Standex International Corp (SXI) 2009 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third quarter 2009 Standex International Corporation earnings conference call. My name is Shanika, and I will be your coordinator for today. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of this conference. (Operator Instructions).

I would now like to turn the call over to Mr. David Calusdian, Director at Sharon Merrill. Please proceed.

Thank you and good morning. Please see Standex's Safe Harbor passage on slide two.

Matters Standex management will discuss on today's conference call will include predictions, estimates, expectations and other forward-looking statements. These statements are subject to risks and uncertainties that could cause actual results to differ materially. You should refer to Standex's recent SEC filings and public announcements for a detailed list of risk factors.

In addition, I would like to remind you that today's discussion will include references to EBITDA, which is earnings before interest, taxes, depreciation and amortization. Non-GAAP net income, non-GAAP income from operations, non-GAAP net income from continuing operations, and free cash flow. 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. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP measures is available in Standex's third quarter news release.

On the call today is Standex Chief Executive Officer, Roger Fix, and Chief Financial Officer, Tom DeByle. I'd now like to turn the call over to Roger.

Thanks, David, and good morning, everyone. Please turn to slide three.

Standex felt the full impact of the current recession during the third quarter. The only business that was not affected was Spincraft, which resides within our Engineered Products Group. Our third quarter revenues were $131 million, down 22.5% compared with a year ago.

As we discussed on our second quarter investor call, we have taken aggressive actions to address the two factors that management can control under these types of recessionary market conditions -- namely, our cost structure and cash flow.

On our last call, we reviewed the specific actions we had begun to implement in order to significantly reduce our cost structure. Our cost reduction actions are focused on work force cutbacks, compensation controls, plant consolidations, and material cost reductions. We've already seen a dramatic improvement in Q3, with our operating expenses across the Company coming in 28.3% lower than the same quarter a year ago. Our total compensation expense run rate in the US at the end of Q3 is down 20.5% since the beginning of the fiscal year.

Let me give you some added context in terms of how our cost reduction actions are affecting the bottom line. In the third quarter of last year, our operating expenses, combined with indirect labor -- which is in the Cost of Goods line -- was $54.7 million. In the third quarter of 2009, our operating expenses and indirect labor total was 28.7% lower at $39 million.

I should note that the $15.7 million year-over-year reduction included a $3.6 million bonus and long-term incentive accrual reversal. Without this accrual reversal, our operating and indirect labor expenses were still down $12.1 million or 22.1% versus the prior-year quarter. The 22% reduction in operating and indirect labor expense is directly in line with the year-over-year decline in sales volume.

Since several of our cost reduction activities are ongoing, we expect to see further improvement in operating expenses through the course of the calendar year. Based on our cost reduction efforts implemented and identified to date, we expect to realize annualized savings of about $25 million beginning in the first half of fiscal 2010. This exceeds the $20 million we originally projected on our last call.

We're pleased with the results of our efforts to significantly reduce our cost structure going forward. In fact, this success has enabled us to substantially decrease our breakeven to be profitable at much lower sales volumes.

While our cost savings have been dramatic, the significant reduction in sales volumes still had a negative impact on our bottom line. We reported a GAAP operating loss in the quarter of $19.9 million. Excluding several extraordinary items, which Tom will discuss in just a minute, non-GAAP operating income declined 60.2% to $2.7 million compared with $6.8 million last year.

In addition to our focus on cost reductions, we have continued to aggressively pursue cash flow generation and debt reduction. During the quarter, we generated exceptional free cash flow, excluding non-recurring items of $28 million, bringing our total free cash flow for the fiscal year to $44.4 million.

The strong cash flow generation was primarily the result of a $24.0 million reduction in working capital that we achieved during the quarter. The combination of very good operating cash flow coupled with repatriation of foreign cash enabled us to reduce our net debt during the quarter by $19.1 million.

Now Tom will provide you the details on our financials, and then I'll be back to review each of our business segments and offer our perspective going forward.

