Standex International Corp (SXI) 2008 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to Standex Fiscal 2008 Third Quarter Earnings Conference Call. My name is Jasmine and I'll be the operator for today. At this time, all attendees are in a listen-one mode. We will conduct a Question and Answer session towards the end of this conference.

(OPERATOR INSTRUCTIONS)

I will now like to turn the presentation over to your host for today's call, Mr. Roger Fix, President and CEO, and Tom DeByle, Chief Financial Officer. You may proceed.

Good morning, and thank you for joining us. Please note that our third quarter financial results news release, which we issued earlier this morning is available on Standex's Web site at standex.com.

Joining us on this morning's call is Tom DeByle, our recently appointed CFO. Tom joined Standex in March and he's responsible for external reporting, financial planning and analysis, treasury, tax, internal audit, information technology, risk management, and investor relations. Tom brings more than 25 years of financial management experience to Standex, including senior roles in large multi-national industrial manufacturing companies. We expect his extensive and successful experience working with publicly-held companies with multiple operating units will be instrumental in our efforts to expand our operations in the U.S. and internationally.

This morning Tom will begin with a review of our third quarter financial results. Then, as we usually do, I'll follow with an update on our operating groups. So with that, let's begin. Tom?

Thanks, Roger, and good morning, everyone. I am pleased to be joining you this morning and I look forward to meeting all of you in the upcoming months.

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 filing and public announcements for a detailed list of the risk factors.

Standex performed well in the third quarter, delivering solid top-line growth and substantially profit improvements in a difficult economic environment. For the third quarter of fiscal 2008, net sales were up 5.2% over last year at $169 million, versus $160.7 million. The increase was completely organic and was driven by solid growth across the three of our operating groups, namely Food Service, Engraving, and Engineered Products.

Ongoing weakness in our residential construction and the off-road heavy construction vehicle market continued to negatively affect sales volumes at our ADP and Hydraulics Groups, respectively.

Third quarter income from operations grew 41% to $6.8 million, compared with $4.8 million in the third quarter of last year.

Operating income, as a percent of sales, was 4%, compared with 3% in the third quarter a year ago.

Interest expense for the quarter was $2.3 million compared to $2.8 million in the prior year.

The third quarter net income from continuing operations was $2.6 million, or $0.21 per diluted share, compared with $1.9 million, or $0.15 per diluted share in Q3 of fiscal 2007.

Our 2008 third quarter net income from continuing operations reflects a tax rate of 32.8%. This compares with a much lower tax rate of 11.5% in the corresponding quarter of last year, due to a decrease in our tax accruals as a result of an expiration of income tax statutes. Our normalized tax rate in the year-ago period would have increased income tax expense by $0.6 million, or $0.05 EPS.

The third quarter of 2008 benefited from a favorable actuarial adjustment to Standex's Workers' Compensation accrual. The year-over-year after-tax effect of the favorable adjustment was $0.5 million, or $0.04 per share.

Net income for the third quarter of fiscal 2008 was $1.6 million, or $0.13 per diluted share. This compares with net income of $1.3 million, or $0.10 in the third quarter of fiscal 2007.

Net loss from discontinued operations was $1 million for the third quarter of 2008, versus a loss of $0.6 million in the prior year. The net loss from discontinued operations in the third quarter of fiscal 2008 included a $1.3 million after-tax accrual for an environmental expense. This had a negative effect on discontinued operations and net income of $0.10 per share.

The U.S. Environmental Protection Agency has requested Standex's participation in a cleanup activity at a site located in Cleveland, Ohio, where the Company leased a building and conducted operations from 1967 until 1979. The site is a former location of the Club Products and Monarch Aluminum Divisions. We are currently evaluating the extent of Standex involvement at the site and have therefore established the accrual.

Net working capital was $133.7 million at March 31, 2008, compared to $129 million at March 31, 2007. We define working capital as accounts receivable plus inventories less accounts payable. Working capital turns increased to 5.1 turns from 5.0 turns in the prior year quarter.

