Standex International Corporation (SXI) Q1 2020 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Standex Fiscal First Quarter 2020 Earnings Teleconference. [Operator Instructions]. Please note that this event is being recorded. I would now like to turn the conference over to Gary Farber. Please go ahead.

Thank you, operator, and good morning. Please note that the presentation accompanying management's remarks can be found on the Investor Relations portion of the company's website at www.standex.com. Please refer to Standex's safe harbor statement 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 most 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 the non-GAAP measures of EBITDA, which is earnings before interest, taxes, depreciation and amortization; adjusted EBITDA, which is EBITDA excluding restructuring, purchase accounting, accounting, acquisition-related expenses and onetime items; EBITDA margin; and adjusted EBITDA margin. We will also refer to other non-GAAP measures, including adjusted net income, adjusted income from operations, adjusted net income from continuing operations, adjusted earnings per share, adjusted operating margins, free operating cash flow and pro forma net debt to EBITDA. These non-GAAP financial measures are 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. On the call today is Standex's Chairman, President and CEO, David Dunbar; and Chief Financial Officer and Treasurer, Ademir Sarcevic.

I would like to point out that this month, Standex celebrates 50 years on the New York Stock Exchange. The number of companies that have been continuously listed for 50 years are small, and we're proud to achieve this milestone. I'll begin with an overview of our fiscal quarter results and provide an update on our continued progress in executing on our strategic priorities. Ademir will follow with a discussion of our financial performance in the quarter, then I'll provide some additional thoughts on our outlook. Now please turn to Slide 3. The quarter's results were in line with our overall expectations and our commentary on August fourth quarter conference call. Specifically, performance in Engineering Technologies, Hydraulics and Scientific remained strong. The Engraving segment reported a significant sequential margin increase from the fourth quarter of 2019 on a modest sales gain, as we saw improvement in our North American Engraving operations. We did continue to experience macroeconomic headwinds in our Electronics segment, primarily in Asia, which is impacting our second quarter outlook. To manage near-term market conditions, our overall restructuring efforts are proceeding as expected, and we're pursuing additional efficiency opportunities, both at this segment and companywide. Despite the macroeconomic headwinds we're facing, particularly in Electronics, we continue to successfully position our portfolio for higher growth and profitability on several fronts. In particular, growth laneways increased 12% over first quarter 2019 to $16.6 million. Our most recent acquisition, GS Engineering, is now fully integrated and off to a solid start. We also continue to see very positive trends in our new business opportunity funnel, particularly in the high-reliability Magnetics business, as we're successfully converting our funnel to revenue. We are maintaining investments in our sales and technical teams to convert these opportunities into future sales. At Food Services, Scientific business continues to grow well in excess of GDP, as we leverage our deep technical and application expertise against the backdrop of higher demand in the pharmacy and retail markets. Finally, our current restructuring program is on plan to generate $3.8 million in cost savings on a run rate basis as we exit the second quarter. In addition, we continue to have an active pipeline of other efficiency opportunities, some of which we'll discuss later in the call. From a financial perspective, our position remains strong. Our net debt to adjusted EBITDA is under 1x. We have approximately $250 million in available liquidity, and we've made sustainable improvements in our working capital management. From a liquidity perspective, I'm very pleased with how well we generated free cash flow in the first quarter, which historically has been a negative quarter for us, as our working capital initiatives delivered improved results in all of our segments. In addition, we continue to repatriate cash from international operations. These factors position us well to invest in our active pipeline of high-return internal projects and attractive acquisition opportunities. Our capital allocation approach will remain disciplined and balanced. Ademir will walk through the quarterly financial results in greater detail later in the call. Now let us review the segments beginning with Engraving on Slide 4. Sales increased 6.8% year-over-year, largely reflecting in the recent GS Engineering and Tenibac acquisitions, balanced with a lower level of overall new automotive model introductions due to timing of rollouts as well as the impact of foreign currency. On a sequential basis, we delivered a 300 basis point margin improvement to 17%, reflecting a sequential improvement in automotive-related end market trends, primarily North America and the