The Eastern Company (NASDAQ:EML) Q2 2022 Earnings Conference Call August 8, 2022 11:00 AM ET
Company Participants
Nicholas Vlahos – VP of Finance, Treasurer, & Secretary
Gus Vlak – CEO
Peter O’Hara – CFO
Conference Call Participants
David Cohen – Minerva Advisors
Operator
Good day, ladies and gentlemen, and welcome to the Second 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, Nicholas Vlahos, Vice President of Finance, Treasurer and Secretary. Sir, the floor is yours.
Nicholas Vlahos
Good morning, and thank you everyone for joining us. 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 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. 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 5, 2022 and any 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 Eastern’s performance. These non-GAAP measures should be considered in addition to and not as a substitute 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 available on our website at www.easterncompany.com under the Investor Information tab.
With that, I’ll turn the call over to Gus for opening remarks.
Gus Vlak
Thanks, Nick, and good morning to those who have joined us on the phone and those participating via the web. We released Eastern’s second quarter numbers on our Form 10-Q yesterday afternoon. And before Peter reviews the detailed results with you, I’d 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 $69.5 million in the second quarter of 2022, that’s an increase of 14% over the second quarter of 2021. And it’s another quarterly sales record this year over Eastern 164 year history. Customer orders were strong and importantly, our backlog at the end of the second quarter was $82.8 million stable from where it stood at the end of the second quarter of last year as well as the beginning of 2022. 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 remains well positioned for the anticipated growth in returnable packaging over the remainder of this year and beyond as the pace of new vehicle launches accelerates. Sales from our returnable transport packaging products grew nearly 47% in the quarter compared to the prior year. At the same time, sales of our recently launched truck mirror programs continue to gain momentum, as truck builds for these programs ramp up. According to FTR Transportation Intelligence, demand for new Class A trucks is expected to remain robust into 2023.
Now while raw material cost increases began to moderate for certain key commodities in the second quarter, we continue to operate at a much higher material cost structure than in prior years. We also still experience ongoing labor shortages and supply chain constraints. As such, we remain focused on the need for price adjustments across all of our businesses, most of which took effect towards the latter half of the second quarter and in the beginning of the third quarter of 2022. We expect to see the ongoing benefits of these actions and we’ll start to take more full impact in the third quarter.
We have clearly sustained a momentum from last year with strong sales, a healthy pipeline and growing end markets. These results reflect solid execution by our teams, and we’re well positioned to finish 2022 in record territory. That said, we’re not ignoring the macroeconomic warning signs that are out there, global inflationary pressures and the reaction of the central banks across the world may trigger a natural cyclical contraction. and we will be prepared.
For example, we’re focused on our efforts on inventory production opportunities, inventory as you know, increased in part for a couple of reasons, including protracted supply chains from China and the desire to protect sales during the pandemic and aftershocks with greater safety stocks. And general inflationary cost increases that are also capitalized when the product remains on hand.
All that said, we’re looking for every opportunity to reduce inventory and have two focused teams at our Velvac and Eberhard operation, the largest consumers of our inventory due to the structure of our business to review each of their overall supply chains for opportunities. At the same time, we’re establishing very specific plans at each of our businesses for operating cost reductions should we see certain factors change in a market. At this time, our order intake and backlog across most of our businesses do not suggest the need to deploy these plants on a companywide basis, but we’re going to remain vigilant and ready for such a scenario.
Finally, I think it’s important to stress that our balance sheet remains solid. Our liquidity continues to improve demonstrated by a very strong current ratio of 3.0 times for the second quarter of 2022. We were also able to deploy capital in order to repurchase over 29,000 shares of common stock in the quarter. Moreover, we believe that we’re prepared for a rising interest rate environment with over 50% of our term debt locked in at fixed interest rates through an interest rate swap agreement.
With that, I’ll hand it over to Peter to take you through the detailed commentary on the second quarter results.
