Park-Ohio Holdings Corp. (NASDAQ:PKOH) Q2 2024 Earnings Call Transcript

Park-Ohio Holdings Corp. (NASDAQ:PKOH) Q2 2024 Earnings Call Transcript August 11, 2024

Operator: Good morning and welcome to the Park-Ohio Second Quarter 2024 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. [Operator Instructions] 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 2023 10-K, which was filed on March 6, 2024, 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, operated income to adjusted operated income and 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.

Matthew Crawford: Good morning everyone and thank you for joining this morning’s call. We’re excited to announce record revenue for the second quarter, as well as continued improvement in our margins and overall quality of earnings. We accomplished these strong results against a backdrop of stable, but mixed demand especially in our short-cycle businesses and excellent operating execution across most of the product portfolio. Our diversification once again proved to be our strength, and in particular our investments in aerospace and defense were important positive contributors. Supply Technologies and Assembly Components group, both relatively short-cycle businesses, offset some softening demand in a handful of discrete end markets, with new business and strong execution.

While our Engineered Products group a relatively long-cycle business, continued to see elevated backlogs and benefited from some improved delivery performance. While we expect some variability in our second half demand picture, in the aggregate we see our business as very stable and expect to deliver year-over-year growth. We also expect to make continual progress on our debt reduction goals, and see the second half as meaningful from a free cash flow perspective, which is both seasonal and strategic given our change in business mix and lower capital requirements, after the sale last year of some automotive assets. With that I’ll turn it over to Pat. Presenter Speech

Pat Fogarty: Thank you, Matt. We are pleased with our second quarter operating results, which exceeded our expectations in most of our businesses and were highlighted by record consolidated sales of $433 million, adjusted EPS of $1.02 per share and EBITDA as defined of $39.4 million. Our strong results were driven by record sales and increased margins in our Supply Technologies segment, better-than-expected results in our Assembly Components segment and record sales and improved margins in our Engineered Products segment. Net sales of $433 million compared to $428 million, a year ago and increased 4% from $418 million last quarter. Our second quarter revenues resulted from increasing demand in certain key end markets, with notable strength in the aerospace and defense market, continued growth in our proprietary fastener manufacturing business and improved sales in our capital equipment business where strong backlogs are being converted to sales.

Our consolidated gross margin was 16.9% in the quarter, up 120 basis points from the second quarter of last year. On a year-to-date basis, our gross margin increased 90 basis points to 17% compared to 16.1%, a year ago. The year-over-year improved gross margins are a direct result of ongoing efforts to improve customer pricing, reduce operating costs and increase operational efficiencies throughout each of our businesses. We continue to focus on gross margin improvement, through the implementation of value-driven initiatives in each business. Our GAAP EPS of $0.95 was up 67% in the quarter, and our adjusted EPS of $1.02 increased 23% compared to $0.83, a year ago. Year-to-date, adjusted EPS of $1.87 was up 21% compared to the same period last year.

As I mentioned, we generated EBITDA of $39.4 million in the quarter, an improvement of 10% compared to a year ago. As a percentage of our sales, EBITDA margin was 9.1% in the quarter, which is our highest EBITDA margin since 2018. On a trailing 12-month basis, our EBITDA as defined totaled $145 million. The significant increase in EBITDA and free cash flow over the last 12 months have resulted in an improvement in our net debt leverage of over 30% since June 30, of last year. Consolidated operating income improved 28% to $24.6 million in the second quarter. And on an adjusted basis, operating income increased 11% to $26 million. In addition, operating income margins improved 120 basis points year-over-year, driven by continued strong profit performance in Supply Technologies and higher sales and improved margins in our Engineered Products segment.

SG&A expenses were approximately $47 million and 11% of net sales in both periods. Interest costs totaled $12 million during the quarter compared to $11.1 million last year. driven by higher interest rates in the current year. Our effective tax rate was 19% in the quarter, which reflects the ongoing benefits from research and development tax credits and other tax planning initiatives to reduce our overall effective tax rate worldwide. As a result, we have lowered our expected full year effective tax rate to between 21% and 23% to reflect the impact of these tax strategies. During the quarter, we used operating cash of $3 million, primarily driven by increased working capital to support sales growth in certain businesses, and due to the timing of completion of capital equipment projects.

