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Edited Transcript of EML earnings conference call or presentation 19-Mar-19 1:00pm GMT

Q4 2018 Eastern Co Earnings Call

NAUGATUCK Apr 5, 2019 (Thomson StreetEvents) -- Edited Transcript of Eastern Co earnings conference call or presentation Tuesday, March 19, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* August M. Vlak

The Eastern Company - President, CEO & Director

* Christopher Moulton

The Eastern Company - Head of Corporate Development & IR

* John L. Sullivan

The Eastern Company - VP & CFO

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Presentation

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Operator [1]

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Good day, everyone, and welcome to The Eastern Company's Fourth Quarter and Fiscal Year 2018 Earnings Conference Call. Today's call is being recorded. (Operator Instructions)

At this time, for opening remarks and introductions, I would like to turn the call over to Chris Moulton, Head of Corporate Development and Investor Relations for Eastern. Please go ahead, Chris.

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Christopher Moulton, The Eastern Company - Head of Corporate Development & IR [2]

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Good morning, and thank you, everyone, for joining us. Speaking first today will be Eastern's President and CEO, Gus Vlak; and CFO, John Sullivan. And as mentioned, after that, we'll open the call to questions from participants.

Please note that some of the information you'll hear today during our discussion will consist of forward-looking statements about the company's future financial performance and business prospects, including, without limitation, statements regarding revenue, gross margin, operating expenses, other income and expense, taxes and business outlook.

These forward-looking statements are subject to risks and uncertainties that could cause actual results or trends to differ significantly from those projected in these forward-looking statements. For more information regarding these risks and uncertainties, please refer to the risk factors discussed in our Form 10-K filed on March 14 with the SEC.

Eastern assumes no obligation to update any forward-looking statements or information, which speak as of their respective dates.

Discussions during the call will also include certain financial measures that were not prepared in accordance with U.S. GAAP. Reconciliation of those non-GAAP financial measures to the most directly comparable GAAP financial measures can be found in our Form 10-K. You can obtain a copy of the Form 10-K on our website at easterncompany.com under the Investor Information tab.

Any non-GAAP measures presented are not and should not be viewed as substitutes for financial measures required by U.S. GAAP.

With that, I'd now like to turn the call over to Gus Vlak for introductory remarks.

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August M. Vlak, The Eastern Company - President, CEO & Director [3]

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Thank you, Chris, and thank you for joining us to review the 2018 results of The Eastern Company. On our call today, we'll discuss our financial results for the year as well as our progress on our 3-part strategy to create long-term shareholder value.

In 2018, we made solid progress on our 3-part strategy and our results reflected this.

Our total sales grew to $234 million in 2018 and that's an increase of 15% over 2017. Net income in 2018 was $14.5 million as compared to $5 million in 2017. Now 2017 net income was impacted by several onetime items that John is going to discuss in a few minutes.

Our return on invested capital in 2018 was 11.3% compared to 6.6% for 2015 when we first started reporting on this measure. We believe return on invested capital is an important metric because it basically computes the underlying return that we earn on the cumulative investments in our businesses, no matter how those are financed.

We also look at book value, which grew by 11.5% over the prior year. On December 31, 2018, Eastern's book value was $96.6 million and that's after paying $2.8 million in dividends.

That's a record for our company's 160-year history. Finally, in 2018, Eastern's total return to shareholders was a negative 6.9%. And while, of course, we seek to generate positive returns over any period, we did outperform the Russell 2000 by 4.1% in 2018.

As I mentioned before, our strategy for creating long-term shareholder value includes strengthening our portfolio of businesses, maximizing the performance of our best businesses and using our balance sheet to drive growth. For last year, we were successful in each of those areas.

In 2018 -- in June of 2018, we acquired assets of Load N Lock Systems, a leader in innovative truck cap and tonneau cover locks. And this acquisition helped strengthen our Illinois Lock Company by bringing new and innovative technologies, building scale in some of the attractive end markets that we're targeting, and increasing our access to new markets.

At the same time, we invested in the long-term growth of our best businesses. In 2018, we invested $7 million in product development. That's an increase of 24% over the prior year. Some of the things we worked on include a brand-new closing system for roll-up doors, electronic and automatic door controls for school buses and Bluetooth locking system.

Finally, we took advantage of our strong cash flow and reduced our debt by $6.6 million, used cash to acquire the assets of Load N Lock and allocated $2.5 million towards our pension obligations.

We're proud of the results and the progress our teams delivered in 2018. To tell you more about the results in the fourth quarter and the full year, I'll now turn the call over to John Sullivan.

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John L. Sullivan, The Eastern Company - VP & CFO [4]

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Thank you, Gus. First, I'd like to start off by going over the fourth quarter of 2018. Net sales in the fourth quarter of 2018 increased 5% to $57 million from $54 million a year earlier. Sales increased in the Industrial Hardware segment by 6% for the fourth quarter of 2018 as compared to sales in the fourth quarter of 2017, as a result of strong sales growth to Class 8 truck distribution, specialty vehicle and truck accessory customers. Sales of new products contributed 5% and included a new hood-mount mirror -- truck mirror, a modular toolbox latching system, an electronic activated latching system and various composite panels.

