Standex International Corporation (SXI) Q3 2020 Earnings Report, Transcript and Summary

Good morning, welcome to Standex International Fiscal Third Quarter 2020 Conference Call. All participants will be in a listen-only mode. [Operator Instructions] Please note that this event is being recorded. I would now like to turn the conference over to Gary Farber of Affinity Growth Advisors. Please go ahead.

Thank you, Kate 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' 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' 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, acquisition-related expenses and onetime items; EBITDA margin; and adjusted EBITDA margin. We will also refer to other non-GAAP measure, including adjusted net income, adjusted income from operations, adjusted net income from continuing operations, adjusted earnings per share, adjusted operating margin, free operating cash flow and pro forma net debt to EBITDA. 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. On the call today is Standex' Chairman, President and Chief Executive Officer, David Dunbar; the Chief Financial Officer and Treasurer, Ademir Sarcevic. With that I'll turn it over to David.

Thank you, Gary. Good morning, and welcome to our fiscal third quarter 2020 conference call. I hope that everyone on the call and your families have been doing well, coping with the challenges related to the COVID-19 pandemic. A lot has changed in the last three months since we last spoke on our second quarter call. On today's call, I will share with you the actions we've taken in response to the impact of COVID-19, with our highest priority being on the health and safety of our employees, customers and suppliers. Next, we were very active in the third quarter in regard to financial and strategic initiatives, so I will provide an update on why I believe these actions position us well in this more challenging environment and ultimately, when the environment normalizes. From there, I will discuss performance and segment trends. Ademir will then discuss our consolidated results and financial position in greater detail. Finally, I will conclude with some comments on our outlook and key takeaways from our results and initiatives. Now if everyone can turn to Slide 3, key messages. In regard to the impact of COVID-19, we were fortunate to have been deemed an essential business in most of our plants and have had limited shutdowns in our facilities, excluding our China plants. We indicated on our second quarter earnings call that these plants would be closed for part of the quarter, but all are now fully operational. I'm pleased with how we've responded to the challenges associated with COVID-19. I have so much gratitude for our global leaders for collaborating at a very high level and for all of our employees and their constructive response to this unfolding pandemic. We took immediate and effective actions to support a healthy and safe operating environment for our employees on a company-wide basis, continuity effort to address the pandemic's impact. Our experience in China provided us with an effective playbook that has been shared with and implemented at all of our facilities. Overall, our approach in executing globally has been highly collaborative and coordinated. Besides working remotely from home or appropriate, other actions have included changing workstation configurations and revising shift schedules where necessary. A cornerstone of our approach to supporting our business and growth strategy is maintaining a strong balance sheet. We continue to have substantial liquidity of approximately $220 million and limited leverage with net debt to adjusted EBITDA of under 1x with no debt maturities until December 2023. During the third quarter, we further strengthened our position. We remain a consistent generator of cash with free cash flow of $7.3 million in our third quarter. We swapped all of our variable rate debt to fixed rate, which will decrease annual interest expense by $1 million or a 50 basis point reduction. In addition, our interest coverage ratio is approximately 10. We also reduced our fiscal 2020 capital expenditure estimate to approximately $20 million, $10 million lower than our previous estimate with a focus on maintenance safety and, our highest priority, growth initiatives. Finally, we continue to repatriate cash from foreign subsidiaries with $20 million repatriated year-to-date and are on plan to reach $35 million in fiscal 2020. Our continued focus on driving efficiency and productivity in our operations was evident in several initiatives. We implemented cost reduction actions in response to the weaker economic environment that will result in approximately $4 million of savings in our fourth fiscal quarter. We also announced the closing of our Procon pump rotor plant in Ireland in the quarter. By outsourcing supply, we will save approximately $1 million annually. Through changes in reed switch production and material substitution, we are addressing materials inflation in our Electronics segment, which will ultimately improve our cost position. Besides these actions, as we have previously indicated, we hired a VP of operations in February. While it is still early innings in the limitation of his initiatives, we believe there is an opportunity to enhance our processes and further drive profitable organic growth and cash generation. Next, in March, we announced the divestiture of the Refrigerated Solutions Group and closed on the sale in April. The sale of Refrigeration continues the simplification of our portfolio that began with the divestiture of the Cooking business in early 2019. We believe the refrigeration transaction provides multiple benefits to us. From a margin perspective, we have a stronger profile. Consolidated adjusted EBITDA margin is approximately 300 basis points higher, excluding refrigeration on a fiscal 2020 basis. The divestiture of Refrigeration leaves us with a portfolio of differentiated businesses with competitive advantages in niche markets. We can now focus greater attention on nurturing and driving new business development opportunities. We have a growing pipeline of new technologies and attractive adjacent markets to further our growth while providing customers with differentiated custom solutions to their application needs. As we further shape our portfolio toward building our higher-margin growth businesses into more significant platforms, Standex is strengthening its competitive position. The strengthening of our balance sheet and consistent cash generation will continue to provide us the opportunity to pursue attractive internal projects and inorganic growth opportunities, and we will continue to allocate our capital with discipline. I will now provide a few high-level takeaways regarding our third quarter performance. First, despite the very challenging environment, third quarter earnings improved year-over-year with increased operating margins in Hydraulics, Engineering Technologies and Food Services. Our Engraving segment performance was impacted by temporary shutdowns of our Asian plants due to the COVID-19 pandemic and reduced demand from some of our European customers due to their own shutdowns. The impact on our results in the quarter were approximately $7.4 million in sales and $4.7 million in