Park Ohio Holdings Corp (PKOH) 2007 Q2 法說會逐字稿

Good morning and welcome to the Park-Ohio second-quarter 2007 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 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 the actual results from those projected. A list of [relevant] factors may be found in the earnings press release as well as in the Company's 2006 10-K filed with the SEC on March 16, 2007. 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 the managers believe 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 and July 31, 2007.

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 the second-quarter 2007 conference call of Park-Ohio. We are going to begin today by having Rich Elliott, the Chief Financial Officer, review the second-quarter results and year to date, followed by Matthew Crawford, the COO and President of the Company, to give some insight into the ongoing operations of the Company through the second quarter and prospects for the balance of the year. Richard?

Ed, I'm going to take it from here. It's Matt. Thank you, everyone.

Our company's solid second-quarter performance was underpinned by the strength of our products and end markets' diversification. Despite some of the challenges, specifically in the heavy-duty truck and auto industries, the Company achieved almost 7% sales growth, 12.4% EBITDA growth and 18% growth in EPS. This performance was led by continued strength in the Manufactured Products segment, where we're seeing solid backlogs on most products, reaching well into 2008.

Before talking about the segments, I'd like to also comment on the significant volatility the stock has seen over the last few days. Although it's unclear why the volatility has been so great, we recognize that we're likely to trade with the market in periods of broad-based moves downward, despite our now lengthy record of strong performance. We have no other reason to suspect why such volatility has occurred as of late.

Looking now at ILS, sales were down 12.8%. EBIT was down 46%. As you can see, ILS was by far the most affected by the significant decline in heavy-duty truck production. Sales to this end market were off over 40% versus the second quarter of last year. This drop more than offset a solid quarter of stable and growth in most other end markets.

Although we expect the softness in truck to continue through the third quarter, we are encouraged by recent public comments from one of our largest truck customers, Volvo/Mack, who indicated at their quarterly call that they believe industry production bottomed out in the second quarter, and that the recovery to a stronger 2008 and 2009 starts now. We share their thoughts.

We were, however, very disappointed in the drop in profits of ILS. Some of this poor performance was caused by the cost of our effort to meet our truck customers' expectations during a very volatile period with rapidly changing schedules. We are mindful that these are long-term customers, and we recognize there is likely to be a significant turnaround in this end market over the next 12 months. Having said that, we still moved strongly during the quarter to cut costs, increase the efficiencies so that the second half would improve, whether or not the truck market itself did.

Before I leave the segment, I do want to say that while we're disappointed in the results of this quarter, most of all the trouble was in one end market. New business activity, margin improvement efforts, including cross-selling and sourcing, suggest that ILS will provide strong leadership in our top and bottom-line growth over the next 12 months.

Now, turning to the Aluminum Products segment, sales were up 8.1%. EBIT was down approximately $1 million. Revenue improvement was driven largely by the long-awaited revenue enhancement at the Wapakoneta plant. Although neither of the new blocks of business at that facility have achieved the expected run rates at this time, the second quarter did show some incremental volume.

Unfortunately, these gains were partially offset by continued weakness in the automotive end market and startup costs on these new jobs. We expect this ongoing softness throughout the end of 2007, and anticipate it will dampen the effects of our new business activity. We are optimistic, however, that we continue to be successful in seeing significant quoting and new business opportunities, which will cause a significant improvement during the next 12 months, regardless of the end-market activity.

Manufactured Products sales were up 46%. EBIT was up 131%. Revenue growth was strong across the board in this segment, but was led primarily by our induction in pipe threading businesses, as well as our Forge product business. Our capital equipment companies are benefiting from strategies focusing on both geographic and end-market expansion. These efforts have demonstrated strong growth over the last several years, which we expect to continue. Currently, these companies are at business levels that are 20% stronger than last year, and at this time, many of our products and manufacturing capacity are spilling into mid 2008.

The Forge Group is also at the threshold of several strong years, with backlogs increasing steadily at our Locomotive division, which is experiencing strong demand from surging locomotive builds which are reacting to increase rail freight needs. Equally strong is our Aerospace group, also being led by need for freight planes like the 747-8. Military, stationary power and marine markets also looking strong as well, and we're seeing significant backlogs reaching well into 2008.

