Standex International Corp

NYSE:SXI

Earnings Call Transcript 2024-Q3

[Operator]

Good morning, ladies and gentlemen, and welcome to the Standex International Fiscal Third Quarter 2024 Financial Results Conference Call. [Operator Instructions]

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. Please go ahead.

[Huang Howe, executive]

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' 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 on 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 onetime items. EBITDA, which is earnings before interest, taxes, depreciation and amortization; adjusted EBITDA, which is EBITDA excluding restructuring, purchase accounting, acquisition-related expenses and onetime 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 financial performance. On the call today is Standex's Chairman, President and Chief Executive Officer, David Dunbar; and Chief Financial Officer and Treasurer, Ademir Sarcevic.

[David Dunbar, executive]

Thank you, Chris. Good morning, and welcome to our fiscal third quarter 2024 conference call. Despite continued softness in general market conditions, we continued our trend of strong margin performance. If we exclude the onetime 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.

Now if everyone can turn to Slide 3, the key messages -- In the third quarter, sales into fast-growth end markets grew 9% year-on-year to $26 million. We are on track to achieve our long-term target of $200 million 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 by a 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 Sanyu Switch Company, expanding our relay product offering.

In addition, we continue to work an active pipeline of other inorganic opportunities. During the fiscal third quarter, 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% and which followed a record 40.3% last quarter. 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 onetime stock compensation charge. If it were not for me, reaching my tenth anniversary at Standex and the related onetime 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 5 segments reported adjusted operating margin greater than 17%.

We achieved record fiscal third quarter free cash flow of $19.3 million, 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 fourth quarter 2020 and 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. 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 billion in sales, adjusted operating margin greater than 19%, return on invested capital of greater than 15% and free cash flow conversion of approximately 100% of GAAP net income.

Let's turn to Slide 4, electronics 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. 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 Reeds switches has served as a leading indicator of market turns in our business. They are the first to fall into a downturn in the first horizon when the market picks back up.

We mentioned last quarter that sales share 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. 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 third quarter, 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, 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. 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 by 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 new aero will account for nearly 20% of segment sales in fiscal 2024. Managing an active funnel of new business opportunities is the basic building block of growth in Electronics. Our NBO funnel increased 26% year-on-year in the fiscal third quarter 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. 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. I will now turn the call over to Ademir to discuss our financial performance in greater detail.

[Ademir Sarcevic, executive]

Thank you, David, and good morning, everyone. Let's turn to Slide 5, third quarter 2024 summary. On a consolidated basis, total revenue decreased approximately 3.8% year-on-year to $177.3 million. 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. Third quarter 2024 adjusted operating margin increased 20 basis points year-on-year to 15.4%.

In the quarter, we incurred the onetime stock compensation charge related to our CEO retirement eligibility. This charge impacted adjusted operating margin by approximately 70 basis points. Excluding this charge, adjusted operating margin would have been similar to a record second quarter 2024 performance. In the fiscal third quarter, adjusted operating income decreased 2.2% on a 3.8% consolidated revenue decrease year-on-year.

Adjusted earnings per share grew 6.1% year-on-year to $1.75 in the third quarter of fiscal 2024 compared to $1.65 a year ago. Net cash provided by operating activities was $24.4 million in the third quarter of fiscal 2024 compared to $23.3 million a year ago. Capital expenditures of $5.2 million compared to $5.6 million a year ago. As a result, we generated record fiscal third quarter free cash flow of $19.3 million compared to $17.6 million 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 a record free cash flow of $50.8 million.

Now, please turn to Slide 6, and I will begin to discuss our segment performance and outlook beginning with Electronics. Segment revenue of $80.4 million, 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 currencies. Adjusted operating margin of 20.5% in fiscal third quarter 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 decreased 26% year-on-year and grew 10% organically and is currently at approximately $78 million. We remain confident in our ability to increase share and accelerate presence in fast-growth end markets, such as industrial automation, smart grid, renewable energy and EV-related markets. Sequentially, in fiscal fourth quarter 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 2025.

