Standex International Corp/De/ Q2 FY2022 Earnings Call

Good morning, and welcome to the Standex International Second Quarter Fiscal 2022 Conference Call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded.

Thank you, operator, 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 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 Annual Report of Form 10-K as well as other 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 EBIT, which is earnings before interest and taxes; adjusted EBIT, which is EBIT excluding restructuring purchase accounting, acquisition-related expenses and one-time items; 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, including adjusted net income, adjusted operating income, 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.

Thank you, Gary. Good morning, and welcome to our fiscal second quarter 2022 conference call. I'm very pleased with our strong second quarter results, which were above our expectations with record performance in several areas. Our success reflects the significant repositioning of our portfolio around high growth end markets, where our expertise and innovative solutions provide compelling customer value proposition. We are excited about the growing number of new business opportunities in front of us and are in the early innings of further driving the trajectory of the next leg of our growth strategy. I want to thank our employees, executive teams and the Board of Directors for their continued dedication and support. Now, if everyone can turn to Slide 3, key messages. Both revenue and consolidated adjusted operating margin increased significantly year-on-year in the second quarter. Record sales of both our electronics and scientific segments in the quarter were key drivers of organic revenue growth, which was 20% year-on-year. Electronics segment revenue grew approximately 27% year-on-year with broad based strength across all geographic regions and end markets, such as electric transportation, solar, military, aerospace and semiconductor, all platforms were significant future growth. Scientific segment revenue increased approximately 38% year-on-year with positive trends in our core markets, complemented by ongoing demand for COVID-19 vaccine storage refrigeration. For the third consecutive quarter, we've reported our highest adjusted consolidated operating margin in Standex history, 13.6%, representing a 220 basis point year-on-year increase. This reflected strength in end market product demand, complemented by market share gains, productivity and price realization initiatives. We are entering the second half of fiscal 2022 with a very robust pipeline of new business opportunities in high-growth end markets. We're also further leveraging our business units through highly targeted investments in research and development, strengthening our foundation and outlook for future growth. Total company backlog realizable under one year increased approximately 11% sequentially in the quarter and 53% year-on-year with record backlog levels at the electronics and specialty solutions segment. In addition, our electronics segment new business opportunity pipeline of $64 million represented a 14% year-on-year increase and is expected to contribute $19 million in sales in fiscal 2022, approximately 25% above the previous year. We also achieved an important milestone in our project with ENEL, a global energy company delivering full-sized prototype solar modules in December. We highlighted this opportunity on our fiscal fourth quarter call in August and are now expected to move to design and construction of the pilot plant, further expanding Standex's potential avenues for growth. Our operating approach globally remains highly collaborative and well-coordinated across business segments and leadership teams. A significant portion of our client base is in the same region where materials are sourced and products are manufactured, minimizing supply chain issues. We continue to drive supply chain productivity through proactive and strategic material sourcing and logistics management. We continue to execute on standardized operating disciplines across business units, including new lean programs and highly focused sales, inventory and operations planning processes. In regard to inflationary trends, we have implemented new processes and systems, combined with collaborative efforts among segment engineering, sales and purchasing personnel to effectively implement price realization actions. In addition, at the electronics segment, by the end of fiscal 2022, we expect to substantially complete the expansion of rhodium based reed switch production. We are now able to offer customers a choice of switches with rhodium or other materials, reducing our exposure to future rhodium inflation. In the second quarter, we also further strengthened our balance sheet and liquidity position, supported by continued solid cash generation and have substantial financial flexibility to further expand the number of high return organic and inorganic opportunities across our business units. Ademir will discuss our financial performance in greater detail later in the call. Regarding our financial outlook, we expect the momentum to continue in fiscal 2022 with stronger financial performance in the second half of our fiscal year, both year-on-year and compared to the first half of fiscal 2022. Specifically on a sequential basis in the fiscal third quarter, we expect revenue to be similar to slightly higher and operating margin to be slightly higher sequentially with a significant overall increase year-on-year compared to fiscal third quarter 2022. We are also pacing ahead of the long-term financial targets we provided a year ago. As before, our outlook assumes a continued macroeconomic recovery.

