Standex International Corporation

Good day and welcome to the STANDEX International Second Quarter 2020 Earnings Conference Call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your touch-tone phone. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Gary Farber. Please go ahead.

Thank you, Sarah, and good morning. Please note that the presentation accompanying management's remarks can be found on the investor relations portion of the company's website at www.standex.com. Please refer to 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 most 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 the non-GAAP measures of 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, EBITDA margin and adjusted EBITDA margin. We will also refer to other non-GAAP measures included adjusted net income, adjusted income from operations, adjusted net income from continuing operations, adjusted earnings per share, adjusted operating margin, free operating cash flow, and pro forma net debt to EBITDA. 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. StanX believes that such information provides an additional measurement and consistent historical comparison of the company's performance. On the call today is StanX's Chairman, President, and Chief Executive Officer, David Dunbar, and Chief Financial Officer and Treasurer, Ademir Sarcevic, and I'll turn it over to them.

Thank you, Gary. I will begin with an overview of our fiscal second quarter results and provide an update on our continued progress in executing on our strategic priorities. Ademir will follow with a discussion of our financial performance in the quarter, and I will provide some additional thoughts on our outlook. Now, if everyone could turn to slide three. Let's move into a discussion of second quarter results and key themes. We're pleased with second quarter results as quarterly performance continues to trend in line with our expectations. Results were consistent with our commentary on the first quarter conference call in November as we made further progress driving StandEx's strategy. Specifically, on a consolidated level, we reported $190.6 million in sales, a 2.5% year-over-year decrease, an adjusted EPS of $1.3, 5.1% year-over-year increase. For the third consecutive quarter, the engraving business demonstrated sequential margin improvement on flat sales growth. In addition, operating margin improved on the year-over-year basis for the first time in several quarters. Results of the electronic segment were sequentially similar to the first quarter, as expected, as macroeconomic headwinds continued to impact results, primarily in Asia. That said, the North American funnel of new business opportunities is growing. Also, engineering technologies trends remain strong. We also have an attractive pipeline of opportunities further positioning the company for higher growth and margin. Growth laneways increased 17% over second quarter 2019, propelled by offerings in nickel shell, laser, and tool finishing. We continue to see very positive trends in NBOs and electronics, particularly in North America, where the funnel has increased 6% year-to-date in fiscal 2020. The most recently closed acquisition, GS Engineering, is performing very well, with many opportunities across the global STANDEX engraving MOLTECH footprint. In December, we announced a definitive agreement to acquire Torotel, which specializes in the custom design, manufacture, and sale of precision magnetic components. The Torrentel acquisition is a strong strategic fit, adding expertise in attractive end markets, including aerospace and defense, that will strengthen our customer value proposition. We continue to expect the transaction to close in the first calendar quarter of 2020. The cost savings and restructuring actions announced in engraving and electronics are complete and flowing through the P&L. These initiatives are complemented by a company-wide focus on increased productivity. We also continue to address materials inflation in the electronics segment, through changes in re-switch production and material substitution. In the engineering technology segment, ongoing productivity improvements are further magnifying the benefits of volume leverage and expanding operating income growth. To further drive operational execution and productivity, we expect to have an experienced VP of operations join Standex in late February, further positioning us to achieve the company's long-term goals for growth and profitability by more fully leveraging the Standex value creation system. From a liquidity perspective, our emphasis on working capital management initiatives and free cash flow generation delivered improved results year over year, and the balance sheet remains strong. Net debt to adjusted EBITDA is under one time, and we will have approximately $195 million in available liquidity post the closing of Torretel. We also continue to repatriate cash from international markets and are on plan to repatriate $35 million this year. Now let's review the segments, beginning on page four with engraving, where we continue to make operating margin progress. Sales decreased 0.6% year over year. This largely reflected the timing of customer automotive programs balanced with growth laneways, which increased 22% to approximately $22.4 million, with growth in nickel shell, laser, and tool finishing, as well as the contribution from the GS engineering acquisition. Operating margin of 18.1% represented a 100 basis point sequential increase from the first quarter and a 20 basis point margin improvement year over year, reflecting improved operational execution and leverage associated with prior restructuring actions. Next quarter, we expect year over year improvement due to several top line and operating leverage drivers. From a sales perspective, there will be an increased level of new automotive model rollouts, contribution from new technologies such as soft trims, laser engraving and tool finishing, as well as the GS engineering contribution. Margins will benefit from volume leverage combined with cost savings from recent restructuring activity over the past few quarters. Our focus on operating discipline is gaining momentum as we have fully staffed the regional operations teams and are rolling out standardized ERP tools to support them. Please turn to slide five, the electronics segment. Several factors weighed on electronics results, particularly in Asia. Total sales decreased 13% and operating income declined 25% year-over-year. The sales decline largely reflected weaker end markets in Asia and continued distributed destocking, although these trends appear to be moderating. There were pockets of positive trends including market strength in aerospace and defense and new applications for smart grid products in utilities. Despite the impact of volume deleveraging and material inflation in the Asia read switch operation on operating income year-over-year, Operating margin of 17% was sequentially similar to the first quarter as efficiency actions implemented in fiscal year 20 supported margins. Next year, we expect electronic sales volume to increase slightly sequentially and decline on a year-over-year basis. While there are some near-term challenges, we are successfully pursuing several initiatives. The new business opportunity funnel strengthens, particularly in North America, where it has increased 6% year-to-date in fiscal 2020, positioning the business for future growth. Applications recently awarded from this funnel will deliver an estimated incremental $11 million in sales in our fiscal year 21. An ongoing focus on productivity and cost initiatives, including addressing material inflation through changes in the reed switch production process. Turning to slide six, engineering technologies. Engineering technologies results remain strong, with revenues increasing 12.4%, and operating income growing more than five times that rate at 66% year-over-year. The results reflect strength in core markets of aviation, space and defense, as well as momentum in manufacturing productivity improvements. Backlog to be delivered in under one year grew 17% year-over-year. Due to project timing, we expect revenue in the fiscal third quarter to decrease year-over-year. However, we expect operating income in the third quarter to increase year-over-year, driven by the growth of new aerospace platform parts, Productivity, and Cost Efficiency Initiatives. Turning to hydraulics on slide seven. The 6.6% decrease in sales reflected customers reducing existing inventory levels as well as a slowdown in the dump truck market partially offset by positive refuse market trends. Second quarter operating margin of 16.1% increased slightly from 15.9% a year ago. The margin increase year over year reflected solid expense management and a favorable product mix. We expect revenue and operating income to decrease next quarter year over year, reflecting customer destocking as well as the end of tariff relief on select products from our China plant. Our focus remains on positioning standings for higher growth and margin improvement. For example, in the case of the hydraulic segment, we are realigning capacity towards providing greater support for aftermarket sales growth and additional new business opportunities. Now let's move to slide eight, the food service equipment group. Sales were flat year over year, reflecting a mix of trends, including growth in pumps, balance with relatively flat demand in scientific and refrigeration, and lower sales in merchandising year over year. The 30% increase in operating income was largely reflective of the scientific profit contribution impact, as well as a positive contribution from refrigeration. Next quarter, we expect food service group sales to be relatively flat year over year, reflecting growth in scientific, with refrigeration group and pump sales decreasing slightly. We expect an increase in operating income year over year driven by productivity improvements and favorable mixed friends of some of the higher margin businesses. Now with that, I will turn the call over to Ademir to discuss the financial results in more detail. Ademir.

