RESULTS OF OPERATIONS
Nine
Months Ended
September 30, 2017
Compared with
Nine
Months Ended
September 30, 2016
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Nine Months Ended September 30,
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2017
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2016
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$ Change
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% Change
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(Dollars in millions, except per share data)
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Net sales
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$
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1,046.9
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$
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970.1
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$
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76.8
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7.9
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%
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Cost of sales
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873.9
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813.7
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60.2
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7.4
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%
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Gross profit
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173.0
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156.4
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16.6
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10.6
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%
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Gross margin
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16.5
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%
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16.1
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%
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SG&A expenses
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109.3
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99.9
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9.4
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9.4
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%
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SG&A as a percentage of net sales
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10.4
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%
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10.3
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%
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Litigation settlement gain
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(3.3
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)
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—
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(3.3
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)
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*
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Asset impairment charge
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—
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4.0
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(4.0
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)
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*
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Operating income
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67.0
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52.5
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14.5
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27.6
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%
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Interest expense
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23.1
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21.3
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1.8
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8.5
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%
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Loss on extinguishment of debt
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11.0
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—
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11.0
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*
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Income before income taxes
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32.9
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31.2
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1.7
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5.4
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%
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Income tax expense
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9.4
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5.7
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3.7
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64.9
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%
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Net income
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23.5
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25.5
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(2.0
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)
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(7.8
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)%
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Net income attributable to noncontrolling interests
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(0.7
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)
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(0.3
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)
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(0.4
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)
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*
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Net income attributable to Park-Ohio Holdings Corp. common shareholders
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$
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22.8
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$
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25.2
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$
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(2.4
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)
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(9.5
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)%
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Earnings per common share attributable to Park-Ohio Holdings Corp. common shareholders:
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Basic
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$
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1.87
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$
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2.08
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$
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(0.21
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)
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(10.1
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)%
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Diluted
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$
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1.83
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$
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2.06
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$
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(0.23
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)
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(11.2
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)%
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* Calculation not meaningful
Net Sales
Net sales
increased
7.9%
, to
$1,046.9 million
in the first
nine
months of
2017
, compared to
$970.1 million
in the same period in
2016
, mainly due to higher end market demand for our products in our Supply Technologies and Engineered Products segments, and sales from GH, which was acquired in December 2016. In our Assembly Components segment, lower sales volumes in our rubber and plastic and aluminum product lines were partially offset by higher sales volumes in our filler pipe and fuel rail product lines.
The factors explaining the changes in segment net sales for the
nine
months ended
September 30, 2017
compared to the corresponding
2016
period are contained in the “Segment Results” section below.
Cost of Sales & Gross Profit
Cost of sales
increased
to
$873.9 million
in the first
nine
months of
2017
, compared to
$813.7 million
in the same period in
2016
. The
increase
in
cost of sales was primarily due to the
increase
in net sales during the 2017 period compared to the same period a year ago.
Gross margin was
16.5%
in the first
nine
months of
2017
compared to
16.1%
in the same period in
2016
. The increase in gross margin was largely due to the higher profit flow-through from higher overall sales in the 2017 period.
SG&A Expenses
SG&A expenses increased to
$109.3 million
in the first
nine
months of
2017
, compared to
$99.9 million
in the same period in
2016
. SG&A expenses as a percent of sales increased to
10.4%
in the first
nine
months of
2017
compared to
10.3%
in the first
nine
months of
2016
. These increases were primarily due to the SG&A associated with GH.
Litigation Settlement Gain
During the first nine months of 2017, the Company paid $4.0 million to settle the IPSCO litigation. In connection with the settlement, the Company recognized $3.3 million of income related to the reversal of its excess litigation liability.
Asset Impairment Charge
An asset impairment charge of $4.0 million was recognized in the first nine months of 2016 due to the accelerated end of production in certain programs with an automotive customer in our aluminum products business.
Interest Expense
Interest expense was higher in the first nine months of 2017 due primarily to higher outstanding borrowings in the first nine months of 2017 compared to the first nine months a year ago. Interest expense on the outstanding senior notes was higher due to the higher principal amount, which more than offset the lower interest rate due to the April 2017 refinancing. In addition, the first nine months of 2017 included interest expense on the GH-related debt, which the Company incurred in December 2016. With respect to the revolving credit facility and term loan, higher interest rates in 2016 offset the benefit of lower outstanding borrowings as a result of debt repayments in connection with the debt refinancing in April 2017.