Thank you, David; and good morning, everyone. First, I will provide a few key takeaways from our fiscal second quarter 2022 results. Revenue, operating margin and free cash flow all increased both sequentially and year-on-year. Organic revenue growth of approximately 20% year-on-year reflected record sales of the electronics and scientific segments with 4 of our 5 segment reporting increased sales. 20% year-on-year organic growth consists of approximately 2/3 in volume increase and 1/3 in price realization. In addition, adjusted consolidated operating margin of 13.6% in the quarter represented a 20 basis point sequential increase and 220 basis points increase year-on-year, led by strong operating performance in the electronics and scientific segments. We also further added to our significant balance sheet and liquidity strength the solid free cash flow generation. In summary, supported by continued strong market demand and active pipeline of new business opportunities and new product development, ongoing focus on price and productivity initiatives and with a year-to-date book-to-bill well in excess of 1, Standex is entering the second half of fiscal 2022 with momentum and expectations for continued improvement in financial performance, both sequentially and year-on-year. In addition, all these positive trends provide us with further financial flexibility to pursue a very active pipeline of M&A opportunities.

Thank you, Ademir. If everyone can please turn to Slide 12 for a discussion of our improved growth outlook. We are entering the next phase of our strategy and the growth trajectory, well positioned to exceed our prior long-term organic revenue growth target of mid-single digits. We are focusing on end markets aligned with sustainable growth trends. We can provide innovative solutions, addressing emerging global opportunities in areas such as renewable energy, electric vehicles, human health, commercialization of space and products that emphasize sustainability in their features. Our presence in these high growth end markets is already contributing $64 million in sales annually and increasing at a 25% compound annual growth rate. Our applications typically have multi-year customer purchase lifecycles, providing a recurring revenue stream. We are leveraging our significant pool of internal talent with the recent announcement of a dedicated office of innovation. We are increasing investments in R&D to execute on a very active pipeline of new product introductions and expand the range of high return opportunities company wide. We are focused on driving profitable growth with investment in R&D, which has doubled since the end of fiscal 2019, while our consolidated adjusted margin improved. Recent releases include introducing new product categories at scientific, including blood bank and plasma cabinets and a ground-up redesign at merchandising of our new Vision series, which we introduced in November and is already generating significant customer order flow. Our approach to executing on our projects is highly collaborative and multifaceted to maximize the value of our expertise. In the case of the solar project with ENEL, which I discussed earlier in my comments, electronics, engraving and our innovation and technology office are collaborating to apply custom surface engraving and electronic componentry. In addition, Standex has a minority ownership stake in Gr3n SA, whose recycling process will be used for material inputs to module production. We expect a pilot plant to begin operation in early 2023.

Thank you. We will now begin the question-and-answer session. Our first question comes from Chris McGinnis from Sidoti & Company. Please go ahead.

Yeah. Good morning. Thanks for taking my questions, and congratulations on a very strong quarter.

Yes, thank you. Good morning.

I guess just one thing right off the bat, it's just that, a number of other companies are reporting kind of significant increases in raw material, supply chain issues or labor, can you just address maybe how much of a headwind that is right now? And how are you largely offsetting that?

I'll say a couple of words and then turn it over to Ademir. Our biggest raw material issue in the last few years was rhodium in electronics, and I think you've seen in the last year how we've effectively managed that by passing price through to recover the margin and we've also engineered an alternative products for customers using ruthenium in those switches. The other business that's really affected by material increase in hydraulic and you kind of see that in the specialty module, but hydraulics has always dealt with fluctuations in steel price and has a well-established process for passing price through and we're confident that we're positioned to start recapturing that margin in the coming quarter.

Yeah, Chris, and if I can add. For the most part, we are the regional supplier for regional customers. We don't have really a lot of a long kind of long-haul supply chain, if you will. So we estimate in the quarter, there was about $6 million worth of sales that got pushed from the quarter, pushed to the right, but these are sales that we did not lose, these are not cancellations, it's just something that we will have to ship in Q3 and Q4, but for the most part there has been a pretty limited impact for us.

Great. And then, I guess, just in relation, I'm sorry.

Go ahead.

Regarding the updated long-term target, what factors contribute to achieving that in 18 months instead of 36 months? What do you believe could facilitate a quicker timeline versus a longer execution period?

Well, it's two things, Chris. One is just simply looking at the performance of the business in the last year. I mean, where we're headed now, we're headed where we thought we would be a year ago and even our performance relative to external expectations, we've exceeded the expansion in margin rate and our sales. So we are farther along than we thought we would be. Secondly, we just completed a very granular ground up recast of our five-year projections for all of our businesses. We came out of there with a lot of confidence that our topline growth will continue, we'll leverage margin expansion. And the Page 12 gives a number of the items that go into our enhanced topline expectation. So it's a process of just kind of watching the performance in the last year and also really digging through our businesses to see what they've got in the pipeline to contribute to the next few years.

