EACO CORP Management's Discussion and Analysis of Financial Condition and Results Of Operations (form 10-K)

You should read the following discussion of our financial condition and results of operations in conjunction with our consolidated financial statements and the related notes included in Part II, Item 8, "Financial Statements and Supplementary Data" of this Annual Report on Form 10-K. In addition to our historical consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Annual Report on Form 10-K, particularly in Part I, Item 1A, "Risk Factors."

Overview

EACO is a holding company primarily comprised of its wholly-owned subsidiary, Bisco, and includes Bisco's wholly-owned Canadian subsidiary, Bisco Industries Limited. Bisco is a distributor of electronic components and fasteners with 51 sales offices and seven distribution centers located throughout North America and 1 sales office in Asia located in the Philippines. Bisco supplies parts used in the manufacture of products in a broad range of industries, including the aerospace, circuit board, communication, computer, fabrication, instrumentation, industrial equipment and marine industries.

                                       10

Table of Contents

Impact of COVID-19 on our Business

With respect to the ongoing and evolving coronavirus (COVID-19) outbreak, which was designated as a pandemic by the World Health Organization on March 11, 2020, the outbreak has caused substantial disruption in international and U.S. economies and markets. The outbreak has had, and may continue to have, an adverse impact on the Company, as well as the industries that the Company serves, such as the aerospace, electronic parts, and industrial equipment industries. The Company has had to temporarily close its 52 sales offices to the public, and has experienced temporary closures of certain offices from time to time to keep our employees safe. We have also shifted more than half of our sales force to remote operations and have implemented changes to our warehouse and distribution operations to protect our employees. If repercussions of the outbreak are prolonged, it could have a significant adverse impact to the underlying industries of some of the Company's customers. To date, the Company has incurred disruptions to its business activities and supply chain. Management cannot, at this point, estimate ultimate losses related to the COVID-19 outbreak, if any, and accordingly no adjustments were reflected in the accompanying financial statements related to this matter.

Critical Accounting Policies and Estimates

Revenue Recognition

We derive our revenue primarily from product sales. We determine revenue recognition through the following steps: (1) identification of the contract with a customer; (2) identification of the performance obligations in the contract; (3) determination of the transaction price; (4) allocation of the transaction price to the performance obligations in the contract; and (5) recognition of revenue when, or as, we satisfy a performance obligation.

The Company's performance obligations consist solely of product shipped to customers. Revenue from product sales is recognized upon transfer of control of promised products to customers at a point in time in an amount that reflects the consideration we expect to receive in exchange for these products. Revenue is recognized net of returns and any taxes collected from customers. We offer industry standard contractual terms in our purchase orders.

Deferred Tax Assets

Our income tax expense, deferred tax assets ("DTAs") and deferred tax liabilities ("DTLs") reflect management's best estimate of current and future taxes to be paid. We are subject to income taxes in the United States. Significant judgments and estimates are required in the determination of the consolidated income tax expense.

Deferred income taxes arise from temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements, which will result in taxable or deductible amounts in the future. In evaluating our ability to recover our DTAs in the jurisdiction from which they arise, we consider all available positive and negative evidence, including scheduled reversals of DTLs, projected future taxable income, tax-planning strategies, and results of recent operations. In projecting future taxable income, we begin with historical results adjusted for the results of discontinued operations and incorporate assumptions about the amount of future state, federal, and foreign pretax operating income adjusted for items that do not have tax consequences. The assumptions about future taxable income require the use of significant judgment and are consistent with the plans and estimates we are using to manage the underlying businesses. In evaluating the objective evidence that historical results provide, we consider three years of cumulative operating income.

Inventory

The Company's inventory provisions for obsolescence are based upon management's review of inventories on-hand over their expected future utilization and length of time held by the Company. The Company's methodology for estimating these adjustments to the cost basis is evaluated for factors that could require changes to the cost basis including significant changes in product demand, market conditions, condition of the inventory or net realizable value. If business or economic conditions change, the Company's estimates and assumptions may be adjusted as deemed appropriate.

