The Eastern Company (NASDAQ:EML ) Q1 2022 Results Conference Call May 10, 2022 11:00 AM ET

Chris Moulton - Head, Corporate Development

Gus Vlak - Chief Executive Officer

Peter O'Hara - Chief Financial Officer

John Sullivan - VP & Retiring CFO

Good day, ladies and gentlemen, and welcome to The Eastern Company First Quarter Fiscal Year 2022 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.

It is now my pleasure to turn the floor over to your host, Chris Moulton, Head of Corporate Development. Sir, the floor is yours.

Good morning and thank you for joining us today. Speaking today will be Eastern's President and CEO, Gus Vlak; and our CFO, Peter O'Hara. After that, we'll open the call for questions.

Please note that some of the information we'll 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 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 recently filed Form 10-K.

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 who have joined us on the phone and those participating via the web. We released Eastern's first quarter numbers on our Form 10-Q yesterday afternoon.

Before Peter reviews the detailed results with you, I would like to take a few minutes to reflect on the quarter. This was another strong quarter for Eastern with solid revenue growth. Net sales from continuing operations grew to $69 million in the first quarter of 2022. That's an increase of 12% over the first quarter of 2021. And it's another quarterly sales record in Eastern's 164-year history.

Orders from our customers were strong, and importantly, our backlog at the end of the first quarter reached $86 million. That's a year-over-year increase of 23% and an increase of 4% since the start of the year. A strong backlog positions us well for the coming quarters.

Sales growth underscores effective execution by each of our businesses to benefit from favorable demand trends across our core markets. For example, our Big 3 Precision team build new sales and project management capabilities to capitalize on the increase in new automotive launches, including several electric vehicle launches.

As a result, sales of our returnable transfer packaging products grew approximately 16% in the quarter compared to the prior year. We project that demand for returnable transfer packaging will strengthen further through the remainder of this year and beyond as the pace of new vehicle launches accelerates.

At the same time, sales of our recently launched truck mirror programs gained momentum as truck builds for these new programs ramped up. And sales in this market are expected to remain robust.

According to ACT Research, Class 8 truck builds will reach 220,000 in 2022. That's an increase of 12% over 2021, and ACT Research projects that 265,000 new Class 8 trucks will be built in 2023.

We sustained our momentum from last year through the first quarter and into the second quarter with strong sales, a healthy pipeline, and growing end markets, and solid execution by our teams. Our business portfolio is aligned with significant demand trends, and we're expanding our capabilities to benefit from these trends.

Our balance sheet also reflects our growth to ensure we can fulfill customer demand across a broad range of product offerings. We temporarily dedicated additional capital to improve our inventory on hand, which did impact our free cash flow generation during the quarter. By temporarily increasing our inventory levels, we can best guarantee the availability of all necessary input materials that we need to meet our customer demands and score some impressive competitive wins.

In addition, in the quarter, we experienced a resurgence in raw material costs for certain key commodities. We also continue to see labor shortages and supply chain constraints. And while material cost inflation impacted gross margin in the first quarter, we are working to mitigate the impact primarily through successive rounds of needed price adjustments across each of our businesses. Our most recent rounds have gone into effect in May and will continue through June, and we expect to see significant benefits from these actions in the coming months.

Now, as you may know, John Sullivan is retiring after a 46-year career at Eastern and Peter O'Hara has joined us. So I'm going to turn the call over to Peter to go over the details of our financial results.

Thank you very much, Gus, and thank you to everyone who's on the call today. It's an exciting time to join The Eastern Company, and I look forward to building relationships with our customers, shareholders and analysts. My remarks this morning will focus on Eastern's results for the first quarter of 2022.

For the quarter, net sales increased 12% to $69 million from $61.8 million a year earlier. Sales increased primarily due to increased demand for truck accessories and automotive returnable transport packaging products as well as from distributors.

Our returnable transport packaging sales benefited from an increase in upcoming new automotive product launches, including several electric vehicle launches. The effect of volume on existing products increased net sales by 4% year-over-year, while price increases in new products contributed an additional 8 percentage points.

New products included various truck mirror accessories, rotary launches, D-rings and mirror cams. Price increases primarily reflected our efforts to recover increases in raw material and freight costs. Gross margin as a percent of sales was 21% in the first quarter of 2022 compared to 25% in the prior year. The decline in gross margins in the quarter reflected the ongoing impact of rapid increases in raw material commodity prices. We are currently in the process of making the latest round of price increases to mitigate this impact on future earnings.

Product development costs increased $0.2 million or 18% in the first quarter of 2022 compared to the first quarter of 2021. As a percent of net sales, product development costs were 1.7% for the quarter compared to 1.6% in the first quarter of '21. The cost increase is primarily due to one-time reimbursements in the prior year that did not repeat in the current period from truck OEMs for engineering and product samples relating to new mirror programs.

Selling and administrative expenses increased $0.9 million or 10% year-over-year, primarily as a result of increased commissions and other selling costs, payroll-related expenses and travel costs. The increase in selling expenses reflected both the impact from increased sales as well as strategic investments we have made into our sales capabilities.

Net income from continuing operations for the first quarter of 2022 was $2.7 million or $0.43 per diluted share compared to net income of $5.7 million or $0.90 per diluted share in the prior year. Notably, adjusted for one-time items, earnings per diluted share from continuing operations for the first quarter were $0.46 compared to $0.69 in the prior year. Adjusted EBITDA for the first quarter was $6.1 million compared to $7.9 million in the first quarter of 2021.