Loss on Extinguishment of Debt
During the first nine months of 2017, we incurred $11.0 million of expenses related to our debt refinancing activities. Such expenses included tender premiums, bank and other fees and accelerated amortization of certain debt issuance costs related to our former borrowings that were previously capitalized.
Income Tax Expense
The effective income tax rate was
28.6%
in the
nine
months ended September 30,
2017
compared to
18.3%
in the corresponding period of
2016
. The rates in both periods reflect the reversal of various income tax accruals totaling approximately $1.4 million in 2017 and $4.0 million in 2016 relating to previous uncertain tax positions for which the statues of limitations expired. The rates in both periods were also favorably impacted by earnings in foreign jurisdictions in which the income tax rates are lower than the U.S. statutory income tax rate.
Net Income
Net income
decreased
to
$23.5 million
in the first
nine
months of
2017
, compared to
$25.5 million
in the first
nine
months of
2016
, due primarily to the larger 2016 tax accrual reversal noted above.
SEGMENT RESULTS
For purposes of business segment performance measurement, the Company utilizes segment operating income, which is defined as revenues less expenses identifiable to the product lines within each segment. The Company does not allocate items that are non-operating or unusual in nature or are corporate costs, which include but are not limited to executive and share-
based compensation and corporate office costs. Segment operating income reconciles to consolidated income before income taxes by deducting corporate costs, certain non-cash items and interest expense.
Supply Technologies Segment
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Three Months Ended September 30,
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Nine Months Ended September 30,
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2017
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2016
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2017
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2016
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(Dollars in millions)
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Net sales
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$
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140.2
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$
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122.0
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$
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415.8
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$
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384.8
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Segment operating income
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$
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10.9
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$
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9.7
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$
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34.6
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$
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30.8
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Segment operating income margin
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7.8
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%
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8.0
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%
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8.3
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%
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8.0
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%
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Three months ended September 30:
Net sales increased in the three months ended September 30, 2017 compared to the 2016 period due primarily to higher customer demand in the truck and truck-related market, which was up 24% year-over-year; the semiconductor market, which was up 43% year-over-year; the power sports and recreational equipment market, which was up 10% year-over-year; and the aerospace market, which was up 33% year-over-year. In addition, sales were higher in our fastener manufacturing business in the 2017 period due to increasing customer demand of our proprietary products.
Segment operating income increased by $1.2 million due to the favorable impact of higher sales in the 2017 period compared to a year ago. Segment operating income margin decreased slightly to 7.8% compared to 8.0% in the corresponding period of 2016, due to timing of sales mix.
Nine months ended September 30:
Net sales increased in the first nine months of 2017 compared to the 2016 period due primarily to higher customer demand in the power sports and recreational equipment market, which was up 14% year-over-year; the semiconductor market, which was up 52% year-over-year; and the aerospace market, which was up 29% year-over-year. In addition, sales were higher in our fastener manufacturing business in the 2017 period due to increasing customer demand of our proprietary products.
Segment operating income increased by $3.8 million, and segment operating income margin increased to 8.3% compared to 8.0% in the corresponding period of 2016. These increases were driven by the sales volume increases noted above.
Assembly Components Segment
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Three Months Ended September 30,
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Nine Months Ended September 30,
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2017
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2016
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2017
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2016
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(Dollars in millions)
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Net sales
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$
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127.9
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$
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133.4
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$
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393.2
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$
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399.4
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Segment operating income
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$
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11.4
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$
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13.9
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$
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37.0
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$
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38.3
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Segment operating income margin
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8.9
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%
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10.4
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%
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9.4
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%
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9.6
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%
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Three months ended September 30:
Net sales were lower in the 2017 period compared to the 2016 period due primarily to lower sales volumes in our extruded rubber and plastic product lines, which more than offset higher sales volumes in our fuel filler pipe and fuel rail product lines.
The lower sales in our extruded rubber and plastics product lines was due to the end of life in certain programs. The higher sales volumes in our fuel products businesses were driven by new product launches and higher foreign sales.