Thank you, David, and good morning, everyone. First, I will provide a few key takeaways from our second quarter results. Overall, quarterly financial performance continues to be in line with our expectations. Trends in engineering technologies remain solid. Thank you. Thank you. and finally, we have remained disciplined in managing our cost structure. The cost restructuring actions in engraving and electronics are complete to deliver 3.8 million in annualized savings. And we will implement additional productivity programs across the company. Now let's turn to slide nine, second quarter 2020 financial summary. On a consolidated basis, total revenue declined 2.5% year on year. This reflects organic weakness in electronics Strength in Engineering Technologies and Contribution from GS Engineering in the Engraving Segment. FX remained a headwind, but to a lesser extent than in prior quarters, with a negative impact of 0.4%. Second quarter gross margin improved 70 basis points on a GAAP basis and 60 basis points on an adjusted basis compared to second quarter 2019. This year-on-year increase reflected sales mix and productivity improvements in several businesses, including engineering technologies and engraving. Adjusted operating margin declined 80 basis points from 10.9% in the second quarter of 2019 to 10.1% in the second quarter of 2020. This is primarily due to a $2.2 million increase year-on-year in corporate expenses. Similar to last quarter, the corporate expense headwind reflects increased accrued stock-based compensation and benefit expense in 2020. As we indicated on our call in November, we expect that year-on-year corporate expense comparisons will improve as we move to the rest of the fiscal year. Diluted earnings per share were $1 on a GAAP basis and $1.03 on adjusted basis, representing an increase of 2% and 5.1% respectively year-on-year. This reflected both lower interest expense and tax rate as compared to last year. A slide 10 provides additional detail on revenue by segment and on consolidated basis. Specifically, as mentioned previously, revenue reflects strength in engineering technologies with weakness in electronics, primarily from the Asian market, and the impact of the GS acquisition in the grading segment. Please turn to slide 11, free cash flow. Standards generated free operating cash flow of $9.9 million compared to $7.7 million in the second quarter of 2019, a 25% year-on-year increase. This was due to several factors. a reduction in working capital, which is detailed on slide 12, which we will get to in a moment, capital expenditures of 3.6 million in the second quarter of fiscal 20, compared to 8.7 million in the second quarter of 2019, primarily due to timing of capital projects. These trends were partially offset by a decrease in net cash from operating activities, which was primarily due to an earn-out payment associated with the previous acquisition, and these payments are now complete. Now, please turn to slide 12, working capital trends. The company's initiatives focused on collection efforts, improving inventory turns, and managing payables resulted in year-on-year improvement in key working capital metrics. Overall, working capital turns increased from 5.1 to 5.1 from 4.7, inventory turns increased from 4.6 to 4.8, and the IPO increased by nine days. Please turn to slide 13, which summarizes Standex capitalization structure and liquidity statistics. Standex had net debt of $88.1 million at the end of the second quarter compared to $98.7 million at the end of the first quarter and $104.5 million at the end of fiscal 2019. Our leverage statistics remain strong. The company net debt to adjusted EBITDA leverage ratio was 0.8 compared to 0.9 in the first quarter. Ademir Sarcevic, In January, we declared the company's 222nd consecutive dividend, a 10% increase year-on-year to $0.22 per share. We also repatriated $2.7 million from foreign subsidiaries in the second quarter and $11.9 million year-to-date and plan to repatriate a total of $35 million during fiscal 2020. We have also fine-tuned capital expenditure forecasts between $30 and $32 million compared to the prior $31 to $34 million estimate. and with that, I will turn it back to David.

