Standex International Q3 2024 Earnings Call Transcript

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May 3, 2024

There are 8 speakers on the call.

Operator

Good morning, ladies and gentlemen, and welcome to the Statics International Fiscal Third Quarter 2024 Financial Results Conference Call. At this time, all lines are in a listen only mode. Following the presentation, we will conduct a question and answer And this call is being recorded on Friday, May 3, 2024. I would now like to turn the conference over to Mr. Christopher Howe, Director of Investor Relations.

Operator

Please go ahead.

Speaker 1

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.

Speaker 1

You should refer to Standex's most recent annual report on Form 10 ks 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, pre operating cash flow and pro form a 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 financial performance.

Speaker 1

On the call today is Standex's Chairman, President and Chief Executive Officer, David Dunbar and Chief Financial Officer and Treasurer, Adameur Sarcevic.

Speaker 2

Thank you, Chris. Good morning, and welcome to our fiscal Q3 2024 conference call. Despite continued softness in general market conditions, we continued our trend of strong margin performance. If we exclude the one time stock compensation charge, our streak of record adjusted operating margin performance would have continued. I would like to thank our employees, our executives and the Board of Directors for their efforts and continued dedication and support that drove these results.

Speaker 2

Now if everyone can turn to Slide 3, key messages. In the 3rd quarter, sales into fast growth end markets grew 9% year on year to $26,000,000 We are on track to achieve our long term target of $200,000,000 annual sales into fast growth end markets by fiscal year 2028. We continue to experience the effect of transitory market softness, which led to an organic decline of 5.7%. These headwinds included continued softness in appliances and general industrial end markets in China and Europe, the impact of a lower number of projects and inventory destocking

Speaker 3

by a

Speaker 2

few large electronics customers in the semiconductor and test and measurement end markets. These were partially offset by contributions from our recent acquisitions, including the late February completion of our acquisition of Sonya Switch Company, expanding our Relay product offering. In addition, we continue to work an active pipeline of other inorganic opportunities. During the fiscal Q3, we also continued to generate strong profitability from the execution of our price and productivity initiatives. As a result, we again achieved adjusted gross margin of nearly 40%, which followed a record 40.3% last quarter.

Speaker 2

We continue to demonstrate our ability to drive operating improvements while adapting to changing macro conditions. Consolidated adjusted operating margin increased 20 basis points year on year to 15.4%, which includes a 70 basis point impact from the one time stock compensation charge. If it were not for me reaching my 10th anniversary at Standex and the related one time stock compensation change, our adjusted operating margin would have been similar to last quarter's record. 3 of our 5 segments reported adjusted operating margin near or above 20%, while margin in the Engineering Technologies segment approached nearly 18%. All five segments reported adjusted operating margin greater than 17%.

Speaker 2

We achieved record fiscal Q3 free cash flow of $19,300,000 maintaining record free cash flow year to date. Our consistent and improved cash flow generation and annualized ROIC of over 12% further highlights the quality of our business. On a sequential basis, in fiscal Q4 2024, we expect slightly to moderately higher revenue due to favorable project timing in the Engineering Technologies segment, increased market demand in the Specialty Solutions segment and the impact of our recent acquisitions. We expect slightly to moderately higher adjusted operating margin sequentially due to leverage on higher sales and pricing and productivity actions. In fiscal year 2025, we expect to return to organic growth rates in line with our long term financial objectives.

Speaker 2

We expect our sales into fast growth markets to outpace growth of the general market. We are reaffirming our long term financial outlook by fiscal year 2028. These targets include high single digit organic growth to greater than $1,000,000,000 in sales, adjusted operating margin greater than 19%, return on invested capital of greater than 15% and free cash flow conversion at approximately 100% of GAAP net income. Let's turn to Slide 4, Electronic business focus and market update. I would like to focus on our largest segment, Electronics, how its markets are evolving in the near term and how our longer term efforts to increase its sales growth are progressing.

Speaker 2

The market headwinds we have been experiencing are beginning to abate and we anticipate general market conditions to improve in fiscal year 2025. Typically, the sale of bare read switches has served as a leading indicator of market turns in our business. They are the first to fall into a downturn and the first to rise when the market picks back up. We mentioned last quarter that sales here were bottoming out and starting to show a positive inflection. This positive inflection continued through the quarter and we saw a sequential increase in orders.

