Park-Ohio Holdings Corp.

Q3 2021 Earnings Conference Call

11/3/2021

spk00: Good morning and welcome to the PARCC Ohio third quarter 2021 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 Legation 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 2020 10-K, which was filed on March 5, 2021, with the SEC. Additionally, the company may discuss adjusted EPS and EBITDA as defined. Adjusted EPS and EBITDA as defined are not measures of performance under generally accepted accounting principles. For a reconciliation of EPS to adjusted EPS and for a reconciliation of net income attributable to Park Ohio 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.
spk04: Thank you very much and good morning. Just a few comments before I turn it over to Pat to talk about the details. Despite significant challenges, most of our business continues to perform well. Supply technologies have seen a return to pre-pandemic levels in terms of revenue and profitability. This is despite ongoing challenges in supply chain as it relates to delivery and cost. New business activity is on track for close to $30 million this year. It is also worth noting that These improved market conditions have benefited most of our customers, including many of our small and midsize accounts. We continue to benefit from our broad diversity in this business from a geographic, product, and end market perspective. I also want to highlight the recent addition of Brian Norris as President of Supply Technologies. Brian brings considerable experience and commercial leadership to our team. Engineer Products and our industrial equipment business in particular is seeing a significant uptick in bookings. While this business is traditionally a late cycle business, it is clear that we're seeing a resurgence in industrial capital spending driven by traditional industries and some newer markets like alternative energy that are growing rapidly. We anticipate strong revenue as we enter 2022, and we'll need to focus on execution to track towards historical margin performance. The Forge Group, which has also included an engineered product segment, is beginning to benefit from improved spending in energy, aerospace, and rail, which have all lagged the general recovery. Returning to our challenges in automotive, we're beginning to make progress addressing the daily variances in the business. Operating efficiencies have been negatively affected by availability of labor and the cost and waste related with high turnover. We're accelerating our restructuring and shifting workload where possible within our footprint. We're also investing in process improvements as well. It is important to note that these operational variances are mostly related to two of our facilities. We're also challenged by the incredible spike in raw materials. While in many cases we have a mechanism to retrieve some of these increases automatically, the dramatic spike has disproportionately impacted our current results. We will continue to address these increased costs through improved efficiencies and pricing and expect significant near-term impact. Most importantly, our results should not mask the repositioning of our business for growth and improve profitability as we look into 2022. During 2020 and year-to-date 2021, we've spent over $15 million in restructuring, which will improve our expense profile and reduce our underabsorbed overhead. Also, year-to-date 2021, we have spent approximately $10 million on CapEx aimed specifically on cost savings and business optimizations. All of these investments target less than a two-year return at their worst. So, while these results are disappointing, we believe they are highly localized within our business And while visibility is still very low, at the moment, we see significant improvements as we enter 2022. With that, I'll turn it over to Pat.
