Standex International Corp (SXI) 2006 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second-quarter 2006 Standex International earnings conference call. My name is [Mika] and I will be your coordinator for today. At this time all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of today's conference. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded for replay purposes.

On today's event we have Mr. Christian Storch, Chief Financial Officer, and Mr. Roger Fix, President and Chief Executive Officer. I would now like to turn the presentation over to your host, Mr. Fix. Please proceed, sir.

Good morning and thank you for joining us. Please note that our second-quarter financial results news release, which we released earlier this morning, is available on Standex's website at Standex.com. On this morning's call Christian will begin with a review of our second-quarter financial results; then I'll follow with an update on our operating groups and provide some further insight into one of Standex's key operating businesses, the air distribution products group. After that we'll be happy to take questions. Let's start now the financial review. Christian?

Good morning, everyone. I'd like to remind everyone that the matters we are discussing on this 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 our recent SEC filings and public announcements for a detailed list of risk factors.

For the second quarter of fiscal 2006 revenue was essentially flat at 167.4 million versus 167.9 million generated in the second quarter of fiscal '05. Second-quarter operating income decreased by 10% year-over-year to 10.5 million. Operating income as a percentage of sales was 6.3% compared with 7% in the second fiscal quarter a year ago.

Our operating income performance was primarily affected by a favorable contract adjustment with a large aerospace customer and the year-over-year quarter within our engineered products group, one time restructuring costs related to our fluid dispensing and circulating systems business, and lower high margin sales from our meal delivery business. Roger will discuss these items in his operational review.

It is important to note that in the restructuring of the fluid dispensing and circulating unit we sold the building and property that housed that business. The gain of $670,000, which is reflected in nonoperating income, was slightly higher than the restructuring expense of $614,000 which is reflected in operating income. Manufacturing for this business has been transferred to our Nogales, Mexico plant.

We also sold a facility in Colorado that used to house an air distribution facility, now also being relocated to Mexico. The combined proceeds of $3.4 million related to these sales will be used to offset the investment in our new facility in Mexico.

Net income for the second quarter of '06 was 5.4 million or $0.43 per diluted share. This compares with net income of 6.6 million or $0.53 per share in the second quarter of fiscal '05. Our fiscal year 2006 second-quarter net income reflects a tax rate of 34.4%.

Net working capital increased to 131.2 million at December 31, 2005, up from 130 million at September 30, 2005. We define working capital as accounts receivables plus inventories less Accounts Payable. The increase was due to two acquisitions which were completed in the second quarter, Innovent and Kool Star. Excluding these acquisitions net working capital decreased by approximately 1.4 million. Since our working capital [will] necessarily increase with our sales volume, we are primarily focused on improving our working capital turns. Working capital turns remain constant at 5.2 turns when compared to the fiscal quarter of 2006.

Net debt was 102.7 million at December 31, 2005, up from 88.4 million at September 30, 2005. The increase was primarily driven by the two acquisitions completed in the second quarter. The Company's balance sheet leverage ratio of net debt to total capital was 35.4%. We define debt as short-term debt plus long-term debt less cash.

We continue to manage our balance sheet with an eye on potential acquisition opportunities by maintaining sufficient liquidity. As you may recall, our current bank revolver was scheduled to expire in the third quarter of fiscal year 2006. We completed negotiations with our current bank group during the second quarter and secured a new $150 million revolving credit facility with more favorable terms.

We incurred additional interest expense in the second quarter due to higher floating rates, higher average borrowing levels and the amortization of the prior credit facility. Depreciation for the quarter was 3.1 million and was 5.5 million for the first six months. This indicates an annual run rate of approximately $12 million.

In the first fiscal quarter we started expensing stock options under FAS 123(r). The impact on the second quarter was a year-over-year increase in compensation expense of 82,000. With that I'll turn the conference call back to Roger.

Thanks, Christian. Let's get right into the performances of each operating segment. The foodservice equipment group delivered 2% year-on-year sales growth. This was mainly driven by a very good performance by Norlake which manufacturers refrigerated merchandising cases and walk-in coolers and freezers. This business is increasing market share in key national accounts and buying groups and is benefiting from its efforts to upgrade and expand its foodservice representative network.

