The Eastern Company (EML) Q4 2021 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to The Eastern Company. Fourth Quarter Fiscal Year 2021 earnings call. At this time, all participants have been placed on a listen-only mode. And the floor will be opened for questions and comments after the presentation. [Operator Instructions] sound quality. It is now my pleasure to turn the floor over to your host, Christopher Moulton Head of Corporate Development. Sir, the floor is yours.

Good morning. And thank you, everyone for joining us. Speaking. Today will be Eastern's President and CEO, August M. Vlak, and our CFO, John L. Sullivan III. After that, we'll open the call for questions. Please note that some of the information will hear during our discussion today will consist of forward-looking statements about the company's future financial performance and business prospects, including without limitations. 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 risk factors discussed in our Form, 10-K. 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 over the phone and those participating by the web. We released Eastern's fourth quarter and full-year 2021 numbers on our Form 10-K yesterday afternoon. Before John Sullivan reviews the detailed results with you, I'd like to take a few minutes to reflect on the year. Let me start by saying that 2021 was truly a transformative year for Eastern. We're very proud of how we executed our plan to create a long-term shareholder value in a dynamic environment. We focused on doing everything we could to keep our team safe and our supply chains moving, ramping up production to address the strong demand for our products, and helping our communities recover. At the same time, our focus on performance in innovation remain unwavering. I want to once again thank our high-performing teams around the world for their continued commitment to Eastern. I am truly grateful for their efforts every day to ensure our success going forward. In 2021, we successfully executed several strategic moves to strengthen and transform our business portfolio into a faster growing and more profitable franchise. We announced our intention to divest three non-core businesses and reported them as discontinued operations on our Form-10-Q for the second quarter of 2021. We subsequently divested both Frazer & Jones and Greenwald Industries in November of last year which follows the sale of Canadian Commercial Vehicles and Sesamee Mexicana in 2020, for a total of 4 divestitures in two years. These divestitures allowed us to reduce our outstanding debt by $17.3 million, and repurchased approximately 15,000 shares in 2021. Last year, we also completed the integration of our Eberhard and Illinois lock businesses. We combined these two organizations to build scale, improve innovation, and capture operating synergies. As part of the integration, we closed our manufacturing and warehousing facilities in Tilsonburg, Canada and in Wheeling, Illinois and we moved operations to our current location in Strongsville, Ohio and Reynosa, Mexico. In 2022, we plan to further consolidate manufacturing into Reynosa, Mexico, including moving some production from Asia. We believe that our expansion into Mexico will build shorter supply chains, more robust supply chains, and improved logistics to better serve our core customers. Further, in 2021, we capitalized on the extraordinarily robust demand - rebound in our customer demand, fueled by macro trends, including the surge in outdoor recreational activities and commercial transportation, which in turn, fuel demand for truck accessories and distribution products. We also experienced a meaningful pickup in demand from our transport packaging customers as new automotive and commercial vehicle model launches accelerated. Last year, I remember describing 2020 as unprecedented turmoil. Yet the environment in 2021 proved equally dynamic. As I mentioned before on these calls, we saw unparalleled growth in raw material costs. To give you an example, the price of hot-rolled steel increased from $500 per ton in August of 2020, right at the time we were pricing some of our 2021 sales to a peak of $1,945 per ton in August of 2021, as we were buying some steel to produce [some of] (ph) those sales. And we buy more than 5,000 tons of hot-rolled steel per year. And we were able to pass on most of the increases in raw material and shipping costs, as you can see in our gross margin of 23% for the year. But many of our price increases lagged the growth in material costs, and in some instances, we were not able to raise prices. As a result, the impact on our earnings was material. Our raw material costs are more stable now than they were last year, and even with the war in Ukraine, for example, hot-rolled steel is approximately $1,450 per ton today, which is close to where it was a year ago. It's important to add that we navigated a rapidly evolving operating environment and prioritized meeting the strong demand from our customers by increasing our safety stocks and adding new suppliers. As a result of those decisions, free cash flow was temporarily impacted as we strategically build the inventory required to serve our customers and navigate to stretch global supply chains and support the current backlog, which is up 28% at the end of 2021 over the end of 2020. As you can see, we had a truly transformative year. I'll share some thoughts on 2022 at the end of the call. But for now, I will turn the call over to John to go over the details of the financial results.

