Standex International Corp (SXI) 2018 Q3 法說會逐字稿

Good morning. My name is Christy, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Standex International Inc. Q3 2018 Earnings Call. (Operator Instructions) Thank you. I would now like to turn the call over to David Calusdian, please go ahead, sir.

Thank you, Christy. 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 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'd 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'll 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 to 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's 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 another solid quarter with top line growth across 4 out of our 5 business segments. Overall revenues increased 17.3% to $216.7 million, with organic sales up 5.7% and acquisitions contributing 8.5% to growth. We have strong backlog growth of 19% and strength across our end markets.

Operating income was up 69% in Q3, and GAAP EPS was $1 per share. Adjusted operating income increased 22.6%. EBITDA increased 27.9% to $29 million. While adjusted EPS grew 13.3% to $1.11 a share. Though it is not shown in the chart here, I would like to point out that our trailing 12-month EBITDA is $120.6 million, a record for Standex.

We had a net debt position of $108.4 million at the end of Q3.

Engraving, Electronics and Hydraulics reported robust organic revenue increases. During the quarter, we advanced [growth laneways,] made progress in selling new offerings, and the recent Piazza Rosa and Standex Electronics Japan acquisitions continue to exceed our expectations.

Food Service Equipment sales were up on the strength of Refrigeration national account purchases and Specialty Solutions growth.

Our restructuring initiatives in the Cooking and Refrigeration business in our Food Service segment are taking hold. And we expect to exit the current fourth quarter with sustainable improvements to Food Service margins.

In Engineering Technologies, although we continue to see bottom line drag as we navigate through legacy business pricing pressure and the timing of new platform ramp-ups, we remain encouraged by the long-term prospects of this business and expect that the operational improvements that we have made will pay off meaningfully once we move past this trough.

Overall, I'm proud of the progress that our teams continue to make by deploying the Standex Value Creation System across all businesses to position Standex to be a best-in-class operating company that delivers sustainable shareholder value. With diverse and growing end markets, a strong performance across our growth engines, and restructuring improvements beginning to take hold, we are entering the final quarter of our year with momentum and we remain excited for the opportunities ahead at Standex.

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

Thank you, David. And good morning, everyone. Slide 4 shows 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 $2.98 through March 31, 2018. This compares with $3.47 through March 31, 2017. Our trailing 12-month adjusted earnings of -- earnings as of March 31, 2018, were $4.97 versus $4.47 in the prior year period, which is an 11% increase.

Q3 sales were up 17.3% year-over-year to $216.7 million. Sales on a trailing 12-month basis were up 17.9%, to $858 million as of March 31, 2018.

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

Please turn to Slide 5, which details our revenue changes by segment. Overall, organic growth was up 5.7% in Q3 with 4 of our 5 businesses, Food Service, Engraving, Electronics and Hydraulics, demonstrating organic growth. For the quarter, the acquisitions of Standex Electronics Japan and Piazza Rosa contributed 8.5% to our sales growth and foreign exchange had a positive impact of 3.1%. On a year-to-date basis, all 5 segments demonstrated organic growth.

Please turn to Slide 6, which summarizes our third quarter results on a GAAP and adjusted basis.

Operating income was up 270 basis points on a GAAP basis and 40 basis points on a non-GAAP basis. EBITDA was up $6.3 million versus prior year for the quarter or 27.9%. Earnings per share was up 66.7% on a GAAP basis. On a non-GAAP basis, EPS was up 13.3%.

Please turn to Slide 7, which is a bridge that illustrates the impact of special items on net income from continuing operations. Tax-affected special items included restructuring charges of $1 million, acquisition-related costs of $0.9 million and discrete tax benefits of $0.5 million. Restructuring charges in the quarter primarily related to the Refrigeration Cabinet move and improving the Nogales plant [4] layout. GAAP net income was up 67.4%, and adjusted net income was up 14.5%.

