Earnings Call Transcript - PKOH Q4 2022

Operator, Operator

Good morning. Welcome to the Park-Ohio Fourth Quarter and Full Year 2022 Results Conference Call. At this time, all participants are in a listen-only mode. After the presentation, the company will conduct a question-and-answer session. Today's conference is also being recorded. If you have any objections, you may disconnect at this time. Before we get started, I want to remind everyone that certain statements made on today's call may be forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those projected. A list of relevant risks and uncertainties may be found in the earnings press release as well as in the company's 2021 10-K, which was filed on March 16th, 2022, with the SEC. Additionally, the company may discuss adjusted EPS, adjusted operating income, and EBITDA as defined on the continuing operations or consolidated basis. These metrics are not measures of performance under Generally Accepted Accounting Principles. For a reconciliation of EPS to adjusted EPS, operating income to adjusted operating income and net income attributed to Park-Ohio's common shareholders to EBITDA as defined, please refer to the company's recent earnings release. I will now turn the conference over to Mr. Matthew Crawford, Chairman, President and CEO. Please proceed, Mr. Crawford.

Matthew Crawford, Chairman, President and CEO

Thank you, and good morning. We're proud of our accomplishments during 2022. Revenue growth from continuing operations of 17% helped us achieve record annual sales and improved operating profit across all three business segments. As we enter 2023, our markets continue to be robust and we expect to achieve increased margins and profitability versus 2022 as well as a substantially improved balance sheet, this after three years of battling inflation, supply chain, and a myriad of other challenges. While our job is never complete, I want to highlight the incredible effort by our entire team in both restructuring much of our business as it relates to our cost structure and also the ongoing efforts to achieve commercial terms, which addresses substantial inflation in the marketplace. These efforts continue, but much of the heavy lifting is now complete. Notably during the year, we allocated approximately $27 million in capital to many of our most promising products and services, which will ensure future growth at accretive margins. Here I would highlight improved large forging capabilities, increased capacity for highly engineered fasteners, and expanded capacity in our Rubber business. In addition, we added two small, but strategic and accretive acquisitions to Supply Technologies, which will both add new capabilities and customers. Challenges still remain, in particular, attracting and retaining skilled associates to the business during this period continues to be a challenge. But we have seen some modest stabilization and have begun to see the benefits of reduced overtime and other inefficiencies. We're also announcing the potential sale of our Aluminum Products business. This was a difficult decision given the substantial opportunities in front of them, largely due to light-weighting, electrification and reshoring, which has begun to occur meaningfully within the auto industry. While the business has struggled to be profitable since the beginning of COVID, our investments there have caused it to 'turn the corner' and we have seen improved and stabilized performance recently. Despite these positives, we've chosen to invest in other opportunities in our business, which are demonstrating impressive growth opportunities. As we look into 2023 and beyond, we're particularly excited about a few trends we're seeing in our business. First, even as consumer demand may dampen due to increased cost and availability of credit, many of our customers desperately need to restock their supply chain or improve their manufacturing capacity or productivity as evidenced by large backlogs in our Engineered Products Group. Second, we've seen evidence of reshoring by many of our customers. While this has been a storyline for years, we have recently received orders intended by our customers to reduce their reliance on foreign suppliers. Third, the green energy transition has benefited our European business during the last 18 months meaningfully. We anticipate whether it's electric cars, wind energy, or electric furnace technology, we will continue to benefit globally. Lastly, improved government spending in infrastructure and defense will accelerate the need for capacity in many basic industries like forging and steelmaking, which are areas where we will benefit. While we've had a challenging couple of years, we're pleased with the progress we're making and want to thank all of our team, including the many new and talented people that have joined our firm recently and are making a big difference. With that, I'll turn it over to Pat.