In terms of operating cash flow, the Company consumed approximately $3.6 million of cash from continuing operations during the first quarter of '22 compared to generating approximately $1.3 million in the prior year.

Cash flow during the quarter was impacted by an increase in working capital. The effect of COVID-19 pandemic and the related recent shutdowns in China continue to impact our supply chain.

And so as a result, both inventories and accounts payable have increased due to increased shipping time, port congestion, and selective pre-buying of raw materials to ensure availability and to mitigate the impact of likely future inflationary price increases. As of April 2, 2022, we held cash and cash equivalents of approximately $5.1 million.

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

Thanks Peter. Operator, we'd like to open the line for questions.

Ladies and gentlemen, the floor is now open for questions. [Operator Instructions]

And we do have several questions that have come in via the webcast. So we'll tackle them first. The first question is what is our view on the likelihood and impact of an economic downturn on Eastern?

So we are monitoring demand very closely and not just demand for our products by our customers, but also the drivers of demand for our customers' products. And while demand remains strong right now and our backlog is very solid, we have begun to prepare some plans for what we might do to respond quickly if we see any softening in our end markets. And we take some confidence in the way that we were able to respond during the onset of the COVID-19 pandemic.

Okay. We have another question. What is the direct impact of increasing interest rates on the Company?

Sure. I'll take that one. We're fortunate enough that most of our floating rate term debt is covered by an interest rate swap, which simply means the impact of increases in interest rates on our monthly interest payments will be relatively muted.

Okay. We do have another question, actually, two questions on the same topic here. When do we expect to -- when do we expect to sell Argo? It's our only remaining noncore business.

Well, we continue to evaluate options for Argo. With the current dynamics in the market for printed circuit board assembly, Argo is a really good asset and the business reported very strong sales and earnings in the first quarter. So we're committed to maximizing the value of Argo for our shareholders as we proceed down this path.

And we have, I think, one other question to -- does management disclose the percent of revenue that comes from Big 3?

What we have told our investors is that within our continuing operations, each of our three core businesses is roughly the same size. They're not exactly the same size, but they're directionally the same.

Okay. First, you have a question from Ross [Teverson] from [indiscernible] Capital.

Great. And welcome, Peter. I had a question just about gross margin. Material costs clearly have increased quite a bit over the last year, looking year-over-year. But looking sequentially, it seems like at least in some key commodities like steel, prices have been more stable or maybe even down sequentially, I guess, depending on how you look at it. And I know you guys have taken a series of price actions in the past or at least that's my impression. But we didn't see a whole lot of improvement in gross margins sequentially. So just comparing to Q4.

Can you guys talk at all about why maybe these price increases you've already implemented, like you referenced the 8% impact from price increases from a year ago? Why has that not had more of an impact in restoring margins relative to that sequential quarter relative to Q4?

Yes, I'd be happy to address that. So the price increases that we took last year helped us with some of the raw material and a lot of the increase in shipping rates that we experienced throughout the year. These recent -- the latest price increases or cost increases to us were primarily in zinc, some of the cost for zinc, and we use quite a bit of zinc and aluminum.

And when we pass through those price increases, we have more of a delayed impact based on the nature of the customers that we serve with those kinds of products. So as those commodity prices continue to increase, we started to prepare with our customers for those price increases. But the impact there is more delayed than it has been in some other parts of our business. And as a result, we are still catching up. There is nothing structural in our business that cause us to believe that our margins would stay where they are today, but it is taking us some time to get back on track here.

Fair enough. That's really helpful, Gus. And do you -- I guess, to that point to the delay, which I totally understand why there is that delay. When you look at that very large backlog that you have, does that imply also that within that backlog, there's still a fair amount to work off in terms of maybe where you quoted prices that don't reflect the current raw material costs?

Actually, no, that's not the case. If the -- the price increases that we're working on right now are ongoing programs. And the price increases would -- as soon as they take effect, also be effective for anything that's in the backlog that has not yet shipped.

No, we did have one other question on the webcast, but I believe that we had addressed that on the previous question. But if you do want more insight, please let us know, e-mail us or call us, and we can provide you with more. It doesn't appear as though we have any more questions on the webcast.

Operator, do we have any on the line?

There are currently no more questions on the line, sir. [Operator Instructions] Okay, sir. There are no more questions in the queue. Do you have any closing comments you'd like to [indiscernible].

Yes. I'll turn the call over to Gus for closing remarks.

Thanks, and thanks, everyone, for joining us this morning. We're pleased by the continued acceleration in demand for our products and services across all of our businesses. The strength in the growth of our backlog during the first quarter provides us with a great deal of comfort and confidence that we'll be able to sustain growth across our businesses in the coming quarters.

Supply chain and inflation-related pressures aside, we are optimistic about the remainder of this year and our long-term future. Over the last year, our teams have become increasingly effective at managing the supply chain pressures, volatile raw material costs, and that we've driven dramatically better throughput. Our team is committed, resilient and prepared for the challenges ahead, and we are well positioned to capture the opportunities in front of us. We all share a great deal of optimism and urgency to show you what we are truly capable of delivering. Thank you.

Thanks, Gus. With that, I'll turn the call back to the operator.

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