The Eastern Company — Q1 2018 Form 10-Q
Business context and reporting period. The filing covers the three months ended March 31, 2018, compared with the three months ended April 1, 2017. Eastern operates in Industrial Hardware, Security Products and Metal Products. Results include Velvac, acquired in April 2017; the acquisition materially affects year-over-year comparability.
Key financial results
| Metric | Q1 2018 | Prior-year quarter |
|---|---|---|
| Net sales | $59.4 million | $36.0 million |
| Gross profit / margin | $14.7 million / 24.8% | $8.7 million / 24.1% |
| Operating profit | $4.2 million | $2.2 million |
| Interest expense | $296,330 | $21,024 |
| Net income | $3.1 million | $1.5 million |
| Diluted earnings per share | $0.49 | $0.24 |
| Operating cash flow | $95,875 | $2.4 million |
| Cash and cash equivalents, quarter-end | $16.4 million | $23.6 million at prior-year quarter-end |
Quarter-end total debt was approximately $30.8 million: $2.55 million current and $28.29 million long-term. The company reported a 3.6 current ratio and total debt to shareholders’ equity of 34.2%. Working capital was $71.4 million. The quarterly dividend was $0.11 per share, unchanged from the comparable quarter.
Changes versus the prior-year quarter
- Sales rose 65%; management reported 15% organic growth companywide. Industrial Hardware sales increased 137%, with Velvac accounting for most of the segment’s increase; the segment also reported 19% organic growth.
- Security Products sales grew 9% and Metal Products sales grew 16%. Metal Products operating profit declined $255,000, while Industrial Hardware operating profit increased $2.2 million; Security Products operating profit was approximately flat.
- Consolidated gross margin improved to 24.8% from 24.1%. Industrial Hardware margin rose to 25.2% from 21.9%, while Security Products and Metal Products margins declined to 29.1% from 30.0% and 14.4% from 17.8%, respectively.
- Engineering expense increased 120% and selling and administrative expense increased 55%, primarily reflecting the Velvac acquisition and related costs. Interest expense increased with acquisition-related borrowing.
- Operating cash flow fell to about $96,000, mainly as receivables and inventory absorbed cash amid higher sales. Inventory was $49.0 million at quarter-end, up from $47.3 million at fiscal year-end.
Outlook, risks and other notable items
- Management expects cash, operating cash flow and revolving-credit availability to cover foreseeable working-capital needs. No quantified revenue or earnings guidance is provided; management cautions that future revenue and margin trends cannot be reliably predicted.
- Raw-material inflation is a pressure point: management cited year-over-year increases in hot-rolled steel (16%), cold-rolled steel (5%), zinc (39%), brass (12%) and scrap iron (17%), depending on segment. Other stated risks include competition, customer and product changes, foreign sourcing, economic conditions, litigation and Velvac integration.
- The company had $1.0 million outstanding on its $10 million revolving facility at March 31, 2018 and reported compliance with debt covenants. Variable-rate debt creates interest-rate exposure; an interest-rate swap had a $273,154 fair value and a $14.9 million notional amount.
- Environmental contingencies include an estimated $411,000 for a New York foundry-sand landfill remediation, fully accrued, and an estimated $50,000 for Illinois site remediation. Management said other ordinary-course legal matters were not expected to materially affect the company.
- ASC 606 was adopted at the start of fiscal 2018 using the modified retrospective method; management said its effect was not significant. The company was still evaluating the effect of the forthcoming lease accounting standard.
- Management reported effective disclosure controls and no material changes in internal control over financial reporting. It reported no material changes to the risk factors in its 2017 Form 10-K.
Important facts for investors to verify
- How much of future growth and earnings comes from Velvac versus organic demand, and how acquisition integration is progressing.
- Whether working-capital absorption—especially receivables and inventory—continues to constrain operating cash flow.
- Whether raw-material inflation can be offset through pricing, product mix or operating efficiencies, particularly in Metal Products.
- Debt levels, variable-rate exposure, covenant headroom and the company’s ability to sustain scheduled repayments and dividends.
- Final remediation costs and timing for the New York and Illinois environmental matters, and any updates to tax estimates related to the 2017 Tax Act.