Christopher Moulton - Head of Corporate Development and Investor Relations August Vlak - President and Chief Executive Officer John Sullivan - Vice President and Chief Financial Officer.

Q -.

Good day, everyone, and welcome to the Eastern Company's Second Quarter 2018 Earnings Conference Call. Today's call is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to Chris Moulton, Head of Corporate Development and Investor Relations for Eastern. Please go ahead, Chris..

Thank you, and good morning, all. Speaking first today will be Eastern's President and CEO, Gus Vlak; and then our CFO, John Sullivan. After that, we'll open the call for Q&A.

Please note that some of the information you'll hear today will consist of forward-looking statements about the Company's future financial performance and business prospects, including statements regarding revenue, gross margin, operating expenses, other income and expenses, taxes and the 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 our most recently filed form 10-Q filed yesterday and our most recent 10-K. Eastern assumes no obligation to update any forward-looking statements or information, which speaks as of their respective dates.

I'd now like to turn the call over to Gus for opening remarks..

Thank you, Chris, and good morning to those joining us on the phone and online. This morning, we will review our sales and earnings for the second quarter and first six months of 2018. Our business has generated strong results in the second quarter. Net sales in the quarter were $60.9 million and earnings were $3.3 million, or $0.52 per diluted share.

Results in the second quarter and, indeed, the first half of 2018 demonstrate considerable progress on our three-part strategy of improving execution across our businesses, optimizing our portfolio and making a strong balance sheet.

Net sales of $60.9 million represent the highest sales for any quarter that Eastern has achieved in its 160-year history. Several of our businesses, including Eberhard and Velvac, have continued to build scale and deepen their relationship in key transportation markets.

These businesses are well positioned and benefit from the strong growth in Class 8 trucks. According to the Freight Transportation Research Associates, a business intelligence firm, orders for Class 8 trucks in the second quarter of 2018 nearly doubled compared to the same period in 2017.

And while Eastern is well diversified across end markets, including several transportation related end markets, as a result of the recent growth in Class 8 trucks, Class 8 truck OEMs now represent the largest end market. And this market is expected to remain strong.

According to IHS Markit, Class 8 truck sales are expected to increase at an average rate of 7% through 2020. Across our portfolio, we allocate capital to and invest in our highest-return businesses.

In the second quarter, Illinois Lock, or IOC, part of our Security Products segment, acquired Load N Lock, a leader in innovative truck cap and tonneau cover locks. This business provides innovative products and solutions to the industry's leading manufacturers in the U.S. and in Asia.

This transaction builds further scale and capabilities in our IOC business, including the addition of several very talented engineers. Load N Lock will operate as part of IOC, and the integration of the business is going extremely well. Moreover, we believe that this acquisition will be immediately accretive, excluding the impact of onetime expenses.

We're beginning to see results from our investments in technology products at Road-iQ and gPay at Greenwald Industries. We've begun to battle back development expenses at Road-iQ, as we're transitioning to supporting OEM installations. At the same time, we continue to invest in new product development in other parts of Eastern.

At Eberhard, we're working with a leading door manufacturer on the development of a new innovative access system for roll-up doors. And in addition to creating new hardware for these doors, we're also integrating electronic systems as part of those solutions.

At Illinois Lock, we're currently working on a Bluetooth locking system, which we call [indiscernible] will offer wireless sensing and activation of up to 12 locks in a system, with applications in vehicle accessories, storage and medical carts. Finally, we continue to strengthen our balance sheet.

In 2018, July of this year, we repatriated approximately $5.5 million in cash from our overseas subsidiaries, and used these funds to repay our outstanding revolving line of credit, paying down our debt, but maintaining ample liquidity. John will give additional detail and talk us through the results for the quarter..

Thank you, Gus. On a consolidated basis, sales increased to $60.9 million in the second quarter of 2018 from $58 million during the same period in 2017. That's an increase of approximately $2.8 million, or 5%. Sales increased across all our business segments.

The second quarter of 2018 was favorably impacted by the introduction of new products, which increased sales 4%. Sales increased to $120.3 million in the first six months of 2018, an increase of $26.2 million from the $94.1 million in the same period in 2017. That's an increase of 28%. Organic sales in the first six months of 2018 increased 9%.

Velvac acquisition contributed 19%. Sales volume of existing products increased by 23% in the first six months of 2018 compared to the first six months of 2017.

The increase in sales in the first half of 2018 when compared to the respective corresponding prior year period reflects the full six months of sales from the Velvac acquisition in 2018 versus only three months of sales in 2017. The first six months of 2018 was also favorably impacted by the introduction of new products, which increased sales by 4%.

