Business context and reporting period
The Eastern Company’s unaudited Form 10-Q covers the 13 weeks ended March 29, 2014, compared with the 13 weeks ended March 30, 2013. The company reports three segments: Industrial Hardware, Security Products, and Metal Products.
Financial performance
| Metric | Q1 2014 | Q1 2013 |
|---|---|---|
| Net sales | $35.85 million | $34.69 million |
| Gross margin | $7.51 million; 21.0% of sales | $6.27 million; 18.1% of sales |
| Operating profit | $2.30 million; 6.4% of sales | $1.59 million; 4.6% of sales |
| Net income | $1.50 million | $1.01 million |
| Diluted EPS | $0.24 | $0.16 |
| Operating cash flow | $0.41 million | $0.71 million |
Revenue increased 3.3% and net income increased about 49%. Management attributed the improved consolidated gross margin primarily to higher production-capacity utilization. Selling and administrative expenses rose 11.4% to $5.22 million. Interest expense fell 20% to $68,569, principally because debt was lower. The effective tax rate was 32.8%, versus 33.3%.
Segments
- Industrial Hardware: Sales fell 7.1% to $14.13 million, while pretax segment income rose to $1.10 million from $0.60 million. Weakness included composite panels for a fracking customer that exited the business, and lower distributor and military sales; new products and growth in several vehicle-related markets partly offset declines.
- Security Products: Sales increased 14.3% to $12.55 million and pretax segment income rose to $0.56 million from $0.25 million, driven mainly by higher existing-product volumes.
- Metal Products: Sales increased 7.9% to $9.17 million, but pretax segment income declined to $0.65 million from $0.73 million. Management cited product mix and higher production costs; mining and contract-casting sales increased.
Financial position, cash flow and liquidity
At March 29, 2014, cash was $18.52 million, current assets were $71.20 million, and current liabilities were $12.85 million. Working capital was approximately $58.3 million and the current ratio was 5.5. Total debt was approximately $5.71 million, comprising $1.79 million current and $3.93 million long-term; debt to shareholders’ equity was 7.0%. Shareholders’ equity was $82.15 million.
Operating cash flow of $0.41 million, capital expenditures of $0.69 million, debt principal payments of $0.36 million, and dividends paid of $0.68 million contributed to a $1.47 million net reduction in cash during the quarter. Cash was $1.47 million below year-end 2013. Management said the decrease in operating cash flow versus the prior-year quarter primarily reflected timing of receivable collections, liability payments, and inventory changes. Receivables increased from year-end to $18.18 million; inventory was $30.27 million, down modestly from year-end.
The company expects 2014 capital expenditures of approximately $5 million and reported about $0.5 million of related outstanding commitments. It expects cash, operating cash flow, and available revolver funds to cover foreseeable working-capital needs. Approximately $9.1 million of cash was held by a foreign subsidiary; the company intends to reinvest foreign earnings abroad indefinitely and notes that repatriation could result in U.S. income taxes.
Changes, outlook and risks
- On January 23, 2014, the company amended its secured bank loan agreement, extending the $10 million revolving facility’s maturity to July 1, 2016 and changing its rate to LIBOR plus 2.25%, with the previous floor removed. The amendment eliminated the leverage covenant and set a fixed $55 million minimum tangible net worth covenant effective March 29, 2014. The company reported compliance with all covenants.
- Outstanding term debt bears fixed rates of 4.98% and 3.90%. The filing does not state a drawn balance on the revolver.
- No specific revenue or earnings guidance was provided. Management said existing cash, operating cash flow, and revolver availability should be sufficient for foreseeable requirements and that cash resources should support obligations and quarterly dividend payments. Expected 2014 pension contributions are $2.5 million; none had been made to the pension plans by quarter-end.
- Management warned that raw-material prices had risen and could continue increasing, potentially pressuring future margins; it is seeking to recover costs through customer pricing. Other cited uncertainties include customer demand and preferences, new-product execution, customer losses, competition, foreign sourcing, economic and industry conditions, and litigation or legislation. Management stated it currently had no indication of an inability to obtain required raw materials.
- An Illinois environmental matter concerning potential ground contamination at the Wheeling plant remains under voluntary investigation and remediation planning. The filing says no estimate of potential remediation cost was available.
- Other unusual comparison: foreign-currency translation reduced other comprehensive income by $0.37 million in Q1 2014, versus a $0.10 million loss in Q1 2013. Management reported no material change in market risks and no material change in risk factors. Disclosure controls were considered effective at the reasonable-assurance level.
Important facts for investors to verify
- Whether the Illinois environmental review results in required remediation and a measurable cost.
- Whether raw-material inflation can be passed through to customers without eroding margins.
- Whether Industrial Hardware’s customer and market declines persist, and whether growth in Security Products and Metal Products continues.
- The company’s progress on planned capital spending and the expected $2.5 million pension contribution, alongside pension and postretirement obligations.
- Availability and terms of the revolving facility, covenant headroom, and any tax cost if foreign-held cash is repatriated.