The Eastern Company — Q1 2020 Form 10-Q
Business context and period. The Eastern Company is a manufacturer reporting across Industrial Hardware, Security Products, and Metal Products. This unaudited report covers the 13 weeks ended March 28, 2020; the comparable period ended March 30, 2019.
Key financial results
| Metric | Q1 2020 | Q1 2019 |
|---|---|---|
| Net sales | $65.3 million | $60.9 million |
| Gross profit / margin | $14.7 million / 22.4% | $13.8 million / 22.7% |
| Operating profit / margin | $3.9 million / 5.9% | $2.3 million / 3.8% |
| Net income | $2.9 million | $1.6 million |
| Diluted EPS | $0.46 | $0.25 |
| Operating cash flow | $1.5 million | $1.5 million |
Sales increased 7.3% and net income rose approximately 84%. Industrial Hardware sales grew 23% to $47.2 million, primarily reflecting the August 2019 acquisition of Big 3 Precision; excluding that acquisition, segment sales fell 11%. Security Products sales declined 16% to $12.4 million, and Metal Products sales fell 27% to $5.7 million. Segment pretax results were $3.5 million for Industrial Hardware, $0.8 million for Security Products, and a $0.4 million loss for Metal Products.
Gross margin narrowed slightly year over year. Operating profit improved amid lower product-development expense and no repeat of prior-year restructuring costs. Interest expense increased $0.5 million to $0.8 million, primarily due to acquisition-related borrowing. Other income rose to $0.7 million, mainly from pension-asset returns and a one-time sale-leaseback gain.
Liquidity, debt, and cash flow
- Cash was $16.5 million at March 28, 2020, down from $18.0 million at fiscal year-end 2019. Working capital was $81.8 million; the current ratio was 3.4.
- Long-term debt, including the current portion, totaled approximately $97.5 million, versus $98.8 million at year-end. Total debt to shareholders’ equity was 92.8%. The company had not drawn on its $20 million revolving facility.
- Operating cash flow of $1.5 million was offset by $0.4 million of net investing outflow and $2.3 million of financing outflow, including $1.2 million of debt payments, $0.7 million of dividends, and $0.4 million of share repurchases.
- Capital expenditures were $0.8 million. The company reported approximately $0.1 million of outstanding capital-expenditure commitments.
- The credit agreement requires a senior net leverage ratio no greater than 4.25:1 and a fixed charge coverage ratio of at least 1.25:1. The term loan carries variable LIBOR-based rates; a swap fixed the rate on approximately half the borrowing.
Material changes, outlook, and risks
- COVID-19: The company estimated an approximately $0.6 million adverse first-quarter impact on operating profit, net of tax, and expected effects to continue. China-related shutdowns delayed some products by four to six weeks; about 15% of products and components were sourced from China. Most company operations remained open at reduced levels, while customer shutdowns affected demand and shipments. Management warned that the pandemic could materially harm earnings, cash flow, and financial condition; it provided no quantitative full-year guidance.
- Demand and operations: Excluding Big 3 Precision, Industrial Hardware sales were weaker in distribution, Class 8 trucks, recreational vehicles, and aftermarket truck parts. Security Products faced lower market demand and nonrecurring prior-year supply contracts. Metal Products was affected by lower coal use, the loss of temporary casting business, and completion of a transit-industry contract. Metal Products gross margin fell to 2% from 9%.
- Cost and acquisition effects: Lower raw-material and freight costs, and improved sourcing for a truck-mirror program, supported results. China-related tariffs were approximately $1.4 million, and the company said these costs were recovered through price increases. Big 3 Precision increased reported sales and expenses.
- Liquidity and credit risk: Management expected cash, operating cash flow, and revolver availability to cover foreseeable working-capital needs, but gave no assurance financing would remain available on acceptable terms. COVID-related earnings declines or additional borrowing could pressure credit covenants and borrowing costs.
- Other exposures: One customer represented 11% of receivables ($4.2 million); another customer filed for Chapter 11, prompting a $152,000 increase in the bad-debt reserve. Variable-rate debt and potential LIBOR replacement create interest-rate uncertainty. The company reported no material pending legal proceedings; a previously accrued $430,000 landfill-remediation project was scheduled for construction in 2020.
Most important facts to verify
- Whether COVID-19 disruptions, customer shutdowns, and shipment delays materially affected subsequent-quarter sales, margins, and cash flow.
- Big 3 Precision’s contribution to revenue, earnings, and debt service, and the company’s underlying performance excluding the acquisition.
- Compliance with the credit agreement’s leverage and fixed-charge coverage covenants under weaker operating conditions.
- Receivable collectability, particularly the 11% customer concentration and the Chapter 11 customer exposure.
- Whether low Metal Products margins and the expected pension contributions or remediation work created additional cash requirements.