restructuring actions announced in third quarter results. Growth laneways in Engraving grew 20% year-over-year to $11.4 million, supported by growth in nickel shell, laser and tool finishing. We also have moved into a new larger facility in Dongguan, China, which will provide capacity to address further laneway growth expansion. In the second quarter of fiscal 2020, Standex expects year-over-year improvement as new global automotive rollouts increase. The restructuring actions announced in third quarter of '19 are completed, and we continue to focus on new technologies, such as soft trims, laser engraving and tool finishing. Please turn to Slide 5, the Electronics segment. Several factors affected Electronics' results, particularly in Asia. Total sales decreased 9.4%, and operating income declined 36.7% on a year-over-year basis. The sales and operating decline largely reflected volume decline in the reed switch markets, primarily in Asia, as well as the impact of ongoing material inflation. Our Asian reed switch operation is highly profitable, and our operating income decline is largely due to its deleverage on double-digit declines due to current market slowdowns. This is a cyclical decline in our end markets, and we remain committed to this business and enthused about its prospects. This decline was countered by growth in our Magnetics business, driven by strength in Military and Aerospace end markets. Next quarter, we expect Electronics' sales volume to decline year-over-year, although will be sequentially similar to last quarter as these headwinds continue. Previously announced restructuring in Q3 will deliver $1.1 million of annualized savings. Despite the near-term challenges, we're very well positioned in this segment for the longer term. In particular, we are addressing material inflation through changes in our reed switch production process to permanently improve our cost position. As we communicated last quarter, our new business opportunity pipeline includes over $50 million of new opportunities. This is the result of several years of development in our sales and engineering organization and positions us well for future sales growth. Despite the current softness in this end market, Standex Electronics has a strong market position. It serves good markets, has strong customer relationships and our investments in sales and engineering are paying off with significant new business opportunities that position it well for long-term growth. Turn to Slide 6, Engineering Technologies. Engineering Technologies' results remained strong with revenues increasing 18.6% and operating income growing at 89.2% year-over-year. The result reflects higher-margin new applications, volume leverage associated with growth in our core markets of Aviation, Space and Defense, as well as continued improvements in our manufacturing processes and efficiency initiatives. We expect revenue and operating income growth year-over-year to continue in the second quarter with backlog to be delivered in under one year, increasing 7% year-over-year in first quarter of 2020. Aviation programs, such as the A320 and A350, continue to ramp. I am pleased to communicate, we recently received a new award to produce the lipskin for the C919, equipped with GE LEAP-1C engines. In addition, our new business opportunity pipeline is also solid in this business. From an efficiency perspective, the actions that benefited our first quarter results will continue, such as reducing the level of scrap and rework and increasing machine utilization. Turn to Hydraulics on Slide 7. The 9.7% increase in sales reflected continued strong OEM demand, particularly in the North American refuse market, including a new application such as the new pack eject cylinder for front-end loading of trucks, which continue to ramp to full volume. First quarter operating margin of 18.4% increased from 12.6% a year ago. The margin increase reflected the higher volume, slightly lower material costs and ongoing efficiency initiatives. While we expect improved financial performance year-over-year for the fiscal year 2020, in the second quarter, we expect Hydraulics' revenue and operating income to be relatively flat year-over-year. We're also pursuing initiatives to deploy capacity to higher-margin market opportunities as well as expansion in our traditional offerings, such as in roll-outs and Dump Trailer applications. Now let's move to Slide 8, Food Service Equipment Group. Sales increased 1% year-over-year, reflecting scientific double-digit revenue growth and strengthened merchandising revenue, balanced with Refrigeration business, which was flat compared to prior year. The 25.6% increase in operating income was due to higher volume in Scientific and favorable margin product mix at merchandising. In the coming quarter, we expect sales in the Food Service Group to decline slightly year-over-year, primarily due to declines in Refrigeration group sales due to fire-related customer order cancellations. We also anticipate continued momentum in Scientific and merchandising sales. Finally, we continue to pursue productivity improvements in commercial refrigeration with a focus on lean related efficiencies. With that, I will turn the call over to Ademir to discuss the financial results in more detail. Ademir?