Great. And then just one more for me and I'll jump back in queue. Just in relation to the balance sheet and the opportunity for M&A. I know last quarter you bought back some shares that didn't happen in Q2. I'm just guessing, is the opportunity for M&A becoming maybe more apparent at this point?

Yeah. I'll say a word about that. Every quarter we look at our cash, what are the best uses of cash, continue to buy back shares is always on the table, but it's in context with the other options in front of us. So, obviously, we have some great internal investment opportunities. The acquisition pipeline has become busier in recent quarters. Our intent is not to sit on cash for a long time. We're going to put it in the most productive uses and I can only say we follow the same quarter-by-quarter valuation. Ademir, do you want to add anything to that?

Yeah. The only thing I would add, Chris, our share repurchases will continue to be an important part of our capital allocation strategies. And I wouldn't read too much into the fact that we didn't repurchase any shares last quarter.

Okay. I appreciate that. I'm going to jump back in queue. Good luck in Q3, but I'll talk.

Yes. Thank you.

Thank you.

The next question comes from Chris Moore from CJS Securities. Please go ahead.

Good morning, guys. Thanks for taking my questions.

Hi, Chris.

Good morning. You mentioned that the reed switch production material substitution project is expected to be completed by the end of 2022. I'm curious, if it had been finished by the end of 2021, approximately how much of an impact would that have had in 2022? Would that be more related to volume or margin?

That's a great question. When we initially discussed this, our goal was to recover the margins lost due to rhodium inflation by implementing the ruthenium production. However, starting around Q3 of 2021, our electronics business adopted a more disciplined pricing strategy and began to recover the margins from rhodium. By the end of the year, the focus of the ruthenium project shifted from recapturing margins to expanding capacity and providing our customers with a choice between ruthenium and rhodium switches. If we had that capacity available last June, for instance, it likely would have increased our capacity and potentially boosted our sales.

Got it. Thank you. Engraving is a one segment that lagging a little bit, just maybe talk about visibility and expectations beyond Q3?

In the engraving business, we see that 70% of our sales are tied to the auto industry, which is driven by new platform rollouts that are expected to remain stable or show slight growth. This is comparable to a GDP-growing market. There is a shift in the industry towards more soft trim parts compared to hard trim, which has been our primary focus for many years. We acquired a business a few years back to boost our soft trim sales, and we're seeing a growing backlog in that area. We expect soft trim sales to increase in the upcoming quarters, and our laneway growth this quarter is solid. We believe we are well-positioned to capitalize on the soft trim trend in the auto market, with our laneways contributing to that growth. In the non-auto segment, which constitutes about 30% of our business, we've encountered more competition recently as smaller regional competitors have invested in lasers. We are in the process of rolling out our new laser technology across our regions this year. To return this business to a 20% operating income, three key factors will be critical. First, Jim Hooven is now leading the business and is focused on implementing consistent operating disciplines across our regions, particularly in labor management and pricing, which are essential. Second, increasing soft trim growth, especially in Asia, will help drive our top line. Lastly, the introduction of our new laser technology across all segments will enhance our standing in the non-auto market.

Got it. And that laser rollout, that's more of a second half calendar 2022 when it really gets moving or is that a calendar 2023?

We currently have two installs, with a couple more expected in the next quarters and several more in the first half of the next fiscal year. This will unfold throughout the calendar year.

Got it. Specialty was a nice beat in revenue certainly where we were looking for, $30 million, you're talking about kind of sustaining close to that in Q3, what would it take to increase that quarterly revenue closer to $35 million?

Well, the end markets are almost back to the pre-COVID levels in the foodservice equipment. I think our team believes that this quarter they will get back to the pre-COVID levels. So for the display merchandising, we'll continue to see end market strength. The new products that we've released we think are going to take some share, so that will accelerate growth there. With the hydraulics business, we will be a beneficiary in the coming years of this North American infrastructure spend. That's not going to be a pop to the earnings, but it provides some laneway over the next 5 to 10 years to continue to grow. So I think that favorable external market conditions plus our new product releases will help us continue to grow the topline.

Got it. And for my last question, could Ademir please repeat the breakdown of the organic growth in the quarter between price and volume? Did I hear that correctly as one-third price and two-thirds volume?

Yes, you did, Chris.

Okay. All right. I'll jump back in line. Thanks, guys.

Thank you.

Thanks.

Our next question comes from Chris Howe from Barrington Research. Please go ahead.

Good morning, David and Ademir.

Good morning.

