The Eastern Company (EML) Q3 2019 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen. And welcome to The Eastern Company's Third Quarter Fiscal Year 2019 Earnings Conference Call. [Operator Instructions] At this time, it my pleasure to turn the floor over to Chris Moulton, Head of Corporate Development and Investor Relations. Sir, the floor is yours.

Thank you. Good morning, and thank everyone for joining us. Speaking today will be Eastern’s President and CEO, Gus Vlak; and our CFO, John Sullivan. After that, we'll open the call for questions. Please note that some of the information you will hear during our discussion today 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 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 risk factors discussed in our Form 10-Q, filed yesterday and also in our most recent 10-K. With that, I will turn the call over to Gus for opening remarks.

Thanks Chris, and good morning to those of you who have joined us on the phone and those participating via the web. I'll start this morning with an overview of our sales and earnings for the third quarter and then update you on our recent acquisition of Big 3 Precision. Adding this leading provider of engineered turnkey packaging to our portfolio of businesses was a significant step forward for us. After that, I'll take a few minutes to talk about some of the new products our businesses have recently launched. Together they provide a good illustration of the approach we're taking to respond to our customers needs, bring new technologies and materials to market and ensure the vitality of our businesses. So looking at the financial results, net sales for the quarter were $60.7 million, that's an increase of almost 6% from the 2018 period. Our growth was led by the Industrial Hardware segment, which includes one month of Big 3 Precision results, partly offset by some of the softness in several end markets. In addition, we realized growth through new product launches with Class 8 truck customers, and experience continued strength in commercial transportation markets. On the bottom line, our results were solid with an increase of more than 11% to 67% per diluted share, reflecting both revenue growth, our continued focus on productivity, and our successful pass through of the record trade tariffs that we paid to the U.S. government in the third quarter. Third quarter earnings also include a one-time nonrecurring transaction costs of approximately $800,000, or roughly $0.13 per diluted share. This double-digit increase demonstrates the power of our business model and our focus on investing in areas that offer long-term growth opportunities. Now turning to Big 3 Precision, as you know during the past several years, we've established a track record of successful acquisitions. Still the size and strategic significance of this transaction really sets it apart. I discussed many of those attributes on our conference call in September, but I just want to highlight a few of them again today. First, we acquired a business that generated approximately $72 million in revenue for the first 12 months ended June 30, 2019. Second, we added scale and expanded our presence with several of our key customers in leading niche industrial markets. Third, we took a big step towards our goal of generating $100 million in EBITDA, a number which we believe reflects our commitment to creating long-term shareholder value. And finally, Big 3 Precision offers an especially attractive opportunity for us to create value both through organic growth and through - for the bolt-on acquisitions. When we announced the acquisition, I mentioned that we expected it to be an accretive to Eastern's earnings for fiscal 2020. Big 3's performance in the past quarter has reinforced that expectation. In fact, we now anticipate that not including transaction expenses, it will be accretive to our full year 2019 results. Over the past few months, we focused on integrating Big 3 Precision and I'm very happy to say that that process has been proceeding very smoothly. We've met with nearly all the team members at the company's main locations, talked about our values, expectations and our commitment to the business. We continue to be impressed with the quality of the company's leadership and workforce, as well as the scope and strength of its customer relationships. We're also very pleased with the way Big 3 Precision has added to our overall backlog, which remains robust through the end of 2019. Now let's talk briefly about some of the new products we launched during the past several months. As you know, one of our principal goals is to provide highly engineered value added solutions. And in the third quarter, new products grew by 6%, that's an important measure of our vitality. To illustrate how we're expanding and enhancing our offence, I'll run through a few examples of products that we recently launched. In the third quarter, our Eberhard manufacturing business launched its new evolution whale tail latch and lock, which is a lighter weight version of our original whale tail latch with a composite cover, as services manufacturers of truck storage and enclosure products. Eberhard also secured a new rotary system for truck chassis sparing, which allows for easy release of bearings on the bottom of trailers for repairs and service. This product will be offered by a leading Class A truck manufacturer starting early next year. And finally, our Illinois Lock business launched several products including a new tunnel cover handle, which is based on the technology from loading lock, which we acquired in 2018. The new handle is easily upgradeable from an existing mechanical to an electronic model and it's made from an automotive composite that allows for better detailing and a closer match to truck body styling. In summary, the past quarter was successful for Eastern. In addition to sales and earnings growth, we generated approximately $3.5 million in cash from operations out of adding previous strength to our balance sheet. Our solid financial results, the acquisition of Big 3 Precision, and the launch of a range of new products all support our strategy generating positive long-term results for our shareholders by continuously optimizing our portfolio businesses, improving execution and building our balance sheet. With those comments, I'll turn it over to John to walk us through the results of the quarter. John?

