Item 2. Management’s Discussion and Analysis
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Our condensed consolidated financial statements include the accounts of Park-Ohio Holdings Corp. and its subsidiaries (collectively, “we,” “our,” or the “Company”). All significant intercompany transactions have been eliminated in consolidation.
EXECUTIVE OVERVIEW
We are a diversified international company providing world-class customers with a supply chain management outsourcing service, capital equipment used on their production lines, and manufactured components used to assemble their products. We operate through three reportable segments: Supply Technologies, Assembly Components and Engineered Products.
Supply Technologies provides our customers with Total Supply Management™, a proactive solutions approach that manages the efficiencies of every aspect of supplying production parts and materials to our customers’ manufacturing floor, from strategic planning to program implementation. Total Supply Management™ includes such services as engineering and design support, part usage and cost analysis, supplier selection, quality assurance, bar coding, product packaging and tracking, just-in-time and point-of-use delivery, electronic billing services and ongoing technical support. Our Supply Technologies business services customers in the following principal industries: heavy-duty truck; sports and recreational equipment; aerospace and defense; semiconductor equipment; electrical distribution and controls; consumer electronics; bus and coaches; automotive, agricultural and construction equipment; HVAC; lawn and garden; plumbing; and medical.
Assembly Components manufactures products oriented towards fuel efficiency and reduced emission standards. Assembly Components designs, develops and manufactures aluminum products and highly efficient, high pressure direct fuel injection fuel rails and pipes; fuel filler pipes that route fuel from the gas cap to the gas tank; flexible multi-layer plastic and rubber assemblies used to transport fuel from the vehicle's gas tank and then, at extreme high pressure, to the engine's fuel injector nozzles. Our product offerings include gasoline direct injection systems and fuel filler assemblies, and industrial hose and injected molded rubber and plastic components. Additional products include cast and machined aluminum engine, transmission, brake, suspension and other components, such as pump housings, clutch retainers/pistons, control arms, knuckles, master cylinders, pinion housings, brake calipers, oil pans and flywheel spacers. Our products are primarily used in the following industries: automotive, including automotive and light-vehicle; agricultural equipment; construction equipment; heavy-duty truck; and marine original equipment manufacturers (“OEMs”), on a sole-source basis.
Engineered Products operates a diverse group of niche manufacturing businesses that design and manufacture a broad range of highly-engineered products, including induction heating and melting systems, pipe threading systems and forged and machined products. Engineered Products also produces and provides services and spare parts for the equipment it manufactures. The principal customers of Engineered Products are OEMs, sub-assemblers and end users in the following industries: ferrous and non-ferrous metals; silicon; coatings; forging; foundry; heavy-duty truck; construction equipment; automotive; oil and gas; locomotive and rail manufacturing; and aerospace and defense.
Sales and operating income for these three segments are provided in Note 4 to the condensed consolidated financial statements, included elsewhere herein.
COVID-19 Pandemic
In March 2020, the World Health Organization categorized the novel coronavirus (“COVID-19”) as a pandemic, and it spread throughout the United States and other countries around the world. The pandemic has negatively impacted several of the markets we serve, as well as contributed to a global semiconductor micro-chip shortage, raw material price inflation, higher labor costs and various supply chain constraints, including supplier delays that caused extended lead times and increasing freight costs. In response to the ongoing COVID-19 pandemic, we continue to manage our operating costs, including through actions to reduce costs, including plant consolidation, severance, and discretionary spending cuts, and we are taking aggressive actions to improve results in response to these macroeconomic conditions. We also continue to manage both working capital and capital spending. Although there continues to be uncertainty related to the anticipated impact and duration of the COVID-19 pandemic on our future results, we believe our diversified portfolio of global businesses, our liquidity position of
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$224.8 million as of March 31, 2022, and the steps we have taken during the past two years to reduce costs leave us well-positioned to manage our business through this crisis as it continues to unfold.