Thank you, Gus. For the fourth-quarter, 2021, net sales increased 18% to $59.6 million from $50.6 million in the fourth quarter of 2020. Sales increased primarily due to higher demand for truck accessories, distribution products and automotive returnable packaging, as well as improved pricing. Sales volume of existing products increased 6% and price and new products contributed 12% in the quarter. New products included various truck mirrors, latches and accessories. For the full-year 2021, net sales increased 25% to $246.5 million from $197.6 million in 2020. Gross margin as a percent of net sales for the fourth quarter of 2021 was 20% compared to 23% in the prior year fourth quarter. The decrease reflects the combination of higher material and freight costs. Gross margin for the year as a percentage of sales was 23% in 2021 compared to 24% in 2020. Product development expenses in the fourth quarter of 2021 of $1 million was up a 192% when compared to the fourth quarter of 2020. As a percentage of net sales, product development expenses were 1.7% compared to 0.7% in the fourth quarter of 2020. The increase is primarily related to our investment in new products at Eberhard and Velvac. Selling and administrative expenses in the fourth quarter of 2021 increased 8% compared to the fourth quarter of 2020. The increase was primarily the result of increased payroll, payroll-related expenses, increased travel and other expenses as business returned to more normal operations in 2021. Net income for the fourth quarter of 2021 increased 24% to $3.9 million or $0.62 per diluted share from $3.2 million or $0.50 per diluted share in 2020. In the fourth quarter of 2020, net income was negatively impacted by non-cash goodwill impairment charge of $0.7 million net of tax and non-recurring restructuring, factory relocation, and transaction costs of $0.9 million net of tax. For the full year 2021, net income increased by 40% to $16.2 million or $2.58 per diluted share from $11 million or a $1.76 per diluted share in 2020. Adjusted EBITDA from continuing operations for the fourth quarter was approximately $5.7 million compared to approximately $7.3 million for the fourth quarter of 2020. Adjusted EBITDA from continuing operations for the full year of 2021, increased approximately 8% to $26.7 million from $24.7 million in 2020. For a quick summary on the cash flow in the balance sheet highlights, on a full-year basis, net cash used for operating activities was $7.8 million in 2021, compared to $14.6 million net cash provided by operating activities in 2020. In 2021, we contributed $2.3 million to our defined benefit retirement plans. During 2021 cash used to support additional working capital, requirements was $22.9 million, which was primarily due to management's focus on ensuring availability of inventory, to meet customer demands during the current supply chain constraints. By way of comparison in 2020, cash usage to support additional working capital, was $5.6 million. Total capital expenditures for 2021 was $3.7 million, of what we expect capital expenditures in Fiscal Year 2022 to be approximately $5.3 billion. In 2021, the company made total debt payments of $17.3 million, of which $11 million was on an accelerated principal payment. As of January 1, 2022, we had cash and cash equivalents of $6.2 million. Our net leverage ratio stood at 2.46 and our fixed coverage ratio at 2.2, both of which are well within our bank covenants of 4.25 and 1.25 respectively. With that, I'll turn the call over to Chris for questions.

Thanks John. Operator would you like to open the line for questions.

Certainly, ladies and gentlemen, once again if you have any questions or comments, you may type them into the ask question box via the webcast or [Operator Instructions]. Please hold a moment while we poll for questions.

Okay. We do have some questions that have come in via the webcast so we can begin with them. We have one question, bear with me, I'm going to read it out, it’s regarding the Big 3 returnable packaging business, obviously a big year for that segment as OEMs get their supply chains ready for introduction of new vehicle models. Do you expect that the recent growth in the segment will continue through '22 and '23 as these models are introduced. Or rather do OEMS essentially pre-order Big 3 products such that growth one -- such that the growth one would expect to take place as a result of new model introduction during 2022, 2023 already been placed this year. I think we can answer that question.

