Standex International Corp (SXI) 2018 Q2 法說會逐字稿

Good morning. My name is Stephanie, and I will be your conference operator today. At this time, I would like to welcome everyone to the Standex International's Second Quarter 2018 Earnings Conference Call. (Operator Instructions) Thank you.

I would now like to turn the call over to David Calusdian. Please go ahead.

Thank you, Stephanie. Please note that the presentation accompanying management remarks can be found on Standex's Investor Relations website, www.standex.com. Please see Standex's safe harbor statement on Slide 2.

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 onetime 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 Chairman, President and Chief Executive Officer, David Dunbar; and Chief Financial Officer, Tom DeByle.

Please turn to Slide 3 as I turn the call over to David.

Thank you, David. We delivered a fourth consecutive quarter of broad-based top line growth across all 5 business segments. Overall revenue increased 20.6% to $209.8 million, with organic sales up 8.8%. The momentum is also evident in organic bookings growth of 16% and organic backlog growth of 7.5%.

Operating income was up 37.4%, and adjusted operating income increased 19.2%. GAAP EPS of a loss of $0.22 per share reflects the impact of the new tax legislation, while adjusted EPS grew 8.7% to $1.12 a share. We had a net debt position of $106.8 million at the end of Q2.

During the quarter, our businesses outpaced the rate of growth for the markets that we serve, proof that our Standex growth disciplined process continues to deliver sales and momentum for future growth. Our recent acquisitions, Horizon Scientific in Food Service, Standex Electronics Japan in Electronics and Piazza Rosa in Engraving have continued to exceed our expectations as our team successfully capitalized on cost and revenue synergies.

We experienced strong demand in Engraving, Engineering Technologies and Electronics. We did not see the margin leverage we would normally expect in these businesses, and we are focused on fully realizing the top and bottom line potential of these businesses. We have identified the key operational and organizational areas where we need to drive improvement, and have several initiatives underway.

In Engineering Technologies, we continue to work through issues that have created near-term bottom line drag. We remain very excited about the long-term opportunities for this segment and believe we will see margin improvement as we exit this fiscal year.

In addition, we remain very encouraged by the progress that we are making with Food Service restructuring in our standards products businesses.

Overall, I'm very proud of the progress that our teams are making in deploying the Standex Value Creation System across all businesses. This work is critical to position Standex to become a best-in-class operating company, serving attractive, differentiated markets with solid growth prospects. We are in early innings of realizing the benefits of this work, and remain excited for the opportunities ahead at Standex.

With that, Tom will review our second quarter results. Tom?

Thank you, David, and good morning, everyone.

Slide 4 illustrates our historical trend of adjusted earnings per share and sales on a GAAP basis as well as on an adjusted basis. On a trailing 12-month basis, GAAP earnings were $2.58 through December 31, 2017, which included a negative impact from the new tax legislation in December, as David mentioned. This compares with $3.79 through December 31, 2016.

Our trailing 12-month adjusted earnings as of December 31, 2017, were $4.83 versus $4.40 in the prior year period, which is a 9.8% increase. Sales on a trailing 12-month basis were $825.9 million versus $724.7 million in the comparable period in the prior year, up 14%.

As shown on the chart at the bottom of this slide, our revenue and earnings performance this quarter were consistent with our historical seasonal trends. Generally, our sales and earnings are the highest in our Q4 and Q1 during the heavier construction season. We typically experience lower sales and earnings in Q2 that bottom in Q3 as cold weather slows activities.

Please turn to Slide 5, which details our revenue changes by segment. Overall, organic growth was up 8.8% with 4 of the 5 businesses -- Engraving, Engineering Technologies, Electronics and Hydraulics, having double-digit organic growth. The acquisitions of Horizon Scientific, Standex Electronics Japan and Piazza Rosa contributed 10% to our sales growth, and foreign exchange had a positive 1.8% impact.

Please turn to Slide 6, which summarizes our second quarter results on a GAAP and adjusted basis. Sales growth was 20.6%. Operating margin was up 105 basis points on a GAAP basis and down 12 basis points on a non-GAAP basis. Earnings per share was down 127% on a GAAP basis largely due to the tax charge. On a non-GAAP basis EPS was up 8.7%.

Please turn to Slide 7, which is a bridge that illustrates the impact of special items on net income from continuing operations. Special items included discrete tax items due to the new tax law of $15 million, a tax effective charge for restructuring of $1.5 million and acquisition costs of $0.5 million. GAAP net income was down 126.9%, and adjusted net income was up 8.3%.

