating costs and expenses consist primarily of sales and administrative-related personnel costs, sales commissions and advertising expenses directly related to product sales and administrative costs relating to business unit and corporate management activities, as well as gains and losses on plant, property and equipment. Operating costs and expenses for first quarter of 2020 were comparable to the same period in 2019. Operating income. As a percentage of net sales, operating income for the first quarter of 2020 increased compared to the same period of 2019 and was primarily impacted by the factors impacting cost of sales, gross margin and operating costs discussed above. Provision for income taxes. A tabular reconciliation of our actual tax provision to theU.S. federal statutory income tax rate is included in Note 6 to the Condensed Consolidated Financial Statements. Our operations are wholly within theU.S. and therefore our effective income tax rate is primarily reflective of theU.S. federal statutory rate and applicable state taxes. - 12 -
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Segment Results
The key performance indicator for our segments is operating income.
Three months ended March 31, % 2019 2020 Change (Dollars in thousands) Security Products: Net sales$ 24,704 $ 25,469 3 % Cost of sales 16,733 16,911 1 Gross margin 7,971 8,558 7 Operating costs and expenses 2,895 2,845 -2 Operating income$ 5,076 $ 5,713 13 Gross margin 32.3 % 33.6 % Operating income margin 20.5 22.4 Security Products. Security Products net sales increased 3% in the first quarter of 2020 compared to the same period last year. The increase in sales is primarily due to higher sales to existing government security customers, partially offset by lower sales to transportation and distribution customers. Gross margin and operating income as a percentage of sales increased in 2020 compared to the same period in 2019 due to favorable customer and product mix on higher sales, partially offset by increased medical costs. Three months ended March 31, % 2019 2020 Change (Dollars in thousands) Marine Components: Net sales$ 6,472 $ 6,842 6 % Cost of sales 4,819 4,969 3 Gross margin 1,653 1,873 13 Operating costs and expenses 752 791 5 Operating income $ 901$ 1,082 20 Gross margin 25.5 % 27.4 % Operating income margin 13.9 15.8 Marine Components. Marine Components net sales increased 6% in the first quarter of 2020 compared to the same period last year primarily due to increased sales to the towboat and center console boat markets, partially offset by lower sales to distribution customers. Gross margin and operating income as a percentage of sales increased in the first quarter of 2020 compared to the same period last year due to a favorable customer and product mix on higher sales, partially offset by increased medical costs. Outlook. We experienced minimal disruptions to our supply chain or customer base from COVID-19 during the first quarter of 2020. First quarter sales reflect continued strong demand for our products, including high-security applications for our existing government customers as well as our marine products. We have been identified as an essential business in the states where we operate, and are considered critical in supplying components to many essential and mandatory markets. Beginning in lateMarch 2020 , we began receiving requests from certain customers of both our Security Products and Marine Components segments to delay or postpone shipments, in some cases because our customers' production facilities have temporarily closed. We operate three facilities, each of which specializes in certain manufacturing processes and is therefore dependent upon the other facilities to some extent to manufacture finished goods. With the onset of COVID-19, within each facility we increased sanitizing, mandated social distancing and implemented other health and safety protocols. In lateApril 2020 , we temporarily closed our facility that is located outside of - 13 - --------------------------------------------------------------------------------Chicago, Illinois , which has been considered a COVID-19 "hotspot," due to an increase of COVID-19 cases in the community. During the closure we completed a deep clean and sanitization within the facility, and we successfully reopened the plant and resumed production after a one week pause. We believe the temporary closure of ourIllinois facility will have minimal negative impact on our ability to manufacture and ship during the second quarter, in part due to the anticipated decline in demand during the same period. The advance of the COVID-19 pandemic and the global efforts to mitigate its spread have already resulted in sharp contractions of vast areas of the global economy and are expected to continue to challenge workers, businesses and governments for the foreseeable future. Government actions in various regions to gradually permit the resumption of limited commercial activities following various regional shutdowns are currently in progress, but it is believed that the success and timing of these actions will depend in part on deployment of effective tools to fight COVID-19, including increased testing, enhanced monitoring, data analysis and effective treatments, before economic growth returns to pre-pandemic levels, particularly in service related sectors of the economy. Even as these measures are implemented and become effective, they will not directly address the business and employment losses already experienced. As a result, we expectU.S. and worldwide gross domestic product to be significantly impacted for an indeterminate period. Based on current conditions, we expect to report reduced revenue and operating income during the second quarter of 2020 compared to the first quarter of 2020, but the severity of the decline will depend on customer demand for our products, including the timing and extent to which our customers restart their operations, on our customers' perception as to when consumer demand for their products will return and on any future disruptions in our operations or our suppliers' operations, all of which are difficult to predict. Our operations teams meet daily to ensure we are maintaining a safe working environment for all of our employees, minimizing operational disruptions and managing inventory levels. It is possible we may temporarily close one or more of our facilities again for the health and safety of our employees before the COVID-19 crisis is over. We have significant cash balances of approximately$64.0 million atMarch 31, 2020 , and we believe we are well positioned to navigate the uncertainty ahead.