Speaker 2

We have mentioned before the continued softness in appliances and general industrial markets in China and Europe related to electronics. This continued in the fiscal Q3, but we are now seeing orders pick up in Europe and for appliances and consumer related end markets globally. Our top customers that manufacture critical equipment for end markets like semiconductor, semiconductor, automation and smart grid have indicated order trends are likely to improve through the second half of the calendar year. This is supported by U. S.

Speaker 2

Investments in infrastructure and domestic chip production. The markets we serve will always ebb and flow. The longer term prospects of the Electronics business will be shaped more the investments and focus we are bringing to increase its growth trajectory. This is a long term effort and I'm pleased to see that our projects are gaining traction. Sales into fast growth markets like renewable energy, electrical vehicles, smart grid and Mill Aero will account for nearly 20% of segment sales in fiscal 2024.

Speaker 2

Managing an active funnel of new business opportunities is the basic building block of growth in Electronics. Our NBL funnel increased 26% year on year in the fiscal Q3 and grew 10% organically. We started ramping up new product development a few years ago and I'm happy to share that this development is beginning to convert to sales. We are in the early days of new product sales and though the numbers are small in the single digit millions, they are growing nicely contributing to our fiscal 2024 results. Research and development investments continue to increase and we have multiple new products slated for release in fiscal year 2025.

Speaker 2

The new product development cycle and the commercial focus on faster growing markets creates a flywheel that gradually builds momentum and is having an increasing impact on sales in Electronics. This leaves us confident as we look to fiscal year 2025 and beyond. Will now turn the call over to Adamir to discuss our financial performance in greater detail.

Speaker 4

Thank you, David, and good morning, everyone. Let's turn to Slide 5, Q3 2024 summary. On a consolidated basis, total revenue decreased approximately 3.8% year on year to $177,300,000 This reflected an organic revenue decline of 5.7% and a 0.9% impact from foreign exchange, partially offset by a 2.7% net impact from recent acquisitions and the prior Procon divestiture. 3rd quarter 2024 adjusted operating margin increased 20 basis points year on year to 15.4%. In the quarter, we incurred a onetime stock compensation charge related to our CEO reaching retirement eligibility.

Speaker 4

This charge impacted adjusted operating margin by approximately 70 basis points. Excluding this charge, adjusted operating margin would have been similar to a record Q2 2024 performance. In the fiscal Q3, adjusted operating income decreased 2.2% on a 3.8% consolidated revenue decrease year on year. Adjusted earnings per share grew 6.1 percent year on year to $1.75 in the Q3 of fiscal 2024 compared to $1.65 a year ago. Net cash provided by operating activities was $24,400,000 in the Q3 of fiscal 2024 compared to $23,300,000 a year ago.

Speaker 4

Capital expenditures were $5,200,000 compared to $5,600,000 a year ago. As a result, we generated record fiscal 3rd quarter free cash flow of $19,300,000 compared to $17,600,000 a year ago. Our free cash flow conversion ratio as a percent of GAAP net income was 121%. Likewise, on a year to date basis, we generated record free cash flow of $50,800,000 Now please turn to Slide 6, and I will begin to discuss our segment performance and outlook, beginning with Electronics. Segment revenue of $80,400,000 increased 2.8% year on year as a 13.5% benefit from recent acquisitions was mostly offset by an organic decline of 9.3% and a 1.3% impact from foreign currency.

Speaker 4

Adjusted operating margin of 20.5 percent in fiscal Q3 2024 decreased 130 basis points year on year as the contribution from recent acquisitions and productivity initiatives were more than offset by lower organic sales and product mix. Our new business opportunity funnel increased 26% year on year and grew 10% organically and is currently at approximately 78,000,000 dollars We remain confident in our ability to increase share and accelerate our presence in fast growth end markets such as industrial automation, smart grid, renewable energy and EV related markets. Sequentially, in fiscal Q4 2024, we expect similar revenue and slightly lower to similar adjusted operating margin due to unfavorable mix. We anticipate general market conditions to improve in fiscal year 20 25. Please turn to Slide 7 for a discussion of the Engraving and Scientific segments.

Speaker 4

Engraving revenue decreased 1.7% to $36,300,000 driven by an organic decline of 0.2% and a 1.5% impact from foreign currency. Operating margin of 72.2% in fiscal Q3 2024 increased 270 basis points year on year due to realization of productivity actions. In our next fiscal quarter, on a sequential basis, we expect slightly lower revenue and slightly to moderately lower operating margin due to unfavorable project timing in North America and Europe. Scientific revenue decreased 10.4% to $16,900,000 due to general market softness and the related impact on retail pharmacies. Operating margin of 28.9% increased 480 basis points year on year due to lower freight costs and productivity initiatives offsetting lower volume.