Net debt, which we define as short-term debt plus long-term debt less cash decreased to $127.6 million at March 31, 2008 from $129.1 million at December 31, 2007. The Company's balance sheet leverage ratio of net debt to capital was 36% at the end of the quarter, compared to 36.4% at the end of December 31, 2007.

For the third quarter, depreciation and amortization expense was $4.1 million, down from the prior year of $4.9 million. Capital expenditures during Q3 totaled $1.9 million.

So, with that, I'll turn it back to Roger.

Thanks, Tom. As Tom mentioned, we reported good organic growth from several of our business groups and demonstrated good improvement in the overall profitability of the Company during the third quarter. Let me get right into the details of our third quarter performance and future growth opportunities. Let's start with our largest segment, Food Service.

Food Service Equipment revenues increased by 9.9% year over year to $90.6 million. All of this growth was organic and was driven by double-digit sales increases across most of our food service businesses. Third quarter operating income growth of 72.5% far outpaced the revenue increase due to purchasing cost reductions and improved manufacturing efficiencies. We are taking costs out of our operations, better optimizing our factories, and continuing to implement lean manufacturing techniques to drive improvement in operating margins in this business.

Let me update you on the factors that drove growth during the quarter. First, our existing accounts contributed nicely this quarter. We have a very good base business in our Food Service Group, as comprised of blue chip customers with whom we have long-term relationships. These customers have consistently relied on Standex for their food service equipment needs. Second, we benefited from increased market share at buying groups that we are participating in, as well as some chains that we penetrated during the past few years. Specifically, our federal business benefited from a rollout of specialty merchandising equipment sold to the QuikTrip convenience store chain, and Nor-Lake saw increased volume at a number of quick service and casual dining chains that they have penetrated over the past one to two years. Third, our American Food Service business did a great job in executing on their strategy to expand their network of food service consultants, dealers, and large institutional feeding companies which provide food service to applications such as stadiums and university and hospital cafeterias. We're beginning to see solid traction from this growth strategy and we expect this momentum to continue.

And, finally, our PROCON business delivered solid top- and bottom-line growth this quarter. The margin improvement we have experienced in this business is a reflection of the move to Mexico and material cost reductions due to low cost sourcing.

We're very pleased that many of the initiatives we've been speaking about with you during the past year are resulting in real revenue and operating income growth in our Food Service Equipment business.

Another initiative that we believe will result in growth in future quarters is our move to diversify our revenues geographically. During the third quarter, we made good progress in expanding our presence in Canada. One of our key competitors in Canada went into receivership in the third quarter of this year. As a result, a significant amount of volume was freed up on the cold side of the business and we believe we'll capture more than our fair share of this available sales volume. We've moved aggressively to expand our manufacturer rep and dealer sales channels into Canada where we had previously had limited presence. We expect this move will lead to sales growth ramping up over the next several quarters, especially for our Nor-Lake, Master-Bilt, Federal, and APW Wyott businesses.

Our Nor-Lake business continued to gain momentum this quarter as we moved to diversify our reach and expand it in more U.S. and Canadian quick-serve chains. The largest Canadian quick-serve chain named Nor-Lake as their primary supplier for their indoor walk-in cooler business, which we estimate to be well over $1 million of new business. Nor-Lake already had this chain's U.S. business. Nor-Lake also was successful in signing up one of the premiere dealer representative organizations in Canada, which should generate significant business in the region.

To sum up this segment, we're excited by our long-term opportunities in food service. We plan to continue to leverage sales synergies, drive top-line growth, and enhance operating margins in each one of our food service businesses.

Our Engraving Group led sales growth in the quarter with a 16% year-over-year increase, driven primarily through the Mold-Tech mold texturizing businesses which saw a strong demand in both North America and Europe from our global automotive OEM customers. Third quarter income from operations increased by 38% year over year, primarily due to sales leverage and productivity gains.