Well, thank you, David, and good morning, everyone. And now let me provide an overview of our first quarter results. From both revenue and EPS standpoint, results were in line with our previously communicated expectations. We experienced continued strength in ETG, Hydraulics and Scientific, as well as sequential improvement in Engraving margin. This was balanced with weakness in our Electronics business. Our financial position continues to be very strong, as evidenced by our liquidity and leverage statistics. In addition, our working capital initiatives drove improved cash flow performance year-on-year, with all segments reporting improvement to key metrics. Finally, we are on plan to achieve annualized cost savings run rate of $3.8 million by the end of the second quarter from our prior restructuring announcement in Q3 of last year. Now turning to Slide 9, which provides a financial summary of our results. Total revenue increased 1.7% year-on-year. This reflects organic sales decline of 1.7%, primarily due to Engraving and Electronics segments, which was balanced with strong growth at ETG and Hydraulics. Acquisitions added 4.4% to growth from our recent acquisitions of GS Engineering, Agile and Tenibac. FX remained a headwind, with a negative impact of 1%. Gross margin declined on a GAAP and non-GAAP basis year-on-year, 110 basis points and 130 basis points to 34.8% gross margin in the quarter. The year-on-year decrease was driven by weakness in our Electronics business, particularly in Asia, as well as lower level of new model automotive rollouts at our Engraving segment. GAAP operating margin decreased 230 basis points to 9.4% and non-GAAP basis operating margin decreased 260 basis points to 10%. This decrease primarily reflected the gross margin decline as well as year-on-year increase in corporate expense. The corporate expense increase primarily relates to increased accrued stock-based compensation and benefits expense in fiscal '20, along with management transition cost. We expect corporate expense year-on-year comparisons to improve as we move to the balance of the year. Earnings per share were $0.97 on an adjusted basis, a decrease of 19.8% year-on-year. And Slide 10 provides greater detail on the drivers of revenue by segment and on a consolidated basis. Now please turn to Slide 11, which provides a reconciliation between first quarter reported GAAP EPS and adjusted EPS with a net difference of $0.03. The items in the quarter, which created a bridge from $1 and GAAP EPS to $0.97 in adjusted EPS include: adding back restructuring charges of $1.5 million and acquisition-related expenses of $0.7 million, which had a net EPS impact of $0.13. This is balanced with a tax-free life insurance benefit of $1.3 million and approximately $1 million of fire-related insurance proceeds related to our New Albany facility for an EPS impact of $0.16. All this resulted in a net EPS reduction of $0.03 from GAAP to non-GAAP EPS. Now please turn to Slide 12, free cash flow. Our free cash flow improved year-on-year from a negative $10 million in the first quarter '19 to a positive $1.3 million in the first quarter '20. Three key takeaways from our fee free cash flow results. We had positive free cash flow in the first quarter of 2020 compared to a prior historical trend of negative free cash flow in the first quarter results. Key working capital metrics all showed year-on-year improvement at each of our 5 segments. Our initiatives around focused collection efforts, improved inventory turns and accounts payable supply management all contributed to the improvement in year-on-year free cash flow. Now turning to Slide 13, working capital trends. Key working capital metrics all showed year-on-year improvement and our working capital turns increased from 4.5 a year ago to 5.4 in the first quarter of 2020. Specifically, AR DSOs improved by 4 days, inventory turns increased by a full turn to 5.4x and DPOs increased by 2 days. Slide 14 summarizes our capitalization structure, liquidity statistics and capital expenditure trends. Standex had net debt of $98.7 million at the end of September '19 compared to $104.5 million at the end of June 2019. Our leverage statistics are strong. The company net debt to adjusted EBITDA leverage ratio was 0.9 at the end of the first quarter, sequentially flat with the fourth quarter of 2019. The net debt to capital ratio was 17.3% compared to 18.4% at fourth quarter fiscal '19. In addition, we have approximately $250 million of available liquidity. All this places us in a very favorable position to invest in internal growth initiatives, pursue strategically sound and financially attractive acquisitions, as well as return capital to shareholders. In October, we declared our 221st consecutive dividend, a 10% year-on-year increase. In first quarter fiscal '20, we repatriated $9.2 million from foreign subsidiaries and plan to repatriate a total of $35 million during the fiscal year. Total capital expenditures were approximately $7 million compared to approximately $7.5 million in the first quarter of last year. We have also fine-tuned the range of our capital expenditure forecast to between $31 million to $34 million compared to the prior outlook of between $33 million and $34 million for fiscal '20. With that, I will turn it back to David.

Thank you, Ademir. Our formal remarks conclude with Slide 15. We expect second quarter financial performance to be similar to first quarter results, followed by strengthening in the second half. This assumes continued weakness in the Electronics segment, particularly in Asia, improved Engraving segment performance and continued growth in the Engineering Technologies and Scientific businesses. As our previously announced restructuring contributes at its full run rate, we expect to further leverage our cost structure. We will continue to drive efficiency and productivity initiatives throughout our businesses. Our improvements in free cash metrics is a good example of how our initiatives are benefiting results and driving value throughout the company. We expect execution on our higher growth and return opportunities to continue to gain traction as evidenced by the trends and growth rates discussed today. Finally, we're pursuing our strategic priorities from a position of financial strength, given our liquidity and leverage metrics as well as consistent free cash flow generation. With that, we will open up to questions. Operator?

[Operator Instructions]. Our first question is from Chris Moore from CJS.