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RESULTS OF OPERATIONS
Three Months Ended March 31, 2022 Compared with Three Months Ended March 31, 2021
Three Months Ended March 31,
2022 2021 $ Change % Change
(Dollars in millions, except per share data)
Net sales $ 418.4 $ 359.6 $ 58.8 16.4 %
Cost of sales 364.7 307.6 57.1 18.6 %
Gross profit 53.7 52.0 1.7 3.3 %
Gross margin 12.8 % 14.5 %
Selling, general and administrative (“SG&A”) expenses 45.8 39.7 6.1 15.4 %
SG&A expenses as a percentage of net sales 10.9 % 11.0 %
Operating income 7.9 12.3 (4.4) (35.8) %
Other components of pension income and other postretirement benefits expense, net
2.8 2.4 0.4 16.7 %
Interest expense, net (7.8) (7.4) (0.4) 5.4 %
Income before income taxes 2.9 7.3 (4.4) (60.3) %
Income tax benefit (expense) 3.4 (1.9) 5.3 *
Net income 6.3 5.4 0.9 16.7 %
Net (income) loss attributable to noncontrolling interests (0.2) 0.1 (0.3) *
Net income attributable to Park-Ohio Holdings Corp. common shareholders $ 6.1 $ 5.5 $ 0.6 10.9 %
Income per common share attributable to Park-Ohio Holdings Corp. common shareholders:
Basic $ 0.51 $ 0.46 $ 0.05 10.9 %
Diluted $ 0.50 $ 0.45 $ 0.05 11.1 %
Net Sales
Net sales increased 16.4% to $418.4 million in the first three months of 2022 compared to $359.6 million in the same period in 2021. This increase was primarily due to higher customer demand in all three of our business segments.
The factors explaining the changes in segment net sales for the three months ended March 31, 2022 compared to the corresponding 2021 period are contained in the “Segment Results” section below.
Cost of Sales & Gross Profit
Cost of sales increased 18.6% to $364.7 million in the first three months of 2022 compared to $307.6 million in the same period in 2021. The increase in cost of sales was primarily due to the increase in net sales described above.
Gross margin was 12.8% in the first three months of 2022 compared to 14.5% in the corresponding period in 2021. The 2022 period included expenses of $1.8 million related to plant closure and consolidation and other costs. The 2021 period included expenses of $0.6 million related to plant closure and consolidation, severance and other actions to reduce costs. The
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remaining decline in margin was driven by the ongoing impacts of inflation, higher labor costs and supply chain constraints in the 2022 period.
SG&A Expenses
SG&A expenses were $45.8 million in the first three months of 2022, compared to $39.7 million in the same period in 2021, an increase of 15.4%. As a percentage of net sales, SG&A expenses were approximately 11% in the first quarter of both 2022 and 2021. SG&A expenses in the 2022 period included $1.6 million of expenses related to plant closure and consolidation, severance and other costs and $0.3 million of acquisition related expenses. Selling expenses were higher in the 2022 period as a result of higher sales levels, and other expenses were higher due to inflation. SG&A expenses in the 2021 period included expenses of $0.7 million for plant closure and consolidation, and lower incentive compensation expense due to lower operating results.
Other Components of Pension Income and OPEB, Net
Other components of pension income and OPEB expense, net was $2.8 million in the first three months of 2022 compared to $2.4 million in the corresponding period in 2021. This increase was driven by higher returns on plan assets and lower actuarial loss in the 2022 period compared to the same period a year ago.
Interest Expense, Net
Interest expense, net was $7.8 million in the first three months of 2022 compared to $7.4 million in the 2021 period. The increase was due primarily to higher outstanding debt balances in the 2022 period compared to the same period a year ago.
Income Tax Benefit
In the three months ended March 31, 2022, income tax benefit was $3.4 million on pre-tax income of $2.9 million. The benefit included a discrete tax benefit of $4.1 million related to a federal research and development credit. In the three months ended March 31, 2021, income tax expense was $1.9 million, representing an effective income tax rate of 26%. This rate is higher than the U.S. statutory rate of 21% primarily due to income subject to foreign tax at tax rates higher than the U.S. statutory rate and state taxes.
SEGMENT RESULTS
For purposes of business segment performance measurement, the Company utilizes segment operating income, which is defined as revenues less expenses identifiable to the product lines within each segment. The Company does not allocate items that are non-operating or unusual in nature or are corporate costs, which include but are not limited to executive and share-based compensation and corporate office costs.
Supply Technologies Segment
Three Months Ended March 31,
2022 2021
(Dollars in millions)
Net sales $ 168.8 $ 157.7
Segment operating income $ 12.0 $ 12.2
Segment operating income margin 7.1 % 7.7 %
Three months ended March 31:
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Net sales increased 7.0% in the three months ended March, 2022 compared to the 2021 period due primarily to higher customer demand in many of the Company's key end markets, with the largest increases in semiconductor, civilian aerospace, industrial and agricultural equipment and heavy-duty truck.
