Park-Ohio Holdings Corp. (PKOH) Q1 2015 Earnings Report, Transcript and Summary

Good morning, this is the conference operator and thank you for joining the Park-Ohio 2015 First Quarter Results Conference Call. As a reminder, all participants are in listen-only mode and the conference is being recorded. After the presentation, there will be an opportunity to ask questions. [Operator Instructions]. At this time, I'd like to turn the conference over to Mr. Edward Crawford, Chairman and CEO. Please go ahead Mr. Crawford.

Welcome, ladies and gentlemen to the first quarter 2015 operational report of Park-Ohio. I would like Scott Emerick, the Chief Financial Officer to read our guidance.

Thank you, Ed. Good morning, everyone and thank you for joining us today. If you have not received a copy of our earnings press release, you can find it on the Investor Relations section of our corporate website at www.pkoh.com. I want to remind everybody that certain statements we make on today's call, both during opening remarks and during the question-and-answer session 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 2014 10-K that was filed on March 16, 2015 with the SEC. The Company undertakes no obligation to update any forward-looking statements whether as a result of new information, future events or otherwise. Additionally, the Company may discuss as adjusted earnings and EBITDA as defined. As adjusted earnings and EBITDA as defined are not measures of performance under Generally Accepted Accounting Principles. For a reconciliation of net income through as adjusted earnings 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. Any references we make to earnings per share are on a fully diluted basis. Back to you, Ed.

Thank you, very much, Scott. May I now introduce Matthew Crawford, the President and COO of Park-Ohio? Matthew?