Similar to prior years, we expect strong operating and free cash flow in the second half of the year, driven by continued strong EBITDA and lower working capital levels. Our liquidity continues to be strong and totaled $161 million at June 30, which consisted of approximately $60 million of cash on hand and $101 million of unused borrowing capacity under our various banking arrangements. Turning now to our segment results. Supply Technologies generated record net sales of $203 million in the second quarter, representing a 3% increase year-over-year. We continue to see strong customer demand in several key end markets led by a 56% increase in sales in the aerospace and defense market. Average daily sales also improved in the heavy-duty truck, off-road construction, electrical distribution and consumer electronics end markets.

In addition, sales in our fastener manufacturing business grew 12% year-over-year as global demand for our proprietary products continues to be robust. Although, revenues in many end markets continue to trend positively, slowing demand is expected in the semiconductor, agricultural equipment and certain consumer end markets throughout the rest of the year. Operating income in the segment totaled $19 million, an increase of 23% year-over-year. Operating margins were 9.4% and an improvement of 160 basis points from 7.8% a year ago. The higher profitability in the quarter was driven by an increase in sales of higher-margin products, lower operating costs in our supply chain business and continued strong demand in our proprietary fastener business.

On a year-to-date basis, sales in this segment were a record $400 million and operating income was a record $38.5 million. Operating margin was 9.6%, an increase of 210 basis points compared to the 2023 period. The strong liquidity — I’m sorry, the strong quarterly and year-to-date results in this segment reflect our continued focus on expanding product margins, increasing sales in our higher-margin industrial supply business and growing revenues in our proprietary fastener manufacturing business. In our Assembly Components segment, sales were $103 million in the quarter compared to $112 million a year ago. The year-over-year decrease in sales was driven by lower unit volumes and end-of-life programs and lower product pricing on certain legacy programs, which partially offset the sales growth on other OEM platforms.

Segment operating income decreased to $6.9 million from $8.4 million a year ago. Profitability in the second quarter was impacted by the lower unit volumes and product pricing, which more than offset margin expansion on several products resulting from implemented margin improvement initiatives. On a year-to-date basis, sales were $210 million compared to $222 million a year ago, and adjusted operating income margin was 7.4% compared to 7.7% a year ago. In this segment, we continue to implement profit improvement initiatives, which will enhance operating margins in future quarters. Key initiatives include increasing customer pricing on low-margin products, improving operational efficiencies, such as scrap reduction programs, increasing cycle times, reducing operating costs through the automation of certain processes and increasing our rubber mixing capacity.

In our Engineered Products segment, sales were a record $127 million and increased 7% compared to $119 million a year ago, driven by higher demand in both our industrial equipment business and our Forged Machine Products group. Higher sales in the Industrial Equipment Group resulted from strong sales of new capital equipment primarily in North America and Europe. During the quarter, new equipment sales in North America grew 19% year-over-year. Also, sales of aftermarket parts and services in North America grew 12% year-over-year, while aftermarket sales in Europe and Asia were stable compared to a strong prior year quarter. During the second quarter, new equipment bookings were approximately $50 million, and equipment backlog continues to be strong totaling $173 million, an increase of 7% compared to backlogs on December 31.

Revenues in our Forged Machine Products business increased 8% year-over-year driven by increased unit volumes on products sold into the aerospace and defense industry, which more than offset weaker demand for rail forgings, which impacted our results. During the quarter, operating income in this segment was $6.3 million compared to $3.2 million a year ago. And on an adjusted basis, operating income increased 20% year-over-year to $7.3 million in the quarter. The increase in profitability year-over-year was driven by higher sales and improved margins, primarily in our Industrial Equipment Group. Compared to the first quarter operating income almost doubled, reflecting significant operational improvements in the current quarter. In our Forged and Machine products business profit flow-through from the 8% year-over-year sales increase was offset by lower margins isolated in our forging operation in Arkansas.