Turning to Slide 8. Net working capital at the end of the third quarter of fiscal 2018 was $181.5 million compared with $159.2 million in the prior year. Working capital increased due to acquisitions and a bill to support increased volume. Working capital turns improved to 4.8% from 4.6% in the year ago period due to lower DSO.

Slide 9 illustrates our debt management. We ended Q3 in a net debt position of approximately $108 million, an increase of $1.6 million since the second quarter, reflecting higher working capital to support anticipated volume growth in Q4. We define net debt as funded debt less cash. Our balance sheet leverage ratio of net debt to capital was 19.5%, compared with net debt to capital of 20.2% last quarter.

Slide 10 summarizes our capital spending, depreciation and amortization trends. Our capital spending was 2.6% of sales during the quarter and was the heaviest in Electronics and Engraving, in line with our strategy to focus spending on our fastest-growing highest margin opportunities. The investments in Electronics were focused on SAP CRM, a sealing machine and breaking ground on our new plant in Cincinnati. While Engraving investments were focused on adding additional capacity to nickel shell and laser engraving.

We also continue to invest in our Food Service, Engineering Technologies and Hydraulics where we see the highest returns on investment. For 2018, our capital spending is now expected to be in the range of $28 million to $30 million, slightly below our prior expectation. We continue to expect depreciation in the range of $21 million to $22 million, and amortization remains in the range of $8 million to $9 million.

Slide 11 details our reconciliation of operating cash to free cash flow on a non-GAAP basis. Conversion of free operating cash flow was negative for the quarter due to higher working capital. Conversion of free operating cash flow was positive 18.9% on a year-to-date basis. The adjustments to net income in Q3 and year-to-date exclude the one-time discrete tax item related to the tax on foreign cash. We anticipate improving our cash flow in the fourth quarter based on our historical trends.

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 Food Service Equipment Group. Revenues for this segment overall increased 3%, led by strong sales in our Refrigeration, Federal and Procon groups, which were partially offset by lower cooking sales, where we experienced slower growth restore in fried chicken chain demand. Refrigeration solution sales were up $3.4 million or 7%, as we saw resumed strength from nearly all top national accounts, a reflection of improved market conditions as well as our focus on customer service. In fact, by taking methodical 80-20 approach to customer excellence, our sales team has approved its conversion rate on quotes. In Specialty Solutions, Procon sales were up 11% on strength in the espresso market.

Cooking sales were down, largely due to project timing. Scientific sales were down slightly due to project timing and product rationalization in cooking.

Also in the quarter, Scientific implemented a new ERP system, which caused a one-time adjustment in the quarter, affecting profitability. Overall segment profitability was also negatively impacted by a lower mix of high-margin specialty business and a continued drag from our low-margin Commercial Refrigeration and Cooking product line businesses.

We had an excellent progress with the restructuring programs for these 2 businesses delivering bottom line improvements as we exited the quarter. We expect to realize a full quarter of benefits from our restructuring efforts in Q4.

Looking ahead, we are focused on leveraging the strong momentum with our restructuring programs to deliver meaningful and sustainable margin improvements by year-end, while we also drive improved operational efficiencies in our Nogales plant. We have also advanced our strategy to grow differentiated products through expanded market tests and growth laneways, while we take full advantage of the many new product rollouts that are on the horizon for this segment. This includes a new convenient store product, the new BKI commercial touchscreen controlled deep fryer, shown on this side, and 2 new innovative products from Horizon and Nor-Lake.

Turning to slide 14, Engraving. Sales increased 32.4%, driven by strong Mold-Tech sales across all regions as automotive OEMs continued a record year of new model introductions. The Piazza Rosa acquisition contributed $3.3 million this quarter, ahead of our internal projections. Our new technology sales from products like Achitexture, Laser, Tool Finishing and Nickel Shell contributed $3.6 million.

Through our market tests, we have a rich funnel of additional potential growth opportunities that further strengthen this segment's growth prospects.

