The Eastern Company (NASDAQ:EML) Q4 2019 Earnings Conference Call March 6, 2020 11:00 AM ET
Chris Moulton - Head of Corporate Development and IR
Gus Vlak - President and CEO
John Sullivan - CFO
Conference Call Participants
Good day, ladies and gentlemen. And welcome to The Eastern Company's Fourth Quarter Fiscal Year 2019 Earnings Conference Call. [Operator Instructions] At this time, it my pleasure to turn the floor over to your host for today, Mr. Chris Moulton. Sir, the floor is yours.
Thank you. Good morning, and thank everyone for joining us today. 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 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 certain 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 an isolation from GAAP results.
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.
We released Eastern's fourth quarter and full year numbers last Friday, and the full Form 10-K yesterday afternoon. Before John reviews the detailed results with you, I'd like to take a few minutes to reflect on our progress and take stock of where we are, especially as events are moving so fast these days.
I want to emphasize that we brought 2019 to a strong close and that we are on the right track to increase shareholder value by optimizing our portfolio of businesses strengthening execution and keeping our balance sheet strong.
I am pleased with Eastern's accomplishment in 2019. To call out just a few. First, our acquisition of Big 3 Precision in August was an important step towards our long-term goal of building a larger stronger company with significant presence with key customers.
We completed a seamless integration of Big 3 Precision into Eastern in just a few months. And we are working with the management team to realize the full potential of this business. And we're already seeing some early synergies between Big 3 Precision and some of our other businesses.
The acquisition also made a substantial contribution to our fourth quarter results. And as I forecasted last quarter, was accretive for 2019 as a whole, that's before transaction costs. Second, we've been generating strong sales from new products.
Including, for example, a new hood mount truck mirror, which we launched with a leading truck OEM that addresses some functionality concerns raised by the market replacing a fixed mirror with a pivoting mirror. We also introduced a new modular toolbox latching system that will be available through dealerships and is branded as an OEM toolbox.
In total, sales of new products accounted for 5% of our sales growth in the fourth quarter of 2019 compared to sales in 2018. And in the industrial hardware segment, new products represented 15% of sales growth.
Third, Eastern's cash flow from operations was exceptionally strong for both the fourth quarter and the full year. In fiscal 2019 full year, we generated $23 million in cash from operations, that's a 78% increase compared to the prior year. And most of this improvement came from a reduction in our working capital sort of better at matching inventory to demand as well as growth in net income adjusted for non-cash charges.
Fourth, we ended the year with a robust backlog, totaling $72.2 million which reflects both the acquisition of Big 3 Precision, but also very strong order flows that ever heard manufacturing. Not all sales flow through our backlog and the importance varies across some of our different businesses. But we believe it is a relevant leading indicator of our overall growth.
That brings me to where we stand today. There is obviously a significant amount of uncertainty in the macroeconomic environment as a result of the coronavirus and the financial impact as measures [ph] to respond to it could have.
As a result of the Chinese New Year holiday extension, and the delayed opening of our own China locations and our suppliers, some of our businesses have been experiencing some supply chain disruptions in China. And while the situation is obviously very fluid, local conditions have improved in the last few weeks.
In Southern China we're operating at 95%. At an Eastern China we're at 60% this week and expect to be at 85% by the end of next week. Our supply base in China is anywhere from 50% to 85%. But even before the coronavirus issues surfaced in mid-January, we've been focusing a good deal of our attention on Eastern supply chain, really with an eye towards making structural changes that can help us reduce working capital and shorten [ph] our supply chains.
Our business philosophy has been to enhance the reliability and quality of our suppliers and free up cash flow. Obviously, these goals have taken on added urgency with today's situation. At the moment, we're monitoring the situation closely. And we're taking common sense actions to protect the health of our employees.
We're implementing the guidance offered by the CDC to keep our U.S. locations healthy. And to the extent that our sales are adversely impacted in the short term by a delay in shipments from China. We believe that we can substantially make up the gap during the remainder of 2020 based on what we know today.
Cut [ph] from headwinds from the coronavirus will require a concerted effort, but we're very focused on this. At the same time, we're looking beyond the immediate situation and working hard on developing new and innovative products for our customers in 2020.
Innovative solutions whether components or packaging solutions that support our customers' new product launches will help us offset the main challenges in certain of our end markets like Class A truck. It's also important to remember that while we're facing pressure in some of our markets, Eastern serves a wide diversity of customers across the broad range of industries.
Finally, we're very focused on maintaining our strong balance sheet. Our book value grew by 9% in 2019. Our current ratio is 3.6 that's compared to 3.4 in 2018. And we have ample flexibility and capacity under our credit agreement. As John will discuss momentarily we entered into a new credit agreement last August with very favorable terms.
With our acquisition of Big 3 Precision successfully completed, we are more committed than ever to identifying bolt-on acquisitions that will further strengthen Eastern's presence in key markets and build relationships with our customers. This is a basic part of our business strategy. And given the strength of our balance sheet, we are well positioned to take advantage of any opportunities that arise.
I'll now turn the call over to John to go over the details of our financial results and we'll come back at the end of this call.
Thank you, Gus. My remarks this morning will focus primarily on Eastern’s results for the fourth quarter of 2019. Our full year results are available in yesterday's 10-K filing and are also summarized in last Friday's press release.
