The Eastern Company — Q2 2018 Form 10-Q
Business context and period: The filing covers the quarter and six months ended June 30, 2018, compared with periods ended July 1, 2017. The company operates in Industrial Hardware, Security Products, and Metal Products. Results include the Velvac business for six months in 2018 versus three months in the comparable 2017 period. The Load N Lock asset acquisition closed June 1, 2018 and is included in Security Products.
Financial performance
| Metric | Three months | Six months |
|---|---|---|
| Net sales | $60.9 million, up 5% from $58.0 million | $120.3 million, up 28% from $94.1 million |
| Gross margin | $15.1 million; 24.7% of sales, versus 26.7% | $29.8 million; 24.8% of sales, versus 25.8% |
| Operating profit | $4.4 million, versus $2.5 million | $8.6 million, versus $4.7 million |
| Net income | $3.3 million, versus $1.5 million | $6.4 million, versus $3.0 million |
| Diluted EPS | $0.52, versus $0.23 | $1.01, versus $0.47 |
| Cash from operations | Not provided separately for the quarter | $5.6 million, versus $6.3 million |
Second-quarter sales rose across all three segments: Industrial Hardware 2%, Security Products 10%, and Metal Products 6%. First-half segment sales increased 43%, 10%, and 11%, respectively. Management attributed first-half growth to 9% organic growth and a 19% contribution from Velvac; it also cited new products as a source of sales growth.
Cash and cash equivalents were $19.0 million at June 30, 2018, down from $22.3 million at December 30, 2017. Current assets were $103.2 million and current liabilities $34.6 million; the reported current ratio was 3.0. Total debt was $35.45 million, including $6.0 million outstanding on the revolver. Shareholders’ equity was $92.5 million. The six-month dividend was $0.22 per share.
Changes, drivers, and notable items
- Sales growth substantially reflected the additional three months of Velvac results in the first half. Higher raw-material prices pressured margins: management cited increases in steel, zinc, copper, and scrap iron. Second-quarter consolidated gross margin fell two percentage points year over year.
- Second-quarter selling and administrative expense declined 20% year over year, partly because the prior-year quarter included Velvac transaction costs, environmental remediation expense, and personnel-change costs. First-half selling and administrative expense increased 5.3%.
- Interest expense was broadly comparable in the quarter but rose $0.3 million for the first half, reflecting debt used in the Velvac acquisition. Other income increased in the first half, partly due to the presentation change under ASU 2017-07.
- Load N Lock cost approximately $5.0 million; $2.7 million of the purchase price was recorded as goodwill. Management said the acquisition’s actual and pro forma effects were not material.
- First-half investing cash outflow was $7.7 million, including the Load N Lock acquisition, capitalized software, and capital expenditures. Financing cash outflow was $1.2 million.
Liquidity, outlook, and risks
Management said operating cash flow, cash on hand, and availability under the revolving facility were expected to meet foreseeable working-capital needs. After quarter-end, the company repatriated $5.5 million from foreign operations and used it to repay the revolver. At quarter-end, $14.9 million of cash was held by a foreign subsidiary and $4.1 million in the United States.
Debt bears variable interest generally based on LIBOR plus a 1.75%–2.50% spread. The company had an interest-rate swap with a $14.7 million notional amount. It reported compliance with its loan covenants; required debt-service coverage and leverage thresholds tighten in future periods. No specific revenue or earnings guidance was provided.
Management highlighted risks including raw-material prices, customer preferences and concentration, competition, new-product execution, foreign sourcing, economic and industry conditions, and acquisition integration. It stated that risk factors had not materially changed from the 2017 Form 10-K. Legal matters were described as ordinary-course proceedings with no expected material adverse effect. Environmental remediation accruals included $50,000 for an Illinois site and $411,000 for a New York landfill.
Important facts for investors to verify
- How much of reported growth and segment profitability is sustainable organic performance versus the Velvac acquisition, and what contribution Load N Lock may make.
- Whether pricing, product mix, or other actions can offset continued increases in raw-material and labor costs and stabilize gross margins.
- Cash conversion and working-capital trends, particularly the increase in inventories and receivables, and the effect of the post-quarter revolver repayment.
- Debt balances, variable-rate exposure, swap terms, and compliance with covenants as covenant thresholds tighten.
- The adequacy of pension funding and environmental remediation estimates, and any material developments in legal or tax contingencies.