Looking at the balance sheet and cash, inventory and accounts receivables both decreased in the second quarter, although overall non-cash working capital increased somewhat, due to the effect of customer deposits and percentage of completion accounting on prepaid and accrued expenses. During the second quarter, we paid down approximately $3.6 million of debt. We anticipate very strong cash flow in the second half, especially from our capital equipment businesses, and our expectation of causing bank debt to go down by $25 million for the full year or over $40 million from the end of the second quarter is still intact.

In June, we moved to ensure plentiful liquidity and cause costs to go down by amending our bank agreement. We increased the credit facility side to $270 million and incorporated within that limit a $25 million tranche not linked to any of the borrowing base items. The amendment improved the pricing grid as well, so that we reached the lowest interest rate level with less challenging ratios.

Capital expenditures in the first half totaled $9 million. We now expect full-year CapEx to total $16 million to $17 million. First half D&A was $10.7 million, and we expect full-year D&A of approximately $21 million.

Cash tax payments in the first half totaled $2.7 million or about 16%. This is a reasonable estimate for the full-year percentages of cash taxes, although it is possible that the Company's NOL will be fully consumed this year and some federal cash tax payments may be made. We expect a full-year effective tax rate for book purposes of approximately 36%.

In closing, we're pleased that the Company achieved its objectives for the second quarter, particularly in light of some dramatic end-market volatility. We are therefore very excited about the prospect of the future, as we see the combination of ILS getting back on track, our casting strategy take hold and strong global demand for our Manufactured Products. We stand by our 2007 earnings estimate of $2.10 to $2.35. Thank you very much.

Let me point out a couple of the important issues relative to the trucking slowdown, this 40% that Matthew talked about. Keep in mind that this is a very, very important part of our business. Although we have written new business, as we have indicated, this rather dramatic quarter-over-quarter number can only be looked at on the basis that we have to maintain our capabilities at any time. When we are being signaled by companies like Volvo and others that the drought could be coming to an end, we must maintain the facilities, the inventory levels. We have to be in a very, very strong position to respond. So there is an embedded cost in being prepared for the reemergence of a very, very strong trucking market, which we anticipate, again, as Matthew indicated, in the near future.

As far as the Aluminum business is concerned, yes, we are disappointed in the overall performance. The ramp-up of the two large orders in Wapakoneta are behind schedule. But we're still optimistic, and hopefully look forward to writing some additional business or additional wins in this sector. As indicated in previous conferences, we still feel very strong about the potential for the Aluminum business, particularly in the latter part of this year and the years in the future.

Now we'll be glad to open up the lines of communication to any questions.

(OPERATOR INSTRUCTIONS). Richard Paget, Morgan Joseph.

I just wanted to talk about some margin trends here. Manufactured Products -- obviously, very strong. What is the sustainability of this north of 13% operating margins? Was there anything in particular in this quarter, whether it was mix, or are you guys getting really strong pricing now, and we can at least expect some pretty strong margin performance throughout the end of the year?

I think that there's going to be some volatility in that margin number, principally because we see large capital equipment OEM jobs flow through that number now and then. Having said that, everything we're doing in those businesses lends itself to higher margins. As we have discussed on the call in the past, our effort to expand our service and parts business, which is very high-margin, globally is really enhancing our margins, not just for this quarter but in the long term.

Obviously, the significant growth in backlogs in things like locomotive crankshaft and aerospace parts, which we are in many cases the sole source on, are giving us not only really better overall margins because of the absorption; we're also getting it because, really, pricing power has come to us in a big way.

So while I would hesitate to comment on a specific quarter's margin or trend in margin, I will tell you we're very specific in our effort to expand quickly into higher-margin businesses.

So if you look at last year, I know there were some operational issues. We were looking at a range from 8.5% to close to 11%. It seems these days now that range is kind of north of 10% to over 13%.

I think what happened, Richard -- you saw what we saw last year was the flowing through of our rubber products losses. So by and large, 90% of the volume in the Manufactured Products group has been at or above the margins you are currently seeing or in line with the margins you are currently seeing. You just saw the flow-through last year of the rubber losses.

So overall, do you think there's still room for expansion through pricing? Will you have still more capacity to get some good incremental margins there?

Yes, I think there's opportunity for growth. We've seen a lot of it on the margin side, so -- but having said that, I think that particularly the capital equipment businesses, where we're really leveraging intellectual property -- our ability to grow that business is significant.

I guess kind of the opposite story -- is there a way you can give us a sense of ILS margins, if you kind of back out this truck issue?