Segment operating income decreased by $0.2 million and segment operating income margin decreased 60 basis points in the 2022 period compared to the same period a year ago. The decrease in margin was driven by higher freight costs in the 2022 period as a result of global supply chain constraints.
Assembly Components Segment
Three Months Ended March 31,
2022 2021
(Dollars in millions)
Net sales $ 158.6 $ 126.0
Segment operating income $ 2.0 $ 6.4
Segment operating income margin 1.3 % 5.1 %
Three months ended March 31:
Net sales increased 25.9% in the three months ended March 31, 2022 compared to the 2021 period due primarily to higher customer demand driven by fuel-related products launched in 2021; increased net price realization; and the pass-through of higher aluminum and rubber compound prices in the 2022 quarter. In addition, sales in the 2021 periods were negatively impacted by the semiconductor micro-chip shortage and supply chain disruptions in the automobile industry.
Segment operating income was $2.0 million in the 2022 period compared $6.4 million in the 2021 period. The decrease was due to the unfavorable impacts of inflation, higher labor costs and supply chain constraints in the 2022 quarter compared to the same period a year ago, and expenses of $2.0 million related to plant closure and consolidation activities and other costs. Income in the 2021 period included expenses related to plant closure and consolidation of $0.6 million.
Engineered Products Segment
Three Months Ended March 31,
2022 2021
(Dollars in millions)
Net sales $ 91.0 $ 75.9
Segment operating income (loss) $ 1.8 $ (1.3)
Segment operating income (loss) margin 2.0 % (1.7) %
Three months ended March 31:
Net sales were 19.9% higher in the 2022 period compared to the 2021 period. The increase was due to stronger demand in the 2022 period in both our capital equipment products and our forged and machined products business as key end markets continue to recover from the COVID-19 pandemic.
Segment operating income in the 2022 period increased $3.1 million and segment operating income increased by 370 basis points compared to losses in the corresponding 2021 period. The income improvement in the 2022 first quarter compared to the prior year period was driven by the higher sales levels, benefits of cost-reduction actions, and operational improvements. Expenses related to plant closure and consolidation were $0.6 million and $0.7 million, in the first quarter 2022 and 2021, respectively.
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Liquidity and Capital Resources
The following table summarizes the major components of cash flow:
Three Months Ended March 31,
2022 2021 $ Change
Net cash (used) provided by: (In millions)
Operating activities $ (10.1) $ 9.9 $ (20.0)
Investing activities (7.1) (6.6) (0.5)
Financing activities 25.2 1.5 23.7
Effect of exchange rate changes on cash (0.5) (0.9) 0.4
Increase in cash and cash equivalents $ 7.5 $ 3.9 $ 3.6
Operating Activities
In the 2022 first quarter, we had cash usage of $10.1 million compared to cash provided of $9.9 million in the same period of 2021. The usage of cash was driven by higher working capital in the three months ended March 31, 2022 compared to the same period a year ago. In the 2022 period, working capital increased $25.9 million, compared to $5.0 million in the 2021 period, with the higher amount in 2022 driven by an increase in accounts receivable of $45.0 million resulting from higher sales levels.
Investing Activities
Capital expenditures were $7.1 million in the three months ended March 31, 2022 and were primarily to provide increased capacity for future growth in our Assembly Components segment, for facility consolidation in our Engineered Products segment and to maintain existing operations.
Capital expenditures were $6.6 million in the three months ended March 31, 2021 and were primarily to provide increased capacity for future growth in our Assembly Components segment and to maintain existing operations.
Financing Activities
During the three months ended March 31, 2022, we had net debt borrowings of $26.9 million to fund our higher working capital levels. In addition, in the three months ended March 31, 2022, we made a cash dividend payment to shareholders totaling $1.6 million.
During the three months ended March 31, 2021, we had net debt borrowings of $3.2 million and paid dividends to shareholders of $1.6 million.
We do not have off-balance sheet arrangements, financing or other relationships with unconsolidated entities or other persons, other than the letters of credits disclosed in Note 10 to the condensed consolidated financial statements, included elsewhere herein.