Sales in the Security Products segment increased by 2% for the fourth quarter of 2018 compared to the fourth quarter of 2017. Sales in the Metal Products segment increased 5% for the fourth quarter of 2018 from sales in the fourth quarter of 2017 as a result of an increase in sales to industrial casting customers.

Cost of products sold in the fourth quarter of 2018 increased $1.4 million or 3% from the corresponding period in 2017. The increase in costs primarily reflects increased material costs associated with increased sales volume and higher cost of scrap iron, which was up 15% used in our Metal Products segment.

Gross margin as a percentage of net sales for the fourth quarter of 2018 was 26% and 25% in the fourth quarter of 2017. Product development expenses as a percentage of sales in the fourth quarter of 2018 and 2017 were comparable at 3%. And selling and administrative expenses in the fourth quarter of 2018 were comparable with the fourth quarter of 2017 at approximately $8 million or 15% of sales.

Net income for the fourth quarter of 2018 increased to $4.4 million or $0.70 per diluted share from a loss of $0.2 million or $0.03 per diluted share for the comparable period in 2017. In the fourth quarter of 2017, we incurred an incremental onetime charge of $2.5 million or $0.41 per diluted share, consisting of a $2 million charge on our undistributed earnings of foreign subsidiaries as well as a $0.5 million charge related to the impact of the Tax Cuts and Jobs Act on the deferred tax assets.

Net sales for the fiscal year 2018 increased 15% to $234 million from $204 million in 2017. Sales growth in 2018 reflected a full year of sales from the Velvac acquisition, which closed on April 3rd of 2017 as compared to 9 months of sales from Velvac in 2017. Excluding the effects of Velvac, sales growth was approximately 6% in 2018.

Net income for 2018 increased 187% to $14.5 million or $2.31 per diluted share from $5 million or $0.80 per diluted share in 2017. The effective tax rate for 2018 was 18% compared to 2017 effective tax rate, which was 56%. In 2017, net income was adversely affected by the recognition of 1x charges of $2.5 million related to the enactment of the Tax Cuts and Jobs Act in 2017, and $1.8 million net of tax expense related to the Velvac acquisition, environmental remediation and personnel-related expenses.

I'd like to talk about the segments, I'll start with the Industrial Hardware segment. Net sales in the Industrial Hardware segment increased 22% in 2018 from the 2017 level. Sales volume of existing products increased 19%. However, excluding Velvac acquisition, sales volume increased 3% from growth in Class 8 truck distribution, specialty vehicle and truck accessory customers, while price and new products contributed 2%, respectively. Net product sales included a new hood-mount truck mirror, modular toolbox latching system and electronic activated latching systems and various composite panels.

Products sold in the Industrial Hardware segment increased $17.8 million or 20% from 2017 level. The increase in the cost of product sold primarily reflects the Velvac acquisition in 2017. Other significant factors resulting in change of cost of goods sold in 2018 compared to 2017 was rising metal costs during the year, which increased in hot rolled steel costs by 30%, increased in cold rolled steel costs by 15%, increased in stainless steel costs by 14% and increased in aluminum costs by 6%. Where possible, our business pass along higher metal cost products to customers.

Gross margin as a percentage of sales increased 25% in 2018 from 24% in 2017, in the Industrial Hardware segment. The increase reflects the combination of favorable product mix, greater utilization of productive capacity and nonrecurrence of onetime charges of $1.2 million to cost of goods sold related to the impact of purchase accounting in connection with Velvac acquisition in 2017.

Product development expenses as a percentage of sales increased 4% in 2018 from 3% in 2017. The increase was primarily the result of a new truck hood-mount mirror program awarded to Velvac in 2018. Selling and administrative expenses in the Industrial Hardware segment increased $1.5 million or 8% in 2018 from the 2017 level. The increase in selling and administrative expenses in 2018 reflects a full year of the Velvac acquisition as compared to a partial year related to Velvac in 2017.

Moving on to the Security Products segment. Net sales in the Security Products segment increased 6% in 2018 from the 2017 level. Sales volume of existing products increased 3% while price of new products contributed 1% and 2%, respectively. New product sales included a custom-designed lock core for a removable tie-down system, a backrest docking system, a miniature tubular lock, a flip cover modular lock and a power lock module.

Cost of products sold in the Security Products segment increased by $2.3 million or 5% in 2018 from 2017. The increase in cost of goods sold was primarily attributable to higher factory costs -- higher factory payroll costs, which increased $1.2 million or 36%. Gross margin, as a percentage of sales in the Security Products segment, remained comparable to 2017 levels of 31%. Lower material costs, primarily in zinc and brass, down year-over-year by 19% and 11%, respectively, helped offset higher factory payroll costs in our Asian factory.