Thank you, very much and good morning. We're happy to report that we set a new record for quarterly revenues in the first quarter of 2015 and our earnings was slightly better than we're forecasting internally. Specifically, our U.S. GAAP earnings increased 6% to $0.87 per share compared to $0.82 per share in 2014. Our as adjusted earnings increased 11% to $0.93 per share compared to $0.84 per share in the prior-year. For record, that I'd like to draw your attention to, we established a new quarterly EBITA record by increasing EBITDA as defined, 16% to $33.5 million. Let's begin our discussion of the first quarter results with revenue. Net sales increased 18% to a quarterly record of $375 million, compared to $318 million in the prior year. The revenue increase is attributable to each of our business segments with every segment reflecting double-digit revenue growth. A little less than half the revenue growth is attributable to acquisitions, while the majority of growth is attributable to organic growth initiatives. Gross profit increased $2.4 million to $58.4 million for the first quarter. The gross profit margin was 15.6% which is 200 basis points down from the 17.6% in the first quarter of last year. The decline in gross margin is largely due to the sales mix changes and lower current your margins in the Engineered Product segment. On a sequential basis with the fourth quarter of 2014, gross margins were relatively comparable. Consolidated SG&A expense of $34.1 million are nearly flat with the prior year, but SG&A expenses as a percent of sales declined 150 basis points to 9.1% in 2015, from 10.6% last year. Even though we incurred $2.7 million of incremental SG&A costs in the first quarter of 2015 associated with recent acquisitions, we incurred less professional service fee than we had in 2014 and did a good job with cost containment. Interest expenses of $6.8 million is $500,000 more than last year, primarily due to the fourth quarter 2014 acquisitions. Our effective tax rate for the first quarter was 36.6% and was comparable to last year's first-quarter effective tax rate of 35.2%. Our full year effective tax rate estimate is still hoping to be approximately 35.3%. I'd like to make one last comment on consolidated results before we get to the segment discussions. If you saw our Annual Report recently, you would've noticed that 26% of our business is outside the U.S. As the U.S. dollar has strengthened over the last year, this has unfavorably impacted our international results. We completed an internal pro forma calculation of the impact on currency to our top line and bottom-line by calculating what our results would've been on a pro forma basis using last year's first-quarter exchange rates. This callous calculation indicates that our first quarter 2015 revenues were unfavorably impacted by $9 million and our 2015 net income was unfavorably impacted by $1.3 million or $0.11 per share from the effective currency between the two years. Now, looking at segment results. First, we'll look at Supply Technologies. Supply Technologies segment revenues represented 40% of consolidated revenues for Park-Ohio. Revenues increased $17 million during the quarter or 13% and totalled approximately $151 million. Almost all of this growth is organic. The majority of our growth in the first quarter was generated with especially strong performance in heavy-duty truck, which is up 24%, power sports and recreational equipment, which increased 24% as well and semiconductor, which is up 58%. In addition, our automotive business increased 24% as well. We remain encouraged by the continued growth and momentum in these well diversified markets as we continue to grow within the global product platforms of our key customers. With the increases in net sales, segment operating income increased $4.1 million or 41% to $14.2 million. Segment operating income margin was 9.4% in the first quarter of 2015, which was a 190 basis point improvement compared to last year's first quarter segment operating income margin of 7.5%. These improvements were driven largely by improved operating leverage, the full integration of the late 2013 and 2014 European acquisitions and the continued focus on more highly Engineered Products in the portfolio. Next, let's discuss the Assembly Components segment. Assembly Components revenues represented 38% of consolidated Park-Ohio revenues. Net sales increased $32.4 million or 30% to approximately $141 million for the first quarter of 2015 compared to last year. Approximately 46% of this growth in the segment is attributable to the Autoform acquisition and 48% of the growth is attributable to the organic growth in our aluminum business on the strength of our key programs. In particular, the Chrysler 200 and Jeep Cherokee platforms are performing very well for Chrysler and the Dodge Dart has shown significant improvements, and these platforms are the primary drivers to this increase. Based on this strength and the continued implementation of new business, aluminum revenues increased 36% compared to the prior year. In the first quarter of 2015, segment operating income grew $2.5 million to $10.6 million, which was a 31% improvement over the prior year. Segment operating income margin was flat at 7.5%. Continued consistent performance outside of the aluminum business in fuel systems and rubber and plastics were augmented by the Autoform acquisition in its first year of ownership and the improved performance of our 2013 Bates acquisition. The aluminum business did generate modest dollar profitability improvement, sequentially and year-over-year. Although margins and total returns still significantly lag our expectations. We continue to focus on improved operational and commercial execution within the aluminum business to generate improved performance. We're trending in the right direction. Now, let's move into a discussion of Engineered Products segment. Engineered Products revenue represented 22% of consolidated revenues. Net sales increased 10% to approximately $83 million in the first quarter of 2015 versus last year. Even with the significant revenue increase, our higher margin aftermarket product sales declined 18% and on a sequential basis, declined 11%. With the aftermarket product line -- within the aftermarket product line, oil and gas aftermarket product sales declined 60% compared to the prior year and 49% sequentially. As you know, the volatility and low price commodities in the oil and gas market have adversely affected the entire industry. Outside of oil and gas our order bookings continue to be very strong and backlog in the industrial equipment business grew 74% in this year's first quarter compared to last year's first quarter, and this excludes the healthy backlog it obtained in the Saet acquisition. Our forging business revenues declined 7% in the first quarter of 2015 as our Ohio-based locomotive crankshaft operation waits for its primary customer to complete its design on the next-generation North American emission compliant diesel locomotive engine. Segment operating income decreased $4.4 million or 42% to $6.2 million. In addition, segment operating income margin decreased to 7.5% in the first quarter of 2015, compared to 14.1% in the first quarter of 2014. While segment operating income contribution for the forging business was relatively flat between the two years, and so lower earnings impact of lower revenue volumes in 2015 were offset by the harsh winter cost in '14, segment operating income of the industrial equipment business was much lower this year versus last. As we just mentioned, the portion of revenue mix of typically lower margin capital equipment business was much more significant in the higher margin aftermarket business compared to last year or for that matter was normal in the business. In addition to the unfavorable product mix between capital equipment and aftermarket, the mix within aftermarket product sales were unfavorable as we just discussed. Furthermore, we've seen our order pattern for oil and gas capital equipment and aftermarket products continue to be wildly unpredictable and have been challenging to forecast. On the bright side, our equipment backlogs remain strong by a circle [ph] of standards. So, we're still winning business but at a cost in some cases of lower margins. Next, I'd like to mention cash flows for 2015. As is typical for our business, our operating cash flows are generally light in the first quarter as we ramp up working capital from our traditionally lower levels of working capital at the end of our calendar year. We forecasted operating cash flows will increase during the year and are more typical cycles and we estimate that are full year operating cash flows will be approximately between $70 million and $75 million. Net capital expenditures were $11.5 million in the first quarter of 2015 and this sets the pace for our previously communicated capital investment amount of between $40 million and $45 million. Overall, we're pleased with our first quarter performance and the solid growth and earnings improvements over the prior year. We remain confident that we can achieve our earnings targets for 2015. Accordingly, we're reaffirming the guidance that we established in March for 2015, as adjusted earnings to be in the range of $4.32 to $4.72. A reconciliation to U.S. GAAP is included in our press release. Thanks. I'll turn it back over to our Chairman.

