August Vlak - CEO and President John Sullivan - CFO and VP.

Analysts:.

Good day, everyone, and welcome to The Eastern Company’s Third Quarter Fiscal Year 2017 Earnings Conference Call. Today’s call is being recorded. [Operator Instructions]. At this time for opening remarks and introductions, I would like to turn the call over to Mr. Chris Molten [ph], Head of Corporate Development and Investor Relations for Eastern.

Please go ahead, Chris..

Thank you. Good morning, and thanks everyone for joining us. Speaking first today is Eastern’s President and CEO, Gus Vlak; and CFO, John Sullivan. And after that, we’ll open the call to questions from participants.

Please note that some of the information you will hear during our discussion today will consist of forward-looking statements of 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 the risk factors discussed in Eastern’s most recently filed periodic reports on Form 10-K and Form 10-Q and the Form 8-K filed with the SEC yesterday, along with the associated press release.

Eastern assumes no obligation to update any forward-looking statements or information which speak as of their respective dates. Discussions during the call will also include certain financial measures that were not prepared in accordance with U.S. generally accepted accounting principles.

Reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures can be found in our earnings release, issued yesterday, and in our Form 8-K filed yesterday with the SEC. You may obtain a copy of the 8-K and our earnings release on our Web site at easterncompany.com.

Any non-GAAP measures presented or not and should not be viewed as substitutes for financial measures required by U.S. GAAP. I’d now like to turn the call over to Gus for introductory remarks..

Thank you, Chris, and good morning and thank you for joining us on our first quarterly earnings call. We’re starting these calls to offer our investors another way to get the financial information that we currently report in our periodic filings and to create more opportunities for our investor to ask us questions.

Today’s call will focus on the results for the quarter and the nine months through September 30, 2017. In the past quarter, we generated earnings of $0.35 per fully diluted and for the first nine months of the year, we generated earnings of $0.83 per fully diluted share. These earnings are chiefly the result of four factors.

First, on April 3 this year, we completed the acquisition of Velvac for $39.5 million plus an earn-out which is contingent upon Velvac achieving certain minimum earnings levels.

Velvac is a premier designer and manufacturer of proprietary vision technology, primarily for leading original equipment manufacturers in the heavy-duty and medium-duty truck, motorhome and bus markets.

We believe that the acquisition has had a significant impact on our overall performance and Velvac’s mirror and camera business performed well this year in part due to strong demand for RVs and the recent increase in Class 8 truck production.

The second factor that’s driven our results is the continued strong performance of our core businesses, excluding Velvac. We believe that our core businesses are fundamentally sound. Our Industrial Hardware business grew sales by 12% in the third quarter over the prior period, excluding Velvac.

And our Security Products business and Frazer & Jones both delivered strong top line growth. Sales at Frazer & Jones have benefitted from a recovery in coal mining which is largely attributable to increases in natural gas prices and easing of environmental regulations, both of which created an increase in the demand for mine-related products.

A third factor that’s affected our results so far this year is the $2.2 million in accelerated engineering investments, primarily related to new product development in the first nine months of this year. These investments represent our strong commitment to the development of technology vision products at Road-iQ, which is a division of Velvac.

Road-iQ is a connected vehicle technology that integrates up to seven cameras and a video processor into a unique telematics server platform which provides both active and passive safety to drivers of RVs, trucks and other specialty vehicles.

We acquired Road-iQ with Velvac and fast tracked the development of these products and we expect to launch the latest version of Road-iQ at the National RV Trade Show at the end of this month, and we’re excited about its prospects. In addition, our team at Greenwald Industries has been working on a product which we call gPay.

gPay is a mobile payment solution for the commercial laundry industry that’s great for consumers and for laundry facility operators. gPay allows consumers to pay for their laundry over the phone. And based on the feedback we’ve received from laundry operators, it’s extremely easy to install.

A fourth factor, we also incurred $2.5 million in one-time costs in the first nine months of this year. These costs primarily relate to the acquisition of Velvac and we incurred most of them in the second quarter. Together, these nonrecurring costs affected our earnings by approximately $0.28 per share.

