The Eastern Company — Q3 2018 Form 10-Q
Business context and reporting period. The filing covers the quarter ended September 29, 2018, and the first nine months of fiscal 2018. The company reports Industrial Hardware, Security Products, and Metal Products segments. Comparisons below are with the corresponding 2017 periods unless otherwise noted. Dollar amounts are in U.S. dollars.
Key financial results
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net sales | $57.36 million | $56.01 million | $177.66 million | $150.10 million |
| Gross margin | $14.22 million; 24.8% | $11.95 million; 21.3% | $43.99 million; 24.8% | $36.21 million; 24.1% |
| Operating profit | $4.74 million | $3.57 million | $13.30 million | $8.30 million |
| Net income | $3.77 million | $2.23 million | $10.13 million | $5.21 million |
| Diluted EPS | $0.60 | $0.35 | $1.61 | $0.83 |
| Operating cash flow | Not separately provided for Q3 | Not separately provided for Q3 | $7.10 million | $10.17 million |
Financial position and liquidity
- At September 29, 2018, cash and cash equivalents were $11.17 million, down from $22.28 million at December 30, 2017. The company reported $7.8 million of cash held by a foreign subsidiary and $3.4 million held in the U.S.
- Current assets were $96.71 million and current liabilities $29.71 million; the reported current ratio was 3.3. Working capital was $67.0 million.
- Total debt was approximately $29.06 million: $1.94 million current and $27.13 million long-term. The revolving credit facility had no balance at quarter-end. Total debt to shareholders’ equity was 30.5%, compared with 40.5% at year-end 2017.
- For the first nine months, cash used in investing was $9.33 million, including $4.99 million for the Load N Lock acquisition and $2.85 million for property, plant and equipment. Cash used in financing was $8.55 million. Ending cash declined by $11.10 million.
- Inventory rose 8% from year-end to $51.20 million; accounts receivable rose to $30.52 million from $27.12 million. Management attributed lower operating cash flow in part to higher receivables and inventory accompanying increased sales and the inclusion of Velvac.
Changes versus comparable periods
- Q3 sales increased 2.4%, operating profit increased 32.6%, and net income increased about 69%. Gross margin improved to 24.8% from 21.3%.
- Nine-month sales increased 18.4%, operating profit increased 60.3%, and net income increased about 94%. Management said the sales increase reflected higher existing-product volume, new products, and a full nine months of Velvac sales in 2018 versus about six months in 2017.
- For Q3, Industrial Hardware sales rose 4% and Security Products rose 5%, while Metal Products sales fell 10%. Nine-month sales rose 28% in Industrial Hardware, 8% in Security Products, and 4% in Metal Products.
- Nine-month operating cash flow fell to $7.10 million from $10.17 million. Interest expense increased by about $0.3 million year over year for the nine-month period, primarily reflecting the debt used to acquire Velvac.
Outlook, commentary, risks and unusual items
- The filing provides no quantified earnings or revenue guidance. Management said operating cash flow and available revolving-credit capacity were expected to cover foreseeable working-capital needs.
- Management cited new-product sales and favorable product mix as contributors to sales and margin performance. It also noted higher raw-material prices, including increases in steel prices, and higher payroll-related costs. Metal Products’ Q3 sales were affected by lower mining-product sales as the company pursued diversification into industrial products.
- The company acquired certain Load N Lock assets effective June 1, 2018, for approximately $4.995 million. The acquisition added approximately $2.695 million of goodwill and was included in Security Products; management said actual and pro forma effects were not material.
- Other income increased by approximately $0.6 million in the nine-month period. The company attributed this to adopting accounting guidance that presents pension and postretirement plan income separately; such amounts can vary with interest rates, asset performance, and discount rates.
- The company had $29.06 million of debt bearing variable interest rates linked to LIBOR, with an interest-rate swap covering approximately half of the term loan. It reported compliance with loan covenants. The term loan matures in 2022, with scheduled quarterly principal payments increasing beginning July 2019.
- Risks identified include changing customer preferences, new-product execution, customer losses, competition, raw-material price increases, foreign sourcing, economic and industry conditions, litigation, and integration of acquisitions. Management reported no material change in the risk factors from the 2017 Form 10-K.
- Environmental matters include a New York foundry-sand landfill remediation estimated at $411,000, accrued and expensed; a closure design was expected to be presented to regulators in Q4 2018. Illinois remediation work was completed, with state sign-off still pending. Management said ordinary-course legal matters were not expected to have a material adverse effect.
- The company had accrued a $2.07 million contingent liability at quarter-end; the filing excerpt does not clearly identify its nature. The Tax Cuts and Jobs Act measurement period remained open, with any adjustments expected in Q4 2018; none were recorded in the first nine months.
Important facts for investors to verify
- Whether higher inventory and receivables convert into operating cash flow, and whether cash generation improves after the acquisition-related and growth-driven working-capital demands.
- Whether gross-margin gains persist amid raw-material cost pressure, especially steel, and changes in segment and product mix.
- Velvac and Load N Lock contribution to growth and profitability, including acquisition integration and any effects not yet evident in reported results.
- Debt repayment, variable-rate exposure, covenant headroom, and the use and location of cash, including the company’s foreign-held cash.
- The status and ultimate cost of environmental remediation, the $2.07 million contingent liability, and any Q4 tax measurement-period adjustments.
- The company’s execution on diversification away from mining products and its ability to sustain new-product sales.