Standex International Corp (SXI) 2017 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Standex International's second quarter 2017 earnings conference call. At this time, all participant lines have been placed in a listen-only mode, and the floor will be opened for your questions following today's prepared remarks. (Operator Instructions). It is now my pleasure to turn the call over to Matt Roache to begin. Please go ahead.

Thank you Maria. Please note that the presentation accompanying management's remarks can be found on Standex's Investor Relations website, www.standex.com. Please see Standex's Safe Harbor statement on slide two. Matters that Standex management will discuss on today's conference call include predictions, estimates, expectations, and other forward-looking statements. These statements are subject to risks and uncertainties that could cause actual results to differ materially. You should refer to Standex'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, adjusted EBITDA, which is EBITDA excluding restructuring, purchase accounting, acquisition related expenses, and one-time items. We will also refer to non-GAAP net income, non-GAAP income from operations, non-GAAP net income from continuing operations, and free operating 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 second quarter news release.

On the call today is Standex President and Chief Executive Officer, David Dunbar, and Chief Financial Officer, Tom DeByle. Please turn to slide three, as I turn the call over to David. David.

Thank you Matt, and good morning. Second quarter fiscal 2017 sales declined 4.4% to $173.9 million from a year ago, primarily driven by soft refrigeration end market conditions, as expected. As well as customer project pushouts in engineering technologies and engraving. GAAP operating margin was down by 120 basis points on the sales decline, however, non-GAAP operating margin was relatively flat. The performance was a result of good operating execution in our business, adjusted EPS of $1.01 was flat to last year, and we ended the quarter in a net debt position of $3 million.

In the quarter we were pleased that earnings held up despite the soft top line. We also completed the acquisition of Horizon Scientific in the quarter, and are happy to see our newest business off to a great start at Standex. Finally in our electronics business, yesterday we announced an agreement to acquire OKI Sensor Device Corporation, a Japanese manufacturer of reed switches. The acquisition expands our global reach in our electronics business, and increases our ability to capitalize on new sensor opportunities in Asia. We'll present details of this exciting acquisition after reviewing our quarterly results. I'll touch more on our achievements in each business when I go through the segment review. First, Tom will review our second quarter results. Tom.

Good morning. Slide four shows our historical trend of adjusted earnings per share, and sales on a GAAP basis, as well as an adjusted basis without the US rolled plate and machining, or RPM business. On a trailing 12-month I adjusted basis without RPM, earnings per share were $4.36 through December 31, 2016, versus $4.68 in the 12 months ended December 31, 2015, which is a 6.8% decrease. Sales on an adjusted basis were $716 million on a trailing 12-month basis as of December 31, 2016, versus $743 million in the prior year period.

Please turn to slide five, which details our revenue changes by segment. You can see that the electronics reported positive organic sales growth for the second quarter. The acquisition of Horizon Scientific contributed 4.1% to our sales growth, while the divestiture of RPM had a negative effect of 2.7%. Going forward, we should see organic growth in the second half of our fiscal year, due to increased orders, backlog, and easier year-over-year comparison to prior year.

Slide six summarizes our second quarter results on a GAAP and adjusted basis. Adjusted gross margin increased 70 basis points, against a 1.8% adjusted sales decline compared to the last year. Adjustments from GAAP to non-GAAP operating income were $4.3 million this quarter, and are itemized on the bridge on the following slide.

Please turn to slide seven, which is a bridge that illustrates the impact of special items on net income from continuing operations. Tax effected special items include restructuring charges of $1.2 million, purchasing accounting of $0.8 million related to the Horizon Scientific acquisition, other acquisition related costs of $1.1 million, and $0.5 million of discrete tax benefits. GAAP net income was down 17.6%, and adjusted net income was nearly flat year-over-year.

