Park Ohio Holdings Corp (PKOH) 2006 Q2 法說會逐字稿

Good morning and welcome to the Park-Ohio second-quarter 2006 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 objection, you may disconnect at this time.

Before the conference call begins, please remember that the Company will be discussing some issues that are historical and some issues that are forward looking. When the Company speaks about future results or events, there are a variety of factors that may materially change their actual results from those projected.

A list of relative factors may be found in the earnings press release, as well as in the Company's 2005 10-K filed with the SEC on March 16, 2006. 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 EBITDA. EBITDA is not a measure of performance under generally accepted accounting principles and is considered a non-GAAP financial measure as defined by the SEC. The Company may present EBITDA because management believes that EBITDA could be useful to investors as an indication of their ability to incur and service debt and because EBITDA is a measure used under their credit facility to determine whether they may incur additional debt under such facility. For a reconciliation from income before income taxes to EBITDA, please refer to the Company's current Report on Form 8-K furnished to the SEC on July 31, 2006.

Now the meeting will be turned over to Mr. Edward F. Crawford, Chairman and Chief Executive Officer. Gentlemen, you may begin.

Good morning, ladies and gentlemen. Welcome to Park-Ohio's second reporting quarter conference. May I introduce Matt Crawford, the President and COO of the Company.

Thank you very much. We are pleased to announce our second-quarter results. Sales for Park-Ohio continue to accelerate, growing 17.3% from the second quarter of 2005 to the second quarter of 2006 at a level of $268,453,000, driven most significantly by ILS and our Manufactured Products segment.

EBITDA sales also grew 6.5% to 20,810,000. EPS decreased on a tax-adjusted basis by $0.02 or 4%. This reduction was caused principally by continued softness at our aluminum segment as we await new business at the end of the year, and some operational issues we will talk about later at one of our smaller companies.

Beginning with ILS, the second quarter was a record quarter for both sales and earnings. Revenue was up 16%. Growth was strong, especially in end markets including truck, semiconductor HVAC, construction and plumbing. New account activity was very strong again, as we continue to see record levels of quoting activity with current customers and new customers in new end markets.

EBIT for ILS for the quarter was up 23.7% to 10,231,000. This improvement was mirrored at the EBIT margin line, where we saw the expected improvement from 6.4% in 2005 to 6.8% this year. We expect that the increased revenue, based on the new sales activity, will continue to meaningfully impact the EBIT margin as we better leverage our global sourcing and engineering infrastructure.

Turning to the casting unit, revenues were up slightly during the second quarter by 4%. This increase was representative mostly of the increase in the value and the cost of the actual raw material that we are buying, which is a direct pass-through to our customer at zero margin. As we stated during the prior-quarter call, we don't expect to see much change in the volumes here until the end of the year, when our new contracts begin.

EBIT was down 31.2% year over year, but up 17.5% from the first quarter. We continue to expect little progress at the EBIT line until the end of the year as well.

Turning to Manufactured Products, revenue was up sharply again at Manufactured Products, by 30%. Capital equipment was an important part of that again. We did see some minor shifting of revenue in the capital equipment group associated with some large jobs into the second half.

The forge group also continued to significantly grow and improve as we have seen significant improvement in our rail and aerospace end markets. We continue to expect very strong revenue growth in both of these areas, forge and capital equipment, into the foreseeable future.

Unfortunately, EBIT was up only slightly, about 3% during the quarter. This is obviously very disappointing, particularly because of the significant increase in revenue. But as I mentioned earlier, this was largely due to one significant operational issue, which at this point we've made some significant changes to.

The specific business is the rubber business, which represents less than 3% of our overall sales during the quarter. This unit incurred meaningful losses due to significant operational issues, which we made aggressive changes to deal with during the second quarter, and we expect immediate impact to the profitability of this unit, which should have the Manufactured Products segment return to its typical margins going forward.

Cash flow during the quarter -- the Company's net debt position increased by 7.6 million from the first quarter. Interest expense was up a few hundred thousand dollars from Q1, principally on higher rates. Approximately $9.4 million of extra funds were invested in working capital to fund the growth in the second quarter.

The days outstanding on all the working capital components stayed basically flat. So there was no significant change in any of those items from an operational perspective.

CapEx was 4.2 million, which is in line with our annual estimate for this year of 15 to 16 million. At the end of June, the Company had approximately $52 million open on its bank line. We continue to expect significant cash paydown in the second half of the year.