Thanks, Roger, and good morning, everyone. Thanks for joining us today. Let's turn to slide four and get right into our quarterly results.

For the third quarter of fiscal 2009, our 22.5% net sales decline included a negative foreign exchange impact of 2.5%.

On slide five, we take a closer look at our income statement. Our third quarter operating loss on a GAAP basis was $19.9 million compared with an operating income of $6.8 million in the same period last year. As Roger just mentioned, on a non-GAAP basis, operating income was down 60.2% to $2.7 million compared with an operating income of $6.8 million in the same period in 2008.

Non-GAAP results for the third quarter of 2009 exclude a pretax, non-cash, goodwill and intangible impairment charge of $21.3 million. The non-cash goodwill and impairment charge was a result of an interim goodwill impairment analysis as required by the Statement of Financial Accounting Standards number 142.

As a result of this analysis, and due to the worldwide economic downturn and the decrease in our market valuation, we wrote off $21.3 million of goodwill and intangible assets relating to the acquisition of Associated American Industries, AAI. While this non-cash charge had a significant effect on our GAAP results for the quarter, it does not affect our liquidity.

I should note that although the Company has completed its goodwill impairment analysis, we are currently awaiting finalization of goodwill considerations from our auditors. We expect to report the reviewed goodwill and intangible asset impairment charge when we file our Form 10-Q for the third quarter of fiscal 2009.

Our non-GAAP results also exclude a restructuring charge of $1.4 million related to severance and plant consolidations of $3.5 million lower of cost or market adjustment to the inventory at Air Distribution Products Group, and a benefit of $3.6 million from the reversal of accruals from the Company's long-term incentive plan and bonus program.

We announced in the third quarter that for 2009, there'd be no FY '09 incentive bonuses across the organization, no payouts for the FY '09 long-term incentive plan for senior management, and that employer contributions to non-union employee 401(k)'s would be temporarily suspended after April 15, 2009.

It is important to note that adjusting for these items, our operating income leveraged down 10.7%. This is a positive sign, given that without the cost reductions we had implemented, normal leverage down would have been in the range of 35% to 40%.

Due to the lower borrowing and the lower effective interest rate, interest expense for the quarter was $1.4 million compared with $2.3 million in the prior year.

Third quarter net loss was $19.9 million or $1.48 per share. Non-GAAP net income from continuing operations was $1 million or $0.08 a share in the third quarter of fiscal 2009, compared with net income of $1.6 million or $0.13 a share a year ago.

Non-GAAP net income from continuing operations for 2009 excludes the non-cash goodwill impairment charge, the lower cost [to] market adjustment, the restructuring charges, and the benefit from the bonus and LTIP accrual reversal that I had mentioned. It also exclude a non-cash $1.7 million tax benefit related to the realignment of the Company's foreign legal structure.

We have made some changes to our foreign legal structure to better manage our cash on a global basis. One outcome of this realignment was that we were able to reduce a deferred tax liability on the US books, resulting in a discreet tax benefit.

Our 2009 third quarter net loss from continuing operations reflects a tax rate of 15.1%, which is primarily the result of the aforementioned discreet tax benefits and the goodwill impairment charge recognized in the quarter. This compares with a tax rate of 32.8% in the corresponding quarter last year.

Third quarter fiscal 2009 EBITDA, including non-recurring items, was a loss of $17.8 million. Excluding these items, EBITDA was $4.9 million. This compares with EBITDA of $10.3 million in the third quarter fiscal 2008.

Before leaving slide five, let me leave you with one main message. Excluding all non-reoccurring charges, the Company generated $0.08 earnings per share on sales of $131 million, which were down 22.5% from the prior year. This is a direct result of the significant cost reductions that were achieved across the business.

Turning to slide six, you can see that, as Roger mentioned, our focus on working capital resulted in significant improvements in the third quarter. We decreased networking capital by $24.1 million in the quarter to $102.2 million at March 31, 2009, compared with $126.3 million at December 31, 2008.