Liquidity and Capital Resources
Consolidated cash flows -
Operating activities. Trends in cash flows from operating activities, excluding changes in assets and liabilities, have generally been similar to the trends in operating earnings. Changes in assets and liabilities result primarily from the timing of production, sales and purchases. Changes in assets and liabilities generally tend to even out over time. However, period-to-period relative changes in assets and liabilities can significantly affect the comparability of cash flows from operating activities. We generally report a net use of cash from operating activities in the first three months of each year due to seasonal changes in the level of our working capital. Our net cash used by operating activities for the first three months of 2020 decreased by$1.8 million as compared to the first three months of 2019. The decrease in net cash used is primarily due to the net effects of:
• A
• A
timing of interest received,
• A
timing of payments; and
• A lower amount of net cash used by relative changes in our inventories,
receivables, prepaids, payables and non-tax related accruals of
approximately
Relative changes in working capital can have a significant effect on cash flows from operating activities. As shown below, the change in our average days sales outstanding fromDecember 31, 2019 toMarch 31, 2020 varied by segment, primarily as a result of relative changes in the timing of collections. For comparative purposes, we have providedDecember 31, 2018 andMarch 31, 2019 numbers below. Days Sales Outstanding: December 31, 2018 March 31, 2019 December 31, 2019 March 31, 2020 Security Products 43 Days 48 Days 38 Days 46 Days Marine Components 30 Days 34 Days 27 Days 33 Days Consolidated CompX 40 Days 45 Days 36 Days 43 Days Our total average number of days in inventory is comparable fromDecember 31, 2019 toMarch 31, 2020 . The variability in days in inventory among our segments relates to the differences in the average length of time it takes to produce and sell end-products. For comparative purposes, we have providedDecember 31, 2018 andMarch 31, 2019 numbers below. Marine Components days in inventory was unusually low atMarch 31, 2019 as a result of rapid sales growth for Marine Components which increased average days sales while temporarily limiting opportunities to strategically restock. - 14 - -------------------------------------------------------------------------------- Days in Inventory: December 31, 2018 March 31, 2019 December 31, 2019 March 31, 2020 Security Products 77 Days 81 Days 76 Days 78 Days Marine Components 91 Days 68 Days 100 Days 82 Days Consolidated CompX 80 Days 78 Days 81 Days 79 Days Investing activities. Our capital expenditures were$0.4 million in the first three months of 2020 and 2019. During the first three months of 2020, Valhi repaid a net$2.6 million under the promissory note ($15.6 million of gross borrowings and$18.2 million of gross repayments). During the first three months of 2019, Valhi borrowed a net$6.0 million under the promissory note ($17.4 million of gross borrowings and$11.4 million of gross repayments). See Note 8 to the Condensed Consolidated Financial Statements. Financing activities. Financing activities consisted only of quarterly cash dividends. InFebruary 2020 , our board of directors increased our regular quarterly dividend from$.07 per share to$.10 per share beginning in the first quarter of 2020. The declaration and payment of future dividends and the amount thereof, if any, is discretionary and is dependent upon our results of operations, financial condition, cash requirements for our businesses, contractual requirements and restrictions and other factors deemed relevant by our board of directors. The amount and timing of past dividends is not necessarily indicative of the amount or timing of any future dividends which we might pay. Future cash requirements - Liquidity. Our primary source of liquidity on an ongoing basis is our cash flow from operating activities, which is generally used to (i) fund capital expenditures, (ii) repay short-term or long-term indebtedness incurred primarily for capital expenditures, investment activities or reducing our outstanding stock, (iii) provide for the payment of dividends (if declared), and (iv) lend to affiliates. From time-to-time, we will incur indebtedness, primarily to fund capital expenditures or business combinations. Periodically, we evaluate liquidity requirements, alternative uses of capital, capital needs and available resources in view of, among other things, our capital expenditure requirements, dividend policy and estimated future operating cash flows. As a result of this process, we have in the past and may in the future seek to raise additional capital, refinance or restructure indebtedness, issue additional securities, modify our dividend policy or take a combination of such steps to manage our liquidity and capital resources. In the normal course of business, we may review opportunities for acquisitions, joint ventures or other business combinations in the component products industry. In the event of any such transaction, we may consider using available cash, issuing additional equity securities or increasing our indebtedness or that of our subsidiaries. We believe that cash generated from operations together with cash on hand, as well as our ability to obtain external financing, will be sufficient to meet our liquidity needs for working capital, capital expenditures, debt service, dividends (if declared) and any amounts we might loan from time to time under the terms of our revolving loan to Valhi discussed in Note 8 to our Condensed Consolidated Financial Statements (which loans would be solely at our discretion) for both the next 12 months and five years. To the extent that our actual operating results or other developments differ from our expectations, our liquidity could be adversely affected.
All of our
Capital Expenditures. Firm purchase commitments for capital projects in process atMarch 31, 2020 totaled$0.5 million . Our 2020 capital investments are limited to those expenditures required to meet our expected customer demand and those required to properly maintain our facilities and technology infrastructure.
Commitments and Contingencies. There have been no material changes in our contractual obligations since we filed our 2019 Annual Report and we refer you to that report for a complete description of these commitments.
Off-balance sheet financing arrangements -
We do not have any off-balance sheet financing agreements.
Recent accounting pronouncements -
See Note 9 to our Condensed Consolidated Financial Statements.
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Critical accounting policies -
There have been no changes in the first three months of 2020 with respect to our critical accounting policies presented in Management's Discussion and Analysis of Financial Condition and Results of Operations in our 2019 Annual Report.
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