Thank you, Matthew. Now, I would like to open the phone lines for a Q&A.

Thank you. [Operator Instructions] We have a question from Mr. Steve Barger, KeyBanc Capital Markets. Please go ahead sir.

Good morning, everyone.

Good morning, Steve.

First question on Supply Technologies, net margin in the quarter, Matt, you did give some detail there, but I'm trying to get a sense for whether that's sustainable above 9% going forward. So, any more color on how much of the benefit came from higher margin products and when you say the full integration of the acquisitions helped, is that costs rolling off or just improved efficiency?

The answer's all of the above. I would suggest that the improvements in the business were ahead of our internal plan, so we did have a number of things happen to us favourably in the quarter, as it relates to product mix, as it relates to some expenses rolling off, expense that relates to strong organic performance as we've discussed. So, I would hesitate to forecast margin at this point because we've often mentioned this is really a return on invested capital picture. I would often take lower margin business if the investment is low as well, particularly if it supports a broader commercial relationship. So, I would hesitate to answer questions directly other than to tell you this was an excellent quarter on many fronts.

Well, I guess, to the point about taking a lower margin business, if it supports the relationship, how is European kind of go to market strategy working out? Is there any update on how the customers are receiving the kind of Supply Tech push?

Once again, I would choose not to focus too directly on Europe, other than to discuss the acquisitions. We have integrated those acquisitions totally now, but our customer model is a global model. So, I would say that our key relationships -- in our key relationships our customers accept that we are there to service them, wherever they're going to be, Europe, Asia et cetera. So, I think that what you're seeing in the numbers is a full integration of some European acquisitions, but more importantly, our model relative to our customers is global and yes, I do think they are -- the number of key accounts embrace that vigorously and I think we continue to build the brand globally to sell and provide the same services in Shanghai as Seattle.

Steve, let's look at it from another viewpoint. In the eurozone, what is happening is the operating companies there, even some of the companies that we acquired, relationships with our acquisitions, the pressure for operating companies in the eurozone to make a profit is increased as the world's gotten more competitive, like in America, when you drive and try to drive business and be more efficient, supply chain systems or Supply Tech fits that model. So, we're excited about, in my view point, the recession in the eurozone, as we begin the process of introducing this system in that geographical area. So, it's a lot easier to talk about what we're doing and how we're doing, if they're looking to save or they have to reduce their cost. I think anyone in business in Europe, is trying to figure out how to reduce their cost. So, it really is a good time to be there with a new idea that makes your company more efficient.

Understood. That's good detail. Shifting to Engineered, obviously still feeling the pain of some high margin businesses seeing weaker demand, has that allowed you to reposition workers or assets to maybe accelerate shipments in some other area?

That's an excellent question, Steve and it's something that we are working very hard on. We have the interesting dilemma seeing weakness in a number of high margin key markets, but then an extremely robust, almost inefficiently robust from an operational perspective demand in other markets. So, we have been able to do some of that repositioning and this has provided, what I would consider to be a refocusing and a reenergizing of an initiative that is always common in our equipment group which relates to cross-training of engineers, production people. I was recently in our Warren facility, which is one of our key manufacturing locations for equipment in the world and, was not surprised to see a crew of half a dozen guys from our Belgium group there, supporting the high levels of production. So, we continue to focus on that and in this environment, yes, we're focusing on it with more energy. We need to, because, we're not being as efficient as we can, once again, because we're exploding in areas where we don't have enough people and then there are areas or other geographies we have to too more or too little.

Steve, what has happened in the gas and oil activities of the Company, we all know that this sector's been hit very, very hard, beginning as early as July of 2014. I want to point out though, this is an example of the diversity of the earnings across all our silos. The gas and oil was down, on one side and the other side, we produced can't produce enough truck parts and components as well as recreational vehicles. So, diversity, always touch points that we talk about and being a diversified industrial company, there's always something good happening or there's always something that's a little underachieving. So, it's -- I think this is, really a kind of a shiny example of how you can lose one of the most profitable segments in your portfolio, in the margins, in the gas and oil business but we'll be there in the gas and oil business, because they don't get these projects cancelled, they just push them out, because it's tied to other great investment and we're just part of a production line. So, they don't just cancel the production line. So, we're excited about that, but again, I think this is a good example of how we can overcome as a Company through the silos of real compression here, our most profitable area and still put up record revenues and earnings.