We have taken several actions to improve the results in this plan including personnel changes and operational improvements to reduce equipment downtime and increase production efficiencies. In the year-to-date period, sales in this segment were $240 million, an increase of 2% compared to the 2023 period. Adjusted operating income was $11.1 million compared to $13.1 million a year ago with the decline due to lower margins in our Forged Machine Products business. And finally, corporate expenses totaled $7.6 million during the quarter compared to $7.8 million a year ago. And year-to-date, were approximately 2% of net sales in both periods. Overall, our results in the second quarter were strong and our results year-to-date have exceeded our expectations.

With respect to our full year guidance, we now expect year-over-year revenue growth to range from 2% to 4% due to slowing but stable demand in certain end markets. We continue to expect year-over-year improvement in adjusted EPS and EBITDA as defined. Now, I’ll turn the call back over to Matt.

Matthew Crawford: Great. Thank you very much, Pat. We’ll now open the line for questions.

Q&A Session

Operator: Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Dave Storms with Stonegate. Please proceed with your question.

Dave Storms: Good morning.

Matthew Crawford: Good morning, Dave.

Dave Storms: Just hoping we could start with maybe some of the puts and takes on guidance. I know previously you were guiding to mid-single-digits. It looks like that might be coming in at the lower end of that previous guidance between 2% and 4% on the top line. Are there any end markets that you’re seeing as have an outsized importance for this guidance, anything that could put you on the higher or lower end? Really any color here would be great.

Matthew Crawford: Yes, it’s a great question. I think that broadly described the sort of business-to-business capital industry manufacturing side of the business continues to be strong. Where we are seeing a very different view is in our book of customers that are more consumer-facing. So I think that, it’s a little hard to predict right now quite candidly. There’s a lot at play, but it doesn’t disconnect too much from what you read in the Wall Street Journal. What is unusual at an extremely high level is the difference between where you see pockets of strength in any market connected to aerospace and defense as we described steel for that matter electrical. Again, parts of the automotive business where they’re reshaping it regardless of powertrain, all continue to be fairly positive but things that are a touch more consumer-facing are problematic.

And those — the difference between those are double-digit growth versus double-digit shrinkage. So, I don’t know that I would describe our forecast as meaningfully different. I think we have to appreciate the risks that weren’t here to the downside if you will in the prior or three months ago, when we had this call, particularly on the consumer side. Everything just feels a little more delicate but having said that, in no way do I want to suggest in the aggregate we don’t feel that the positives outweigh the negatives, and feel strenuously that we’ll have a stronger second half than we did last year.

Dave Storms: Understood. That’s very helpful. Thank you. And then just looking at Engineered Products, it had a really strong quarter kind of top to bottom. I know you’ve mentioned in the past that EP is really an important driver for the company. How would you categorize the sustainability of this quarter’s performance in Engineered Products?

Matthew Crawford: Let me — I’ll give Pat a bit to think about that while I answer the easy part. For those of us that have been around this company for a while, we recognize that Engineered Products should has been and will be again the driver for quality of earnings in this business. In that segment, we have some of the most unique assets, some of the best brands and also a nice diversification of aftermarket versus OE. It’s really a nice business and has been a leader traditionally in terms of our business both on the sales side periodically and also it’s a long-cycle sales business is a bit lumpy, but particularly on the quality of earnings and margin side. We have sacrificed some of that due to execution as we’ve discussed in prior calls because retirements lack of knowledge, supply chain challenges that while they become a little easier or still challenging changes in geopolitics and how you source products.

These are things that we continue to work through. And every day we get a little better but they’re not a late switch. So that journey is underway. It hasn’t been a demand issue. It’s been an execution issue. We have made meaningful changes there in terms of personnel. We’ve spent meaningful dollars in terms of training. We’ve made changes in leadership. We continue to attack this from all levels. So what I would tell you is from a historical perspective that business is still underperforming meaningfully underperforming. So I don’t mean to suggest that it’s a low bar but we would expect to see maybe again it could be a bit lumpy but we continue to expect meaningful improvement in that business over the medium-term.