The decrease was due to $10.9 million reduction in accounts receivable; $9.3 million reduction in inventory; and a $4 million increase in accounts payable. We define working capital as accounts receivable plus inventories, less accounts payable. Working capital turns improved to 5.1 from 4.9 during the quarter.

Let's turn to slide seven and take a look at our success in generating strong free cash flow for this quarter.

As you can see from this slide, we generated cash from EBIT and EBITDA, excluding the goodwill impairment charge. And as you saw in the previous slide, we generated $24.1 million for the quarter and $22.3 million year-to-date from our working capital improvements. We are proud of this accomplishment. We have limited CapEx in Q3 of only $1 million and $5 million year-to-date.

In total, we generated $28 million in free cash flow for the quarter and $44.4 million for the year. Again, this excludes the non-reoccurring items.

If you turn to slide eight, I'd like to focus on the progress we made in reducing the funded portion of our debt. This has been a key financial objective for us, and we were very successful in dramatically reducing funded debt in the quarter.

We reduced funded debt by $22.4 million or 16.9% in the quarter to $109.6 million. This was a result of our focus on repatriation of cash as well as cash generated from operations to pay down debt. It is important to emphasize that we were able to repatriate cash without any significant tax impact.

Let's turn to slide nine and take a look at our net debt. We define net debt as short-term debt plus long-term debt, or funded debt, plus cash. Net debt decreased by 16.7% from $114.5 million at December 31, 2008 to $95.4 million at March 31, 2009. Again, this demonstrates our focus on paying down debt.

The Company's balance sheet leverage ratio of net debt to capital declined to 33.2% at the end of the quarter, compared with 35.1% at December 31, 2008.

Before I turn the call back to Roger, I'd like to provide updates on two issues related to our discontinued operations.

First, the remediation activities at the Cleveland site have been completed. We have demobilized our consultants from the site, and we are in the process of writing and submitting the final report to the EPA. At this point, we believe we are on budget relating to the $4 million accrual that was established for remediation activities.

The other issue relates to leases associated with the divestiture of Berean Christian bookstore. As a reminder, we sold Berean in 2006 to a private equity group. And as part of the divestiture, Standex remained as a guarantor of the original leases for the stores.

Although Berean continues to operate, we had booked an accrual for our exposure on those leases at the end of the second quarter because we had sufficient concerns regarding their financial condition. We continue to believe that the impairment of those leases will result in a liability of approximately $2.7 million net of sublease income.

So with that, I'll turn the call back to Roger, and you can turn to slide 10.

Thanks, Tom. Let me take you through how each one of our operating groups performed in the quarter and discuss what we see ahead of us. It's important to note in looking at our operating income for each segment, that the benefit from the LTIP and bonus accrual reversal amounting to $3.6 million is included in those figures.

Let's start with food service and you can turn to slide 11, please.

Food service equipment third quarter revenues fell by 18.2% year-over-year, as the global economic recession continued to pressure industry spending on new food service equipment. Operating income was down 7.2% year-over-year, excluding a $21.3 million non-cash goodwill and intangible asset impairment recorded at AEI.

As we've discussed on past calls, the recession is affecting various components of the food service equipment business at different rates, based on both equipment type and end markets. The hot side of our business has been faring worse than the cold side. Since our hot side products typically carry higher margins, this has created an additional deleveraging effect on our bottom line.

Let me provide you with some additional context on the food service business.

Our hot side of the business manufactures a variety of products -- hot display cabinets and storage systems; commercial ovens; rotisseries; cooking equipment; and hot food countertop products, just to name a few. The hot side of our business has a higher exposure to the casual dining sector and small specialty food outlets, which continue to be among the most severely impacted segments of the industry, as consumers dine out less, and when they do, downgrade to quick service restaurants.