I wouldn't even begin to try and do that. Our business is too commingled to make that happen. We service too many of our truck customers out of too many warehouses that are affected by other customers as well. There's no question that there was a blend of two things. One was, as Dad talked about, our need to continue to service what are very long-term customers, particularly as they battle through this one or two-quarter trough.

But I think we could have acted more aggressively earlier in the second quarter on the cost side. We've done that at this point. We've done a couple rounds of layoffs, unfortunately, not just here in Cleveland but really throughout the country. So I think you're going to see a movement in our margins really kind of regardless of the overall revenue numbers.

So sequential of improvement, I guess, is what you're suggesting?

Absolutely.

Have you seen any other weakness in some end markets, especially some of your kind of housing-related, whether it's Maytag or Carrier or some things impacted by the slowdown in residential construction?

Not in any meaningful way, but I would also tell you that a very small percent of our business goes into the housing end markets.

So overall you're saying the rest of your customers are still doing --

Are doing fine. As I said in my comments, they are either stable or growing, particularly in those end markets that we're signing new business. Oddly enough, one of our growth markets during the quarter was auto, because we've got some new customers there. As we've talked in the past, auto is a very small percentage of the ILS sales. We've actually picked up some additional Johnson Controls business there. I hate to say it, because I don't want to jinx this, but this was largely an isolated event in what is still our largest market.

(OPERATOR INSTRUCTIONS). Sarah Thompson, Lehman Brothers.

It's [Doric Koenig] for Sarah Thompson. Do you have a CapEx number for the quarter?

Yes, I think we gave that in my comments, but let me have Rich touch that up.

The total for the half was $9 million. I forget how much of that was in our first quarter; it was roughly half and half.

Do you guys have a free cash flow number for the quarter?

We paid down debt overall $3.6 million, and we pretty much paid down debt when we got cash. That's it.

Can you guys please provide us with an update on how the NABS business is doing, and what sort of contribution it provided this quarter?

NABS -- I'll speak to that. It is becoming relatively difficult to break NABS' numbers out on a stand-alone basis because, as we indicated when we made the acquisition, we anticipate some of the synergies associated with becoming part of ILS. But we continue to expand that business. They continue to meet all of the objectives, from a business and numbers perspective. That continues to be a strong opportunity for us, and we're still pleased with the acquisition.

[Jayant Ishwar], Singular Research.

The question I had was on the ILS division. When can we expect to see profitability back up to last year's levels -- that is, [over 6%] EBIT?

As I indicated to the prior question, we're expecting incremental margin expansion as soon as next quarter. So I think we've hit that trough. We're anticipating heading back north, if you will. So I am not in a position right now to tell you where I think that -- when we can reach that historical level. But frankly, I expect it to be quite soon.

As I mentioned, since most of the fundamentals in ILS are doing very well, then I would expect that, once we weather this trough of the truck market, and particularly some of the numbers you're seeing about some of the real strengths that they are anticipating in 2008, I would expect that at the very latest to be back at those margin levels by the start of 2008.

[John Baum], Shareholder.

A great quarter, guys, in a tough ILS market. Any comment regarding the NABS acquisition in China and India, if you want to get any color on that and some of the international sales?

Yes. The two businesses, as you point out, that are exposed to those markets in a big way there are our capital equipment product lines. Much of the growth you're seeing continues to be overseas. So our exposure into markets like India, like China, like the former Russian states, even South Africa and so forth, is fantastic. So that business continues to grow because of that global content, and will continue to grow because of thatlobal content.

The NABS business -- we are definitely through what I'll call our stabilization period, our integration period. This is good and bad -- we see less business domestically today for NABS. So all of their growth is coming internationally. We have largely capped -- as we've talked about in past calls, we largely kept their management team intact. We have even augmented it now with some strong players that will give us that local flavor that I think we're going to need to keep getting business, not just from the IBM's but from the [Foxconn's], who are their tier, if you will.

So on an order of magnitude, those numbers out of NABS are not huge, because the business was only a $50 million business when we bought it. But they are very significant from a strategic standpoint and a long-term standpoint.

Are you getting some tailwinds with foreign currency translation?

Yes, I would say a little bit, yes.

Thank you. Good quarter.

Philip Volpicelli, Goldman Sachs.