Pat Fogarty: Yes, Dave, this is Pat. I agree with Matt’s comments. I think when you look at that segment of our business we have seen meaningful improvement in our Industrial Equipment Group. The backlogs have been strong. The bookings have been pretty consistent quarter-by-quarter. And the operational performance has improved to the point where we’re approaching those double-digit operating income margins in that business. The acquisition of EMA is in the transition into our business is underway. We get a lot of good things to happen throughout Europe as a result. They are performing as planned right now and their backlogs continue to be strong. The challenges that we’ve been faced with have been isolated in our forging group.

As Matt mentioned we’ve made meaningful changes across the board in leadership not only on the plant floor but across all aspects and all disciplines of the business and expect our customer base to continue to support that business going forward. So we expect improvement there and to get back to those historic levels that Matt mentioned. So that gives you a little bit more color, but we feel we’re heading in the right direction there and we expect continued improvement.

Dave Storms: Understood. That’s great color. Thank you. I’ll get back in queue.

Operator: Thank you. Our next question comes from the line of Steve Barger with KeyBanc Capital Markets. Please proceed with your question.

Steve Barger: Thanks. Good morning.

Matthew Crawford: He, Steve. How are you?

Steve Barger: Okay. I think Pat mentioned in his prepared remarks increased pricing on some low-margin product lines. What percentage of the portfolio do you think is not priced for the value that you provide. And can you accelerate price actions in those areas?

Pat Fogarty: Steve, this is Pat. Yes, the answer is, yes. And we’ve proven over the last few years that we’ve been able to get pricing across to our customer base. And as we’ve talked about the labor inflation that we’ve experienced has been permanent and we’re still working to recover much of that. The raw material side of price increases has been mature for customers to understand. But we continue to look for ways to increase product pricing especially within the automotive segment as volumes are lower than what was expected [Audio Gap] Not going to be a material improvement but coupled with operational efficiencies value-driven [Audio Gap] all of which will be a driver towards improved margins in that business.

Matthew Crawford: Steve, I would say that if there’s such a thing as a silver lining to COVID. I think the leadership in the business across the board and Supply Technologies was an early mover and thoughtful on it across a very complex portfolio of products was pricing was addressed aggressively. And we had some pains as you know particularly in the automotive segment on that front and that caused some losses. And we’ve got ourselves in a much — much more stable circumstance. The good news is as Pat described while there’s always opportunity the opportunities are more limited. But nonetheless, I think that the inflation that exists in the market the ongoing demand in certain pieces allow us to keep focused on it to keep pushing the lessons that we’ve learned from the past keeping an eye on additional areas of volatility like freight.

So I think the dynamics have changed in a positive way. Having said that, I don’t — I agree with Pat the opportunity for it is not as meaningful as it would have been in the prior couple of years. .

Steve Barger : Yes. As you think about the new business that you’re quoting, do you have more flexibility in there vis-à-vis escalators and that sort of thing than you did historically?

Matthew Crawford : Yes, that’s — contractually, that is an interesting question. There’s no doubt that there have been challenges in the marketplace to some of the customary design of products and relationships. I can tell you deemphasizing through asset sales, the automotive business, that’s where the pressure is always worse and is at its worst. And I think that, that again, I talked a lot about having changed or evolved business model to make us more sustainable from a quality of earnings in a sustainable earnings and a free cash flow earnings through the business cycle, this is part of it. So, no, there’s no doubt that the evolution has been in the supply basis favor. Our business mix has been in our favor. Having said that, we deal with the biggest, most sophisticated companies in the world, their hands are always out.

They always want the best deal. So I think that what we need to preserve and make sure is that we can meet them in the middle. And we have spent a lot of time over the last few years reducing our cost to serve, and we continue to do it, whether they be in implementing pure restructuring and reducing footprint as we’ve discussed, whether it be implementing new software tools and technology. Our positioning of our business today is meaningfully better in terms to get awarded new business at attractive pricing that’s accretive to our business model. And that’s what it’s all about, right? That’s what it’s all about. So, I think that as we focus and begin to see the needle move a little bit in the second half and into 2025 on these new blocks of business, we’re going to see better margins.

