Earnings Call Transcript - PKOH Q3 2023

Operator, Operator

Good morning, and welcome to the Park-Ohio Third Quarter 2023 Results Conference Call. Today's conference is also recorded. 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. The list of relevant risks and uncertainties may be found in the earnings press release as well as in the company's 2022 10-K, which was filed on March 16, 2023, with the SEC. Additionally, the company may discuss adjusted EPS, adjusted operating income and EBITDA as defined on a 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 attributable to Park-Ohio common shareholders to EBITDA as defined, please refer to the company's earnings recent release. I will now turn the conference over to Mr. Matthew Crawford, Chairman, President and CEO.

Matthew Crawford, Chairman, President and CEO

Thank you very much. And good morning to everybody. Let me start by going off script here a little bit and discuss how we view our results as compared to prior periods. As I've stated before, despite demand volatility, supply chain challenges, inflation and labor, which have challenged our results over the last couple of years, our business model and our value proposition remain unchanged. This is why we often choose to compare ourselves to the financial record-setting of 2018 and not 2022 as we do in this report. On that note, we're pleased to have achieved an all-time record revenue year-to-date in 2023 and expect, based on our forecast, to have a record-setting year for revenue in 2023. While we've not achieved the same in profitability metrics, it's important to note that third quarter EBITDA was nearing the record also set in 2018. Turning to the results, the third quarter showed strong revenue growth of 9% as well as solid operating leverage in our gross margins and other profit results. Additionally, we're pleased to see significant free cash flow during the quarter, which we anticipate will extend through the end of the year and will continue to strengthen our balance sheet and liquidity position. Again in this quarter, diversity in end markets continues to be our strength. While revenue growth overall moderated from a blistering rate of 17% in the first half, all three business segments contributed to our improved performance during the third quarter. While the demand continues to be stable across the business, it's worth noting that aerospace and defense has become an increasing part of our growth profile. We continue to benefit from commercial and pricing adjustments, which have been our priority this year as we grapple with inflation, especially in relation to labor. As we conclude our restructuring of our operations over the last several years, we're now pursuing a more focused operating model, which aims to increase productivity by allocating capital to our best products, services and centers of excellence. While the UAW strike at some of our truck and auto customers will provide a headwind to our fourth quarter results, I am certain that we will end the year a much stronger, more focused and disciplined company than we began the year and well positioned to take advantage of important macro trends around industrial policy, infrastructure spending and reshoring.

Patrick Fogarty, CFO

Thank you, Matt, and good morning. Our third quarter results reflect continued strong sales growth year-over-year and significant profit improvement across all three of our business segments. Sales were at a near-record level, gross margins were at their highest level in over five years, and operating income, earnings per share and EBITDA were higher than both last quarter and the third quarter of last year. Our year-over-year sales growth in the quarter was driven by continued strong customer demand in each of our business segments and increased product pricing. Sales growth was achieved in each business unit within our three business segments as we continue to benefit from our very diverse and global customer base. Our consolidated net sales from continuing operations were $419 million, up 9% compared to $384 million in the third quarter of last year. For the first nine months of this year, our sales were a record $1.3 billion, representing a 14% growth rate. We estimate that approximately half of our growth was volume driven and the remainder was driven by material and value-added price increases implemented across each business to offset higher raw material, labor and operational costs. In addition to the strong sales quarter, we also delivered sequential and year-over-year improvement in our gross margin. In the current quarter, our gross margin was 16.7%, which is an increase of 300 basis points over 13.7% last year and our highest gross margin percentage since the second quarter of 2018. SG&A expenses compared favorably to the second quarter levels and totaled $43 million in the third quarter, up approximately $6 million year-over-year. The increase compared to the prior year quarter was due to higher sales levels, increased personnel costs and general inflation. As a percentage of sales, SG&A was 10.3% in the third quarter compared to 10.9% in the second quarter of this year. Consolidated operating income from continuing operations was $27 million compared to $11.6 million a year ago. On an adjusted basis, operating income was up 70% compared to the third quarter of last year and 16% sequentially compared to the second quarter. Our third quarter improvement in operating margins reflects the positive impact resulting from plant consolidation actions completed in prior periods, from customer price increases implemented and operational improvement initiatives across our businesses. Interest expense was $11.6 million in the quarter compared to $9 million a year ago. Of the $2.6 million year-over-year increase, $2.4 million was driven by higher interest rates, with the remainder due to higher average borrowings year-over-year. Our effective income tax in the quarter was 24%, which is in line with our expectations for the full year. GAAP earnings per share from continuing operations for the quarter was $0.99 per diluted share compared to $0.58 in the third quarter of last year. On an adjusted basis, diluted earnings per share was equal to our GAAP earnings of $0.99 compared to $0.85 per share last year, an increase of 16%. On a sequential basis compared to last quarter's $0.83 per share, our adjusted earnings per share was up 19%. Our EBITDA from continuing operations was $38.5 million in the third quarter compared to approximately $30 million a year ago, an increase of 29% and improved 8% sequentially. This is our highest EBITDA level since the second quarter of 2018. On a year-to-date basis, EBITDA from continuing operations has increased 35% over last year. During the third quarter, we generated $23 million of operating cash flows and $17 million of free cash flow. During the first nine months of the year, we have made significant progress in reducing our net working capital days and are seeing the benefits across most of our businesses. Consequently, we continue to expect strong free cash flow during the fourth quarter and estimate our full year free cash flow to range between $20 million and $25 million. Our liquidity remained strong at the end of the third quarter and totaled $175 million, which consisted of $51 million of cash on hand and $124 million of unused borrowing capacity under our various banking arrangements. In September, we amended our existing revolving credit facility to extend the scheduled maturity date. The amended facility combined with expected free cash flow of $20 million to $25 million this year enhances our strong liquidity foundation to support our future growth strategy.

