Standex International Corporation (SXI) Q2 2013 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Second Quarter 2013 Standex International Earnings Conference Call. My name is Derek, and I'll be your operator for today. [Operator Instructions] We shall facilitate a question-and-answer session at the end of the conference. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to Mr. David Calusdian from Sharon Merrill. Please proceed.

Thank you, Derek. 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 would 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 item; 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 second 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 continued to perform well in the second quarter, reporting 8.9% growth in revenue, with 0.5% increase in organic revenue and acquisition growth of 8.5%. Foreign exchange was negative at 0.1%. Our year-over-year organic growth rate was negatively impacted by difficult year-over-year comparison in Q2 at our Engineering Technologies segment as a result of lower sales of high-margin products to the oil and gas market, as well as softening demand we experienced late in the second quarter. On the bottom line, we reported year-over-year non-GAAP operating income growth of 15%, with the Electronics and Hydraulics segments reporting double-digit increases. Non-GAAP EPS from continuing operations was up 10.8% to $0.92 per diluted share. This included accretion from our Meder acquisition. During the quarter, we booked $0.7 million of income from operations from a retrospective payment from a customer in the space sector related to incremental costs reported in the cost of sales in prior periods, which were attributable to customer-supplied materials. Given the softening demand environment that we experienced in several of our end-user sectors, we're pleased with our overall top and bottom line performance in the quarter. Looking at the balance sheet, we generated good cash flow in the quarter, which resulted in net debt at December 31 of $29 million, a sequential decrease of about $6 million from the first quarter and our net-debt-to-capital ratio improved to 9.8%. As a result, we remain in a very good position to make further strategic acquisitions. Please turn to Slide 4, which provides an update on the transformation that we've made on the bottom line performance of the company over the past 4 years. With the $0.92 per share we reported in Q2, we've now achieved $3.59 per share in non-GAAP EPS for the trailing 12 months. This demonstrates the impact of our lower-cost structure and the success of our organic and acquisition growth initiatives. With that, Tom will discuss our second quarter results in some detail. After which, I'll discuss the recent performance of each our business segments. Tom?

Thank you, Roger, and good morning, everyone. Please turn to Slide 5, which summarizes our second quarter results. Net sales for the second quarter increased 8.9% to $168.6 million from $154.9 million in the second quarter last year. Excluding special items, operating income grew 15% to $17.3 million from $15.1 million a year ago. Adjusted EBITDA grew 16.5% to $21.4 million. As Slide 6 illustrates, net income from continuing operations for the quarter include posttax $645,000 of restructuring charges and $59,000 of acquisition-related costs. The second quarter of 2012 included $459,000 of restructuring charges. Excluding these items from both periods, non-GAAP net income from continuing operations increased 11.3% to $11.7 million. Earnings per share from continuing operations, excluding special items, grew 10.8% year-over-year to $0.92 per share. Turning to Slide 7, net working capital at the end of the second quarter was $130 million compared with $131 million at the end of Q1 and $116 million at the end of Q2 last year. Working capital turns were 5.2 turns in Q2, down from 5.3 turns at the end of Q2 last year. Inventory turns were 4.8 compared with 5.1 a year ago. We continue to strive for working capital turns hovering around the sixth level. Looking at Slide 8, we had free cash flow from continuing operations of $10.3 million during the quarter, up from $8.9 million in Q2 last year. Capital spending for Q2 of fiscal 2013 was $4.8 million, consistent with our previously disclosed increase to our capital budget to fund top line growth and productivity improvement. In fiscal 2013, we continue to expect that our capital spend will be slightly greater than depreciation, more in the range of $14 million to $15 million. Slide 9 illustrates our net debt as of December 31st. Our net debt decreased both sequentially and on a year-over-year basis to $28.9 million from $37.6 million a year ago and $35 million at the end of Q1. We define net debt as funded debt less cash. Our balance sheet leverage ratio of net debt to capital was 9.8% at the end of the second quarter of fiscal 2013 compared with 13.3% a year earlier and 12.1% in the sequential first quarter. Our strong balance sheet is well positioned to meet our needs. We continue to have ample financial flexibility to fund growth, acquisitions and other strategic initiative. 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 and operating income at Food Service were essentially flat for the quarter. On the refrigeration side of the business, continuing strong sales to quick-serve restaurant chains were substantially offset by softness at drug retail stores. We also saw a seasonal pause in demand at the dollar store segment. We continue to expect full year sales in dollar stores to be equal to or greater than in fiscal 2012, and we believe this segment will be a very good long-term growth opportunity for us. To enhance our competitiveness in the drug retail, dollar store and convenience store segments, we have begun working aggressively to reduce the costs of our refrigerated merchandising cabinet product line. These efforts include value engineering of products to standardize components in order to reduce part count and weight of the cabinets, while adding features as well as aligning our manufacturing processes using lean manufacturing techniques to lower labor costs. On past calls, we provided details on our rack refrigeration, ultra low scientific refrigeration and Value Line refrigeration offerings. These products continue to be well received by the market and should yield good growth for the foreseeable future. Turning to Cooking Solutions. Demand further softened in the retail grocery segment in the U.K. as a result of the macroeconomic conditions there. We also experienced lower sales to the U.S. grocery store segment, where key customers continue to constrain capital spending. We've implemented headcount reductions in both the overhead and direct labor areas in light of the lower volume in this segment. On the positive side, the Cooking Solutions Group made good progress in our effort to penetrate a greater number of major chains, both domestically and internationally, much like…