Segment operating income in the 2017 period decreased by $2.5 million, driven by the lower sales levels noted above. The segment operating income margin for the quarter was also down due to start-up costs related to our new facilities in China; and lower absorption due to lower sales in our extruded rubber and plastics business in the third quarter of 2017 compared to the same period a year ago.
Nine months ended September 30:
Net sales were lower in the 2017 period compared to the 2016 period due primarily to lower sales volumes in our extruded rubber and plastic and aluminum product lines, which more than offset higher sales volumes in our fuel filler pipe and fuel rail product lines. The lower sales in our extruded rubber and plastic product lines were due to the end of life in certain programs. The lower sales in aluminum were due to the end of production in certain programs in 2016. The higher sales volumes in our fuel products businesses were driven by new product launches and higher foreign sales.
Segment operating income in the first nine months of 2017 decreased by $1.3 million, and segment operating income margin decreased to 9.4% compared to 9.6% in the corresponding period of 2016. These decreases were driven by the lower sales volumes noted above.
Engineered Products Segment
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Three Months Ended September 30,
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Nine Months Ended September 30,
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2017
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2016
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2017
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2016
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(Dollars in millions)
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Net sales
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$
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84.1
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$
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57.3
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$
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237.9
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$
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185.9
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Segment operating income
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$
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6.0
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$
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4.0
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$
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13.5
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$
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8.6
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Segment operating income margin
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7.1
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%
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7.0
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%
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5.7
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%
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4.6
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%
|
Three months ended September 30:
Net sales were 47% higher in the 2017 period compared to the 2016 period due primarily to sales from GH of $13.2 million, which was acquired in December 2016, and increased customer demand for our induction heating and pipe threading products.
Segment operating income in the 2017 period increased by $2.0 million and segment operating income margin improved to 7.1% compared to 7.0% in the corresponding 2016 period. These increases were driven by the higher sales in the 2017 quarter compared to the same quarter a year ago.
Nine months ended September 30:
Net sales were 28% higher in the 2017 period compared to the 2016 period due primarily to sales from GH of $37.3 million, which was acquired in December 2016, and increased customer demand for our induction heating and pipe threading products.
Segment operating income in the 2017 period increased by $4.9 million, and segment operating income margin improved to 5.7% compared to 4.6% in the corresponding 2016 period. These increases were driven by the higher sales in 2017 compared to a year ago.
Liquidity and Capital Resources
The following table summarizes the major components of cash flow:
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Nine Months Ended September 30,
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2017
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2016
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$ Change
|
Net cash (used) provided by:
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(In millions)
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Operating activities
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$
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27.2
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$
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40.8
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|
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$
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(13.6
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)
|
Investing activities
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(29.4
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)
|
|
(20.3
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)
|
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(9.1
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)
|
Financing activities
|
13.5
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|
|
(24.4
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)
|
|
37.9
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|
Effect of exchange rate changes on cash
|
5.1
|
|
|
(0.4
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)
|
|
5.5
|
|
Increase (decrease) in cash and cash equivalents
|
$
|
16.4
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|
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$
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(4.3
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)
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$
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20.7
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|
Operating Activities
Cash provided by operating activities decreased from the prior-year period due to higher working capital needs driven by higher sales levels in 2017, as well as the $4.0 million litigation settlement payment in the first quarter of 2017. Higher sales levels drove an increase in accounts receivable of $29.9 million.
Investing Activities
Capital expenditures decreased by $1.4 million compared to the prior-year period due to timing of expenditures. In 2017, we completed the acquisition of AMC for $10.5 million. See Note 4 to the condensed consolidated financial statements for details.
Financing Activities
Cash provided by financing activities in 2017 reflected the net proceeds from our issuance of senior notes in April 2017, partially offset by net repayments under our amended and restated revolving credit facility and the payoff of our previously-outstanding term loan. Overall, our net borrowings and cash provided by operating activities were used to fund higher working capital needs, the litigation settlement payment, our quarterly cash dividend payments, share repurchases, and debt refinancing costs. In addition, our cash balances increased by $16 million at September 30 compared to the beginning of 2017. In the 2016 period, net cash used by financing activities reflected debt pay-downs and our quarterly cash dividends, which were both funded by our operating cash flows in the 2016 period.
