Standex International Corporation (SXI) Q3 2013 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Third Quarter Fiscal 2013 Standex International Corporate Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the call over to Mr. David Calusdian from Sharon Merrill. Please begin.

Thank you. Please note that the presentation accompanying management's remarks can be found on Standex' Investor Relations website, www.standex.com. Please see Standex' safe harbor passage 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' 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 expenses and onetime items; 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 believe 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' third quarter news release. On the call today is Standex Chief Executive Officer, Roger Fix; and Chief Financial Officer, Tom DeByle. I'd now like to turn the call over to Roger.

Thank you, David, and good morning, everyone. Please turn to Slide 3. We grew sales and operating income in the quarter despite softening demand in several end user segments, and the fact that we had about 3% fewer shipping days during the quarter as compared with Q3 of fiscal 2012. Total sales were up 10.2%, which consisted of 1% organic sales growth and 9.3% growth from acquisitions, offset slightly by a negative 0.1% foreign exchange impact. This quarter, we experienced push outs on the refrigeration side of our Food Service segment as a result of the prolonged winter weather, and demand continued to be soft on the hot side of that business as well. On the bottom line, we reported year-over-year non-GAAP operating income growth of 21%, with the Electronics and Engineering Technologies segments reporting double-digit increases. Non-GAAP EPS from continuing operations was up 17.5% to $0.74 per share. During my segment review, I'll discuss a few items that had a negative effect on our non-GAAP bottom line results, including significant disruption and relocation expenses caused by our engraving facility move in Brazil, as well as warranty expenses at our beverage dispensing business. In addition, Tom will also discuss special items that we've excluded from our non-GAAP results. Looking at the balance sheet, we ended the third quarter with net debt of $41 million and a net debt-to-capital ratio of 13%. We remain in very good position to make further strategic acquisitions. Please turn to Slide 4, which provides an update on the transformation that we've made on the bottom line during the past 4 years. For the $0.74 per share we reported in Q3, we've now achieved $3.70 per share in non-GAAP EPS for the trailing 12 months. This demonstrates the impact of our lower cost structure and the success of our organic and acquisition growth initiatives. With that, Tom will discuss our third quarter results in some detail. After which, I'll discuss the recent performance of each of the business segments. Tom?

Thank you, Roger, and good morning, everyone. Please turn to Slide 5, which summarizes our third quarter results. Net sales for the third quarter increased 10.2% to $166 million from $150.7 million in the third quarter last year. Excluding special items, operating income grew 21% to $13.3 million from $11 million a year ago. Adjusted EBITDA grew to 17.6% to $17 million. Slide 6 is our quarterly bridge that illustrates the tax affected impact of the special items on net income from continuing operations. Four adjustments were made to normalize earnings: $760,000 of restructuring charges, a $2 million legal settlement expense, a $1.6 million gain from the cancellation of retiree life insurance benefits and $1.4 million of favorable discrete tax items. The legal settlement expense is related to the final resolution of the litigation in our Food Service Equipment Group that had previously been disclosed in our 10-Q and 10-K filings. During the quarter, we made a decision to cancel a retiree life insurance benefit, that the majority of which was associated with discontinued operations. The discrete tax items include the benefit from the prior year of the renewal of the R&D tax credit in the U.S., and a reduction of the deferred tax asset that we had determined was no longer required. Excluding these items from both periods, non-GAAP net income from continuing operations increased 17.1% to $9.4 million. Earnings per share from continuing operations excluding special items grew 17.5% year-over-year to $0.74 per share. Turning to Slide 7, you can see that we have performed well year-to-date, recording 11.4% growth in sales. Breaking sales growth down into its components, 8.9% came from acquisitions, 3.1% from organic growth, partially offset by a negative 0.5% from FX. Non-GAAP operating income excluding special items grew 17% to $50 million, and adjusted…

