Standex International Corporation (SXI) Q3 2017 Earnings Report, Transcript and Summary

Good morning. My name is Hope and I will be your conference operator today. At this time, I would like to welcome everyone to the Standex International's Q3 2017 earnings call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be question-and-answer session. [Operator Instructions]. Thank you. I would like to turn the conference over to Matt Roche. Please go ahead.

Thank you Hope. 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 statement on slide two. 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, purchase accounting, acquisition related expenses and one-time items. We will also refer to 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 third quarter news release. On the call today is Standex's Chairman, President and Chief Executive Officer, David Dunbar and Chief Financial Officer, Tom DeByle. Please turn to slide three, as I turn the call over to David. David?

Thank you Matt and good morning and thank you everybody for joining us this morning. Our third quarter fiscal 2017 sales increased 4.1% to $184.7 million from a year ago, with organic sales increasing 2.9%. We saw demand increase across most of our businesses while growth laneway initiatives in electronics, engraving and engineering technologies delivered topline sales increases. As we anticipated, orders on backlog increased in refrigeration. Unfortunately, sales declined in that business as our Wisconsin plant experienced operational difficulties changing over production to a new foam formulation. GAAP operating income was down 33.4%, while adjusted operating income was up 3.3% on higher sales and adjusted EPS grew 6.8%. We ended the third quarter with a net debt position of $127 million, reflecting the OKI sensor device acquisition, which we completed in the quarter. We have renamed this business, Standex Electronics Japan. The integration is proceeding according to plan and we are excited by the potential of this business to accelerate our global growth plans in electronics. Our investment in growth laneways is beginning to deliver sales growth in electronics, engraving and engineering technologies. As anticipated, refrigeration demand increased as seen in orders and backlog which should deliver solid sales growth in Q4. Finally, Horizon Scientific, acquired in October 2016, continues to outperform our expectations. I will touch more on our achievements in each business when I go through our segment review. First, Tom will review our third quarter results. Tom?

Good morning. Slide four shows our historical trend of adjusted earnings per share and sales on a GAAP basis as well as on adjusted basis without the U.S. roll, plate and machinery business or RPM business. On a trailing 12 month adjusted basis, earnings per share were $4.42 through March 31, 2017 versus $4.58 in the 12 months ended March 31, 2016, which is a 3.5% decrease. Looking at sales on a trailing 12 month basis, adjusted sales were $728 million versus $739 million in the prior year period. Please turn to slide five, which details our revenue changes by segment. Overall, organic growth was 2.9%. The acquisition of Horizon Scientific contributed 4.3% to our sales growth, while the divestiture of RPM and foreign exchange had negative impacts of 2.3% and 0.9%, respectively. During the quarter, engraving, engineering technologies and electronics reported positive organic sales growth. We anticipate these businesses to continue to grow in the fourth quarter. Slide six summarizes our third quarter results on a GAAP and adjusted basis. Sales growth was 4.1% on a GAAP and 6.5% on an adjusted basis. Operating income was down 350 basis points and 30 basis points on a GAAP and non-GAAP basis, respectively GAAP income from operations was impacted by $6.5 million of acquisition related and restructuring costs. Earnings per share was down 34.1% on a GAAP basis and up 6.5% on a non-GAAP basis. Please turn to slide seven which is a bridge that illustrates the impact of special items on net income from continuing operations. Tax effected special items included restructuring charges of $0.7 million and acquisition related costs of $4.1 million. On the slide, you can see the breakdown of pretax acquisition costs in the quarter. The majority of the costs are related to Standex Electronics Japan acquisition, which was strategic and complex requiring substantial in country expertise to assist in due diligence GAAP net income was down 33.9% and adjusted net income was up 5.9%. Turn to slide eight. Adjusted net working capital was $149 million at the end of the third quarter as compared to $141.3 million on an adjusted basis in the prior year. Net working capital in both years have been adjusted for acquisition and disposition results. In the quarter, results exclude $10.1 million related to the OKI acquisition. In the prior year, we excluded $3.3 million of working capital related to RPM. Working capital turns improved slightly excluding the items previously mentioned to five turns compared with 4.9 a year earlier. Slide nine illustrates our debt management. We ended Q3 in a net debt position of approximately $127 million, reflecting the OKI acquisition, compared with a net cash position of approximately $7.4 million a year earlier. We define net debt as funded debt less cash. Our balance sheet leverage ratio of net debt to capital was 24.7% compared with a net debt to capital of a negative 2% a year ago. We financed the OKI acquisition using approximately $63 million of foreign cash and $73 million from our existing credit facility. Slide 10 summarizes our capital spending, depreciation and amortization trends. We expect our capital spending to be between $6 million and $7 million in the fourth quarter. Total capital spending for the year will be in the range of $24 million to $25million. Slide 11 details our reconciliation of operating cash to free cash flow. Mix of business profitability along with acquisition transaction cost and higher capital spending resulted in lower free cash flow conversion this year. We expect improvement in free cash flow conversion during our Q4. With that, I will turn the call back to David.