Notwithstanding the meaningful losses at the rubber group, our current business outlook and the effort in the first half at the vast portion of our operations allow us to reconfirm our estimates of $1.65 to $1.75 for 2006, seasonally stronger in the fourth quarter versus the third.

Thank you very much, and I'll turn it back over to Ed Crawford.

Thanks, Matt. Just a brief comment about ILS, which is running on all cylinders. We were all looking forward with somewhat of a concern about the impact of any reduction in sales revenue of ILS in '07 anticipated in the reduction of manufacture of Class A trucking. We have initiated, early this year -- we've talked about it on our first conference call -- an effort to replace those sales.

At this juncture, we are very, very happy that what is appearing to happen to us is there's a shift here. We anticipate new sales of the quantity at least of the ramp-down of the trucking. We believe at this point there will be, even if there is a slowdown in the trucking in the first and second quarter of '07, which everyone anticipates, we'll be picking up and have picked up new business.

I'd like to point out one particular area we are doing very well, is with companies like Johnson Controls and York and others that are deeply embedded in the air conditioning business. This is not new customers, but new products, new business. So we are very optimistic about ILS and how it is going to perform, not through the balance of this year, but in '07. We don't see any breakdown in the revenue stream there. The initiative to replace the anticipated reduction in trucking sales is on target.

General Aluminum -- the aluminum business that we've advertised -- this is what I call the shakedown cruise -- the new business year. We've talked about new business. Today we are going to put some additional color in it.

In the Wapakoneta plant, which was one of the hand-cast plants, and we've talked about the strategy of buying the [technical difficulty] assets like in hand-casting the aluminum business, where these auto parts companies are breaking down. Our strategy is to buy assets and redeploy them. There is a process in the manufacturing of new business in which you have a pre-path, which is, in essence, having the customers come in, look at your tooling, look at your equipment and tell you -- give you the green light to ultimately go into production.

As discussed in our other calls, we have two major platforms coming on at that particular plant, a part of General Aluminum, is probably up and ramped up in November and December. Obviously, there are startup expenses involved in this, but they are a very sizable platform. One of the two is a $31 million platform for five years. The other is a $28 million platform for five years. We are talking about 59 to $60 million in business. So in essence, it's $300 million of new business in a plant that, quite frankly, of our five aluminum plants, is the most efficient or was the most efficient.

We are very excited about this. It is right on schedule. There's always dollars involved in starting up, but this is brand-new business in a plant that has been very successful. So we've been talking about '07 being a big year, a change year for General Aluminum -- in fact, this is happening. We've got good customers and we are very excited about the potential for General Aluminum in '07 and beyond.

Matt made reference to our rubber division. This is less than 3% of the total revenue of the Company. But it's like a toothache -- regardless of the size, sometimes it really hurts. And this one, we're bringing a lot of new business on there. We have -- it's a process that called matching rubber to metal. It's a bonding process. It is a startup situation, a lot of new business. And it has been tough.

And we think we have got it under control. We keep making some changes there. We are directly involved in it. Big nuisance, but something that will be solved before the year end. But it is, from our viewpoint, something that we would prefer not to happen. But when you have a number of manufacturing companies, this is going to happen.

It is correctable. It's not a meltdown. It's just about not meeting the objectives of getting equipment up and running. If they would have performed at top at our rubber division, had they performed at Wapakoneta, I wouldn't be having to mention this to you. So at least it's about new business, about new opportunities and about a breakdown in the startup.

At this juncture, we are prepared to answer any questions, ladies and gentlemen.

(OPERATOR INSTRUCTIONS). Philip Volpicelli, Goldman Sachs.

Just with regard to the two new aluminum platforms that you mentioned, what, I guess, end markets are those in, can you tell us?

They are both auto. And they are -- when we think of auto, we think of the platforms that the cars go on. These are, in both cases, two different end customers. We are a supplier to someone else, so we are not direct here, we are a supplier. There's two customers. We don't want to comment on who the customers are. But they are on platforms. And one of them is clearly, by most standards, is one of the most successful platforms in the auto industry.

So these are into two platforms that we consider ones that will be here and they'll be selling cars. But these are one of the -- two of the higher-performing end-use models. So we are pretty excited about that.

So you've got to sell -- when you're selling something, if you're making -- if someone gives you an order for $60 million for Chevette parts, you don't get too excited. But if they give you something that is really going to sell, that's on the list every single day of cars sold, you feel pretty good about. So we take that into consideration when we go after these large contracts.

