Standex International Corporation (SXI) Q1 2013 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the First Quarter Fiscal 2013 Standex International Corporation Earnings Conference Call. My name is Jeff, and I'll be your coordinator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Mr. David Reichman from Sharon Merrill. And you have the floor, sir.

Thank you, Jeff. Please note that the presentation accompanying management's remarks can be found on Standex's Investor Relations website, www.standex.com. Please see Standex's Safe Harbor passage on Slide 2. Matters that Standex management will discuss on today's conference call include predictions, estimates, expectations and other forward-looking statements. These statements are subject to risks and uncertainties that could cause actual results to differ materially. You should refer to Standex's recent SEC filings and public announcements for a detailed list of risk factors. In addition, I'd like to remind you that today's discussion will include references to EBITDA, which is earnings before interest, taxes, depreciation and amortization; adjusted EBITDA, which is EBITDA excluding restructuring expenses and onetime items; non-GAAP net income; non-GAAP income from operations; non-GAAP net income from continuing operations and free operating cash flow. These non-GAAP financial measures are intended to serve as a complement to results provided in accordance with accounting principles generally accepted in the United States. Standex believes that such information provides an additional measurement and consistent historical comparison of the company's performance. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP measures is available in Standex's first quarter news release. On the call today is Standex Chief Executive Officer Roger Fix; and Chief Financial Officer Tom DeByle. I'd now like to turn the call over to Roger.

Thank you, David, and good morning, everyone. Please turn to Slide 3. We began fiscal 2013 on a positive note with Q1 revenue up 15.1%, including organic growth of 7.7% and acquisition growth of 8.8%. Negative foreign exchange partially offset our strong sales growth by 1.3%. All 5 of our groups reported year-over-year sales growth. On the bottom line, we reported year-over-year operating income increases at 4 of our 5 segments, with 3 reporting double-digit growth. We had a difficult year-over-year comparison at our Engineering Technologies segment as a result of lower sales of high-margin products to the oil and gas market in Q1 of 2013. This had a negative effect on our overall operating leverage. On the other hand, we're optimistic about the improvement in the operating performance of the Food Service Equipment Group, which has made progress in resolving past inefficiency and productivity issues and reported good operating growth this quarter in challenging market conditions. Our Engraving and legacy Electronics businesses also had very solid quarters, reporting double-digit improvements in profitability. Also contributing to our bottom line performance this quarter was good accretion from our Meder acquisition, which I'll discuss in more detail during our Electronics segment review. Overall, non-GAAP operating income was up 16.2%, and non-GAAP EPS from continuing operations was up 10.9% to $1.02 per share. Our net debt is down about $15 million from a year ago to $35 million, and our net debt-to-capital ratio is down 450 basis points to 12.1%. To put this in perspective, during the past 12 months, we sold our ADP business for about $13 million and redeployed that cash into the strategic purchase of Meder Electronics for about $40 million. We fully funded the Meder acquisition and made a $9 million voluntary contribution to the U.S. employee pension plan using cash from operations, and still reduced our net debt by about $15 million. As a result, we're at very good position to make further strategic acquisitions. Please turn to Slide 4, which provides an update on the transformation that we made on the bottom line during the past 4 years. With the $1.02 per share earnings we reported in Q1, we now achieved $3.50 in non-GAAP EPS for the trailing 12 months. This demonstrates the impact of our lower cost structure and the success of both our organic and acquisition growth initiatives. With that, Tom will discuss our first quarter results in some detail, after which I'll discuss the recent performance of each of our business units. Tom?