Thank you Tom. Please turn to slide 13 and I will begin our segment overview with the food service equipment group. Sales increased 5.4% in the quarter including a $7.7 million contribution from the Horizon Scientific acquisition. As anticipated, we are seeing a strong increase in demand for refrigeration products as national accounts begin to ramp up spending. With a 24% increase in backlog during the quarter, we expect good sales growth in refrigeration during Q4. Despite the backlog increase, organic sales declined 3.2%, largely due to operational difficulties in our Wisconsin refrigeration plant as it introduced a new foam formulation into production. We estimate that we experienced sales declines between $1.4 million and $3.8 million from that issue during the quarter. The issue is behind us and in April, we have returned to normal production. In addition to volume deleveraging, income from operations was affected by increased freight, lower productivity and higher material costs related to the delayed product introduction in refrigeration as well as expenses associated with exhibiting at the biennial NAFEM trade show. Horizon Scientific, acquired in October 2016, had a strong quarter with Standex and has thus far performance of our expectations. The integration plan remains on track and we are leveraging synergies between Horizon and our NorLake scientific brand. We expect this momentum to continue into the fourth quarter. As I mentioned on last quarter's call, we brought in a new President to run our refrigeration group in February. Kevin Fink is off to a great start and has had an immediate impact on the business. Moving on to cooking solutions. Sales were down approximately 8.5%, primarily as a result of nonrecurring prior-year rollouts, proactive rationalization of low margin products and slower sales to select major dealers. Our operational performance in Nogales has stabilized in the past year, however we are learning that it is taking longer to win back business lost during the plant move from Cheyenne, Wyoming. Even with the topline softness, gross margin was flat versus the prior year due to our continued focus on operational improvements. We have seen early success and have received positive feedback about our new combi mini oven and speed oven. We remain encouraged by the growth in our specialty solutions business which was up 4.9% year-over-year. Our beverage pump business grew year-over-year for the fifth consecutive quarter as it builds momentum. We remain excited by new pump products that will provide our customers with opportunities to offer innovative carbonated beverages, enhanced CO2 safety and lower maintenance costs. Looking forward in food service, we anticipate improved sales and profitability in the fourth quarter as we convert on our refrigeration backlog and recover from the production delays in our Wisconsin plant. We will also be focused on growing sales with the large national chains and executing the ramp-up of new applications in our beverage pump business, specifically for nitro beverages. Turning to slide 14, engraving. Adjusted sales were up 5.5% organically, excluding RPM. We saw an increase in mold texturizing demand in North America as new auto platform launches occurred as anticipated. In addition, sales in Asia grew double digits due to increased automotive launches and a strong demand for nonautomotive services in Korea and China. Europe was up modestly versus the prior year. Our growth laneways, including Architexture design centers and nickel shell and laser technologies, continued to be well received contributing $3 million to revenues in Q3. We expect them to have an increasing contribution to revenues. During the quarter, we were awarded contracts to develop the texturization of the interior molds for the iconic London taxicabs through an Asian manufacturer. We also were awarded a contract from a major American automaker who was moving some tooling sourcing to China to support an expedited program timeline. Because of our global presence, capabilities and flexibility, Standex is the only company that could meet this automaker's changing needs by supporting them seamlessly in China and North America. Looking ahead, we anticipate continued momentum into the fourth quarter with growth in nonautomotive and automotive programs and increased demand for all technologies, including lasers, nickel shells, Architexture, traditional chemical etching and weld and polishing. Please turn to slide 15, our engineering technologies group. We saw good growth across most of engineering technologies end markets in the third quarter including the continued ramp up of long-term aviation deliveries. Overall, sales increased 22.3%. Sales in the space market increased by $2.2 million from the prior year quarter due to demand in the unmanned segment of the market. Energy market sales increased by $2.8 million, compared