Matthew Crawford, Chairman, President and CEO

Turning now to our segment results. In Supply Technologies, net sales were $193 million during the quarter, up 4% compared to $186 million a year ago. On a year-to-date basis, sales in this segment have grown 10% to a record $586 million. Average daily sales in our supply chain business were up 6% year-over-year. The sales increase was driven by higher customer demand in most key end markets and realized customer price increases. During the quarter, the largest end market increases were heavy-duty truck and bus, military and civilian aerospace, power sports, and industrial and agricultural equipment. A few end markets, which defined year-over-year, were again isolated in certain consumer-related end markets and in the semiconductor end market. In addition, our fastener manufacturing business continues to perform well and achieved strong sales in the quarter, driven by an increase in global demand for our proprietary self-pierce and clinch products. Operating income in this segment totaled $15.6 million compared to $10.7 million a year ago, an increase of 46%. Operating margins were up 230 basis points year-over-year to 8.1% in the current quarter, driven by profit flow-through from higher sales levels, customer price increases and reduced operating costs. We remain focused on our initiatives to grow our higher-margin industrial supply business and our proprietary self-piercing clinch products in this segment. The integration of our prior year acquisitions has gone well, as both Southern Fasteners and Charter Automotive have exceeded our expectations and will position our industrial supply business and our SPAC products for future growth. In our Assembly Components segment, sales for the quarter were $108 million compared to $101 million a year ago, an increase of 7% year-over-year. Sales from each of our product categories, which include our rubber and plastic products as well as our fuel-related products, grew year-over-year, resulting from new business launched in the last year and increased customer pricing realized during the quarter. Segment operating income in the quarter increased significantly to $11 million compared to $3 million a year ago, and operating margins exceeded 10% in the quarter. On a year-to-date basis, adjusted operating income has improved $23 million year-over-year. The significant increase in margins has been driven by lower operating costs resulting from our plant consolidation efforts and other profit enhancement activities, including increased customer pricing. With respect to our aluminum business, which has historically been included in this segment, the sales process is ongoing. We continue to implement operational improvements and customer price increases, which will positively impact future results. During the third quarter, the operating loss incurred in this business was approximately $1 million. We continue to believe the automotive OEMs' initiative around lightweighting, electrification, and the onshoring of certain products for key auto platforms will benefit this business over the long term. In our Engineered Products segment, sales in the third quarter were $118 million, up 21% compared to $97 million a year ago, driven by strong customer demand in both our capital equipment business and our forged and machine products business. In our capital equipment business, sales of new equipment and aftermarket parts and services were both higher year-over-year, resulting in a sales increase of 21% in this business compared to a year ago. Revenues increased again this quarter in every region as our strong backlogs are being converted into sales. Bookings remained strong in the quarter and totaled $44 million, and our backlog as of September 30 was $172 million, an increase of 6% compared to the end of last year. In our forged machine products business, sales in the quarter were up 22%, driven by increasing customer demand in several key end markets, including rail and aerospace and defense. During the quarter, operating income in this segment was $7 million compared to $6 million a year ago, and on an adjusted basis, operating income was $7 million in each period as the profit flow-through from higher sales was offset by lower operating margins in our forging business. Our capital equipment operating income margins were strong in the third quarter and were approximately 9%. In our forging business, equipment downtime in the early part of the quarter and start-up costs incurred on our newly installed forging line in our Canton, Ohio facility impacted our results. On a year-to-date basis, sales in this segment were $354 million, an increase of 23% year-over-year and adjusted operating income increased to $20 million, 15% higher than the prior year. We continue to win new business in this segment in support of increased production of electrical steel used in battery technologies and certain munitions used in defense end markets. This year, we have received over $50 million of new equipment orders directly related to these market trends and believe this part of our business will continue to benefit. Finally, with respect to our full year 2023 sales guidance, we are maintaining our sales growth range of 10% to 15% year-over-year. Our fourth quarter revenues will be negatively impacted by the United Auto Workers strike, which affected several OEM customer plans. Although there appear to be tentative agreements between the OEMs and the UAW, it's difficult to estimate the full impact of the strikes on our fourth quarter revenues as production ramps back up to normal levels. Our current revenue levels from the OEM plants impacted by the strikes total approximately $25 million to $30 million per month across our Assembly Components and Supply Technologies segments. We continue to expect year-over-year improvement in adjusted operating income, EBITDA as defined, free cash flow and adjusted earnings per share for the full year. Great. Thank you very much, Pat. We'll now open the line for questions.