Part of it because, as you described, the marketplace is a little bit different, but part of it is because we reduced our cost to serve.

Steve Barger : Yes. No, that’s good color. And I guess as you think about your sales force, do they have an understanding of the hurdle rate required to bid new business? Do they have the tools they need to make sure that you do walk away from business that is less favorable, when it doesn’t make sense to take it?

Matthew Crawford : Yes. No, there’s no question. I think the most certainly, the ACG and engineered components, the size, the sheer size of some of the orders and opportunities and nature of the long-term agreements get a lot of attention from the whole executive team. Supply technology certainly is the most complex business where a lot of people touch pricing in the process, and some of our best opportunities are some of our smaller accounts. So, no, there’s no question that’s where we have — continue to try and invest in business processes that identify not only low margin or underperforming accounts, warehouses, whatever end markets you name it. But we continue to invest heavily there in technology tools to make sure that we don’t make mistakes.

So no, you’re absolutely, I think, hitting an important point. And I would tell you, to the extent — most of our portfolio are big orders that get attention with big companies and long-term contracts. We are — I won’t say best-in-class, but we work every day to be best in class to make sure that our team makes the right decisions, even on the small orders at a place like Supply Technologies. And I’m confident that today, we’re meaningfully better than we were a year ago and two years ago. And I think we’re going to be twice as good a year or two from now, given some of the investments we’re making. So no, I do feel pretty comfortable and again, I don’t want to say a silver lining to COVID, but we have to address pricing across the board. As a matter of life and death, you get a little better at this stuff, right?

Pat Fogarty: Steve…

Steve Barger : Right. And Pat, you said — oh, sorry. Go ahead.

Pat Fogarty: I was just going to add that when we look at hurdle rates, whether it’s with sales folks or the executive teams that run the business, we go very deep into that process and look at IRRs, return on capital, if there’s capital needed. So — and those hurdle rates are well described within each of the business. So I would say that that’s been an evolving process with each of the — whether it’s the financial teams within each business or the sales teams within each business. So, I feel very good about kind of where we’re at as we look at opportunities across the board.

Matthew Crawford : Steve, I want to say one last thing. As we think about where we have underperformed, it hasn’t been because of poor quoting, or not understanding our hurdle rates. It has been by poor execution. And we’ve seen that a bit in Engineered Products. And again, I’m not — I mean we see it everywhere, but I’m saying some of the challenges of the retirements, of the loss of knowledge, those kinds of things affected our ability to convert some of the orders at what we expected. I’m not so sure that’s a pricing issue or a visibility issue. I think it’s more an execution issue and one, we’re again trying to get better at every day.

Steve Barger: Understood. And Pat you said bookings were good in some parts of Engineered Products. Can you talk more about that? And what were orders for the company this quarter?

Pat Fogarty: Yes. So the bookings in the quarter see were $50 million. And really across several of our brands in both Europe and in North America is where we’re seeing the most strength. Backlogs continue to be good and the operational improvements we saw at least sequentially, we believe are sustainable and having better throughput through the plants with a strong backlog is good and it takes out a lot of the inefficiencies that we see in the plants.

Steve Barger: Yes. And I guess that’s a good segue to my last question. I heard you say free cash flow will be better in the back half, typically is. But did you say what you expect for full year free cash flow realization?

Pat Fogarty: No I did not comment on that but we expect second half free cash flow to be $25 million to $30 million. And year-to-date, we’re at $13 million. So, those are hurdles that we expect to exceed, but I’m comfortable laying that out for you right now.

Steve Barger: Okay. Appreciate that. Thanks.

Matthew Crawford: Steve, I’m not going to miss the opportunity to say, achieving record results after having sold a business that represented about 12% on average of our sales, but 20% to 25% of our CapEx through the business cycle has changed our mix from a cash flow perspective permanently. So, I’m not saying we have enough good ideas we may spend a little more here, but we are fundamentally a different business model from a cash flow perspective post sale.

