Business context and reporting period
The Eastern Company’s unaudited Form 10-Q covers the quarter and 26 weeks ended July 2, 2011, compared with the periods ended July 3, 2010. The company reports Industrial Hardware, Security Products, and Metal Products. Management attributed sales growth to improving conditions in several markets.
Financial performance
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Net sales | $35.52m | $32.58m | $68.71m | $63.53m |
| Gross margin | $6.93m | $6.90m | $13.25m | $12.96m |
| Operating profit | $2.30m | $2.28m | $4.02m | $3.90m |
| Net income | $1.48m | $1.41m | $2.58m | $2.42m |
| Diluted EPS | $0.24 | $0.23 | $0.42 | $0.39 |
- Q2 sales rose 9%; six-month sales increased 8%. Q2 net income rose about 5% and six-month net income about 7% year over year.
- Gross margin was 19.6% in Q2 versus 21.2% a year earlier, and 19.3% for the first half versus 20.4%. Operating margin was 6.5% in Q2 versus 7.0%, and 5.8% for the first half versus 6.1%.
- Six-month sales increased across all segments: Industrial Hardware 4%, Security Products 12%, and Metal Products 11%. Q2 increases were 6%, 9%, and 15%, respectively. Industrial Hardware operating profit declined; Security Products and Metal Products operating profit increased.
- Operating cash flow was a use of $0.41m, versus a source of $5.02m in the first half of 2010. Capital spending was $1.84m; cash declined $3.78m to $8.45m. Dividends paid were $1.11m.
- At July 2, cash was $8.45m, working capital $49.8m, and the current ratio 5.4. Total debt was about $3.93m, down from $4.46m at year-end; debt to equity was 5.4%. The $5m term loan bears fixed interest of 4.98%; the $10m revolving facility had no balance outstanding.
- Accounts receivable was $19.72m and inventory $28.70m, both higher than at year-end. Average days’ sales in receivables rose to 51 from 47 at year-end.
Changes, outlook, and risks
- Management said lower gross margins reflected higher manufacturing and raw-material costs that were not yet fully recovered through pricing, as well as product mix. Industrial Hardware margins were also affected by lower military business and startup costs at its Ontario composite-panel facility.
- Metal Products benefited from stronger coal-mining demand, price increases, improved processes, and discontinuation of products with unacceptable margins. Security Products growth reflected stronger existing-product sales and new locks.
- Management expects raw-material prices to continue rising and warned that margins could be pressured if price increases do not recover the added costs. The company reported no current indication of raw-material supply shortages.
- Management expects cash, operating cash flow, and available revolver capacity to cover foreseeable working-capital needs and existing obligations, including quarterly dividends. It expected 2011 capital expenditures of approximately $4m–$5m; about $0.65m of commitments remained at quarter-end. No specific revenue or earnings guidance was provided.
- Required 2011 contributions were $2.301m to pension plans and $0.151m to the postretirement plan; $0.985m and $0.058m, respectively, had been contributed by July 2.
- Environmental matters include potential contamination at the Wheeling, Illinois plant, where remediation testing was underway and no cost estimate was available, and an EPA-identified Cleveland site for which the company said it would defend against liability. A New York tax audit was ongoing; management did not expect a material financial-statement impact.
- Management judged disclosure controls effective at a reasonable-assurance level and reported no significant changes in internal controls or material changes in previously reported risk factors.
Important facts for investors to verify
- Whether pricing actions keep pace with rising raw-material and manufacturing costs, and whether margins recover.
- Working-capital conversion, especially the increase in receivables and the first-half operating cash outflow.
- Progress and costs at the Ontario facility, and execution of the $4m–$5m capital-spending plan.
- Required pension and postretirement contributions, and any developments or cost estimates for the Illinois and Cleveland environmental matters.
- Future operating cash flow and the company’s capacity to sustain dividends while meeting debt and investment needs.