Turn to slide eight. Net working capital at the end of the second quarter of fiscal 2017 was $150 million, compared with $144.2 million a year ago. Working capital turns were 4.6, compared with 5 turns a year earlier. Overall working capital turns were impacted by lower volume in refrigeration and engineering technologies. Slide nine illustrates our debt management. We ended Q2 in a net debt position of approximately $3 million, compared with a net debt position of approximately $4.7 million a year earlier. We define net debt as funded debt and less cash. Our balance sheet leverage ratio of net debt to capital of 0.8%, compared net debt to capital of 1.3% a year ago.

Slide ten summarizes our capital spending depreciation and amortization trends. In 2017 we expected our spending will be in the range of $26 million to $28 million. We expect approximately $15 million of CapEx in fiscal 2017 will be to drive sales and improve productivity. This includes $8 million of a carryover spending from fiscal 2016, primarily related to the new engineering technologies plant in Wisconsin to support aviation growth. The remainder will be for maintenance capital.

Slide 11 details our reconciliation of operating cash to free cash flow. Our free cash flow conversion averages over 100% during the past 5 years. Note that our cash flow conversion typically builds throughout the fiscal year. Free cash flow conversion was less than prior year, due to lower income from operations primarily in food service, along with higher capital spending this year. With that, I'll turn the call back to David.

Thank you Tom. Please turn to slide 13, and I'll begin our segment overview with the foodservice equipment group. Sales increased 1.4% in the quarter, including the $7.4 million contribution from the Horizon Scientific acquisition. Organic growth declined 6.7%, driven mostly by continued weakness in the refrigeration business, specifically in the dollar store market and in national chains, which we anticipated. We believe we left the trough in the small footprint retail market, and the large national chain market. Beginning in the third quarter, we will have lapped sales declines in the dollar stores, and we expect a minimal impact on sales going forward.

We anticipate the national chain sales activity will increase during the second half of the fiscal year, due to planned investments by customers. Horizon Scientific performed well during its first quarter with Standex, and the integration plan is on track. We also experienced solid performance out of our Nor-Lake Scientific brand. Despite the sales decline, the refrigeration business increased their margin rate on operating improvements and cost management. After the close of the quarter, we announced Kevin Fink as our new Refrigeration Group President. Kevin is an experienced industry executive, we are pleased to have him join our team, and we look forward to his contributions.

Moving on to cooking solutions, sales were down approximately 9.7% primarily due to non-recurring rollouts in the supermarket channel that were fulfilled in the prior year. Coupled with our proactive rationalization of lower margin products to improve profitability, which affected sales by approximately $1 million. Cooking solutions remains on track with its product rollout strategy. Including the most recent launches of the mini-combi oven, the conveyor oven, and the speed oven. We have seen early success with these products, which will be on display at NAFEM, the North American Association of Food Equipment Manufacturers show, in Orlando next week. We also are encouraged by the growth in our specialty solutions business, which was up in the single digits year-over-year. Our beverage pump business grew year-over-year for the fourth consecutive quarter, as it continues to generate solid momentum. We remain excited by new pump products that will provide our customers with opportunities to offer innovative carbonated beverages, enhance CO2 safety, and lower maintenance costs.

Looking forward in foodservice, as I mentioned, we expect improvement in the second half of the year, as a number of our customers begin to invest in new rollouts. We are focused on delivering against the increased refrigeration backlog, and growing sales with large national chains. We continue to drive growth of new oven products and remain focused on executing the ramp-up of new applications in our beverage pump business, specifically for nitro beverages.

Turning to slide 14, engraving. Adjusted sales excluding rolled plate machinery were down 1.3% organically, largely due to the pushout of automotive program launches in North America into our third and fourth fiscal quarters in mold texturizing. Sales in North America were down by double digits, which were partially offset by single digit growth in Asia, and relatively flat in Europe. Our new growth [inaudible] continued to demonstrate good progress delivering $3 million in new sales, nickel shell sales are tracking well in North America and China, while laser sales continue to ramp up in all regions. Our Architexture design services are growing, and delivering value to our OEM. We are optimistic going forward as the North American automotive launches, coupled with expected growth in Asia and Europe should contribute to growth in the second half of the fiscal year. In addition, we will continue our efforts to capitalize on our Architexture design centers, nickel shell and laser technologies, as well as increasing participation in the growing Chinese electric vehicle market.