Please turn to Slide 8, which highlights the impact of the new U.S. tax legislation. On a partial year basis, the new law lowered Standex's effective tax rate by 0.7% to 24.5%. In the December quarter, there were 2 onetime charges that impacted Standex's results, a $13.8 million charge against foreign earnings and a $1.2 million revaluation of deferred taxes for the tax rate changes. As a result, the overall impact on Standex's tax in fiscal '18 is expected to be a negative $15 million.

Given the current mix of domestic versus foreign earnings, we expect the tax law change to be a relatively neutral event for Standex that should marginally decrease our effective tax rate by approximately 50 to 100 basis points.

Turning to Slide 9, net working capital at the end of the second quarter of fiscal 2018 was $169.3 million compared with $150 million in the prior year. Working capital increased due to acquisitions and a build to support increased volume. Working capital turns improved to 5 turns versus 4.6 in the year-ago period.

Slide 10 illustrates our debt management. We ended Q2 in a net debt position of approximately $107 million, a decrease of $24 million since the prior quarter, reflecting improved operating cash flow conversion during the quarter. We define net debt as funded debt less cash. Our balance sheet leverage ratio of net debt to capital was 20.2% compared with net debt to capital of 23.4% last quarter.

Slide 11 summarizes our capital spending, depreciation and amortization trends. Our capital spending was 3.4% of sales during the quarter and 3.7% year-to-date.

I have just returned from my trip to China energized after visiting our Electronics, Engraving and Hydraulics sites. In our Electronics Shanghai facility, the new selective soldering machine eliminates waste, reduces floor space and improves quality. In Engraving, the new Mold-Tech facility had a production line up and running for tool finishing, which capitalizes on technologies from our Piazza Rosa acquisition. While our Hydraulics facility in Shenzhen had a new CNC machine to help meet increasing demand.

The bottom line is that we continue to invest across all our businesses where we see the best opportunities for growth and productivity. For fiscal year 2018, our capital spending is excited to be in the range of $31 million to $32 million, our depreciation in the range of $21 million to $22 million and amortization remains in the range of $8 million to $9 million.

Slide 12 details a reconciliation of operating cash to free cash flow on an adjusted basis. Conversion of operating cash flow was 199% for the quarter and 38.1% on a year-to-date basis, both favorable to prior year. The adjustments in Q2 exclude the onetime discrete tax items imposed by the new tax law.

With that, I'll turn the call back to David.

Thank you, Tom. Please turn to Slide 14, and I'll begin our segment overview with the Food Service Equipment Group.

Sales for this segment increased 5.4%. In commercial refrigeration, sales were up 3.1% and bookings increased more than 15%. Scientific refrigeration sales growth of 18.5% benefited from the full quarter contribution from Horizon Scientific, which we acquired 2 weeks into Q2 last year.

The Horizon Scientific team continues to do an excellent job of leveraging sales channel synergies with our legacy Nor-Lake Scientific business to drive sales growth, and advancing market tests to explore attractive adjacencies and identify new innovative products to bring to the marketplace.

Cooking sales declined 1.3% from a combination of the continued rationalization of low-margin range product lines and issues related to last quarter's implementation of a new ERP system. Specialty Solutions continue to perform nicely with sales up 8.8%, driven primarily by growth in the beverage and merchandising businesses.

Overall segment profitability was negatively impacted by less favorable rebate terms on historical contracts that hit in the quarter. We have now exited these low-margin buying group contracts and have renegotiated more balanced terms going forward.

In addition, the standard products businesses of commercial refrigeration and some cooking product lines continued to deliver lower margins, as we implement the plant transformation, consolidation and restructuring plans discussed last quarter.

Looking ahead in Food Service, we remain focused on advancing our strategy to grow our differentiated products through expanded market tests and growth laneways, while we simultaneous execute on our standard products restructuring plans.

During the quarter, we implemented several lean manufacturing and operational programs in tabletop cooking solutions that are expected to start flowing through to the bottom line in Q3. In addition, we have implemented focused manufacturing footprint activities in Refrigeration to consolidate our cabinet business, and expects to realize a benefit from these efforts as early as Q4.

Turning to Slide 15, Engraving. Sales increased 31% driven by strong Mold Tech sales across all regions, including a 64% increase in North America, as automotive OEMs ramped up what is still expected to be a record year of new model introductions. The Piazza Rosa acquisition contributed $3.4 million this quarter.

Our efforts to develop growth laneways in Engraving have continued to be very successful, with new technology sales from products like architecture, laser, tool finishing and nickel shell up $3.1 million.