Thank you, Tom. Please turn to Slide 13, Food Service Equipment Group, and I'll begin our segment overview. Sales were down 1.5% at Food Service in the third quarter, which is typically the seasonally slowest for the segment because of significant percentage of our sales for this group are tied to the construction of new stores. This quarter was lower than normal on the refrigeration side of the business, primarily because of prolonged winter weather throughout the quarter caused customers the delay openings and remodeling until weather improved for site construction and coordination. In addition, general consumer uncertainty caused customers on the hot side of the business to delay equipment purchases. Non-GAAP operating income was down 17.6% due to the deleveraging effect of the lower volume, warranty expenses at our beverage dispensing business, a higher mix of lower margin quick service chain customers and significantly higher margin expenses than in the year ago quarter. We attended the North American Association of Food Equipment Manufacturers or NAFEM exhibition during the quarter. This show occurs every other year, so sales and marketing expenses in the quarter were higher than last year by approximately $600,000. Let's take a closer look at the developments at the Food Service business during the quarter, beginning with refrigeration. As we have seen in the past few quarters, strong sales to quick serve restaurant chains were substantially offset by softness at drug retail stores. During the quarter, we had a greater mix of sales to the smaller chains, which had a negative effect on margins. Our sales to the smaller chains our through dealers as opposed to the large chains where we sell direct. We have been successful in expanding our customer base in the dollar store segment, and in the third quarter, we received a commitment from…

[Operator Instructions] Our first question is from the line of Jason Nacca from Sidoti. Jason Nacca - Sidoti & Company, LLC: I just wanted to first get into Meder. We're beginning to see more synergies. I'm just looking for the operating margin, if you believe that's going to start trading, when do you think it's going to start being in the range of historical levels?

Well, we don't speak to margins specifically, but we do speak to the cost reductions. So the facility rationalization, as we mentioned, should be done by the end of this fiscal year, so that $1.5 million will start to flow through the P&L beginning in early part of fiscal 2014. And we mentioned that the other $2.5 million of cost savings are going to be kind of feathered in if you will over the next 12 months, starting really in the current quarter. So we would expect by, say, 12 months from now that the $2.5 million of savings associated the material cost reductions would be fully into the P&L. Jason Nacca - Sidoti & Company, LLC: Okay. And also we saw some push-outs on the refrigeration side of the Food Service. Are we going to be seeing some of that execution in the fourth quarter? Or is that more going to be pushed into fiscal '14?

No, we expect it to happen in fiscal '14. We've actually seen some improvement in activity as the weather's warmed up this month, bookings have strengthened a bit and the push-outs that we have produced, a lot of which was in inventory have started to flow through already. Jason Nacca - Sidoti & Company, LLC: Okay. And also going to Engineering Technologies, you see with the sequestration with NASA, are we seeing any -- provide me a little color on what you're seeing on that side besides the increase -- the unmanned kind of trends growth that we're seeing there? But how about on NASA? Are we seeing any pullback from there with their spending?

That's a very good question. Congress, in particular, the Senate, has been very forceful in authorizing NASA to continue to spend their budget on continuing resolutions. And that money has flowed specifically into the new Senate-approved launch systems called the Space Launch System, SLS system. And a lot of the development work that we're doing for NASA, it's not all for -- directly to NASA, but a lot of it goes through Boeing and other OEMs. That funding continues and we're seeing pretty solid demand from a development standpoint. The other side, the unmanned, as we mentioned in the past, again, a lot of that flows through government funding. But those platforms, those launches are actually funded out 3 or 4 years. So we have a very good visibility on both the manned and unmanned, and both are very, very strong robust. Jason Nacca - Sidoti & Company, LLC: Okay. And also a little bit on the Engraving segment. I know -- we saw some disruption of the Brazil relocation, and most of that happen second, third quarter. How quickly do you anticipate some improvement on that side and the margins on Engraving in fiscal '14?

Again, we've made good progress already. We weren't quite ready to call a victory for the fourth quarter. We expect there to be some minor additional expenses in the fourth quarter, but the majority of it's definitely behind us. And as we go into the next fiscal year, we should have that all buttoned down. Jason Nacca - Sidoti & Company, LLC: Okay. And also I know we're still seeing a bit of weakness on the drug retail. When are we going to be kind of seeing some reversal? I know we've got some bigger orders of $5 million to $8 million in the next 12 months. But I mean, are you seeing any particular strength with any of the particular chains or your offerings that you're providing?

