The Eastern Company (EML) Q1 2020 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to your Eastern Company First Quarter 2020 Earnings Call. All lines have been placed on a listen-only mode and the floor will be opened for your questions and comments following the presentation. [Operator Instructions] At this time, it is my pleasure to turn the floor over to your host, Chris Moulton, Head of Corporate Development. Sir, the floor is yours.

Thank you. Good morning, and thank you, everyone, for joining us today. Speaking today will be Eastern’s President and CEO, Gus Vlak; as well as our CFO, John Sullivan. After that, we will 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 margins, 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. These risks include, but are not limited to, the effects of the COVID-19 pandemic and the measures being taken to speed – to limit the spread of COVID-19. For more information regarding these risks and uncertainties, please refer to risk factors discussed in our Form 10-Q filed yesterday. In addition, during today’s call, we will discuss non-GAAP financial measures that we believe are useful as supplemental measures of Eastern’s performance. These non-GAAP measures should be considered in addition to and not as a substitute for, or in isolation from GAAP results. With that, I’ll 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 also those participating via the web. We released Eastern’s first quarter results last Wednesday, and the full Form 10-Q yesterday afternoon. I would like to start by taking a moment to thank our employees around the world for their sacrifices, hard work, and openness to embrace new ways of working during this very difficult time. And I’d also like to acknowledge the exemplary efforts of our healthcare professionals and workers on the frontlines, we are very appreciative of their commitment to keep us all healthy and safe. I want to highlight the efforts of our team at Big 3 Precision, who partnered with TriEnda to manufacture thousands of frames for emergency and disaster relief beds under an incredibly tight timeframe. These beds have been used across the country, including in the field hospital in the Boston Convention Center. In addition, I want to tell you about our UK-based subsidiary for its efforts in designing and manufacturing molds for COVID-19 test tubes that are going to be part of COVID-19 testing kits. As difficult as this time has been, the way in which our leadership and our teams across our company have stepped up is really impressive and deserves to be recognized. That brings me to where things stand today. There is clearly still a significant amount of uncertainty in the macroeconomic environment as a result of COVID-19 and the financial impact that the measures to respond to it are having and could continue to have on our company. In late January, when news of COVID-19 in China began to surface and when we were starting to see the impact across our operations in China, we spoke with you and mentioned that we had already implemented a series of mitigation steps there to reduce the risk to our China employees. Unfortunately, COVID-19 would soon spread rapidly across the world, requiring all of us to react extremely quickly. Across our businesses, we have since then implemented a broad range of policies and procedures to ensure that employees at all of our locations remain safe. We listened to and we learned a great deal from our colleagues in China and took necessary action early on across our North American operations. These include implementing social distancing measures, staggering staff and shifts, enabling work from home for as many employees as possible, implementing enhanced cleaning programs across all of our sites and strongly advising our employees on personal hygiene and the importance of wearing face masks to reduce the spread of COVID-19. In some locations, we’ve even rented private buses, which enable us to ensure that our employees have access to clean, safe transportation to and from work. All of our businesses are learning, sharing and working together to protect everyone who shows up to work. As governments continue to offer guidance to commercial operations, we will continue to ensure compliance with these directives in order to maintain business continuity for our operations. Importantly, the majority of our businesses are deemed essential, and accordingly, have remained open, albeit at reduced levels. Beginning the last week of April, many of our customers who had closed had begun to open up. And by the middle of this month, we expect that the vast majority of our customers who have previously closed will have resumed operations at some level. Importantly, until now, disruption in our supply chain has been minimal, and we’re continuously working with our suppliers to make sure that we are ready to meet our customers’ needs. It’s worth adding that while some of our customers closed plants and stopped manufacturing products, the engineering departments continue to work on new products, and our engineers have kept pace to support with this new product development, which will help us launch new products later on in the year. Now turning to the financial highlights for the quarter. Net sales for the first quarter increased by 7% to $65.3 million from $60.9 million in the first quarter of 2019, driven primarily by the addition of Big 3 Precision, which we acquired in August of 2019. This was our third acquisition in as many years. Net income for the first quarter increased to $2.9 million, or $0.46 per diluted share, and that’s from $1.6 million, or $0.25 per diluted share for the first quarter of 2019. I’ll now turn the call over to John to go over the details of our financial results.