Sales of new products include tumbler paddles, latch brackets, mini rotary locks and in various industrial castings, primarily for the Class 8 truck, specialty vehicle and oil, water, gas end markets.

On a segment base level, net sales in the Industrial Hardware segment were up 2% in the second quarter and 43% in the first half of 2018 as compared to the same period in 2017.

The increase in sales in the first half of 2018 when compared to the prior year period reflects the full six months of sales from the Velvac acquisition in 2018 versus only three months of sales in 2017.

Sales of new products included tumbler paddles, latch brackets, mini rotary locks, primarily for the Class 8 trucks within speciality vehicle end markets. Net sales in the Security Products segment increased 10% in the second quarter and in first half period of 2018 as compared to the same period in 2017.

The increase in the second quarter 2018 sales resulted from a 6% increase in the sales volume of the existing – of existing products for the commercial laundry market and new products sales of 4% to the commercial lock market.

The increase in the first half of 2018 sales resulted from an increase of 5% sales volume of existing products and 4% from new products. New product sales included a zinc-branded puck lock, a spring return lock, a push button lock and a mini cam lock.

Net sales in the Metal Products segment increased 6% in the second quarter and 11% in the first half of 2018 as compared to the same period in 2017.

Increased sales volume of industrial casting products represents the entire increase relative to the second quarter of 2017, as the Company [Audio Dip] diversify away from the traditional mining products. New products were sold into the oil, water, gas and rail industries.

On a consolidated basis for the three months ending June 30, 2018, gross margin as a percentage of sales was 25% compared to 27% in the comparable period in 2017, while the first six months ending June 30, 2018, gross margin as a percentage of sales was 25% compared to 26% in the comparable period of 2017.

The decrease was primarily the result of increased raw material prices in steel, zinc, copper and scrap iron. Product development expenses decreased $0.1 million or 6% in the second quarter of 2018, an increase of $0.8 million or 33% for the first six months of 2018 as compared to the same period in 2017.

The increase in the first six months of 2018 is a result of the inclusion of the Velvac acquisition in the second quarter of 2017. Selling and administrative costs decreased $2.3 million or 20% in the second quarter of 2018 compared to the same period in 2017.

In the second quarter of 2017, selling and administrative costs were adversely impacted by several onetime charges, which included $0.9 million of transaction expenses related to the Velvac acquisition; $0.3 million of environmental remediation expenses related to the Metal Products segment; and personnel changes of $0.2 million in the Security Products segment.

Selling and administrative costs increased 5.3% or $29 million for the first six months of 2018 compared to the same period of 2017, as a result of the inclusion of the Velvac acquisition in the second quarter of 2017.

The Company generated approximately $5.6 million of cash from its operations during the first six months of 2018 compared to approximately $6.3 million during the same period in 2017.

The decrease in cash flows in the 2018 period compared to 2017 period was primarily the result of increased inventories and accounts receivables on increased organic sales during the 2018 period. Total inventories of $49.9 million increased 5% in the second quarter of 2018 as compared to $47.3 million at the fiscal year-end of 2017.

Inventories increased 12% in the second quarter of 2018 as compared to $44.1 million in the same period in 2017. Accounts receivable were $29.7 million for the second quarter of 2018 as compared to $28.9 million in the same period of 2017.

Cash flows from operations, coupled with cash from the beginning of the year, were sufficient to fund the capital expenditures, debt service and dividend payments. With that, I'll return the call back to Gus..

Thank you, John. Overall, our businesses are performing very well. We continue to benefit from the strong economic conditions, and we have further work to do on our portfolio looking for additional acquisitions and evaluating options for our businesses with more limited long-term prospects.

We recognize that we're operating in a changing macroeconomic environment and continue to monitor closely the industry trends, tariffs and business conditions in both Mexico and China. At the same time, however, we believe our businesses are well positioned and look forward to a record-breaking year for Eastern.

With that, I'd like to turn the call over to the operator for questions..

Thank you. The floor is now open for questions. [Operator Instructions] Our first question comes from [Miles Jennings]. Miles, state your question..

Good morning. Congratulations on nice quarter..

Thank you..

There are a couple of areas that I wanted to ask about which you don't break out in your financial report. And I do realize that you may not want to break them out for various competitive reasons, et cetera, but I thought I'd push you on this just a little.

Can you first give us a sense of the rough revenue from the JLTV ongoing contract for the joint light-weight tactical vehicle? And then secondly, could you give us a rough sense of the number of subscribers for Flash Cash and gPay and, generally, the trend of that customer take-up of those products?.

So I'll try to answer both questions as well as we can. The JLTV program, as you recall, was a big program for the Company in 2006 and 2007. While we continue to supply that program, the vehicle builds there are at a much lower level than they were historically. They're continuing, but they're much lower.