Speaker 4

Although market conditions have been challenging, new product development volume increased approximately 60% year on year and new product development sales represented approximately 10% of segment sales in the quarter. Sequentially, we expect slightly higher revenue and similar operating margin. We anticipate market condition to start to improve in fiscal year 2025. Now turn to Slide 8 for a discussion of the Engineering Technologies and Specialty Solutions segments. Engineering Technologies revenue of $20,100,000 increased 11.3% year on year as higher demand in aviation was partially offset by lower defense sales caused by delays in government funding.

Speaker 4

Operating margin of 17.5 percent increased 450 basis points year on year as leverage on higher aviation sales and pricing of productivity initiatives were partially offset by research and development expenses. This margin result is near the lower end of our long term target for the segment and represents the 4th consecutive quarter of operating margin improvement. Sequentially, we expect moderately to significantly higher revenue and moderately higher operating margin due to more favorable project timing. Specialty Solutions segment revenue of $23,500,000 decreased 27.1 percent year on year, primarily due to the Procter divestiture and normalization in the display merchandising business, partially offset by organic growth in the Hydraulics business. Operating margin of 19.9% decreased 230 basis points year on year as the impact of the proppant divestiture and less sales in the display merchandising business more than offset higher sales in the Hydraulics business.

Speaker 4

Sequentially, we expect moderately higher revenue and operating margin to improve end market demand and leverage on higher sales. Next, please turn to Slide 9 for a summary of Sandex's liquidity statistics and the capitalization structure, which remains strong. Standex ended fiscal Q3 2024 with $347,000,000 of available liquidity. At the end of the 3rd quarter, Standex had net debt of $10,000,000 compared to $6,200,000 at the end of the fiscal Q2 2024. Sanofi's long term debt at the end of fiscal Q3 2024 was $148,800,000 Cash and cash equivalents totaled 138 point $8,000,000 With regards to capital allocation, we repurchased approximately 34,000 shares for $5,100,000 in the 3rd quarter.

Speaker 4

We also declared our 239 quarterly consecutive cash dividend of $0.30 per share, an approximately 7.1% increase year on year. In fiscal 2024, we expect capital expenditures to be between $28,000,000 $32,000,000 compared to approximately $24,000,000 in fiscal 2023. I will now turn the call over to David to discuss our key takeaways from our Q3 results.

Speaker 2

Thank you, Adamir. Please turn to Slide 10. I'm very proud of our team for their continued operational excellence and focus on growing markets that led to our quarterly results. We are prepared as inventory levels normalize and demand returns, while our fast growth markets will continue to evolve and accelerate. We have proven over the 11 consecutive quarters of record margin that we can expand margin and grow earnings by adapting to changing macro conditions.

Speaker 2

Excluding the one time charge in the quarter, this streak would have continued. We remain optimistic about the long term secular trends that will benefit from the transition from internal combustion to hybrid and electric in automotive, infrastructure spending in smart grid, defense applications and next generation aerospace development and from the evolution of space exploration. Broadly speaking, these trends are still in the earlier stages of development. We are on track to achieve our long term target of $200,000,000 plus in annual sales into fast growth end markets by fiscal year 2028. To support our growth, we continue to expand our engineering capabilities to drive new product development and new applications across markets with growth potential.

Speaker 2

In fiscal year 2025, for the first time in the company's history, new products will be released in every one of our businesses. We continue to maintain a strong balance sheet that allows us to prudently assess an active pipeline of organic and inorganic growth opportunities. In fiscal 2025, we expect to return to organic growth rates in line with our long term financial objectives. We reaffirm our long term financial outlook by fiscal year 2028. These targets include high single digit organic growth to greater than $1,000,000,000 in sales, adjusted operating margin greater than 19%, return on invested capital of greater than 15% and free cash flow conversion at approximately 100% of GAAP net income.

Speaker 2

We will now open the line for questions.

Operator

Thank you, listeners. Thank you. Ladies and gentlemen, we will now begin the question and answer session. Your first question comes from the line of Chris Mora of CJS Securities. Your line is now open.

Speaker 5

Hey, good morning guys. Thanks for taking a couple of questions.

Speaker 6

Good morning, Chris. Good morning.