Please turn to slide 15. Our engineering effect technologies group. Overall sales decreased 10.4%. Sales were down in aviation as a result of customer pushouts on select engine programs. Space sales declined in the quarter as a consequence of project timing. We also saw continued softness in the medical market. These decreases in the engineering technology segment were partially offset by higher energy market sales for power generation demand. Despite the sales decline, we were pleased that the business maintained its margin rate. The key growth in this business is aviation, and our capacity ramp-up is on schedule as we create capacity to fulfill customer needs. We remain on track to meet the increase in Airbus production by the end of calendar 2017, we do however need to assess the impact of pushouts in the geared turbofan production. This is a growth platform for engine parts from Enginetics, as well as for our lipskins.

We continue to pursue new business opportunities. During last quarter's conference call, I mentioned that we were awarded a new aviation part in Europe for the A400 military fighter, and secured a long term agreement for MRI heads for a prominent maker of medical equipment. We continued this momentum in Q2, by being awarded a contract from a new major European OEM for engine components for Enginetics. Looking ahead, our focus for the second half of the fiscal year is to deliver on developmental programs in both space and aviation, and to meet delivery schedules on long term aviation contracts. Finally we are completing a manufacturing layout redesign in Enginetics to improve efficiencies.

Please turn to slide 16, Electronics. Sales were up in the quarter driven by demand in Europe and Asia. Offset by slower sales in North America, as a result of inventory reductions by a large power grid customer. We expect that customer to revert to normal levels going forward. Operating margin was 21% due to cost savings activities, operating efficiencies, and continued move of our product mix to include more sensors. Our sensor and reed switch businesses showed solid growth in the quarter. But these increases were partially offset by lower reed relay and magnetic sales. I also want to recognize the accomplishments of our China team, in moving our Shanghai plant in only two months, as a result of a government mandated move of the industrial zone where we were located. The business did not skip a beat, and delivered a terrific quarter despite the plant move. Looking ahead at the near term, we are focused on meeting customer demand for reed switches, and pursuing new sensor opportunities in all markets.

Our Hydraulics group as you can see on slide 17 slowed in Q2. Sales were down 12.7% year-over-year, primarily the result of further softening in the North American dump truck and dump trailer markets. Both aftermarket and export sales were strong, and the refuse market was flat. We anticipate a pick-up in the dump truck and dump trailer markets as we enter the spring construction season. The prospects for increased infrastructure spending should also drive demand. We are making progress in several growth opportunities, including completing field tests and prototyping activities with key refuse customers, in launching new hydraulic system solutions.

Please turn to slide 18. In summary we performed well from a profitability standpoint, despite mixed market conditions and the resulting lower year-over-year sales volume. Looking forward we anticipate growing demand in the coming quarters across the Company. We believe that we are now at the trough in refrigeration, and expect sales in the second half of the fiscal year to rebound. We will continue to build on the success of the Horizon Scientific acquisition. We also anticipate renewed growth in engraving in the third and fourth quarters, as a result of North American automotive program launches, and growth in Europe and Asia. We will continue to capitalize on Aviation opportunities in Engineering technologies, and focus on growth laneways in hydraulics. In electronics new applications continue to ramp up and deliver organic growth. As we look to the future, our balance sheet is well-positioned to fund growth, CapEx, and acquisitions, as we continue to deploy the Standex value creation system. With that, I would like to close the discussion of our second quarter results, and provide more information of our recently announced acquisition.

