The Eastern Company — Q3 2012 Form 10-Q
Business context and period. The company manufactures and sells products through its Industrial Hardware, Security Products and Metal Products segments. This unaudited report covers the quarter ended September 29, 2012 and the first nine months of fiscal 2012; comparisons are with the quarter and nine months ended October 1, 2011, unless otherwise noted.
Financial performance
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Net sales | $39.64 million | $36.09 million | $121.70 million | $104.80 million |
| Gross margin | $8.17 million; 20.6% | $6.56 million; 18.1% | $25.60 million; 21.0% | $19.80 million; 18.9% |
| Operating profit | $3.33 million | $2.13 million | $10.65 million | $6.15 million |
| Net income | $2.22 million | $1.46 million | $6.90 million | $4.04 million |
| Diluted EPS | $0.36 | $0.24 | $1.11 | $0.65 |
| Cash dividends per share | $0.10 | $0.09 | $0.30 | $0.27 |
Cash flow and investment: Nine-month operating cash flow was $10.77 million, versus $1.65 million in 2011. Capital expenditures were $3.55 million, compared with $2.93 million. Cash increased by $6.68 million to $17.82 million.
Liquidity and debt: At September 29, cash was $17.82 million, working capital was $56.1 million and the current ratio was 4.8. Total balance-sheet debt was approximately $7.86 million, compared with $6.75 million at year-end 2011. The company added a $5 million term loan in January; outstanding debt carries fixed rates of 4.98% and 3.90%. The revolving facility was not used in Q3. The company reported compliance with its loan covenants.
Other balance-sheet items: Inventories were $28.98 million, down from $29.79 million at year-end 2011. Accounts receivable were $19.68 million. Accrued pension cost was $14.36 million. The company held $8.3 million of cash at foreign subsidiaries; it intends to reinvest foreign earnings indefinitely, and U.S. taxes may be due if funds are repatriated.
Material changes and segment performance
- Sales rose about 10% in Q3 and 16% in the first nine months. Management attributed growth to existing products, selective price increases and new products. Gross margin increased in both periods, which management attributed to higher volume, product mix, pricing and new products.
- Industrial Hardware: Sales increased 9% in Q3 and 19% year to date. Nine-month segment sales were $55.61 million; pretax segment income was $6.14 million. Product demand and new internally developed products contributed to growth.
- Security Products: Sales increased 1% in Q3 and 5% year to date. Nine-month segment sales were $38.69 million; pretax segment income was $3.49 million.
- Metal Products: Sales increased 29% in Q3 and 30% year to date. Nine-month segment sales were $27.40 million; pretax segment income was $1.02 million. Mining demand and new contract-casting products supported growth, although higher raw-material and other costs remained significant.
- Interest expense increased 74% in Q3 and 62% year to date, reflecting higher debt. The effective tax rate was 32% in Q3 and 34% year to date, compared with 30% and 33% in the respective 2011 periods.
Outlook, risks and contingencies
- Management expected 2012 capital expenditures of approximately $4–$5 million; about $428,000 of commitments remained at quarter-end. Management stated that cash, operating cash flow and available revolving credit should cover foreseeable working-capital needs and existing obligations, including quarterly dividends.
- Management warned that raw-material prices were rising and could pressure future margins if the company could not recover increases through customer pricing. It reported no current indication of a raw-material supply shortfall.
- Management cited a possible softening in coal usage beginning in the second half of 2012, related to new EPA clean-air rules, as a potential risk to mining-product sales. The company was developing new products to offset possible weakness.
- Forward-looking statements are subject to risks including customer preferences, new-product success, customer loss, competition, input costs, foreign sourcing, industry and economic conditions, litigation and legislation. Management said future revenue and margin trends could not be reliably predicted. No specific revenue or earnings guidance was provided.
- The company is participating in an Illinois voluntary remediation program concerning potential contamination at its Wheeling plant; the remediation cost was not estimable in the filing. The EPA had also identified the company as a potentially responsible party concerning a Cleveland site formerly owned by a company division; the company intended to defend against liability.
- The company moved its annual goodwill impairment evaluation from the second to the fourth fiscal quarter. Its Q2 2012 qualitative assessment found it more likely than not that goodwill was not impaired; another assessment was planned for Q4. The filing reports no material changes in risk factors from the 2011 Form 10-K.
- Required 2012 pension contributions were $3.47 million and postretirement contributions $155,000. By September 29, the company had contributed $2.68 million and $80,000, respectively, with remaining contributions expected during the year.
Important facts for investors to verify
- Whether raw-material inflation and the coal-market outlook affect segment margins and demand, and how much cost can be passed through in pricing.
- The Q4 goodwill impairment assessment and any subsequent changes in the underlying business outlook.
- Potential scope and cost of the Illinois remediation, and the status and possible exposure of the Cleveland environmental matter; no Illinois remediation estimate was available.
- Debt and covenant headroom, scheduled term-loan payments, and the availability of the revolving facility.
- Foreign cash balances and any tax consequences if the company changes its stated indefinite-reinvestment intent.
- Completion of required pension and postretirement contributions and actual 2012 capital spending relative to the $4–$5 million estimate.