In sum, the acquisition of Velvac and the related one-time expenses, our ongoing investments in product development and the strong growth of our core businesses have driven our performance so far this year. I’ll return later on this call to talk more about our future, but I’ll turn it over right now to John to share our detailed financial results..

Thank you. I’ll now share with you the results of the third quarter of 2017. Overall, sales in third quarter of 2017 increased 67% when compared to the third quarter of 2016. Sales volume of existing products, which include the sales of Velvac products, increased by 61% in the third quarter of 2017 compared to the third quarter of 2016.

The third quarter of 2017 was favorably affected by the introduction of new products which increased sales by 6%. Sales in the Industrial Hardware segment increased by 117% in the third quarter of 2017 when compared to the third quarter of 2016, primarily as a result of sales generated from the Velvac acquisition.

Excluding Velvac sales in the third quarter of 2017, sales in the Industrial Hardware segment increased 12% when compared to the third quarter of 2016. Sales of new products in the Industrial Hardware segment included Class 8 truck tumbler paddles, latch brackets, and panels.

Net sales in the Security Products segment increased 18% in the third quarter of 2017 and increased 6% in the first nine months of 2017 compared to the respected corresponding periods of 2016. The increase in sales in the third quarter of 2017 was primarily a result of introduction of new product in the vehicle lock market.

Sales of new products included locking kits for the motorcycle market and connecting rods for the vehicle market. Sales increased 50% in the Metal Products segment when compared to the third quarter of 2016. Sales of the new products in the Metal segment included numerous types of pipe and gas fittings for the oil, water and gas industries.

Sales for the first nine months of 2017 increased 45% compared to the corresponding prior year period, primarily as a result of the Velvac acquisition. Excluding Velvac, sales for the nine months ending September 30, 2017, sales in the Industrial Hardware segment increased 13% when compared to the first nine months of 2016.

Sales volume of existing products, which include the sale of Velvac products, increased by 40% in the first nine months of 2017 compared to the first nine months of 2016.

The results of the nine months ending September 30, 2017 were favorably affected by the introduction of new products which increased sales by 5% as compared to the nine months ending October 1, 2016.

The Industrial Hardware segment sales increased 83%, Metal Products segment sales increased 45% and Security Products segment sales increased 6% as compared to the first nine months of 2016. For our three months ending September 30, 2017, gross margin was 21% compared to 28% for the comparable period of 2016.

The decrease was primarily the result of the Velvac acquisition, shift in product mix and rising material costs. The gross margin was 24% in the third quarter of 2017, when you exclude Velvac. Gross margins for the first nine months of 2017 were 24% compared to 25% for the prior year period.

In general, raw material prices increased in the first nine months of 2017 compared to 2016 and are expected to increase during the fourth quarter of 2017. We seek to recover these costs through price increases when possible. Cost reduction in components along with manufacturing efficiencies helped to minimize the impact of commodity price increases.

For the three and nine months ending September 30, 2017, engineering expenses as a percentage of sales was 3% compared to 2% for the comparable period of 2016. This increase was primarily due to the Velvac acquisition.

Selling and administrative costs increased 1.1 million or 20% in the third quarter of 2017 compared to the third quarter of 2016, primarily as a result of the inclusion of the Velvac acquisition.

Excluding Velvac's selling and administrative costs in the third quarter of 2017, selling and administrative costs increased 0.3 million or 5% compared to the third quarter of 2016. Selling and administrative costs increased 7.7 million or 47% in the first nine months of 2017 compared to the first nine months of 2016.

Excluding Velvac's selling and administrative costs in the first nine months of 2017, selling and administrative costs increased 1.9 million or 11% compared to the nine months of 2016.

Selling and administrative costs were adversely impacted by several one-time charges, which included personnel charges of 0.2 million in our Security Products segment, environmental costs of 0.4 million in the Metal Products segment, and acquisition costs of 0.9 million in the Industrial Hardware segment.