Operating income was up 17.1% compared with last year, with an operating income margin of 20.8%. We identified 3 factors affecting margin in this segment. First, margins have been impacted by growth investments, including the costs to support growth laneways and the lower margin profile of early-stage new technology revenue. As new products ramp, margins are expected to improve. Second, we experienced high labor costs from overtime and travel for high-value service workers to meet growing customer demand. And finally, we have identified operational inefficiencies in certain geographies and have already taken actions to address these, including management changes in lower-performing countries.

Looking ahead, we remain focused on serving customers on a record number of new model rollouts. We also continue to ramp-up sales of new technologies in our Piazza Rosa acquisition and continuing the rollout of Tool Finishing services throughout the Mold-Tech network as we effectively manage costs and enhance margin performance.

Please turn to Slide 15, Engineering Technologies. Sales were essentially flat as strength in space and aviation were largely offset by the decline in high-margin energy and oil and gas businesses. Operating income was down 53.3% and operating margins were 4.9%, reflecting the mix shift away from higher-margin business as well as the pricing pressure that we continued to face on legacy aviation platform engine parts. While we await the ramp-up of new aviation platforms, we anticipate another challenging quarter due to customer aviation delays. However, we are focused on preparing the plants for the increased aviation volume projected to begin this summer and illustrated at left. We also remain focused on completing developments for new space and aviation programs.

Over the long term, we remain positive about the growth prospects for the Engineering Technologies business. We believe that once we navigate through the trough caused by legacy pricing pressure and the new platform ramp-up delays, the operational improvements that we have made with the Enginetics plant will pay off meaningfully, and we will be well positioned to deliver sustainable top and bottom line growth for our shareholders.

Please turn to Slide 16, Electronics. Electronics continues to prove to be a strong and consistent growth engine for Standex. In Q3, sales increased by 58.5%, driven by double-digit organic growth in all regions and strength across all end markets as well as another great quarter by our Standex Electronics Japan acquisition. Sensor sales increased by 17.8% and Reed Relay switch sales were up 28%. Operating income was up 71.9% and operating margins were 21.8%. The Standex Electronics Japan acquisition, which was completed just over a year ago, is performing exceptionally well as we deliver on cost synergies and exceeding our sensors synergy sales target. Supply for the Reed switch market remains tight. And we capitalized on this by increasing the Standex Electronics Japan Reed capacity by 7.5%.

Looking ahead, we will focus on leveraging our market leadership position and expand our capacity in Reed Relays switches to capitalize on increased market demand. We also focused on delivering growth by executing on our market tests for new sensor technologies like next-generation magnetics, and electric vehicles, advancing growth laneways and capitalizing on our active M&A pipeline in magnetics and sensors. We also broke ground for our new headquarters and plant to support this business' significant growth.

Please turn to Slide 17, Hydraulics. The 22.6% sales increase in Hydraulics was driven by strength across all sectors. Margins were 13.4%, a decline from the prior year due to material cost increases, which now have been covered by sales price increases.

Orders were up 26% and backlog grew by 98% as we won new applications, a reflection of market strength and our competitive position. Looking ahead, we are focused on leveraging recent new business wins, pursuing market tests to grow the business and increasing solution sales.

We expect a strong fiscal Q4 and are optimistic about the future of this segment.

Before we go to questions, let me leave you with a few key thoughts on Slide 18. First, our growth engines, mainly Engraving, Electronics and certain specialty businesses within our Food Service Equipment segment, continued to deliver on the growth prospects by converting growth laneways, market tests and acquisitions. Second, the restructuring programs that are now in place in our Food Service segment are already delivering bottom line results and we have a good line of sight to achieving sustainable margin improvement as we exit the fiscal year. Although we continue to face near-term pressure in our Engineering Technologies business, we are confident that we are in an excellent position once the long-awaited new aviation platforms begin to ramp-up this summer. Third, our recent acquisitions of Standex Electronics Japan and Piazza Rosa in Engraving continue to perform well. And finally, with a strong balance sheet and active acquisition pipeline, we are well positioned to capitalize on additional bolt-on M&A opportunities to drive growth.

