Standex International Corp (SXI) 2006 Q3 法說會逐字稿

Good day ladies and gentlemen.

Welcome to the Q3 2006 Standex International Corp. earnings conference call. My name is Tony and I'll be your coordinator for today.

[OPERATOR INSTRUCTIONS.]

I'd now like to turn the call over to your speakers for today, Mr. Roger Fix, President and Chief Executive Officer, and Christian Storch Chief Financial Officer.

Please proceed.

Good morning and thank you for joining us.

Please note that hour third quarter financial results news release is available on Standex's website at standex.com.

On this morning's call, Christian will begin with a review of our third quarter financial results, then I'll follow with an update on our operating groups. After that will be happy to take your questions.

Let's start now with our financial review. Christian?

Thanks, Roger, and good morning everyone.

I'd like to remind everyone that 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 third quarter of fiscal 2006, revenues increased 8% to $148.5 million,. from 137.7 million in the third quarter of fiscal 2005. Third quarter income from operations increased by an impressive 35% year over year to $9.3 million from $6.9 million in the third quarter of last year. Operating income as a percentage of sales was 6%, compared to 5% in the third fiscal quarter a year ago . As Roger will discuss in more detail, our operating performance resulted from an efforts to enhance our operational efficiency and improve margins as well as strong sales leverage.

During the quarter, the company completed the sale of Standex Direct, a component of the consumer products group. We believe that we are far enough along with our plans to divest of the rest our consumer products group businesses to reclassify these businesses as discontinued operations. The results from our USECO business unit have also been classified as discontinued operations. Over the past two years we have restructured USECO and worked hard to diversify its product lines into new markets. However the market that this business serves are not growing, and they are not core to that of other equipment businesses. We're now planning to divest of this business which accounted for less than 3% of all food service equipment group sales and incurred a charge to write down the carrying value of the assets in the quarter. The gain of the sale of Standex Direct is included in the results from discontinued operations, and is roughly equivalent to the operating loss and the write-down amount to fair value on the USECO business.

Net income from continuing operations increased 17% to $4.8 million or $0.38 per diluted share in the third quarter of 2006, up from $4.1 million or $0.33 per diluted share in the year ago quarter. Third quarter fiscal 2006 income from discontinued operations was $741,000 or $0.06 a share compared with $622,000 or $0.05 a share in the third quarter of '05. Net income for the third quarter was $5.5 million or $0.44 per diluted share; this compares with net income of $4.7 million or $0.38 per share in the third quarter of fiscal 2005. Our fiscal 2006 3rd quarter net come from continuing operations reflects a tax rate of 34%; this rate is consistent with our year to date rate.

Net working capital decreased to $133.6 million on March 31, 2006 from $134 million at March 31, 2005. As you recall, we define working capital as accounts receivables plus inventories less accounts payable. Since our working capital would not necessarily increase with our sales volume, we are primarily focused on improving our working capital turns. Working capital turns were 5.1 turns of for the fiscal third quarter of 5.0 turns for the fiscal quarter of 2005.

Net debt was $101 million, at March 31, 2006 compared with $102.7 million at December 31, 2005. The decrease was primarily driven by an improvement in inventory turns as well as the proceeds for the Standex Direct business. The company's balance sheet leverage ratio of net debts to total capital improved to 34.9%. We define net debt as short-term debt plus long-term debt less cash.

We continue to measure our balance sheet with an eye on potential acquisition opportunities by maintaining sufficient liquidity.

We began expensing stock options on our FAS 123-R in the fiscal year's first quarter. The impact on third fiscal quarter was a year over year increase in compensation expense of $60,000. Year to date, expense associated with stock-based compensation has increase to $795,000, due in large part to the acceleration of [restricted] stock awards for retirement eligible employees.

With that I'll turn the call back to Roger.

Thanks Christian.

We had an excellent third quarter.

We recorded strong sales and operating profit growth. Three of our four core operating groups showed very significant year over year improvements in their financial performance. In fact, engineered products, engraving, and air distribution products all reported double-digit scores or greater gains in operating income for the quarter.

In addition to our strong financial performance, we also made great strides with our major strategic initiatives. Our divested share of the consumer group businesses is proceeding according to plan. We believe our China sourcing and manufacturing efforts will meet and even exceed our expectations. Further, we expect that our investment this year in our low-cost manufacturing plant in Nogales will yield tremendous benefits for our bottom line for years to come.

Let's get right into performances of each operating segment.