Thank you, Ademir. I will conclude with slide 14. In the third fiscal quarter of 2020, we expect total revenue to increase slightly sequentially but be similar to third quarter of 2019. In regard to operating income, Standix expects operating income to be sequentially similar, slightly better than second quarter results and show significant improvement year over year as we realize additional benefits of the company's cost reduction actions. Our outlook assumes the following. Improved engraving and scientific segment performance and increased profitability in engineering technologies year over year. Performance in the electronic segment will improve sequentially, although be lower year over year. At the hydraulic segment, we expect third quarter results will be similar to second quarter 2020 results, but a decrease year over year as customers destock inventory against the backdrop of a softer market environment. Underpinning Standex's ongoing success is a focus on operational discipline and improvement, further driving continued emphasis on productivity and efficiency initiatives as evidenced by improvement in working capital metrics and engraving margin the past few quarters. This focus will be further supported now by the hiring of a VP of Operations. We remain focused on positioning the company's portfolio on higher growth and return opportunities and further extending Standex's competitive advantages, This is evident in the trends for growth laneways and NBOs, as well as recent transactions such as the GS Engineering and the definitive agreement to acquire Tornatel. Finally, we are committed to maintaining a strong balance sheet, complemented by a disciplined approach to capital allocation, and will be opportunistic as we pursue further value creation opportunities. With that, we will open the call up to questions. Operator?

We will now begin the question and answer session. To ask a question, you may press star then 1 on your touch tone phone. If you are using a speaker phone, please pick up your handset before pressing the keys. To withdraw your question, please press star then 2. At this time, we will pause momentarily to assemble our roster. Our first question comes from Chris Moore with CJS. Please go ahead.

Hey, good morning guys. Good morning. Maybe we could start on the electronic side. Just, you know, kind of bigger picture. I'm trying to get a feel for the geographic mix. You know, obviously the headwinds have come from Asia. If we look, you know, back a year and then currently and then, you know, kind of maybe out a little bit further, do you expect that, you know, that there's a shift going on? Is there something kind of structural in Asia that would make it difficult to, you know, to rebound, you know, later this year or into 21 and, you know, kind of just how you kind of see that geographic mix from here and moving forward?

You know, at a high level, the mix of the business is roughly a third in Europe, in America, and in Asia. Asia has come down a bit. It's probably ticked down a few percentage points relative to the others. What's driven it down in the last year is softness in global auto. A lot of our sales into Asia are to suppliers to auto OEMs that make various devices that include our sensors. In general, slowdown in industrial activity in China in part due to tariffs. So we think those things are temporary in nature and cyclical relative to the markets that we serve. We don't think there's a long-term shift in our geographic balance.

