Eastern Company (The)

Greetings and welcome to the Eastern Company's first quarter fiscal year 2023 earnings call. At this time all participants are in listen only mode and a question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. Please note, this conference is being recorded. I will now turn the conference over to your host, Mr. Ernie Hawkins. Sir, you may begin.

Good morning, and thank you, everyone, for joining us this morning for a review of Eastern's results for the first quarter of 2023. With me on the call are Eastern's president and CEO, Mark Hernandez, and CFO, Nicholas Flejos. We issued an earnings press release yesterday after the market closed. If anyone has not yet seen the release, I invite you to visit the investors section of the company's website, www.easterncompany.com, where you will find the release under financial news. Please note that some of the information you will hear today here during today's call 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 expenses, 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. We undertake no obligation to review or update any forward-looking statements to reflect events or circumstances that occur after the call. For more information regarding these risks and uncertainties, please refer to risk factors discussed in our SEC filings, including Form 10-K filed with the SEC on March 14, 2023, for the fiscal year 2022, and Form 10-Q filed with the SEC on May 9, 2023. 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. A reconciliation of each of the non-GAAP measures discussed during today's call to the most directly comparable GAAP measure can be found in the earnings press release. With that, I'll turn the call over to Mark.

Thank you, Ernie, and good morning to those who have joined us by phone or participating via the web. It's a pleasure to speak with all of you today. I'm going to begin the call today with some high-level observations about our first quarter performance. Then I'll turn the call over to Nick, who will take you through the detailed review of our financial results. After that, I will come back and share with you many of the initiatives we have underway to improve our operational performance and enhance our return to our shareholders. and the goals of this management team intends to achieve in 2023. When I accepted the appointment as Eastern CEO four months ago, I saw a company with capable people and three promising businesses, each which faced a very challenging market environment. As you know, frequent supply chain disruptions and increases in freight and material costs were the order of the day in 2022. As a result of these severe headwinds, our businesses did not perform to their full potential, and our 2022 financial results suffered. Clearly, we needed to immediately change the way we were running our business. To that end, during the quarter, we undertook thorough review of our businesses, products, and began to implement an action plan consisting of several operational initiatives. We've set quantitative goals for these initiatives and are tracking performance to completion. I'm pleased to report that we began to see initial benefits of these operational improvement initiatives during the first quarter. Inventory declined 11% from the end of the fourth quarter, particularly at ValVac and working capital as percentage of sales declined to 22.1% from 26.1% for the fourth quarter as we flushed out a portion of our lower margin orders from our backlog. Supply chain bottlenecks are easy, and raw material and freight costs are moderated. Our backlog at the quarter end was $72 million compared with $85.8 million as April 1st of 2022 when backlog was artificially inflated because of supply chain constraints that delayed shipments. We continue to see pricing improvements at Velbec, which are resulting in addition of higher margin orders to our backlog. At Velvac, demand remains strong, and we're receiving orders for new products introduced last year to serve several new truck mirror programs and orders on existing programs as commercial vehicle customers get closer to producing at planned capacity. Eberhardt's electromechanical business is gaining momentum and has won sizable orders. Big Three Precision Products is generating increased quote activity and winning awards for returnable transport packaging solutions designed for new automotive model launches, primarily in the electric vehicle space. With that, I'll now turn the call over to Nick.