Moreover, the smaller casual dining restaurants are typically sourced through smaller food service equipment dealers, which are being hurt by the credit market freeze.

The cold side of our business also experienced year-over-year sales declines, but not as severe as those on the hot side. This is because our Refrigerated Solutions Group has a higher exposure to both quick service restaurants and retail chains, which performed much better in the quarter, as these chains have continued with their new store opening program and as the quick service restaurant low-priced menus continues to appeal to consumers.

We're continuing to see demand from the institutional side of our business. The institutional food service providers that sell to stadiums, as well as university and hospital cafeterias, typically have longer-term pipelines so they are slower to be affected by swings in the economy.

As you look to the final quarter of the fiscal year and into fiscal 2010, we're focusing on achieving market share gains, cost reductions across the business units, and operating cash flow. However, we expect that the economy will continue to have a negative effect on our sales and margins for the near-term.

Turning to slide 12, Engraving Group sales decreased by 24.4% year-over-year and operating income was off by 34%, as sales continue to be affected by lower overall global demand. Operating income in our North American operations benefited from plant consolidations, cost reductions, and productivity improvements. However, operating income performance at our international operations was negatively affected by three factors.

First, we reported lower year-over-year volumes. Second, we had a negative foreign exchange impact due to the strengthening of the US dollar. And third, we recorded a lower proportion of higher-margin sales to automotive OEM manufacturers.

Looking ahead, we expect international sales to continue to be weak due to the lack of automotive platform work. And we are concerned about the financial welfare of US automotive OEMs and the potential impact that it could have on our mold texturizing business. While the automotive markets will continue to struggle due to the economy, we are pleased with the progress we've made in taking market share in diverse, non-automotive markets.

We continue to be very excited about the new technologies that our Engraving Group began introducing during the third quarter to our automotive customers in Europe. As you may recall from our last investor call, we developed two new patented engraving processes to expand our automotive mold texturizing business.

These two new processes -- slush molding and laser engraving of (inaudible) covered rolls enable us to offer our automobile customers all of the tooling required to produce all the texturize components in the interior of their new and updated platforms, in the plastic interior parts and upholstery to the instrument panel and leather passenger seats.

Now instead of going to three or more different suppliers, OEMs can get all of their texturized tooling needs met through Standex. Moreover, automotive OEMs find our value propositions very compelling, as it enables them to produce car interiors with superior cosmetics and at the same time streamline the development time and costs.

These premium processes create richer, deeper grains, and present excellent growth opportunities for engraving, as we look to 2010 and beyond. Already we have secured purchase commitments of approximately $1 million related to these technologies after only 90 days on the market.

These technologies currently have been introduced to our customers in Europe and we'll soon be introducing them to our customers in North America and Asia.

Turn to slide 13, please. Our Engineered Products Group reported a 27.1% year-over-year increase in profitability on a sales decline of 13.5%. Spincraft sales continue to grow as it benefited from the strength in all of its end markets, including energy, aerospace, and aviation, and its backlog remains strong.

Turning to the electronics business, sales were down year-over-year as weaknesses in the housing and automotive sectors continue. Nonetheless, we reported double-digit operating income growth as a result of the cost reductions and plant consolidations that was implemented during the past 12 months.

During the quarter, we leveraged our engineering expertise in electronics and launched a new line of miniature, engineered reed switches. These switches will be engineered and manufactured for use in medical devices, initially in hearing aids, and eventually for other medical-related applications where zero-power on/off switching is important. This represents a new market opportunity for us and positions us to grow in the higher-margin medical device market. We expect this will be a key growth area for electronics in fiscal 2010 and beyond.

On slide 14, we discuss the Hydraulics Group. Hydraulic Products Group revenues for the quarter declined by 47.4% year-over-year, and the Group reported an operating loss for the quarter. Sales were severely impacted by extreme weakness in both the North America and export markets caused by the continued downturn in hydraulics end markets.

