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 experienced normal sales volumes and operations during the first quarter of 2020. Beginning in lateMarch 2020 as a result of the COVID-19 pandemic, we began receiving requests from certain customers of both our Security Products and Marine Components segments to postpone shipments, in some cases because our customers' production facilities were 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 enhanced cleaning and sanitization procedures, mandated social distancing and implemented other health and safety protocols. In late April, we closed ourChicago area location for one week due to COVID-19 activity in the area. The temporary closure of ourIllinois facility had a minimal negative impact on our ability to manufacture and ship during the second quarter due to the decline in demand during the same period. Second quarter 2020 net sales and operating income were significantly impacted by reduced demand for our products as a result of orders postponed at the request of our original equipment manufacturing customers and distributors. We reported operating income of$2.4 million in the second quarter of 2020 compared to$5.6 million in the same period of 2019. Operating income for the first six months of 2020 was$7.4 million compared to$9.9 million for the comparable period in 2019. We sell a large number of products that have a wide variation in selling price and manufacturing cost, which results in certain practical limitations on our ability to quantify the impact of changes in individual product sales quantities and selling prices on our net sales, cost of goods sold and gross profit. Results of Operations Three months ended June 30, 2019 % 2020 % (Dollars in thousands) Net sales$ 33,730 100.0 %$ 23,800 100.0 % Cost of sales 22,791 67.6 16,434 69.1 Gross margin 10,939 32.4 7,366 30.9 Operating costs and expenses 5,317 15.7 4,997 20.9 Operating income$ 5,622 16.7 %$ 2,369 10.0 % Six months ended June 30, 2019 % 2020 % (Dollars in thousands) Net sales$ 64,907 100.0 %$ 56,111 100.0 % Cost of goods sold 44,344 68.3 38,314 68.3 Gross margin 20,563 31.7 17,797 31.7
Operating costs and expenses 10,650 16.4 10,408 18.5 Operating income
$ 9,913 15.3 %$ 7,389 13.2 % Net sales. Net sales decreased$9.9 million and$8.8 million in the second quarter and for the first six months of 2020, respectively, compared to the same periods in 2019. The significant decrease in sales is due to lower sales volumes at both of our segments in the second quarter of 2020 as many of our customers were temporarily closed or reduced production during the quarter due to government ordered closures or reduced demand resulting from the COVID-19 pandemic. 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 for the second quarter of 2020 was 1.5% higher than the same period in 2019. As a result, gross margin as a percentage of sales decreased over the same period. The decrease in gross margin percentage is the result of the decline in both Security Products and Marine Components gross margin percentage for the second quarter. See segment discussion below. Cost of sales and gross margin as a percentage of sales for the first six months of 2020 is comparable to the same period in 2019. 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 - 12 - -------------------------------------------------------------------------------- the second quarter and first six months of 2020 were lower than the same periods last year, particularly travel and advertising costs which declined by$0.2 million for the second quarter compared to the same prior year period. Operating costs and expenses as a percentage of net sales increased in both periods due to the lower sales. Operating income. As a percentage of net sales, operating income for the second quarter and first six months of 2020 decreased compared to the same periods of 2019 and was primarily impacted by the factors impacting cost of goods sold, gross margin and operating costs. See segment discussion below. Provision for income taxes. A tabular reconciliation of our actual tax provision to theU.S. federal statutory income tax rate is included in Note 6 to the Condensed Consolidated Financial Statements. Our operations are wholly within theU.S. and therefore our effective income tax rate is primarily reflective of theU.S. federal statutory rate and applicable state taxes.
Segment Results
The key performance indicator for our segments is operating income.
