Matthew Crawford - Chairman and Chief Executive Officer Pat Fogarty - Vice President and Chief Financial Officer

Edward Marshall - Sidoti & Company Ryan Mills - KeyBanc Capital Markets Matthew Paige - Gabelli & Company

Good morning and welcome to the Park-Ohio Third Quarter 2018 Results Conference Call. [Operator Instructions] Today's conference is also being recorded. If you have any objections you may disconnect at this time. Before we get started, I want to remind everyone that certain statements made on today's call may be forward-looking statements as defined in the Private Securities 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 2017 10-K, which was filed on March 8, 2018 with the SEC. 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 to 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. I would now like turn the conference over to Mr. Matthew Crawford, Chairman and CEO. Please proceed, Mr. Crawford.

Thank you, Kevin. Good morning and welcome to our third quarter call. Joining me this morning are Pat Fogarty, our CFO and Director of Corporate Development; and Ed Crawford, our President. We are pleased to report excellent performance which included third quarter record in both revenue and profitability. I am particularly about this performance during the period where we continue to invest aggressively in people and hard assets which will underpin our objective to be $2 billion in revenue with a 10% EBITDA margin by 2021. These investments are a headwind to our current performance but as Pat and I will discuss has significant value to our future. Our strategy for growth and value creation has three pillars. First, new products and services; second international expansion and third strategic acquisition. In some cases like our recent acquisition of Hydrapower in the UK, we see value being created in more than one pillar. Looking at the third quarter performance, I also want to highlight the operating leverage we saw across almost all of our businesses. Year-over-year I specifically want to point out the improvements in our aluminum casting business and in our Forge Group which acquired Canton Drop Forge last February. These businesses have grown aggressively during the last 12 months and are managing the increased demand very successfully. Turning to the segments themselves. Supply Technologies continue to see strong double-digit growth albeit slightly more moderate from the first half of the year. New sales have continued to accelerate during the third quarter and of great interest to us has been the 43% increase in aerospace and defense business during the third quarter. As most of you recall, this has been an area of new product and service focus for us during the last couple of years. Assembly Components continue to benefit from the transition and orders to zero emission vehicles. During the quarter we benefited most from our light weighting initiatives, but important milestones were met also relating to product launches and OE qualification of new products globally in our rubber and extrusion platforms. We expect the international expansion and new product development to be a big part of our success in late 2019 and beyond. Specifically, we expect these investments to add $150 million in revenue by 2020 and more than half of this growth is already booked. Perhaps our most exciting segment this quarter included our strong Engineered Component segment, which continues to see strong demand from not only aerospace but also from agriculture, rail and the oil patch. Relating to our growth and value creation strategy, we took delivery of a new frame for a 7,000 pound mechanical forging press which we expect to commissioned at our Arkansas plan in early 2019. While these are exciting developments, we continue to battle signs of inflation across the board. We are doing what is to be expected including reducing these costs and managing both the internal and external supply chain, but we are also increasingly focused on pricing strategy. We have and will continue to implement price increases when appropriate. Lastly our acquisition pipeline remains robust and includes several highly strategic opportunities. At this point the year though these will likely spill into early 2019. Thank you very much, and I'll now turn it over to Pat Fogarty.