Peter O’Hara
Thank you, Gus, and good morning to everyone who is on the call today. My remarks this morning will focus on Eastern’s results for the second quarter of 2022. For the quarter, net sales increased 14% to $69.5 million from $61.2 million a year earlier. Sales increased primarily due to the increased demand for truck accessories and automotive returnable transport packaging products as well as from distributors.
Our returnable transfer packages sales have continued to benefit from an increase in upcoming new automotive launches, including several electric vehicle launches. The effect of volume on existing products increased net sales by 9.3% year-over-year while price increases in new products contributed to the initial 4.2%. Price increases primarily reflected our efforts recover increases in raw materials and freight costs.
Gross margin as a percent of sales was 23% in the second quarter of 2022 broadly in line with the prior year. As Gus outlined, we have worked with our — many of our major customers to agree upon new pricing, that took effect towards the latter half of the second quarter and the beginning of the third quarter of 2022. We expect those increases will continue to have a more fuller effect in the third quarter and beyond.
Product development costs increased $100,000 or 12% in the second quarter — decreased 100,000 or 12% in the second quarter of 2022 compared to the second quarter of 2021. As a percent of net sales, product development costs were 1.4% for the quarter compared to 1.8% in the second quarter of 2021.
Selling, general and administrative expenses increased $800,000 or 8% 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 reflects both the impact from increased sales as well as strategic investments we have made in our sales capabilities.
Net income from continuing operations for the second quarter of 2022 was $3.7 million or $0.59 per diluted share compared to net income of $2.8 million or $0.44 per diluted share in the prior year. As reflected in the supplemental financial information of our press release, we did not have any adjustments for events outside of our ongoing operations during either the second quarter or for that matter the second quarter of the prior year.
Adjusted EBITDA from continuing operations for the second quarter was $7.2 million compared to $5.8 million in the second quarter of 2021, that represents a 24% increase in EBITDA year-over-year. In terms of operating cash flow, the company generated approximately $1.1 million in cash from continuing operations during the second quarter of 2022 compared to generating approximately $3 million in the second quarter of the prior year.
In the second quarter of 2022, cash flow was impacted by an increase in working capital, principally resulting from the settlement of payables associated with the build of inventory during the first quarter of 2022. The effect of COVID-19 pandemic and related recent shutdowns in China continue to adversely impact our supply chain and as a result, inventories increased in the first quarter and largely remained at those levels for the second quarter as well. As of July 2, 2022, we held cash and cash equivalents of approximately $7.2 million.
And with that, I’ll now turn the call over to Nick.
Nicholas Vlahos
Thanks, Peter. Operator, I’d like to open the line for questions. I do see that we ask some questions on the webcast and we’ll address those questions first. And then, we’ll turn the questions over to the operator for the ones on the phone.
Question-and-Answer Session
A – Nicholas Vlahos
What is your view on the likelihood and impact of an economic downturn?
Gus Vlak
So we’re monitoring demand in our backlog very closely and not just demand by our customers, but also the demand in many of the end markets or demand by their customers and while it remains strong right now and our backlog is very solid. As I mentioned earlier, we have begun to prepare plans so that we can respond very quickly, if we see any softening in any of our end markets.
Nicholas Vlahos
Thank you, Gus. The next question is, what is the direct impact of increasing interest rates on the Eastern Company?
Peter O’Hara
We’re fortunate that over half of the $78 million of financial debt that we have on the balance sheet currently was swapped from floating to fixed at origination. And that means that the impact from an increase in the interest rates in our monthly interest payments is now muted.
Nicholas Vlahos
Thank you, Peter. For the next question, when do you expect to sell Argo?
Gus Vlak
As you’ll recall, we report Argo as discontinued operations, while we continue to evaluate options to maximize its value. With the current dynamics in the market for printed circuit board assembly, orders are really good asset and the business reported strong sales and earnings in the first half of 2022. So as we explore these options, we are committed to make sure that we maximize the value of Argo for our shareholders.
