Earnings Call Transcript - EML Q4 2022

Operator, Operator

Greetings, and welcome to The Eastern Company's Fourth Quarter Fiscal Year 2022 Earnings Call. At this time, all participants are in a listen-only mode, and a question-and-answer session will follow the formal presentation. It is now my pleasure to turn the conference over to your host, Mr. Ernie Hawkins. Please go ahead.

Ernie Hawkins, Host

Good morning, and thank you to everyone for joining us. Speaking today will be Eastern's President and CEO, Mark Hernandez; and our CFO, Nicholas Vlahos. 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 and 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 revise 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 Form 10-K for the fiscal year filed with the SEC on March 14, 2023, and our other filings with the SEC. In addition, during today's call, we will discuss non-GAAP financial measures that we believe are useful as supplemental measures of The 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 measures can be found in the earnings press release available on our website at www.easterncompany.com, under the Investor Information tab. With that, I'll turn the call over to Mark for opening remarks.

Mark Hernandez, CEO

Thanks, Ernie, and good morning to those who have joined us on the phone and those participating via the web. We released Eastern's fourth quarter and full year 2022 numbers in our Form 10-K yesterday afternoon. Before I get into the financial figures, I would like to introduce myself to our shareholders and investor community. I have been in the commercial vehicle industry for 29 years, mostly manufacturing trucks under the Freightliner international brands as well as managing supply chain operations in those brands. I am well positioned to understand the dynamics of the companies that make up The Eastern Company, especially after serving as an Independent Director on the Board. After a thorough analysis of working capital, return on invested capital, onshoring and other key ratios, The Eastern Company is positioned for solid operating results and future growth. Of course, our greatest asset is our people, and they are the team that will deliver the results. So that is one of my key areas of focus along with solid operating performance. Prior to Nick's review of the detailed results, I would like to take a few minutes to reflect on the year. 2022 represented a year of continued transformation and focus on our operations for long-term growth and shareholder value creation. Each of our businesses experienced varying degrees of instability due to freight bottlenecks and cost fluctuations for freight and raw materials. Our team continued to execute in a very challenging market environment. All of our businesses experienced supply chain disruptions and increases in freight and raw material costs. We were able to partly offset these costs through timely price increases and cost recovery actions. We also reduced late deliveries through active sourcing and supply chain management and ended 2022 with working capital as a percentage of sales of 26.1% compared to 27.2% at the end of 2021. We were also able to divest our last remaining non-core business, Argo EMS, which will allow us to focus on our core capabilities and offerings. In all, I believe our execution in 2022 underscores the quality of the leadership team we have built. Nick will now take you through more detailed commentary on the fourth quarter and full year results.

Nicholas Vlahos, CFO

Thank you, Mark, and good morning to everyone who is on the call today. For the fourth quarter of 2022, net sales from continuing operations increased 16% to $69.1 million from $59.6 million in the fourth quarter of 2021. Sales increased primarily due to higher demand for truck accessories, distribution products and automotive returnable packaging and improved pricing. Sales volumes of existing products increased 10.5%. Prices and new products contributed 5.3% in sales growth in the fourth quarter of 2022 when compared to sales in the fourth quarter of 2021. New products included various truck mirrors, latches, and accessories. For the full year 2022, net sales from continuing operations increased 13% to $279.3 million from $246.5 million in 2021. Gross margin as a percentage of sales for the fourth quarter of 2022 was 17% compared to 20% in the prior-year fourth quarter. The decrease reflects the combination of higher material, freight costs, and other inventory write-offs. Gross margin for the year as a percentage of sales was 21% in 2022 compared to 23% in 2021. Product development expenses in the fourth quarter of 2022 were $1.1 million, which were flat when compared to the fourth quarter of 2021. As a percentage of net sales, product development expenses were 1.5% compared to 1.7% in the fourth quarter of 2021. These expenses are primarily related to our investment in new products at Eberhard and Velvac. Selling and administrative expenses in the fourth quarter of 2022 increased 1.1% when compared to the fourth quarter of 2021. The increase was primarily the result of increased payroll and payroll-related expenses, increased travel, and other selling expenses. Restructuring expenses of $0.7 million were recognized in the fourth quarter of 2022 due to warehouse consolidation in Eberhard. Net income from continuing operations for the fourth quarter of 2022 decreased to $0.2 million or $0.03 per diluted share from $3.9 million or $0.62 per diluted share in 2021. For the fourth quarter of 2022, net income was negatively impacted by restructuring costs of $0.5 million net of tax related to a warehouse consolidation into Eberhard. For the full year 2022, net income decreased 32% to $11.1 million or $1.77 per share from $16.2 million or $2.58 per diluted share. Adjusted EBITDA from continuing operations for the fourth quarter of 2022 was $3.3 million compared to $5.7 million in the fourth quarter of 2021. Adjusted EBITDA from continuing operations for the full year decreased 9% to $24.3 million from $26.7 million in 2021. Finally, a quick summary of cash flow and balance sheet highlights. For 2022, net cash provided by operating activities was $7.3 million compared to $7.8 million net cash used in operating activities in 2021. In 2022, we contributed $0.2 million to our defined benefit retirement plans. During 2022, cash used to support additional working capital requirements was $5.2 million, which was primarily due to management's focus on ensuring the availability of inventory to meet customer demands during current supply chain constraints. In 2021, cash used to support additional working capital requirements was $22.9 million. Total capital expenditures for 2022 were $3.4 million, and we expect capital expenditures in fiscal 2023 of approximately $6.9 million. In 2022, the company made total debt payments of $17.5 million, of which $10 million was a repayment of the $10 million drawn under the revolving credit facility during 2022. As of December 31, we had cash and cash equivalents of $10.2 million. Our net leverage ratio at the end of 2022 was 2.27, down from 2.46 at the end of fiscal 2021. With that, I'll turn the call over to Ernie for questions.