We're very proud of the hard work of the Standex team across the organization and appreciative of our shareholders. We look forward to keeping you updated as we continue to execute against Standex Value Creation System and position Standex to fulfill our mission to become the best-in-class operating company.

I would like to point out that we will be having an Investor Day at our lipskin plant outside of Milwaukee on May 17. We will feature 3 of our businesses, Electronics, Engraving, and Engineering Technologies with a special emphasis on the growing aviation exposure in Engineering Technologies. And with that, I'll be pleased to take your questions.

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

Maybe we can start on the Electronics side. Just the -- kind of -- what's behind the current tight supply of Reed switches? And how long do you think that will likely continue?

First of all, strong market demand in all the sectors that we serve in Electronics around the world. We are seeing new applications for Reed switches in alternative energies, in solar, in wind. There's growth in electric vehicles. These are not yet significant volumes, but they are a sign of future growth prospects for the Reed switch market. The underlying -- I guess the underlying issue is just simply market demand.

Got you. Are the electronic opportunities in North America, say versus Asia, are they -- are there many significant differences between the 2?

They are in similar end markets, if that's what you mean. In fact, many of the applications [and] the NBOs that we win in North America end up being manufactured in China. So in our view, from a business development and sales growth standpoint, there's not really a difference.

Got you. You had mentioned in the past that OKI kind of gave you an insight into the Asian markets that you didn't have before. So I wasn't sure if there was something...

No, no, no, okay. Let me comment on that. I misunderstood your question. They are fundamentally similar markets, but prior to that OKI acquisition, we didn't really have the window to the value-add opportunities in Asia. Now we have that window and I will say that we are exceeding the expectations we had for our Asia value-add sales based on the window that OKI has given us.

Got you. Got you. Okay, terrific. On the Food Service restructuring, you are talking about as you exit Q4, the margins would be more in line. Can you -- what's the kind of a reasonable expectation for operating margins in that area as you exit Q4?

Well within the quarter, we definitely said, January, February, March, we had a very strong March. February, we signed the plants that we've been working on; improvements in February, March was very strong. And I guess the way I would frame the answer to your question is relative to our commitment to getting this segment to 15% in 2020. And you'll see in Q4, a step in the right direction with our margins. If you look on the year-on-year compare, you'll see an improvement.

Got it, okay. Last question. Just in terms of R&D, what percentage of revenue do you currently spend on R&D? And is that the level you're comfortable with? Is that increasing? Can you just talk about that a little bit?

In -- it is a level that will be increasing, especially in Electronics and Engraving. We'll talk a bit more about this at the Investor Day in a couple weeks. When we think about our R&D, think about business development. We put some resources into both our Electronics and our Engraving businesses that are focused on business development, on new applications, on new technologies that aren't specifically engineers and R&D. So as I said, wait for the Investor Day for a little more on that, but the punchline to the answer is, this is a new area we want to increase.

Next question is from George Godfrey with CL King.

A couple questions. First one, the restructuring charges this quarter, $1.33 million, are those all in the Food Service? Or there are some charges in other segments?

There's minor charges in other segments. Specifically in Engraving, we had, let's say, $200,000, but primarily in Food Service.

Okay, and the acquisition-related costs, those are just Engraving and the Electronics segment, is that correct?

That was actually Food Service where we had a prior earnout that's captured in that figure.

Okay. So really that $2.5 million really is then -- if we adjust margin, it really is all in the Food Services just about?

Correct.

Got it. Okay. And then in Engineering Technologies, typically low margin this quarter and for the year. Is -- can this division still be double-digit operating margin do you think as we move forward into '18 -- excuse me, fiscal '19 and '20?