This strong performance was partially offset by lower sales at Procon Products, our fluid dispensing and circulating systems business, where sales were impacted by startup activities and a sales decline at the meal delivery systems business. As Christian noted, the manufacturing of Procon product pumps has been relocated to our Nogales plant, so we expect significant improvement in sales and profits of this business as we complete the ramp up of production in Mexico.

In terms of the meal delivery systems business, we are aggressively working to increase volumes including expanding our sales channel and product offerings. Operating income for the foodservice group declined by 33% in the second quarter. This was a result of the Mexico operation startup charges, the volume decline of our high margin, high -- meal delivery systems and higher expenses related to the temporary relocation of manufacturing for our newly acquired Kool Star walk-in cooler and freezer products.

After we purchased Kool Star we immediately shut down the operation and temporarily began to support Kool Star customers from our New Albany, Mississippi plant, resulting in higher transportation and over time costs. We began manufacturing Kool Star products at Nogales last week and will transfer Kool Star production back to Mexico over the next several months.

During the past year we downsized our meal delivery systems business from a cost standpoint. We continue to focus on improving margins at this business and throughout our foodservice group through lean enterprise, sourcing initiatives and continued implementation of low-cost manufacturing.

Sales at our air distribution products group decreased by 3% year-over-year due to a softer housing start market in the geographic areas where we have our strongest presence. In just a few minutes I'll be discussing this group in more detailed including our strategy to penetrate the fastest growing geographic segments of the market.

Operating income at ADP increased by 14%. ADP's bottom-line performance outpaced sales due to efficiencies gained through lean manufacturing and lower steel prices. Sales at our engineered products group were down 5% year-over-year and operating income was down 23%. Results for this group in the second quarter were driven by the stellar performance of our hydraulics business and the negative year-over-year effect of a special contract payment in the year ago quarter that Christian mentioned earlier.

This payment represented an access charge for us to keep our facility available in exchange for the customer reducing the quantity of products shipped under the contract. This significantly affected our year-over-year sales and income for the quarter in this group and more than offset the great performance of our hydraulics business. The hydraulic business is gaining share in a strong demand environment as customers move to Standex for a higher level of service than our competitors.

At the same time we've also been able to aggressively reduce costs through the addition of more automated manufacturing equipment, offshore sourcing of components and lean activities. As a result, operating income at this business has more than doubled year-over-year. So you can see why we're very excited about the sales and income growth prospects for the engineering group going forward now that the effects of the special payments in fiscal 2005 are behind us.

Consumer products group sales increased by 2.4% year-over-year. This growth was a result of solid performance by both the publishing and religious bookstore businesses. The group was able to delivery a 44% increase in operating income. Our religious bookstore chain turned in good growth as a result of a strong Christmas buying season and a great performance from our new store in the Phoenix area. This new location is part of a rollout of a new store format which has been very well received by our customers. We believe the early success of the Phoenix store confirms our expectations for the new store strategy established by this division's management and positions them for good growth in the future.

Standard publishing also had a good quarter. Driven by a strong holiday season and a good front list performance, sales were strong across the board including small chains, independent bookstores and large-scale distributors. We're very enthusiastic about the positive results from our Heart Shapers Sunday school curriculum. In fact, we added more than 300 Churches to our roster in the second quarter. This brings the total number of churches using our curriculum to more than 500 at the end of December of this year.

In addition, we continue to leverage the power of the Internet to improve market penetration, customer loyalty and brand recognition. This past quarter we launched our sermon resource website that offers pastors online materials to aid in sermon preparation. Already we have more than 250 subscribers to this service. We've also recently expanded our product offerings that are available online, facilitating the process of purchasing for our customers in large churches.

The engraving group grew sales by 2% on a year-over-year basis while operating income declined by 33%. This decrease in operating income was due to product mix, certain productivity issues and pricing pressure from automotive customers in North America. We've all read the headlines about the auto industry; their cost-cutting efforts clearly have had a negative effect on our margins. In terms of productivity, we are taking aggressive steps to reduce over time and avoid rework. In addition, we are expanding the use of digital technology to help us improve our productivity.