Nicholas Vlahos
Thank you, Gus. The next question is, what are your near-term plans for M&A activity?
Peter O’Hara
We remain committed to complete multiple accretive bolt-on acquisitions. However, in the current environment and more specifically with the risk of an economic downturn, we believe that we may be great through future acquisition opportunities. And so we continue to actively look at potential near term transactions. While we continue to look at near term transactions such as say, we’re also primarily focused on using those excess funds to strengthen our balance sheet by reducing our debt.
Nicholas Vlahos
Thank you, Peter. The next question we have is year-over-year price increases have been 2.5%, which is well below inflation. Does the company have plans to increase prices further to restore margins?
Gus Vlak
Thank you. So the 2.5% price increase reflects the entirety of all price increases over the entirety of all our sales. Now a lot — now the price increases are — we only take price increases on recurring sales. So these are products that we sold last year and are selling again this year. A big part of our volume is new products and we will — you won’t see any price increases on that because those are priced or repriced each time we sell them or they are the launch of new programs that came in since the prior year. So that 2.5% is the entirety of the price increase, but over a much larger sales volume.
Peter O’Hara
If I may add to that as well, the price increases principally happened in the back half of the second quarter. And so the 2.5% is a measurement of just really kind of the entire quarter, but the increase is occurring only in the second half of that, the latter half of that.
Nicholas Vlahos
Thank you, Gus and Peter. For the next question, can you speak to the expected margin cadence for Q3 and Q4 given price and actions?
Gus Vlak
So generally, we continue — we expect margins to continue to expand into Q3 and into Q4. And we see no reason why we could not bring our gross margins back to the margins that we held in 2019. There is nothing structural about our business that would prevent us to do that. I’m not going to forecast where we will be by Q4, but I do believe that we will get there.
Nicholas Vlahos
Thank you, Gus. We have no more questions online. Operator, do we have any questions?
Operator
Ladies and gentlemen, the phone lines are now open for questions. [Operator Instructions] Your first question for today is coming from David Cohen. Please announce your affiliation, then pose your question.
David Cohen
Hi. Minerva Advisors. Good morning, guys. My question relates to the working capital accounts for obvious reasons, they grew meaningfully during the first half, I think about $14 million or $15 million of incremental working capital. I’m wondering what sort of expectations you’d like to provide about the trend in the second half and when might we be able to start to release some funds from the working capital? Thanks.
Nicholas Vlahos
Thank you, David.
Peter O’Hara
As Gus outlined in his discussion, we’re very focused on looking for opportunities to reduce inventory at the company and that’s going to be the major consumer of working capital overall. At this time, I don’t think we’re going to be able to give you guidance as to exactly the amounts and the timing of when it will come down. But I can tell you, it’s a project focused internally within the company.
Nicholas Vlahos
Thank you, Peter. Operator, do we have another question online?
Operator
There are no questions in queue at this time.
Nicholas Vlahos
Okay. Thank you. We see no other questions on webcast either. So with that, I’ll turn the call over to Gus for closing remarks.
Gus Vlak
Thank you, Nick, and thanks, everyone for joining us this morning. We’re pleased with the continued acceleration in demand for our products and services across all of our businesses. The strength of our backlog provides a great deal of comfort and confidence, they will sustain growth across our businesses in the coming quarters. Supply chain and inflation related pressures aside we’re optimistic about the remainder of this year and our longer term future.
Over the last year, our team has become increasingly effective at managing supply chain pressures and volatile raw material costs and has driven 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 share a great deal of optimism and urgency to show you what we’re truly capable of delivering.
Nicholas Vlahos
Thanks, Gus. With that, I’ll hand the call back to the operator.
Operator
Thank you, ladies and gentlemen. This does conclude today’s conference call. You may disconnect your phone lines at this time and have a wonderful day. Thank you for your participation.
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