spk05: Thank you, Matt, and good morning. Our results in the third quarter reflect continued strength in our supply technology segment and improving performance in our engineered product segment. In our assembly component segment, the ongoing automotive OEM production challenges, raw material price inflation, and higher labor costs have affected our quarterly results and continue to be a challenge for this business segment. Overall, our consolidated net sales of $359 million in the quarter were up 5% compared to a year ago, with improved year-over-year sales occurring in our supply technologies and engineered product segments. Sales in our assembly component segment were lower year-over-year as a result of the continued supply chain challenges, which have caused production volatility throughout our OEM and Tier 1 automotive customer base. Gap EPS for the quarter was a loss of 60 cents, and adjusted EPS, which excludes primarily plant closure and consolidation costs, was a loss of 32 cents. Our operating loss in the quarter, which was approximately the same as our second quarter operating loss, continues to be a result of the semiconductor chip shortage which caused low OEM production levels on certain auto platforms, primarily affecting our assembly component segment. We estimate the impact on our consolidated net sales in the quarter was $15 million, resulting in an EPS impact of approximately $0.34 per share. In addition, labor inefficiencies caused by labor shortages and significant raw material increases, primarily aluminum and rubber compounds, impacted our results by an estimated 49 cents per share. SG&A expenses in the quarter were $45 million compared to $39 million a year ago. Our current quarter SG&A expenses were at a more normal level versus a year ago when SG&A levels were significantly reduced during the pandemic shutdowns. Interest expense totaled $7.6 million compared to $7.4 million a year ago, the increase driven by higher average borrowings during the quarter to fund higher inventory levels. The income tax benefit in the quarter of $2.8 million represented an effective tax rate of 27%, which is higher than the U.S. statutory rate of 21%, due primarily to state and local taxes. For the full year 2021, we estimate an effective tax rate of 26 to 29%. Our liquidity continues to be strong and total $218 million as of September 30th compared to $243 million a year ago and $220 million last quarter and consisted of $60 million of cash on hand and $158 million of unused borrowing capacity under our various borrowing arrangements. During the first nine months of the year, net cash used by operating activities was $26 million, primarily to fund higher inventory levels caused by supply chain constraints and increasing customer demand. During the third quarter, our inventory levels increased $24 million in support of customer demand levels and continued long supplier lead times caused by freight carrier delays. In addition, Higher raw material and inbound freight costs also affected our inventory levels. We estimate we are carrying approximately $30 million of incremental inventory as a result of the global supply chain challenges as of September 30th. Capital expenditures during the quarter were $11 million, primarily in our assembly component segment for growth and margin enhancement projects. We continue to estimate our full year 2021 capex will be in the range of $28 to $32 million. Turning now to our segment results, in supply technologies, net sales were $154 million during the quarter, compared to $155 million in the second quarter and $132 million a year ago. Average daily sales during the quarter were similar to second quarter levels and up 20% year over year. In the quarter, we saw strength in most end markets, most notably in the heavy-duty truck, semiconductor, and agricultural industrial equipment end markets. In addition, demand in our civilian aerospace market was up nearly 10% from last quarter and 36% compared to a year ago. We continue to have success with our new business initiatives centered around industrial supply and mid-market accounts. Year-to-date, new customers total over 150,000 including over 30 new customers in the third quarter in various products and end markets. Operating income in this segment totaled $10.7 million in the quarter, and operating income margin was 6.9%, up 30 basis points compared to last quarter. Operating income and margin were both impacted by higher inbound domestic and ocean freight costs, including expedited freight caused by global supply chain constraints. We expect the ongoing global supply chain challenges to continue to impact our customer demand for the remainder of this year. So far this year, our active price management strategy has minimized the margin impact of increasing product and freight costs. We expect our team will stay ahead of these issues and continue to work with our diverse customer base and supply chains to minimize any future margin impacts. In our assembly component segment, Sales were $120 million compared to $110 million in the second quarter and $127 million a year ago. Sales in the current quarter were again negatively affected by the ongoing chip shortage, which resulted in lower sales and operating income in this segment of approximately $13 million and $5 million, respectively. Weekly demand fluctuations and OEM plant shutdowns and delays impacted certain plant production schedules again this quarter. We expect the microchip shortage will most likely remain a challenge for our OEM customers throughout the fourth quarter and into 2022. Although it is difficult to project the full year impact at this time, we estimate that the sales impact in the fourth quarter will be similar to third quarter levels. The third quarter operating loss of $8.9 million in this segment continues to be driven by several factors. First, supply chain disruptions continue to impact automotive production on certain key platforms, primarily in two of our aluminum plants, causing extreme fluctuations in production and