David Storms, Analyst

Good morning. Just wanted to start. You mentioned in the call that your strong revenues were a product of half volume and half pricing. How do you see that going forward? Is there still room to push pricing? Or do you think volumes are going to kind of be the driver through the remainder of '23 and into '24?

Matthew Crawford, Chairman, President and CEO

Yes, it's a great question. I would love to know the answer. No, I made a joke. There's no question that pricing during what's been a very challenging inflationary market in the industrial space over the last couple of years, migrating from supply chain issues to raw material issues to now labor has provided the opportunity for us to push pricing. It has been a strategic priority, as I mentioned, and one that has required an incredible amount of focus over the last couple of years. Clearly, as inflation subdues, particularly in those first two areas, not so much in labor yet, the opportunity is lesser. We have not entered our business planning process yet, so it's really difficult to comment on next year. But I would say that our ability and our efforts around pricing will become less significant as we close out what has been a very challenging period with a lot of robust and difficult conversations. And they're not complete yet, and we're still dealing with inflation and labor. So I don't want to suggest it's over. I just think that the opportunities will get smaller and smaller moving forward. And we have to anticipate that we can manage the additional inflation. If we can't, then that's a different issue.

David Storms, Analyst

Understood. Very helpful. And then just switching to cash flows for a second. It looks like you had a nice bump in cash flows in Q3. Obviously, you have your stated goal of the $20 million to $25 million for 2023. Kind of what levers do you expect to pull to close out the end of the year and hit those goals?

Patrick Fogarty, CFO

David, this is Pat. As I mentioned, we've set very aggressive working capital reduction targets in terms of the days of working capital to manage the business. Progress has been made throughout the first three quarters, and we expect that to continue in the fourth quarter. So it's really driven off of reduced working capital. The investments that we made in 2022 when supply chain restrictions required us to carry more inventory are starting to reduce. And as you look at the sales growth that we've seen in the current year, we've invested very little in working capital, which is a tremendous achievement by our business units, and we expect that to continue in the fourth quarter.

Matthew Crawford, Chairman, President and CEO

I would like to mention that while this is not directly related to your question, we foresee our business model, especially concerning ongoing operations, becoming less capital-intensive. As we consider cash flows and my earlier comments about becoming a stronger, more focused business, this factor is integral to our capacity to generate cash flow throughout the business cycle.

Christian Zyla, Analyst

Good morning, everyone. It's actually Christian Zyla on for Steve Barger. Thank you for taking my questions. First question, with your guidance held, that implies about a 6% year-over-year growth rate in 4Q on a pretty nice 17% comp. During a time where customers and suppliers continue to talk about destocking and broad macro uncertainty, which end markets do you see that strength continuing? And are you hearing any slowdowns from your customers?

Matthew Crawford, Chairman, President and CEO

I'll give Pat a minute to answer that question. I try to beat the drum on diversity full time. There's no doubt that unit volume year-over-year has softened in terms of growth perspective. Our numbers and forecasts incorporate some of the pricing work that I alluded to earlier. So no, I think we agree. We've seen some of the unit slowdown that you mentioned. But again, I think our diversity is strong. I would highlight a couple of different areas. One is I mentioned the rotation and, I guess, leadership, for lack of a better word, to aerospace and defense. Again, an important part of our business. Not one we spend a lot of time on, but that is not slowing down. It's increasing. So that diversity continues, I think, to support. The other thing I will mention is while Supply Technologies, in particular, is affected by consumption and demand rates at our customers on a daily, weekly, monthly basis, we also have an equipment business and a forging business that have backlogs that extend, in some cases, beyond 2024. So this is our diversity at play.