EBIT. Lastly, in addition to facing similar COVID-19 challenges, the Electronics segment was negatively impacted by material cost increases. However, on a sequential basis, revenue in the Electronics segment increased and operating margin declined only slightly. Please turn to Slide 4, where I will discuss our segments, beginning with Electronics. Total sales decreased 4.2%, and operating income declined 14.9% year-over-year. Although on a sequential basis, revenue in the Electronics segment increased and operating margin declined only slightly. The primary driver of the year-over-year sales decrease was the economic impact of COVID-19, which reduced capacity in our China plants as well as shutdowns at some of our European customers in the automotive end market Despite these significant headwinds, some of our markets delivered positive sales trends, including our magnetics business in the military and home appliance markets and the new sensors, switch and relay applications used in electric vehicles, security markets and the European heavy truck end market. Our operating margin was 16.7% compared to 18.8% a year ago. However, on a sequential basis for our second fiscal quarter, it was a 30 basis point decline. The year-over-year operating margin decrease was primarily due to the impact of lower volumes and raw material price increases offset somewhat by cost initiatives as well as incremental costs from the temporary shutdown of our China plants. As I look into the fourth quarter, Electronics fiscal fourth quarter will be impacted by lower volumes and higher raw material costs in the reed switch business as well as expenses associated with the temporary shutdown of our Mexico plant in the fourth quarter. As a result, sequentially, we expect a slight decline in revenue, but a more significant decrease in operating margin in the fiscal fourth quarter of 2020. Longer term, we are excited to see continued strength in our new business opportunity funnel, which has grown 10% since the beginning of the fiscal year. The example on the left is a good illustration of how electronics works with customers to solve applications with new products. In this case, we began developing a reed switch based solution, but discovered it was not the right technology for this specific application. Our engineers proposed a new solution-based on applying a new technology used in Formula One race cars. Our testing showed this was effective. We proceeded to development and are now selling the sensor. This process of following customers’ unmet needs gave us a low-risk path to develop a new technology and a strong relationship with a new customer who will have a stream of new applications in the future. Please turn to Slide 5 for a discussion of the Engraving segment. Sales decreased 4.6% with operating income flat year-over-year. The sales decline reflected COVID-19-related economic impact, which delayed both the receipt of customer tools from customers and shipments of our completed work with our China plants closed for nearly half a quarter. Operating income was flat at $4.5 million, primarily related to the volume decline. Despite these challenges, laneway growth remained healthy with a 15% year-to-date increase to $32 million, driven by nickel shell, laser and tool finishing. In our fiscal fourth quarter, we expected a slight decline in revenue and flat operating margin performance, primarily due to volume trends. We continue to focus on the technology laneways as soft trim tools, laser engraving and tool finishing as well as continued operational efficiency initiatives. The example on the left shows the new Land Rover Defender now released for sale in the U.S. Standex Engraving worked with Land Rover’s design team to develop innovative textures for the interior, and we delivered our full suite of texturizing services. This also exemplifies our unique global presence and ability to consistently support the customer’s global supply chain. Turning to Slide 6, Engineering Technologies. Sales decreased 2.7% year-over-year due to lower aviation related end market sales, partially offset by increased sales in the space end market. However, operating income increased 10.6% year-over-year as a result of cost control actions and manufacturing efficiencies. In our fiscal fourth quarter, we expect a sequentially moderate revenue decline in Aviation end markets due to COVID-19 related customer pushouts, while we anticipate defense markets to remain stable. In this environment, our cost actions will be focused around our Aviation end markets. Under the Spincraft brand, Standex engineers work intensively with customer engineers – engineering teams to develop next-generation space craft, missiles and single-piece lipskins using our proprietary spin forming process. Turning to Hydraulics on Slide 7. Sales decreased 10.3% year-over-year due to a slowdown in the dump market and customer inventory destocking at selected customers in the refuse market. Despite the sales decrease, operating margin increased 260 basis points year-over-year to 17.4%, reflecting increased contribution from aftermarket sales and solid expense management. In Hydraulics, we expect sequential revenue decline in the fiscal fourth quarter due to the economic impact of COVID-19 on customer production levels, along with continued imposition of tariffs on rod cylinders. These tariffs will be partially offset by continued focus on expanding our aftermarket presence and operating efficiency initiatives. I’m very proud of the Hydraulics team for using our growth discipline processes to identify the profit improvement opportunity by allocating more capacity to aftermarket sales. This project began last summer. And began to have an impact on this past quarter, making a significant contribution to the margin improvement. Now let’s move to Slide 8. The Food Service Equipment Group now restated without Refrigeration. Sales increased 3.7% in the third quarter year-over-year, reflecting growth in Scientific, particularly in the retail drug sector, balanced with relatively flat demand in merchandising and lower sales in our pumps business. Operating margin increased 60 basis points year-over-year to 18.1%, primarily due to increased margin in both scientific and display merchandising, reflecting product mix and expense control. Sequentially, we expect a significant sales decline in the fiscal fourth quarter for a few reasons. The display merchandising of Pumps business will reflect the economic impact of COVID-19 in the restaurant sector due to closures and a reduced level of Food Services. In the fourth quarter, we expect the Scientific business to be moderately impacted by the near-term customer focus on supplying personal protective equipment for healthcare workers in lieu of capital equipment expenditures like refrigerators for vaccines. In response to these challenges, the Food Service segment has begun implementing rolling furloughs, temporary planned shutdowns and headcount reductions. The Scientific business using our growth discipline process brought to market an innovative small freezer with controlled auto defrost. It is the first patent-pending development of this business and provides a product that is ideal for the storage of frozen vaccines. Ademir will now discuss our quarterly results in greater detail.