significantly higher plant operating costs. Second, rising raw material prices in our aluminum and rubber products businesses impacted our profitability. In our aluminum business alone, raw material prices have increased 55 percent since the beginning of the year and 20% during the quarter. And finally, increased labor costs caused by local labor shortages is a challenge for many of our plants. Our third quarter results were impacted by increased wages, training and recruiting costs, production inefficiencies, and higher scrap levels resulting from these labor shortages. Also during the quarter, we incurred $1.8 million of one-time charges related to plant restructuring, closure, and consolidation activities. In response to the supply chain challenges and higher raw material and labor costs in this segment, we have relocated production to lower cost facilities with open capacity, automated certain manufacturing processes, and implemented and will continue to implement customer price increases. In our engineered product segment, sales were $84 million compared to $86 million in the second quarter and $81 million a year ago. In our capital equipment business, Sales were up 10% compared to a year ago, and operating margins were at their highest level in recent years, driven by strong aftermarket sales and lower operating costs. Bookings of new capital equipment totaled more than $60 million in the third quarter, an increase of 40% compared to last quarter, and almost three times new equipment bookings in the third quarter of 2020. Our improving performance in our capital equipment business was partially offset by the results in our forged and machine products business, where sales continue to be impacted by low demand from several key end markets, including oil and gas, commercial and military aerospace, and rail. In addition to the strong bookings in our industrial equipment business in recent quarters, our backlogs in our forged and machine products business are also improving and expected to continue to increase as we close out the year. During the quarter, this segment had adjusted operating income of $1.2 million, excluding the $600,000 of charges for plant closure and consolidation. This was an improvement of last quarter's adjusted operating loss of $100,000. And finally, corporate expenses totaled $7.4 million during the quarter, compared to $6.8 million last quarter and $7.6 million a year ago. On a year-to-date basis, corporate costs total $19.4 million in 2021, compared to $19.7 million in the 2020 period. With respect to our previously communicated 2021 financial outlook, we expect year-over-year organic sales growth to be within the range of 10% to 12%, and capital expenditures to be in the range of $28 to $32 million. We expect EBITDA margins as defined to approximate 5% for the full year, and we expect to use up to $25 million to $30 million in free cash flow for the year. Now I'll turn the call back over to Matt.
spk04: Thank you, Pat. We'll now open the floor for questions.
spk00: Thank you. We will now be conducting the question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. The confirmation tone will indicate that your line is in the question queue. You may press star two if you would like to remove yourself from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Our first question is coming from the line of Steve Barger with KeyBank. Please proceed with your question.
spk02: Thank you. Good morning. Good morning, Steve. Good morning, Steve. I'm going to start with the addition of Brian Norris. He came from Grainger, very data-driven organization. I know it's only been a couple of weeks, but any thoughts on how strategy or execution might change under his leadership?
spk04: Well, I appreciate the question. I would like to highlight that certainly it's been a wonderful transition. John Shanowski was a wonderful leader of that business. He retires down to Florida, so we wish him well. We've got a nice overlap period between he and Brian, so we expect that transition to go very well. I can't really comment yet, I think, on specific thoughts and strategies around that Brian will have. I will say that we've spent an extensive amount of time with him. We think he'll bring wonderful leadership experience and particularly commercial experience that I've mentioned. He has observed to me that we also use data very well. So I think we're aligned on a number of our important strategic missions, including continuing to develop strategic strengths outside of our core business. Certainly he understands our industrial supply and MRO offering and has a great appreciation for our core competencies as well. So a little bit too early to tell, but I think that he brings a really nice combination of someone who's in adjacent industry and truly understands what we do while having a sort of broader view of the field, if you will.
spk02: Yeah, thanks. Looking forward to hearing his thoughts on, you know, what is arguably your best business and how he can make that better. So just going back to assembly, Pat, I think you said the revenue will be flat sequentially in 4Q. Can you get back to break even on the operating line or between seasonality and everything else that's going on, is that unlikely?
spk05: You know, the fourth quarter, Steve, you know, with holiday shutdowns and some supply chain constraints that we expect to continue to challenge the business, you know, we're likely to not get back to that level that you mentioned. You know, during the quarter, the operating loss of $8.9 million was significant, and there are some one-time items in there, plus we expect to begin to recover some of that lag on raw material prices. But if you look at solely aluminum and what's happened even through the month of October, although the rate of increase may have lessened in the month, the price of aluminum that we use in making our aluminum castings is still very, very high. And so likely the recovery will not occur until next year, only in the event prices stabilize and begin to drop.