Thanks Matt. As Matt mentioned the third quarter was a strong quarter and exceeded our expectations on a number of fronts. We saw continued end market strength in many businesses which resulted in outstanding year-over-year growth in both sales and profitability. Each of our business segments contributed to the sales growth on the quarter, continuing the momentum that each segment experienced in the first half of the year. Our net sales of $414 million in the third quarter were an increase of 18% year-over-year. Of the increased 7% was due to organic growth and the remaining 11% was due to acquisitions completed in 2018 and 2017. On a year-to-date basis through September 30th, our revenues were a record $1.3 billion, up 20% compared to a year ago. Gross margin as a percentage of sales was approximately 16% in the third quarter above 2018 and 2017. We realized solid operating leverage and income flow through in many of our businesses, most notably in our aluminum casting, forging and industrial equipment businesses. However, compared to a year ago third quarter margins in our assembly component segment were impacted by continued new plant start-up costs and higher operational costs which I will discuss later in my comments. Third quarter SG&A expenses which totaled $41 million decreased to 9.8% of sales compared to 10.7% of sales a year ago due to higher sales volumes in the third quarter. The increase in SG&A dollar were due primarily to the SG&A expenses from acquisitions. Operating income was $24.8 million in the third quarter, an increase of 31% from $19 million last year due primarily to the strong sales volumes in the quarter and the favorable impact of the Canton Drop Forge acquisition. Segment operating income margins in the third quarter increased to 7.9% compared to 7.5% a year ago. Interest expense of $8.9 million was slightly higher in the third quarter compared to the third quarter of last year resulting from higher average borrowings during the quarter. The impact of the increased borrowings under interest expense was partially offset by the positive impact of the lower average borrowing rate driven by our debt refinancing in April of last year. Our effective income tax in the third quarter was 18% compared to 21% in the third quarter of last year. Our tax provision in the quarter included an income tax benefit to reduce our transition tax liability resulting from the US Tax Reform. The impact of this adjustment was $0.07 per share and is excluded from our third quarter adjusted EPS of a $1.07. Excluding this item, our third quarter 2018 effective tax rate would have been 23% which is due to the full recognition of certain benefits in our businesses in Italy and England. For the full year of 2018, we now expect our effective income tax rate to be approximately 27% to 29%. Our GAAP earnings per share in the third quarter was a $1.17 compared to $0.80 last year, an increase of 42%. On an adjusted basis our third quarter EPS was $1.07 up 30% from $0.82 in the prior year. Operating cash flows for the third quarter were $23 million driven by profitability and improved working capital performance during the quarter. Also during the third quarter, we repatriated $24 million in cash from a foreign subsidiary and used the funds to pay down a portion of our US revolving credit facility. As a result, our total debt was reduced by $28 million since June 30th, and our gross debt leverage was reduced by nearly 10% compared to last quarter. We ended the quarter with continued strong liquidity, including cash on hand of $63 million and approximately $200 million of unused borrowing availability under various global banking arrangements. For the full year of 2018, we continue to expect to generate $40 million to $50 million in operating cash flows, to spend CapEx of approximately $42 million to $45 million and to further pay down long-term debt in the fourth quarter by approximately $15 million to $20 million. Now I will comment on our segment results. In Supply Technologies sales were up $15 million or 11% year-over-year. Organic growth accounted for 4% and 7% came from acquisitions made during 2017. The sales growth was driven by higher customer demand in many of our key end markets including aerospace and defense which was up 43% year-over-year; heavy-duty truck which was up 27% year-over-year and industrial and agricultural equipment related which was up 12% year-over-year. Our average daily sales were up 13% for the quarter and 20% year-to-date reflecting strong customer demand year-over-year. Also in this segment, our fastener manufacturing business continues to perform well with their quarter results in line with a strong prior year quarter. Operating income in this segment increased to $11.3 million from $10.2 million a year ago, an increase of 11% driven by the increase in sales volumes. Operating margins as a percentage of sales were comparable year-over-year at 7.3% as the flow-through benefit from higher sales was offset by unfavorable product mix and the continued investment in strategic sales initiatives and to a lesser degree the impact of commodity price increases. Now we will turn to the Assembly Components segment, sales were up 14% year-over-year in the quarter driven primarily by higher sales volumes in our aluminum business. The improved sales in our aluminum business were due to an expected increase in volumes and products launched in 2017, primarily on high-volume platforms which use 10-speed transmissions including the 4F1-50 truck and the increasing demand for compact crossover SUVs including the Jeep Cherokee. In the third quarter, our fuel related and rubber product revenues were up slightly year-over-year due to the continued strength of global automotive build rates. As we have discussed on previous calls, we have continued to invest in three new production facilities in both China and Mexico. These plants which produce fuel rails, fuel filler systems and various extruded and molded rubber products for the global auto market are progressing well. Two of the replants are in production and shipping product. The third production plant which is located in China will be operational by the end of the year. Our current projections continue to show a steady sales ramp up beginning in 2019 which should approximate $150 million revenue run rate in 2020. Segment operating income decrease year-over-year from $10.7 million in the third quarter of last year to $9.3 million this year and operating margins declined from 8.4 % to 6.4% in the third quarter of 2018. These decreases were due to the impact of startup and production launch costs in our new production facilities, unfavorable sales mix and excess operational costs. The increase in operational costs was due primarily to incremental costs of hiring and training new employees as a result of higher production levels. We believe we are making progress and eliminating and controlling these excess costs, and we are seeing evidence of our efforts so far in the fourth quarter. We expect continued improvement in operating margins once production levels ramp up in our new facilities, and the excess startup and product launch costs are eliminated. In October, we acquired Hydrapower Dynamics Limited located in Birmingham, England. The business will be included in our Assembly Components segment beginning in the fourth quarter. Hydrapower provides fluid assemblies which incorporate extruded rubber hose, tubing and fasteners into its end products and serves customers in the bus and truck, agriculture and rail end markets. We believe there are significant synergies with our fuel, rubber and supply chain businesses that will provide future growth for Hydrapower. In our Engineered Product segment, sales were up 34% compared to a year ago, driven by a combination of organic growth of 10% and 24% from the acquisition of Canton Drop Forge. The organic growth in this segment was driven primarily by increased global demand for our induction hardening and pipe threading equipment which is up 15% year-to-date over the prior year. Our backlogs in our capital equipment and forging businesses continue to be strong. Our acquisition of Canton Drop Forge continues to perform well as demand in the aerospace and oil and gas end markets has been strong. The integration of Canton with our other forging businesses is progressing well, and we are seeing the benefit of the synergies we identified when we acquired Canton. Operating income in this segment was up significantly in the third quarter compared to a year ago from $5.6 million to $12.2 million. Our third quarter operating income margin of 10.8% is an increase 410 basis points year-over-year. The significant increase in profitability in this segment was due to an increase in plant absorption, resulting from higher sales levels and the impact of the Canton acquisition. Finally, I would like to comment on the remainder of 2018. Although, we are optimistic that we will end the year at the mid to higher end of our adjusted EPS guidance range, we are seeing customer demand in certain automotive platforms begin to soften slightly in the fourth quarter. In addition, we continue to manage the impact of commodity price increases. Although, we fully expect to recover such increases, there is a slight lag on their recovery with our customer base. As a result, we are maintaining our full year 2018 adjusted EPS guidance of $3.80 to $4.00 per share. Now I'll turn the call back over to Matt.

