The Eastern Company — Q3 2013 Form 10-Q
Business context and period. The company reports three operating segments: Industrial Hardware, Security Products and Metal Products. The unaudited quarter ended September 28, 2013; year-to-date results cover the first nine months of fiscal 2013 and are compared with the corresponding 2012 periods. Amounts below are U.S. dollars.
Financial performance
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Net sales | $34.3 million | $39.6 million | $108.2 million | $121.7 million |
| Gross margin | $7.2 million; 21.1% | $8.2 million; 20.6% | $22.0 million; 20.4% | $25.6 million; 21.0% |
| Operating profit | $2.5 million; 7.2% | $3.3 million; 8.4% | $7.3 million; 6.8% | $10.6 million; 8.7% |
| Net income | $1.8 million | $2.2 million | $5.0 million | $6.9 million |
| Diluted EPS | $0.29 | $0.36 | $0.80 | $1.11 |
| Cash from operations | Not separately stated for the quarter | $7.9 million | $10.8 million |
- Q3 sales fell 13.6% and net income fell 19.1% year over year. Nine-month sales declined 11.1% and net income declined 27.9%.
- Q3 gross margin improved modestly, but operating margin contracted. For the nine months, both gross and operating margins declined, with management citing lower volume and reduced production-capacity utilization.
- Cash and cash equivalents were $19.1 million at quarter-end, versus $18.5 million at fiscal year-end 2012. Total debt was approximately $6.4 million, down from $7.5 million; the company reported no revolving-credit borrowings. Cash exceeded debt by about $12.7 million.
- Working capital was $59.4 million and the current ratio was 5.5. Nine-month capital expenditures were $4.2 million; full-year spending was expected to be approximately $5–$6 million, with $1.3 million of commitments outstanding.
- Nine-month dividends paid were $1.9 million. The board increased the quarterly dividend 10% in Q3 to $0.11 per share.
Material changes and operating drivers
- Q3 segment sales changed year over year as follows: Industrial Hardware down 19%, Metal Products down 23%, and Security Products up 1%. For nine months, Industrial Hardware declined 16%, Security Products 5%, and Metal Products 9%.
- Management attributed broad sales weakness mainly to lower sales of existing products in served markets; new products and selective price increases partly offset the declines. Nine-month existing-product volume was down 14.5% overall, partly offset by price increases and new products.
- Security Products incurred $0.6 million of severance costs related to relocating a facility in China, contributing to its Q3 gross-margin decline to 19% from 24% a year earlier.
- Metal Products’ gross margin improved substantially, reflecting product mix, removal of low-margin products, selective pricing and efficiency gains. Contract-casting sales fell sharply, largely due to lower tie-plate sales.
- Interest expense declined year over year with lower debt. The nine-month effective tax rate was 30%, versus 33% in 2012. The IRS completed its examination of 2010 and 2011 returns with no changes; the company recorded tax benefits related to released accrued interest and expired statutes of limitation.
Outlook, risks and contingencies
- Management said cash, operating cash flow, spending controls and available revolving credit should cover foreseeable working-capital needs and existing obligations, including quarterly dividends. It did not provide specific revenue or earnings guidance.
- Raw-material prices had increased; management was seeking to recover costs through customer price increases and warned that margins could be pressured if recovery is insufficient. The company reported no current indication of supply shortages.
- Management noted uncertainty about weaker coal-mining sales, including possible effects of EPA clean-air rules, broader economic uncertainty or temporary factors. Forward-looking risks also include customer preferences, new-product execution, customer loss, competition, foreign sourcing, economic conditions, litigation and legislation.
- Cash held by foreign subsidiaries was approximately $10.6 million and management intended to reinvest foreign earnings abroad indefinitely. Repatriation could require U.S. income taxes.
- The company disclosed potential environmental matters at a Wheeling, Illinois plant under voluntary review, with no remediation-cost estimate available, and a disputed potential liability relating to a Cleveland, Ohio site. It stated it intended to defend against liability for the latter matter.
- Debt covenants require minimum fixed-charge coverage and tangible net worth and limit leverage, among other restrictions. The company reported compliance for the quarter and nine-month period. Outstanding debt had fixed interest rates of 4.98% and 3.90%; the revolving facility was scheduled to mature January 31, 2014.
Important facts for investors to verify
- Whether sales and volume weakness persisted, particularly in Industrial Hardware and Metal Products, and whether new products and pricing offset declines.
- Whether raw-material inflation, lower utilization and the China relocation costs affected subsequent margins.
- Full-year capital spending, pension contributions and operating cash flow versus management’s expectations.
- Availability and terms of the revolving credit facility approaching its January 2014 maturity, and continued covenant compliance.
- Potential costs or developments in the Illinois and Ohio environmental matters, and tax implications of foreign cash.