We do not have off-balance sheet arrangements, financing or other relationships with unconsolidated entities or other persons.
Liquidity
Our liquidity needs are primarily for working capital, capital expenditures 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 funds from operations are expected to be adequate to meet anticipated cash requirements for at least the next twelve months, 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 shares.
The Company had cash and cash equivalents held by foreign subsidiaries of
$72.5 million
at
September 30, 2017
and
$54.4 million
at
December 31, 2016
. For each of our foreign subsidiaries, we make a determination regarding the amount of earnings intended for permanent reinvestment, with the balance, if any, available to be repatriated to the United States. The cash held by foreign subsidiaries for permanent reinvestment is generally used to finance the foreign subsidiaries’ operational activities and/or future foreign investments. At
September 30, 2017
, management believed that sufficient liquidity was available in the United States, and it is our current intention to permanently reinvest undistributed earnings of our foreign subsidiaries
outside of the United States. Although we have no intention to repatriate the approximately
$148.1 million
of undistributed earnings of our foreign subsidiaries as of
September 30, 2017
, if we were to repatriate these earnings, there could potentially be an adverse tax impact.
Senior Notes
On April 17, 2017, we 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 outstanding under our revolving credit facility.
Credit Agreement
On April 17, 2017, the Company entered into Seventh Amended and Restated Credit Agreement (the “Credit Agreement”). The Credit Agreement, among other things, provides an increased revolving credit facility of up to $350.0 million and extends the maturity date of borrowings under the facility to April 17, 2022. Furthermore, the Company has the option, pursuant to the Credit Agreement, to increase the availability under the revolving credit facility by an aggregate incremental amount up to $100.0 million.
As of
September 30, 2017
, we had
$100.3 million
outstanding and
$205.3 million
of unused borrowing availability under the revolving credit facility provided by the Credit Agreement, which includes the effect of Amendment 6 to the Amended Credit Agreement. Also, as of
September 30, 2017
, we had cash and cash equivalents of
$80.7 million
.
Capital Leases
On August 13, 2015, the Company entered into a Capital Lease Agreement (the “Lease Agreement”). The Lease Agreement provides the Company up to $50.0 million for capital leases. Capital lease obligations of
$18.9 million
were borrowed under the Lease Agreement to acquire machinery and equipment as of
September 30, 2017
.
Covenants
The future availability of bank borrowings under the revolving credit facility provided by the Credit Agreement is based on our ability to meet a debt service ratio covenant, which could be materially impacted by negative economic trends. Failure to meet the debt service ratio covenant could materially impact the availability and interest rate of future borrowings.
At
September 30, 2017
, our debt service coverage ratio was
2.1
, and, therefore, we were in compliance with the debt service coverage ratio covenant in the revolving credit facility provided by the Credit Agreement. The debt service coverage ratio is calculated at the end of each fiscal quarter based on the following ratio: (1) the most recently ended four fiscal quarters of consolidated EBITDA, as defined in the Credit Agreement, minus cash taxes paid, minus unfunded capital expenditures, plus cash tax refunds; to (2) consolidated debt charges, which are consolidated cash interest expense, plus scheduled principal payments on indebtedness, plus scheduled reductions in our term debt as defined in the Credit Agreement. The debt service coverage ratio must be greater than 1.0 and not less than 1.15 for any two consecutive fiscal quarters. We were also in compliance with the other covenants contained in the revolving credit facility as of
September 30, 2017
. While we expect to remain in compliance throughout
2017
, declines in sales volumes in
2017
could 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, 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 of
$5.0 million
during the
nine
months ended
September 30, 2017
. In November 2017, our Board of Directors declared a quarterly dividend of
$0.125
per common share. The dividend will be paid on November 28,
2017 to shareholders of record as of the close of business on November 14, 2017 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, 2016
, both contained in our Annual Report on Form 10-K for the year ended
December 31, 2016
. 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: 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; 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 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 domestic 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; adverse impacts to us, our suppliers and customers from acts of terrorism or hostilities; 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; the outcome of the review conducted by the special committee of our board of directors; 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 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, 2016
. 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.