For the fourth quarter, net sales increased 21% to $68.7 million from $56.6 million a year earlier. Sales growth reflects the Big 3 acquisition, which we acquired on August 30, 2019. Sales increased in the industrial hardware segment by 46% to $49.2 million in the fourth quarter of 2019 from $33.7 million a year earlier.
Excluding Big 3 Precision, sales decreased 3% due to lower sales in Class A trucks and specialty vehicles partly offset by the impact of new product launches and stronger sales to military customers.
Sales in the security product segment decreased 13% compared to the fourth quarter of 2018 as late year product launches didn't completely offset lower demand for commercial launch payment products, and point of sale security products, as well as the loss of supply contracts for mechatronic padlock systems in Load N Lock [ph].
Sales in the middle product segment decreased 18% compared to sales in the fourth quarter 2018. Sales of mining products decreased 11% while sale of industrial casting products decreased 30% as compared to the fourth quarter of 2018.
Mining sales were impacted by a business combination between two customers and the filing for bankruptcy protection from one of the largest coal mines in the U.S. Industrial castings were negatively affected by the loss of a customer was suffered a foundry fire in 2018 and as temporarily sourced these products from our facility.
Cost of products sold in the fourth quarter of 2019 increased by $8.8 million, 21% from last year's fourth quarter. The increase was attributable to the Big 3 acquisition. Gross margin as a percent of sales remain comparable to 2018 at 26%.
Product development expenses as a percent of sales in the fourth quarter 2019 decreased by 58% as compared to last year's period. This decrease relates to the closure of the Velvac Road-iQ development operation in Bellingham, Washington in the second quarter of 2019, as we adopted a legal approach to developing new vision products.
Selling and administrative expenses in the fourth quarter 2019 increased 31% as compared to 2018 period, primarily due to the Big 3 Precision acquisition. Now I'll give you a quick summary of our balance sheet and cash flow highlights for the full year.
Our financial position strengthened in 2019. Net cash provided by operating activities was $23 million in 2019, compared to $4.9 million in 2018. We used $85.8 million and $10.4 million for investing activities in 2019 and 2018, respectively.
Included in 2019 amount is approximately $81.2 million for the Big 3 acquisition. Included in the 2018 amount, there's approximately $5 million for the acquisition of Load N Lock. The balance of $5.4 million and $3.6 million in 2019 and 2018, respectively, was used to purchase fixed assets. Capital expenditures for the year 2020 are expected to be in the range of $4 million.
In addition, in 2019, we received approximately $67 million from financing activities. We refinanced an existing loan for $19.1 million. We used approximately $10.8 million for debt repayments, and $2.8 million for dividend payments.
In 20 -- in August of 2019, we entered into a new credit agreement for $120 million with Santander Bank as lead ranger, along with People United and TD Bank of which we received $100 million for a term portion and $20 million for revolving credit portion.
Proceeds of the term portion we used to repay the remaining outstanding term loan approximately $19 million and to terminate its existing credit facility and to acquire the Big 3 Precision.
I'll now turn the call over to Chris for questions.
Thank you, John. Operator, do we have any participants who have dialed-in for questions.
And while we wait, we do have a couple questions that come in via the webcast. So let's get to those.
First question, will you continue to have onetime charges?
Well, the onetime charges are related to transactions and to restructuring costs. Right now we have no plans on restructuring costs. If we do make some small bolt-on acquisitions, that would be transaction costs. But they usually would be smaller.
Our second question, what is the impact of a downturn in Class A trucks to the business?
Well, Class A trucks is obviously an important market for us. And despite the downturn in that end market, we do believe we can continue to grow our business because we fell into many end markets. And when the Class A trucks market turns down, we have the opportunity to take advantage of growth with other customers in other markets.
And at the same time we are growing our share of programs in Class A trucks. These are programs that have very long lead time. So we have ample visibility into the revenue rank up there.
And then we have a third question, what does it mean when your factory is at 60%?
That percent refers both to the percent of employees that are back at work, as well as the factory's ability to meet demand. There's a very close relationship between those two. So at the end of next week, we anticipate that approximately 25% of employees of our East China factory will have passed the 14 day quarantine period and they will be allowed to work which brings the factory percentage up from the current 60% to 85%.
That's important to note that we do have other ways to meet our customers' orders. Just because our factory is operating at 60%. And we can ship out of inventory or in some cases, we've got other production options.
Okay. Operator, do we have any callers, questions?
So far, I do not have any questions from the phone line.
Okay. It appears that we have no further webcast questions. So I'd like to turn the call back to Gus for closing remarks. Thanks.
Well, thanks, everyone for joining us this morning. As you've heard, we're very carefully monitoring and responding to the impact of the coronavirus on our business. While at the same time we are steadfastly adhering to our roadmap to increase shareholder value by optimizing our portfolio of companies, enhancing execution and keeping our balance sheet strong.
2020 marks Eastern's 163rd year and our 80th consecutive year of paying quarterly dividends. And we look forward to another good year in 2020. Thanks again for joining us and your interest in The Eastern Company.
Thank you. With that, we'll turn the call back to the operator.
Thank you. Ladies and gentlemen, that does conclude today's call. We thank you for your participation. You may disconnect at this time and have a great day.