The Eastern Company — FY2013 Form 10-K
Business context and reporting period. The company manufactures industrial hardware, security products and metal products through U.S. operations and wholly owned foreign subsidiaries. This annual report covers the fiscal year ended December 28, 2013 (52 weeks); fiscal 2012 is the principal comparable period. Fourth-quarter figures are also summarized below.
Financial performance and position
| Metric | FY2013 | FY2012 | Change |
|---|---|---|---|
| Net sales | $142.5 million | $157.5 million | Down 9.6% |
| Gross profit / margin | $30.1 million / 21.2% | $33.4 million / 21.2% | Gross profit down 9.6%; margin flat |
| Operating profit / margin | $10.4 million / 7.3% | $13.6 million / 8.6% | Down 23.4% |
| Net income | $6.9 million | $8.6 million | Down 20.0% |
| Diluted EPS | $1.11 | $1.38 | Down 19.6% |
| Operating cash flow | $11.3 million | $13.6 million | Down $2.3 million |
| Capital expenditures | $5.5 million | $4.2 million | Up $1.3 million |
Year-end cash was $20.0 million, including $9.8 million held by foreign subsidiaries. Working capital was $57.4 million and the current ratio was 5.2. Total debt was $6.1 million, down from $7.5 million; the company reported no revolver borrowings in 2013. Total debt to shareholders’ equity was 7.4%. Operating cash flow less capital expenditures was approximately $5.8 million.
Shareholders’ equity rose to $81.5 million from $71.6 million. The recorded pension liability fell to $10.9 million from $20.2 million, while the company still expected approximately $2.5 million of pension contributions in 2014. FY2013 dividends were $0.42 per share, following a 10% quarterly dividend increase effective in the third quarter.
Material changes versus the prior comparable period
- Industrial Hardware sales fell about 17%, chiefly from weaker demand for lightweight composite products and lower sales in distribution, trailer, truck accessory, service body and military markets. Segment operating profit fell 36.6%.
- Security Products sales declined about 3%, reflecting lower volume in cash management, computer and commercial laundry markets; segment operating profit fell 32.4%, with lower gross margin.
- Metal Products sales declined about 5%, primarily because contract-casting sales fell 44% following reduced railroad tie-plate sales. Mine-product sales rose 2%; segment operating profit increased 50.1%, helped by improved product mix, pricing and production efficiency.
- Consolidated selling and administrative expense was nearly flat in dollars but increased as a share of sales, contributing to lower operating margin. Interest expense declined 13% with lower debt. The effective tax rate fell to 32% from 35%.
- Fourth-quarter sales were $34.3 million, down 4.3% year over year; net income rose 12% to $1.9 million and diluted EPS increased to $0.31 from $0.28. Quarterly gross margin improved to 23.7% from 21.6%.
Outlook, risks and unusual items
- Management expected 2014 capital expenditures of approximately $6 million and said foreseeable needs for operations, debt service, capital spending and dividends should be met through operating cash flow and available credit. No specific revenue or earnings guidance was provided.
- On January 23, 2014, the company extended its $10 million revolving facility’s maturity to July 1, 2016 and changed its rate to LIBOR plus 2.25%, eliminating the prior rate floor. The amendment also eliminated the leverage covenant and set a $55 million minimum tangible-net-worth covenant effective at the end of first-quarter 2014. The company reported compliance with covenants in 2013.
- Key risks include raw-material price increases that may not be recoverable through pricing or cost reductions; competition and changing demand in served markets; foreign currency, sourcing and logistics exposure; customer credit risk; and the possibility that coal-market changes weaken mining-product demand. Jennmar accounted for 11.5% of consolidated sales in 2013; no other customer exceeded 10%.
- Potential ground contamination at the Wheeling, Illinois plant remained under voluntary investigation and remediation planning; the filing said the cost could not yet be estimated. Ordinary-course litigation provisions were not material, and management did not expect pending matters to have a material adverse effect.
- Raw-material costs had risen in recent years. Management cited U.S. EPA clean-air rules and competition from natural gas as potential longer-term risks to coal-related product demand, although the company said these forecasts had not affected it in 2012 or 2013.
- Foreign-subsidiary earnings are intended to be reinvested abroad indefinitely; repatriation of amounts not otherwise provided for could incur U.S. income taxes. The company also disclosed unrecognized tax benefits of $0.2 million at year-end.
- The independent auditor issued unqualified opinions on the financial statements and internal controls; management and the auditor concluded internal control over financial reporting was effective.
Important facts for investors to verify
- Whether sales and operating profitability recover, particularly in Industrial Hardware, and whether new products offset weaker demand in established markets.
- Whether the improved Metal Products profitability is sustainable given the sales decline in contract castings and longer-term coal-demand risks.
- The funding trajectory of pension and postretirement obligations, including 2014 contributions and the assumptions used for discount rates and investment returns.
- The amount and potential timing of costs for the Illinois environmental matter, which were not estimable in the filing.
- The terms and ongoing covenant compliance under the January 2014 credit-facility amendment, plus the tax consequences of any future repatriation of foreign cash.
- Inventory rose to $30.7 million while inventory turnover declined to 3.7 from 4.2; investors may wish to monitor inventory levels and conversion to cash.