Yes. So the OEMs order somewhere in the 18 to 24 months prior to product launch is when they start working with us on the design of returnable transport packaging. For Tier 1s, that's probably a little bit later. So that's all driven by new product launches. And based on the latest data that we have, which gets aggregated by Bank of America, the forecast for new vehicle launches remains strong through 2025. So Bank of America estimates approximately 55 new product launches in 2022 and that remains at 60 or above through 2025. That compares to an average of 35 to 40 launches over the last three years. So we're expecting demand here to remain strong for the foreseeable future.

Maybe another question, can you comment on your current level of working capital and where we see it headed in coming quarters.

Sure. So obviously our working capital is above our historical level. And there is really three main factors that are driving this. I mentioned our investments in safety stocks. I think I mentioned a long time that product sits in transit. And the third reason our working capital is above where we would expect it to be is that we do have a higher level of past due as we are not able to complete all orders while we're waiting on certain components to finish those products. All of which is driving our working capital. And we can see this declining, but it's got to take a few quarters to do this. It won't -- it doesn't happen right away, but we don't have any concern about inventory spoilage based on the quality of what we've got. Now of course, as that happens, we will generate cash which will further drive down our net leverage ratio.

Then we have another question around gross margins, and we're currently at about 20% in the quarter. Do we think that we can get back to our previous highs that we experienced back in 2019? Not sure. John, do you have any?

Well, actually yes. So I think we will see that go forward and increase and improve as we can get our prices normalized with the material costs. As Gus had said earlier, many of the material is rising so fast that we couldn't keep up with the pricing and we had to negotiate a lot of the price recoveries with our customers, which took time, so we lagged. As the price of material starts coming down, and our prices are holding, we should see a marked improvement in the gross margin.

And we have another question on SG&A, it says, "Notably below other quarters in the year. " Do we feel this is an appropriate run rate going forward?

I think it's appropriate. It really is, where we actually should be running for. I know that we do monitor our selling administrative expenses and we do put a lot of controls on them. But as I know, also as business starts improving, we will be bringing on some additional people and additional sales staff which might increase a bit. But it should be relative to sales.

Okay. It appears as that we have no further webcast questions. Operator, do we have anyone on the line that would like to ask a question?

Yes. Our first question from the line today is coming from Miles Jennings, a private Investor. Your line is live. You may begin.

Good morning and thanks for the good report. I just had a few questions and I suspect that maybe you'll answer one of them at least. I see that your pension fund has about 219,000 shares of Eastern common stock. That's 6.8% of your plan assets, and about 3.5% of your shares outstanding. I just wondered, have you considered buying back those shares from the plan? It seems as though employees have sort of double jeopardy by owning shares of stock as well as having funds available for various expenses and everything. And I'm sure the cash and the pension plan is easier to handle than the volatility shares.

Well, actually we do have -- we do look at that every quarter when we have our Board meeting and we do review our pension investments. However we feel that we've been acquiring the shares at a fairly low price relative to where we know the market was going to go, and we expect it to actually be a benefit into the overall funding. We are capped though. We cannot include into the pension plan any more than 10% cost. So that would be the limiting factor. But at this point in time, we don't see a reason to try to divest that out of there.

Thank you. This is along the lines of what you're planning to do this year as far as further consolidation of facilities and businesses, which I commend you for. I see that at year-end, you owned 376,000 square feet of industrial space at year-end. I just looked at globestreet.com, which is a service for evaluating commercial real estate - industrial real estate, and they said that the average price based on large data set is about $145 a square foot. That's just the value about $54 million versus your carrying value of $17 million and that excess works out to just about $6 per share. I just wondered, do you have plans to reduce your square footage on facilities? I think I saw on the 10-K that you sold the building in Wheeling lock -- Wheeling, Illinois, which was tied to Illinois lock company. But it seems like a very heavy facilities resource that you're carrying.

Just to discount to two parts to your question, one has to do with the optimization of our manufacturing footprint. And do we believe that we've got the more square footage than we need to support our current production levels. And the second part of your question is, I think if I understand it correctly, is more to do with whether we should own release the manufacturing sites, that we currently own. I would say both, we are continuously evaluating and each year when we put our plans together, we look at what manufacturing capacity we need. I know that today with the goals that we have, we're in fact looking at some ways to add, I would say on the margin some space so we can support our production levels.