Thank you, David, and good morning, everyone. First, let me provide a few key takeaways from our fiscal third quarter 2020 results. While we reported a significant year-on-year increase in adjusted EPS. Our sales and margins were impacted by the economic effects of COVID-19, primarily within our Engraving segment. As David previously discussed, we strengthened our financial flexibility on several fronts through continued cash flow generation, reducing interest expense, continuing to repatriate cash and lowering our capital expenditures for the year. Finally, we implemented several cost-saving actions in the quarter. The cost actions announced today will generate approximately $4 million in savings in the fiscal fourth quarter and $7 million in annualized savings. We plan to incur approximately $1.5 million in restructuring charges in the fiscal fourth quarter related to these actions. We also announced closure of a pump’s facility in Ireland, which will result in approximately $1 million of savings on an annualized basis. Now let’s turn to Slide 9, third quarter 2020 financial summary. On a consolidated basis, total revenue declined 3.1% year-on-year for the fiscal third quarter. This reflects organic weakness, primarily in Electronics and Engraving due to the economic impact of COVID-19. Acquisitions contributed 0.9% to overall growth in the quarter, while foreign exchange remained a headwind with a negative impact of 0.8%. Gross margin decreased 50 basis points year-on-year, reflecting volume decline and material inflation in the Electronics segment. Adjusted earnings per share were $0.96, reflecting the decrease in interest expense due to lower borrowings and lower overall interest rate. In addition, our tax rate was 470 basis points lower year-on-year due to the mix of U.S. and non-U.S. earnings. Please turn to Slide 10, fiscal third quarter 2020 free cash flow. We reported free cash flow of $7.3 million compared to $11.3 million in the third quarter of 2019. The year-on-year decrease reflected increased tax payments and pension contribution payment and higher capital expenditures. Working capital turns in the quarter improved to 4.7x, a 10 basis points improvement year-on-year with continued focus on collections and accounts payable management. Now please turn to Slide 11, summary of Standex’ capitalization structure and liquidity statistics, which remain very strong. Standex had net debt of approximately $102.8 million at the end of the third quarter compared to $88.1 million at the end of the second quarter of 2020. The increase primarily reflects the impact of our share repurchased in the quarter and negative cash flow in the quarter from now divested RSG group. Leverage statistics remains strong. The company’s net debt to adjusted EBITDA leverage ratio was 0.95x with a net debt-to-capital ratio of 18% and interest coverage ratio of approximately 10x. We also had approximately $220 million of available liquidity at the end of the fiscal third quarter. From a capital allocation perspective, we repurchased shares in the quarter, reduced our capital expenditure outlook and continued to pay a dividend. During the fiscal third quarter, we repurchased approximately 129,000 shares for $8.1 million. There's approximately $44.7 million remaining under the Board's current repurchase authorization. We are reducing the outlook for fiscal 2020 capital spending to between $19 million to $21 million compared to between $30 million to $32 million previously. The focus of capital expenditures for the balance of fiscal 2020 will be on maintenance, safety and our highest priority growth initiatives. In addition, in April, we declared our 223rd consecutive dividend, a 10% year-on-year increase or $0.22 per share. I will now turn the call over to David for closing comments.