Three months ended Six months ended June 30, June 30, % % 2019 2020 Change 2019 2020 Change (Dollars in thousands) (Dollars in thousands) Security Products: Net sales$ 26,927 $ 18,573 -31 %$ 51,631 $ 44,042 -15 % Cost of sales 18,000 12,679 -30 34,733 29,590 -15 Gross margin 8,927 5,894 -34 16,898 14,452 -14 Operating costs and expenses 2,879 2,533 -12 5,774 5,378 -7 Operating income$ 6,048 $ 3,361 -44$ 11,124 $ 9,074 -18 Gross margin 33.2 % 31.7 % 32.7 % 32.8 % Operating income margin 22.5 18.1 21.5 % 20.6 Security Products. Security Products net sales in the second quarter of 2020 decreased 31% compared to the same period in 2019 due to reduced demand attributed to COVID-19 as discussed above. Relative to prior year, we experienced$2.5 million lower sales to the government security market,$2.4 million in lower sales to the transportation market, and$1.4 million in lower sales to distribution customers during the quarter. Security Products net sales decreased 15% in the first six months of 2020 compared to the same period last year due to the lower second quarter 2020 sales. Gross margin as a percentage of net sales for the second quarter declined as compared to the same period last year due to less favorable customer and product mix and reduced fixed cost coverage from lower production and sales volumes. Gross margin as a percentage of net sales for the first six months of 2020 is comparable to the same period last year. Operating costs and expenses decreased in the second quarter and the first six months of 2020 compared to the same periods last year predominantly due to decreased second quarter expenses related to travel, certain employee benefits expenses, and cancelled or postponed advertising expenses which were$0.3 million lower in aggregate for the second quarter of 2020 compared to the same period in 2019. Operating income as a percentage of net sales for the second quarter and first six months of 2020 decreased compared to the same periods of 2019 as a result of the factors impacting gross margin for the second quarter as well as reduced coverage of operating costs and expenses from lower sales for both comparative periods. - 13 - --------------------------------------------------------------------------------
Three months ended Six months ended June 30, June 30, % % 2019 2020 Change 2019 2020 Change (Dollars in thousands) (Dollars in thousands) Marine Components: Net sales$ 6,803 $ 5,227 -23 %$ 13,276 $ 12,069 -9 % Cost of sales 4,791 3,755 -22 9,611 8,724 -9 Gross margin 2,012 1,472 -27 3,665 3,345 -9 Operating costs and expenses 732 673 -8 1,484 1,464 -1 Operating income$ 1,280 $ 799 -38$ 2,181 $ 1,881 -14 Gross margin 29.6 % 28.2 % 27.6 % 27.7 % Operating income margin 18.8 15.3 16.4 15.6 Marine Components. Marine Components net sales in the second quarter of 2020 decreased 23% compared to the same period in 2019 due to COVID-19 related reduced demand as discussed above. During the quarter, we experienced$0.8 million lower sales to the towboat market,$0.4 million in lower sales to the engine manufacturing market, and$0.3 million in lower sales to the industrial market as compared to 2019. Marine Components net sales decreased 9% in the first six months of 2020 compared to the same period last year due to the lower second quarter 2020 sales. As a percentage of net sales, gross margin and operating income decreased in the second quarter of 2020 compared to the same period in 2019 due to reduced overhead coverage from lower production and sales volumes. Gross margin percentage for the first six months of 2020 is comparable to the same period last year. Operating income as a percentage of net sales decreased in the first six months of 2020 compared to the same periods in the prior year due to reduced coverage of operating cost and expenses on lower sales. Outlook. In the second quarter of 2020, the COVID-19 pandemic created multiple challenges, both in our operations and from the reduced demand for our products. Both global and domestic supply chains remain intact and we have experienced minimal supply chain disruptions. We continue to work closely with all of our customers and monitor their progress as they continue to adjust their operations. While some of our customers expect to recover quickly, others expect to take longer to recover, including transportation, office furniture and cabinetry manufacturers. Considerable effort continues at all of our locations to manage current COVID-19 conditions including, enhanced health and safety protocols and additional cleaning and disinfecting efforts. After the temporary closure in lateApril 2020 at our manufacturing facility outside ofChicago, Illinois , we have been able to operate the facility at normal operating rates. Throughout the course of the COVID-19 pandemic, we have focused our efforts on maintaining efficient operations, while closely managing our expenses and capital projects. In this regard we are