The Eastern Company — Q3 2016 Form 10-Q
Business context and period. The company manufactures and sells products through Industrial Hardware, Security Products, and Metal Products segments. This unaudited report covers the quarter and 39 weeks ended October 1, 2016; comparisons are with the periods ended October 3, 2015. Interim results are not necessarily indicative of full-year results.
Financial results
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net sales | $33.5 million | $36.2 million | $103.5 million | $110.2 million |
| Gross margin | $8.9 million; 26.4% | $9.0 million; 24.9% | $23.9 million; 23.1% | $24.3 million; 22.0% |
| Operating profit | $3.3 million | $3.4 million | $7.3 million | $5.7 million |
| Net income | $2.4 million | $2.5 million | $5.1 million | $4.0 million |
| Diluted EPS | $0.38 | $0.41 | $0.82 | $0.64 |
| Operating cash flow | Not separately provided | Not separately provided | $9.0 million | $3.6 million |
Balance sheet and liquidity at October 1, 2016: Cash was $21.6 million, total current assets $77.6 million, and working capital $64.1 million. The current ratio was 5.7. Total debt was approximately $2.1 million ($1.1 million current and $1.1 million long-term), versus $3.2 million at January 2, 2016. The $10 million revolving facility was unused; its maturity had been extended to July 1, 2018. Total shareholders’ equity was $81.6 million. Cash included $9.7 million held in the U.S. and $11.9 million held by a foreign subsidiary.
Nine-month capital expenditures were $1.8 million; cash dividends paid were $2.1 million. Cash increased $3.8 million during the period, to $21.6 million. Inventory declined to $34.1 million from $36.8 million at year-end 2015, while receivables rose to $19.0 million from $17.5 million. Accrued pension cost increased to $26.4 million from $24.3 million.
Changes and operating drivers
- Quarterly sales fell 8%; nine-month sales fell 6%. Management attributed the declines mainly to lower volumes of existing products, partly offset by new-product sales growth.
- Industrial Hardware sales fell 7% in Q3 and 1% for nine months, with weakness in the Class 8 truck market partly offset by other markets and new products.
- Security Products sales fell 2% in Q3 but rose 1% for nine months. Segment margins improved, with nine-month gross margin rising to 27.2% from 24.7%.
- Metal Products sales declined 23% in Q3 and 31% for nine months amid depressed mining and coal markets and weaker industrial castings demand. Nine-month segment operating loss was $1.0 million, compared with a $0.1 million loss a year earlier; gross margin declined to 2.9% from 9.1%.
- Despite lower sales, nine-month net income rose 29%, principally alongside lower selling and administrative expenses (down $2.1 million, largely because 2015 included proxy-contest costs) and improved margins. Q3 net income fell 5% year over year.
Outlook, risks, and unusual items
- Management expected 2016 capital expenditures of approximately $2.5 million, with about $250,000 of commitments outstanding at October 1. It stated cash, operating cash flow, and available revolver capacity should cover foreseeable working-capital needs. No specific revenue or earnings guidance was provided.
- Management cited customer preferences, new-product execution, customer retention, competition, raw-material prices, foreign sourcing, industry and economic conditions, litigation, and legislation as risks to forward-looking results. Mining-industry weakness and lower truck-market demand were current segment pressures.
- The salaried pension plan was frozen effective May 31, 2016. Its remeasurement increased the pension benefit obligation by about $3.0 million, while the plan change reduced pension expense by approximately $0.9 million in Q3 and $1.5 million for the first nine months. The filing reports no curtailment gain or loss recognized.
- The company was in compliance with debt covenants. It expected approximately $25,000 in additional remediation costs for potential contamination at its Wheeling, Illinois plant. No other material changes to reported risk factors or market risks were identified.
- The company had not provided U.S. income taxes on certain undistributed foreign-subsidiary earnings and intended to reinvest those earnings abroad indefinitely. It said repatriation could require U.S. taxes.
Important facts for investors to verify
- Whether sales and margins recover, particularly in Metal Products and markets exposed to coal mining and Class 8 truck demand.
- How much of the earnings improvement reflects sustainable operating performance versus lower 2015 proxy-contest costs and pension-plan changes.
- Future pension funding requirements and the effect of discount-rate and other actuarial assumptions on the pension liability.
- Cash availability and potential tax consequences associated with the $11.9 million held by foreign subsidiaries.
- Actual capital expenditures, cash generation, and covenant compliance through year-end.