Thank you, Ademir. If everyone can please move to Slide 15. I would like to take a brief moment to express the significant impact the divestiture of our refrigeration business has had on Standex. I want to first thank the employees of the refrigeration group for their hard work and dedication over many years at Standex. The refrigeration business was largely a standards product business. This was also true for the cooking business, which we divested a year ago. With these two divestitures, we now possess a portfolio of businesses that have leading positions in niche markets and compete on a common basis through customer intimacy to deliver customized solutions and have competitive advantage in their spaces. They have track records of delivering good margin performance, and the new Standex has an operating margin 200 basis points higher than the business did with refrigeration in the portfolio. Our current businesses are big fish in small ponds, and we can now focus much more management attention on feeding and growing them. In closing, I want to thank our employees for their dedication and efforts as well as our customers and suppliers for their ongoing support. I'm very proud of our team. Following our experience in China in regard to COVID-19, we deployed an effective playbook through a high degree of intercompany coordination and collaboration, focusing on employee health and safety. This effort continues as we work our way through this situation. Out of necessity, this has created a deeper level of cooperation between our business than we've ever seen. While this remains an extremely challenging environment, we're confident in our ability to safely and successfully execute and progress on our strategic initiatives. Based upon our segment discussion earlier in the call, let me summarize our expectations for the fourth quarter. In the fiscal fourth quarter 2020, the company expects that each of its segments will experience some sequential revenue decline as a result of the economic impact of the COVID-19 pandemic. The Electronics, Engraving, Engineering technology segments are expected to have slight to moderate sequential revenue declines in the fourth quarter. Food Service segment is likely to have the most significant sequential decrease in revenue as restaurants throughout the United States remain closed or focused solely on takeout sales. In addition, the scientific business will be impacted by the current market shift toward consumable protective equipment due to COVID-19 with less near-term emphasis on capital equipment expenditures. Lastly, on several fronts, we made substantial progress in the third quarter, further preparing Standex for the challenges ahead in this unprecedented operating environment as well as for the resumption of a more normalized environment. From a financial perspective, we further strengthened our position in the quarter to continue free cash flow generation, reducing our interest expense, cost structure and capital expenditure and continuing to repatriate cash. Operationally, with our recent VP of ops hire now in place, we are in the early innings of further driving process improvement. Lastly, strategically, with the divestiture of Refrigerated Solutions, our focus will further intensify in our pipeline of organic and inorganic opportunities, which are well-funded to opportunistically pursue. With that, I will turn it over to the operator to take questions.