Thank you, Roger, and good morning, everyone. Please turn to Slide 5, which summarizes our first quarter results. Net sales for the first quarter increased 15.1% to $183.4 million from $159.3 million in the first quarter last year. Excluding special items, operating income grew 16.2% to $19.3 million from $16.6 million a year ago. Adjusted EBITDA grew 13.6% to $23.1 million. As Slide 6 illustrates, net income from continuing operations for the quarter includes, post-tax, $0.2 million of restructuring charges, and $1 million of non-cash purchase accounting expenses. The first quarter of 2011 included $0.3 million of restructuring charges and discrete tax items of $0.5 million. Excluding these items from both periods, non-GAAP net income from continuing operations increased 12.7% to $13.1 million. Earnings per share from continuing operations, excluding special items, grew 10.9% year-over-year to $1.02 per share. For the second consecutive quarter, we have delivered more than $1 of EPS, another record for Standex. Turning to Slide 7. Net working capital at the end of the first quarter was $131 million compared with $110 million at the end of Q4 and $115 million at the end of Q1 last year. Working capital turns were 5.6 in Q1, up from 5.5 turns at the end of Q1 last year. Inventory turns improved year-over-year and were 5.8 compared with 5.3 a year ago. As we've mentioned on previous calls, we continue to strive for working capital turns hovering around the 6 level. Looking at Slide 8. We had free cash flow of $4.6 million during the quarter. Excluding a voluntary pension contribution during the quarter, free cash flow from continuing operations was $7.9 million. As discussed in our last call, we increased our capital budget for the fiscal year to allow us to fund a number of top line growth and productivity improvements, many of which are already underway and showing early signs of progress. Capital spending for Q1 of fiscal 2013 was $4.9 million. In fiscal 2013, we are anticipating that our capital spend will be slightly greater than our depreciation or in the range of $14 million to $15 million. Slide 9 illustrates our net debt as of September 30. As Roger discussed, our net debt from the quarter decreased to $35 million from $49.6 million a year ago and increased sequentially from the fourth quarter from a net cash position of $4.7 million. We define net debt as funded debt less cash. Our balance sheet leverage ratio of net debt to capital was 12.1% at the end of the first quarter of fiscal 2013, compared with 16.6% a year earlier and negative 2%, a net cash position in the sequential fourth quarter. We have ample financial flexibility to fund future growth, acquisitions and other strategic initiatives. Overall, our debt position remains solid, and our balance sheet is well positioned to meet our needs. With that, I'll turn the call back to Roger.

Thank you, Tom. Please turn to Slide 11, Food Service Equipment Group, and I'll begin our segment overview. Sales at Food Service were up 4.9% in the first quarter, and operating income increased by 7.6%. Sales on the refrigeration side of the business continue to be very strong, growing by double digits and driven by demand from quick-serve restaurant chains, drug retail stores and the dollar store segment. We've discussed our rack refrigeration product on past calls, and that offering continues to do very well. In fact, during the quarter, we shipped over $3 million of rack refrigeration, inclusive of a single $1 million order to a national drug retailer. We expect another large order from this customer in Q4. Sales for this type of product are inherently lumpy as they are typically project driven, but we expect rack refrigeration to continue to be a growth area for us going forward. During the last 12 months, we've hired additional sales and engineering personnel to accelerate the growth from the rack refrigeration product line, and we're seeing the results of our investments. Our Value Line of upright cabinets and undercounter refrigeration products continues to be very well received by the dealer market. Sales are growing in the double digits, and we recently replaced a competitor at a major nationwide dealer. Our bottom line performance in refrigeration also continues to improve as operating income was up in the double digits over last year. We resolved the inefficiencies related to the Kool Star relocation into our New Albany, Mississippi facility, and we expect to continue to enhance productivity at our refrigeration businesses on an ongoing basis. Turning to Cooking Solutions. We believe this business is stabilizing as we reported flat operating income on a slight decline in revenue. We've begun to see the…

[Operator Instructions] Our first question comes from the line of Joe Bess with Roth Capital Partners.

First, starting with Food Service Equipment, can you give us a little bit more detail on the ongoing changes that are happening behind the scenes with your cooking equipment? And when should we be expecting the impact from these deficiencies on operating margins in future quarters?