Operating income was up 4.4% compared with last year, with an adjusted operating income margin of 20.1%. The Engraving margin was at the low end of our target range due to sales mix dynamics as well as the integration of Piazza Rosa and investments to support new technology growth programs. These are quite literally growing pains and we are taking actions to address them, and expect margins to return closer to historic levels in Q3 and Q4.

Looking forward, our 2018 priorities in Engraving are focused on driving sales and operating growth by capitalizing on the increased automotive launches worldwide and expanding Piazza Rosa's tool finishing capabilities worldwide. In addition, we are launching several market tests to identify additional potential growth opportunities.

In anticipation of continued growth laneways and new offerings to roll out in the future, we will also be modifying our organizational structure to create a focused group responsible to ramp up new offerings and allow the operating organization to focus on current offerings.

Please turn to Slide 16 to our Engineering Technologies group, where overall sales grew 18.2%. In aviation, sales were up 43.3% or $3.5 million. Space sales were flat year-over-year due to the natural lumpiness in that market. However, we remain quite positive about our long-term opportunities in space.

Despite the significant growth, operating income was down 18.6% and operating margins were 7.0%. As we mentioned last quarter, we're facing significant pricing pressure on legacy aviation platform engine parts, which continued in the quarter. In addition, we delivered large space development program with single-digit margins.

Looking forward, we remain focused on executing key aviation and space development programs for future volume production. In the engine parts business, we anticipate margin pressures to continue into Q3. However, exiting our fiscal Q4, we believe he we will start to see margins improve as new parts begin to ramp and supply chain improvement actions yield results.

We believe that once we navigate through the trough caused by the pressure on legacy engine parts and the delays in the ramp-up of new platform parts over the next few quarters, we will be in a solid position to deliver sustainable top and bottom line growth in this segment for our shareholders.

Please turn to Slide 17, Electronics. Electronics continues to demonstrate a strong competitive position in a growing market. In Q2, sales increased by 61.5% driven by double-digit organic growth in all regions, another strong quarter by our Standex Electronics Japan acquisition and strength across a broad set of end markets, including utilities and smart grid.

Sensor sales increased by 20.2% and reed relay switch sales were up 31.7%. Operating income was up 67.8%, and operating margins were 22.2%.

The integration of our Standex Electronics Japan acquisition continues to advance exceptionally well, delivering on cost synergies and making great progress toward our Asia sensor sales targets.

Looking ahead, we are focused on leveraging our leadership position in reed relays switches to capitalize on increased market demand. We are also focused on developing market tests for new sensor technologies, expanding our upstream growth laneways and capturing new business opportunities in the sensor and reed relay markets.

Please turn to Slide 18, Hydraulics. The 22.2% sales increase in Hydraulics is primarily the result of strength in refuse and dump trailer markets. Margins were 14%, an improvement over the prior year due to volume growth and improved manufacturing efficiencies.

We continue to expect a strong fiscal Q3 and Q4 in Hydraulics as we focus on converting our strong project pipeline and solid backlog, which increased 90% over the prior year period. And finally, the addition of new pumps for wet kits are expected to increase solutions sales going forward.

Before we go to questions, let me leave you with a few key thoughts. First, our GDP+ activities are proving successful, as we are delivering top line growth outpacing the markets we serve. And for the second consecutive quarter, we had organic growth across all Standex businesses. Looking ahead, we expect to remain in this growth path in FY '18 across all Standex businesses.

Second, we are confident in our ability to deliver bottom line improvements. The lean manufacturing and cabinet consolidation restructuring activities underway in our commercial refrigeration business should start to improve margins by the end of the fiscal year. Cooking standard products lean work is showing early results and expected to generate expanded margins in Q3. And in Engineering Technologies, despite near-term macro dynamics that are pressuring margins, we are excited for the projects and programs underway and are confident in the prospects to deliver improved profitability.

Third, our recent acquisitions continued to perform very well, with all 3 contributing to quarterly sales and margin expansion, a demonstration of how we effectively identify, acquire and integrate high-value businesses.

And finally, as we look ahead, our acquisition pipeline remains active, and our strong balance sheet will enable us to capitalize on additional bolt-on M&A opportunities.

I'm very proud of our team, appreciative of our shareholders and excited for the future of Standex as we continue to execute against the Standex Value Creation System and position our company to fulfill a mission of becoming the best-in-class operating company.

And with that, we'll go to your questions.

(Operator Instructions) Your first question comes from Chris Moore with CJS Securities.