In addition to supporting our traditional customers from our locations in North America and Europe, we continue to execute on our strategy of securing long-term growth in emerging markets. We experienced good progress in this area as well during the quarter. First, we continue to see good growth at our new facility in Turkey, from both automotive and non-automotive customers. Several quarters ago, we shared with you that we had recently established a texturizing facility in Turkey to capitalize on the business opportunities we see developing in this region. Second, we've begun to experience increased sales in Eastern Europe as a result of our new much larger engraving facility in the Czech Republic, which we opened in the second quarter of this year. And, finally, another bright spot for us internationally has been China, where we are experiencing nice growth from our mold-texturizing facilities.

Recently, we appointed Phil Whisman as the new president of our Global Engraving Operations. Phil is a seasoned executive with significant experience in managing performance improvement and growing margins. He comes to Standex with solid tier one and tier two experience in the auto industry. He's known for his ability to manage cost-down pressures as well as to expand geographically and grow the business. He'll be seeking opportunities to grow our engraving business into new customer and geographic segments and to enhance the profitability of the business. In order to enhance profitability for this group, we're continuing to implement cost reductions, optimize our manufacturing footprint, and improve the overall productivity from our infrastructure.

Engineered Products Group revenue for the third quarter increased by 16% year over year. Operating income declined by 13% due to a significant increase to a legal reserve relating to a current legal action, temporary manufacturing inefficiencies, and higher material costs.

Sales in our Electronics business were relatively flat year over year. The Electronics business serves five primary markets - automotive, housing, industrial, medical, and aerospace. Sales to the automotive market were flat, while the housing market, not too surprisingly, was down. The weakness in housing was offset by strong demand in new customer sales in the industrial, medical, and aerospace markets.

During the quarter, we announced the closing of one of our facilities in Canada. While the closing of the plant will benefit margins beginning in fiscal 2009, the consolidation process resulted in some short-term manufacturing inefficiencies as we relocated product from Canada into Mexico and China.

Higher costs for precious metals used in the production of reed switches affected electronic margins as well during the quarter, although material substitutions should eliminate this issue beginning with the first quarter of fiscal '09. We continue to focus on margin improvement in the electronics business through plant consolidations, price increases, material cost reductions, and the use of low cost manufacturing in Mexico and China.

Our Spincraft business continues to see excellent demand in the energy, aerospace, and aviation markets. On our last call, I mentioned that we would be installing the necessary equipment to capitalize on the major contracts that we were awarded during the past year. We completed the installation of that equipment in Q3 and have begun the process of training the operators and perfecting the manufacturing processes and tooling for the new equipment. That process created some inefficiencies on the shop floor and affected margins. We believe these inefficiencies should be substantially resolved by the first quarter of fiscal 2009.

Hydraulic Products Group revenues for the quarter fell by 2.4% year over year and operating income decreased by 4.5% as a result of the lower sales volume. The weak demand environment for off-road heavy construction vehicles in the U.S. continued to affect sales and operating income in the quarter. For the past few quarters, the same level -- the same sales level from this group has been relatively flat. So we continue to believe that we're at the bottom of the downturn in the domestic market. The recovery of the market, however, is still uncertain. Internationally, we're continuing to see growth opportunities for our hydraulic cylinders, primarily through export sales into the Middle East, South America, Mexico, and China.

Air Distribution Products Group sales were down 25% as the result of the continued severe downturn in the residential construction market. ADP reported a loss for the quarter due to the sharp decline in sales volume combined with significantly higher material costs. According to some analysts, housing starts are at their lowest point since 1991 and off more than 58% from the peak that occurred roughly just 24 months ago. Clearly, there is a great deal of uncertainty as to when this market will begin to recover.

We do have a few sources of optimism during the next several months. After several quarters of widening cost of raw materials, the market implemented a price increase at the end of April. This should help us offset some of the margin decline we experienced in previous quarters.