Patrick Fogarty, CFO

Thank you, Matt. During 2022, we were able to achieve significant year-over-year improvement in sales and operating income in the majority of our businesses despite inflationary and supply chain challenges and believe we are positioned for further sales growth and improved earnings in 2023. Key highlights in 2022 included the following; first, we achieved record consolidated net sales from continuing operations of $1.5 billion, up 17% year-over-year, driven by growth in all three of our business segments. Excluding discontinued operations, our full year adjusted EPS was $1.76, an increase of more than 300% compared to adjusted EPS of $0.42 in 2021. We implemented significant customer price increases throughout the year to offset product inflation and higher operating costs in every business. We expect these actions will improve operating margins in the current year. We substantially completed our facility consolidation activities in our Assembly Components and Engineered Product segments, which impacted four manufacturing plants. We also started up a new rubber mixing facility and relocated several product lines and related operating assets including a 50,000-pound forging hammer, which is now installed in our Canton Drop Forge facility. We expect these actions will also contribute to improved operating margins in 2023. In connection with the consolidation activities, we sold real estate and other assets during the year for cash proceeds of $10 million. Over the past two years combined, cash proceeds from our asset sales totaled $30 million, resulting in gains of $17 million. We completed two strategic acquisitions in our Supply Technologies segment in support of our initiative to expand our industrial supply and MRO business and to accelerate the global growth of our proprietary self-piercing and clinch products in our Fastener Manufacturing business. And finally, during the fourth quarter, we made a strategic decision to exit our Aluminum Products business and on December 30th, we signed a memorandum of understanding with a third-party to acquire the business. Pursuant to the MOU, we received $20 million and a promissory note in the amount of $25 million, representing a portion of the final sale price. The sale of the business is subject to various conditions, including the final execution of a purchase agreement. Now, I'll review our full year and fourth quarter 2022 results in detail. Consolidated net sales from continuing operations in 2022 were $1.5 billion, up 17% compared to $1.3 billion a year ago, with higher year-over-year sales in all three of our business segments. We estimate that 70% of the overall increase was driven by volume growth from higher customer demand in new programs, while the remaining 30% was due to the impact of customer price increases achieved during the year. GAAP EPS for the year was $0.83 per diluted share. Adjusted earnings per share, which excludes primarily one-time non-recurring items related to plant closure and consolidation costs, improved significantly year-over-year to $1.76 per share compared to adjusted EPS in 2021 of $0.42 per share. Excluding plant closure costs, 2022 gross margin was 14.1% compared to 13.9% in 2021. SG&A expenses were higher in 2022 due primarily to the higher sales levels, higher employee-related costs, and unfavorable foreign currency exchange impact. Our 2022 adjusted operating income was $48 million or 3.2% of sales compared to $22 million or 1.7% of sales in 2021. Significant improvement in operating income was delivered in each business segment, most notably in our Engineered Products segment, which improved year-over-year by $22 million. Interest expense was $34 million compared to $27 million in 2021, with the increase due to higher interest rates and higher outstanding borrowings in 2022. These amounts exclude approximately $2.5 million in each year that has been allocated to discontinued operations. Our full year income tax provision was a benefit of $700,000 on a GAAP pre-tax income of $10.7 million. The benefit reflects the positive effects of tax planning initiatives, which include an increase in Federal research and development credits during the year. For 2023, we estimate our effective income tax rule will range from 23% to 25%. We ended the year with $180 million of liquidity which consisted of $58 million of cash on hand and $122 million of unused borrowing capacity under our various banking arrangements, which included $12 million of suppressed availability. During the fourth quarter, free cash flow, including cash proceeds of $6 million from asset sales, was a use of $1 million. As we have discussed on recent calls, strong end market demand and supply chain challenges have resulted in additional investments in net working capital compared to historical levels. We estimate the excess working capital to be approximately $50 million. During the fourth quarter, we reduced net working capital by $7 million and over the next 12 to 18 months, expect further reductions in net working capital days, resulting in significant improvement in free cash flows year-over-year. With respect to our Aluminum Products business, which is now classified as discontinued for financial reporting purposes, we reported a net loss for the year of $24.3 million, which was driven by losses incurred on a product line that we exited in midyear, non-cash charges for idle