During the quarter we acquired the Innovent special products group, a maker of processed tooling. That business is now part of our engraving group and thus far has performed above our initial expectations.

During the quarter we also made good progress in our efforts to divest the businesses in the consumer group. We have completed offering memorandums for all three businesses and have initiated management presentations to interested buyers. We have received early interest from a number of strategic as well as financial buyers for all three businesses. As we stated earlier, our goal is to substantially complete the divestiture of these businesses by the end of our current fiscal year.

Let's now spend a few minutes discussing the air distribution products group in more detail. Air distribution products, or ADP as we call it, is the U.S. leader in residential galvanized sheet metal, pipe, ductwork and fittings and has a 70-year heritage in the industry. the group manufactures products for residential and light commercial heating, ventilation and air-conditioning systems. These components are used primarily in new home construction and light commercial applications.

In addition to the Standex brand, ADP's products are marketed under the brand names Snappy, ACME and ALCO. The products are sold by a direct sales force to HVAC wholesalers and do-it-yourself big box retailers. In terms of our competitive position, we are the share leaders in a very fragmented marketplace. We are the only company with a nationwide manufacturing presence in this space and have about 13% of the total market.

ADP and its closest two competitors comprise about 30% of the total market. After those two competitors, which can be described as regional players, the market is comprised of about 40 [modest] to small, typically single location niche driven businesses. Standex HVAC products are primarily used in new home construction; the HVAC market is of course very closely linked to housing starts. Within that context there are five key growth drivers currently influencing the market.

First is the emergence of central air-conditioning as a standard amenity in new single-family housing. The second growth driver is the steadily increasing size of the average new home. This is important because many large new homes now require two or more HVAC systems and therefore more duct system components. The third driver is the growth of remodeling opportunities. These opportunities are created by the aging of the nation's existing housing stock.

Increasing environmental and health concerns regarding indoor air quality also are driving opportunities in the market. And finally, stricter guidelines for the replacement of old HVAC equipment are driving the need for new high-energy or high-efficiency furnaces, air conditioners, heat pumps and water heaters.

Housing starts have remained at all-time highs during the past 12 to 18 months as developers have taken advantage of extremely low interest rates for new home construction. As a result, U.S. HVAC production has been growing steadily. With higher interest rates we expect that the overall market may not experience the same growth in 2006. Even so, ADP's competitive advantage positions us to take share and grow faster than the market in 2006.

Our first competitive advantage is the strength of our product suite. From core duct systems components to fittings and accessories we sell more than 4,000 high-quality products. In fact, ADP offers the broadest productline in the industry. We are the only manufacturer to harness the power of the Internet, making available all of our product catalogs online and providing electronic commerce possibilities with our largest customers.

Bit even more important than our breadth of product is our product quality. Our size and resources give us the ability to install the most modern technology into our plants and equipment to ensure consistent product superiority. This commitment to quality has earned our Standex, Snappy, ACME and ALCO brands very high name recognition in a solid reputation in the marketplace.

Another competitive advantage is the relationships we have with the leading multi-location industry wholesalers. ADP has commercial agreements with nine of the 12 leading HVAC segment leading wholesalers. In addition, we have preferred vendor relationships with many of these top wholesalers. Essentially this means that customers must at least consider ADP's productline before submitting purchase orders with any other manufacturer.

Our relationships with top wholesalers are very critical right now due to a strong consolidation trend. The larger multi-location wholesalers are aggressively acquiring many of the hundreds of local, regional wholesalers. We expect to grow along with our large wholesaler customers as this consolidation trend continues.

Another competitive advantage is our geographic presence. The basic reason behind this is freight cost. The pipe, ductwork and fittings we manufacture are difficult to package and very expensive to ship. For this reason it is critical to have facilities located near customers, especially the major multi-location wholesalers.

Our geographic breadth gives our customers a large degree of security. They know that we fill 100% of their orders and will deliver the products faster than any of our competitors. With this kind of geographic coverage our wholesaler customers have steady fill rates and reduced stock outs at store locations. Even when the customer has a crisis at a particular site and cannot accept shipments at one location due to work stoppage, severe weather or other issues, we are able to quickly deliver products from on our facilities to the customer's desired location.