                                       11

  Table of Contents

Results of Operations

Comparison of the Fiscal Years Ended August 31, 2022 and 2021

Revenues and Gross Margin (dollars in thousands)

                          Fiscal Years Ended August 31,           $          %
                            2022                 2021           Change     Change
Revenues               $       292,562      $       237,962    $ 54,600      22.9 %
Cost of revenues               209,060              177,177      31,883      18.0 %
Gross margin           $        83,502               60,785    $ 22,717      37.4 %
Percent of revenues               28.5 %               25.5 %

Revenues consist primarily of sales of component parts and fasteners and also include, to a lesser extent, kitting charges and special order fees, as well as freight charged to customers. The increase in revenues in fiscal 2022 compared to fiscal 2021 was largely due to a higher volume of product sales due to a better economic environment creating additional buying from manufacturers. Revenues have also increased due to added employees during fiscal 2022, increasing by 22 employees when comparing to fiscal 2021. There was also an increased focus to sell to international customers, which increased $9.1 million or 1% as a percentage of revenues when comparing fiscal 2022 to fiscal 2021.

The gross margins in fiscal 2022 increased by 3.0%, as a percentage of revenues, when compared to fiscal 2021. This increase in margins is due to better economic conditions and the Company carrying local inventory stock that other distributors did not have available. Further, in fiscal 2021, the Company had higher material expenses due to the global industry-wide shortages and the impacts from the COVID-19 pandemic.

Selling, General and Administrative Expense (dollars in thousands)

                                                  Fiscal Years Ended
                                                      August 31,             $          %
                                                   2022         2021       Change     Change

Selling, general and administrative expenses $ 53,970 $ 48,072 $ 5,898 12.3 % Percent of revenues

                                   18.4 %      20.2 %               (1.9) %

Selling, general and administrative expense ("SG&A") consists primarily of payroll and related expenses for the sales and administrative staff, professional fees (including accounting, legal and technology costs and expenses), and advertising costs. SG&A in fiscal 2022 increased from fiscal 2021 largely due to an increase in the number of sales and administrative employees, from 484 employees in fiscal 2021 to 506 employees in fiscal 2022. Fiscal 2022 also incurred additional employee travel costs due to the economy opening up and sales personnel visiting customers, vendors, and sales office locations. In fiscal 2022 and fiscal 2021, the Company received federal tax credits related to the Employee Retention Credit (ERC) of $5.3 million and $5.4 million, respectively, which have been offset against SG&A. SG&A as a percentage of revenue in fiscal 2022 decreased from fiscal 2021 primarily due to higher sales growth due to expanding customer base and increased sales to existing customers.

Other Income (Expense), Net (dollars in thousands)

                                              Fiscal Years Ended
                                                  August 31,             $           %
Other income (expense):                       2022         2021        Change     Change
Realized gain (loss) on sales of
marketable trading securities               $     138    $   (890)    $  1,028      115.5 %
Unrealized gain (loss) on marketable
trading securities                              (351)           83       (434)    (522.9) %
Interest and other (expense)                    (201)        (226)          25       11.1 %
Other income (expense), net                 $   (414)    $ (1,033)    $    619       59.9 %
Other income (expense), net as a percent
of revenues                                     (0.1) %      (0.4) %


                                       12

  Table of Contents

Other income (expense) includes income or losses on investments in marketable equity securities of other publicly-held domestic corporations, interest income (expense), and other nonoperating activities. The Company's investment strategy consists of both long and short positions. The Company experienced net realized and unrealized losses from trading securities of approximately $213,000 and $807,000 in fiscal 2022 and fiscal 2021, respectively. The trading securities losses in fiscal 2022 and fiscal 2021 was primarily due to timing of sale of investments and general market climate of investment positions at year-end.

Interest and other expense decreased by $25,000, which was primarily due to reduced interest expense due to a zero balance held on our line of credit during fiscal 2022.

Income Tax Provision (dollars in thousands)

                                Fiscal Years Ended
                                    August 31,             $         %
                                 2022         2021      Change     Change
Provision for income taxes    $    7,810     $ 3,293    $ 4,517     137.2 %
Percent of pre-tax income           26.8 %      28.2 %              (1.4) %

The provision for income taxes increased by $4,517,000 in fiscal 2022 compared to fiscal 2021, which was primarily a result of higher book income in fiscal 2022 as compared to fiscal 2021. The income tax provision as a percentage of pre-tax income decreased by 1.4% in fiscal 2022 compared to fiscal 2021, which was primarily due to a lower blended state tax rate used in fiscal 2022 and also due to the fiscal 2021 tax provision having a larger return to provision and deferred true ups when comparing to fiscal 2022.

Liquidity and Capital Resources

As of August 31, 2022 and 2021, the Company held approximately $17,386,000 and $4,455,000 of unrestricted cash and cash equivalents, respectively. The Company also held $3,925,000 and $3,741,000 of marketable securities at August 31, 2022 and August 31, 2021, respectively, which could be liquidated, if necessary.