assets, and startup expenses related to our plant in Mexico. A significant portion of these losses were non-recurring and non-cash related. For the year, the business used cash in its operating activities of $1 million and had capital expenditures of $3.6 million. Moving now to our fourth quarter results, net sales from continuing operations of $382 million were up 17% year-over-year compared to $327 million in the prior year, driven by strong year-over-year customer demand across all three of our business segments. GAAP EPS for the quarter was a loss of $0.58 per diluted share. Adjusted EPS, which excludes primarily one-time non-recurring items, was a loss of $0.09 per share. The $0.09 loss in the fourth quarter included two unfavorable tax items consisting of evaluation allowance against foreign tax credits of $1.8 million and other adjustments to previously recorded estimates, which together negatively impacted the fourth quarter by $0.26 per share. In addition, our fourth quarter results included an unfavorable foreign currency impact totaling $0.10 per diluted share. Turning now to our segment results. In Supply Technologies, 2022 net sales for the full year were a record $712 million, up 15% compared to $620 million in 2021. Average daily sales were up 14% year-over-year as we saw strong customer demand in most key end markets with the biggest increases in the heavy-duty truck, power sports, agricultural, industrial equipment, semiconductor, and civilian aerospace end markets. In addition to increased customer demand and improved pricing, sales in the current year also benefited from the acquisitions of Southern Fasteners and Charter Automotive. Operating income in this segment totaled approximately $46 million in 2022, up 7% compared to $43 million in 2021, driven by the higher sales levels. Operating margins were 50 basis points lower year-over-year and were impacted by higher supply chain costs, primarily related to and sales mix. In the fourth quarter of 2022, net sales were $181 million were up 18% compared to $153 million in the fourth quarter of 2021 and operating income was $10 million in each period. In our Assembly Components segment, which now excludes our Aluminum Products business, sales were $389 million for the year, up 21% compared to $322 million in 2021, resulting from sales on new programs launched and increased net price realization, which helped offset product inflation and other increased costs in this segment during the year. Excluding charges related to plant closure and consolidation activities, 2022 adjusted operating income was $7 million compared to $3 million in 2021 with the improvement driven by profit flow-through from the higher sales levels, price increases, and benefits from profit improvement initiatives in this business. In the fourth quarter, net sales of $95 million were up 13% compared to $83 million in the fourth quarter of 2021 and adjusted operating income improved $5 million year-over-year to $2 million in the quarter. In our Engineered Products segment, 2022 sales were $393 million, up 17% compared to $336 million in 2021, driven by strong customer demand in both our Capital Equipment and Forged and Machine Products businesses. Our bookings of new equipment for the full year were $201 million, an increase of 9% compared to 2021 levels. Our new equipment backlog as of December 31st was $163 million, 35% higher than a year ago and demand for our aftermarket parts and services continues to be strong. In our Forged to Machine Products business, full year sales were up almost 30% and at their highest level since 2019, driven by strength in several key end markets, including the continuing recovery of the rail, oil, and gas, and aerospace and defense markets. Excluding charges related to plant consolidation activities, our adjusted operating income for the year was $23 million compared to $1 million a year ago, with a significant improvement driven by profit flow-through from higher sales levels, implemented operational improvements, the benefits of plant consolidation actions, and other margin enhancement initiatives. We will complete the consolidation of our Crop Forge business in the first half of this year and expect to incur costs of less than $2 million to finalize the project. In the fourth quarter of 2022, net sales of $106 million were up 17% compared to $90 million in the fourth quarter of last year and adjusted operating income was $6 million in the quarter compared to a loss of $100,000 a year ago. Corporate expenses were up $3 million in 2022 due to higher employee-related costs and professional fees related primarily to tax planning initiatives implemented during the year. And finally, looking into 2023, we expect year-over-year revenue growth of approximately 5% to 10%. The revenue growth will be driven by strong demand in Supply Technologies in most end markets from improved product pricing and increased volumes in Assembly Components and from the strong backlogs and increased productivity in our Engineered Products segment. In addition, we expect year-over-year improvement and adjusted operating income, EBITDA as defined, free cash flow, and adjusted EPS in 2023, driven by the sales growth, benefits from the plant consolidations completed over the last two years, and other implemented margin improvement initiatives across each business segment. Now, I'll turn the call back over to Matt.