The engineered products group led sales growth for the company with a 15% increase. We saw strong demand across all three of our businesses from this group. This group, this growth was primarily driven by double-digit sales increases by our hydraulics and aviation aerospace products businesses. Our electronics business also performed well in the quarter, after a few quarters of the year over year sales decline. Strong customer demand from the aviation and aerospace segment, and newly acquired and existing industrial customers drove sales in electronics, as we continue to work to diversify the customer base of this business.

The engineered products group bottom-line performance improved significantly from the third quarter a year ago, with a 29% increase in operating income. Operating income growth was primarily due to sales leverage. However we also reduced cost, through productivity improvements gained through investing in automated manufacturing processes, lean manufacturing initiatives and off-shore sourcing of components.

Our engraving group posted a 14% increase in sales year-over-year, as we are seeing very robust global demand. In fact all of our 19 mold-texturizing factories all around the world are working at full capacity. This demand is primarily coming from automotive customers that are revamping existing models and introducing new models in order to stay competitive in a soft auto demand environment. We expect to see strong demand in our engraving group well into fiscal 2007.

Sixty-five percent of the year over year sales growth in engraving can be attributed to our acquisition of Innovent in the second quarter. The Innovent integration process went smoothly and the business has been very accretive since day one. As you may remember, the integrated Innovent into our engraving group because Innovent has a close synergistic fit with the engraving group's role in plate engraving and process equipment businesses. Innovent's products are complementary, and both businesses sell to major manufacturers of goods for consumer markets. We are now in the early phases of our plan to leverage mutual sales channels to help Innovent and the engraving group to accelerate growth into Asia, South America, Eastern Europe, and other developing parts of the world.

We're also making progress with our China manufacturing strategy for for the engraving group. Our current engraving operations in Guangdong is profitable and is growing quite nicely. Because of our positive experience in Guangdong, we expect to bring in a new plant in Shanghai on line on fourth quarter of fiscal 2006. The area in and around Shanghai is one of the fastest growing areas for the production of automobiles and components in China. Our new plant in this area will serve both the Chinese and global OEM customers, and we are very excited about the growth prospects that this plant will open up to the engraving group.

While our sales growth at engraving was impressive, even more exciting was our operating income performance. Operating income for the engraving group rose 83% year over year, driven primarily by sales leverage. The success of the group's productivity enhancement initiatives also had a positive affect on margins. The group has taken aggressive steps to reduce overtime and avoid re-work, and is expanding the use of digital technology to help improve productivity.

The food service equipment group grew sales year-over-year by 8%. The organic growth rate for the group in the quarter was approximately 5%, with the remaining sales growth coming from the Kool Star acquisition. This organic increase was driven by demand for our refrigerated merchandise cases and cabinets, and our walk-in coolers and freezers. A refrigerated merchandising case and Cabinets continues to increase market share in key national accounts and buying groups. The organic sales growth is even more impressive considering the group's strong top-line group growth in the corresponding quarter of fiscal 2005, whereby we benefitted from two major rollouts.

Food service operating income declined by 45%, and was affected by two factors. The first factor was the material cost increases for the company's refrigerated and cabinets and walk-in products. We have already implemented price increases and the third fiscal quarter; as a result, we expect to see a strong recovery in the final quarter of this fiscal year.

The second and most significant factor that affected profitability of the food service group in the third quarter was a slower than expected ramp up of production at our new low cost manufacturing facility in Nogales. As you may remember, our food service group is going to be a key beneficiary of our low-cost manufacturing initiative in Mexico. We have begun ramping up production of the walk-in products that we acquired from Kool Star as well as pumps for beverage dispensing and circulating systems. All the facility and labor costs, product quality, employee skillsets, and employee turnover that we have experienced inMexico are in line with the budgets and expectations. We're also very pleased with the management team we have assembled in Mexico, which has experience in running maquiladora operations. It is simply taking longer than expected to ramp up production, thereby resulting in unplanned startup expenses and underabsorption of this facility which impacted profitability in the quarter. We estimate that it will take about three to four months longer than we expected to complete the ramp up for the products currently being produced in Mexico. We are encouraged by the production rates which we have achieved in Mexico over the past several weeks, and we believe that we will begin to see the financial benefits of this relocation at the beginning of the next fiscal year.

We estimate that the diluted impact of them Mexican facility was approximately $1.6 million in the third quarter, and that the total dilution of our investment in this plant will be up approximately $2 million for fiscal 2006. We had initially expected total dilution for fiscal 2006 of approximately $1 million. But this is a short-term obstacle. While we expect that this initiative will be diluted for one more quarter, we fully expect that our investment in Mexico will yield very positive contributions to our bottom line performance for the long term.