[Operator Instructions] Our first question will be coming from the line of Joe Bess from Roth Capital Partners.

Roger, I was hoping that you could drill down a little bit more into the cost savings that you're going to be looking at achieving with the merchandise cabinets. What sort of percentage of revenue would you say that these cabinets provide to Food Service Equipment? And then also, is this margin meaningfully -- is their margin meaningfully below the total group?

We don't go into percentage of sales. But what I can tell you is that we're targeting on the order of a 20% cost reduction in total between the material and labor savings. We believe that will be very significant. It's really not so much about improving operating margin as it is improving our competitive position to be able to take share and grow the top line. And we think the 20% move in cost will be very significant in our ability to generate top line growth.

Okay. So are you anticipating that with these cost reductions, you'll be dropping price and you'll be able to get a little bit more revenue?

As required. Again, many of these opportunities are very large in scope, requiring obviously more aggressive pricing, which is pretty consistent with large project or roll-offs as we call them. So yes, I think it will improve our competitiveness and allow us to take share.

Okay. So with that, we shouldn't see too much affecting operating margin, but revenue growth should improve as you guys improve these margins then? I'm trying to get an idea just of how meaningful this can be to the top line then.

Well, again, we haven't given specific guidance. But what I can tell you is a typical dollar store, and we're looking at the major players, the value add of these systems per store is probably between $10,000 and $25,000 per store depending on the size of the store, the number of cases, that type of thing. And the dollar stores have total installed base. And the largest guy is about 6,000 stores. They're growing stores anywhere from 250 to 1,000 stores for some of the larger guys. So there's a sizable market growth out there as well as replacement opportunities as the equipment ages and needs to be replaced.

Okay, that's really helpful. And then also on the M&A pipeline, are you able to talk about what you guys are seeing? What the type of valuations are out there? And then is -- which may be segments that you guys see, things that could be coming in the near term?

Well, we don't disclose which segment. I can say we're looking broadly across the portfolio, looking again for very strategic sales and cost synergies to help us build our existing platforms. As far as multiples, I think they tended up, certainly, over the last say, 12 to 18 months. But again, it's very much size dependent as well as driven by the kind of the strategic fit. So tending up a bit.

[Operator Instructions] Your next question is from the line of Jason Nacca from Sidoti. Jason Nacca - Sidoti & Company, LLC: I just want to first go into the drugstores and those sales you're seeing. I understand there's a bit of a slowdown, but I'm just wondering what you guys are seeing? If this is kind of a shift in strategy to employ refrigeration? Or maybe this is just some seasonal softness you're seeing?