Great, thank you very much, Pat, for your detailed report. We will now open the floor for questions.

[Operator Instructions] Our first question today is coming from Edward Marshall from Sidoti & Company. Your line is now live.

Hi, gentlemen. How are you? Good morning. So I wanted to ask about your investing vigorously I mean that's the language in the in the press release, and I know your focus is on the horizon. I'd like to get a sense of how much the impact is on the near-term, if you can quantify the headwinds that you kind of highlighted and maybe where are they coming from in the individual segments? I know you mentioned quite a few during your prepared remarks. Thanks.

Let me maybe Pat would have more detailed financial answer, but let me talk to you in terms of the scale of what's going on in some of the new facilities. For example, I keep our headcount currently in the New Mexican facility, its several hundred employees. That's business, if it's profitable at all right now is marginally profitable it's been losing money for most of 2018. So the launch has been as you would expect are even. Some of the business which we've been effective in moving around in our plant structure has launched, other launches have been delayed in some cases months not years. Other OE qualifications have taken longer than we thought. So this is very, very typical for a launch of this scale, but to be clear that gives you a sense of the amount of people that we have in the facility both in terms of direct labor roles and in terms of management and supervisory roles. To different extents, the same is happening in China. I don't know that there's any more important time in the launching of a new facility than the period at which you are qualifying your asset. You need to essentially be able to validate to the OE that you're ready --you are production ready. So and yet that doesn't come, all that comes with is pre-production order. So I would argue that the number is clearly in the millions of dollars, but other than that I wouldn't want to comment with any specificity. Pat anything you want to add there, is that -

No. I think the only thing I would add is the amount of cost that is being incurred in setting up new plants not only on the people front but also in facility costs that we're incurring, it's significant and as production levels ramped up, you'll get the absorption and we expect that to begin in the first quarter of 2019.

Got it and--

Ed, we spent a lot of time as well talking about the three launches because I think it's the easiest places to put our finger on, a lot of money, but as I mentioned in my comments, we've got really wonderful opportunities going on in other parts of the business. That is also a bit of a drag as we invest. I mentioned our new 7,000 pound forging, mechanical forging press we're putting down in Arkansas. I've talked in prior periods about our investment in supplies technologies in MRO. Those are not of the scale but those are significant relative to the fact that none of those are producing profits right at this point.