spk04: I would add, our visibility is poor. There's no question about it. We've learned that all too well this year. A couple comments. One is on the labor front, I think there was some addition of a fairly significant amount of jobs we heard about this morning in the country. So I do think and hope that people will continue to return to the workforce, any stability there will be a significant game changer for our business. But we're not waiting for that. In the meantime, we're moving work to where we can find people that will work. So I think we're not just sitting on our heels here. That takes time. We're beginning to see the benefit of it. So the trajectory on labor, I think, is going the right direction, regardless of what the visibility is. The volatility in demand, plant by plant, program by program, is very, very challenging. They're changing sort of releases week to week. We can expect to see that through the holidays, which is a little frightening. But the trajectory on labor, for the reasons I've mentioned, is in the right direction. As you think about raw materials, the consumer-facing part of our business, wherever it is, we've seen it in the marketplace. They just change the price. I mean, cars are a great example. Selling half the cars, making twice the money. I'm obviously being a little aggressive there, but it's a little harder for us to recapture that. Whether it is successful price negotiations that just haven't been implemented yet or ongoing ones, the trajectory there is good as well. So You know, we can say with confidence that we're moving in the right direction, but a lot depends on build rates and the things that are going on in the fourth quarter and shutdowns, as you mentioned. But I don't want to leave it as though we're just waiting to get lucky here. We're not. We're not waiting for there to be a magic wand relative to the semiconductor situation. We're not. We're doing some things that are going to get this ball moving meaningfully in the right direction now.
spk02: Understood. Yeah, we can see that you're being proactive in the things that you're doing. But just from a conservatism standpoint, we should probably model that the next couple of quarters, 1Q22, 2Q22 maybe, probably look more like the last part of this year versus seeing some step change as you go into next year.
spk05: I think we should see some improvement. I'd hate to say that we would continue to lose $9 million a quarter in the first two quarters of 2022. That will not happen.
spk04: I think we'll see some improvement as we go into the end of the year, and then I think that will give us a greater ability to forecast the beginning of next year.
spk02: Great.
spk04: But no, I agree with Pat. I am, I guess I got to be careful these days saying I'm certain. I believe we have, with a high conviction that we've seen the bottom.
spk02: That's good to hear. And I'll just ask one more. maybe on a happier automotive topic, can you remind us how you're thinking about your strategy around EVs? How many EV OEMs are you talking to? What does content look like? How do you see that progressing? Is that mix ultimately shifts? I know we're still obviously much heavier towards internal combustion, but that's what people are starting to talk about.
spk04: Yeah, I get it. I think that Let me tell you how I've answered that question in the past, and I will say it with more conviction, a little more detail this time. Our portfolio of business in automotive, the majority of that work is not focused completely on internal combustion engine, meaning we like products that are agnostic. Steve, you know our product line. When we think about rubber-molded products, we think about extruded products, and all the applications that are not just fuel related. When you think about our fastener technology, when you think all these applications I'm discussing right now are, are non ice focused. So we feel very, very, our aluminum, excuse me, as challenges that businesses right now, lightweighting is more important. Um, our products are in the suspension and chassis area. So I, I feel very good about our product portfolio unquestionably. we do have positions in ice focus, whether that be some of the extruded product or our direct injection business. Ironically, we see the direct injection business getting a lot stronger as they try to make these engines more powerful while they're reducing the emissions along the way. So we think that will buck the trend in the ice space as adoption increases, but it's still an ice application. So that's been our storyline when people look at our businesses. And we are talking heavily to the domestic companies in terms of dollars, but we sell into certainly into Tesla. We sell into Chinese companies as well. So it's not always easy to know where one of these products ends up, right? We don't really know every time we ship GM what's going on the bolt, for example. So I think that that's the point I want to make with more granularity now. Much of the stuff we are quoting today is where they are trying to commonize, you know, customers are trying to commonize parts among platforms. They don't know how many of a particular platform they're going to make, whether it's going to be internal combustion engine, hybrid, or an EV. We could take a control arm or a steering knuckle, aluminum, cast, that particular product, it depends on how each sells. So I would argue that that product is really well positioned for the adoption, whatever direction it goes. So that's our strategy. So in that sense, we're talking to all the major domestic companies in terms of their EV expansion. And we're certainly also talking to and servicing some of the pure BEV people like Rivian, like Tesla, and also some of them in CHIME.