Agreed. And, I guess, to the point about projects not getting cancelled but pushed out, we've seen oil prices come up a little bit, still well below peak, but any way of knowing where channel inventory is? Are you seeing used equipment out there? Just trying to get a sense for when customers might come back and has the tone of the conversation you have with people in that business changed at all?

The answer, Steve, generally is no. The tone has not changed. There's really two different kinds of conversations, of course. One is in the aftermarket products, which tend to respond more quickly to changes in the marketplace. I would say that if we do see interest, we'll see it there first. We have not, as I pointed out in my comments. Horribly difficult to forecast now, and no, unfortunately the tenure of those conversations has not changed. So, at this point, we don't anticipate that it will. Having said that, these are the kinds of products that people tend to, when they pull the purse strings in, tend to have a little pent up demand when they do get back into the business, so to speak or when the rig count starts to bump back up a little bit. So, I would anticipate when we do see it, we'll see some nice early benefit based on how people have driven down their -- inventory, maybe not done the preventative maintenance they typically would've. On the equipment side, Steve, that's going to be -- that's more of a long-term investment cycle. There is -- there are geographies around the world that are still looking to make investment [indiscernible]. So, I wouldn't call the market completely dead. I would say that we are still enjoying the revenue associated with the completion of some key jobs that were booked well over a -- or call it a year ago, but there really is a sort of a cloud over any meaningful discussions particularly here in North America for new equipment.

Got it. I'll ask one more and get back in line. When you look at the big declines in the oil patch, or just philosophically, when you see declines like this in any industry, do you start to think about getting more acquisitive or at least looking at more deals in the space, because I would think, potentially some of the stress sellers, multiples might come down, is it too early to be thinking that way?

No, I don't think so. I mean, firstly, we like this space. We've got an important niche there. It'd be great to have other products that we could sell to the same customers. That's the way we're looking at it. We're not looking out to increase the capacity of what we have. We'd like to look at other products to sell the same customer. So, that's a little refinement on it, but we are where we want to, but there are other areas and other channels to increase the revenue and again do business with people we know and we have a relationship with.

Great. Thanks for the time. I'll jump back in line.

[Operator Instructions] We have a follow-up question from Mr. Steve Barger, KeyBanc Capital Markets. Please go ahead, sir.

I guess, I'll take a little bit of your time. When you look back at the challenges in the aluminum business over the past year or two, just help me frame up where we've come from, has it been more pricing? Was it input cost? Is it asset utilization? Maybe talk about what you've done in reaction to what you've seen in the market and just kind of where are we now as an update.

Well, this is a, well, number one, a premise of investing in the auto industry, on three platforms. Firstly, aluminum, and steering knuckles and that part of the business, turbo-charge hosing, we've got a pretty serious commitment there in most region, gas injection and the rest of it. So, we like the auto business, not only in North America, but in the world, when you just start thinking of 70 million, 80 million cars. So, we like the space, and -- but the margins that we've been able to accomplish here have been below our expectations, and I will frame -- there is a lot of dynamics in this space right now, the largest Company in this business, really our fiercest competitor, recently filed for bankruptcy and there is another company of size that we understand is for sale. So, this has been a tough business. No one's really been able to make the margins they expected, but the belief that our investment as a Company on the international and North American basis, we like being there, now we're in four platforms. We're talking about again knuckles, in any aspects, steering knuckles and that part of the business -- turbo-charging, these are all type of products. The turbo-chargings make the four cylinder act like a six-cylinder, the gas injection makes the car more efficient. The aluminum makes the car lighter. So, we think -- we have numerous programs and we just hope that the margins stabilize and something that warrants a type of investment will [indiscernible] it, but we haven't lost our interest in this market, particularly the aluminum businesses from the fact of the point is underperforming and has -- and we're doing what's necessary to hopefully get that in the line.

Ed, a bit of a fixer upper, you mentioned that there's a sizable backlog there. Is that backlog priced correctly for you to make what you would consider an acceptable return or do you need to work through that and then kind of focus on booking better business?

Steve, are you referring to -- which part of the business are you referring to?

The Italian acquisition.