Liquidity
Our liquidity needs are primarily for working capital, capital expenditures, dividends and acquisitions. Our primary sources of liquidity have been funds provided by operations, funds available from existing bank credit arrangements and the sale of our debt securities. Our existing financial resources (working capital and available bank borrowing arrangements) and anticipated cash flow from operations are expected to be adequate to meet anticipated cash requirements for at least the next twelve months and the foreseeable future thereafter, including but not limited to our ability to maintain current operations and fund capital expenditure requirements, service our debt, pay dividends, pursue acquisitions, and repurchase common shares.
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As of March 31, 2022, we had total liquidity of $224.8 million, which included $61.6 million cash and cash equivalents, $163.2 million of unused borrowing availability under our credit agreements, which included $45.0 million of suppressed availability.
The Company had cash and cash equivalents held by foreign subsidiaries of $51.4 million at March 31, 2022 and $44.2 million at December 31, 2021. We do not expect restrictions on repatriation of cash held outside the U.S. to have a material effect on our overall liquidity, financial condition or results of operations for the foreseeable future.
The Company has two components to its assertion regarding reinvestment of foreign earnings outside of the United States. First, for all foreign subsidiaries except RB&W Corporation of Canada (“RB&W”), all earnings are permanently reinvested outside of the United States. Second, for RB&W, dividend distributions may be made, but only to the extent of current earnings in excess of cash required to fund its business operations; all accumulated earnings are permanently reinvested.
Senior Notes
In April 2017, Park-Ohio Industries, Inc. (“Park-Ohio”), the operating subsidiary of Park-Ohio Holdings Corp., completed the sale, in a private placement, of $350.0 million aggregate principal amount of 6.625% Senior Notes due 2027 (the “Notes”). The net proceeds from the issuance of the Notes were used to repay in full our previously outstanding 8.125% Senior Notes due 2021 and our outstanding term loan, and to repay a portion of the borrowings then outstanding under our revolving credit facility.
Credit Agreement
Park-Ohio’s Seventh Amended and Restated Credit Agreement (as amended, the “Credit Agreement”) provides for a
revolving credit facility in the amount of $375.0 million, including a $40.0 million Canadian revolving subcommitment and a
European revolving subcommitment in the amount of $30.0 million. Pursuant to the Credit Agreement, the Company has the
option to increase the availability under the revolving credit facility by an aggregate incremental amount up to $100.0 million.
The Credit Agreement matures on November 16, 2024.
Finance Leases
In August 2015, the Company entered into a Capital Lease Agreement (the “Lease Agreement”). The Lease Agreement provides the Company up to $50.0 million for finance leases. Finance lease obligations of $16.0 million were borrowed under the Lease Agreement to acquire machinery and equipment as of March 31, 2022.
Covenants
The future availability of bank borrowings under the revolving credit facility provided by the Credit Agreement is based on (1) our calculated availability under the Credit Agreement and (2) if such calculated availability decreases below $46.875 million, our ability to meet a debt service ratio covenant. If our calculated availability is less than $46.875 million, our debt service coverage ratio must be greater than 1.0. At March 31, 2022, our calculated availability under the Credit Agreement was $109.5 million; therefore, the debt service ratio covenant did not apply.
Failure to maintain calculated availability of at least $46.875 million and meet the debt service ratio covenant could materially impact the availability and interest rate of future borrowings. Our debt service coverage ratio could be materially impacted by negative economic trends, including the negative trends caused by the COVID-19 pandemic. To make certain permitted payments as defined under the Credit Agreement, including but not limited to acquisitions and dividends, we must meet defined availability thresholds ranging from $37.5 million to $46.875 million, and a defined debt service coverage ratio of 1.15.
As our calculated availability under the Credit Agreement was above $46.875 million, we were also in compliance with the other covenants contained in the revolving credit facility as of March 31, 2022. While we expect to remain in compliance throughout 2022, declines in sales volumes in the future, including any declines caused by the COVID-19 pandemic, could
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adversely impact our ability to remain in compliance with certain of these financial covenants. Additionally, to the extent our customers are adversely affected by declines in the economy in general, including the decline caused by the COVID-19 pandemic, they may be unable to pay their accounts payable to us on a timely basis or at all, which could make our accounts receivable ineligible for purposes of the revolving credit facility and could reduce our borrowing base and our ability to borrow under such facility.