Even with our broad national presence we still have opportunity to take share in geographic areas of the U.S. in which we are under penetrated. The two geographic territories we are targeting are the Southwest and Southeast of the united dates. It's very important to note that these are the two geographic regions which have been experiencing the highest housing start growth rates.

As with other Standex groups such as foodservice, our new manufacturing plant in Nogales will help to expand ADP's products into untapped markets and geographic territories. Until now we have not been able to penetrate the U.S. Southwest effectively or profitably due to freight costs. Prior to the opening of Nogales our closest plant was ADP's now closed Northglenn, Colorado facility. However, this plant was nearly 1,000 miles away from Phoenix, the nation's hottest housing market.

Now Arizona is within our reach as is Nevada, a close second to Arizona in terms of housing start growth. We also can now very efficiently reach New Mexico, parts of Texas and California. Through Nogales, we will now be able to service the Southwest facilities of the big national wholesalers like Ferguson and Hughes and major regional wholesalers in the Southwest such as Air-Conditioning Supply.

It is important to note that none of our major competitors have a presence in the Southwest. And none of the regional competitors that are in that market have national account association with the large national wholesalers that have offices in that region. So this is really an exciting opportunity for market share gains and profitable growth.

In addition to the Southwest, we expect to make further inroads in the Southeast market as well. The Southeast is second only to the Southwest in terms of housing start growth. We are currently under penetrated in this region; certainly see room to take share. We plan to step up our pace with national account wholesalers and try to market more aggressively in this area.

In addition to housing start growth, another trend that benefits the HVAC market in the Southwest and Southeast are new regulations for energy conservation. For example, we are already starting to see an increase in the sales of energy efficient sealed fittings in Florida, Arizona and California. In fact, California recently passed a proposition mandating specific building codes that require sealed fittings.

Before we go to our question I want to address how we are focusing ADP to become a more profitable group for Standex. I've already discussed how our Nogales facility will enable us to enter new markets and enhance our volumes. Nogales also enables us to save on labor costs. And we are the only company in our market to be in Mexico and benefit from these savings.

In the fourth quarter of fiscal 2005 we closed our Northglenn, Colorado facility. The Northglenn operations are currently being transferred to Nogales. By moving the Northglenn plant to Mexico we expect to reduce our costs, improve efficiency and enhance distribution time to customers.

About a year and a half ago ADP also embraced lean manufacturing as a way to lower costs by eliminating wasted time and effort, improve throughput time and deliver responsiveness and improved working capital performance. Since that time we have begun to redesign every facility from the cellular level. We are still at the beginning of this lean manufacturing journey, but our efforts thus far have resulted in substantial savings in terms of the amount of personnel it takes to make a product and the time it takes to produce it. In fact, we have seen a 7.5% increase in productivity across the organization. We expect to see additional benefits as we continue to mature and expand the use of lean techniques and methods.

To summarize, the future looks very bright for ADP. We have many exciting opportunities for growth in 2006. We plan to increase sales by growing share in the hottest housing markets in the nation by leveraging our size and scale to provide customers with special volume programs and by maintaining our relationships with the largest HVAC wholesalers who continue to grow by acquisition.

At the same time we plan to improve ADP's bottom-line performance by leveraging our Nogales facility to provide low-cost manufacturing and to save on freight cost to the Southwest. This should start next month. We also plan to reduce our raw material costs by leveraging our size and scale. And we expect our lean manufacturing efforts will continue to yield positive results.

Before we take your questions, just a few quick comments on our low-cost sourcing and manufacturing initiatives in China. We're well on our way to meet or exceed our expectations in terms of savings. Our plan for fiscal 2006 was to achieve an exiting run rate of $5 million in purchases with savings of 20 to 30%.

In addition to our sourcing initiative, we have some other exciting activities going on in China. We recently committed to a new 35,000 sq. ft. facility in Tianjin, nearby Beijing. It will house our sourcing office and we'll also be using the facility for electronics assembly. We anticipate beginning early production at this facility by the end of this fiscal year.