Although the downturn in the US offroad heavy construction vehicle market continues to depress sales for another quarter, three factors lead us to be cautiously optimistic about this group.

First, we believe that the economic stimulus package could stimulate infrastructure-related construction, which would lead to growth in this group.

Second, metal prices are coming down and will be lower in the fourth quarter compared with the third quarter of fiscal 2009. And finally, the automated machining equipment we installed in the first half of 2009 is fully up and running, which should help with productivity going forward.

During the quarter, we met our goal of shipping our first production lot of telescopic hoists out of our new manufacturing facility in Tianjin, China. We expect this facility should be profitable in fiscal 2010 and beyond.

Turning to slide 15, you'll see that air distribution products sales were down by 40% and recorded an operating loss in the quarter. As we had cautioned on our Q2 call, three major factors affected our results in ADP for the quarter.

First, sales volume continued to decline in line with housing starts. We also saw a pricing pressure as competitors dropped their prices in order to win business. And finally, average metal cost increased in the quarter.

As a result of high-priced fuel on hand and the significant decline in ADP sales volumes, we recorded a $3.5 million lower of cost or market inventory adjustment in the third fiscal quarter. As a result of this adjustment in our lower-cost [deal on order], we expect to report operating income in the fourth quarter of 2009 and through the first half of fiscal 2010, assuming sales volumes do not deteriorate further.

Going forward, ADP will continue to focus on what we can control -- namely costs. At the same time, we're being more aggressive on the sales side and adding some new products.

Let's turn to our summary on slide 16. While visibility remains very difficult, we expect that the worldwide recession will continue to have an affect on our financial results, as we complete the fiscal year and head into fiscal 2010. As a result of the economic conditions and our lack of visibility, we'll continue to drive cost reductions and focus on cash generation.

The cost reductions we are implementing should result in approximately $25 million of annualized cost savings during the first half of fiscal 2010. In addition, given the uncertainty regarding the length of the recession and our current lack of visibility to future earnings, our Board of Directors has voted to temporarily reduce the Company's quarterly dividend from $0.21 per share to $0.05 per share.

The Board is firmly committed to Standex remaining a dividend-paying Company for the long-term, and believes this temporary reduction is prudent, given the current lack of visibility into the state of the economy.

Certainly, we have near-term challenges caused by the worldwide -- by economic downturn, but we're taking the necessary actions to reduce our cost structure, maximize profitability, and strengthen our balance sheet. And we're continuing to innovate at each of one of our operating groups, which should enable us to take market share and outperform our competition when our end markets rebound.

With that, Tom and I are available to take your questions.

(Operator Instructions). DeForest Hinman, Walthausen & Co.

I have a few questions. To start with the air distribution business -- there's quite a bit of weakness with new home construction. It looks like sales really kind of fell off a cliff year-over-year and sequentially. Are we going to need to do more restructuring in that business?

We think we've done about as much restructuring as we can do. We closed one of our plants in our first quarter of our fiscal year. This business is very geographic in nature. The product doesn't lend itself to easily being shipped long distances because of the configuration.

We closed the plant in Illinois because we felt we could service the customers in that area from other facilities nearby. One was in Mississippi; the other was in Minnesota, for example. We were shipping down into that kind of upper Midwest area.

As we look at the remaining platform we don't see much opportunity. Having said that, we do seem to see some final stability beginning to form in housing starts.

Our third quarter sales are related to housing starts that occurred probably four to five months earlier. We normally see about a four to five-month lag. So, our third quarter sales really were affected by housing starts sort of in that September through December timeframe. And as you recall, there was a really bad decline in housing starts.

You look more recently, we seem to have stabilized, particularly single-home starts have stabilized. Some of the multi-home have still been a little softer. So we're cautiously optimistic that we're at the bottom and that we'll start to see some recovery going forward.

All right. And then when I look at that segment just historically, there seems to be a little bit of seasonality in terms of the first half sales look to be a little bit stronger than the second half.