I guess, first off, starting with Slide 12, if we think about the new product pipeline across the businesses, perhaps more specifically around solar energy, can you talk about just the puts and takes and how you balance your level of R&D investments? And also your level of investment in pursuing new opportunities beyond what you already have?

I was really thrilled to create this slide. It reflects eight years of effort aimed at helping our businesses focus on taking control of their own future through organic growth initiatives. In the past, Standex reported that our R&D spending was less than 1% of sales, and I must admit that a significant portion of that was allocated to customer and manufacturing support, rather than developing new products. A few years back, through the GDP+ process led by Paul Burns in the Business Development Group, we began to prioritize new product development and encouraged our businesses to increase their engineering investments. This year, we'll be around 2%. Ademir, is that correct?

Yeah.

About 2% of our sales go towards R&D. If you compare us to other companies, I believe that long term, as we discover appealing new products to invest in, this percentage may rise to around 3% or even higher. This is part of a structured stage gate process, which addresses your question on how we determine where to invest. We begin with ideation sessions involving all business units. From these sessions, we compile a portfolio of opportunities and select the most promising ones to develop a market test. The market test involves engaging with customers, conducting research, and possibly providing prototypes for feedback. After a few months, we assess whether there's potential worth pursuing. If it is, the opportunity enters our stage gate process. We have monthly reviews between the business and our Business Development team to monitor the progress of these ideas until we receive approval to initiate new product development. It’s a rigorous process applied across all business units, and the results of this effort, which has been underway for several years, are now materializing. The new products are starting to generate sales, and we are confident enough to highlight their potential contribution to long-term growth.

Okay. Helpful. And then just following up on a previous question related to the reed switch substitution and how if it were completed sooner perhaps it would have helped on the revenue line. As we think about the differences in material, how should I think about it as it relates to demand for certain applications?

The characteristics of rhodium are particularly suited for the most mission-critical applications. For instance, if you have a switch that needs to operate a billion times without interruption, rhodium provides greater security. It is also advantageous for switches that must endure very high voltage across an open switch, like during safety isolation testing for electric vehicles. Conversely, for lower-end applications, such as home security systems that use a reed switch with a magnet, our ruthenium switch is fully sufficient. This illustrates how the two materials cater to a range of application requirements, from high-end to lower-end uses.

Okay. Is it fair to say then based on the lower end applications of ruthenium that the cost of the switch is lower, but perhaps the demand for ruthenium for exceeds what it is now for rhodium? That's it from.

Well, first of all, there is more ruthenium in the world, the market for ruthenium is more liquid, there is higher supply. And if you count up all the reed switches sold in the world, there are more ruthenium switches sold than rhodium switches and they are more lower end applications. So I think that's what you're getting at.

Yeah. Okay. And then, lastly just of the.

If I could, Chris. I apologize. Let me make one point. Our margins on ruthenium switches are equivalent to our rhodium switches. So maybe a lower price point, but it's lower cost as well, because of ruthenium. So we're agnostic about which switch customer chooses.

Okay. And then, lastly on the scientific segment, there is ongoing replacement of cabinets as we move further down the line. Talking about that, but also can you talk about the global opportunity for scientific. I know, domestically you continue to be strong, perhaps COVID-related, perhaps not, but how should we think about opportunities outside of our order for scientific?

Yeah. This is something we've actually spent some energy in the last year. Through that same growth process I mentioned, we have conducted some market tests to look at the opportunity. What we discovered is, in many parts of the world, they are still using the same kind of refrigerator you might have in your office to keep drinks in or something that you buy at Costco, so they are very low price point, lower quality cabinet and not very attractive for us at this moment. For those countries that do have higher quality standards for medication and vaccine storage, they have their own unique requirements and certification requirements. And we are looking at ways that we can play in those markets. It's not as simple a matter as just exporting the products you make here in America to those countries, we have to find a way to either reengineer and get certified to those local protocols, but we are actively exploring those things.

Okay. That's all I have. Thank you.

Thank you. We delivered strong topline growth and record margins in the quarter. We see substantial runway to further drive Standex growth and profitability given our strengthening positions in high growth markets and are also aligned with sustainable global trends and investment in innovative solutions, which leverage our significant technical and application expertise to provide compelling customer solutions. I want to thank everyone today for their interest in Standex, in our discussion of our fiscal second quarter and current outlook. And, again, I want to thank our employees and shareholders for their continued support. We look forward to speaking with you again on our fiscal third quarter 2022 call.

Conference has now concluded. Thank you for attending today's presentation. You may now disconnect.