Chris Moulton - Head of Corporate Development and Investor Relations Gus Vlak - President and Chief Executive Officer John Sullivan - Chief Financial Officer.

Analysts:.

Good day, everyone, and welcome to The Eastern Company’s Fourth Quarter and 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 Moulton, Head of Corporate Development and Investor Relations for Eastern.

Please go ahead, Chris..

Thank you. Good morning and thank you everyone for joining us. Speaking first today will 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 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 the risk factors discussed in Form 10-K filed yesterday with the SEC.

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. GAAP.

Reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures can be found in our Form 10-K filed yesterday with the SEC. You may obtain a copy of the Form 10-K on our website at easterncompany.com, under the investor information tab.

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 thank you for joining us to discuss the 2017 results of The Eastern Company. Today is our second earnings call following our third quarter 2017 call in November of last year.

The purpose of today’s call is to provide our shareholders and investors with another way to learn about what’s happening at the company and review our results. We believe that last year we made significant progress on our commitment to creating long-term value for our shareholders.

Eastern generated a total return to shareholders of 27% for the full-year outperforming the Russell 2000 Index by 12 percentage points and we grew our book value to $86.9 million, and it’s paying our dividends of $2.8 billion. Furthermore, we were pleased to see that Eastern was added to Russell 3000 Index on June 23 of last year.

As we have shared with you before our strategy for creating long-term shareholder value includes strengthening our portfolio of businesses, maximizing the performance of each of our best and highest return businesses, and using our balance sheet to drive growth. In 2017, we were successful in each of these areas.

On April 3, we acquired Velvac Holdings for $39.5 million. We truly believe that Velvac strengthens our portfolio of businesses by helping us build scale in some of the attractive end markets that where we have a position and increasing accesses of new markets for several of our other businesses.

And we're beginning to see some of these synergies from the acquisition take hold.

We also took advantage of our strong cash flow and strong balance sheet to add leverage borrowing $36 million to finance the acquisition of Velvac, and at the same time we invested in the long-term growth of our best businesses by, for example, adding new sales and engineering capabilities at Illinois Lock to expand our market and product coverage.

Our 2017 sales were $204.2 million and earnings before any adjustments were $5 million. Our financial results in 2017 are primarily the result of four factors. First and foremost, our core businesses delivered solid growth across each of our business segments.

Sales for Industrial Hardware segment, which includes Eberhard increased 11%, excluding Velvac, and that’s compared to 2016. Sales for the security products and metal products segment is included increased 7% and 45% respectively.

The second factor that drove our results to see acquisition of Velvac Holdings in April of last year, Velvac had $47.2 million in sales from mirror and vision products that OEMs, trucks and recreational vehicles, as well as sales to its aftermarket customers. Third, we accelerated several research and development projects.

Last year, we invested $3.7 million in R&D and that’s $2.2 million more than in 2016. Most of the research and development occurs at Velvac, Eberhard, and Greenwald last year. Velvac's R&D includes both the traditional mirrors, as well as its Road-iQ business.

You might recall that Road-iQ provides connected vehicle technology that offers both active and passive safety to drivers and recreational vehicles, trucks, and specialty vehicles. We launched Road-iQ in the recreational vehicle market last year and are currently testing the product with several manufacturers in place.

Also, Greenwald invested in the development of a Bluetooth payment solution to complement our existing cash and electronic products. The fourth factor that drove our results is a one-time tax as a result of the Tax Cuts and Jobs Act.

We expensed $2 million of taxes on $70 million of undistributed earnings from our foreign subsidiaries, and we also recognized the deferred income tax expense of $531,000, which came from a remeasurement of deferred tax assets and liabilities to the new lower rate of 21%.

I’d like to turn the call over to John Sullivan for a more detailed discussion of our financial results for 2017, and then I’ll come back at the end of the call to put some more thoughts on the outlook for 2018..

Thank you, Gus. I’ll now review our financial results for the fourth quarter and the full-year 2017. Net sales in the fourth quarter of 2017 increased 59% to $54 million from $34 million a year earlier.

Sales growth reflects the acquisition of Velvac, as well as organic growth of approximately 13% in the fourth quarter of 2017, compared to the same period in 2016. Sales increased in the Industrial Hardware segment by 107%, and excluding Velvac, increased 6%, as compared to the fourth quarter in 2016.

A result of strong growth in Class A trucks, service bodies, and bus customers. Sales of new products contributed 6% and included various paddles, handles, latches, and lightweight composite panels for the Class A truck, off highway and industrial customers.