Matthew Crawford, Chairman, President and CEO

Great. Thank you very much, Matt. We'll now take some questions.

Operator, Operator

Thank you. Our first question is from Yilma Abebe with JPMorgan. Please proceed.

Yilma Abebe, Analyst

Thank you and good morning.

Matthew Crawford, Chairman, President and CEO

Good morning Yilma.

Patrick Fogarty, CFO

Good morning.

Yilma Abebe, Analyst

My first question is on the Aluminum Products asset sale. I guess, firstly, can you put some context for us what was the relative revenue contribution in 2022 EBITDA, if you have it so that we can model it going forward appropriately?

Patrick Fogarty, CFO

Yes, approximately $200 million Yilma is the revenue and the EBITDA as we define it was a loss of approximately $12 million.

Yilma Abebe, Analyst

Okay, great. Thank you. And in terms of the business, was it a standalone business within the portfolio? Are there sort of friction costs in terms of separating the business from the rest of the enterprise?

Matthew Crawford, Chairman, President and CEO

Yilma, this is Matt. Our Automotive segment Assembly Components is really grouped into two businesses. One is our Assembly Components division, which includes most of our Rubber business and some other companies as well and the General Aluminum, the Aluminum Products. So, the General Aluminum Products, which is the $200 million piece is a standalone business. So, no, it is not incorporated deeply inside of the rest of the business, either Park-Ohio or the rest of the automotive business, which we are retaining.

Yilma Abebe, Analyst

Okay, great. And then I guess looking forward to 2023, in free cash flow expectations of $40 million. Just so that sort of we have apples-to-apples comparison, is this sort of when you think of free cash flow for 2022, the comparable number, cash from ops less CapEx, I'm getting about a $54 million number. Is that the right number in terms of the free cash flow for 2022 and then going to $40 million for next year?

Patrick Fogarty, CFO

Yes, Yilma, the cash flow for 2023 as we've laid out in our press release of $40 million excludes any transaction related to our Aluminum Products segment. So, I think that'll at least give you an apples-to-apples comparison. And then in the current year as laid out in our cash flow statement, you'll be able to see the free cash flow, Matt referenced $27 million of CapEx during the period. And then obviously, there was a use of cash from operating activities relative to the increase in working capital that we've seen in the business.

Yilma Abebe, Analyst

Okay. So, to be clear though, the free cash flow as you see it in 2022, comparable to this $40 million forecast for 2023, that's sort of gone from $54 million to plus $40 million, Is that correct?

Patrick Fogarty, CFO

That's correct.

Yilma Abebe, Analyst

Minus $54 million to plus $40 million?

Patrick Fogarty, CFO

That's right.

Yilma Abebe, Analyst

Thank you. To clarify, the free cash flow for 2022, in comparison to the $40 million forecast for 2023, has changed from a negative $54 million to a positive $40 million, correct?

Matthew Crawford, Chairman, President and CEO

I would like to provide some context. This point seems to be getting overlooked. If we consider the midpoint of the revenue range we discussed for 2023, it indicates that the business has grown by approximately $300 million over the past 24 months. We have made significant investments in the business during a period when profitability was not strong. As we look ahead to 2023, a major focus will be on generating cash and optimizing some excess working capital that we accumulated while strengthening supply chains and other areas. This presents an opportunity for improved free cash flow as growth stabilizes. Managing $300 million over a span of 24 months is substantial.

Yilma Abebe, Analyst

Thank you. I think you partly answered sort of my last follow-up question on the free cash flow. And that is sort of, I guess, a bit of a bridge. It sounds like some of it is going to be from driven by revenue increase in the related profitability. A lot of it appears to be working capital come back. If you're ready, maybe to help us in terms of the relative size, what is the working capital contribution to this $40 million free cash flow forecast versus the growth in the business and improving profitability? Thank you.

Patrick Fogarty, CFO

Yes, Yilma, I would comment that the excess working capital, as I mentioned in my comments, we believe, is roughly $50 million. That recovery or the harvesting of that excess working capital to cash will not occur overnight. We estimate that that will occur over the next 12 to 18 months as supply chain stabilizes, as further reductions in supplier lead-times take place. And I think clearly that will happen over 12 to 18 months. The additional working capital needed to grow our business into next year depends on the business segment. But in general, if you use 25% to 28% of every new sales dollar is invested in working capital, I think that's a good starting point. And then consider the harvesting of the $50 million over the next 12 to 18 months.