Yes, absolutely. This has all been predicated -- for a few years we've been talking about this, this is all predicated on those new generation platforms getting to full volume. We won the first lipskin awards back, gosh, when we started in the early 2014, January 2014 was our first lipskin award.

We're talking Engraving.

I'm sorry, I thought you said Engineering Technologies.

No, I did say Engineering Technologies...

Yes, so on Engineering Technologies. The projection from Pratt & Whitney on their geared turbo fan for the A320neo was in the full volume in 2017, that is now looking like 2019. When we talk to our customers now, GE, engine providers as well as the frame providers, the discussion was all about capacity. Are we ready for the ramp? Are we ready for the ramp? Now many of the decisions, the factors are outside of our control. But the payday for this whole business is this ramp in this new engine. We've been talking about this for years. And it does look like we are quarters away from that ramp beginning.

Got it. And that was my follow-up question, because you called out you're waiting for the volume ramp with the long-term aviation programs begin this summer. So specifically the lipskin program is what you're waiting for?

Well. It's also Enginetics. The Engine business, that's really been struggling the most in the last few quarters has a strong position in the geared turbo fan, also on next-generation engines from GE and with some parts with Rolls as well. So it's important for that business to mix in next-generation parts, which are to be higher-margin.

Got it. And then, the last question is Electronics. That margin up 170 basis points year-over-year. Now it looks like the first 3 quarters of this year are roughly 22%. Is that a peak level of performance do you think in the Electronics segment as the product portfolio is constructed today?

I wouldn't call it peak, but we think this is the level it can perform at. Now there were a couple of sources of improvement and expansion in margin. But a significant one is just moving up the value chain because as you move up from the Reed switch to relays or molded-packaged to switches and sensors, we have a higher gross margin on higher value-add. And we've really made progress in the last year moving our mix to the higher value-add.

(Operator Instructions) And your next question comes from Chris McGinnis with Sidoti & Company.

Just one quick question, just on the Engraving side. You talked about kind of new products coming in at a lower margin and they take time to kind of ramp-up. And can you maybe just walk through that process and your experience before as you're starting to offer a lot more products I guess as you expand that division?

So the new products, Tool Finishing, Laser, Nickel Shell. Nickel Shell and Laser had some upfront investment that's showing up in depreciation right now in that business. All 3 of the businesses, we put in business development people to drive their sales. So there's some dedicated SG&A to it. In the early days of the ramp-up, the margins of these businesses are running in the teens. The gross margins of these offerings are similar to our -- to the gross margins across the rest of the Engraving business or constant as they ramp to volume. They will -- they'll deliver EBITs in the low-20% range.

Okay. And just on the Food Service, I know you guys are expecting obviously that to pick up significantly in 4. But I guess just any way to bracket that improvement in terms of maybe looking at historically how strong it can be?

Even for Q4?

Yes, for Q4. Or maybe even longer term. I know you may have numbers out there longer term, but how quickly can we get this to I guess a stronger operating margin?

Well, I guess I'd answer this way. We left the quarter confident that restructuring is on track and is delivering, we saw it in our internal numbers month-to-month. It does not show when you report the entire quarter. And this gives confidence that this is getting to that 15% in 2020, we're on track to do that. But I guess I wouldn't put out any intermediate waypoints. Maybe we'll wait. Let's wait and see how Q4 comes in and we'll -- we can update the bridge, typically every year we've been updating that bridge to 15% at that pointer.

And Chris, we also -- I mean we showed you the seasonal trends and Food Service definitely follows that seasonal trend. Q1, it's high, a little bit less in Q2, a little less in Q3 and then up in Q4. That's, I guess, the modeling.

There are no further questions at this time. I'll turn the presentation back to Mr. David Dunbar for any closing remarks.

Thank you all for joining us today. We look forward to coming back to you at the end of our fiscal year reporting on our Q4 results. Thank you.

Thank you. This does conclude today's conference call. You may disconnect your lines at this time, and have a wonderful day.