The Company currently has a $15.0 million line of credit agreement with the Bank. On December 4, 2019, the Company entered into a Change in Terms Agreement dated November 27, 2019 with the Bank (the "Amendment"), which modified the Company's $10.0 million line of credit between the Company and the Bank to increase the maximum amount that may be borrowed thereunder from $10.0 million to $15.0 million. In addition, the Amendment removed the Company's interest rate options and set the rate at the bank prime rate, but provided that in no event would such interest rate be less than 3.0% per annum. On July 5, 2022, the expiration date of the line of credit under the line of credit agreement was extended to November 5, 2022 and the Company intends to renew the line of credit beyond maturity. Borrowings are secured by substantially all of the assets of the Company and its subsidiaries. The amounts outstanding under this line of credit as of August 31, 2022 and August 31, 2021 were zero.

In September 2019, Bisco entered into the Hunter Lease with the Trust, which is the grantor trust of Glen Ceiley, our Chief Executive Officer, Chairman of the Board and the Company's majority shareholder. Under the Hunter Lease, Bisco leased from the Trust the Hunter Property, which consists of approximately 80,000 square feet of office and warehouse space located at 5065 East Hunter Avenue, Anaheim, California, which serves as the Company's new corporate headquarters. The Hunter Lease has a term that expires on August 31, 2029.

The Company entered into a new Construction Loan with the Bank to borrow up to $5,000,000 for the primary purpose of financing tenant improvements at the Hunter Property. The Construction Loan was a line of credit evidenced by a Promissory Note in the principal amount of up to $5,000,000 with a maturity date of May 15, 2027. The terms of the Construction Loan provide that the Company may only request advances through July 15, 2020, and thereafter, the Construction Loan would convert to a term loan with a fixed rate of 4.6% and entitled to a .25% rate discount if a demand deposit account is held with the Bank. On July 15, 2020, the amount drawn on the Construction Loan and converted to a term loan was $4,807,000. Interest on the Construction Loan is payable monthly (4.35% at August 31, 2022 and 2021). Concurrent with the execution of this Construction Loan, Bisco entered into a commercial security agreement, dated July 12, 2019, with the Bank, pursuant to which Bisco granted the Bank a security interest in substantially all of Bisco's personal property to secure Bisco's obligations under the Construction Loan. The outstanding balance of the Construction Loan at August 31, 2022 and August 31, 2021 was $4,584,000 and $4,698,000, respectively.

                                       13

Table of Contents

EACO has also entered into a business loan agreement (and related $100,000 promissory note) with the Bank that is renewed annually in order to obtain a $100,000 letter of credit as security for the Company's workers' compensation requirements.

Cash Flows from Operating Activities

During fiscal 2022, the Company provided $16,866,000 in net cash from its operating activities. The current period cash provided by operating activities was primarily due to net income of $21,308,000 and an increase in trade accounts payable and accrued expenses. This was partially offset by increases in trade accounts receivable and inventory. Increases in accounts payable and accrued expenses is primarily due to increases in inventory.

During fiscal 2021, the Company provided $8,818,000 in net cash from its operating activities. Fiscal 2021 cash provided by operating activities was primarily due to net income of $8,387,000 and an increase in accrued expenses. This was partially offset by increases in trade accounts receivable and prepaid expenses. Increases in accrued expenses was primarily due to increases in accrued bonuses due to higher sales and margin borrowings of $848,000 on the brokerage account.

Cash Flows from Investing Activities

Cash used in investing activities was $2,098,000 for fiscal 2022. This was primarily due to the purchase of equipment for offices and distribution centers and the purchase of marketable securities.

Cash used in investing activities was $7,042,000 for fiscal 2021. This was primarily due to the purchase of marketable securities and a decrease in liability of short sales, which is due to timing of investing activities.

Cash Flows from Financing Activities

Cash used in financing activities for fiscal 2022 was $1,231,000, which was primarily due a reduction in bank overdraft when comparing fiscal 2022 to fiscal 2021.

Cash used in financing activities for fiscal 2021 was $6,308,000, which was primarily due net payments of $5,100,000 in fiscal 2021 to pay down the line of credit with the Bank to a zero balance.

Contractual Financial Obligations

In addition to using cash flow generated from operations, the Company finances its operations through borrowings from banks. These financial obligations are recorded in accordance with accounting rules applicable to the underlying transactions, with the result that debt agreements are recorded as liabilities in the accompanying consolidated balance sheets while obligations under operating leases are disclosed in the notes to the accompanying consolidated financial statements.

© Edgar Online, source Glimpses