You've guys have both been around the business for a long time. I am curious to get your opinion. Is this the biggest investment period that Park has ever gone through in kind of your tenure, your familiarity with the business?

The answer is unquestionably yes. I think that we talked about the pillars I spoke in my comments about the pillars for the success of this business, and meeting our financial goals of $2 billion and 10%. And I think that what I think we've focused on more aggressively. We've always, the pillar which includes strategic investment or acquisition. We've always been excellent at. I think where you're seeing us accelerate our investment is on the international expansion and on the new product development. We are spending considerable resources there focusing on our own business, our own competitive advantages and our own opportunities for growth in our current teams and businesses and products. And there's a lot of ways to look at that but one of the ways I think that would be sum it up is our CapEx forecast I think is between $40 million and $45 million. That is only --that is 2x or 2x that you have found --would have found us to spend three or four years ago. So that I think, now to be clear at the business is twice the size. I mean we've grown considerably so some of that we expected but the opportunities we see today not just in the forging business but also in the aluminum light weighting business and most notably in the rubber and extruded hose business, all have tremendous opportunities particularly in this zap or zero emission vehicle space.

Got it. And I'm curious the softness in auto that you referred to in the fourth quarter orders. Are they related to kind of the legacy business or they linked to the facilities in Mexico and China?

Yes, no. Really unrelated to the facilities in Mexico and China. And really what we're seeing there at is some schedules being changed in the fourth quarter on certain platforms that we work with. I don't think it's an indication of where things are heading into 2019 but it's really a function of kind of current year inventory levels and where things are playing out through the rest of the year.

And I would add to Pat's comments. I think that those are discrete stories at the moment related to the fourth quarter. There are significant decisions being made at the OE level relative to current platforms and how they're going to reposition themselves for some of the key truck platforms and SUV platforms. And right now it's tough to know if something's just a typical holiday shutdown or if they're modifying production lines. So I agree with Pat. This is not a 2019 story. This may just be some discrete story about the fourth quarter and most notably December.

Got it, and on Hydrapower. I know it's small but I'm curious what the --was --is it typically -is that a bolt-on deal or there are other technologies or customers or markets that they serve? And I'm assuming it will be pretty quick to integrate into the existing AC business?

Yes and I would say it's more than just a bolt-on. Although there are specific synergies within our extruded hose business and our assembly of hose and fittings into various end markets, it provides us with a key location in Europe which today we currently don't have in the assembly components group. And with that comes tremendous synergies from a marketing and sales standpoint with supply technologies. As you know, we've acquired many companies over the last three years throughout the UK to really support customer demand in not only England but also throughout Europe.

Our next question today is coming from Steve Barger from KeyBanc Capital Markets. Your line is now live.

Good morning, guys. This is Ryan Mills on for Steve. Congrats on the quarter. Yes starting with the supply tech, organic growth came in about 4%; it was running on double digits over the past year. Are these just tougher comps or are you seeing signs of slowing in some sectors? And should we be taking low to mid single digit organic growth rates going forward.

You want to start with that Pat?

Sure. I'll answer that for you, Ryan. The third quarter of last year was a strong quarter as heavy-duty truck and other end markets began to ramp up. We continue to see strength in year-over-year comps in the quarter, most notably aerospace and defense. Some of the other markets were growing at less than 10%. So I don't think it's indicative of the future organic growth in this business, which we still believe to be in the mid to high single digits, but the quarter-over-quarter comps were somewhat difficult because last year was such a strong quarter.

We, this is Matt. We continue to see robust new sales growth and we're pleased the progress we've made this year. We're just about on plan for our new sales estimate for the year. So we're excited about that, but to be clear it is the comps are getting more difficult as you suggested.

And with customers running at higher levels and labor getting tighter. Are you seeing more inquiries in supply tech to take more product lines from existing customers? Or you are having any luck prospecting for new customers looking outsourcing processes?

I think it's a delicate situation at many customers out there. Whether they're prospective customers for us or current customers. Most of this year they've been trying to keep their plants running. There has been a lot of disruption relative to just securing parts. So fortunately that has - we have not had that issue, but it has been hand to mouth for us at times. And we have had to absorb some express freight and some did --to do some things that were extraordinary to keep our customers happy with a spike in demand. So while it's a tremendous opportunity to sell our value proposition in supply tech. And I agree with you, there are more conversations happening. It's also a really difficult time sometimes to consider an OE of scale trying to transition a relationship in an environment where they're just happy to be getting parts.