What we expect to happen is that we really see a bottoming and we're lapping as we speak, and over the next quarter, we'll lap the big downturn. And what we're really seeing there is kind of a steady state kind of lower demand. These lower store openings have been forecast by our customers and it's really in the public domain. Walgreens, for example, has announced that whereas historically, they were building 400 to as many as 500 stores a year, that they're going to anticipate 200, 250 stores as more of the run rate going forward. And much similar for CVS and for Rite Aid. So what we're really seeing is more of a bottoming out, where the year-over-year will not continue to impact us as much after, say, the next couple of quarters. But our focus then has been to get into other segments, and that's why we've emphasized things like the dollar store segment, which is still rapidly growing. You read many articles about the dollar store chains opening literally hundreds of stores on an annual basis. We see very solid growth opportunities there, that's why we've emphasized the rack refrigeration, the Value Line refrigeration and this new redesigned merchandising case. We think those really open up additional sales opportunities that will allow us to grow that segment going forward. Jason Nacca - Sidoti & Company, LLC: Okay. And now moving to the acquisition pipeline. Just maybe a little color on what you guys are seeing there? Any -- on the deal side? I know that we want to move into some higher margin segments, but what kind of color are you seeing within the whole M&A activity?

Again, I think reasonably, good pipeline and opportunity, we never disclose who we're looking at and what we're looking at, other than say that we're interested in doing acquisitions across the breadth of our companies. So we're seeing properties, assets come to market. We typically try to stay away from the auctions. A lot of what we do is proprietary kind of transactions. Obviously, multiples have trended up certainly over the last 6 to 9 months. But I think just a continuation of what we've been seeing over the last couple of years. Jason Nacca - Sidoti & Company, LLC: Okay. And my last question is just for Tom with the tax rate. I'd see we have some favorable discrete tax items here. But how should we be looking at it in the fourth quarter and in fiscal 2014? Should we kind of expect in the 30% historical run rate?

Yes, we expect it to return to normal about 28% to 30% tax rate going forward.

Your next question comes from the line of DeForest Hinman from Walthausen & Company. DeForest R. Hinman - Walthausen & Co., LLC: Sorry, I was off the call for a few minutes, so I apologize if it's already been answered. But in terms of the inventory build, can you kind of go into what's really driving that? Is it primarily related to the Food Service side? Or is there something else going on there?

The inventory build really occur in 2 segments, definitely in the Food Service side where, again, sales were lower than expected, so we were forecasting greater demand which brought inventories that we weren't able to use. There was also again the kind of the delays on the refrigeration side, particularly in the walk-in side of the business where we had produced walk-ins for sale, where the job sites weren't ready because of the weather. So we saw -- because of lower sales than anticipated because of the push-outs, we saw increases in the inventory, both on the raw side and finished goods within the Food Service segment. And the other occurred in Electronics where, again, we are consolidating 2 facilities in China. We're moving our Tianjin operation down to Shanghai. We put in, what we call, buffer inventory, so that we could -- if we had any disruption or any downtime as a result of the relocation, we could continue to serve our customers. The one disadvantage of being in China is that we're -- on-the-water time is roughly around 4 weeks or roughly about 1 month, so we want to put enough inventory, finished goods inventory in place, so we could support our large OEM customers out of China without any disruptions. So both those are very manageable in the sense that we know where it's at. We know it can be burnt down over time. Certainly, this is not inventory that's old or stale, but we just need to adjust now our incoming raw to our total demand to be able to bring the inventory levels back down again. DeForest R. Hinman - Walthausen & Co., LLC: On the refrigeration side, should I assume that those are finished goods, and those are kind of working their way out rather quickly in the spring?

A part of it is finished goods, more of it is raw material. So the finished goods side, you're right. We'll go very quickly in a matter of weeks. The raw material side of that build will take longer to burn off. DeForest R. Hinman - Walthausen & Co., LLC: Okay. And once again, I apologize if it's already been asked. But can you discuss with a little bit more color this warranty issue on the beverage side that you had spoke of?

