The Eastern Company — FY 2016 Form 10-K
Business context and reporting period. The company manufactures industrial hardware, security products and metal products through three segments and U.S. and foreign operations. This annual report covers the 52 weeks ended December 31, 2016; fourth-quarter comparisons are also disclosed. The financial statements received an unqualified audit opinion, and management and the auditor concluded internal controls over financial reporting were effective.
Financial performance
| Metric | FY 2016 | FY 2015 | Change |
|---|---|---|---|
| Net sales | $137.6 million | $144.6 million | -4.8% |
| Gross profit / margin | $34.3 million / 24.9% | $32.4 million / 22.4% | Margin +2.5 percentage points |
| Operating profit / margin | $11.1 million / 8.1% | $8.0 million / 5.6% | +38.7% |
| Net income | $7.8 million | $5.7 million | +36% |
| Diluted earnings per share | $1.25 | $0.92 | +$0.33 |
| Operating cash flow | $12.4 million | $9.1 million | +$3.3 million |
| Capital expenditures | $2.9 million | $2.5 million | +$0.3 million |
Liquidity and debt. Year-end cash was $22.7 million, including $11.5 million held by foreign subsidiaries. Working capital was $64.8 million and the current ratio was 6.0. Total debt was $1.8 million, down from $3.2 million; the $10 million revolving facility was unused and extended to July 1, 2018. The company reported covenant compliance and stated it had sufficient cash and credit resources for the next fiscal year. Total assets were $124.2 million and shareholders’ equity was $82.5 million.
Fourth quarter. Sales were $34.1 million versus $34.4 million, down less than 1%. Net income rose to $2.65 million from $1.74 million, and diluted EPS increased to $0.42 from $0.28. Gross margin improved to 30.5% from 23.5%, chiefly reflecting lower production costs, product mix and greater capacity utilization in Metal Products.
Material changes and drivers
- Industrial Hardware sales were down less than 1%; reduced Class 8 truck composite-panel sales were largely offset by new smartboard-panel sales. Segment operating margin improved to 9.3% from 7.0%.
- Security Products sales increased about 1%, supported by laundry payment products and new locking products. Segment operating margin improved to 9.9% from 6.7%.
- Metal Products sales fell 28%, reflecting weak coal-mining demand and lower industrial-casting sales. The segment reported a $0.2 million loss before income taxes, versus a $0.1 million loss in 2015.
- Profit growth despite lower sales reflected cost reductions, a stronger U.S. dollar, the absence of 2015 proxy-contest costs, and lower pension expense after the company froze its salaried pension plan effective May 31, 2016. The freeze reduced 2016 pension expense by approximately $2.45 million.
- Income tax expense rose to $3.44 million; the effective tax rate was 31%, versus 29%, partly due to the mix of U.S. and foreign earnings. Interest expense declined to $0.12 million with lower debt.
Outlook, risks and unusual items
- Management expected U.S. coal production and mining demand to rise slightly in 2017, while noting continued work to develop utility, rail, construction and industrial-casting products to diversify Metal Products. This is a qualitative outlook, not formal earnings guidance.
- Planned 2017 capital expenditures were approximately $3 million. Expected 2017 cash contributions were approximately $700,000 to pension plans and $103,000 to the other postretirement plan.
- Raw-material price increases could pressure margins if the company cannot pass costs through or offset them. Other principal risks include market and customer demand, competition, new-product execution, overseas sourcing and operations, currency fluctuations, acquisitions, and customer creditworthiness.
- Union agreements covering about 14% of the workforce were due to expire in 2017, creating potential negotiation and production-disruption risk.
- The Wheeling, Illinois site remains in a voluntary environmental remediation process. A remediation-system design was expected to be approved in 2017; final costs had not been determined, though management did not expect them to be material.
- The pension plans were underfunded by $26.6 million at year-end. Management lowered the expected return assumption from 8.0% to 7.5% for 2017; pension obligations and expense remain sensitive to actuarial assumptions and asset performance.
- About 51% of cash was held abroad. The company intended to reinvest foreign earnings indefinitely; repatriation of earnings not otherwise provided for could trigger U.S. income taxes.
- The company had not determined the effect of the new revenue-recognition standard; adoption was expected for fiscal years beginning after December 15, 2017. The lease standard’s impact was also still under evaluation.
Important facts for investors to verify
- Whether Metal Products’ coal-market recovery and new-market products offset continued weakness in mining and castings.
- How much of the earnings improvement persists after the pension-freeze benefit and nonrecurring absence of proxy-contest costs.
- Progress on pension funding, the 2017 contribution outlook and the impact of the revised pension assumptions.
- Final scope, timing and cost of the Illinois environmental remediation, and outcomes of 2017 union negotiations.
- Availability and potential tax cost of foreign-held cash, and the expected effects of revenue-recognition and lease-accounting changes.