Okay and then switch into assembly components, margins for the year look like they might be down a couple hundred basis points. And I'm assuming it's still from the impact of the new plants in China and Mexico. So I guess my question is where does this business stabilize and can you talk about how you see the margins progressing as everything come online?

I'll let Pat comment about the numbers, but I think the 2019 is going to be a very interesting year. We have seen sustained margins in that business in the 12% to 14% range. And I don't see any reason why we can't get back there. The question will be how quickly can we come online with the appropriate amount of volumes in 2019 to get the absorption that we need to make these businesses anywhere near the kinds of margins that we're talking about. So I have a lot more confidence about end of 2019, 2020 than I do about the first half of next year. But I don't, we don't manage this business that way. We make investments for the long haul.

Okay then my last question, free cash flow has been tracking below prior years, and I know it's an investment year for you guys but what do you expect for the fourth quarter and how are you thinking about free cash flow conversions for 2019 or just on a more normalized basis going forward?

Well, Ryan. As I mentioned, we expect the fourth quarter to be a very strong cash flow quarter not only through the management of working capital, but also due to profitability. This year was an unusual year and that we spent $40 million to $45 million in CapEx. That if you look back over our history that's probably 15% higher than where we've been historically. But we continue to see strong cash flow and the conversion of our EBITDA will continue to be strong and will give us the opportunity to further de-leverage the company.

Our next question is coming from Matthew Paige from Gabelli & Company. Your line is now live.

Good morning. In relation to the Chinese facility that you're ramping up especially, are there any key end market levels that you watch as you ramp up production? And how does the potential slowdown in global automotive production impact your ability to ramp up to your production targets?

Great question, Matthew. It is - we're very mindful of some of the disruption we've seen in the Chinese market space on the demand side. So absolutely that is-- we have some concern over that going into next year. But what we do have concern about is the importance of our products and the market positioning for, you mentioned, you use the singular, I'll use the plural. We've launched two plants in China and are launching two plants in China. One of them is around our direct injection technology which is extremely important not just to the foreign control JVs but also to the domestic OEs as they look to once again sort of create this transition in many cases through the hybrid space to better performing internal combustion engines combined with the electrification. That will be a 10 or 15 or 20 years plank and it is as fast as we can get up and running. We have customers for that part regardless of the overall demand. That conversion is extremely important to what they're trying to do through the regulatory environment there. Our second facility that we're really just at the initial stages of launching and getting some approvals on the product qualification from the OEs. Once again, both foreign controlled and Chinese national as our extruded hose and rubber. These are vital as well for this transition. These products can be --is typically particularly extrusion side can be for fused for fuel which has historically been our strong spot, but more broadly our hydraulic hose. They can be used in multiple facets particularly for expansion into the full zero emissions car and the battery and electric car. So this is once again focused very much on that transition. And I think that despite some volatility maybe in early 2019 nineteen or throughout 2019 on the Chinese demand for new cars. I think we will continue to benefit from that transition.

Great, that's really helpful color on the product lines that you have, and I guess that really leads into my second question of, are there any products or new end markets that you think you need to add to your portfolio right now to hit some of those coming needs of your OEM customers?

I think we will continue --I think the exciting story for 2018 will be this rubber and extrusion investment. I think that our ability to adapt some of our extrusion technology into air-conditioning hose could generally cool and hose for batteries and otherwise. This is going to be pretty exciting stuff for us. So we are spending a lot of money in development in that area, and believe that our history and expertise in that space is going to provide us tremendous market opportunities particularly in China. Some in places we probably don't even fully appreciate.

Thank you. We reach the end of our question-and-answer session. I like to turn the floor back over to management for any further or closing comments.

Great. Thank you very much for your time today and your interest everyone. We are pleased with the performance in the third quarter. We do think we will perform well in the fourth quarter. As Pat mentioned, we are cautiously optimistic. But to be clear, we are very focused on the future. I continue to use the word reinvestment because that's how we feel about what we are doing. We are making investments to meet our strategic goal for 2020 and beyond. And that's what keeps us our team focused and excited. With that, I'll wish you good day. Bye-bye.

Thank you. That does conclude today's teleconference. You may disconnect your line at this time. And have a wonderful day. We thank you for your participation today.