In addition, during the quarter, we began to realize orders from several of our new HVAC wholesaler customers in Texas, the southeast and northeast. Part of our strategy for ADP is to leverage our unique nationwide manufacturing infrastructure to achieve market share gains at major HVAC wholesalers.

Before I take your questions, I'll sum up by saying that even in this uncertain economy, we're taking every opportunity to gain share in each and every one of our operating segments. We're opening new geographic and end-user markets for our products, leveraging sales synergies, and we're making the strategic investments necessary to capitalize on these new sales opportunities. At the same time, we're focused on improving operating margins by reducing costs through lean manufacturing, low cost sourcing and manufacturing, plant consolidations, and investments in automation.

We'll now turn to your questions. Operator, please?

(OPERATOR INSTRUCTIONS)

And your first question comes from John Walthausen. Please proceed.

Yes, good morning, and congratulations on good progress here.

Good morning.

I guess the first question is sort of an overall one. Price inflation and raw material inflation is on everybody's lips now. Could you talk about what part of your growth was due to higher prices and which part of your business you are being successful in passing along costs and where there are challenges?

We don't have a precise way of measuring price across the units, but our estimates would indicate that about a percent of our total growth this past quarter was in the form of price. Clearly, most of the cost increases are in the area of commodities. Cold-rolled steel costs have been going up pretty significantly over the last 60 to 90 days. And a number of our businesses are, in fact, impacted by either cold-rolled or products that are made from cold-rolled, specifically our custom hoist business, which put a price increase into effect very recently. Our ADP business, which I mentioned in my comments, put a price increase into effect as well very recently, and also in our food service business, a lot of cold-rolled steel goes into our walk-in cooler business and we're increasing pricing there as well.

Okay, that's helpful. And then if I may, I noticed that over the last few quarters inventory levels have been creeping up. Could you talk about why that is and whether you think that that's a -- that inventories are at a satisfactory level or need to come down or where do you see them?

They have crept up slightly. There's no particular area in which those inventories have gone up. We want to refocus our efforts to lower those inventories back down to a more normal level. But there's no particular emphasis in any one of our business groups, it's just a general creep.

Okay. And you say it's a bid over -- does the bid mean, like, $5 million? Is that a reasonable number?

Yes. We've seen about a 5 or $6 million increase in inventories over the last six months. A lot of that is just associated with -- a couple of our businesses have an ADP. And in custom hoist, our sales volume has been below our forecasted level. We've had to make long-term commitments for inventory, so we've had a bit more inventory come in while we are readjusting our longer-term forecast for those businesses.

Okay, that's helpful. And, then, the food service business, obviously there was a nice gain over last year, but when I look it's sequentially over -- the first quarter, second quarter, third quarter, it's somewhat downward. Can we talk about that? Is some of that -- is there a seasonal aspect or is that a weakening of the business that we should expect to see continuing?

No, it's definitely a seasonal pattern in food service. A significant part, well over 50% of our business in food service, is tied to the construction season. It's tied specifically to new store openings. And, obviously, during our third quarter, the first quarter calendar is one of the slow periods from a weather standpoint for construction. As a result of that, historically, if you look back over the years, you'll see that the sales and profits from the food service business are at their lowest point in the third quarter. Conversely, our fourth quarter and first quarter, the second and third quarter calendar tend to be our strongest quarters.

Okay, great, that's very helpful. And, then, the final one is, in your comments, I think it was on the engineered business, you said that profits were hurt by a legal reserve. Could you expand on what that issue is and whether we would expect to see additional costs related to that in subsequent quarters?

Yes. We have a current court case that's pending in our electronics business in the Engineered Products Group and we took an accrual of roughly $470,000 during the quarter.

Okay. But the court case is ongoing and so it's uncertain as to whether that is the sum total or whether there might be more reserves?

That's our best estimate at this point in time. You're correct in that the court case is ongoing.

Okay. Okay, great. Thank you very much. I'll step back.