Obviously, there's a little bit of a disconnect recently. But if I'm thinking about next year, is that seasonality going to be as apparent? Or are we kind of trickling along or moving up a little bit directionally from that third quarter result? Can you help me think about that going forward?

Well, your observation is exactly right. The seasonality you described is there. What we've seen over the last two or three years is that -- of course, housing starts have been following so rapidly that it's overwhelmed, if you will, the traditional seasonal pattern.

Recall that -- I think it was April of 2006, housing starts peaked at about 2.2 million starts. And we're down to, what, 500,000 -- over 500,000 starts now. That's an 80% decline. So you can envision that that seasonality, which is more on the order of maybe 10% plus or minus, up or down from relative quarters, that that decline obviously overwhelmed it. Assuming we see a bottom, yes, I think you'll see that seasonality return.

The other thing I would point out to you, if you take a look -- as obviously we've been monitoring starts very closely, this market is subject to very big extremes. It seems it wants to overcorrect, both up and down. So our hope is that when it does turn, it will be a rather sharp uptick.

All right. And from the air distribution product standpoint, is there a fair amount of inventory held on a distributor basis? Or is that mainly pretty thin? Because I could imagine in this type of environment it's already low to begin with.

Yes. We go through a two-step distribution. We'll sell to wholesalers who will inventory and they in turn will sell to contractors who, generally speaking, will be installing the equipment. The wholesalers do hold inventory, but we have very routine inventories to them -- a normal size wholesale location probably will receive product -- well, at these lines, perhaps a little less often, but let's say every couple of weeks, if not more often.

So their inventory -- they're obviously working on pretty thin margins and are trying to maximize their inventory turns. So as a result, they don't hold a lot of inventory. And that pipeline is pretty responsive; it doesn't get caught with a lot of excess inventory, generally speaking.

All right. And kind of that same question for the food service business -- sales were progressing, it seemed to be fairly strong in the first quarter. I think we may have had some acquisition benefit in there but I'm not exactly sure, but now it seems to have really fallen. I know restaurants are more cautious with CapEx spending and also their new location openings, but how are the distributors thinking about products?

Sure. First of all, in that timeframe, there were no acquisitions. So everything you saw there was organic with a little bit of FX because there was some international exposure. But there's no acquisitions in that timeframe.

We began to see the impact of the recession on our food service business in the early part of our second quarter, let's say in the October timeframe, particularly on the hot side of the business, where, again, we've mentioned that -- we do not go through distributors, typically but we go through dealers.

The dealers, again, are much like we saw on ADP, they do stock product. And they're working again on inventory turns. And as their business started to slow down, they obviously saw that their inventories were not moving as rapidly. And we believe that there has been a destocking going on.

The other point to make about food service is that most of the dealers are in some type of incentive program, either a buying group or a specific incentive program set up for them. Those run on a calendar year. And typically, what they'll do is they'll not reduce their inventories or their buying activities late in the year because they want to maximize their rebates.

So the combination of slowing business and the fact that they didn't respond quickly in order to be able to maximize their rebates coming into the November/December timeframe, really caused us to see a pretty big slowdown through the dealer operations in this past Q3.

We don't have specific data, but certainly anecdotal comments we're getting from dealers is that it took them that Q3 timeframe to destock and we're hopeful that we'll see some pickup in bookings as that destocking has been completed.

Now, if I look at the business sequentially from a margin basis and I add back the impairment charges on the goodwill and intangible basis, it looks like we've got 160 basis points sequentially of operating margin improvement. Is that materials prices falling? Is it labor benefits? Or can you help me understand that?

Yes. And I don't have precise figures, but a fair amount of that would have been the bonus collapse. We mentioned to you that the bonus collapse had been obviously put into the segment data. But we are seeing very significant cost reductions coming through. We have one plant closing and a lot of material cost improvements that are coming through, as well as the headcount reductions. So it's a combination of all the above.

So is the bonus collapse primarily in the food service business?

