The Eastern Company: Q1 2017 Form 10-Q
Business context and period. The filing covers the 13 weeks ended April 1, 2017, compared with the 13 weeks ended April 2, 2016. The Eastern Company reported three segments: Industrial Hardware, Security Products and Metal Products. The April 3, 2017 Velvac acquisition occurred after quarter-end and is not included in Q1 results.
Financial performance and position
| Metric | Q1 2017 | Q1 2016 |
|---|---|---|
| Net sales | $36.04 million | $33.10 million |
| Gross margin | $8.29 million; 23.0% of sales | $6.42 million; 19.4% of sales |
| Operating profit | $2.24 million; 6.2% of sales | $0.96 million; 2.9% of sales |
| Net income | $1.52 million | $0.65 million |
| Diluted EPS | $0.24 | $0.10 |
| Operating cash flow | $2.39 million | $0.66 million |
| Cash dividends per share | $0.11 | $0.11 |
- Sales increased 8.9%; gross profit rose 29.1%, operating profit 132.6%, and net income 134.1% year over year. The effective tax rate was 32.0%, versus 31.5%.
- Cash and cash equivalents were $23.58 million at April 1, up from $22.73 million at year-end 2016. Working capital was $65.6 million and the current ratio was 6.2.
- At quarter-end, long-term debt including its current portion was approximately $1.43 million; the company said it had not used its revolver during Q1. Total debt to equity was 1.7%.
- Q1 capital expenditures were $0.49 million. Management expected approximately $2.5 million of capital expenditures for 2017 and reported approximately $0.2 million of outstanding commitments.
Material changes and operating drivers
- Metal Products sales rose 55%, largely on stronger U.S. coal-industry demand; mining product volume was up 47%. The segment moved from a $0.86 million pretax loss in Q1 2016 to $0.67 million of pretax income in Q1 2017, as higher volume improved capacity utilization.
- Industrial Hardware sales increased 5.8%, with new products contributing; segment pretax income declined to $0.57 million from $0.70 million. Higher raw-material costs and expenses contributed to lower segment gross margin.
- Security Products sales fell 2% due to lower volume in the commercial laundry market. Segment pretax income was $0.99 million, down from $1.13 million.
- Consolidated selling and administrative expenses increased 11% to $6.05 million, primarily reflecting payroll-related costs. Interest expense declined 42% to $21,000, attributed to lower debt.
- Operating cash flow improved year over year, reflecting higher earnings and timing changes in receivables, liabilities and inventories. Receivables rose to $20.0 million from $18.1 million at year-end; inventories declined to $32.5 million from $34.0 million.
Outlook, risks and subsequent events
- Management said raw-material prices had begun increasing versus 2016 and expected to recover some added costs through customer price increases where possible. It reported no current indication of supply shortages. No specific revenue or earnings guidance was provided; management cautioned that future revenue and margin trends could not be reliably predicted.
- On April 3, the company acquired 100% of Velvac Holdings for $39.5 million plus contingent earnout consideration tied to earnings and sales of its Road-iQ product line. Velvac reported approximately $60 million of 2016 sales. The filing does not provide a purchase-price allocation or quantified expected acquisition synergies.
- The acquisition was financed under a restated facility comprising a $31 million term loan and a $10 million revolver; approximately $6.6 million was drawn on the revolver on April 3. The term loan matures in 2022, has variable-rate pricing, and is subject to leverage and debt-service covenants. A $15.5 million interest-rate swap was entered into April 4.
- Management expected cash, operating cash flow and revolver availability to cover foreseeable working-capital needs. It also stated that foreign-subsidiary cash was intended to remain invested abroad; repatriation could incur U.S. income taxes.
- Risks include acquisition integration and realization of expected benefits, customer demand and product success, competition, raw-material cost increases, foreign sourcing, economic and industry conditions, and the coal-demand exposure evident in Metal Products. A proposed Illinois environmental remediation system was under review, with estimated cost of approximately $50,000.
- A prospective change in the method for measuring pension and postretirement service and interest costs reduced Q1 2017 combined benefit expense by approximately $135,000 versus the prior method; benefit obligations were not affected. Management also reported compliance with the pre-acquisition loan covenants at quarter-end.
Important facts for investors to verify
- Velvac’s purchase accounting, contingent earnout terms, contribution to results, and integration performance after closing.
- Post-acquisition debt, variable interest costs, swap accounting, and compliance with the new leverage and debt-service covenants.
- Whether elevated coal-related demand and improved Metal Products capacity utilization persist, and whether raw-material inflation can be offset through pricing.
- Cash held by foreign subsidiaries, potential tax consequences of repatriation, and the adequacy of pension funding and assumptions.
- The filing states that disclosure controls were effective at a reasonable-assurance level; investors should also review the company’s cited prior-period risk disclosures.