That's great. So can you just give us a sense -- is it a sedan? Is it an SUV? What kind of platforms are they?

Well, they are not SUVs, I can tell you that.

That answers my question.

I thought that might be your question.

I appreciate that. With regard to working capital, it seems that you have consumed more working capital in the first half of this year than you did the last year. Should we likewise expect a similar or same-size reduction year over year in the second half?

We anticipate a significant reduction in the second half.

No more color than that? Is it correct, Richard, to assume that with ILS possibly having a changeover from heavy truck to others that you might not see as much of as a reduction as we did last year?

I think we should see a substantial reduction. It shouldn't be back towards the levels we began the year. And the fact that there's a transition from heavy truck to other sales simply means we have different inventory and stock as opposed to having less reduction in inventory.

Great. And then, just with regard to the rubber business, I think, Ed, you mentioned that it is matching rubber to metal. Is this a new process for you guys? Or is that just something that the materials were wrong? I guess I'm --

It is a new process for our Company and it is a little more sophisticated. I think we were basically just making generic rubber parts. On a scale from 1 to 10, these parts from degree of difficulty were 5 and 6s. This is better work from the margin viewpoint, harder for a startup. But we will get it. It's just, quite frankly, I think we were a little undermanned there relative to technical people. And it got a little bit out of control.

But it's no big deal. It's solved right now. It's a matter of just going after it. But this is not -- we're not building rockets over here. I mean, this is a pretty simple process, quite frankly. I don't know why it didn't turn out the way I wanted it. But it is what it is. But I think we are fine with it.

Richard Paget, Morgan Joseph.

Just want to be clear on the rubber products issue. Is this something you still have a little bit more to work out? Or this kind of hit, and I guess maybe around 1 million, 1.5 million -- is that fair, in terms of magnitude? Or is that mostly over?

Richard, we are not going to comment -- we specifically didn't comment on the earnings. As you know, we make a habit out of not talking about individual businesses in our segment. We chose to characterize the amount of volume that this business does because it was important in the context of our comments.

But what is important to note is this is an issue which we have taken strong corrective action, including changing management, including adding some skill sets there that will allow us to see better profitability almost immediately. And to the extent that we are seeing improvements in the short period we've been in the third quarter, we are seeing those. But the reality of the circumstance is this continues to be a difficult situation. We don't expect it to be a miracle solved, but we are seeing substantial strides in better overall both operational and numbers effort.

So directionally, there will be some improvement in the third quarter. Maybe historical margins might be closer of a fourth-quarter event?

Right. I think as Ed pointed out, we expect the return to our segment margins to happen very quickly.

And then looking at ILS, sequentially from the first quarter, it was somewhat flattish. I know you guys have said that there's a lot of new business coming in. How should that trend sequentially for the rest of the year? I mean, is 150 per quarter kind of a good run rate now? Because I know there is some seasonality, but not as much as the other businesses.

Yes, there is some seasonality, correct. There are less than -- you've heard us mention this on prior calls -- there are less shift days in the third and fourth quarter based on vacation schedules in the third and based on holidays in the fourth.

So if you look historically at the numbers, and there have been aberrations, of course, in general, but we'd hope to offset that with some of the new business we are seeing. As we have mentioned, as Dad pointed out in his comments, we have done an excellent job, I think, this year of instituting changes in our sales force, which we've seen a lot of quoting activity and a lot of new business being awarded to us. There is a duration, pipeline that it will take to get that business in place.

So we anticipate that that is a later -- that significant changes in the volume of this business are a later '06, early '07 event, obviously, to the extent necessary, coming right on time to offset any softness in the truck market, which we view as an issue in '07, but not, certainly, an issue in '08 and beyond.

And then getting back to Manufactured Products, you talked about in aluminum, where volumes are kind of flat, but you've got some good pricing, or I guess some of it was pass-through because of aluminum, is a similar issue happening in Manufactured Products, given where a lot of raw materials have gone?

Yes and no. Because of our proprietary products, which are the vast majority of the Manufactured Products group, we just have better pricing leverage, more immediate pricing leverage, particularly in the capital equipment group, where a lot of this is proprietary large equipment, which has sort of order to ship time, I will call it, six to 12 months. So they're reasonably short term, and I would say on the parts business, even less, obviously.

But the point is you can react very quickly to changes in the marketplace and you're not quite as exposed. So I would say that pass-throughs are more difficult, sort of from an institutional standpoint. But having said that, they are not as important because we have significant pricing leverage and more sort of customized jobs.