Also in China we expect to begin production at a new engraving group facility in Shanghai in the fourth fiscal quarter. This new plant will support our global OEM customers in that area. We're very enthusiastic about this plant because our current engraving operation in Guangdong has been such a success. It is growing rapidly and is profitable.

So we're making very good progress in China and, as you've heard this morning, the ramp up of manufacturing at our Mexico facility is coming along according to schedule as well. Of course, our low-cost manufacturing and sourcing initiatives are in the very early stages, but we expect significant returns from both over the long term.

In the coming quarters we'll also expect to make important progress in our efforts to divest the consumer group and to acquire companies that complement our existing businesses and quickly contribute to our profitability. With that, Christian and I are ready to take your questions.

(OPERATOR INSTRUCTIONS). Michael Gardner, Wedge Capital Management.

Good morning. Just a couple of questions. First, in the engineered products group, I think I'm clear that the hydraulics business is doing very well and I think I'm clear that these one-time payments a year ago are now finished. Please correct me if I'm wrong. But my question is how about the other parts of the engineered products group like the basic Spincraft business or electronics? Could you give us some sense of how they are doing?

Both of your statements about the special payments and the hydraulics group are very accurate. As far as the other two business units, the Spincraft business has both an aerospace component and an energy side to it. The energy side remains growing very robustly. Aerospace has been a bit soft as of recent. On the electronics side, we've been impacted a little bit on the top line by automotive and have seen some pricing pressure there. That's why the big move to China is no very important and we're moving very rapidly on that.

Tell me, Roger, what does Spincraft do for energy?

The Wisconsin plant has a very large presence in the turbine market with Rolls-Royce. And they make a number of components on the hot side of land-based power turbines.

Okay. And on the aerospace side, I guess I would have thought that business was pretty strong on both commercial and military. Can you just elaborate on why business is kind of soft there?

A lot of it is more customer timing. I mentioned the aerospace side, there are some push outs, push ins that happen periodically in that business. The other aspect of what they do in that particular plant is related to aftermarket in the turbine energy business; that market has also experienced some customer delays as well. Again, we concur with you, we think the long-term trends in that segment are good.

Okay. And the other thing is -- and perhaps it's just me not being clear, but in the foodservice on the meal delivery side, if you could just elaborate a little, Roger, in this way, I guess I thought much of the current weakness versus year ago, particularly last quarter and maybe also in this second quarter, was the fact that a year ago there were some extraordinarily large sales. So I'm just trying to get a better sense as to how much of the apparent weakness is based on the tough comparison versus how much is due to ongoing issues, particularly in this meal delivery area? Have we reached a bottom on a year-over-year basis? So if you could just help me on that a little.

Sure, Michael. There really are two factors. We did exceptionally well in the first quarter and to some extent even the second quarter last year, both were strong the first being much stronger than the second. However, at the same time a fair amount of what that business does is sell these systems to the veteran's hospital organization. The veteran's hospitals are obviously funded by the federal government and they have seen some reduction in their budgets due to the reprioritization of government spending back to the defense side, back to the war side (multiple speakers). So that has impacted them this year as well.

Any feeling as to whether you've kind of hit bottom or it could even tick lower before it picks up, any idea?

I don't think it can lower. We're not, obviously, pleased with where it's at. And the real objective there is to see what we can do to diversify outside of some of the traditional segments because we do expect that the spending in the VA will be down for some time and we clearly need to grow sales or take other action with that business.

Okay, thanks a lot, Roger.

Scott [Honia], CJS Securities.

Good morning. I'm new to your story, so I apologize if you've covered this in a previous release. But I was sort of wondering if you could walk me through each of your segments, in particular where you are now on margins, where you think you can get to and how do you get there over the next several years?

Scott, we haven't really talked to margins in any significant way. So I'd just as soon not take that question at this point in time.

Okay, thank you very much.

(OPERATOR INSTRUCTIONS). At this time, gentlemen, I'm showing no questions.

Okay, if that's all the questions, thanks very much. We look forward to talking to next quarter.

Once again, ladies and gentlemen, we thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a great day.