Thank you.

And your next question comes from Michael Gardner. You may proceed.

Good morning, Roger, and welcome Tom.

Good morning, Michael.

Good morning.

I just have a couple of questions left over. Just a follow-up, so the environmental reserve is where, then, in the P&L for the quarter?

The significant reserve that Tom mentioned is in discontinued operations. Again, it's related to this Monarch Aluminum business which we actually sold in 1984. We've been out of that business for almost 25 years now.

Okay, okay. I just wanted to talk on the Hydraulic Products Group. You indicated that no certainty about when we turn up, but some believe that we've hit a bottom. Is that only because you've experienced a few sequential flat quarters or do you have any other indications from customers or model changes or anything else that gives you confidence that we're indeed at a bottom?

Certainly, the sales is one observation, but to your point, this business, the domestic dump truck/dump drive business is historically very cyclic. Typically, we'll have three to four years of an up cycle and then a down cycle of one -- more around two years. And so we see this as kind of a typical pattern. We're in the second year of a two-year downturn. I think the other thing that we expect, which is a bit abnormal but we'll overlay on top of the normal cyclic aspect of the market, is that the next round of EPA emission standards that go into effect for Class A trucks will go into effect January 1st of 2010. So we do expect that prior to that round of EPA emissions it will be a flurry of new trucks that are purchased because the new trucks will, again, be less fuel efficient than the older models. So a combination of a normal cyclic pattern coupled with some new emissions standards that we think will cause a recovery in the near term.

Is that the same kind of pop that you saw the last time when emissions standards were tightened? Is that --?

Exactly.

Okay.

Exactly. The government, much like in the automotive industry a number of years ago, has put in what I call a staggered implementation of these new emissions every two years. So, the last one, as you mentioned, Michael, was January 1, 2008, and the next one is January 1, 2010.

Okay. My only other question is on ADP. It seems like it's about as bad as it could get, Roger, just in terms of decline in housing starts and the major rise in input costs. So is it fair to say -- I mean, as far as that perfect storm, is that perfect storm consistent with, say, a $2 million loss rate on an annual basis or do you think even if it stayed at these very pressured levels you could do a little better than that? Might it be worse than that? So I guess I'm asking two things. One is do you also see it as a kind of a near worst case currently and, if so, what do you think that run rate loss might be?

Okay. I can comment to the first one, I'll probably not comment to the second, Michael. You're right; there is a combination of, at least in my perspective, historically high metal costs coupled with a precipitous decline in housing starts that really has over the last, say, 18 months. I'm not going to make a forecast on housing starts, but as I read some of the published forecasts that are out there, NHB and a few others, there's a lot of speculation that housing starts are going to bottom in that 900 to 950,000 annualized starts per year. The March results -- excuse me, February results were 947,000. So, if those forecasts are accurate, it would seem that we are at the bottom from a housing start standpoint. And the housing starts are really a key driver for our volume. The real unknown in my mind is we have a significant amount of inventory on hand, both new and existing homes. More homes coming on the market as a lot of these subprime foreclosures go into effect. So the real question is how long are we going to bounce around at this level? How long will it take before those inventories come back to more normal conditions? And, again, the forecast that I'm reading would say that's out there, at least foreseeable future, 12 months, perhaps even more than that. So I see us kind of bouncing along, hopefully, at the kind of housing start levels we're seeing right now, which would say that, hopefully, our sales volume has more or less flattened.

Metal costs are the real unknown. There's a lot of dynamics out there. Cold-rolled steel, as I mentioned earlier, has spiked very significantly over the last 90 days. Forecast varies to whether or not we've seen the peak or whether we'll start to see some softness in that. And it's all about does the market put into place and does the market accept a price increase. As I mentioned, there was a significant double-digit kind of price increase that went into effect over the last 30 days in the marketplace which will help us with some of the prior cost increases. So I'll give you factors, but, Mike, I'm not really in a position to really predict what the EBIT of this business is going to look like in the near term.