Speaker 5

Good morning. Maybe we'll start Electronics. So, I mean, you've called out electronics in Europe and Asia being softer for a while. Can you just remind us kind of what percentage of total electronics we're talking about there?

Speaker 2

Well, roughly electronics is about 1 third in each region of the world, North America, Europe and Asia.

Speaker 5

Got you. And in terms of kind of North American performance, again, there was the semiconductor that challenges you referenced, those were within North America or those were within Asia, where was that?

Speaker 2

Yes, actually, that's a good point. Yes, those are customers of our magnetics business and that is in North America. Yes, and typically we sold those products to the semiconductor equipment manufacturers, then they export globally. There is an expectation that we hear from the customer by the end of this year, we should see a ramp in orders specifically for installations in North America following the CHIPS Act investment.

Speaker 5

Got it. Appreciate that. You mentioned kind of REIT switches as a leading indicator, improving sequentially. Just give me how long has it been since you can make that statement? Has it been the last couple of quarters or just starting now?

Speaker 5

I'm just trying to understand how long it's been since we've been kind of seeing that indicator.

Speaker 2

Well, first of all, the idea that read switches serve as an indicator for Standex in general, this goes back to well before I joined the company. It's been kind of a shorthand that the company used. Back in the days when we had dozens and dozens of different businesses, REIT switches were used as a leading indicator. Our REIT switch sales began to drop in this order orders begin to drop in Q22222. So it's really just the last two quarters, I'm starting to see them firm up.

Speaker 5

Got it. Very helpful. Obviously, you guys have done an exceptional job on margins even lately without the benefit of much volume leverage. Maybe just which segments do you still expect to drive the biggest increase over the next few years to meet your longer term goals?

Speaker 4

Hey, good morning, Chris. It's Adam here. I would tell you the answer to that question is all of us. We believe all of them have an opportunity to expand the margin. And if you look at kind of our long term margin projections for all of those businesses, for example, we think we can get electronics to 25% operating margin.

Speaker 4

The last quarter, they were a little north of 20%. So you can see the opportunity we see in the electronics business, for example. But really, the answer is we feel there's an opportunity to expand the margin in all of our businesses.

Speaker 5

All right. Appreciate that. I will leave it there. Thanks guys.

Speaker 3

All right. Thank you.

Operator

And your next question comes from the line of Mike Legg of Benchmark. Your line is now open.

Speaker 6

Thanks. Good morning, everyone.

Speaker 3

Good morning, Mike.

Speaker 6

Following up on the REIT switch piece, what is the lead time for those orders versus delivery?

Speaker 2

A lot of these go through distribution and we it's about a month. We have about a month cycle. We can get an order from our distributors. Then we ship within 3 to 4 weeks. In some cases with our larger distributors, they'll have kind of a block order or commitment for a year and then they'll call off orders as the year progresses, but individual orders are about a 1 month delivery.

Speaker 2

Okay.

Speaker 6

And then you talked a lot about new product development in each of the divisions. Can you talk a little bit about the cycle there for new product development? How long it takes? And then these are obviously all new products. What that means to additional revenue?

Speaker 2

Yes. That's a great question. And recall that we sell components or sub assemblies that then go to either Tier 1s or to OEMs that are incorporated in their designs. So our new products are subject to the cycle that our customers have. So let's say we identify a new opportunity, it may typically take a year for us to settle on the design, develop the product and then be ready to present it to our OEM customers.

Speaker 2

We began working with them incorporating it in their design that may be a year to 2 years. Then they launch their product. And I think in the past, we've shown data that once our OEM customers begin shipping a new product, it typically ramps for 2 to 3 years before it hits max volume. So if you add all of that up, it's from the beginning of new product development to sales of any significance could be 3 to 5 years.

Speaker 6

Okay. So it's fair to say that with new product developments coming online in 2025 fiscal 2025 that This is really the culmination of efforts over the past couple of years?

Speaker 2

Yes. Yes, these are largely development projects that began a few years ago.

Speaker 6

Okay, great. And then just last question, you mentioned the pipeline for M and A being robust. Can you just comment on that a little bit more?

Speaker 2

Yes. It remains robust. And we have 2 kinds of deals that we work on. The bread and butter Standex acquisition for years was a family owned business, privately owned business where the owner founders are approaching an exit. We have a very healthy funnel of those opportunities and they're a little smaller, dollars 20,000,000 $30,000,000 maybe $50,000,000 in sales at the top.