spk02: Really appreciate the detail. Thanks.
spk00: Thank you. Our next question is coming from the line of Sarkis Sherbetchian with B. Reilly. Please proceed with your question.
spk01: Hi, good morning. Thank you for taking my question here. Good morning. Yeah, so I just want to focus on the pricing initiatives to respond to the higher production costs and also the rising aluminum and rubber prices here. At what point do you think you can catch up to pricing where effectively your margins are not as sacrificed anymore?
spk03: So let me begin by saying and reminding everyone that a lot of our business naturally
spk04: is able to reprice itself. And what I mean by that is, when I think about engineered products group, for example, those, whether it be in a forge business or in the equipment business, those quotes and those jobs tend to turn over fairly quickly. I won't say there's no risk in supply chain and in inflation, there certainly is, but you're not signing a five-year deal. So in that sense, that engineered product is to some extent insulated from some of those risks. The spikes in some of these areas doesn't let anyone be insulated, but the reality of it is that business should be able to reprice more efficiently. Much of our supply chain business is either non-long-term agreement, smaller customers that are fairly easily repriced appropriately. And then the remainder, some of the large accounts, often have indexing on raw material. So it's the remaining 25, we'll call it, percent of our business that is challenged. And those tend to be, not surprisingly, disproportionately in the automotive sector. Some of that, we still have raw material pass-throughs. And we'll benefit from that as the pricing catches up to the index. But there's a chunk of it that we've signed long-term agreements that we need to negotiate meaningfully and aggressively to stop the losses. So that's what we're in the middle of. And it's hard to answer your question, but I do want to remind you that 80% of our business kind of somewhat fairly within less than six months or within less than three months, kind of reprices itself. I think in the third quarter, we got the worst of all, right? We got some of the business that naturally repriced were upside down a little bit. And I think that the ones that don't naturally reprice were at their worst moment. So I think we will see meaningful traction, particularly on the material. in the next three, four, five months for sure. I think that recapturing labor is always more challenging, recapturing margins, always recapturing. But I think, again, we've seen a lot of our business reprices naturally, and we will see that build momentum going into the new year.
spk01: Okay, understood. That's a helpful discussion. I suppose if I kind of step back and then think about the three different business segments. Is there any particular end market that you see today that's giving you excitement? I know you talked about the EV opportunity, but just wanted to kind of touch on the other segments as well, whether it be engineered products or supply tech. And then also to that, what industry maybe looks a little bit challenging? I know you mentioned oil, gas, rail. But any other industries that are maybe non-obvious that look challenging?