Thank you, Gus. On a consolidated basis, net sales in the third quarter of 2019 increased 6% to $60.7 million as compared to $57.4 million in the third quarter of 2018. The increase in net sales was driven by continued strengthen the industrial Hardware and Metal product segments offset by a decline in net sales in the Security Product segment. Total sales volume in the third quarter of 2019 decreased by 2% due to a decline in sales volume in the Security Product segment, a decline in the recreational vehicle market and the decline in our composite panel business, which more than offset the addition of one month sales related to the acquisition of Big 3 Precision. New Products contributed 6% to the quarter sales increase. New product sales included a hood mount truck mirror, a molded tool box latching system for pickup trucks, and electronic switch lock, a key lock for storage inventory, a canopy lock assembly for vehicles and various industrial castings for the agricultural market. On a segment level basis, net sales in the Industrial Hardware segment increased by 15% in the third quarter of 2019, as compared to the net sales in the third quarter 2018 as a result of strong sales growth in Class A truck distribution and specialty vehicle markets, in addition to the acquisition of Big 3 Precision. Net sale decreased in the Security Product segment by 16% in the third quarter of 2019 as compared to the net sales in the third quarter of 2018. Sales from the Load N Lock business we acquired in June of 2018 partially offset the impact of the lower demand for commercial laundry products, a decline in our point-of-sale Security Products, the termination of a supply contract to manufacture mechatronic padlock systems for cell phone tower security access applications, and lots of customer service in the recreational vehicle market. Net sales increased in the Metal Product segments by 14% in the third quarter of 2019, as compared to the net sales in the third quarter of 2018, as a result of a 20% increase in sales to mining product customers, and an increase of 3% in the sale to industrial casting income customers, compared to the third quarter of 2018. On a consolidated basis gross margin as a percent of sales was 25% in both the third quarter of 2019 and the third quarter of 2018. Cost of product sold in the third quarter of 2019 increased by $2.6 million or 6% as compared to the third quarter of 2018. The increase in cost of product sold for the third quarter 2019 reflects the mix of the products being sold increased costs due to additional sales volume and costs incurred in producing a new Class 8 truck mirror that was awarded in 2018. The increase in cost of product sold in the third quarter of 2019 was partially offset by declining raw material prices by 13% for hot rolled steel, 3% for cold rolled steel, 24% for scrap iron, 5% for copper and 18% for zinc as compared to the third quarter of 2018. We experienced $0.9 million in tariff related costs on China source products in the third quarter of 2019 that were not incurred in the prior year period, the majority of which has been recovered in price increases. Product development expenses decreased by $1.2 million or 59% in the third quarter of 2019 as compared to the third quarter of 2018, the majority of the decrease relates to the closure of the Velvac Road-iQ development operations in the second quarter of 2019. Selling and Administrative expenses increased by $0.9 million or 12% in the third quarter of 2019 compared to the 2018 period, primarily as a result of an increase in payroll and payroll related expenses. Acquisition expenses of $0.8 million and increase amortization expenses related to the acquisition of Big 3 Precision. Net income for the third quarter of 2019 increased 11% to $4.2 million or $0.67 per diluted share from $3.8 million or $0.60 per diluted share for the 2018 period. We generated approximately $12.2 million in operating cash flow during the first nine months of 2019 as compared to approximately $7.1 million during the same period in 2018. We allocated $9.5 million of the cash towards the paydown of our long-term debt, of which $8 million was on an accelerated payment. We subsequently entered into a new credit arrangement that refinanced the outstanding $19.1 million in principal and provided $81 million for the acquisition of Big 3 Precision during the third quarter of 2019. During 2019, we repatriated $0.7 million from our Canadian operations, $1.5 million from our Chinese operations, $0.5 million from our Mexican operations. We subsequently repaid three and an additional $1 million from our Chinese operations in the fourth quarter of 2019. Cash flow from operations coupled with new credit agreement were sufficient to acquire Big 3 Precision to cover related expenses, and to fund capital expenditures, debt service and dividend payments. Addition to property, plants and equipment were approximately $1.9 million for the first nine months of 2019 compared to $4.2 million for the 2018 period. As of September 28 2019, there was approximately 0.3 million in outstanding commitments for capital expenditures. I'll turn the call back over to Chris for M&A question.