Patrick Fogarty, CFO

Yes. I mean Matt touched on the topics that will show increases in revenue year-over-year in the fourth quarter, but we have tremendous backlogs right now in our Engineered Products segment and the diversity of our Supply Technologies segment that stretches beyond one particular part of the market, whether it be bus and truck, aerospace, agricultural. We see strength year-over-year in each of those markets. And Matt highlighted aerospace and defense, where we expect that to continue to be strong for us. The last two years have been quite sluggish in that end market. So the increases are going to be seen not only on the commercial aerospace side but on the defense side as well.

Christian Zyla, Analyst

Moving to the UAW comments, just want to make sure I understand your comment. You quantified about $27 million in monthly revenues from the Detroit 3 automakers impacted by the strikes. How should we think about haircutting that? I guess, is like a 20% haircut on those revenues fair? Or are you shifting production from some of those products in the near term? Just trying to think about how we should haircut that.

Matthew Crawford, Chairman, President and CEO

I'm going to let Pat gather his thoughts here for a second. Please understand that the UAW strikes have not only impacted the big three. While that is the significant chunk of impact, there have been other labor disruptions in the marketplace. I might point out Mack Truck, which is still currently dealing with a strike. I just want to point out in this environment that this is an ongoing situation happening in the industrial workplace. Many of these unions are sort of the last people at the table relative to what the non-union workers have gotten, particularly on the direct labor side over the last several years. So we probably will see more of this, in my guess. But this isn’t just the big three for starters, particularly as we think about Supply Technologies, which does not do as much automotive. So I would just comment briefly on that risk and then turn it back over to Pat.

Patrick Fogarty, CFO

Yes. I would comment that the ability to forecast the impact of the strikes is very, very difficult. It's fluid. There are tentative agreements that still have to be voted on. Ramping up each of our production sites based on volume demand coming not only from the OEMs but as Matt mentioned, the Tier 1s and Tier 2s, we'll start to see that come back throughout the month of November. My script included the monthly impact based on what we knew as of the end of October, and that's probably a good barometer. As the production plants get back to work and volumes start to return to normal levels, the $25 million to $30 million a month will drop significantly. However, it's unknown right now how quickly that's going to happen.

Christian Zyla, Analyst

Got it. That's helpful. And then I guess switching over to M&A. So Southern Fasteners seems to have been a really good value deal when you guys bought it. Are there other good value deals out there? And what does your pipeline look like? And what are you most interested in acquiring?

Patrick Fogarty, CFO

The pipeline has always been consistent. The diversity of our business allows us to look at a number of strategic opportunities throughout the year. We're cautious with capital allocation. Southern Fasteners was a tremendous acquisition that allowed us to expand our industrial supplies business. What we're seeing in the marketplace is that credit markets are tightening. As a result, valuation multiples are starting to drop. There could be more opportunities that come our way. We continue to look for strategic acquisitions that are accretive to our margins, both gross margins and our operating income margins, and those businesses that we can grow at a faster pace than our current organic growth levels.

Christian Zyla, Analyst

Great. And just the last one for me, I guess a follow-up on Fasteners or Southern Fasteners. Can you just remind us how Southern's margins are relative to the overall ST segment? And then what are the opportunities that you guys think about for improving that in the long term?

Patrick Fogarty, CFO

Sure. Before we acquired Southern Fasteners, we had built an industrial supply business within Supply Technologies, which is primarily an OEM production supply chain manager. The margins are higher than our segment margins would indicate in that space. Typically, those are MRO products or products used to fix equipment, fasteners and other supplies used in production plants that often are critical spares needed in the business that generate higher margins. I won't comment on the individual margins in that particular business for us, but they're higher than the traditional segment margins that you see.

Matthew Crawford, Chairman, President and CEO

I would also like to add that as we think about how to identify opportunities in Supply Technologies, our focus is going to be on bringing value to our customers. We think that there are opportunities to do that, which will be accretive and provide improved consolidated margins. Our strategy, both internally and externally, is to continue to provide more value to our customers. So, while there are opportunities to expand that product portfolio in a very accretive way, the systems are already set up, which is advantageous. Great. Thank you all for your interest and your ownership in our company. While times are still interesting and challenging in many ways, we have a more focused, disciplined business model here, and we're anxious to take advantage of what we see as a very bright future in the industrial space, both globally and particularly in the U.S. Thank you very much. Bye-bye.

Operator, Operator

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and enjoy the rest of your day.