with the prior year quarter due to improved market conditions in both power generation and oil and gas. Aviation sales increased by $0.8 million from the prior year due to higher sales for engine components and structural hardware. Sales in the defense market were down $1.2 million due to project timing for deliverables in the nuclear market. During the quarter, we announced the closure of our Eastlake Enginetics plant, which was a redundant facility with low utilization. This move will result in annualized savings between $2.5 million and $3 million and $0.5 million with the third quarter restructuring charge that Tom mentioned was from this closure. The key growth laneway in this business is aviation and our production ramp-up is on schedule to fulfill customer needs. We remain on track to meet the increase in Airbus production by the end of calendar 2017. This is a growth platform for engine parts from Enginetics as well as for our lipskins from Spincraft. Going forward, we are focusing on ramping up to deliver on long term aviation programs for next-generation aircraft and completing facility consolidation and manufacturing layout redesign to improve efficiencies. We also continued to drive operational excellence, increase throughput and margin enhancement programs. We anticipate continued strong growth in the fourth quarter in both the space and aviation markets. Please turn to slide 16, electronics. We are driving excellent operating leverage from good sales growth in the electronics segment. Sales in North America increased 6.6% driven by sensors and transformers. In Europe, sales were up 10.7% due to automotive and electric utility applications. And in Asia, sales increased 21.1% as a result of strong demand for home appliance sensors. Operating margin was a strong 21% due to cost savings activities, operating efficiencies and the continued shift to our product mix to include higher margin sensors. Income from operations increased 23.5%, primarily due to the higher sales based operational cost efficiencies and favorable earnings impact from foreign exchange. As noted previously, we closed on the OKI sensor device acquisition, now named Standex Electronics Japan. At the end of March, the integration is proceeding well. I was in Japan at the facility for the first week of operations to meet with our employees and customers and I am happy to say that they are excited to be a part of the Standex team and are off to a great start. Looking forward, we anticipate growth in the fourth quarter due to strong momentum in all geographic regions. Investments in growth take time, but we are beginning to see the initial results for our growth laneways and expect continued success. We remain focused on accelerating the integration of Standex Japan and expanding field engineers in Asia to drive specialized sensor sales. We are quite optimistic about the prospects for growth out of that business and are making an investment to add three additional machines which will increase capacity by 5%. Please turn to slide 17, hydraulics. The 10% sales decrease in hydraulics is primarily the result of softness in the North American dump truck and dump trailer markets. While the lower revenue had a deleveraging effect on operating income, we maintained a strong EBIT margin of 15.9% as a result of our operational excellence initiatives. Looking ahead, we anticipate a pickup in the dump truck and dump trailer markets as we enter the spring construction season. As plans for infrastructure investments become clear, we anticipate additional new demand. In addition, our new pack eject cylinder product has been gaining traction with our customers and we expect this to contribute to sales growth in the refuse market. Before we go to questions, let me give you a few key thoughts. First, we are bullish on our recent acquisition of OKI Sensor Device Corporation. We have a team on the ground working diligently on the integration and capturing near-term synergies. Secondly, we saw organic growth in Q3 in three of our five businesses, including engraving, electronics and engineering technologies and we expect continued momentum in the fourth quarter. These three businesses have done an excellent job of using our growth disciplines process to identify attractive growth opportunities and develop programs to capture them. It takes time to ramp-up an organic growth engine and I am pleased to see these businesses now benefit from their hard work. Third, demand is increasing for refrigeration and we should see higher year-over-year refrigeration sales in the fourth quarter as a result of increasing orders and backlog conversion in that business. And finally, as we look to the future, our balance sheet is well position to fund CapEx, organic growth and acquisitions as we continue to deploy the Standex value creation system. And with that, I will be happy to take your questions.

