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Standex International Corp (NYSE:SXI)
Q2 2020 Earnings Call
Feb 4, 2020, 8:30 a.m. ET
Contents:
- Prepared Remarks
- Questions and Answers
- Call Participants
Prepared Remarks:
Operator
Good day and welcome to the Standex International's Second Quarter 2020 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Gary Farber. Please go ahead.
Gary Farber -- Investor Relations
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 2. Matters that Standex's 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. Standex believes that such information provides an additional measurement and consistent historical comparison of the company's performance.
On the call today is Standex's Chairman, President and Chief Executive Officer, David Dunbar and Chief Financial Officer and Treasurer, Ademir Sarcevic. And now, I'll turn it over to them.
David Dunbar -- President and Chief Executive Officer
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 then I will provide some additional thoughts on our outlook.
Now if everyone can turn to slide 3. Let's move into a discussion of the second quarter results in 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 and adjusted EPS of $1.03, 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 Electronics 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 in 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 Mold-Tech 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 Torotel 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 companywide focus on increased productivity.
We also continue to address materials inflation in the Electronics segment through changes in reed switch production and material substitution. In the Engineering Technologies 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 1 times and we will have approximately $195 million in available liquidity post the closing of Torotel. 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 4 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 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 roll-outs, 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 5, 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 distributor 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 reed 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 follow up strengthened 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 and ongoing focus on productivity and cost initiatives, including addressing material inflation through changes in the reed switch production process.
Turning to slide 6, Engineering Technologies. Engineering Technologies results remain strong with revenues increasing 12.4% and operating income growing more than 5 times the net 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 7. 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 Standex for higher growth and margin improvement. For example, in the case of the Hydraulics segment, we are realigning capacity toward providing greater support for aftermarket sales growth and additional new business opportunities.
Now let's move to slide 8, the Food Service Equipment Group. Sales were flat year-over-year, reflecting a mix of trends, including growth in pumps, balanced with relatively flat demand in Scientific and Refrigeration and lower sales in merchandising, year-over-year. The 30% percent 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 mix trends 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?
Ademir Sarcevic -- Vice President, Chief Financial Officer and Treasurer
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. Engraving segment improved its operating margin, both sequentially and year-on-year on relatively flat sales. Electronics, which has faced a challenging market for the past few quarters, held its margin sequentially in the 17% range by leveraging productivity initiatives.
We also continue to execute on key initiatives to maintain our strong balance sheet position. Working capital and cash flow metrics both improved year-on-year. We continue to successfully repatriate cash from international markets. 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 9, 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 our 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 of $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.
Slide 10 provides additional detail on revenue by segment and on consolidated basis. Specifically, as mentioned previously, revenue reflect the strength in Engineering Technologies with weakness in Electronics, primarily from the Asian market and the impact of the GS acquisition in the Engraving segment.
Please turn to slide 11, free cash flow. Standex 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 the timing of capital projects. These trends are 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 to 5.1 times from 4.7 times, inventory turns increased from 4.6 times to 4.8 times and DPO increased by 9 days.
Please turn to slide 13, which summarizes Standex's 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 '19. Our leverage statistics remain strong. The company's net debt to adjusted EBITDA leverage ratio was 0.8 times compared to 0.9 times in the first quarter. The net debt to capital ratio was 15.2% compared to 17.3% at the end of the first quarter. We also expect to have approximately $195 million of available liquidity, post the closing of Torotel acquisition. This places us in a very favorable position to invest in internal growth initiatives, pursue strategically sound and financially attractive acquisitions, as well as return capital to shareholders.
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 repay a total of $35 million during fiscal '20. We have also fine-tuned capital expenditure forecast between $30 million and $32 million, compared to the prior $31 million to $34 million estimate. And with that, I will turn it back to David.
David Dunbar -- President and Chief Executive Officer
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, Standex expects operating income to be sequentially similar to 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 Electronics segment will improve sequentially, although be lower year-over-year. At the Hydraulics 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 in 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 Torotel.
Finally, we are committed to maintaining a strong balance sheet complemented by a disciplined approach to capital allocation and we'll be opportunistic as we pursue further value creation opportunities. With that, we will open the call up to questions. Operator?
Questions and Answers:
Operator
We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Chris Moore with CJS. Please go ahead.
Christopher Moore -- CJS Securities, Inc. -- Analyst
Hey, good morning, guys.
David Dunbar -- President and Chief Executive Officer
Good morning, Chris.