Please turn to slide 19. We are delighted to announce an agreement to acquire OKI Sensor Device Corporation in our electronics business. This accelerates our strategy by increasing our presence in Asia, and giving us a broad product line. Slide 20. OKI Sensor Device Corporation is the world's largest manufacturer of reed switches, with a reputation for high quality and performance. Sales in the 12 months ended March 31, 2016 were 6.8 billion Yen, or $56 million, with an EBITDA over 25%. These sales figures include $12 million in sales to Standex, primarily in Europe where we have resold OKI reed switches for 20 years. The pro forma financials of the combined electronics segment are sales of $161 million, and EBITDA of approximately $36 million.

We anticipate that this will be accretive to EPS by $0.08 to $0.11 in FY 2017, excluding the impact of purchase accounting and $0.40 to $0.44 in FY2018. The purchase price will be 15.4 billion Yen, or about $135 million. Standex will fund over half the acquisition with foreign cash, and the remainder through our revolver. Our leverage post-close will be between 1.5 and 2 times debt to EBITDA. Our two businesses are complimentary, in terms of product offering, geographic presence, and served end markets. OKI is the leading manufacturing of reed switches, and Standex is a leading developer of sensor solutions. Together we will make an even better partner for our customers, and have balanced geographic presence. Our two organizations have worked together as partner suppliers for over 20 years, and we are happy to welcome all OKI Sensor employees to Standex. We look forward to working together to create a bright future.

Turn to slide 21 for an explanation of reed switches and sensors. A reed switch is a mechanical switch that is closed by the presence of a magnetic field. You can see an image on the left of a reed switch in an open and closed position. Reed switches have inherent advantages over other mechanical and electronic switch technologies. Chief among there is that they are hermetically sealed, and require no power to indicate. A typical application is fluid level sensing. On the right you see a brake fluid level sensor. A magnet carried in a float rests at the top of the fluid. When the reservoir is full the magnet is far from the reed switch, which remains open. When the reservoir empties, the magnet lowers until it reaches the switch, which closes and activates the check brake fluid light.

Turn to slide 22 to see the reed switch value chain. Starting at the bottom, a bare reed switch may have a sale price of between $0.07 and $0.20. Before being used to the switch may be sorted, characterized, packaged, and/or formed, which adds further value. It is then mounted in a printed circuit board to fulfill its functioning of opening and closing in the presence of a magnetic field. Finally the printed circuit board may be assembled into a sensor assembly, such as the brake fluid level sensor, for final delivery to an OEM. You can see how the value increases through this value stack. For those who have followed Standex Electronics, you know it has been a strategic priority for us to grow our sales of custom engineered sensors.

Slide 23 clearly shows the improved geographic coverage of the combined business. Standex Electronics today only has about 16% of our sales in Asia. We have communicated in the past, that it is priority for us to create a stronger presence in this important market. 81% of OKI Sensor sales are in Asia. Together we create a geographically balanced business, with one-third of our sales in each of North America, Europe, and Asia. Working with the OKI Sensor's distribution channels in Asia, will give our team greater visibility to new customer applications, so that we may grow our Sensor solutions business in Asia.

On slide 24 you can see how our product offerings are complimentary. Whereas 16% of Standex sales are of reed switches, 97% of OKI Sensor sales come from bare reed switches. Together, we will provide the broadest line of reed switches in the industry. They have a highly automated, high performing plant in Kofu, Japan, with an excellent workforce.

Turning to slide 25 in summary. This acquisition creates combined entity with balanced global revenues, a broad line of high quality reed switches, and a proven ability to deliver customized sensor solutions to demanding applications. Pro forma sales were approximately $160 million, and EBITDA of $36 million. We will finance more than half of the deal with foreign cash, and the transaction is scheduled to close March 31, 2017. With that we will open the lines for questions.

Thank you. (Operator Instructions). Our first question comes from line of Chris Moore of CJS Securities.

Thanks. A couple of questions on the acquisition. In terms of the guidance that you gave, $0.40 to $0.45 for fiscal year 2018. You can get a little more specific in terms are there any growth assumptions behind that for that segment?