I just want to talk a little bit about the Aluminum business. It seems that the revenue was up and the rate of decline on the operating income seems to be abating. What do we need to do to get that to start comping positive and get those, I guess, margins in that business back up to 4% or 5% or higher, if possible? What is the next step in Aluminum?

Well, the Aluminum business -- as we've indicated, we have brought on two very large orders in our Wapakoneta plant in Ohio, anticipating and necessarily being prepared in the first quarter to meet their expectations when it comes to volume. That volume has not materialized, I think for obvious reasons. That does not set aside the fact that we had to be prepared, hire the people, put in place all the necessary production capacity to meet those requirements.

So when you have a trailing period of time with the sales dramatically under -- in that particular location, although the absorption is not completely there, it will affect the Company, affect that particular plant, until the latter part of this year. So this is a volume-related issue, and we have seen light in the total relative to that particular plant and increased volume there, which will result in impacting the margins dramatically.

Were those automotive big three contracts, or can you give us any more color as to when (multiple speakers)?

There are two Tier 1's -- excuse me, one Tier 1 and one direct. These are substantial contracts. They are in our sweet spot relative to our production capabilities. But again, the ramp-up of any of these orders -- and we see, hopefully, more in the future -- just take a little bit longer, particularly in light of the fact the volume isn't there.

So for example, the really direct -- I mean, we had to hire and then subsequently let go, I think, some 65 employees in the Wapakoneta plant in the first quarter. We were prepared, had the expenses. The volume wasn't there. All that training and all that startup and all that energy, and what I call the shakedown crews was all for naught. But we are optimistically now beginning to expand and retrain our employees to meet the expectations of these particular --

So we, in fact, now know who our customers are. We know who are their customers are. We know the platforms and the automobiles and trucks that these items go on. So we can read the information coming out of Detroit, and we're getting more optimistic that those particular platforms will be up and running.

As we look at ILS and your comments regarding Volvo/Mack and them believing that the Class A trucks had bottomed out in the second quarter, what are you guys basing that on? What's giving you guys confidence that you are agreeing with what they are saying?

A think it's a blend of a lot of different facts we get. As you know, we get our facts and figures not just from our customers -- from our competitors, from sources around the industry, from our vendors. I think what we saw in the second quarter was very unusual, not just in the fact that they were expecting a downturn, but the volatility not just in terms of how surprised some of our customers were at how much and were taking weeks out of the schedule, literally days before that week happened.

So we saw unannounced shutdowns really crop up throughout the whole industry. Some customers handled it better than others, which also made it a little bit difficult for us, because a company, for example, like Volvo/Mack did a great job of anticipating what they were going to see in the market and, of all the customers in the industry, probably did the best job.

So handling that volatility, not just from an industry perspective, handling it from a timing perspective with surprise shutdowns and then handling it differently for each customer has given us a lot of information. I think that what we've tried to see most of our customers do is an inventory correction in the second quarter. While they expect very little improvement in the sale of heavy-duty trucks in the third quarter, we're starting to see inventory numbers that make a little more sense to us.

So if I were to think about that, last year in the third quarter you did about $8.8 million of operating income in the ILS segment. You did $5.5 million here in the second quarter. So to get back -- you probably won't get back all the way to $8.8 million, but you will probably get closer. So that rate of change in operating income will probably continue to abate. Is that (multiple speakers)?

I don't want to comment specifically on third-quarter ILS projections. But let me give you a sense of -- as I indicated in my comments, we're not expecting this trough -- we expect things to improve in the third and fourth quarter and going forward. We do not expect -- we still expect the numbers from heavy-duty trucks to be dismal in the third quarter.

Having said that, we have made significant changes in our cost structure, and we'll also get the benefit of some investments that were made in the first half, like we have absorbed all those shutdown costs of the location that we had shut down in the first half. So we'll begin to get the benefit of that restructuring across the board. I expect to see margin enhancement on volumes that -- even if the volumes don't meet our expectations. So I'm not prepared to wait until the truck market comes back to hit those kinds of profit numbers.

One other thing -- all you have to do is get in your car and drive to any interstate. These trucks are running 24/7 and we've got to look back. This market is off dramatically, because there was a prebuy of trucks because of the emissions change. That cycle is going through itself. We have to be prepared, and we are, again, burning some of the costs relative to what we anticipate could be a rather quick ramp-up in the volume when and if it happens.