And we think that's an opportunity for us in the future, but it's not a material contributor to our overall sales volume this year. The subscriber base for Flash Cash, as you alluded to, is a rather competitive number.

I can tell you that we are continuing to develop products that have more value to our Flash Cash installed base to both better – to take advantage of that installed base and to increase the switching cost there. So we feel confident that we are well protected in that market segment..

Another question I had was, you mentioned the repatriation of $5.5 million from overseas subsidiaries. And I see in your 10-Q that, as of quarter-end, you had $14.9 million in balances.

Is that $5.5 million substantially most of the funds that you expect to repatriate? Or is that additional $9.4 million a target of yours to pull back?.

To answer to that question, we have approximately $600,000 that we would be repatriating in August from our Taiwan subsidiary. We also expect to repatriate approximately $1 million in 2019 from our Chinese subsidiaries. But as of this point in time, we've taken back the maximum amount we can in the form of dividends..

Good. Just a last question for me. It's not a question, more of a statement.

I was very pleased to see that as far as this environmental remediation, there are a couple of issues that have, for probably 15 years, been in your various SEC reports, and I see that you finally have reached agreements with the regulatory bodies and the states that we're involved, and it looks like that is complete now.

And congratulation, I'm sure it's been a very long process for you..

Yes, it has, and thank you..

We have a few questions online. There's a question about passing on higher material costs to our buyers? And we are, indeed, in an environment where, I think, like most manufacturers, we're experiencing increased raw material prices.

We are able to pass those on to a portion of our customers or some where that is – has just historically been more difficult. And so we are left with the absorbing some of those prices.

And then what we inevitably experience is that there is a lag between the increase of raw material prices and our ability to pass those on as some of our customers require demonstration to go through internal approval processes to accept those higher prices.

So we don't see a perfect match in terms of our price increases and our ability to pass those on. There is a question about Velvac in the second quarter. So, interested in learning more about the sales performance there? Velvac has performed in many of its markets exactly on plan, exactly as we anticipated.

But obviously, with the growth in Class 8 trucks, they've seen higher volumes there. Their aftermarket business has been performing well, which also serves the heavy-duty truck segment. The RV segment has grown a little bit more slowly than we had planned. It's kind of on par with last year.

And I think that we read what's happening in the RV industry that's consistent with the experience of other suppliers to that – kind of to that business.

There's a question about the performance of Road-iQ? Road-iQ, as you recall, is a connected vehicle technology that provides both active and passive safety to drivers of RVs, trucks and other specialty vehicles. Our Road-iQ has secured initial orders for it's blind spot protection application with a leading [indiscernible] manufacturer.

And we're currently preparing for installation in several of that manufacturer's models starting in the fall. And at the same time, the business is negotiating with several additional manufacturers for installation..

Do we want go back to – well, I'm not sure.

Operator, do we have anymore telephone questions?.

There appears to be no further questions on the phone portion..

Okay. I do notice a couple more webcast questions. One is related to Load N Lock.

Can you provide us with more information or background on the acquisition of Load N Lock?.

first, there's some significant sales synergies because we believe that the introduction of the Illinois Lock sales infrastructure will support the growth of Load N Lock's current product offering beyond the penetration that Load N Lock itself has been able to penetrate.

And also Illinois Lock is able to introduce some of its current product offerings to some of the key Load N Lock customers, which we believe will further increase sales in those accounts. There are some cost synergies.

Over short term, there's an opportunity to eliminate some of the redundant costs through the integration of Load n Lock with Illinois Lock. And in the long term, there's potential for incremental margin expansion by looking at the supply chain for Load N Lock Systems manufacturing.

And then finally, we believe the engineer capabilities at Load N Lock are strong. And we see opportunities to further leverage those capabilities and IP for some of the Illinois Lock products, which will foster further growth. So overall, we see a lot of upside to this potential transaction..

Okay. I see another webcast question.

What are your funding requirements for the pension plan over the next few years?.

Our funding for the pension plan is basically on a minimum required by law. In 2018, the minimum recorded contribution is $510,000 into our hourly-rated pension plan. In 2019 and 2020, the estimated minimum contribution is expected to be twice of it.

The Company has elected to prepay $2 million of that amount during the third quarter of 2018 to take advantage of the higher tax deductions on our 2017 tax returns..

All right. Well, as of now, I think that does it on the webcast questions. Operator, I'm not sure if anyone else has called in on the telephone..

No telephone questions..

Okay. Great. Well, thank you very much for joining us today. If you have any questions, you can always feel free to reach out to any one of us. With that, I'll turn the call back to the operator..

Thank you. This does conclude today's webcast. We thank you for your participation. You may disconnect your lines at this time. And have a wonderful day..