Right, we introduced a new product that we were rolling out to the marketplace for dispensing -- beverage dispensing applications, and there was a problem with one component that was in that system that we hadn't seen as part of our field testing or laboratory testing, and that recalled -- that require that we pull those units back, rework them, and so we took an accrual in anticipation of the cost associated with the rework process for warranty repair. DeForest R. Hinman - Walthausen & Co., LLC: And have we -- is that still ongoing, or is that completed?

We think we have captured the cost of that in the accruals. The actual service work will go on over the next several quarters. But we believe we've properly captured all the cost, so it shouldn't impact our results in the future quarters.

[Operator Instructions] Our next question is from the line of Beth Lilly from Gabelli Investors.

I have a couple of questions. Can you refresh us about the legal settlement, and what was involved in the $1.9 million and what that refers to?

Yes. We've disclosed it was related to a redhibition claim in the State of Louisiana, where there was a suit brought against us -- a part of our Food Service Group in the refrigeration side of the business. It's been ongoing lawsuit that's been in place for a couple of years. We were able to get to a point where we could settle at a reasonable amount, and so we did so, and we're moving on.

Okay. So the total amount is $1.9 million?

The pretax cost to us was about $2.6 million, with a couple of hundred thousand dollars of legal expenses on top of that.

Okay. Okay, great. And then can you just spend a minute and talk about is there any change in the competitive environment in terms of the Food Service Equipment business? Or do you think it's just more related to the environment, the tough economic environment, as well as just the weather?

We definitely think it has more to do with economics, surely not a competitive issue on our part. Our products and our price points are very competitive in the marketplace. But again, on the refrigeration side, the weather really impacted store openings really across the U.S. We've seen that really open back up over the last several weeks. Now the weather has improved. A lot of those sites were awaiting products from us. And on the hot side, again, we have a focus with our BKI unit on the grocery store segment. And you've read, I'm sure, Tesco took a big charge this past quarter. They're withdrawing from the U.S. market. They cut their capital spend pretty significantly in the U.K. That was one of our biggest customers in the U.K. So they, along with the rest of the grocery store segment in U.K., are down pretty substantially. And then SUPERVALU was also a big customer of ours, and they're going through their own financial problems as well right now. So it really has to do with the fact that a couple of our major customers have really reduced substantially their capital spend.

Okay, okay. Right. And then the other thing I wanted to ask you about is, so you're working capital turns were down in the quarter. And as you look out, do you think that those will go back over 5 next quarter, as well as into 2014?

Yes. They definitely go back over 5. We do have seasonality in our turns. The third quarter is our historic weakest, because our sales are the lowest in the third quarter. We're -- our inventories, in particular, were not able to reduce the same amount as our sales. So our turns are always the lowest in the third quarter. But our fourth quarter, where our sales were strong and first quarter where our sales are strong, are typically our 2 largest, if you look -- our 2 highest, I'm sorry, working capital turns quarters. If you look at our history being in the sort of high 5s, mid to high 5s is where we need to be in the fourth and the first coming up.

Okay. And so as you look at the overall environment in your -- on an organic basis, your revenues were up 1%, which is light for the company historically. Going forward, do you think that the -- as the economic environment improves, you should experience -- are you expecting faster revenue growth, maybe a little -- would you say mid single digits to high single digits?

Again, we don't give projections, but definitely, our aspiration that we've stated in our external communications is that we can look at GDP, global GDP as kind of a proxy for kind of a consolidated market growth of our various end user segments, and that we believe we should be able to grow a couple of point in excess of that GDP, which is, where we -- to your point, that's what we've been able to achieve really over the last 3 or 4 years. We've seen some real softening, though, in a couple of our markets, and that impacted our sales both this year -- this quarter, as well as last quarter.

At this time, there are no other questions. I'd like to turn the call back over to Mr. Fix for your closing remarks.

Thank you, everybody, for attending the conference call and your questions, and we look forward talking to you again next quarter. Thank you.

And ladies and gentlemen, this concludes your presentation. You may now disconnect. Have a great day.