Sarah Thompson, Lehman Brothers.

It is actually Lawrence on behalf of Sarah. Most of our questions have been answered. Just a couple of housekeeping items. Can you provide a cash flow from operations for the quarter?

Cash flow from operations, we can discuss that offline. I don't have the sheet right in front of me.

And then I missed the availability on your revolver that you referenced earlier in the call.

52 million.

52 million. Okay. And is it fair to say for free cash flow for the year that you expect it to be comparable to '05 levels?

I'm sorry, ask that again?

For free cash flow for the year as we define it, cash flow from operations less CapEx, you guys posted about 14 million in '05. I know you said you're expecting to see some reduction in working capital in the back half of the year. Do you all feel comfortable generating a similar amount of free cash after CapEx in '06 as compared to '05?

We should generate a significant amount. I think it would be something comparable to that. Our CapEx should be less than last year's, which should help that process. I don't know that I want to give a specific cash flow forecast other than we are anticipating that the end-of-year debt should resemble the beginning-of-year debt.

Chris Dougherty, Jefferies & Co.

In terms of working capital, AP this quarter seemed to be up relative to last year, but I think last year it seemed to be relatively low. Is the current AP a number that you are comfortable with, or should we see a lower number in terms of a use of working capital?

The number we're at now is not stretched. The days are very reasonable and comparable to historical, although I think you are correct that in comparison with precisely 12 years [sic] earlier, is up a bit. But it's not -- we haven't pushed that beyond any normal limit. Part of the reason it is up, obviously, was related to the acquisition of PPG and a couple other small units where we show payables up because of that.

In terms of inventory for the second half, with the autos, which I'm sure is a significant part of your business, would inventory be coming down just due to lower production estimates at the OEMs?

Perhaps we can take that in two parts. This is Matt Crawford talking. I do want to mention that the areas of the business in which we do -- well, let's first start by saying we've mentioned in the past that automotive is on the order of mid-20s as a part of the overall business. I would also mention that the business that drives that percentage is the aluminum casting segment, where inventory is not a significant component.

So our inventory dollars are not reflectively matched -- invested in auto companies. So I just wanted to correct you, because I think you kind of mischaracterized our inventory investment as associated with our auto customers.

Good. I mean, that was actually the question -- how does it work.

Our casting unit, which drives that number at 160 million last year revenue or something, had very little inventory. I don't have the number at that tip of my tongue. But --

It is quite small. It is consignment on the raw material end and it's very little on the [WIP] and finished goods?

Yes. Auto does not drive our inventories to any real significant degree.

And one last thing if I missed it -- CapEx for the quarter?

4.2.

[John Vaughan], private investor.

Great quarter. Couple of quick ones and then a couple a little bit more open-ended. The cash taxes -- either a percentage you expect to pay this year -- are you still working with the 20% range for state and local and foreign?

State, local and foreign actually was less than 20. We were down in the young teens, 12%, something like that last year. And that in terms of state, local and foreign is still a reasonable range to be in for us this year as well. And again, we are not anticipating federal cash taxes.

Very good. I'm not sure if Ed wants to comment on this, but there was an SEC filing on the proposed issuance of the 100 million with debt versus equity. And my quick back-of-the-napkin numbers are if we've got -- it seems like if you issue equity right now at less than that, maybe $30 a share, it seems to be dilutive. But on the other hand, if you issue too much debt, then Wall Street is looking at high leverage right there. How are you balancing that? And would this potentially be used for acquisitions or is there any public comment on that at this juncture?

It is Matt. I will jump in and start with that. The shelf filing, as we mentioned, is really motivated by a need to include flexibility in what had become a fast-growing company. Particularly at ILS, the Manufactured Products segment as well, has continued to not only have shown strong recent growth, but we expect significant growth into the future. We have also continued to see opportunities to acquire what Dad called bolt-ons at very attractive ROI.

So this has become a very robust growth picture for us. And we filed the shelf to really not to do anything necessarily imminent, but to make sure that we had the flexibility, depending on what opportunities that we saw. Clearly, we believe with $52 million worth of bank line that is open to us at this juncture, we can finance our current business. We will throw off enough free cash flow to do that.

But we do see opportunities to grow the business significantly, whether they are organic or external. And given the right opportunity and the right investment opportunity, internally or externally, if we could use equity to finance that, although it may look somewhat I guess dilutive in the short term, it would be expected ultimately to be invested in something that has very high ROI.