We generated approximately 10.1 million of cash from operations during the first nine months of 2017 compared to generating 9 million during the same period in 2016.

Gus?.

Thank you, John. In conclusion, I’d like to add that we believe that we continue to make some progress with our three-part strategy including optimizing our portfolio, improving execution and building our balance sheet.

We believe that the addition of Velvac strengthens our portfolio and we’ll continue to look for bolt-on acquisition opportunities that have strong economics and help us build scale in attractive end markets.

In addition, we’re investing in new products, sales and marketing capabilities, as well as in our operations in each of our core businesses in order to drive growth. We’ve already talked to you about our ongoing commitment to the development of technology vision products at Road-iQ and gPay at Greenwald Industries.

And third, we believe our balance sheet remains strong. Our total cash position at the end of the third quarter was $21.2 million. With that, I’d like to turn it over to questions. Chris, can you tell us if we have any questions..

Yes, we actually do. Our first question is regarding pensions.

What are the funding requirements of the pension plans?.

Eastern has several non-contributory defined benefit pension plans covering certain U.S. employees. Plan benefits are generally based on the age at retirement, years of service and for our salary plan, the level of compensation.

Our funding policy with respect to the qualified plans is to contribute at least a minimum amount required by applicable laws and regulations. In 2017, we expect to contribute 700,000 into our pension plan and 140,000 into post-retirement plans.

As of September 30, 2017, we have contributed 322,000 into our pension plans and 109,000 in our post-retirement plans and will make the remaining contributions as required during the remainder of the year..

Okay.

Do we have another question?.

How did you fund the acquisition of Velvac?.

The acquisition was financed with a $31 million term loan from People's United Bank, a $5 million drawdown on Eastern’s $10 million revolving credit facility with People's and 3.5 million in cash. At the end of the third quarter, our total debt to shareholder equity was 40.6%..

Third question, are raw material prices in the Security Products segment increasing by 30% as you suggest in the 10-Q?.

I’ll take that. Raw material prices are indeed increasing rapidly. And the prices of some raw materials have increased by as much as 30% in the third quarter compared to the prior year. The figure in the 10-Q refers to the total cost of raw materials and so it also includes any changes in volume of the raw materials we purchased.

As John mentioned, we try to increase these – increases in raw materials through price increases and by finding other areas to improve efficiencies and reduce costs..

Another question, what marketable securities does the company hold?.

By the end of the third quarter, we held marketable securities equal to approximately $367,000. We didn’t purchase any additional marketable securities during the last quarter. And we buy marketable securities primarily for investment purposes, but we don’t disclose the issue at hand..

Impressions of Velvac?.

Well, we believe that the acquisition has had a significant positive impact on our overall performance. And as I mentioned before, Velvac’s traditional OEM mirror and camera business performed well this year, in part due to continued strong demand for RVs and the pickup in Class 8 truck production.

At the same time, we’re very excited about the prospects for Road-iQ. As we see it, this product offers a very compelling and competitive active and passive safety solution for drivers of some of our core markets like RVs, trucks and other specialty vehicles..

We have another question.

Are you still looking to divest businesses?.

We are actively pursuing opportunities to optimize our portfolio. And in this process we remain committed to making sure that our investors get a fair deal in any acquisitions or divestitures that we do..

Okay. And it looks like we have a follow up to that.

What about divesting in real estate?.

Today, we own facilities in Naugatuck, Connecticut; Strongsville, Ohio; Wheeling, Illinois; Tillsonburg, Canada; and Chester, Connecticut, as well as Secaucus.

Although the combined value of these facilities is just a small portion of our overall balance sheet, we are looking for opportunities to optimize the balance sheet, including the real estate..

Okay. It looks like that is it for questions. So if that’s the case, we appreciate your time and interest in The Eastern Company. Have a nice day. With that, I’ll turn the call back to the operator. Thank you..

Thank you. This does conclude today’s webcast. We thank you for your participation. You may disconnect your lines at this time..