Dividends
The Company paid dividends to shareholders of $1.6 million during the three months ended March 31, 2022. On April 22, 2022, the Company's Board of Directors declared a quarterly dividend of $0.125 per common share. The dividend will be paid on May 20, 2022 to shareholders of record as of the close of business on May 6, 2022 and will result in a cash outlay of approximately $1.6 million. Although we currently intend to pay a quarterly dividend on an ongoing basis, all future dividend declarations will be at the discretion of our Board of Directors and dependent upon then-existing conditions, including our operating results and financial condition, capital requirements, contractual restrictions, business prospects and other factors that our Board of Directors may deem relevant.
Seasonality; Variability of Operating Results
The timing of orders placed by our customers has varied with, among other factors, orders for customers’ finished goods, customer production schedules, competitive conditions and general economic conditions. The variability of the level and timing of orders has, from time to time, resulted in significant periodic and quarterly fluctuations in the operations of our businesses. Such variability is particularly evident in our capital equipment business, included in the Engineered Products segment, which typically ships large systems at a relatively lower pace than our other businesses.
Critical Accounting Policies
Our critical accounting policies are described in "Item. 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations," and in the notes to our consolidated financial statements for the year ended December 31, 2021, both contained in our Annual Report on Form 10-K for the year ended December 31, 2021. There were no new critical accounting policies or updates to existing critical accounting policies as a result of new accounting pronouncements in this Quarterly Report on Form 10-Q.
The application of our critical accounting policies may require management to make judgments and estimates about the amounts reflected in the condensed consolidated financial statements. Management uses historical experience and all available information to make these estimates and judgments, and different amounts could be reported using different assumptions and estimates.
Forward-Looking Statements
This Quarterly Report on Form 10-Q contains certain statements that are “forward-looking statements” within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. The words “believes”, “anticipates”, “plans”, “expects”, “intends”, “estimates” and similar expressions are intended to identify forward-looking statements.
These forward-looking statements, including statements regarding future performance of the Company, that are subject to known and unknown risks, uncertainties and other factors that may cause our actual results, performance and achievements, or industry results, to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. These factors that could cause actual results to differ materially from expectations include, but are not limited to, the following: the ultimate impact the COVID-19 pandemic has on our business, results of operations, financial position and liquidity, including, without limitation, supply chain issues such as the global semiconductor micro-chip shortage and logistic issues; our substantial indebtedness; the uncertainty of the global economic environment; general business conditions and competitive factors, including pricing pressures and product innovation; demand for our products and services; the impact of labor disturbances affecting our customers; raw material availability and pricing; fluctuations in energy costs; component part availability and pricing; changes in our relationships with customers and suppliers; the financial condition of
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our customers, including the impact of any bankruptcies; our ability to successfully integrate recent and future acquisitions into existing operations; the amounts and timing, if any, of purchases of our common stock; changes in general economic conditions such as inflation rates, interest rates, tax rates, unemployment rates, higher labor and healthcare costs, recessions and changing government policies, laws and regulations, including those related to the current global uncertainties and crises, such as tariffs and surcharges; adverse impacts to us, our suppliers and customers from acts of terrorism or hostilities, including the evolving situation with Russia and Ukraine; public health issues, including the outbreak of COVID-19 and its impact on our facilities and operations and our customers and suppliers; our ability to meet various covenants, including financial covenants, contained in the agreements governing our indebtedness; disruptions, uncertainties or volatility in the credit markets that may limit our access to capital; potential disruption due to a partial or complete reconfiguration of the European Union; increasingly stringent domestic and foreign governmental regulations, including those affecting the environment or import and export controls and other trade barriers; inherent uncertainties involved in assessing our potential liability for environmental remediation-related activities; the outcome of pending and future litigation and other claims and disputes with customers; our dependence on the automotive and heavy-duty truck industries, which are highly cyclical; the dependence of the automotive industry on consumer spending; our ability to negotiate contracts with labor unions; our dependence on key management; our dependence on information systems; our ability to continue to pay cash dividends, and the timing and amount of any such dividends; and the other factors we describe under “Item 1A. Risk Factors” included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021. Any forward-looking statement speaks only as of the date on which such statement is made, and we undertake no obligation to update any forward-looking statement, whether as a result of new information, future events or otherwise, except as required by law. In light of these and other uncertainties, the inclusion of a forward-looking statement herein should not be regarded as a representation by us that our plans and objectives will be achieved.