Thank you, Gus. In my remarks this morning, I’m going to focus on Eastern’s results for the first quarter of 2020, as compared to the first quarter of 2019. For the first quarter of 2020, net sales increased 7% to $65.3 million from $60.9 million in the first quarter 2019. Sales growth was largely attributable to the inclusion of Big 3 Precision. Sale of existing products increased in the first quarter by 5%, while new – price and new – price increases and new products contributed 2%. New products include a handle and finger pull assembly, an emergency door latch, a mount plate latch, a top mount power lock module, a cross bar lock assembly and various industrial castings serving the water and gas industry. Sales increased in the industrial hardware segment by 23% to $47.2 million in the first quarter of 2020 from $38.4 million in the first quarter of 2019. Excluding Big 3 Precision, sales decreased 11% in the Industrial Hardware segment in the first quarter compared to the first quarter of 2019. Increased sales in the specialty vehicle, off-highway and military markets were not sufficient to offset declines in distribution, Class 8 truck, recreational vehicle and aftermarket truck replacement parts. Especially during the last-half of March, when certain customers closed their operations due to actions they had taken to help stop the spread of COVID-19. Sales in the Security Products segment decreased 16% in the first quarter of 2020 compared to the first quarter of 2019 due to lower demand across the majority of the markets we serve, including distribution, industrial, vehicular accessories and commercial laundry, as well as a loss of supply contracts for mechatronic padlock systems and RV door latches, which generated sales in the first quarter of 2019 that did not reoccur in 2020. Sales in the Metal Products segment decreased 27% in the first quarter compared to the first quarter of 2019. Sale of mining products decreased 21% and sale of industrial casting products decreased 35% in the first quarter compared to the first quarter of 2019. Mining sales in the first quarter were impacted by a combination of growing renewable energy capacity, extremely low natural gas prices and unusually warm weather in the first quarter, which led utilities to cut back on coal usage. Sales of industrial castings in the first quarter were negatively impacted by the loss of a customer who temporarily sourced products from us due to a fire at their facility in 2018, which had temporarily shutdown production of products that would otherwise have been sourced internally. In addition, sales were negatively impacted due to the completion of contracts from a customer serving the transit industry. Cost of products sold in the first quarter increased $3.6 million, or 8% compared to the first quarter 2019, primarily as a result of the inclusion of Big 3 Precision. Excluding Big 3 Precision, cost of products sold would have decreased by 14%, reflecting the reduced sales levels. Gross margin as a percent of sales was 22% in the first quarter, compared to 23% in the first quarter of 2019. Product development expenses decreased $1.5 million, or 65% in the first quarter compared to the first quarter of 2019. The reduction in this expense relates to the closure of the Velvac Road-IQ development operation in Bellingham, Washington, which took place in the second quarter of 2019, a strategic decision made to adopt a leaner approach to the development of new vision products. Selling and administrative expenses increased $1.6 million, or 19% in the first quarter compared to the first quarter 2019, primarily as a result of the inclusion of Big 3 Precision. Excluding Big 3 Precision, selling and administrative expenses in the first quarter 2020 would have decreased by $0.5 million, or 6% from the first quarter of 2019. The most significant factor contributing to this reduction was a decrease in payroll and payroll-related expenses of $0.3 million. For a quick review of the balance sheet and cash flows. Cash generated by operating activities was $1.5 million during the first quarter of 2020, in line with approximately $1.5 million generated during the first quarter of 2019. Capital expenditures was approximately $0.8 million for the first quarter of 2020, compared to $0.7 million for the first quarter 2019. As of March 28, 2020, there was approximately $0.1 million of outstanding capital commitments for the remainder of 2020. In light of the current uncertainties, we made the strategic decision to limit capital expenditures to those critical for maintenance, safety, regulatory, and special projects with immediate return on investment for fiscal 2020, as compared to the point – the $4 million that we had previously communicated on our Q4 fiscal year 2019 earnings call. As of March 28, 2020, we had total cash and cash equivalents of approximately $16.5 million and total debt of approximately $97.5 million, and we were in compliance with our bank covenants. I’ll now turn the call over to Chris for questions.