Well, I'll answer that kind of a high level, I won't talk to specifics on margins. But over the past 4 quarters, we really had a couple of moves, relocations going on. We closed the Tri-Star facility that we acquired in Southern California and transferred that product line into Mexico. And subsequent to that, we also moved some products from our Wyoming facility to alleviate some capacity issues into Mexico. And the restructuring activities causes some additional costs, as well as impacted our ability to service customers. The good news is that we've resolved all of that. Our customer metrics are back to A class levels in terms of stocking levels, on-time delivery and lead times. And as you can see from the financial results for the quarter, despite the fact that our revenues were slightly down, our operating income was flat year-over-year. So we're seeing, if you will, the stability that we referred to in our comments, and we expect to see further improvements, particularly as we're able to gather more volume.

Okay, great. And then with Q2 typically being your seasonally low -- lower quarter than first quarter, are you expecting margins to come down kind of towards a normal level but up year-over-year for operating margins? Is that kind of how you'd look at it?

I would say that's generally correct. But let me add one thing. Q3 is actually our lowest, from a volume standpoint, Q2 sequentially being less than Q1. So yes, our normal seasonality, Q1 to Q2 is down, Q2 to Q3 is down, and you'd expect some margin deterioration as a result of just volume. But yes, our expectation is to improve year-over-year.

Okay. And then switching over to Engraving. With these new facilities coming online in the next couple quarters, what should we expect from them in terms of revenue run rate? And how should we think about profitability margins for them as you guys kind of ramp up those facilities?

Well, I'll be honest with you. They don't materially impact the top line in the first couple of quarters. You're new in a territory, we have automotive OEM customers that are global in nature, but we still have to be able to acquire orders from the local OEMs. For example, in Korea, we have, say, probably $0.25 million of business that we expect to produce there through the first couple of months and then to ramp it up from there. So they're not instantaneous, big contributors to sales and profits, but over time, they do definitely add to both.

Okay. And then as you guys penetrate these newer markets, do you typically have to drop costs a little bit or price a little bit? And then so we should expect lower margins from the new facilities in the beginning?

No, no, the margins are really unaffected because I think the value-add that we provide is to be able to now be close to the customer, where we're working directly with their designers from a technical standpoint. Being closer allows us to be more responsive from a delivery standpoint. So if anything, I'd think it's perceived -- not perceived but it's, in fact, reality, that being closer is an improvement to them in terms of customer support. So we don't expect margin deterioration from that. Margin deterioration could come from the fact that due to low volumes in the first quarters or 2, we could see some volume deleverage as again, the new facility have certain amount of fixed cost that you have to cover.

Okay, okay, great. And with the Meder acquisition, can you give me a little bit more color behind the reasoning for higher guidance for $0.15 to $0.20 range? What kind of is behind that? What's the driving factors?

Strictly, the finalization of purchase accounting. We had a fairly conservative initial estimate on purchase accounting that we complete as part of our due diligence and business planning, pre-close, on the acquisition. And those were the numbers that we would announce typically as part of the announcement of the acquisition. And as you know, during the first quarter of ownership, we actually go through the detailed purchase accounting. In this case, it turns out our initial estimates were conservative.

Okay. And then how do you view the production and the business of Meder now that you kind of had a little bit more time to kind of look at what they're doing? And do you see more opportunities with the medical market or anything like that?

I would say that every day that goes by, we're even more enthused about both the sales synergies, as well as the cost synergies. We haven't tried to reflect that in any of our earnings estimates. But clearly, you make some initial estimates about these synergies, and as you learn more, you solidify that. And I would say that the first 3 months is, not only solidified, but given us expectations that over time, benefits will be even greater.

Okay, great. And then just a last question. Could you talk a little bit more about the M&A pipeline? Are you guys seeing anything right now where evaluations are making sense or product -- or filling product portfolio in some of your segments?

Yes, and yes, and then no. We're definitely very active in identifying and engaging with potential acquisition targets. It really depends on the asset as to where prices are at. We've seen some attractive situations, and we've seen some that we frankly have walked away from. So it's hard to generalize, but I would say this, the pipeline is as robust today as it's been for quite some time.

Okay. And the things that you guys are seeing right now in M&A, is it more opportunistic? Or would you say they're more strategic?