spk04: I'll make two quick observations, and I'll give Pat a minute to think because he'll be smarter than this. So I'll tell you, first of all, I am thrilled. I mentioned briefly that we're seeing a little pickup, not just in oil and gas, but in aerospace and rail. Those have lagged. I'm certainly not telling you anything you don't know. So while everything else has been booming, the problem for us is, We've got a fair amount of investment in an overhead related to those businesses, particularly in our engineer products group, which is often our highest margin business. So to the extent that we see a little wind at our back on those markets, the flow through on those incremental sales will be significant and meaningful. So while we may not return to historic levels there, particularly in oil and gas, in terms of the money they're investing in that sector. I do think we're going to see, one, the benefit of incremental revenue, particularly at rail and aerospace as it rebuilds, with outsides flow through. And then I also think we're going to benefit in that business disproportionately on the restructuring, because that's where we did a lot of heavy lifting on the restructuring, because guess what? Oil and gas and the capital investment in oil and gas is never going back to where it was in our opinions. So we need to right-size our business. So those are industries that I know are kind of traditional and not exciting new. I will say and speak briefly in supply technologies, I mentioned some of the enthusiasm, excitement around new business and the strength in our small and mid-sized account business. This is an exciting area for us. Because we do do very well with the large accounts, but watching our sales organization, it's not really end market focused. That business lends itself to assemblers of all industries that require a lot of pieces, parts. So I'm less focused there and would answer your question by saying, I'm not going to talk about end market there. I'm going to talk about the idea that we're seeing a lot of new logos, we call them, a lot of new names and not a new opportunity for the future. And that reorientation of our sales team is very exciting. And I think, you know, as I've said before, a $100,000 account has a much more highly likelihood of turning into a million-dollar account than you can go out and get a million-dollar account. So very exciting. I will say, and I mentioned in my opening comments, seeing some strength out in the capital equipment group out of alternative energy, particularly out of Europe, is also really exciting as well. So that's not new to us. but the strength in it and our positioning from a product perspective is pretty cool.
spk05: I think Matt covered an awful lot there. He didn't give me much to cover, but I will like to comment on a couple of other areas. I think within supply technologies, the demand increases we're seeing on the aerospace side hopefully will continue to build momentum into 2022. That's exciting for us because of how low it's been. Within that same segment, our SPAC product, our fastener manufacturing business, continues to penetrate OEMs throughout Europe and Asia with many different applications at decent margins. So that is a very exciting business for us as we head into 2022. And just to add on the capital equipment side, you know, $60 million of new orders in the quarter, you know, following up on a $40 million new order level in the second quarter, in equipment that historically we've had very high margins on. This is not new technology as much as induction hardening type capital assets that that our customers are investing in. This is the type of equipment that we specialize in and should yield higher margins in. So those are the things that, in addition to what Matt said, are exciting to me.
spk01: No, great. Thank you for the comments there. And one final one for me. I guess, you know, just kind of looking at the updated full year outlook, on the year, it seems like EBITDA margins going to be approximately 5%. I guess if we look out and take into consideration all the comments you have from this call, from today's call, and then kind of the trends maybe into even the first half of 22, would it be fair to say that as we look into modeling 22, EBITDA margins should be better than 5%, but maybe below kind of the high single-digit level that you've historically done? Or do you think you can get to the high single-digit level? What are your initial thoughts there?
spk04: I'm going to let Pat answer that, but I'm going to tell you this is going to be a journey. I mean, we're, you know, as I mentioned earlier, pricing, you know, material is something we need. Getting, you know, paid for what we do, and there's a lot of tough conversations we have to have to be sustainably where we need to be in a business. So I don't think it's going to be a light switch, personally.
spk05: Yeah. As you read, you know, The current situation with the semiconductor chip shortage and the various supply chain constraints that are out there, it could impact demand levels at certain of our customers. And that's the unpredictability of next year. When will this stabilize? Will it stabilize by mid-year? And if that's the case, then the second half of next year should yield very strong results. But it's a challenge to even try to forecast at this time. Understood.
spk01: Thank you for the comments.
spk00: Thank you. We have no additional questions at this time, so I'd like to pass the floor back to management for any additional closing remarks.
spk04: Well, thank you for your questions today. We appreciate it. This is not the call we had hoped to have or the results we hoped to have, but I want to emphasize I think we're on the right path, and we've got some heavy lifting to do and a portion of the business, but there's a lot of good things going on, too. I hope that came through and we appreciate everyone's patience and we appreciate everyone's investment and interest. Thank you.
spk00: Ladies and gentlemen, this does conclude today's teleconference. Once again, we thank you for your participation and you may disconnect your lines at this time.
Disclaimer

This conference call transcript was computer generated and almost certianly contains errors. This transcript is provided for information purposes only.EarningsCall, LLC makes no representation about the accuracy of the aforementioned transcript, and you are cautioned not to place undue reliance on the information provided by the transcript.

-

-