Yilma Abebe, Analyst

Thanks very much. That's all I had.

Matthew Crawford, Chairman, President and CEO

Thank you.

Patrick Fogarty, CFO

Thank you.

Operator, Operator

Our next question is from Dave Storms with Stonegate Capital Markets. Please proceed.

Dave Storms, Analyst

Morning, gentlemen and thanks for taking my call. Just wanted to kind of start on backlogs. I know last quarter you mentioned you were looking at probably about six to nine months of backlogs. Has that kind of shortened up a little bit or what's the color that you're seeing there?

Matthew Crawford, Chairman, President and CEO

No activity. Our Capital Equipment business is what we refer to when discussing those backlogs. Most of the other parts of the business have a shorter-term visibility. When we mention the Capital Equipment backlogs, they have remained strong. The order book can be a bit uneven, but overall, the order book and interest are still robust. Despite some concerns about a recession, I would highlight that the manufacturing sector in the United States has been significantly underinvested. Considering the major trends I discussed earlier, particularly concerning infrastructure and defense, our country remains underinvested. Therefore, I expect to see ongoing investments aimed at enhancing capacity, productivity, and our foundational elements. Although there may be fluctuations and some influence from credit, generally, I believe we are observing positive trends.

Dave Storms, Analyst

That's a good transition to my second question. I've heard that some funds related to the Inflation Adoption Act are starting to enter the market. Are you expecting any of that to reach Park-Ohio? Also, do you have any visibility into 2023 regarding potential impacts?

Matthew Crawford, Chairman, President and CEO

I think it's a great question, and I wish I had a better answer. The best way to describe it is that there is a limited amount of visibility on how that money will be spent at our position in the supply chain. However, large defense contractors and other significant government suppliers are undoubtedly in discussions about how to invest these funds. There are important strategic conversations happening between us and well-known manufacturers about increasing their capacity with our equipment to support them, and I believe this is quite real. Moreover, we are also seeing some reshoring efforts driven by the Infrastructure Bill and the Inflation Reduction Act, which indicate a growing need for more American manufacturing. While I wouldn't say our visibility is strong, it is somewhat reflected in our backlog for the equipment. Overall, I would characterize our visibility as still weak, but the discussions taking place suggest that improvement is on the horizon.

Dave Storms, Analyst

That's very helpful. Thank you.

Operator, Operator

Our next question is from Steve Barger with KeyBanc Capital Markets. Please proceed.

Steve Barger, Analyst

Thanks. Good morning.

Matthew Crawford, Chairman, President and CEO

Good morning.

Steve Barger, Analyst

Pat you said the $20 million received and the $25 million promissory note is a portion of the sales price for the aluminum business. Any more details you can provide on what that total sales price could be?

Patrick Fogarty, CFO

Yes, Steve. I really can't comment right now. We're in the middle of the process. And so I can't comment and won't comment until we have a definitive agreement in place. But to reiterate, the $20 million in cash and the promissory note was a portion of the anticipated sale price of the business.

Steve Barger, Analyst

Understood. And this looks like it should be nicely deleveraging, which is great and you expect improving cash flow. I know you put the initial $20 million to the revolver. But with the bonds trading at a discount, is there any thought to allocating some capital to take advantage of that?

Patrick Fogarty, CFO

Steve, we historically have purchased the bonds. We expect the proceeds on any sale to deleverage the company and reduce our net debt. And we'll be flexible to different ways to do that. But we agree it will be a deleveraging event and we're going to give ourselves the flexibility to be open to reduce bank debt or buy back the bonds if there's an opportunity to do so.

Steve Barger, Analyst

Got it. Okay. I understand that it's not finalized yet, but when that deal closes, Matt, what will you focus on next? What will your priorities be? I know you mentioned a few items, but how are you planning to approach this once that's settled?