Thank you, Mark, and good morning, everyone. Net sales from continuing operations increased 5% to $72.5 million from $69 million in the first quarter of 2022, reflecting increased shipments of truck accessories and automotive returnable transport packaging products. Returnable transport packaging sales benefited from new automotive product launches, including several electric vehicle launches. Sales of existing products increased 3.3%, Price increases and sales of new products contributed 1.7% in sales growth for the first quarter when compared to the first quarter last year. New products included various truck mirror assemblies, rotary latches, electronic latches and locks, D-rings, and mirror cams. Gross margin as a percentage of sales was 21%, unchanged from the first quarter of 2022, reflecting improved price-cost alignment and the easing of some raw material and freight costs. Product development expenses were $1.4 million, up $0.2 million, reflecting increased investment in new products at Eberhard and Bellvac. As a percentage of net sales, product development expenses were 1.9% compared to 1.7% for the first quarter of 2022. Selling and administrative expenses were $11.9 million compared to $9.9 million for the first quarter of 2022, an increase of $2 million. $1.8 million of the $2 million year-over-year variance relates to one-time severance expenses associated with the elimination of the COO position and the departure of our previous CEO. The remaining $0.2 million increase reflects higher sales and investments in sales capabilities. Other expense of 0.6 million for the first quarter of 2023 includes 0.4 million reflecting the final working capital adjustment related to the sale of the Greenwald business. Net income from continuing operations was 0.6 million or 10 cents per share compared to 2.7 million or 43 cents per share for the first quarter of 2022. Adjusting for the severance expenses and working capital adjustment net of tax, which totaled $1.6 million, or $0.26 per share, adjusting that income from continuing operations was $0.36 per share. Adjusted EBITDA from continuing operations was $5.5 million compared to $6.1 million for the first quarter of 2022. Net cash provided by operating activities swung $10.4 million to 6.9 million compared to net cash used in operating activities of 3.6 million for the first quarter last year. The improvement reflects reduction in cash used to support working capital, primarily a 7.2 million decrease in inventory. By comparison, in the first quarter of 2022, cash was used to ensure availability of inventory to meet customer demands in light of supply chain constraints. As a result, inventory turnover improved four times compared to 3.2 times for the first quarter of last year. Operating cash flow was used primarily to fund capital expenditures of $1.2 million, repay $4.9 million of long-term debt, and pay dividends of $0.7 million. At quarter end, our net leverage ratio was 2.05, down from 2.76 at the end of the first quarter last year and 2.27 at the end of fiscal 2022. Cash increased 2.9 million to 13.1 million at quarter end. That completes my financial review. I'll now turn the call back to Mark.

Thank you, Nick. Our team strategy falls into four categories. Discipline operations that deliver consistent results, strong commercial business focus, effective capital allocation and utilization, and value-adding acquisition. Our priority this year is to ensure that all facets of Eastern operations, our pricing strategy, cost structure, working capital management, meet profitability and return on invested capital thresholds that each business contributes to building overall shareholder value. As you've heard during the first quarter, we improved working capital significantly to a record low of 22.1% of sales. We're now sharpening our focus on profitability. With operations optimized, we will be in good shape to move forward with the fourth category of bolstering growth through acquisitions. As I mentioned in my opening remarks, our action plan and initiatives we're implementing this year are expected to have a quick impact on the company's financial performance and be apparent in our results in the second half of the year. I'll start with the review of the first category, discipline operations that deliver consistent results. With more efficient operations, we'll be much better positioned to deal with market challenges and in addition to take advantage of growth opportunities. We're scrubbing the cost side of the business, making sure that the cost of goods sold and operating expenses meet internal profitability targets. Let me give you a couple of examples of initiatives we're employing. We're addressing supply chain inefficiencies, reducing lead times from our Asian suppliers, and leveraging nearshoring capabilities. We're also leveraging our Mexico operations to overcome labor shortfalls in the U.S. and taking steps to reduce manufacturing costs. Finally, we've implemented a hiring freeze throughout our businesses, and we're cutting non-essential expenses, looking for ways to realize cost synergies across our three businesses. The second leg of our four-pronged strategy is effective capital allocation and utilization. Here, we're instilling disciplines in our working capital management process to improve utilization and enhance return on invested capital. We're allocating capital expenditures to projects that will generate highest return on investments. As part of our inventory reduction effort, we've calculated aspirational targets for turn rates. And as the great Vince Lombardi once said, perfection is not attainable, but if we chase perfection, we can catch excellence. The third category is a strong commercial business focus. In this area, we're focusing on improving return on invested capital through pricing, actions, and margin disciplines. During the first quarter, we completed an evaluation of the margin of each product as part of our overall portfolio optimization exercise and determined that we're missing opportunities to enhance margins through pricing and that we needed to change our approach. An example, we're engaging in conversations with our customers about contract terms, shifting the conversations to real-time pricing model in order to ensure we're covering costs driven by macroeconomic pressures. Going forward, bids on new business must meet predetermined return on invested capital and return on sales targets. We are also leveraging business growth opportunities from automotive sector in Mexico and the uplift opportunity led by the Australian off-road and commercial vehicle markets. We're pursuing activities to reduce lead times by 50% in our mold business. Finally, our strategy contemplates value-added acquisitions. As we work to bring Eastern's debt to EBITDA ratio down, we will continually be on the lookout for companies that fall into two different categories. Those that can be absorbed in one of our existing divisions to complement operations, and second, those that will be added to the Eastern level and operated separately. Either way, we'll make sure that they augment income, EBITDA, return on capital employed, return on invested capital before we pursue them. In summary, I want you to take away from my remarks today is that we're focused on execution and creating value for our stakeholders. While we have many initiatives in process, we're not yet at a stage where we're prepared to share with you forward financial metrics. What I can share with you, however, is, in my view, what defines a successful automotive OEM supplier, which is our ambition for Eastern. Based on my 30-plus years in commercial vehicle space, I learned that successful OEM suppliers proactively respond to changes in cyclical demand while returning 10 to 12 percent return on sales and working capital to sales ratios of less than 22 percent. In addition to focusing on execution, I want to bring cohesion and commonality to our organization. We can do that by sharing best practices and ideas across businesses and locations, crafting sets of common methods, and optimizing processes in the pursuit of perfection. As a leader, I believe working together in a collaborative manner, reaching out to our employees for input, and then making decisions expeditiously and executing on those decisions. I'm asking employees to make changes in their business practices, and I appreciate that this can be unsettling to an organization. Having said that, I'm seeing employees adopt these new business practices openly, and I sincerely want to thank them for accepting the challenge and working together to optimize Eastern operations. Finally, as you know, improving business is not a race with a finish line. It's an ongoing, continual process. No industry is static, and customer needs are always changing. Unlike the baseball game bound by the rules Today for a nine inning game as successful business is an infinite game where we're not only playing Today's game by today's rules, but we're looking forward to anticipate how the rules may change tomorrow We continue to engage Because we like to play the game and the better we get at playing the game the better our results will be in the long term With that I'd like to open up the floor for questions Thank you, okay