Thank you, John. Operator, we'd now like to open the call for questions by chance we have any telephone participants.

[Operator Instructions]

While we wait, we do have a few questions that have come in via the webcast. So let's tackle those first. One, there's been commentary lately about the possibility of an economic slowdown, if not a recession. How do you expect the Eastern's portfolio of businesses to perform under these economic conditions?

Thank you. Well, a lot of our products ultimately supports a very wide scope of economic activity including commercial transportation, oil and gas, construction, and of course, at the end of the line consumer ultimately drives a lot of fundamental demand. Given how our products are used, and the broad range of markets that we support, we're less exposed to any one shock and more impacted by overall economic activity and that would affect our demand. Having said that, we fight hard to grow share, launch more competitive products, and vigorously control costs in these economic conditions. We're trying to continue to work hard to deliver earnings growth, no matter what conditions we operate in.

All right, operator by chance, do we have any telephone participants or questions?

It doesn't look like we have any questions coming in.

Okay, we do have a couple more questions in the webcast. Second question, in your September call, you said you expected Big 3 Precision to be accretive to your ETFs by at least $0.40 for fiscal 2020. Is that still the case? Or do you now expect it to be even higher?

We do expect the acquisition to be accretive to 2020 EPS by at least $0.40. And we are confident in that number and we're working hard to try to beat that number.

Right, we have another webcast question, having completed the acquisition of Big 3 Precision, are you planning to target a similarly sized transaction over the next 12 months or you think it'd be better to digest Big 3 before looking for next acquisition candidate?

So we believe that Big 3 Precision offers an especially attractive opportunity for us to create value both through organic growth and through bolt-on acquisitions, and that's really where we are currently focusing.

Operator by chance, do we have any other questions on the telephone

[Operator Instructions]

Yes, we do have another webcast question. Can we expect that the non-recurring expenses, which were $3.8 million will not extend into the fourth quarter. Have all the write-offs been taken or can we expect zero non-recurring expenses to be over. And then the second part, what was the reduction in debt in the fourth quarter - third quarter I believe that's?

Well, as far as the non-recurring from the write-offs that we incurred in the second quarter and third quarter. Those are over with, we don't anticipate any further write-offs. There are probably a few more acquisition related expenses trickling in that, that we expect to come into the fourth quarter, but minimal.

Then reduction debt reduction in the - that was third quarter?

Not quite sure what that means. I mean, we did pay off debt of approximately $9 million last year or during the year, $8 million was on an accelerated basis. And then in the third quarter it was the acquisition of Big 3 Precision. We refinanced our entire debt and paid for the acquisition of $81 million and to refinance about $19 million that was still standing on our previous debt.

All right. And then we have another question, will Big 3 Precision be accretive in the fourth quarter after expenses?

Yes, it will be. We haven't quite determined, yet how much, but we believe that it's on track to be accretive in the fourth quarter.

And then we have one other question, which of your companies are you particularly excited about in terms of future new prospects and new customers?

So we believe each of our companies has opportunities. And as part of our portfolio I believe there are a couple of companies that are very well positioned and which have a quickest line of sight into opportunities. Our Class 8 truck mirror business has been growing very rapidly in the last year and it's well positioned to continue to expand its business over the next couple of years. Even while that market overall demand in that market is declining, we think that business is well positioned to grow pretty significantly in the foreseeable future. We also think that some of the businesses that we've been trying to reposition, like Illinois Lock is entering higher growth markets, which we think positions it well for accelerated growth in the future.

All right, operator, do we have any callers via telephone?

There are no live questions.

Okay, and it looks as though we have no further questions via webcast. So I will turn the call over to Gus for closing remarks.

Thanks. Thanks, Chris and thanks, everyone, for joining us this morning. As you've heard, we're carefully following our roadmap to increase shareholder value by optimizing our portfolio of businesses, strengthening our execution and keeping our balance sheet strong. Before wrapping up, I want to mention we’ll be participating in the ROTH Capital's Technology and New Industrial Conference in New York next Wednesday. We'll issue an advisory announcement with details later today. And I look forward to seeing some of you guys there. Thank you. And we hope you will join us again next quarter to review the results of the fourth quarter and fiscal year 2019.

With that operator we’ll now turn the call back to you. Thank you.

Thank you. This concludes today's conference call. We thank you for your participation. You may disconnect your life at this time. And have a great day.