constantly evaluating our staffing levels and have recently reduced production staffing levels to adjust to anticipated levels of demand for the second half of 2020. The advance of the COVID-19 pandemic and the global efforts to mitigate its spread have 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 have generally permitted the gradual resumption of commercial activities following various regional shutdowns, but further government action restricting economic activity is possible in an effort to mitigate increases in COVID-19 cases in certain regions. The success and timing of these mitigating actions will depend in part on deployment of effective tools to fight COVID-19, including increased testing, enhanced monitoring, data analysis, effective treatments and a safe vaccine, before economic growth is likely to return to pre-pandemic levels. 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 in 2020 compared to 2019. We believe the second quarter of 2020 will be the period most impacted by COVID-19 but the severity of the impact on the remainder of the year will depend on customer demand for our products, including the timing and extent to which our customers operations continue to be impacted, on our customers' perception as to when consumer demand for their products will return to pre-pandemic levels 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 taking appropriate actions to maintain a safe working environment for all of our employees, minimize operational disruptions and manage inventory levels. We increased inventory at both of our segments during the second quarter of 2020 to keep our workforce productive by focusing on high-demand products and components. We expect inventory balances will decline over the - 14 - -------------------------------------------------------------------------------- remainder of the year as we align our production to current demand 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$62.5 million atJune 30, 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. Net cash provided by operating activities for the first six months of 2020 decreased by$1.0 million as compared to the first six months of 2019. Changes in working capital were not material. The decrease is primarily due to the net effects of:
• A
• A
timing of interest received, and
• A
timing of payments and lower operating income.
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 toJune 30, 2020 varied by segment, primarily as a result of relative changes in the timing of collections. For comparative purposes, we have providedDecember 31, 2018 andJune 30, 2019 numbers. Days Sales Outstanding: December 31, 2018 June 30, 2019 December 31, 2019 June 30, 2020 Security Products 43 Days 42 Days 38 Days 44 Days Marine Components 30 Days 31 Days 27 Days 40 Days Consolidated CompX 40 Days 40 Days 36 Days 43 Days Our total average number of days in inventory increased fromDecember 31, 2019 toJune 30, 2020 as a result of an intentional inventory build during the second quarter of 2020 to keep trained and tenured employees productive. 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 andJune 30, 2019 numbers below. Days in Inventory: December 31, 2018 June 30, 2019 December 31, 2019 June 30, 2020 Security Products 77 Days 70 Days 76 Days 120 Days Marine Components 91 Days 75 Days 100 Days 125 Days Consolidated CompX 80 Days 71 Days 81 Days 121 Days Investing activities. Our capital expenditures were$0.9 million in the first six months of 2020 compared to$1.8 million in the first six months of 2019 as we have limited expenditures to those required to meet our expected customer demand and those required to properly maintain our facilities and technology infrastructure as a result of the COVID-19 pandemic. During the first six months of 2020, Valhi borrowed a net$2.4 million under the promissory note ($23.0 million of gross borrowings and$20.6 million of gross repayments). During the first six months of 2019, Valhi borrowed a net$6.0 million under the promissory note ($28.1 million of gross borrowings and$22.1 million of gross repayments). See Note 8 to the Condensed Consolidated Financial Statements. Financing activities. Financing activities consisted only of quarterly cash dividends. InFebruary 2020 , our board of directors increased our regular quarterly dividend from$.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. - 15 - -------------------------------------------------------------------------------- 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 atJune 30, 2020 totaled$0.4 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. It is possible we will curtail or eliminate planned capital projects based on market conditions.
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.
Critical accounting policies -
There have been no changes in the first six 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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