Sales in the Security Products segment for the fourth quarter of 2017 increased by 9%, compared to the fourth quarter of 2016 as a result of increased sales volume from our investment in growth in Illinois Lock and Argo EMS.

Sales for the Metal Products segment increased 45% from the sales in the fourth quarter of 2016, as a result of a resurgence in sales to mining customers and diversification to other industrial casting markets. Gross margin as a percentage of sales for the fourth quarter of 2017 was 26%, compared to 32% in the fourth quarter of 2016.

The decrease is primarily a result of product mix, increased material costs, and the Velvac acquisition. Net loss for the fourth quarter of 2017 was $200,000 or $0.03 per diluted share, as compared to net income of $2.6 million or $0.42 per diluted share for the comparable period in 2016.

In the fourth quarter of 2017, we incurred a one-time charge of $2.5 million or $0.41 per diluted share consisting of 2 million charge of undistributed earnings from foreign subsidiaries, as well as $0.5 million related to the impact of tax reform and deferred tax assets.

Net sales for the full-year 2017 increased 48% to $104 million from $138 million in 2016. Sales growth reflects the acquisition of Velvac, as well as organic growth of approximately 14% for the full-year. Net income for 2017 decreased 35% to $5 million or $0.80 per diluted share from $7.8 million or $1.25 per diluted share in 2016.

The decrease in the net income was primarily the result of the recognition of one-time charge of $2.5 million, again related to the enactment of tax legislation in December of 2017, and a $1.8 million charge net of tax expense related to the Velvac acquisition, environmental remediation, and some personnel related expenses.

Excluding these one-time charges. We generated adjusted earnings of $9.4 million or $1.49 per diluted share in 2017. Adjusted earnings per share is a non-GAAP measure, a reconciliation to GAAP is provided in our Form 10-K filed yesterday. Taking a deeper look at each of these three segments.

In the Industrial Hardware segment, net sales increased approximately 89% in 2017. Excluding Velvac, the Industrial Hardware segment had strong organic growth in Class A trucks, service bodies, and bus customers, which contributed 11% and increased sales volume in 2017.

Whereas new product sales of tumbler paddles, handle assemblies, latch and composite panels contributed 6%, as compared to 2016. Gross margin as a percentage of sales in the industrial hardware segment decreased to 24% from 27% in 2016. The decrease reflects mix of products produced and the changes in cost of products sold.

Also affecting gross margin in 2017 was a one-time charge cost of products sold for 1.2 million as a result of the impact of purchase accounting in connection with the Velvac acquisition.

In addition, rising prices in raw materials such as stainless steel, cold rolled steel, hot rolled steel, and zinc increased from 10% on stainless steels to 37% on zinc materials used in our products.

Hence a result of these cost increases our margins were negatively impacted and could not be fully recovered in price increases to customers or offset to operational improvements. Engineering expenses as a percentage of sales increased 3% in 2017 from 0.8% in 2016. This increase was primarily a result of Velvac acquisition.

In the Security Products segment, net sales increased approximately 7% in 2017, primarily due to the result of increased sales volume from our investment in growth at Illinois Lock and Argo EMS division. New product sales include a private brand zinc puck lock, a spring return lock, a push button lock and a mini cam lock.

Gross margin as a percentage of sales in the security products segment increased 31% in 2017 from 28% in 2016. The increase reflects the mix of products sold, higher utilization of fixed charges on an increased volume.

Our margins were negatively impacted by higher material costs, primarily in zinc, which was up 37% and brass, which was up 23% from the prior year. Net sales in the Metal Products segment increased 45% in 2017, compared to the prior year.

Sales volume increased 34% in mine roof products sold as a result of a resurgence in the coal mining industry, due to higher natural gas prices, and an easing of regulatory restrictions. Net sales also increased 127% in industrial castings through our continued effort to diversify a way for mining products.

Gross margin as a percentage of sales in the metal business increased 13% in 2017 from 9% in 2016. The increase reflects the mix of products produced in utilization of productive capacity. Our margins were negatively impacted by a 48% increase in raw material scrap prices.

These increases we could not pass on to customers or it could not be fully recovered from customers. Selling and administrative expenses in the metal products segment increased $700,000 or 35% from 2016.

The most significant factor contributed to these changes were an increase of $500,000 or 38% for payroll related charges, due to the increase and business activity; and $400,000 and environmental charge. I would like to take a few minutes to point a few things on our balance sheet.