Ernie Hawkins, Host

Thanks, Nick. Operator, I'd like to open the line for questions. I see that we have some questions from the webcast. We'll address those questions first and then turn to questions on the line. So, our first question is how does the change in management affect Eastern's overall strategy?

Mark Hernandez, CEO

I'll take that one, Ernie. We maintain our commitment to organic growth and acquisitions. In the short term, we plan to focus on people, processes, and systems to improve our operations.

Ernie Hawkins, Host

Okay. Our next question, what is your view on the likelihood and impact of an economic downturn?

Mark Hernandez, CEO

We are monitoring demand closely and not just demand by our customers, but also demand by their customers. Right now, demand remains strong. Industry forecasts for many of our markets remain strong and our backlog is solid. Despite these encouraging signs, we know how fast conditions can change on us. We began to prepare our plans so that we are ready to respond quickly if we see any softening in our end markets. We have eliminated all non-essential travel, hiring, and other discretionary expenses.

Ernie Hawkins, Host

Okay. Another question. How is Eastern reacting to the recent turmoil in the banking system and continued increases in interest rates?

Nicholas Vlahos, CFO

Sure. During our loan syndication process, we perform credit reviews of the banks that we want to engage with. We also maintain redundancy in banks for operating accounts. Over 60% of our $64 million of outstanding debt is covered by an interest rate swap agreement, which minimizes the impact of rising interest rates.

Ernie Hawkins, Host

Okay. Another question. Can Mark describe his experience and how it's relevant to operational excellence and getting margins up? And what are his immediate plans in more detail?

Mark Hernandez, CEO

So, like I said in my introduction, I spent 29 years in commercial vehicles. And if you look across our three companies, they're all tied to commercial vehicles in some sense from Eberhard as a direct OEM supplier, as well as Velvac being a direct OEM supplier and also running supply chain. So, I understand the returnable racks situation. My time at McKinsey has taught me to deal with the facts on the table and the ratios that are in front of us so that we can improve our operating performance going forward, which means that we may have to make tough decisions, but we have to always keep our eye on the numbers and how to move them forward. Being a lean manufacturing expert, I would say that there are ways of doing that that don't necessarily involve people, but they may need to involve people at some point.

Ernie Hawkins, Host

Okay. Another question. From a 30,000-foot perspective, can you please comment on your strategy going forward for each of your core businesses? It appears that your focus is now much more on organic growth. Now that your divestitures are complete, wouldn't now be a good time to start seeking acquisitions to build scale in these businesses?

Mark Hernandez, CEO

Yes. Along with my background, one of the things I came in and did was a complete analysis of the companies and where we are with our current holdings, and looking at each business opportunity and where we're not cost effective on some of our offerings as well as increasing our price margins so that we can make sure that our ratios are aligned with our operating results.

Ernie Hawkins, Host

Okay. Very good. Okay. Operator, do we have any further questions on the line?

Operator, Operator

Yes, sir. We have a question from Ross Davisson with Banneton Capital. Please go ahead.

Ross Davisson, Analyst

Hey, good morning. Thanks for taking the question. I wanted to ask about gross margin specifically. There was a big step down, obviously, both from the prior year, but also even larger sequentially. I was hoping you could provide some more detail on kind of what are the moving pieces there and kind of what led to that change?

Nicholas Vlahos, CFO

Yes. So, we continue to see increases in material and freight costs that have not completely flushed through the inventory of the P&L yet. This is more of a timing issue from a capitalization of the inventory. In addition to that, we recorded some inventory adjustments in Q4 to adjust our inventory to our actions.

Ross Davisson, Analyst

Okay. Thanks. And are you able or willing to quantify how much was that? It sounds like a one-time adjustment.