Well, there's 2.3% of the industry growth we anticipate, and there will be some sales synergies as we start implement our long term plan on going to have more sensors with that acquisition in Asia.

Modest growth in those numbers for 2018. Fiscal year ends March 31st, the last official numbers we have were from a year ago, so we basically took the 2016 numbers and inflated them slightly for FY 2018 to come up with the number.

Got you. Okay. Obviously makes great sense on a geographical side. Are there any specific markets they've done a better job penetrating, automotive, consumer electronics, et cetera, that you might leverage further?

Well, because we sell similar products in North America and Europe we're basically in the same industries and the same applications. However, maybe we will do this in the future, we almost showed the relative split of the industries served, but they're very similar. OKI has a higher concentration in automotive, and in various industrial applications in China. But we are in similar applications in North America and Europe.

Got you. Just from a kind of logistics standpoint, I mean, can you give a little more specific, in terms of interim employees that you're bringing over, the footprint there, that you're acquiring, et cetera?

Yes. About 100 employees. It's a very highly automated plant in Japan. Actually I'll be there on Monday welcoming them to Standex, so that they can put a face to a name. We will report it into the electronics organization, so the current President of that Sensor business will report directly to John Meeks, our Electronics President. We have a dedicated integration manager we'll put on the ground over there. We also had planned in our model to add a couple of people, one be to be essentially a VP of business development for Asia, to drive these synergies. And we also need a financial leader that is very familiar with US GAAP, as well as Japanese GAAP. So that's the headline statement of our integration plan.

Got you. Last question on the acquisition. What are the biggest hurdles that you face, in terms of actually making this happen?

First of all, there is a 14-hour time difference. Everything goes through interpretation or translation. However, I would tell you, we've been working with OKI for 20 years, and this goes back to Meder organization back in the 1990s became the distribution channel for OKI into Europe. And started the working relationship back then. We acquired the Meder business in 2012, and with that came the relationship. So there is a high degree of trust, and a very effective working relationship between the two businesses. So the challenges we see are, I would just say logistical, and the normal challenges that you'd expect in integrating a new business, and across time zones and language.

Got you. Thank you. Let me just back in line.

Thank you.

Thank you, Chris.

Our next question comes from the line of Chris McGinnis from Sidoti & Company.

Good morning, thank you for taking the question. Congratulations on the acquisition. To follow-up on one of the questions regarding the acquisition is just on the purchase price. Is that valuation kind of industry standard, or can you just comment on that a little bit?

It's a Japanese Yen price, Japanese Yen earnings, the dollar has moved a lot. When we first started talking with them the dollar was $1.05. But if you look at it now, the purchase price today dollar value now with their past earnings, it's a multiple just under 9, which is probably on the low end of recent multiples in that space.

Great. Then just turning to the other parts of the business. It sounds like obviously there are easier comps in the second half of the year in the food side. Can you talk a little bit about that confidence, of are you seeing orders already move from the retail side it sounds like?

Yes, we are. In the last earnings call we said that we were getting early indications from customers, they were planning these national programs. We started to see the RFQs and the requests, we are beginning to see the orders. So yes, we do see that playing out.

Okay. And then just on the engraving. Is it really just kind of timing? It has been soft a little bit for the first half of the year on the organic side. Can you talk a little bit more about that, and the confidence that you have got there?

Yes. If you're to go back and look at, I know you've been following the business for a while. Because if you look at the Engraving performance quarter-to-quarter, there is an inherent choppiness in the business, and no typical seasonality as there is with foodservice. We also have good data of the auto OEMs of their scheduled new model rollouts. Last year we had a strong first half, weak second half. This year it is going to be a weak second half, not weak, but weaker first half and stronger second half. And as we mentioned today, most of that had to do with pushouts of North American programs, Jeep and Ford had a program that slipped into Q3 and Q4. Confident in what we stated in the text today that we'll see coming up in the second half.