Yes, maybe we could just focus on Electronics a little bit. David can you talk a little bit kind of a rough breakdown in terms of end markets, both geographically and then how much Auto, et cetera, just to get a, kind of, better understanding of where some of the near-term difficulty is coming from?

Yes. In the last couple of quarters, we shared that shipments in the Auto are about 25% to 30% of the business, some of that goes through distribution. So it's unclear exactly where that goes but 25% to 30% is a good -- it's a good indicator. From a geographic standpoint, it's -- the business has been about 30% in North America, Europe and Asia. I think with this last quarter decline, Asia is going to be -- going to tick down slightly. But balanced global revenues fairly significant exposure to Auto. In the past, we've shown the industry breakdown though is quite wide. I mean, there were military, aero, industrial consumer products, communications, power with Auto being the largest.

Got you. That's helpful. And from -- specifically on the reed switches, it sounds like your -- the cost structure is changing a little bit there, improving. Can you talk about that a little bit?

Yes, there's two things. One is the operation itself is a highly automated cost structure with high fixed costs, and that's one of the reasons that a year ago, I think, one quarter Electronics posted a 26% EBIT. When that -- when the sales go up, it levers beautifully, when it comes down, you get a little more significant decremental, which we've seen. In addition to that, we use rhodium on the majority of our reed switches and the material actions we described are -- there's a series of actions that our team is putting in place to significantly reduce our use of rhodium, so that in the future as that -- and that does a volatile market for rhodium and we'll have a much smaller impact our results.

Got it. And finally, maybe more kind of medium term, you talked about that $50 million pipeline and other things that you're looking at, anything specific you could talk about there?

Well, this is very broad. There's opportunities in the industry, telecommunications, smart grid, there's some auto applications. Just one number that, I guess, we didn't include today is we hadn't expected that, that list of new business opportunities would generate about $9 million of sales for us this year. The first quarter sales were stronger than expected as those new products ramp. So we now think that'll be 11 or more for the year, which provides some upside to counter the downdraft in the core markets we talked about. And these -- a typical cycle for a new business opportunity for us, maybe takes a year or -- year to two in the pre-sales cycle. Once it begins to ramp, it can take a year to two years to ramp to full volume. So we see that $50 million plus funnel as -- that's our growth opportunity for a little bit this year, 2021 and 2022.

The next question is from George Godfrey of CL King.

Two questions. One is, in Engineering Technologies, the organic growth, 18%, how much of that is a temporary buildup or a pent up demand and perhaps an easy compare versus is this a type of organic growth rate, high teens that can be sustainable? And then the second part in Food Service Equipment, margins significantly improved there. Was it more that the restructuring and changes that you made led to the margin mix? Or is it that you offloaded troubled the Cooking businesses and that let to revenue mix that was much more favorable?

Yes. So let's first handle the Engineering Technologies. Had you asked that same question about Engineering Technology last quarter, I would have said Q4 '19 was definitely kind of a one-off. We had some final buys and some last term completion of orders in our Energy business that drove those sales like $32 million in Q4 '19. This quarter, this really represents just the ramp of the new applications we're on and just underlying strength of the business. The -- I wouldn't build into your model an 18% annual growth rate. But I think what we've communicated in the past for this business is that in the coming years, as these new applications ramp like the A320neo and our new -- our lips on A350, we're -- this is a mid- single-digit growth business, 5% to 7% growth long term. And the EBIT, as those things get to full volume, will be over 15%. Those are still fair expectations. On your Food Service question, the cooking business, which we divested in April, is actually -- has been taken out of both year's results. So the year-on-year compare is not muddied by inclusion of Cooking last year. The margin improvement this year was largely due to a mix shift within that business. You know we've got 4 P&Ls in Food Service, Scientific, Merchandising Pumps and Commercial Refrigeration. Scientific continues to grow in double digits. It is a very high-profit business, and our Merchandising business had a very good quarter with very high profits. So the mix effect of those businesses, as we move to more differentiated business mix, drove that EBIT to 11.5%.

[Operator Instructions].

All right. So let me conclude. I know it is a busy day, a lot of companies announcing today. So I thank those of you who listened in today for your participation. We thank you for your interest in Standex, letting us share our results and accomplishments and vision with you. And especially, I want to thank our employees who have fueled us to 50 years on the New York Stock Exchange and our shareholders for their continued support. We look forward to speaking with you again on our next quarter call. Thank you.

Thank you, sir. Ladies and gentlemen, that concludes this conference call. Thank you for attending today's presentation. You may now disconnect your lines.