But we're not expecting a wholesale change in terms of our overall square footage. At the same time, when we look for any acquisitions, our ability to optimize the footprint with an acquisition is what I think to look at very closely because there's potentially quite a bit benefit to begin from that.

Yes.

And to your second question, we have looked and continue to look, I would say, certainly at least once a month, offers that come in for sale leasebacks, and we evaluate those based on the impact it has to shareholders. And until now, the cap rates have been at a level where we don't think it benefits us, if we compare the cap rates with general rates on debt out there. We don't think the offers that we've gotten so far benefit us. That could change. The market for commercial real estate is pretty dynamic. And if that changes, and certainly we would come to a different conclusion.

Excellent. Just one further thing. I saw that you disclosed -- that you sold the business of Greenwald for $8 million, I think. And on Frazer & Jones, you noted some gain on the sale of equipment sales. I just wondered, can you give us the total net proceeds on the sale of these two businesses?

$16 million.

15 million.

16 million.

16 million. Good. Thank you. And that's retaining the building of Greenwald for just Investment research. I assume.

That is correct.

Thanks very much. And do you think your acquisitions have been working out very nicely and it sounds like you're in the right spot on the academy. Thanks, again.

Thank you. Operator, do we have any other questions on the line?

We have no further questions in the queue at this time.

Okay. Thank you. With that, I'll turn the call to August for closing remarks.

Thank you and thank you for those questions. As I reflect on 2022, I believe that there are many reasons to be optimistic about the year. With strong demand in our core markets, recovering supply chains, and a higher level of confidence that raw material price volatility will subside. While the war in Ukraine, as I mentioned, is once against driving up some of the cost of raw materials, we're not seeing the increases that we saw in 2021. In 2022, we should also begin to see the impact of the increase in new vehicle launches, the synergies from our consolidation of Eberhard in Illinois Lock as well as the accelerated growth from the launch of six new truck mirror programs in 2021. As noted earlier, big three precision, are returnable transport packaging business, has seen a material pickup in demand for its products and services throughout 2021, a lot of which was reflected in the year-end backlog. And we expect demand to continue to strengthen in 2022, due to return of new model launches. Were excited about many of the launches that we're working on with our OEMs and Tier 1 customers. These include the upcoming Ford Mustang, Jeep Grand Cherokee, the Ford F250 and 350 Super-duty passenger trucks. We're also working with our customers on numerous near-term electro -vehicle models launch, including among others, Ford F150 Lightning passenger truck and Mercedes EQS SUV and GM EQS SUV. At the same time, we've made significant headway in the heavy-duty truck industry and are excited to report that we're now a primary packaging supplier to one of the leading heavy-duty truck OEMS. And we're building business with the others as well. Our success in this market is in part based on our ability to leverage Eberhard's and Velvac strong relationships with these various commercial vehicle OEMS. Beyond 2022, we believe that our focus on our three core businesses, Big 3 Precision, Eberhard, and Velvac, will deliver innovation led organic growth, capitalizing on several industry trends, including electrification, digitization and automation. Eberhard, for example, recently launched a full line of electro-mechanical solutions, capitalizing on the electrification and digitization across many of our core markets, including commercial transportation and retail. And we anticipate that our innovative products will translate into significant sales earnings and cash flow growth in 2022 and beyond. We're very active in our pursuit of bolt-on acquisitions for 2022, 2023 and beyond that. And we're looking at businesses that expands our access to markets, build our capabilities, and offer synergies for each of our core businesses. As a result, we remain confident in our goal to become a $100 million EBITDA company through the combination of organic growth and built on acquisitions. Last but not least, as you might have seen in our press release, we're excited that Peter O'Hara will, during our senior leadership team as CFO. Most recently, Peter was Vice President of Finance at Navistar. Peter will place John Sullivan, who's retiring on May 15th of this year. John has had an incredible 46 year career at Eastern, and we're deeply grateful for his leadership and commitment. With that, I'll turn the call back to Chris.

Thank you, August. And with that, I'll turn the call back to the Operator.

Thank you. Ladies and gentlemen, this does conclude today's event. You may disconnect at this time and have a wonderful day. We thank you for your participation.