So I think Matthew is absolutely correct; it is on its way. The trucking business has never been running as hot as it is right now, and they will be back for new equipment, because they prebought. So at the rate they are going, again, I'm very optimistic about over the next couple of years. What is a little painful for us right now -- we're in the right position at the right time with the right customers.

The next emission change is 2010. Am I correct on that?

Correct. They are going to have to do the same thing they did on the surface. You could have a huge run in 2008 in 2009 getting ready for 2010. We'll be talking three years from today, and we will be going through our 40% down quarter again.

But there's some great times ahead for this particular company in this segment. We're still energized by what that can do for the Company, particularly in light of the fact that we have added some substantial new business that's underpinning the performance of the Company, even with that aboard.

Yes, I think that's an excellent comment. I think what sounds a little hollow, so we haven't addressed it on this call, is there's still significant new business flowing into our revenue line. It's growing as the year goes on. So it sounds a bit hollow right now, based on this quarter, but it will become more obvious as things normalize in that industry.

Richard Paget, Morgan Joseph.

You guys had talked about Manufactured Products backlog being up strongly. Could you just give us a sense of magnitude, just because -- this run of growth has been, obviously, very strong. But now comparisons are getting a little bit more difficult. How should we think about growth going forward?

As I mentioned when we talked just a few seconds ago, it's very difficult to forecast, because of the size of some of the capital equipment and OEM orders that flow through their P&L. It would not be unusual for the pipe threading business to see a $15 million or $20 million order. That obviously is going to impact the business on a quarter-to-quarter basis.

Having said that, we clearly are seeing demand similar to and greater than what we have seen in the last couple of years, and those demands and backlogs are eking deep into 2008, depending on which product we're talking about. We have no reason to believe that those markets will not stay strong over at least the next 12 months.

The other point I want to mention, because it was asked by one of the callers a few moments ago, is some of this margin expansion isn't truly margin expansion or business expansion in those groups. It's really just a rebound of those rubber numbers flowing through. So this is not -- as much as I know everyone is looking at this piece of paper going, where did this come from, that performance has been pretty solid, both in forging and capital equipment now for well over a year.

But at least you have the backlog numbers now. Is backlog still growing double digits? I don't think it's growing at a 40% clip, necessarily, in this quarter. I'm just trying to get what is the at least near-term sustainable growth range.

I'm not going to comment any more specifically to tell you that the business trends, bookings, backlogs are as strong now as they have been, and we expect them to stay that way and expand as we expand our footprint globally. So I expect it to get the same or better.

Also, let's keep an eye on our end markets that we are serving here -- gas and oil, rail, aerospace. We're in some very, very exciting markets that I haven't heard any lack of enthusiasm what's going to happen to gas and oil. So we positioned this particular unit in some very, very strong markets that appear to be -- are going to be healthy for some time. So if you are in gas and oil, and you are in the railroad business or your in the aerospace business, these are markets that look very solid for the capital goods/equipment side of the business and the forging side for the foreseeable future.

Gives you that strength of pricing.

Hope so, and it has.

(OPERATOR INSTRUCTIONS). Jayant Ishwar, Singular Research.

This one relates to the Aluminum division. The delays you're talking about -- is that internal, or is that caused by a push-out of orders by the customer? (multiple speakers).

Do you want to continue the question?

When do you expect that to turn around?

Well, it's external. It's our customers not buying or parts to continue making automobiles. That is basically in the hands of the marketplace. It's our view that it's beginning to improve, and a lot of parts of this year could be partially improved.

This is still a very difficult area. The Aluminum business is a tough business to be in right now. We need to ramp up; this is a volume-oriented business. The volume is not there and we cannot do anything. We can't create the volume. It's not our internal costs. This is a very well-run, organized, low-cost company. But we are really at the mercy of our volumes. Until these plants reach the volume numbers that we anticipated for the balance of this year, we will continue to have trouble in the automobile sector or in the aluminum sector until the volume increases.

Thank you. There appear to be no further questions. I would like to turn the floor back to management for any closing comments.

Ladies and gentlemen, again, thank you very much for joining us for this conference call. We believe largely we're going in the right direction. The Company feels healthy here. Our end markets are strong, and again, we are well -- we're very pleased with the balance between the ILS and the capital equipment and the Aluminum business. Our diversification and our end-market diversification are serving us well. Hopefully, we will have some positive news again for you at the end of the third quarter. Thank you once again.

Thank you. This concludes today's Park-Ohio Holdings conference call. You may now disconnect.