Air distribution products year-over-year sales decreased by 3%, as they continued to take share amid softening housing starts. As we discussed on our call last quarter we are very upbeat about our prospects for this business. ADP is executing well on its growth strategy, which, first of all, includes growing share in the hottest housing marks in the nation such as the Southwest and Southeast. As you may remember from last quarter's call we have historically been underpenetrated in these regions.

Second ,we plan to continue to leverage our size, scale, and geographic breadth to bring our regional and national wholesaler customers with one-stop shopping in a broad array of products and customer support. And third by maintaining relationships with the largest HVAC wholesalers, who continue to grow by acquisition, and are consolidating distribution channel.

ADP is also making significant operational improvements that result in better on-time delivery and fill rates. We're starting to receive some positive responses from our customers about these improvements.

The exciting story at ADP this quarter is our operating income, which increased year over year by 114% What's even more impressive about this increase is that the ADP's margins were also impacted by startup costs in Nogales. This significant increase in operating income was primarily due to favorable metal prices compared with last year. To a lesser extent of our operational improvements and focus on lean manufacturing contributed to this performance. Going forward, we also expect to improve ADP's bottom-line by leveraging our Nogales facility to provide low-cost manufacturing and to save on freight cost to the Southwest market.

As Christian mentioned, the results are our remaining consumer products groups businesses are now reported in discontinued operations, so I'll forgo a review of those businesses this morning. During the quarter we continued to make very good progress in our efforts to divest of these businesses; just before the close of the third quarter we sold our Standex Direct business to privately held State Street Refrig. We remain on schedule to substantially complete the divestiture of the remaining businesses by the end of the fiscal year.

Before we take your questions, let me leave you with three key thoughts.

First, we're very pleased with our results this quarter, especially our bottom line performance. Our 35% increase in operating income demonstrates our success at leveraging sales growth, increasing operating efficiencies, and leveraging lean manufacturing techniques. Second, our investments in lowcost manufacturing and materials sourcing initiatives will provide us with tremendous benefits to our bottom line for years to come. And third, our focused diversity strategy is working. Divestiture of the consumer group businesses provides us with the opportunity to reallocate resources to those strategic businesses that offer opportunities for profitable growth; it also enables us to acquire businesses such as Innovent and Kool Star that are synergistic with our other businesses and quickly contribute to our profitability. As you can see, we are excited about Standex's future. We believe we have the strategy to grow the company profitably for the long term.

With that, Chris and I would be happy to take your questions.

[OPERATOR INSTRUCTIONS.]

Your first question comes from the line of Michael Gardner with Wedge Capital Management. Please proceed.

Good morning, fellas.

Good morning, Michael, how are you?

How are you?

I'm doing fine, and it sounds like you are as well.

Congratulations on some good pieces of news this year. If I could just kind of swing around to the operations as I often do,

Please.

Just starting with engraving -- Roger, you mentioned how in virtually all your facilities, you are running at capacity and you mentioned the start up of the plant in Shanghai; my first question is that is the only to pass the expansion relative to the engraving that you're planning currently?

For the current near term our focus is on at another plant in Shanghai. However, longer term, there is a good probability that we will end up with more plants in China. We see China as, again, a long-term growth opportunity for us and Guangdong is in the south, Shanghai is in the central part. It would be natural for us to have the facility probably in the Tianjin area. Most likely, Michael, we will continue our idea of using what we call a shelter operation where we co-locate several of our divisions in one area. As you've noticed, that we are also looking at opening an electronics facility in Tianjin; we would have a natural place from which to also expand engraving at the appropriate moment.

OK. Now, so that means nothing outside of China, then in terms of engraving, new facilities?

Well, we actually committed very recently to expanding our operation in the Czech Republic. We're also looking at of the other opportunities, perhaps in Turkey and India. But we don't have any definitive plans at this point.

That's okay, keep, keep it tight and keep those prices strong. That's, I mean, are you actually having to turn away business in Europe, for example?

No. We've moved people around. We've moved business around. We have not turned away business and won't turn away business.

And Roger, if I could just, broadening on the Chinese plant development, just to refresh me and perhaps others, are these 100% Standex owned facilities?

Yes, they are. We previously had a joint venture operation in Singapore and China, but we have subsequently acquired 100% of those operations. So all the operations, now, around the world are 100% owned.

And are the Chinese plants typically run by Americans or are they actually run by Chinese nationals?

By nationals.

Our process not only in engraving but as well as in Mexico, is to, in the start-up phases, to put a considerable amount of our resources from, typically, the States, or in some cases out of Europe into those operations to make sure that we properly train both the management and the staff.