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

Good morning, guys. Maybe we could just – I wanted to focus on Electronics, but perhaps a little – I was future growth, maybe a little longer-term and talk about some of the variables that ultimately might be impacting the longer-term growth in that segment and perhaps the end market focus, is there – do you see any kind of shifting or areas of particular opportunity longer-term?

Yes. So in the Electronics, you recall, we have a high reliability magnetics business and these reed switch and related sensor business. The reed switch business serves about $1.5 billion global market, and its applications evolve with technology. For example, we have a lot of new applications in electric vehicles and new technologies. So that space will naturally evolve to the growth areas in the economy. We talk a lot about our new business opportunity funnel, the NBO funnel, which has grown throughout this year. We're actively working quite a large funnel, and our estimate is just $55 million in there that will convert to sales. This year, we mentioned this in the last call, but not this call. We'll have between $11 million and $12 million of sales in these new applications that will be in our sales in this fiscal year 2020 from Q1 to Q4. So on a $160 million business, a $10 million, $12 million business, that's enough growth to overcome any churn in our core business and help us grow a bit faster than market as we try to inch out our market share in that $1.5 billion segment. So overall, I think the segment grow slightly faster than GDP because of the growth in sensor markets. And we can grow somewhat faster than that as we take share. On the high reliability magnetics business, this is a steadier business and it's the key markets that we serve are aerospace, military, defense, medical devices, products for the smart grid and power gen. So maybe a little slower growing end market, but it's a very steady long-term market with a lot of visibility. So hope that helps frame the growth expectations.

It does, thanks. From M&A perspective, obviously, you've got a strong balance sheet, lots of flexibility. I would guess the next couple of quarters, I don't know much is happening on that end. But can you talk a little bit about the pipeline? And is it really – is it Electronics and Engraving where the focus is on the M&A side?

Yes. We have an active pipeline. We are working some opportunities. And as we've said in the past, the highest number of opportunities are in the Electronics space because that is the biggest end market with the largest number of smaller niche players. There are some opportunities in Engraving. There's some in the scientific space. But as you say, in general, activity is a little slower, although we're keeping our eyes and ears open for any opportunities that might appear from companies that become stressed in this downturn, and we're prepared to take advantage.

Got it. Last one from me, just from a kind of a competitive landscape perspective. Do you see any of your businesses that actually will be in a better competitive position on the other side – or potentially better on the other side of COVID?

Well, yes, we think nearly all of them will be in a better position we can go business by business. But all of them have there's some growth initiatives. We have some new products that are in development that we hope to be announcing later this year. We're working closely with customers on new applications. And because – although we've taken significant actions to reduce our cost position, we're protecting our engineers, we're protecting our applications people, so we can continue to do that work, which will position us for the other side.

That’s really helpful. Thanks, guys.

[Operator Instructions] Our next question is from Chris McGinnis from Sidoti & Company. Go ahead.

Good morning, thanks for taking my questions. And hope you all are doing well. I just want to start a little bit – I was a little surprised and congrats on a good quarter and I think the business is holding up a little bit more resilient than I thought. Can you just maybe talk around the Engraving and maybe also around the Electronics and the Auto exposure and just how that's playing out for you, just given the steep decline within that segment?