But the $481,000 loss in the quarter was not supported. That's to say it wasn't better than it would otherwise be because of any unusual kind of items or anything that you know that's going to tick down even worse, let's say, going forward?

No.

Leaving aside your inability to predict the housing market or steel prices.

Right. It was a normal from operations kind of operating profit. Really didn't benefit from the price increase that went into effect really late March and into the April time frame. So it was basically the reflection of the run rate on housing starts and the metal costs and no price increases.

Okay, thanks a lot, Roger.

Thank you.

And your next question comes from Gerry Heffernan. You may proceed.

Good morning, gentlemen, thanks for the call here today.

Good morning.

I'd like to pursue a topic that I believe the first questioner dove into, and that was asking about the, particularly in the Food Service Group, understanding the sequential results, with the backdrop that there is a seasonality. Because the numbers just seem to be rather large, as far as the margin decline, when I relate it to the amount of revenue that it declined.

Go ahead.

I guess to be more clear, if I look at the first half of '08, the food service operating income was 9.3%. The operating income margin, I should say, was 9.3% and the third quarter '08 was 6.8%. So that's a 250 basis point jump -- drop. And if I look at the consolidated numbers overall, the gross margin drop from the first half number to the third quarter result was only about 70 basis points. So it seems as though there was a big expense issue there in food service, and just would like to go through that a little bit more.

There was really no significant change in the SG&A cost structure. There's been no significant additions from a headcount standpoint. Our SG&A is predominantly fixed as we go through these -- the seasonal down periods in the third quarter. So I really -- there's really nothing unusual that I can point to to respond directly to your question.

Okay. Any changes in the allocation of expenses to the food service equipment that may have occurred?

No.

Okay. I believe in the opening statements when we were talking about the air distribution products, reference was made to a price increase. Could you just review that again please?

Correct. As I mentioned, the market implemented a double-digit, low double-digit, price increase in the late March, early April time frame for orders shipped anytime after that point in time. So none of that was really into effect for our third quarter but will begin to affect our fourth quarter results.

Okay. Now, you say the market implemented it. In other words, what has the customer response to this been? I mean, is this a done deal? Is the price increase in or are we getting push back or why would we be confident that this will be successful?

Our experience at this point has been that the customer base has seemed to accept that price increase and it would appear that most of the competitors in this market have implemented a similar kind of cost increase, price increase, based on what our customer is telling us.

Okay. Looking at a quarterly operating income loss in that area, is this sufficient to get us to breakeven?

It all depends on volume and what happens to future metal costs, but assuming flat volume, flat metal costs, yes, a double-digit increase would get us to -- would get us to profitability.

Okay. You don't seem to be real confident about this holding on or the volumes holding on. Am I reading that correctly?

No, it's just that, again, metal costs are fluctuating pretty significantly, really on a weekly, certainly monthly, basis. We're, as we talked a little earlier, it's a little hard to predict exactly where housing starts are going. But assuming housing starts don't deteriorate dramatically and metal costs stay roughly where they're at, then certainly that would swing us to profitability. But, again, housing starts and metal costs going forward are really the key questions.

Okay. In regards to the legal reserve, was this legal reserve to pay just for the costs associated with the efforts in the case? Was this reserve for the risk of having to make a payout for a legal decision? Could you just give us a little bit more description of what's going on here?

Yes. It's primarily the latter part - anticipation of a potential settlement in that lawsuit and taking the accrual for the settlement and the associated legal expenses.

Okay. And what was the -- did you say the amount was $400,000?

$470,000 in the quarter.

$470,000, okay. Very good. I'll get back in queue. Thank you.

Thank you.

You have no questions at this time. I'd like to turn the call back to Mr. Roger Fix. You may proceed.

Thank you for your questions and we look forward to talking to you again at the end of our fourth quarter. Thanks very much.

Thank you for attending today's conference. This concludes your presentation. You may now disconnect. Good day.