Sure. Great. And then two more questions. One, just on the aviation, can you comment a little bit about, just your comments it sounded like, do you need to get better with the timing, or was it more of in servicing the client, or the it more the client delay?

Yes. This is about the client delay. The key program which is a growth engine for our lipskin business, and as well for Enginetics, is the geared turbofan, and the geared turbofan had a rough ramp-up, UTC has changed their scheduled deliveries. Pushing more out into next year and the year after. And we had a bit of a slowdown in demand from them for engine parts this last quarter, as a result of that rescheduling. However, if you look at our aviation business. Last quarter Aviation was actually down year on year. In the second half we'll see that engineering technologies post growth over the last year. So even though there will be sort of a pushout in that schedule, it still represents growth for us.

Okay. Then lastly just with the change in the administration, I know it's still really early. With the Mexican business, are you worried at all about that, and maybe can you talk a little bit about your thoughts in terms of, if there are in he changes does that change your business at all?

Yes, in business in Mexico we have two plants. We have a cooking plant where we also do pumps for Procon, and an electronics plant. First thing we did is look at where do our competitors manufacture. And their competitors are overseas as well. So from a competitive standpoint we are not concerned about it. From a hassle standpoint, we're very concerned about it. We are looking at contingency plans and different scenarios for both of those plants, depending on what happens with the border tax, and with the competitive environment. But yes, we anticipate we'd be more worse off than our competitors.

Great. Thanks very much. Appreciate the time today.

Thank you, Chris.

(Operator Instructions). Our next question comes from Liam Burke of Wunderlich.

Thank you. Good morning David, and good morning Tom.

Good morning Liam.

You mentioned new technologies several quarters, when do they begin to move the needle on the revenue front, and what kind of margin profile do they have, vis-a-vis the rest of the Engraving business?

We always get asked with Engraving, are you overearning in Engraving. In different quarters we'll be in the mid to upper-20s. This is a very solid business with a solid competitive advantage. And the new technologies keep us a step ahead of competition. With the leading supply, when you visited our plant in Detroit, we're the leading supplier of engraved textured surfaces in the auto industry, we are the only one of our competitors in mold texturizing, that can also offer nickel shell, and we have got the design up, and the design services. In terms of moving the needle, the three of those things combined last quarter was $3 million, and that's a big chunk. That further distances us from our competition. So we think, our assumption is those technologies help us maintain our competitive position, and continue to deliver the margins the business has demonstrated.

Great. FSEG, I know that Horizon is the biggest part of the medical piece of that business. A) How is that integration going and B), how is the rest of the medical, although small, how it that growing?

The rest of the medical is growing fairly well too. I think you know in the Nor-Lake we have a nice product line, good margins, good position, good reputation. It's been, $10 million, $11 million, $12 million for years, it is up over 20% from prior year. Horizon Scientific is growing, also had a very good quarter. If you add the two together, we've got a mid-$40 million scientific business. I was just down at Horizon Scientific on Monday, to basically close out the 100 day integration plan. We've got a wonderful workforce down there, very motivated, they have got some great ideas. We identified some cost synergies. For example, when we acquire a business like that, one of the first things that we do is get them under a UPS contract. There is a nice pick-up for them on that, they identified some cross-selling opportunities between the channel presence that Nor-Lake has, and Horizon Scientific has. I'd say we are on track for the 100 day integration plan, and now well into the synergy planning and delivery phase.

Thank you, David.

At this time I am showing no further questions. I'll turn the floor back over to management for any additional or closing remarks.

I want to thank everybody for the interest in Standex. We are obviously very excited about the opportunities presented by the OKI acquisition. Looking forward to a strong second half. We look forward to reporting to you on our Q3 results in about three months. Thank you.

Thank you.

Thank you ladies and gentlemen, this does conclude Standex International's second quarter 2017 earnings conference call. You may now disconnect.