Go ahead.

Sorry, sir. Thank you. At this time, we will be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue, and you may press star 2 if you would like to remove the question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions.

Okay, we do have a few questions submitted via the web, and we'll go over those now. First question, why did operating income adjusted for one-time expenses decline quarter over quarter?

I'll take that. In the first quarter, we took a challenge of reducing working capital and lowering our working capital ratios. This action had additional effects. primarily around capitalized free. The reduction of inventory within recovering logistics market caused us to recognize this value as an operational loss of income. The long-term logistics market is stabilizing and will minimize the effect going forward.

Okay, second question. How much improvement in gross margin do you think is possible in 2023?

Well, I can't give you an exact answer, but through our strategy, we intend to return historical margin performance to Eastern.

And last question from the web. How should I measure success for Eastern in 2023 and longer term?

Well, I look at the longer term in 2023 in this way. Consistent and stable results quarter by quarter is our first objective. solidifying EBITDA and return on invested capital. In the future, it will be driven by EBITDA growth with solid underlying metrics.

Any other questions?

Okay.

Operator, do we have any other questions on the line? Yes, sir. We have a question from Ross Davidson with Banneton Capital. Sir, you may go ahead.

Hi, Mark and Meg. Thanks for taking that question. Actually, a quick follow-up on something you just said. Did you just explain a little bit more? You said there's, I think you said, capitalized freight costs that were more sort of one time in nature as you clean things up, but they're in SG&A. Is that where they are?

No, they're in cost of goods sold. And what happens is when the freight rates coming from Asia, particularly the container costs were over $10,000 per container, where we normally see about $3,000 per container, the freight gets capitalized at the higher level. Therefore, when we reduce inventory, we have to reduce at the higher level, which hits our income, reduces our income. Okay.

Yeah. Okay. That makes sense. Sorry. Thanks for clarifying. And then the other question I wanted to ask was just around the growth rate. So Q1's growth rate and revenue specifically decelerated as a percentage compared to say Q4 or just all of last year. And it wasn't just price. It looks like volume decelerated too. Anything going on there that you could sort of provide some color around kind of what's leading to the slowdown? You're obviously still seeing growth. I'm curious if there's sort of underlying dynamics, especially since It sounds like things are still pretty robust in terms of demand and wind across the business.

Yeah, last year we were fighting the headwinds. We're heavily into commercial vehicles. We're fighting the headwinds as the commercial vehicle companies try to produce, but they were unable to, the supply chain constraints. Now those constraints are somewhat freed up, but the incremental, the organic growth is not 10%. We're looking at potential growth in revenues of 3% to 4% throughout this year

Yep. Okay.

That makes sense. Thanks so much. I appreciate it.

Thank you.

We currently have no further questions in queue, so I'll hand it back to Mr. Hernandez for any closing comments he may have.

Thanks again for joining us today. To sum up today's discussion, I'm confident that our determined focus on disciplined operations, optimal capital utilization, focused commercial business and value-adding acquisitions will bring positive changes and improve results in 2023 and put us on a path for sustained growth. Our markets have many favorable trends we can leverage, and we look forward to sharing our progress with you after the second quarter.

Thank you. This concludes today's conference and you may disconnect your lines at this time. We thank you for your participation.