Maybe we could start with Electronics. So on the reed switch side, it sounds like you're kind of benefiting both ways, there is increased market demand. What about from a kind of overall industry capacities conversation? Where does that stand and kind of how does that relate to pricing power?

Yes, well, the capacity is -- global capacity is tight. And you'll see in our -- our CapEx increase in Electronics has been to add additional cells to produce more reed switches.

Got you. And the conversation we have in -- from the beginning on the OKI acquisition was to continue to move up that value chain and -- where the margins are even higher. That's a key part of what's going on now?

Yes. And I would say that we're on track -- I mean, ahead of track of where we thought we would be when we acquired the business. I think we mentioned in previous releases that from the day we acquired OKI, we were happy to discover they had already identified a healthy list of sensor opportunities to go after. So we've been quoting and converting those, we have our first orders and we're beginning to see that Asia sensor business ramp up.

Got you. From an overall organic growth standpoint, obviously first half as been terrific. Are there -- trying to -- looking into the second half, it sounds like it's going to continue to be strong. And then, I know you're not forecasting beyond that, but just from a big picture perspective, are there specific initiatives that likely won't carry? For example, you're getting a bump on Engraving from the auto side, is that likely to temper a bit moving out of '18?

Well, the projections for model increases continue to remain robust through '18 and even into '19. Now we had double-digit growth this year on the left. I think the growth will modulate, but the expectation in the industry will be continued growth into '19.

Got it. Terrific. In terms of the margins on the engine part businesses, you talk about, perhaps as you exit Q4, those margins should start to return and -- can you maybe just -- you talked about it a little bit, a little more specific in terms of what's driving that assumption?

Yes. So just -- let me just back up. So this is a business we acquired about 4 years ago, and they have a significant position in all legacy platforms. They also have a terrific position in some new platforms, like geared turbo fan. 2 quarters ago, or last quarter, we announced that a large legacy engine part, which they've been producing for years, had significant cost pressure. We were lining up our supply chain to support the lower-cost position we needed to preserve margins, and we expected that cost position to be established starting this quarter. So what happens in this business, as the legacy businesses come under some cost pressure and maybe those platforms reduce in volume, we count on the new platforms to grow. Well, we're getting the pressure on those legacy parts and the delays in the geared turbo fan and other new platforms have kind of created a trough in that business. Now we've -- in the last quarter, in addition to taking some supply chain actions, we've also won some additional parts that'll be moved to us from our legacy customers at attractive margins. Those will start to flow through in Q4. We've got our supply chain lined up to address the input costs for the -- for those engine parts. And we're also doing a lot of lean activities in the plants to reduce changeover times, increase our throughput and improve our cost position.

Your next question is from Chris McGinnis with Sidoti & Company.

I guess just looking at the Food Service, some solid results. Can you just talk maybe a little bit about -- in Specialty Solutions, I understand the scientific side being strong. But can you just walk through some of the products in Specialty that are driving the growth?

Yes. In the Specialty business, we've got the pump business under the Procon brand and the Federal display merchandising business. Federal is seeing great growth in convenience stores. There's also a rollout international chain that's just ramping up, which -- unfortunately, I can't share with you the name of the customer, that want to highlight the fresh products they use as they serve their customers. So those Federal displays cases will be front and center in those shops, and we started to see those things ramp up. And then in the Procon pump business, it's the applications we've talked about in the past, largely coffee and espresso. Our pumps go into high-end espresso machines. We've talked quite a bit in the past about this nitro coffee opportunity at Starbucks, which continues to flow. But in the quarter, in that business, it was really espresso and coffee OEM growth that drove their sales.

Great. And then can you just maybe -- I don't know if you can give us like the percentage. But just on the stepping away from the buying groups, are you stepping away from them? Or are you just -- or I guess giving greater rebates in that? Can you just walk a little bit through those (inaudible)?

Yes, so this is what happened. So 2 of our businesses were -- we hit almost close to $1 million in kind of exceptional rebates, the way we look at it last quarter. If you rewind the clock a year ago, the discussion on Refrigeration was what's happened to all the volume of national account spending -- the spending on national accounts really dropped. The management team at the time was under a lot of pressure to get volume. They negotiated some aggressive deals with buying groups. And if they were to hit certain targets, they would get is optional rebates. Well, they hit the those targets, they got the rebates. We have -- in the last few quarters, we've talked about the changes in that organization and the team. The new sales leader and president have renegotiated the buying group deals to create, I'd say, more balanced terms. So we give fair growth incentives, but not the aggressive structure we had last year.