Thanks, John. Operator, I’d like to open the call up for questions. While we wait for a queue, we do have questions that have come in via the webcast. So let’s start with them, and then I’ll return back to you for telephone callers. First question, are many of your customers currently still closed?

Well, some of our customers in both the automotive and the nonautomotive industries initiated varying degrees of shutdowns really starting in the last week of March of this year. And these temporary shutdowns obviously had an adverse impact on our demand for our products. But we believe and we’re seeing that our customers are opening back and that the majority of those customers will have reopened by the end of this week. And the remaining are due to open in the next week, the following week and the week after that.

Okay. And, operator, I’m sorry, I believe you’re providing instructions for telephone callers, if you like to finish that?

Thank you. The floor will be opened for questions after we’ve answered the web questions. [Operator Instructions]

Okay, great. And we do have some more questions via the webcast. What was the impact of COVID-19 on the company’s performance in Q1?

Yes. Basically, we were affected in three ways. COVID-19 first affected our operations in Shanghai and Dongguan in China. We source about 15% of our products from China. And due to government-led closures, we were unable to manufacture and ship some of those products to us. Second thing was in the last-half of March. Some of our customers began to close manufacturing operations due to trying to contain the spread of COVID-19. And then finally, we believe that most of our companies are essential businesses, but we did have to shutdown one of our facilities in the first quarter because of a single case of COVID-19. All of this, we estimate that the adverse financial impact due to this virus on our first quarter operating profits to be approximately $600,000 net of tax.

Okay. And then we have the third question via the webcast. Will the company have sufficient cash to get through this pandemic?

Well, we’ve run multiple scenarios, including some pretty dire outlooks for the year, which we don’t anticipate, based on the information that we have available today, but which we do want to be prepared for in any case. And based on this analysis, we believe that cash, cash flow from operations and funds available under our revolving credit portion of our credit agreement will be sufficient to cover our foreseeable cash requirements. However, I know that and I think you understand that based on the current macroeconomic conditions and the uncertainty surrounding COVID-19, we can’t offer any assurances.

Okay. And then we have another question, level of debt reduction in 2019. John, do you have that on hand?

Yes. Well, basically, we have paid down a big portion of our debt on accelerated payment. But when we made the Big 3 acquisition, we had to increase the debt in order to finance that. So we ended up with $100 million of debt, which included about $18 million from the previous loans that we had.

Okay. And then we do have one other question via the webcast. We don’t provide guidance, but maybe, Gus, you can provide some – a little more color even with the difficulties around the world, can we still expect a record year in revenues and earnings for 2020?

Well, at a time when every company that has experience offering guidance is withdrawing their guidance because of the uncertainty surrounding the economic environment, I think, it’s hard for us to predict whether this year will be a record year for 2020. I do think that we are well-positioned to navigate the current environment, that our businesses are well positioned to continue to both be successful through this period and make the investments necessary position the business well enough to thrive over the medium to long-term.

Okay, great. So, operator, do we have any callers via the telephone line?

[Operator Instructions] It appears there are no questions over the phone.

Okay. Gus?

Thank you. Look, while we’re focused on navigating the impact of the measures to mitigate the spread of COVID-19, we remain very confident in our strategy to deliver significant long-term shareholder value. We continue to work on optimizing our portfolio of businesses, which includes working with our most recent acquisition, Big 3 Precision to position it for long-term growth and optimize its performance. We are maximizing the results from each of our businesses, especially now in the current environment, where we are carefully managing our business’ cash generation. And of course, we remain very focused on maintaining the strength of our balance sheet, both to ensure short-term strength, as well as to position us for future growth. Importantly, across our businesses, our backlog has remained robust at the end of the first quarter. Our businesses are resilient, and we believe they can execute as soon as economic activity rebounds. I would like to emphasize that we’re very confident that the actions that we have taken to manage our businesses during this difficult period have positioned them well to withstand an even more prolonged economic downturn should one transpire. As always, please reach out to us and ask us any questions that you may have. Thank you.

Thanks, Gus. With that, I’ll hand the call back to the operator.

Thank you, ladies and gentlemen. This does conclude today’s teleconference. We thank you for your participation. You may disconnect your lines at this time and have a great day.