Thank you. Maybe just talk a little bit about Torotel in terms of further expanding the capabilities and customer value proposition. Can you talk a little bit further about what that brings to Standex?

It brings a few things. First of all, The position that Torotel has in aerospace and defense markets is very attractive to us. These are long-term relationships they have. They are on many significant new platforms that will be ramping up in the coming years. The fundamental characteristic of high reliability magnetics that we like is the business is based on very close collaboration between our engineering teams and customers' engineering teams. which results in essentially functioning as an extension of that technical group with the customers. We get designed into a platform and basically ride that platform through its life and good performance on our part then earns the opportunity to design ourselves into the future platform. So very sticky long-term relationships with these customers and aerospace and defense is an attractive market. We believe we're building a competitive advantage and a strong competitive position in this market with a series of acquisitions and high reliability magnetics. There are still a number of smaller players out there. It's a somewhat fragmented market. And with the Torrential acquisition, we'll have about a $100 million business here in North America. We are able to invest in equipment in our quality labs, in our product development tools, and develop a bigger, deeper New product development capability than many competitors. So Torotel's capabilities are additive to all of that. And so the central premise of our magnetic strategy is to develop the strongest engineering capability in North America for high reliability magnetics. That's what customers really look for us to deliver.

Got it. Very helpful. I'll jump back in line. I appreciate it, guys.

Thank you, Chris.

Our next question comes from Chris McGinnis with Sidoti and Company. Please go ahead.

Hi, good morning. Thanks for taking my questions. Can you just, in the electronics, you used to talk about the changing the composition of the re-twitch. Can you just give an update on that? I know that was one of the pressures over the last year, you know, changing kind of the formation or the composition of it, and maybe just provide an update on that. Thanks.

Yeah, this has really been a pressure point for us the last few years. If you recall back in 2017, we acquired the reed switch business from Oakey. We now call it our Kofu plant. And nearly all the reed switches in that plant are tipped with rhodium. At the same time, our plant in the UK, we tipped about half of our reed switches with rhodium. Rhodium at the time back in 2017 was selling for about $1,500, $1,600 an ounce. It is now over $10,000 an ounce. We use about 2,500 ounces a year. It is a very thinly traded commodity, very volatile. And so what we've done in the last year as the price of rhodium has increased is take a look at all of our applications and determined where the performance advantages of rhodium are necessary. and where we can replace the use of rhodium with other precious minerals, iridium or ruthenium. And so we started a project to begin transitioning those reed switches to other materials and we think we'll be complete in about 18 months as we, you know, every quarter we'll be moving more and more of our reed switches to ruthenium or iridium and then the remainder will be in such mission-critical, high-value applications that we'll be able to pass price through to the market because of the performance advantages.

Right. And then just two more questions. One, you just talked a little bit about Asia and what's happening with coronavirus and any expectations of any potential impact to your business.

Yeah, well, you know, we're a small-cap industrial with... a somewhat modest presence in China. Our current expectation from our businesses that just talked to our customers is our plants will be shut down for an extra week after the Lunar New Year. The current assumption we have baked into our forecast here is that we will get back to production at the end of February and make up any interruption in our business and our supply chain within the quarter. Most of the focus now is within our employees, just staying safe. Many employees are working from home. And we'll be returning to our plants next week when they start operating again.

Thanks. Just one last one on the engineering. Just with that expectation of revenue being down in Q3, can you just walk us through, you know, obviously there's really strong growth coming from that segment. over the last year and a half or two. Can you just maybe talk a little bit about the timing and should that make Q4 even stronger or how does that timing play out? Thanks.

Well, you're right to say it is strictly a question of project timing with our customers. These are large projects and sometimes depending on other items in the customer supply chain, customer inspections or others, These projects can slip from one quarter to the next. However, you see the backlog is up 17%. The prospects for this business are very strong. We do anticipate a strong Q4. And our teams are doing everything they can to try to schedule their capacity so we can get some more shipments this quarter, although current customer schedules don't necessarily support that. So, yeah, the short answer is, yeah, strong Q4 and good long-term prospects. Okay.

Thanks for taking my questions and good luck in Q4.

Thank you, Chris.

Once again, if you have a question, please press star then 1. At this time, there are no further questions. I would like to turn the conference back over to David Dunbar for any closing remarks.

All right. Thank you. I want to thank everyone today for your interest in StandX and letting us share our results, accomplishments, and vision. Also, I want to thank our employees and shareholders for their continued support. We look forward to speaking with you again in the third quarter fiscal 2020 call.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.