We will keep those people in place until such time as the local team is up to speed, but ultimately we will get into the position where we run those with nationals and certianly that's the case in Guangdong.

And you're satisfied in terms of how that's that gone well as 2 your expectations? For management going in?

Yes. It's certainly a process from the start up. There's no question about that, and it takes a lot of time and, frankly, some tender loving care. But clearly for the long term have to be able to manage those facilities locally and that is our expectation, and it's worked out reasonably well for us.

OK.

And just refocusing on engraving, so this nearly 20% operating margin given how you see things, at least in terms of where you have visibility, is that something that can be sustained for a while?

Let's just say that we see this business should be in the high double-digit kind of range and I think if you look at it historically, when volume has been strong that has typically been the case.

Switching to engineered products, that was a heck of a revenue turnaround from the comparison in the second quarter.

And I just want to be sure, I understand where you said the strength came from and is fairly broad-based. I just want to make sure there was no particular delivery blip or something, like maybe a big set of blades, a RollsRoyce or anything like that? Was this really is sustainable kind of shipment distribution?

Well, sustainable or not, there was nothing extraordinary that was going on.

I think, as we tried to explain in the last couple of calls, the extraordinary element, of the comparisons year over year were the special payments, or the one-time payments, that we got in the first and second quarter. We always felt that the underlying businesses during the first and second quarter were performing well, but it was that one-off payment in the prior year's that was kind of distorting things. And as we mentioned, those payments are no longer are impacting year over year in the third quarter.

So I think what you see, it can just appear, year over year, and the markets for hydraulics remain very strong. Aerospace aviation is beginning to pick up. The energy business has been very, very strong for us and we had some good results from -- in electronics as well.

I can imagine how in some of those areas you have, you don't have that much visibility. But I would think in the aviation and aerospace the work with longer lead times and you would have predicted this ability, perhaps I'm wrong, but can you address, are there any of these areas where you actually can see out pretty well?

I think your assessment is pretty accurate.

Obviously, the aviation, energy and aerospace projects are longer lead times and we do have better visibility. And again, we see, whether or not these exact same year over year percentages I won't say, but we see those markets as being relatively strong going forward. And certainly with some of the announcements that have been made more recently about future spending in the space program, some of the pickup in the aviation business, that would seem to bode well for us longer term.

Okay.

Then switching to food service, I just want to make sure, I take your comments on the delay in the Mexican ramp up. But just stepping back a bit, in terms of your expectations today, once everything is up and running, do you expect the long-term cost savings to be what you thought they might be, as I say, a year ago? Has any aspect of this kind of ratcheted down your expectations on a longer-term basis?

No, not at all. Again, we have taken the right steps to eliminate the fixed overhead components for the products that we relocated when we moved Kool Star into Mexico.

We closed a plant and we've moved the Procon, or the pumps for beverage, into Mexico; we closed the facility there so the fixed overhead elements of those operations have been, in fact, eliminated.

So it's now a matter of getting our productivity efficiency levels up in Mexico so we can realize the full labor cost savings coming through.

So what was, Roger, what was the specific problem? Is it, was it the labor learning curve? Was it getting permits? What is it that actually caused the ---

A number of issues. One that you can expect; in some cases, just not having adequate documentation from a manufacturing standpoint. which slowed down the training process.

In other cases, learning the proper material flow across the border. Our operation in Nogales is made up of a warehouse on the U.S. side and a manufacturing facility on the Mexico side. So determining which inventories need to be on which side and what's the best in terms of staging product and releasing work orders, just getting the employees properly trained; the normal kinds of things that you would expect whenever you do a greenfield site as a startup.

That helps. Thanks. And so it sounds like most of the effect of this delay would be in, had have been in, Q3 and maybe go into Q4. Is that a fair statement?

That's our expectation.

And then you talked about USECO.

Was that the one that did a lot of business with the V.A. hospitals and is that what you mean when you -- there was no growth in the market?

That's correct.

USECO -- one of their primary product lines, was rethermalization, in the market they had really utilized, or the utilizers of that product was the V.A.hospital systems. We mentioned in the past that due to the change in the government's budgeting process, that they've withdrawn funding from those investments for a couple of years. That by itself wasn't enough to really cause us to withdraw. Just taking a look at the other markets, we didn't see a lot of growth opportunities, and frankly that whole niche is not core to where our other foodservice businesses are at. The other food businesses are really focused on the national restaurant chains, convenience stores, on retail locations such as drugstores, and the hospital institutional side was just not a big piece of what we do.

And then finally, air distribution.