Well, they always, at the end of the day, have to be strategic. We're not going out and doing acquisitions that grow new legs to the company. So everything has to start with a strategic fit to one of our existing platforms. And within those platforms, we've identified either a product or geographic or there are specific things that we're looking for to help us grow. The opportunistic part is in many cases, these are privately-held businesses. And as I say, it takes a willing buyer and a willing seller to come together to make a deal happen. So the opportunistic side of it is when that seller decides now is the time, that we have to be positioned to engage and quickly go through the due diligence process. And that's the part that is opportunistic.

Let's move on to Jason Nacca with Sidoti.

Just a quick question regarding Hurricane Sandy. Maybe you could provide us some color on how this affects Standex? And maybe some opportunities in any of the segments, as well as a couple of challenges?

Fortunately, we incurred no damage to any of our operating facilities. So that's the good news. And as well, no damage or injuries to any of our employees that we're aware of. So that's very positive. Frankly, our business is spread globally, so I don't see that there will be any significant impact. Certainly, our Food Service Group does have active sales and dealers that we're working with in the Northeast corridor. I'm sure those folks have been, in many cases, negatively affected, so we could see some near-term softness in that part of Food Service, as an example. I don't have any real evidence of that yet, obviously. But ultimately, again, to the extent that there were restaurants that were damaged or got underwater, all that equipment will probably have to be replaced, and so there could be a bit of a pickup. But I don't expect it to be a measurable impact either way.

Right, okay. And regarding the Meder expectations that were risen for fiscal '13, in the last call, you provided some expectation for fiscal '14. Are you raising those estimates as well? Or are you just attributing the '13 change to purchase accounting?

It's really '13, because again, it's a purchase accounting change that would be a one-off that affects the 2013 guidance.

[Operator Instructions] Our next question comes from the line of Jamie Wilen with Wilen Management.

Just a couple of questions about Meder. Operating margins there, are they higher than your standard for the business?

Slightly below.

Slightly below. And is there any seasonality to that business?

Not a significant -- there can be slowdowns, like the latter part of December, like you see in most businesses. But nothing like we would have, seasonality-wise, from [indiscernible] Food Service.

Okay. So it was accretive after the purchase accounting in the quarter, which means the operating profit in that business was more than $1 million in this past quarter?

Well, what I -- I'm not going to do the math for you, but I'll help you with it. So on the slides for Electronics, we provided you the OI for the group without the purchase accounting. And then if you took a look at our fourth quarter, which had only the legacy business, you can kind of do the math and figure out how much Electronics contributed to legacy business versus what Meder did.

Okay. And as you're looking for acquisitions, what are your -- are you focused in all areas? Or are you more targeted into certain ones? Obviously, in the Meder area, you got a great return because you're able to buy things at a very reasonable price maybe because of the situation, there weren't other people competing with you. But are there certain areas where you would target because it's more accretive to EPS as you move on?

No, we're not really targeting because of accretion. Obviously, we have a goal, as we've shared in our investor presentation. We have a goal to make every acquisition accretive in the first year. But I can't say that we're picking acquisitions on the basis of accretion. The primary driver is the strategic fit. If we can get excited about the potential to drive incremental sales and profit growth, then that's really our top priority. And then it's all about, from a financial standpoint, does it make sense. And again, our goal, at least, has been to make all of these accretive in the first year. And for the last several years now, we've been fortunate enough to be able to that.

Okay, perfect. And last question, raw material cost, any difficulties or opportunities that you see?

Some softening, as of recent, not huge. A lot of what we buy is in the steel. There is various -- carbons and galvanized steels, et cetera. Some softening, but it's not huge. But certainly, we haven't seen the upward pressure that we saw several years ago.

Ladies and gentlemen, since there are no further questions in queue, I'd now like to turn the call over to Mr. Roger Fix for closing remarks.

Yes. We appreciate everybody's involvement and attendance at our conference call. We look forward to speaking to you again next quarter. Thank you.

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a wonderful day.