And there was also a public filing regarding the Snow Dragons -- I think we talked about that the last annual meeting. Any idea, like, Ed, can you comment on -- it seems like a neat product. Any idea what the worldwide demand could be for that, or just overall? Is there any comment as far as where you can go with that product?

Well, John, the reception, as you know, we had a full unveiling of the product line here at the Company some 30 days ago. And we had over 100 individuals, I think it was 119, here from every municipality -- virtually every airport in the country, and more important, 25% of the people were from outside America, particularly Russia.

We already have shipped, sold and shipped four units to Russia. They seem to be the first to gravitate towards it. We are really going to be start writing and talking about sales of the Snow Dragon -- for anyone, if this is a new thought to anyone on the line, we have developed and patented the ability to melt snow in airports, and right now, talking through this at the Cleveland Hopkins Airport or the LaGuardia or anywhere in the country, even in Aspen, there is an issue about not only pushing the snow on the runways, piling it up, and in fact, loading it into trucks and taking it off and on the airport with all the security issues.

We have designed, again, and patented and manufactured a line of what we call Snow Dragons. And in essence, it speeds up the process of nature. And in essence, we can push the snow, load it into the Dragon, melt it as fast as it can be loaded, and it runs right down the drain. This is a very important security issue. It is an efficiency issue. It's a lot less than diesel trucks. We have a complete product line. It is out of one of our manufacturing divisions.

And we're really starting to feel this, latter part of the year, John -- I think we are going to get some good sales this year. But in '08, I anticipate this to be a very large part of -- not large, but a big, robust business in our manufacturing group, in our plants -- at two plants.

So I am optimistic. We have sold a lot of the smaller units. We expect to place a couple of the airport units between now and the end of the year. But I will tell you, excitement is very, very high and the level of interest is high. And the quotes are out there, and we are ready to go. It has taken us two and a half years to develop the product line and improve it, but snow melting at airports in towns like Aspen, in communities, in hospital parking lots, retail -- they will be melting snow in the future. They will not been pushing it and loading it and taking it off site.

So I am optimistic about it, John, but we will be talking about more -- it's hard to talk about the Snow Dragon. I appreciated you bringing it up, because I can make a comment about it. But it be virtually 98 degrees in Cleveland today, but very soon, we will be talking about Snow Dragons.

Now let's hope we don't have any global warming.

Well, I hope so, too. There's still a lot of places where it is very, very cold. Actually, one of the groups that were here with the most interest was a group from, believe it or not, from Alaska, that was interested in keeping the municipal buildings open. So it is coming.

Sarah Thompson, Lehman Brothers.

It is Lawrence again. I just want to follow up on Matt's comments regarding the shelf. I appreciate your comments around flexibility, and I know nothing's imminent. I'm just a little surprised to hear Matt focus a little bit more on proceeds from an equity deal to be used to fund growth rather than pay down debt. Is that a change in your view there, or are you just leaving your options open?

I don't know that it's a change in our view. It is just a fact that our Company has been growing double digit now for as long as I can remember. And there's no reason, based on what we're seeing in the marketplace relative to internal growth opportunities, to think that it won't.

So having said that, we need to be flexible in our capital structure and keep things open to us. So no, I don't know that we have ever indicated that we didn't need -- we might not need cash from equity, for example, to grow our business. So if our business was shrinking, and we were generating tons of cash with no growth opportunities, we probably wouldn't consider issuing any equity, correct. So I think we have been consistent on that.

Now I'd like to turn the floor back over to management for any closing remarks.

We would like to thank you for your continuing support. We believe that and we're sensitive to this whole debt issue. And we will continue to manage the Company and try and commit ourselves to not creating additional leverage in this Company. This is about balancing growth, balance the growth and the growth opportunities.

And at this level, it seems like $52 million is a lot of availability. But everyone knows my position on the fact that of our availability, we will not use that last $25 million. So it is not 52 million available -- subtract that 25 million. So we have a very tight control over that.

So we are not thinking about being aggressive here. But there is a balance at some point in the future where we should be able to grow this business by selling some equity and not going further in debt. So our goal is, again, a balanced portfolio of interest. We are very large shareholders, so we are interested in making sure that this thing is under control.

We thank you for your attention and look forward to seeing you at the end of a successful third quarter.

Thank you. This concludes today's Park-Ohio Holdings Corporation conference call. You may now disconnect your lines at this time and have a wonderful day.