The Eastern Company — Q2 2016 Form 10-Q
Business context and reporting period
The Eastern Company reported results for the three and six months ended July 2, 2016, compared with periods ended July 4, 2015. Its segments are Industrial Hardware, Security Products, and Metal Products.
Financial performance
| Metric | Three months ended July 2, 2016 | Six months ended July 2, 2016 |
|---|---|---|
| Net sales | $36.9 million, down 0.4% | $70.0 million, down 5.3% |
| Gross profit / margin | $8.6 million / 23.3% | $15.0 million / 21.5% |
| Operating profit / margin | $3.1 million / 8.4% | $4.1 million / 5.8% |
| Net income | $2.1 million; diluted EPS $0.33 | $2.7 million; diluted EPS $0.44 |
| Operating cash flow | Not presented separately for the quarter | $6.1 million, versus $1.4 million |
For the first half, capital expenditures were $1.1 million and dividends paid were $1.4 million. The company had $20.2 million in cash at July 2, including $11.5 million held by foreign subsidiaries. Current assets were $76.7 million and current liabilities $13.8 million; working capital was $62.9 million and the current ratio was 5.6.
Total debt was approximately $2.1 million, down from $3.2 million at January 2, 2016. The company had not drawn on its $10 million revolving facility; its maturity was extended to July 1, 2018. The company reported compliance with its loan covenants. Total shareholders’ equity was $79.9 million.
Changes versus the prior comparable periods
- Quarterly net income rose 257% to $2.1 million; first-half net income rose 88% to $2.7 million. Operating profit increased to $3.1 million for the quarter and $4.1 million for the half year.
- Quarterly gross margin improved to 23.3% from 21.4%; first-half margin was 21.5% versus 20.6%.
- Selling and administrative expenses fell $1.6 million in the quarter and $2.1 million in the first half. The principal comparison benefit was approximately $1.4 million and $2.0 million, respectively, of prior-year proxy-contest costs.
- Industrial Hardware and Security Products first-half sales each increased 2%. Metal Products sales fell 35%, reflecting depressed mining demand and lower contract-casting sales. Metal Products recorded a first-half operating loss of approximately $1.0 million.
- First-half operating cash flow increased by $4.7 million, primarily reflecting higher earnings, lower inventories, and timing differences in receivables and liability payments.
Outlook, management commentary, and risks
- Management expected 2016 capital expenditures of approximately $2.5 million, with about $370,000 of commitments outstanding at July 2. It said cash, operating cash flow, and available revolver capacity should cover foreseeable working-capital needs.
- Management said it was working with new contract-casting customers and expected this to favorably affect the remainder of fiscal 2016. It gave no specific revenue or earnings guidance and stated that future revenue and margin trends could not be reliably predicted.
- The company cited ongoing pressure in U.S. coal and mining, including plant closures, low natural-gas prices, excess coal inventories, and stricter regulation. It also identified risks including customer preferences, new-product execution, customer losses, competition, raw-material prices, foreign sourcing, economic and industry conditions, litigation, and legislation.
- The board froze benefits under the Salaried Employees Retirement Plan effective May 31, 2016. A subsequent remeasurement increased pension obligations by approximately $3.0 million. The company said the significant event reduced 2016 pension expense by approximately $612,000. The balance-sheet accrued pension cost rose to $27.2 million from $24.3 million at year-end.
- The company expected approximately $25,000 in additional remediation-system costs for potential ground contamination at its Wheeling, Illinois plant. It had expensed $2,500 in fiscal 2016 to date.
- The company disclosed no material changes in risk factors or market risk from its 2015 Form 10-K. Management concluded disclosure controls were effective at the reasonable-assurance level.
Important facts for investors to verify
- Whether the sharp decline in Metal Products sales and its first-half operating loss persist, and whether new contract-casting customers provide the expected offset.
- How much of improved earnings reflects operating performance versus lower prior-year proxy-contest expenses, and whether cost savings continue.
- The effect of the pension-plan freeze and remeasurement on future pension expense, obligations, and required contributions; the filing reports a $594,000 minimum qualified-plan contribution for 2016.
- The location and potential tax implications of foreign-held cash: the company intended to reinvest foreign subsidiary earnings indefinitely and stated that U.S. taxes could be due on repatriation.
- Progress against the $2.5 million capital-spending expectation, continued covenant compliance, and any draw on the revolving facility.