Well, there's really a couple of trends going on. As we talked about, specifically, drugstores, which the biggies clearly are Walgreens, CVS and Rite Aid. If you look certainly at the public filings of Walgreens over the last 2 to 3 years, they've significantly reduced the number of store openings. For example, they're working more on improving their same-store sales as in comparison to building more stores. So that's a longer-term trend that we expect to continue. It would appear that they've kind of bottomed out. They used to build between 400 and 500 stores a year, 450 was a good average. They're now down to around 200 to 250. But again, that seems to have stabilized. In other cases, even at Walgreens, they're introducing new programs, they're introducing a wellness program that's been very well advertised on national TV, and we're participating in some significant opportunities for rack refrigeration to support that. So on one hand, their new store sales are down, but their capital spending on some of these programs are up. The other trend I think we referred to, you maybe intermixing here is in the dollar store area. That's a whole another opportunity for us, and that's clearly one that's on a growth trajectory. We've mentioned it in past calls that a lot of retailer -- retail stores that historically may not have had an emphasis on food, prepared food programs are incorporating them because they see that there's good margin and gross opportunities in them. And the dollar store and the C-store areas are classic examples where over the last 2 or 3 years, there's been considerable emphasis on adding, what we call, food programs. And as a result of that, obviously, capital equipment. What we mentioned in our comments is that, again, particularly in the dollar store segment, which is in our case, more new store driven, there's a seasonal low and it's kind of the late second quarter, November, December, early part of our third quarter but the projections that we're seeing from our customers are that they would expect to resume building in the spring timeframe. And again, their -- the current projections for build count are equal to or greater than what we saw last year. Jason Nacca - Sidoti & Company, LLC: Okay. And shifting gears to Engineering Technologies. I was just wondering if you could go further into the jet engine lipskins and that opportunity and if this is something kind of new? And where you see this going?

We've participated in a lipskin market for a number of years. Goodrich, on the regional jet side, has been where most of our work goes. Again, the lipskin is that kind of silvery looking piece on the inlet side for the inlet of a jet engine. More recently, we're seeing opportunities in some of the larger aircraft. The -- say it, the Boeing and Airbus kind of products, so that represents a new opportunity for us to kind of come off of the regional jet into the bigger aircraft. The other opportunity we refer to is internal through the jet engines. And this is an opportunity that is relatively new for us. We've been working on it for the last year or so. In this case, we're providing near net-shaped spun components that go into the hot sections of the jet engine, which replace forgings. The value proposition here is the forgings are very expensive. You typically throw away 40% to 50% of the weight of the forging in terms of the chips that are machined off of the forging and then you have, obviously, all the machine time required to actual machine the component to finished shape. We're able to take a flat sheet of metal and spin it into near net [ph] condition and save a considerable amount for our customers. So this is a new opportunity, one that will take us several years to develop. But we see it as a very significant opportunity in the future for us. Jason Nacca - Sidoti & Company, LLC: Okay. And now going over to Engraving. Just give us a little color on the Korean -- regarding the Engraving. What you're planning to do with that? And the schedule that you're going to see this plant starting to get online?

Well, again, the 2 major OEMs from Korea that are global players. Obviously, their design center, their engineering, their interior design is all headquartered in Korea. So having a facility on the ground where we can do mold texturizing, work specifically with the designers in regards to grain selection, grain development, working on the interiors of the vehicles in the early days of design is very important to being -- to be able to capture business there. The other aspect is -- and this is not unique to Korea. But General Motors has -- is using Korea currently as the design center for, as I mentioned in my comments, a number of their smaller car platforms. And this is kind of consistent. Ford has become and started to use Thailand in more of their design center work. VW is coming outside of Germany into China for some of the design work. So our global infrastructure, having not only having plants, but technicians and sales engineers that can work directly with these OEMs is very important because when you capture business it's done at the design center, but then that work, historically, could be done anywhere in the world. In other words, obviously, GM is producing vehicles here in North America. But a lot of the design selection, a lot of the texturing selection is being done in Korea. So having that opportunity to call on the customer in Korea then creates more work for us in North America in this case. Jason Nacca - Sidoti & Company, LLC: Okay. Now besides new applications, still in the Engraving segment, are you seeing some pickup in the roll and plate engraving based on some stronger signs in the economy?

Yes. As I mentioned, a lot of our roll and plate work is on building product-related applications. So things like decking material, engraved or embossed plywood materials, wallpaper material, things of that nature are produced by, again, taking either wood or nonwoven material. In the case of say a metal door, metal, running in between 2 engraved or embossed rolls to create the finished product. Obviously, that's driven by both new home construction as well as repair and renovation work. But the new building side of that is very important. So as we've seen housing starts over the last 12 months begin to improve, we've seen a definite improvement in the number of sales and the number of rolls that are being purchased in that area.

At this time, I'm showing no further questions in queue. I would like to turn the call back over to Mr. Roger Fix for any closing remarks.

Well, thank you, everyone, for participating in the questions. And we look forward to talking to you next quarter. Thank you very much.

Ladies and gentlemen, that concludes today's conference. We thank you for your participation. You may now disconnect. Have a great weekend.