Christopher Moore -- CJS Securities, Inc. -- Analyst
Good morning. Maybe we could start on the Electronics item. Just, kind of bigger picture item. I'm trying to get a feel for the -- the geographic mix, obviously the headwinds are coming from Asia. If we look back a year and then currently and then kind of maybe add a little bit further, do you expect that there is a shift going on? Is there something kind of structural in Asia that would make it difficult to -- to rebound later this year or into '21 and kind of just how you -- how you kind of see that geographic mix from here and moving forward?
David Dunbar -- President and Chief Executive Officer
At a high level, the mix of the business is roughly one-third in Europe, in America and in Asia. And 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, a general slowdown in industrial activity in China, in part due to tariffs. So we think those things are -- they're temporary in nature and cyclical relative to the markets that we serve. So we don't think there's a long-term shift in our geographic balance.
Christopher Moore -- CJS Securities, Inc. -- Analyst
Got it. Thank you. Maybe just talk a little bit about Torotel. In terms of that further expanding the capabilities and the customer value proposition, can you talk a little bit further about what that brings to Standex?
David Dunbar -- President and Chief Executive Officer
It brings -- it brings a few things. First of all, the the position that Torotel has in aerospace and defense markets are -- 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 characteristics, 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 us essentially functioning as an extension of that technical group with the customers, we get designed into a platform and -- and basically ride that platform through which we love and good performance on our part then earns the opportunity to design ourselves into the future platform. So very sticky long term relationships for these customers and aerospace and defense is an attractive market. We believe we are 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 Torotel acquisition, we'll have about $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. 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.
Christopher Moore -- CJS Securities, Inc. -- Analyst
Got it. Very helpful. I'll jump back in line. I appreciate it, guys.
David Dunbar -- President and Chief Executive Officer
Thanks, Chris.
Operator
Our next question comes from Chris McGinnis with Sidoti & Company. Please go ahead.
Chris McGinnis -- Sidoti & Company -- Analyst
Hi, good morning. Thanks for taking my questions. Can you just -- in the Electronics you talked -- you used to talk about changing the composition of the reed switch. Can you just give an update on that? I know that was one of the pressures over the last year, change in kind of the formation or the composition of that and maybe just provide an update on that. Thanks.
David Dunbar -- President and Chief Executive Officer
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 OKI. 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 plants in the UK, we tipped about half of our reed switches with rhodium. Rhodium, at the time, back in 2017, was selling for about $1500, $1600 an ounce. It is now over $10,000 an ounce. We used about 2500 ounces a year. It's -- 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 else -- 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 will be -- will be complete, I think, about 18 months as we -- every quarter we'll be moving more and more of our reed switches to ruthenium or iridium and then the remainder with rhodium, will be in such mission critical, high-value applications that -- that we'll be able to pass price through to the market because of the performance advantages.
Chris McGinnis -- Sidoti & Company -- Analyst
Great. And then just two more questions. One, can you just talk a little bit about Asia and what's happening with Coronavirus and any expectations of any potential impact to your business?
David Dunbar -- President and Chief Executive Officer
Yeah, well, we -- we're a small cap industrial with somewhat modest presence in China. Our current expectation from our businesses that just talk to our customers is our plants will be shut down for an extra week after the -- after the Lunar New Year, that 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 -- any interruption in our -- in our business and our supply chain within the quarter. Most of the focus now is within our employees to staying safe, many employees are working from home and will be returning to the -- to our plants the next week when they -- when they start operating again.
Chris McGinnis -- Sidoti & Company -- Analyst
Got it, thanks. Just one last one on the Engineering. Just with that expectation of revenue being down in Q3. Can you just walk us through -- obviously it's really strong growth coming from that segment over the last year and a half to 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 right?
David Dunbar -- President and Chief Executive Officer
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 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 -- try to schedule their capacity, so we can get some more shipments this quarter, although our current customer schedules don't necessarily support that. So the short answer is yeah, we -- strong Q4 and good long term prospects.
Chris McGinnis -- Sidoti & Company -- Analyst
Thanks for taking my questions and good luck in Q4.
David Dunbar -- President and Chief Executive Officer
Thank you, Chris.
Ademir Sarcevic -- Vice President, Chief Financial Officer and Treasurer
Thank you.
Operator
[Operator Instructions] At this time there are no further questions. I would like to turn the conference back over to David Dunbar for any closing remarks.
David Dunbar -- President and Chief Executive Officer
All right, thank you. I want to thank everyone today for your interest in Standex 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.
Operator
[Operator Closing Remarks]
Duration: 27 minutes
Call participants:
Gary Farber -- Investor Relations
David Dunbar -- President and Chief Executive Officer
Ademir Sarcevic -- Vice President, Chief Financial Officer and Treasurer
Christopher Moore -- CJS Securities, Inc. -- Analyst
Chris McGinnis -- Sidoti & Company -- Analyst
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