[Operator Instructions]. Your first question comes from the line of Chris Moore with CJS Securities.

Hi. Good morning guys.

Good morning Chris.

Hi Chris.

Maybe can we start with aviation, obviously an important piece of engineering. Can you maybe just give us kind of a 12 month milestones of what's going to be happening between now and this time in 2018?

Well, if you go back to press releases that we released at some of the major awards, we simply ramp up to full volume by the end of this calendar year with the pushouts of the geared turbo fans, I think that moves into maybe middle 2018, but if you add up the numbers, we are talking about an annualized volume of $13 million to $15 million in sales. So we expect to be there this time next year.

Got you. Thanks. In terms of the Standex Electronics Japan, are there additional, just from a purchase accounting standpoint, so obviously while the acquisition cost this quarter, is there additional amortization? Just trying to get a sense of how significant that will be for the next 12 months?

Of course, there will be amortization. It's a distribution model. So there is a lower step up. So the cost were the majority this quarter and you will have some cost in the fourth quarter. The $1.7 million, I believe.

Okay. That helps. And the last is, just in terms of on the cooking side, obviously, refrigeration looks like it is coming back a little bit. Just from your perspective, what's it going to take for this to get going a little bit more than it is at this point in time, specific things that you are looking for? I know you mentioned that the moving of the plant, other things. But maybe can you just talk to cooking a little bit and the possibilities?

Yes. I look at a couple of things. So the major impact on that business was this move from Cheyenne to Nogales a few years ago. It was really a very difficult move, very disruptive to the business, our deliveries and quality. And two years ago on our calls, we talked a lot about that impact. We are now operating on that plant at a very good level, at levels similar to where we were before the move. I think anticipated that we would regain lost share more quickly than we have. So maybe I was overly aggressive or overlapped domestic on that front. I think that will occur through the course of this year and many of the agreements that we have dealers and buying groups which those products go through dealers and buying groups are negotiated towards the end of the year and they are effective over a calendar year. So some of those buying groups, we anticipated will come back in January. A second impact was, in our BKI brand, we have a very good position in retail and grocery and last year there were a number of large national chains rolling out rotisserie programs and we benefited from that. This year there are not as many programs and we have very good market share in that segment. So we ride that market segment. So it's somewhat lumpy. So I would anticipate next year to be better than this year. And then the third thing is, now that this business is operating at a better level through the plants, we are devoting energies to growth discipline projects, similar to, I talked a lot about the three businesses that are growing well. Just three years ago, they invested a lot of energy in new product development, identifying new acquisitions, getting those new products out. The cooking business is now, in the last six to 12 months, has been begun to do that, but it takes time for that to convert into new products and new sales. We saw in those three other businesses, it took two-and-a-half years for that to result in sales and to move the needle. So I phase it in those ways, those three buckets. The customers that we lost, when we start regain them through this through this year into early next year and if we perform well, we will be back to where we were. Increase rollouts in grocery in the next year to reset that business. And then, maybe year-and-a-half or two years from now new products start to have an overall impact. It's kind of a long answer for your questions.

No. That's good. That's helpful. I appreciate it. All right. That's it for me. Thanks guys.

All right. Thank you.