Nicholas Vlahos, CFO

We cannot quantify that right now.

Ross Davisson, Analyst

Okay. And just stepping back more generally, obviously, raw materials have been volatile, I guess is an understatement. Reflecting on the year and maybe year-to-date, do you feel like Eastern, across its different businesses, has been able to and successful in recovering those changes, albeit with a lag?

Mark Hernandez, CEO

Yes, that's, except in the commercial vehicle industry, something we deal with in a cyclical business, especially when indices change. In some cases, we were very aggressive in getting our cost recoveries. But in other cases, we probably weren't as strong as we needed to be. Going forward, though, we will be looking at what is reasonable based on indices as well as freight indices going forward to make sure that we're covering our costs and we're not seeing increases in the cost of goods sold or other aspects of our businesses.

Ross Davisson, Analyst

Thanks for that insight. Looking ahead, I'm curious about your perspective on the gross margin from this quarter being lower than expected. Is there a shift in the business model, or do you believe the historical gross margin rates are still the benchmarks moving forward?

Nicholas Vlahos, CFO

Yes, we do expect to get back to our historical gross margin rates. It was more of a timing issue than anything in the past year.

Ross Davisson, Analyst

Okay. And then just last question, just switching gears. Obviously, there's a lot of activity around new platforms with the OEMs, with the EVs. I was hoping you could comment sort of what are you seeing? And do you feel like you're getting your share as that business evolves towards new platforms?

Mark Hernandez, CEO

So, we're participating with the OEMs and their development of their transport electrification. As the heavy-duty over-the-road trucks become more and more relevant to the electrical vehicle space, air drag is going to be very significant. So, we participate very favorably in those bid processes with the OEMs to help them with the transition. I feel we're well positioned to be a strategic partner with the OEMs as they develop their over-the-road vehicles.

Ross Davisson, Analyst

Okay, great. Well, thanks, Mark. Thanks, Nick. I appreciate it.

Operator, Operator

Thank you. We have a question from an unidentified analyst, who is an investor. Please go ahead.

Unidentified Analyst, Analyst

Good morning, Mark, and I wish you as a large shareholder the best of luck. But I have two questions. Number one, with freight costs getting back to somewhat normalcy, even though you just stated that they weren't completely, and supply chain restraints as well getting back, you were handed the baton on January 10 of this year, and it looked to me as a stakeholder that the previous management team was a train wreck in regard to the third and fourth quarter of this year. I'd like to know how you're going to approach getting Eastern back to where it should be.

Mark Hernandez, CEO

Hello, Roger. We need to concentrate on our operating performance, which involves analyzing our SG&A and cost of goods sold to ensure they align with our expected sales ratios, return on sales, and return on invested capital. Freight costs have only recovered around 30%, but we are looking ahead. We are assessing the margin, pricing, and cost aspects simultaneously; we cannot prioritize one over the others. Cutting spending at this moment is essential as we navigate this transition period in 2023. I recognize that the demand in the commercial vehicle market remains strong. Therefore, as we implement our plans, we aim to optimize both the pricing and cost areas of the business to restore our margins to the necessary levels.

Unidentified Analyst, Analyst

Okay. So just a follow-up question. I'm sure that management, Board of Directors, and everyone is not proud of what's going on with the common stock today on NASDAQ. I'm certainly not. And I'm not trying to be negative, but it appears to me that I'm hoping that the fourth quarter expense side is pretty much cleaned up and won't carry forward into the first and second quarter of 2023. And that would be a hope, and I wonder if somehow you could try to answer that question.

Nicholas Vlahos, CFO

Unfortunately, that's providing future guidance, and we don't provide future guidance for that, Roger.

Unidentified Analyst, Analyst

Okay. Well, once again, best of luck, and I'm just hopeful that the company is not mirroring what the stock is, down almost 20%, 22% today. So, we look forward to better reports by the new management, you and Nick, and let's get this football team going once again. Thank you.

Mark Hernandez, CEO

Thank you.

Operator, Operator

Thank you. As we have no further questions in queue at this time, I will hand it back to Mr. Ernie Hawkins for any closing comments you may have.

Ernie Hawkins, Host

Okay. So, with that, I'll turn the call over to Mark for closing remarks.

Mark Hernandez, CEO

Thanks, everyone, for joining us this morning. We are pleased by the continued acceleration in demand for our products and services across all our businesses. The strength of our backlog provides us with a great deal of comfort and confidence that we will 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 longer-term future. Over the last year, our team has been increasingly effective at managing supply pressures and volatile raw material costs and have driven drastically 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 sense of optimism and urgency to show you what we are truly capable of delivering.

Ernie Hawkins, Host

Thanks, Mark. With that, I'll hand the call back to the operator.

Operator, Operator

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