Product development expenses as a percentage of sales remained level with 2017 at 3%. And selling and administrative expenses in the Security Products segment increased by $0.4 million or 4% in 2018 from 2017.

The most significant factor resulting in changes in selling and administrative were bad debt expenses of $0.2 million and an increase of $0.2 million in payroll and payroll related expenses.

Finally, moving on to the Metal Products segment. Net sales in the Metal Products segment increased 3.9% in 2018 compared to the prior year period. Sales volume decreased 11% while price of new products were up 2% and 13%, respectively. Sales of Mining Products declined by 13% year-over-year while industrial castings increased 92% over 2017 levels. Although coal demand is expected to decline slightly through 2023, the company is placing more effort in attracting additional industrial casting customers.

New product sales include a bomb plug for the military, torque bolts, a segment [flute] for the utility markets and various castings for oil, water and gas industry. Total cost of products sold in the Metal Products segment increased $1.1 million or 5% from 2017 level. The most significant factor, resulting in changes in the cost of products sold in 2018 was higher raw material scrap iron, increasing for the year by 25%.

Gross margin as a percentage of sales in the Metal Products segment decreased to 12% in 2018 from 13% in 2017. The increase in higher metal costs could not be fully recovered in price increases to our customers.

Selling and administrative expenses in the Metal Products segment decreased to $0.1 million or 5% from 2017. The most significant factor resulting in the decrease in selling and administrative expenses was a reduction in payroll and payroll-related charges.

And moving on to liquidity and sources of capital. The company's financial position strengthened in 2018. The primary source of the company's cash is earnings from operating activities adjusted for cash generated from or used for net working capital and the term loan from People's Bank. The most significant recurring noncash item included in net income are depreciation and amortization expenses. Changes in working capital fluctuate with changes in operating activities, as sales increase there is generally an increased need for working capital. Since increasing in working capital reduces the company's cash, management attempts to keep the company's investment in net working capital at a reasonable level by closely monitoring inventory levels and matching production to expected market demand, keeping tight control over collection of receivables and optimizing payment terms on its trade and other payables.

Net cash provided by operating activities was $12.9 million in 2018 compared to $11.2 million in 2017.

In 2018, the company contributed an excess contribution of $2 million into its defined benefit retirement plan. In 2017, the company was not required to and did not contribute anything into the salaried retirement plan. In fiscal year 2018, cash used in the change in net working capital was $6 million, which was primarily due to increased sales activities that drove up associated inventory and account receivable balances in order to manage the sales activities.

In fiscal year 2017, cash used in the change in net working capital was $0.2 million, which was primarily due to an increase in accounts receivable derived from an increased sales activity at the end of the year. The company used $10.4 million and $42.8 million for investing activities in 2018 and 2017, respectively. Included in the 2018 figure is approximately $5 million for the acquisition of Load N Lock. Included in the 2017 figure is approximately $40 million used for the acquisition of 100% of the outstanding stock of Velvac.

The balance of $5.4 million and $2.6 million in fiscal year 2018 and 2017, respectively, was used to purchase fixed assets. Capital expenditures in the year 2019 are expected to be in the range of about $5 million. In fiscal year 2018, the company paid approximately $10.4 million in cash for financing activity. The company paid $1.1 million for the repurchase of its common stock and used approximately $6.6 million for debt repayment and $2.8 million for the payment of dividends. In fiscal 2017, the company received approximately $30 million in cash from financing activities. The company received proceeds of $37.6 million from the issuance of new debt and used approximately $4.1 million for debt repayment and $2.8 million for the payment of dividends. And with that, I will now turn the call back over to Gus.

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August M. Vlak, The Eastern Company - President, CEO & Director [5]

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Thank you, John. Looking ahead in 2019, we anticipate continued steady growth in sales and earnings, primarily as a result of our investments in new products. We believe that 2019 sales will benefit more modestly from underlying demand growth in our core markets with only modest growth in Class 8 trucks and a cyclical downturn in the market for recreational vehicles. We intend to fund the growth of our highest return businesses by investing in new product development at Eberhard, Illinois Lock and Velvac and making targeted acquisitions. We remain committed to finding acquisition opportunities that have strong economics, help us build scale and create differentiation in attractive end markets.

With that, I'll turn the call back to Chris for questions.

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Christopher Moulton, The Eastern Company - Head of Corporate Development & IR [6]

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Thanks, Gus. Operator, do we have any questions that have come in over the telephone?

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Questions and Answers

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Operator [1]

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(Operator Instructions) And no questions are coming in. Mr. Moulton, I'll turn it back over to you.

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Christopher Moulton, The Eastern Company - Head of Corporate Development & IR [2]

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It also appears that we have no additional questions via the webcast. So with that, thank you very much for joining us today. I'll now turn the call back to the operator. Thanks.

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Operator [3]

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Thank you. That does conclude today's teleconference. We thank you for your participation. And you may disconnect your lines at this time. Have a great day.