No. No, it's spread throughout. Potentially -- I assume you could roughly use sales as an indication of how it's spread.

Okay, that's helpful. And in the food service business with metal prices falling, are we -- how is pricing in that market?

I hope my customers aren't listening. Pricing has been pretty stable.

Okay. Now, when I look at the Engineered Products segment, you talk about the strengths in industrial and aviation, but then at the same time you have housing and automotive weakening. If we think about the mix in that segment, is it possible that if industrial and aviation stayed strong, that segment could possibly be growing in fiscal year '10?

Well, we don't give forward-looking statements, but I would say this -- that our long-term -- there's really two businesses inside Engineered Products. One is called Spincraft, and that's the business that has the exposure to energy, aerospace and aviation. The other business is Electronics, which has a very diverse exposure, but it's the one that has the housing and white goods and automotive exposure.

It really depends on where we're at in the recession, but assuming that we're close to being at the bottom and therefore the electronics volume hopefully won't decline significantly from this point forward, yes, I would hope that because we believe the Spincraft business is going to continue to grow, that we should see sequential growth out of that business.

But again, we're not making a call on the recession.

All right. Well, I guess a different way to ask that question then -- can you tell me what percentage of third quarter sales are Spincraft and what rate that is growing and then Electronics?

We haven't disclosed that.

Well, in terms of ballpark, is Spincraft smaller than Electronics? Because it seems that way, at least in the third quarter.

No, Spincraft is larger.

Okay. And how are we thinking about defense spending in our outlook, I guess, going forward? What is your reading on that?

Very little of our Spincraft sales are defense-related. Most of it is aerospace, which is non-defense, Boeing and Lockheed being our biggest customers on that side. The only major platform we have on the defense side is we're on the V-22 Osprey program and that's got funding out several years where it's been committed. So I don't see a big impact on Spincraft as a result of what might go on in the defense side.

Okay. And on the engraving business, I don't think we commented on this, but obviously the financial conditions of GM and Chrysler are in question. Have we taken increased bad debt reserves in that business in light of what's going on?

We have not, but we've taken -- obviously, we're very concerned about the impact. So we've done a lot to mitigate our exposure.

First of all, although we work directly with the OEMs, Chrysler, GM, Ford, Fiat, et cetera, to design cars and be involved with their design as relative to textures, our payment is through the Tier 1, 2, and 3's. We actually sit at a tier 3 in most cases. So our exposure is not to the OEMs themselves but to the Tier 2's.

What we have done is a number of things. In the US right now what we're doing is we're applying liens on each one of the molds that we texturize, so in the event of a default, we'd stand as a secured creditor.

Also, the vast majority of our North American texturizing work is now going through our Canadian operation. And the Canadian government has actually provided a very affordable AR insurance program for Canadian-based manufacturers, which we have applied for. So, essentially all of our North American automotive work is either secured through liens and/or through the AR insurance.

Our exposure is really more in Europe. But again, there's not a significant amount of North American OEM work going on over there. (multiple speakers) We feel like we're in reasonably good shape, given our mitigation actions.

All right. And then the liens on the malls -- are those interchangeable between OEMs where it's being used on material and anyone can use that? Or is that just because you don't want someone else to get their hands on it?

It's just that -- we've found over the years that if there's a bankruptcy, that the lien makes us, again, a secured creditor and we're able to, in many cases, if not most cases, reclaim a significant portion of our outstanding ER.

Okay. And the dividend policy -- you've made it sound like it's a shorter-term dividend cut. So my question is, what type of environment would lead us to increase the dividend? And that being said, would the goal be to increase the dividend directionally upward? Or would it be to take it back to the historic level of -- I think it was $0.21 a quarter?

We don't have a formal dividend policy. I really can't answer that question directly. What I can tell you is that this Company has a very, very strong commitment to paying dividends.