Yes. As you know, they each have – they're exposed to Auto in different ways. The Electronics business is – sells sensors that go into level of measurement applications brake fluid levels, different liquid reservoirs. In fact, just an interesting fact within an electrical vehicle, there are many more liquid reservoirs for cooling purposes around electric vehicle than in a combustion vehicle. So the Electronics business is going to follow SARS more. And their exposure to Auto is in low-20% of their total sales. The Engraving business, however, is exposed to Auto through the schedule of new platform releases. And that – predicting how that will behave in this downturn is a little trickier because in past downturns, in some cases, OEMs even accelerated new product releases, which was good for us, to compete for share in a tighter market. In other cases, they delayed those new platforms to conserve cash in a deep downturn. For the moment, our visibility over the next quarter or so, our OEMs are telling us, they're maintaining the releases that they foresee this year. There's some delays because it's hard to get people together to do the collaborative markup sessions that are typical in this business because people are working from home and they can't get together. But the platform schedules themselves. For the moment, to the best of our knowledge, we remain on track.

Great. Okay, and thanks for that color. And just with everything that's happening within the marketplace, how is this opportunity for you maybe to go out and get some more growth? How do you see things changing where you can really capitalize on your kind of niche position in the marketplaces that you play within and can you go out and maybe take some share in this opportunity? Obviously, you have a really strong balance sheet. So that may be an opportunity. But what about even also on the organic side? Can you maybe...

Yes. Well, that's a great question. You first have to remember how we compete and win and work with our customers. So we're working with the customers to design a product or an assembly for a new product that they have, a new application they need. Once it is approved and then it goes into production. And we're usually sole-sourced, and we supply that customer for the life of their product. The engineering process can be long; it can be six months to 12 months or more. And that's where the competition takes place. The competition takes place in getting the right to sit down and collaborate with the customers' engineers. You do the work, and that results in revenue and sales that will appear six to 18 months later. We are really well positioned right now. Our MBO list is very healthy. Our engineering teams – their biggest challenges is supporting all of the opportunities they have in front of them. Because we compete with many smaller companies, I can only assume that there are at least some of them that are struggling. So we are – we're positioning ourselves well for that growth. But there's a lag time to it because we first design, it goes into production and then ramps up.

Appreciate that. Thanks for that. And then just two quick ones. Just on the cost savings and I think you said $4 million in Q4, but $7 million annually. Is that on top of the Procon savings and then also the interest expense savings? Or is that configured into that $7 million annual?

No. The Procon savings are – they're going to take us a little while to get those savings to read out. So they're probably going to start reading out over the later part of next fiscal year. So that will be on top of $7 million, but we don't expect to see the $1 million fully read out in fiscal 2021. And the interest expense is going to be just per quarterly base, it's going to be about $1.5 million interest...

It is not in that $7 million. $7 million structural changes to...

Okay. So $9 million, a little over $9 million of cost savings, that's pretty solid. So congrats on that. And then a last question. I know it's probably not on your radar at the moment, just given kind of what's happening in the marketplace. But now that you -- within the Food Service segment, you've changed that pretty dramatically over the last 1.5 years. Any thoughts around maybe changing that segment name just given that now it's maybe a little less Food Service and now you got the Scientific in there that's doing really, really well?

Yes. I think that's a legitimate question. I'd say now we have this quarter behind us, we're businesses kind of know where they stand. We've taken the actions. It was quite a busy quarter for us. But I'd say we'll begin examining that question here in the next quarter. And our fiscal year ends in June that would be an appropriate time to take a look at it.

Got it. Thanks for taking my questions. Good luck to you and stay safe.

Thank you, Chris.

Thanks Chris.

At this time there is no more question. So it concludes our question-and-answer session. I would now like to turn the conference back over to David Dunbar for closing remarks.

All right. Thank you. I want to thank everyone today for their interest in Standex and letting us share our results, accomplishments and vision. Also, I want to thank our employees and shareholders for their continued support. We look forward to speaking with you again on the fourth quarter fiscal 2020 call later this summer. Thank you.

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.