[Operator Instructions]. Your next question comes from the line of Chris McGinnis with Sidoti & Company.

Good morning. Thanks for taking my questions.

Good morning Chris.

Hi Chris.

So I guess just a couple follow-up on some of those questions. Just in terms of the backlog for on the food on the refrigeration side. How quickly should that convert? And it sounds like it would have been a pretty good, great quarter, if not for some of the issues here you ran into.

Yes. You can imagine how disappointed the whole refrigeration team is. For last six quarters, we have been talking about those national accounts will come back, will come back, will come back. They just started coming back in the quarter and they stumbled. The backlog normally converts in four to six weeks. So that growth should all flow through this quarter. And as we mentioned, the plant is running smoothly now.

Okay. So that $24 million roughly should fall largely into Q4, I guess, if that's correct?

Yes. That's right.

Okay. And then you may have answered this and I apologize if you did, but on the cooking solutions ramp you talked about. So it's a year-and-a-half, you think, I guess in terms of when you think about the markets and the way they are positioned. How long until you convert the new sales? Or I guess the new products, so that's a year-and-a-half, what gets you through that timeframe, if your confidence I guess in keeping sales where they are at, even if new products are coming out a year-and-a-half later?

Well, if you take where we are at the base and look forward, we begin to get back some customers progressively through this year, that delivers some growth. Our retail rollouts probably a couple quarters away for grocery. And then new products that's longer, that's year-and-a-half to two years. I think based on the performance of the cooking business, we ought to see some of that business come back and grow in line with the market.

Okay. All right. So lookout a couple of months, you should see just some pretty good organic growth coming out of the food for first time in a while.

Yes. I mean you have got Horizon Scientific in there which is doing very well, Procon and Federal doing very well, refrigeration with the backlog up now, that's 75% of the business right there. And then cooking will start to pick up too.

Next just on the engineering. It sounds like energy markets were helping out a little bit. Can you just maybe talk about how you have changed since the energy downturn and how well you are positioned to capture that rebound? And maybe just how you think about the allocation? I know that you obviously have invested on the aero side. So maybe just where you are at in terms of the energy markets? I know it was very good for you prior to the downturn.

It was. The energy markets peaked between the offshore and the land base turbines, peaked about $32 million annualized sales. It dropped to a lower run rate of $4 million to $5 million. We did over $2 million this last quarter. So it was really, it was a big quarter. It is very choppy. We don't expect that to be a consistent run rate. We are still setting our expectations that it remains at that $5 million annualized level. We are not that heavily exposed to energy. So you know we think the best position for us is to be conservative about it. However, we are well-positioned if the market comes back. I think in the previous call, we mentioned that the manufacturer of the land base turbines that we sold to out of our Wisconsin plant, has moved production for some of those turbines to Europe. Well, we are able to produce those products in our English plant. So we are talking with that manufacturer if they ramp up production in Europe. We think we have a good shot at getting that business. If the plants in North America come back, we are well-positioned to take that. And the plants that produce those products are also producing aviation. So from a plant loading standpoint, the cost position is still good. So we still think we are competitive and well-positioned for it. However, we have low expectations about its return.

Got you. Okay. And just quickly on the SG&A increase. Tom, you said that $1.7 million of the increase is associated to the acquisition. Is that correct?

That's for the fourth quarter. That will be the purchase accounting.

Okay. And so for the increase year-over-year in Q3 wasn't much, but it was a little bit more than I expected.

We have Horizon Scientific in there.

Yes. Horizon Scientific, yes.

Got you. Okay. That's perfect. Thank you very much for the time. I appreciate it.

Thank you Chris.

Thanks Chris.

There are no further questions. I would now line to turn the floor back over to management for any closing remarks.

All right. I want to thank everybody for joining us. Thank you for your interest in Standex. Thank you, operator, for joining us this morning. We look forward to updating you on our business next quarter. Thank you.

Thank you. This does conclude today's conference call. You may now disconnect.