You did come through, as he said, in terms of catching up on those metals prices. So, I simply wanted to ask, as you look forward to from here, assuming no radical changes going forward on input prices, do you think you are, essentially, caught up and we ought to see more of a pure operating effect going forward or are there still some perturbations you can see in the next couple of quarters that have to be digested?

Well, I think as a general statement, we're trying to look out into the future and working with our suppliers, not just in ADP, but even in food service, for example. Their expectations out there that we will see metal price increases driven by the increase in commodity prices. You better than I, Michael, as you've watched what has happened to commodities over the last couple of months, copper is hitting an all-time high, there's movement on the steel, aluminum fronts, so we have exposure out there, and we have to continue to monitor potential cost increases for us and we make sure we do the right thing from a price standpoint.

As you sit here today, can you see that, if commodity prices stay where they are, we're going back in the tank in Q4 or Q1 given what you can already see?

No, we don't expect to go in the tank.

What I'm saying is that we do expect there is some cost increases that will begin to impact us over the next couple of quarters, and we've got to, we'll react to that.

Okay, thanks very much.

Thank you, Michael.

Your next question comes from the line of Arnie Ursaner with CJS securities. Please proceed.

Good morning. Michael so focused on most of the business issues that I would've gone after; I want to shift gears a little, and talk about your capital structure, if you wouldn't mind. You currently have 34% or so debt, and that's pre the sale of your consumer business. Your debt is well below 2 times EBITDA and you have a lot of different business. Can you focus on how your strategists are your thought processes on how you allocate capital and how you intend to specifically try to use some of the proceeds of the sale of the consumer business, and how you evaluate it within the value of various sectors and do you also also consider share buybacks is the way to enhance shareholder value?

Wow, a lot of questions.

Let me try to take them at a time.

As it relates to capital or CapEx allocation, we have what we feel is a pretty disciplined budgeting operating plan process, whereby the beginning of each fiscal year, we sit down and look at each of the businesses, have a detailed review with each business as to not only their needs and plans for growth for the current year, but reaching out into the future. We will roll those up and then go into the process by which we allocate capital for the current year as well as the out years accordingly. That's done to a pretty disciplined return on our investment kind of process for each project is, in fact, evaluated and we allocate capital accordingly.

On the acquisition side, certainly we identified in previous calls and previously , previous quarter releases is that there are certain segments out there that we feel are more attractive. Certainly the foodservice equipment area, we think is very attractive and we're very interested in the possibility of doing acquisitions in those areas. We feel the aviation, aerospace energy, is a very attractive market with good growth potential, good margins; we would be very interested in doing acquisitions out there. So again there is very much is a strategy by which we did we determine where we would try to focus our acquisition monies, if you will, going forward. Having said that, it's again, it takes a willing buyer and willing seller and our ability to connect in any of those given markets obviously is depend on the availability of targets.

Your third question, share buybacks, yes. We have an open share buyback program. Having said that, we have limited our use of share buybacks to internal usage for buying back options, restricted shares issued to management that have not been out on the open market. Currently, we feel a better use of our available leverage is to again invest in our current businesses and drive acquisitions.

The consumer products business has been one of the lower-operating income margin businesses again the only other one lower is foodservice. Would it be fair to say your goal or intent is to expand into other businesses which have higher operating margins?

Not necessarily.

We think there's a lot of opportunity to improve margins in foodservice; that's one of the reasons why were going to Mexico. That's one of the reason we're pushing the China sourcing initiative is to improve margins. Certainly margin, inherent margin is a big driver and where we do place our capital. But having said that, the growth, the long-term growth aspects of foodservice are pretty attractive as well. Also we think foodservice makes sense to grow in, but we have to improve the margins as well.

And on the fourth level, obviously over the last few years have done a pretty good job of narrowing the businesses from excessive amounts to something perhaps a little more manageable. When you think perhaps your business in a world where many companies are the de-conglometizing, would you think is the best way to enhance shareholder value? And do you have any specific businesses that you think might be better served as independent public companies?

We have no such plan.

Again, the focused diversity strategy, we said that, over time, we go from, to your to point, a mini-diversified conglomerate to a multiplatform industrial company.

The divestment of the consumer group is a major step along those lines, and we believe that the business we have are keepers, and our idea is to try to grow that them going forward.

Thank you very much.

Anytime.

[OPERATOR INSTRUCTIONS]

Gentlemen, there are no questions further in in the queue.

If there's no other questions, thanks very much. We look forward to talking to you again next quarter. Thank you.

This concludes here. Thank you for attention to today's conference. This concludes the presentation. You may now disconnect. Good day.