Okay. And one last question. Just with energy prices rebounding here, any -- could that be a positive impact for the business at all? And maybe just the old business, I know you stepped away from a lot of energy, but maybe just some commentary around kind of the energy price. And would you be interested in kind of going back into that business at all?

Well, of course, we'd be interested. It's a high-margin business for Engineering Technologies. We were with the team just 2 weeks ago and we're asking them the same questions. We had very little -- we have relatively low expectations that, that will come back aggressively. However, if it does, we're ready to take it on. We are moving the production and the machining capability for that business to our U.K. facility. In fact, our customers are moving their production to Europe for the land-based turbines, so it will be close to them. And we also -- we're starting to get some inquiries for offshore work, for deep sea platforms, those -- the shims that are part of the mooring systems. So make what you will of that. I guess we're cautiously optimistic that it will at least kind of plateau where it's at, which is about $10 million a year run rate. And we would love to see it increase, but we're not counting on it.

And sorry, one last question. Do you need to do anything? Do you need to invest at all to bring that back? Or are you prepared just to...

No, we don't.

Your next question is from Liam Burke with B. Riley FBR.

David, on the Engraving side, you're having a nice run on the new product introductions. How are you doing outside your traditional automotive applications business?

Most of the growth is coming within automotive, but we're expanding our offerings. We're selling nickel shell, which we hadn't done before; the tool finishing sales, this is a new offering; and our laser engraving has been growing. We have seen some growth in non-auto tools and molds, particularly in China but some in North America as well. And actually one of our markets test laneways in Europe is to find a more cost-effective way to go after that business so we can get more aggressive about it. So the short answer is most of that growth is through increased share of wallet in auto.

Okay. And just getting back to the buying group. You've renegotiated that contract. Will that help move, directionally, the margins either this year or as you move forward on the FSEG side?

Yes. Yes, I mean, we will still continue to pay rebates. And -- but the base rebates were in our business last year. But it's this just short of $1 million kind of exceptional rebates. So if you were to -- if those results were to repeat this year, those sales results, we'd see about $1 million pickup in our margin.

Okay. Great. And Tom, I just want to make sure I have this right. Your effective tax rate now with the tax reform is now 24.5%?

Yes. That's over projecting based on our current mix. It's still an estimate, obviously, until we get to June 30.

(Operator Instructions) Your next question is from George Godfrey with CL King.

I'm traveling, so I've been in and out of the call, but I just wanted to ask one question on the revenue growth. The organic growth was outstanding, 9%; acquisition growth, outstanding, 12%. What -- can you just comment on what your expectations are for the rest of this year on the organic growth level? And then perhaps a comment on the acquisition pipeline and how that's looking.

Yes. Well first, as you know, George, we don't give specific guidance for the quarter. But the way I'd answer your question is you look at our -- our bookings growth was 16%, backlog is up 7.5%. So we see signs that the momentum we saw this last quarter will continue, is probably the best way I can answer that. And on the acquisition pipeline, I can tell you, it's very busy. I mean, we're quite active. No guarantee we'll get a good deal, terms that satisfy both buyer and seller, but the pipeline is looking very good.

Your next question is from John Cummings of Copeland Capital.

On the Electronics side, can you guys break out what portion of the organic growth there was from volume versus price or mix?

Let me just take a look at that and see if we can kind of back into that for you. So if you look at Tom's -- Tom makes this great chart, it's Page 5 in the presentation. So Electronics, the organic growth is 13.6%. But I don't know price, Tom, maybe 1 point?

Yes, it's 1%. [2%], I would say.

Yes.

Okay, so mostly volume? I mean, the...

Oh, yes, mostly volume. We've got reed switch volume. We announced -- we also described our sensor sales were up 20%, so that's kind of a mix to higher dollar per SKU, if you will. And in general, higher margin. But it's volume.

Okay. And then on the margins in that segment, can you comment on sort of what you're expecting going forward?

Kind of where we're at, low, mid 22%, 23%, is where we've been running.

Okay. So any expectations for, I guess, an increase there after you sort of flow through the OKI acquisition and maybe pick up these additional volumes?

No. No, it's 22%, 23%.

Is our target, yes.

And there are no further questions. At this time, I would like to turn the presentation back over to Mr. David Dunbar for closing remarks.

All right. Thank you, operator. Thank you, everybody, for joining us this morning. We look forward to working hard this next quarter and reporting back to you on our Q3 results.

Thank you. That does conclude today's conference call. You may now disconnect.

Thank you.