The Eastern Company — Q3 2014 Form 10-Q
Business context and reporting period. The company reported the quarter and 39 weeks ended September 27, 2014. Its segments are Industrial Hardware, Security Products, and Metal Products. Interim results are unaudited and are not necessarily indicative of full-year results.
Financial performance
| Metric | Third quarter 2014 | Third quarter 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Net sales | $35.8 million | $34.3 million | $106.4 million | $108.2 million |
| Gross margin | $8.6 million; 24.1% | $7.2 million; 21.1% | $23.9 million; 22.5% | $22.0 million; 20.4% |
| Operating profit | $3.75 million | $2.46 million | $8.83 million | $7.35 million |
| Net income | $2.43 million | $1.80 million | $5.63 million | $4.98 million |
| Diluted EPS | $0.39 | $0.29 | $0.90 | $0.80 |
- Quarterly sales rose about 5%; nine-month sales declined about 2%. Quarterly sales increases were led by Metal Products, up 23%, while Industrial Hardware was comparable and Security Products rose 1%. For nine months, Industrial Hardware sales fell 5%, Metal Products fell 2%, and Security Products rose 3%.
- Management attributed improved gross margins to product mix, lower product costs, and, in the quarter, higher production-capacity utilization. Nine-month operating margin was 8.3%, versus 6.8% a year earlier.
- Interest expense fell to $194,000 for nine months from $249,000, reflecting lower debt. The effective tax rate was 35% for nine months versus 30% in 2013, partly due to taxes on cash repatriated from foreign subsidiaries.
- Operating cash flow was $7.0 million for nine months, down from $7.9 million. Capital expenditures were $2.3 million, compared with $4.2 million. Cash increased to $21.2 million from $20.0 million at year-end; working capital was $60.5 million and the current ratio was 5.3.
- Total debt was $5.0 million at September 27, 2014 ($1.8 million current and $3.2 million long-term), down from $6.1 million at year-end. The $10 million revolving facility was unused. The company reported compliance with its debt covenants.
- Quarterly and nine-month dividends per share were $0.15 and $0.37, respectively; the third-quarter amount included a one-time $0.04 dividend. The filing notes this was the company’s 296th consecutive quarterly dividend.
Material changes, outlook, and risks
- Security Products’ nine-month operating profit improved substantially, supported by lower material costs and better product mix; the prior-year period included $0.6 million of China-facility relocation severance costs. Metal Products’ margin declined, with higher raw-material costs and product mix cited as factors. Industrial Hardware sales were affected by a customer exiting the fracking business and lower distributor and military-market sales.
- Management expected 2014 capital expenditures of approximately $3–$3.5 million, with about $725,000 of outstanding commitments at quarter-end. It said cash, operating cash flow, and revolver availability should cover foreseeable working-capital needs and existing obligations, including quarterly dividends.
- Raw-material prices had increased; management said price increases were recovering costs where possible, but further increases could pressure future margins if not passed through. The filing also identifies risks involving customer demand, new products, customer retention, competition, foreign sourcing, economic and industry conditions, litigation, and legislation.
- The company expected to contribute $2.5 million to pension plans and $63,000 to its postretirement plan in 2014; by quarter-end it had contributed approximately $970,000 and $43,000, respectively.
- Potential environmental remediation at a Wheeling, Illinois site remained under investigation, with no cost estimate available. The company disputes potential liability for an EPA-identified Cleveland, Ohio site and intends to defend against claims. No other material legal proceedings were reported.
- The company planned to adopt new discontinued-operations guidance in fiscal 2015 and expected no financial-statement impact. It had not determined the impact of the new revenue-recognition standard, effective for annual periods beginning after December 15, 2016.
Important facts for investors to verify
- Whether higher raw-material costs can be passed through without eroding margins, particularly in Metal Products.
- Durability of the quarterly sales and margin improvement, including the recovery in Metal Products and the nine-month weakness in Industrial Hardware.
- Operating cash conversion and working-capital trends, especially accounts-receivable collections and the timing of liability payments.
- Final 2014 capital spending and pension contributions, and ongoing compliance with loan covenants.
- Potential cost and exposure from the Illinois and Ohio environmental matters; the Illinois remediation cost was not estimable in the filing.
- The tax and cash implications of foreign-subsidiary earnings and any future repatriations; the company stated it intended to reinvest undistributed foreign earnings indefinitely.