Steve Barger: I mean yes that’s kind of my point on some of the pricing questions. You — by exiting low-margin business where there are structural challenges to pricing the whole portfolio becomes better. And I have to think there’s other opportunities to do that. You guys provide a lot of value to your customers. If you’re not getting adequately compensated the question has to become why are you doing it?

Matthew Crawford: You’re preaching to the acquirer. And as I said, we’re better today than we were last year and we’re going to be better tomorrow than we are today. So, we are making the investments necessary to do that. And I would again highlight the use of technology as a key driver, particularly at Supply Technologies and making those decisions. The devil is in the details, but your point is absolutely well made, but we’ve made some real strides in this area and we expect to continue to improve. But again, we’ve done it a couple of different ways. So one structurally, we just got out of a business that was too damn hard in this area. And we’ve moved to businesses where your point is we’ve got a little more leverage, a little more ability, a little more opportunity to get paid fairly. And that was very difficult.

Steve Barger: Exactly. Yes. I’m sure you sleep better with that gone. Thanks.

Matthew Crawford: Our customers are big and tough and we got to do the right thing by them. So this isn’t a straight line.

Steve Barger: Appreciate it.

Operator: Thank you. Our next question comes from the line of Jamie Wilen [ph] with Wilen Management. Please proceed with your question.

Unidentified Analyst: Hi. You talked about the pickup of business in the aerospace and defense side, could you give us a little clarity on that? Are these new customers, existing customers with new projects, the longevity of these projects? And how would you characterize the margins on the business you’re picking up versus your existing business?

Matthew Crawford: Yes, I’ll kick off. I’m sure Pat has a thing to say. One of the nice things about seeing some additional activity in aerospace and defense, it does touch a large percentage of our product portfolio. And that’s good news. So we have seen significant discrete opportunities in our Engineered Products groups related to defense, particularly in capital equipment for building things like ammunitions and so forth. So very discrete there. Also on the aerospace side and defense side as well, but aerospace in particular, you may know that five or six years ago this became an area that we felt was a great adjacency for Supply Technologies and that those customers would appreciate our service model and our brand. And so that business has grown nicely.

We had to sort of fostered a bit and supported a little bit during the more difficult times. But now that they’re trying to reorient their and improve their supply chains, I think we’re in a great place. So we’ve seen the benefit of there in supply technology. So we’ve seen a fairly diverse and impressive and I think sustainable improvement in those areas.

Pat Fogarty: Jamie, this is Pat. Matt mentioned the supply technology business and we think about the OEMs on the commercial side of the business, Airbus and their Tier 1 suppliers, we’re supplying product to. And the growth opportunity is to supply more product different types of Class C componentry into those various programs. The margins typically are higher than other end market margins. So that business continues to grow and we’re seeing tremendous opportunities not only throughout Europe but also here in the States for those products.

Matthew Crawford: When talking about how it impacts our broader portfolio, I should have talked about our Forge Group. We should highlight there that for a while, we were significantly – or past due and unable to deliver because of the struggle to get aerospace grade alloys to the forge, which the whole industry was seeing and gets talked about a lot at the highest levels at Airbus and Boeing. Those supply chains have improved a little bit. So we’re able now to convert some of those orders. So again, I don’t see this as a flash in the pan. I see this as an industry that is reinvesting in on the defense side and I see it as a commercial side that is just only beginning to sort out their supply chain issues and we want to be there to support it.

Unidentified Analyst: Excellent. Thank you.

Operator: Thank you. There are no further questions at this time. I’d like to turn the floor back over to management for closing remarks.

Matthew Crawford: Thank you again for your time today, and I want to thank all of the Park-Ohio family of people that come to work every day and make this happen. That’s what it’s really all about. And we’re again very pleased with the results. But at the same time, there’s plenty of room for opportunity for improvement. Steve, you gave me a nice opportunity to talk about how our business model is evolving and we expect continued deleveraging, continued improvement in quality of earnings, which to us means higher aggregate margins and better sustainable business on the free cash flow side. So that’s where we’re going, and I think this is a nice step in the right direction. Thanks, and have a great day.

Operator: This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.