First, it’s important to note that the company's financial position strengthened in 2017. The primary source of our cash is earnings from operations and changes in working capital. Net cash from operations grew to $11.2 million in 2017.

We were pleased that even though we used $4.1 million of cash for the Velvac acquisition, we still ended 2017 with $22.3 million in cash, close to the $22.7 million in cash we started the year with. Also, changes in working capital fluctuates with changes in operating activities. In 2017, we improved several of our working capital ratio.

Average days' sales and accounts receivable dropped from 49 days in 2016 to 46 days in 2017. Inventory turns increased three turns in 2016 to 3.4 turns in 2017. The ratio of working capital to sales declined from 47% to 34%.

In addition, we entered into a $31 million term loan and a 10 million revolving credit line with People's United Bank to repay of our outstanding term debt and to acquire 100% of common stock for Velvac. As a result, our current ratio declined from 6 to 1 in 2016 to 3 to 1 in 2017.

Our debt-to-equity ratio increased from 2% on December 31, 2016 to 41% on December 30, 2017. With those highlights, I will turn it back to Gus for a few closing comments..

Thank you, John. We’re now more than two months into 2018, and we anticipate good growth in sales and our earnings for the remainder of the year as a result of the Velvac acquisitions and our investments in Illinois Lock last year and Argo EMS in 2016.

We believe that sales and earnings will also benefit from strong ongoing demand in several of our core markets, including Class A trucks and recreational vehicles, as well as from a reduction in the company's taxes, which will contribute to net earnings growth for the year.

We intend to fund our highest return on businesses by investing a new product development in market expansion at Eberhard and Illinois Lock this year and by making further targeted acquisitions. We will again look for acquisition opportunities that have strong economics and help us build scale and differentiation in our best end-markets.

As a result of the Tax Cuts and Jobs Act, we expect to repatriate approximately $6 million to $8 million in cash from our foreign operation and we plan to use this cash to pay down debt and fund our pension and retirement plan obligations.

We’re proud of Eastern 160-year-old history and we’re confident that our focus on allocating capital in a disciplined and patient manner across our portfolio of businesses, and our ability to grow the cash flows of these businesses will create meaningful long-term value for our shareholders.

With that, I will turn it back to the operator for any questions..

Thank you. [Operator Instructions] Okay, it doesn’t look like we have any phone questions coming in..

Thank you. It looks like we do have a few questions that have come in through the webcast. So, let’s get to those..

Our first question, how much do you expect to pay towards your pension plans in 2018?.

During 2018, we will make our minimum contributions to the pension, which would be 510,000. We also have about 100,000 for some post-retirement vested plan payments.

We may and this may contribute between 1 million and 2 million in 2018 to our pension plan to take advantage of our 34% tax rate that we can still claim when we file our 2017 tax return in September. We haven't made that determination yet and we will make it before we file the returns..

Okay.

Number two, house the integration of Velvac going?.

I’ll take that. Overall, we are very pleased with Velvac's performance so far. This business is a Tier 1 supplier to some of the leading truck, recreational, and specialty vehicle OEMs and we’ve now seen first-hand how that leadership team works closely with many of the customers to develop really truly unique and custom engineered products.

And also have they manage a genuinely world-class manufacturing facility in Reynosa, Mexico. As we get to know more, we come to believe that the significant potential in Velvac's aftermarket and business, which includes components and vision systems and will be exploring that this year..

Okay.

We have another question, what impact do you anticipate from the recently announced steel and aluminum tariffs?.

Well, with the caveat we are still waiting for some further details. These tariffs will cause an increase in cost for all domestic manufacturers that by imported steel or aluminum and we can also see an increase in domestic steel prices as the marginal producers of steel and aluminum lead the market.

And of course, because we use steel in a wide range of our products. Any cost increase would result in an increase of our cost of goods, which would require us to raise prices to our customers.

But if we are unable to pass those price increases to our customers or if you find in fact that some of our suppliers can't meet our raw material requirements that would adversely affect our business..

Okay.

We have one final question; how much more do you expect to spend on Road-iQ in 2018?.

We're working very hard to get to a breakeven point for that Road-iQ business. We don't expect the business to breakeven for all of 2018, but the level of investments will begin to taper [ph] off, certainly by middle of this year..

Well it looks like we have no further questions. So, we will turn it back over to the operator. Again, we appreciate you for joining us today. Thank you..

Thank you. This concludes today's webcast. We thank you for your participation. You may disconnect your lines at this time and have a great day..