Speaker 2

In the last few years, we've also been positioning ourselves for larger opportunities, maybe $100,000,000 in sales. And these would be run with a more professional advanced process. And our funnel in the first category always is always relatively healthy. In the last gosh, in the last 6 months, I'd say the funnel of these larger opportunities is starting to perk up. It looks like there are more of these deals that are preparing to come to market.

Speaker 6

Great. Thank you. Look forward to 2025.

Speaker 2

Thank you.

Speaker 7

Your next question comes from the line of Mike Slicely from D. A. Davidson. Your line is open.

Speaker 3

Yes. Hi, good morning and thanks for taking my questions.

Speaker 2

Good morning.

Speaker 3

I guess I want to get a more broad view. I mean, you sound pretty confident about getting back to a more normalized organic growth rate next fiscal year. You kind of outlined a lot of what's happening in electronics. I was wondering if you could give us a couple of other bullet points from the other segments to kind of how you get that confidence that on each segment pretty much it will all turn back to some more normalized organic growth rate?

Speaker 2

Yes. Okay. Well, if you think about the segments that have the best growth profile in the next year, we're the most confident. Engineering Technologies, we have this is a very long cycle business. We have great visibility to our customers' planned shipments.

Speaker 2

And so FY 2025 is going to be a very strong year for Engineering Technologies and Space, Aviation. Our hydraulics business is really starting to see a pickup in order activity. We think some of the infrastructure bill funds are now being appropriated and applied to projects that are resulting in demand for our cylinders. The chassis shortage that was a problem in that business is now cleared up. So more of the trailer capacity is being devoted to the kinds of trailers we do.

Speaker 2

So we're very confident there. Scientific is fundamentally a good underlying business with 3% to 4% growth. We also have new products coming out there and this year we'll have maybe $5,000,000 of sales from new products in that business. In FY 2025, we will start to enter the replacement period for cabinets that were shipped in COVID. I think we regularly mentioned that these cabinets have a 4 to 7 year typical service life.

Speaker 2

As we get into the second half twenty twenty five, we expect some of those will begin to hit that period. Now with Engraving, we called out that some of the push outs in OEM platforms, we're calling for a more modest growth there. But there we have pretty good visibility. So I think I covered them all.

Speaker 4

Yes, you got them. Yes. And electronics, of course.

Speaker 2

And electronics.

Speaker 3

I think you did. Yes. Thank you. And then in that high growth environment, especially if you've got some new products rolling out and perhaps some R and D rolling off, and if I'm wrong there, correct me on that, but do you sense that there is a little bit better than just these small bites of additional margin, excluding your stock cost? Could there be a bit more of expansion in 2025 than we could be seeing here in 2024?

Speaker 4

Yes, Mike, it's Adam. I think we'll continue to expand our gross margin. Some of these new products that we are launching, we expect that they're going to have a little bit of a better margin profile than some of the standard products, if you will, that we sell. So that would be number 1. Other thing I'll just mention, we want to continue to invest in R and D and our commercial sales activity because we believe that's the investment for the future and the investment into new products so we can continue to roll these developments and products over time.

Speaker 4

So yes, we expect that we'll continue to expand gross margin, but we also expect that we're going to stay within about 3% to 3.5% of sales in terms of R and D expenses.

Speaker 3

Okay. That clears it up. I appreciate it. I'll pass it along.

Speaker 7

Thank you. Your next question comes from the line of Gary Prestopino from Barrington Research. Your line is open.

Speaker 1

Hi, good morning all. A lot of questions have been answered, but I guess some of what I'd like to know is with these new products, particularly you're talking about in engineering or in electronics, how much of those are really targeted to what you would call your fast growth markets?

Speaker 2

The new products to be released next year, we have 3 basic categories there are read switches, relays and sensors. We have new products coming out in all categories. I'm just recalling, we reviewed the list last week. At least 2 of them are targeted in fast growth markets and others just expanded to adjacencies to help us fill a broader solution set for current customers. So let's say half of them are fast growth markets.

Speaker 4

Okay. Thank you.

Speaker 7

Thank you. And there are no further questions at this time. All right.

Speaker 2

I want to thank everybody for joining us for the call today. We enjoy reporting on our progress at Standex. And finally, again, I want to thank our leadership, our employees and shareholders for your continued support and contributions. We look forward to speaking with you again in our fiscal Q4 2024 call.

Speaker 7

Thank you presenters. And ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.

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