Okay. So, the Italian acquisition, in our most recent acquisition in our equipment business, the -- as I mentioned in prior call, and you alluded to, there was this -- this was a business which was semi-distressed, which requires and -- required and continues to require some amount of integration with our broader business and some cost initiatives, which we're working through. So, the backlog and the relative pricing and margin opportunity is reasonable on par with the kinds of pricing we see in these similar products with our business but unfortunately the costs -- we don't quite have the costs where we like them to be, so, I guess, it's going a long way in saying that I don't -- I think they're products in demand, they've built backlogs, not necessarily through aggressive pricing, through market pricing. Their demand for their products has been because they are regarded broadly and globally as a leader in some of the types of equipment they sell, and I think it's priced reasonably. Do, I think they may have taken some things a little bit more aggressively as the business became a little more distressed before our ownership? Possibly and we're working through that as well, but the real opportunity for us, integrated, really, get the costs in line, have the benefit of the partnership -- the across the partnership to feed global customers. I'm not worried about the pricing as a long term issue.

Steve, my comments on Saet is, number one, we've made 86 acquisitions in this Company and so these two particularly, that one, there's no buyer's remorse. If you're going to get remorse, it comes three or four months later, when you think you made a mistake. So, we really still like that transaction. And again, the buyer company in Italy, there's a difference between being private equity and being an operating company. We're able to reach out there, go to that transaction, not pay the price of private equity because they had a few warts on it and we're the type of company who can fix that. So, we have an operating team that can go there and make the changes in a very efficient way so we're excited about, this is a transaction where it might take a little more time to percolate, but we went there not only with our money. We went there with our skill also relative to making it a successful integration to our already successful business. So, that's kind of a summary of where we are on that in my opinion.

Great. Thank you. Kind of a granular question, what's going to make the variance between $40 million or $45 million in CapEx? Is there something that could be the specific selling factor there?

Steve, it's all timing. We have a number of growth initiatives we're looking at this year. General aluminum continues to be a significant consumer of capital, which is one of the issues we're dealing with. General aluminum isn't just a margin issue, it's really a return on capital issue that we're struggling with, because of the amount of money it takes to operate that business, in the rear-view mirror, but also going forward, the commitments that people are asking us to make. So we need to adjust our thinking in that area appropriately but secondarily we have -- also have significant growth opportunities and demand from some of other businesses, not the least of which is our forging business, where we're seeing some great opportunities, we're seeing some nice opportunities across the business and then our Assembly Components group outside of general aluminum, we are seeing some wonderful opportunities to expand on global automotive -- global automotive partnerships particularly with General Motors in Shanghai and in Mexico as well as the U.S. So, I would tell you that we're building some great capacity. We're got some great opportunities across the board and the timing of how those hit, relative not only to what we choose to approve or not approve and some things may not be approved that we put in the number, that we put in our estimate for the year, and also the timing on things we do approve and when they actually get spent -- are going to impact that sort of granular type look you're doing.

Understood. Just two more. Back to the return on capital conversation about the aluminum business, where are you seeing capital intensity beyond what you expected? Is it tooling cost? Is it engineering cost on the front end of new programs? What's really driving that increased spend?

Well, it's directed at new business, and keep in mind, Steve that here, all these [indiscernible] compete for the CapEx. So, each one of these has its own story behind it, but when we're talking about CapEx in that particular business, it's around new business not the current business.

Got it. And last one, this is, I guess, just for my own curiosity, Matt, I think you said that the semiconductor exposure, was that 58%? We're not hearing much of anything through industrials except that much. What specifically do you sell under that space? Is that new share wins or is it really the end market growth? I guess, I'm just looking for -- I don't have that much semi-conductor exposure, so any detail would be great.

Well, our key customer there is sort of one of the large brands names in the space, so their revenue has been what has driven it. We do deal with a number of sub-suppliers and other players as well. Steve, to be honest with you, I don't have those answers at the tip of my tongue.

That's fine. Well, very good. Nice quarter. I appreciate the time and we'll talk next quarter.

Thanks Steve.

Mr. Crawford, at this time there are no further questions.

Well, thank you, ladies and gentlemen. We're pleased with the start of the first quarter in 2015, but we're going to continue to work across the board and concentrate on cost and operational numbers. So, we look forward to speaking with you at the end of the second quarter [indiscernible] we hope this trend continues and we're doing our best here at Park-Ohio. Thank you, very much for your involvement and your commitment. Thank you.

Ladies and gentlemen, the conference is now complete. You may disconnect your telephones. Thank you for calling.