Matthew Crawford, Chairman, President and CEO

Yes, that's a great question, Steve. I appreciate the chance to elaborate on my earlier comments. We remain focused on the significant opportunities within the business. General Aluminum presents a fantastic opportunity for us. However, it's important to acknowledge that we can't tackle everything simultaneously. As we observe growth across various segments and anticipate further growth into 2023, it's clear that we have to prioritize. Last year, we allocated funds to our exciting and distinct forging capacity, which aligns with previous inquiries about infrastructure and defense. Our engineered fastener segment, which we value highly, has benefited from the acquisition we made last year, enhancing our capacity in alignment with electrification trends. Our primary focus will be to continue supporting the parts of our business that will receive a substantial share of our capital as we see significant margin growth. Moreover, while we have addressed supply chain issues and customer satisfaction last year, we now aim to shift our attention back to strengthening our balance sheet. We plan to devote considerable effort this year to reducing our leverage, preparing ourselves for continued investments in these segments. If we achieve growth of around 20% or more, ideally 25% or 30%, in these types of products, it will positively impact our trajectory in terms of margin and the kind of business that attracts investors. We have clear objectives ahead of us, and while there may be acquisition opportunities in the background, that aspect ranks third in our current priorities.

Steve Barger, Analyst

Got it. And I know that you guys did a lot of hard work on pricing actions to offset inflation last year. And I think Matt, when you said the heavy lifting is done, it was in reference to that. For the growth of 5% to 10%, can you talk about what your expectation is for price as volume in 2023?

Matthew Crawford, Chairman, President and CEO

Yes, it's interesting. I really probably met the restructuring more than the pricing to be quite honest. But I would tell you on the pricing side, I think in general, with some exceptions, but in general, those areas that were disproportionately and materially damaging our company, particularly in the continuing operations, we've addressed. So, I think that a lot of those tough conversations have been had. That is a work in process because the markets are work in process. So, as I've mentioned on prior calls, I think in many cases raw material was addressed early in the inflationary environment to a lesser extent permanent and significant changes in labor costs have not been addressed. So, no, I think that there is a daily list of opportunities. We continue to work through to identify opportunities where we're not getting paid for what we do because of how the marketplace has changed, where we have not recouped our costs. But I would say that those corners of the business where we were seeing things that were more catastrophic that burned through the P&L over the last 18 months, I think largely those have been addressed. But our work is not done there. So, the restructuring feels like it's mostly done. That piece, until inflation moderates completely, that work is never done.

Steve Barger, Analyst

Understood. That's great detail. Thank you.

Operator, Operator

And we do have a follow-up question from Dave Storms with Stonegate Capital Markets. Please proceed.

Dave Storms, Analyst

Hey, thanks for taking my follow-up here. Just hoping you could give us a little more color on the M&A market. You touched on how that's currently going to be a backdrop for you, but just with the Aluminum Products, was that more of an opportunistic buyer? Or is this a good time to be a seller? Kind of what are you seeing in the external surge from?

Matthew Crawford, Chairman, President and CEO

Yes. At a high level, regarding General Aluminum, I want to mention that we have been investors in General Aluminum for many years, around 30 to 40 years. It is a strong business that is moving in a highly desired direction. To be honest, there isn't enough capacity in that foundry sector to meet the demands of the OEMs. However, as I mentioned, we have numerous opportunities ahead of us. We had to make some strategic choices about where to allocate our capital given the growth we are experiencing. We believe there are several strategic buyers in the market who could manage that business as effectively as we can. Therefore, it seemed like a clear decision to take the opportunity to generate some funds.

Dave Storms, Analyst

That's very helpful. Thank you.

Operator, Operator

We have reached the end of our question-and-answer session. I would like to turn the conference back over to management for closing comments.

Matthew Crawford, Chairman, President and CEO

Great. Thank you very much. I know that there's a lot of noise so to speak in these comments in this press release, but I hope what has been taken away from this call is that we feel as though we're on the backside of COVID finally, so to speak. We feel as though we've got an opportunity to really begin to benchmark against what we were doing pre-COVID in 2019. We certainly hope and anticipate that the General Aluminum business deal will go through, but we're prepared either way to move forward with a solid business plan there. And in the meantime, again, we didn't take any time off in terms of restructuring our business or investing in the kinds of things that will take this business to the next level. So, thank you for your time today and we really look forward to the first quarter call. Thanks.

Operator, Operator

Thank you. This will conclude today's conference. You may disconnect your lines at this time and thank you for your participation.