This was a very signification decision on the Board's part, one that was given a lot of consideration. Typically what the Board will do is look at how the business is performing, how it's expected to perform, will make the appropriate decision relative to what the dividend payment should be.

Clearly, our expectation is long-term the business is going to pick up and improve financially, and you'll see our dividends increase accordingly.

All right. That was all my questions. Thank you.

Thank you for your questions.

Michael Gardner, WEDGE Capital Management.

Good morning, gentlemen.

Good morning, Michael. Long-time no talk (multiple speakers).

Yes, same here, Roger. Thanks for the thorough presentation. I just have a couple of questions. One is on the goodwill impairment. I just want to know, how much of that might you characterize as driven top-down by the fact that you've got to take into account your lower stock price in other top-down type of issues versus bottom-up in the sense of lower, long-term expectations for AAI's actual business?

As a dumb engineer, I'll tell you, 100% of it is top-down. We got caught out -- not caught out, poor choice of words -- and my accounting friends will probably hang me here -- but I don't come across as an impairment expert.

But seriously, the measurement date was March 31 and, Mike, you've been into our stock for over a decade, as I know. And I haven't gone back, but I know in the 15 years that I've looked at it, that was probably the lowest stock price we've had (multiple speakers) [in a 10 year] period.

So exactly the point you made, our measurement for goodwill impairment had to be made given the $9.20 share price. And that caused all that top-down pressure. We still believe very strongly in AAI business. It's a long-term key for us. It's going to be a significant contributor to the food service business. And again, this is all accounting policy-driven situation.

And of course, you can't control the macro situation, but just to be sure, so this is not based on some sort of market share loss or lower long-term expectations for the dynamics of that business.

Absolutely not.

Okay. And then my other question is simply -- can you give us an update on where you stand on the covenants that cover your credit facility? You know, if you can give us a sense of where those metrics stand and how comfortable you are that you'll be able to manage through the next few quarters in that regard?

Well, we haven't revealed specifics. It will be included in our 10-Q and I prefer to wait till the 10-Q comes out to give you specific numbers; but what I can tell you that we've actually seen either flat or moderate improvements over the last several quarters on all of our interest debt, our interest coverage and our debts ratio covenants.

Clearly, we're concerned about the length and depth of the recession and what that might do to our performance, so I'm not going to make any comments going forward. But again, we've actually seen some general improvement or basically being flat, with some good cushion in those covenants.

Can you just qualitatively relate, Roger, whether -- I mean, I assume you're kind of in regular contact with the banks, how cordial are those conversations? Any sense of that, in terms of their understanding of how you're doing relative to the recession?

We do stay in very close contact with the banks. And in fact, because of the significant restructuring that's going on in the business, we actually had a session with all the members of our bank group during this past quarter, to explain to them very thoroughly what we were doing and why we were doing it.

I think generally there, they were very appreciative of being kept abreast and felt we were being very responsive to the recession that had been impacting the Company.

So, overall, Roger, in terms of what causes you concern about your business going forward -- I don't want to put words in your mouth -- it sounds like the covenants on the credit facility would -- it doesn't like the top 3 kind of concern about business going forward, but can you -- let me let you characterize that.

Well, let's say this. As it relates to covenants, the concern we have is how long does the recession go on? And to what depth does it go? And we just don't have the visibility, Michael. And that's why, yes, we are paying very close attention to covenants and covenant compliance, because it's just a prudent thing to do, given the severity of the downturn we've seen.

And I assume that's part of the dividend reduction and part of the very aggressive working capital management, et cetera?

Precisely. Precisely.

Okay, thanks a lot. Take care.

Thanks, Mike.

You have a follow-up question from the line of DeForest Hinman of Walthausen & Co. Please proceed.

My question was on the covenants and it's pretty much been answered. Thanks.

Thank you.

There are no further questions in the queue. I would now like to turn the call back over to Mr. Roger Fix. Please proceed.

Thank you for attending our conference call, and we look forward to chatting with you again next quarter. Thank you.

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