Please turn to Slide 7 for a discussion of the Engraving and Scientific segments. Engraving revenue decreased 1.7% to $36.3 million, driven by an organic decline of 0.2% and a 1.5% impact from foreign currency. Operating margin of 17.2% in fiscal third quarter 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 $16.9 million 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 cost and productivity initiatives offsetting lower volume. 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. Substantially, we expect slightly higher revenue and similar operating margin. We anticipate market conditions 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 $20.1 million, increased 11.3% year-on-year as higher demand in aviation was partially offset by lower defense sales caused by delays in government funding. Operating margin of 17.5%, 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 fourth 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 $23.5 million, decreased 27.1% year-on-year, primarily due to the Procon 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 Procon divestiture, a less sales in the Display Merchandising business, more than offset higher sales in the Hydraulics business. 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 Standex's liquidity statistics and the capitalization structure, which remains strong. Standex ended fiscal third quarter 2024 with $347 million of available liquidity. At the end of the third quarter, Standex had net debt of $10 million compared to $6.2 million at the end of the fiscal second quarter 2024. Standex's long-term debt at the end of fiscal third quarter 2024 was $148.8 million. Cash and cash equivalents totaled $138.8 million.

With regards to capital allocation, we repurchased approximately 34,000 shares for $5.1 million in the third quarter. We also declared our 239 quarterly consecutive cash dividend of $0.30 per share and approximately 7.1% increase year-on-year. In fiscal 2024, we expect capital expenditures to be between $28 million and $32 million compared to approximately $24 million in fiscal 2023. I will now turn the call over to David to discuss our key takeaways from our third quarter results.

[David Dunbar, executive]

Thank you, Ademir. 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.

Excluding the onetime 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 and 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 million 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.

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 billion 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. We will now open the line for questions.

[Operator]

[Operator Instructions] Your first question comes from the line of Chris Moore of CJS Securities.

[Christopher Moore, analyst]

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?

[David Dunbar, executive]

Well, roughly, Electronics is about 1/3 in each region of the world, North America, Europe and Asia.

[Christopher Moore, analyst]

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

[David Dunbar, executive]

Yes, that's a good point. Those are customers of our magnetics business and that is in North America. And typically, we sold those products to the semiconductor equipment manufacturers than the 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.

[Christopher Moore, analyst]

Got it. I appreciate that. You mentioned kind of reed 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? I'm just trying to understanding how long it's been since we've been -- you kind of seeing that indicator?

[David Dunbar, executive]

Well, first of all, the idea that reed 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 is back in the days when we had dozens and dozens of different businesses. Reed switches were used as a leading indicator. Our reed switch sales began to drop in this -- orders began to drop in Q2 '22. So it's really just the last 2 quarters, We're starting to see them firm up.

[Christopher Moore, analyst]

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?

[Ademir Sarcevic, executive]

Chris, it's Ademir here. I will tell you the answer to that question is all of us. We believe all of them have an opportunity to spend 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. The last quarter, they were low 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.

[Operator]

And your next question comes from the line of Michael Legg of Benchmark.

[Michael Legg, analyst]

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

[David Dunbar, executive]

A lot of these go through distribution. And we -- it's about a month. We have about a month's cycle. We could 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 that we'll call off orders as the year progresses, but individual orders are about 1 month delivery.

[Michael Legg, analyst]

Okay. 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?

[David Dunbar, executive]

Yes, that's a great question. And recall that we sell components or subassemblies 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 see if 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. We're again working with them, incorporating it in their design, that may be 1 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.

[Michael Legg, analyst]

Okay. So it's fair to say that with new product developments coming online in '25 -- fiscal '25 that this is really the culmination of efforts over the past couple of years?

[David Dunbar, executive]

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

[Michael Legg, analyst]

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

[David Dunbar, executive]

Yes, it remains robust. And we have two 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 approaching an exit, we have a very healthy funnel of those opportunities. And they're a little smaller, $20 million, $30 million, maybe $50 million in sales at the top. In the last few years, we have also been positioning ourselves for larger opportunities, maybe $100 million in sales, and these would be run with a more professional advanced process.

And our funnel in the first category 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.

[Operator]

And your next question comes from the line of Mike Shlisky of D.A. Davidson.

[Michael Shlisky, analyst]

I guess I want to get a more broad view. I mean, you sound pretty confident about going 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 can give us a couple of other bullet points on the other segments as to how you get that confidence that on reed segment pretty much it will all turn back to some more normalized organic growth rate?

[David Dunbar, executive]

Yes, okay. Well, if you think about the segments that have the best growth profile in the next year were the most confident Engineering Technologies. We have this very long cycle business. We have great visibility to our customers' plan shipments. And so FY '25 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 kind of trailers we do. 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 million of sales from new products in that business.

In FY '25, 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. So as we get into the second half of '25, we expect some of those will begin to hit that period. Now with Engraving, we called out that some of the pushouts in OEM platforms, we're calling for a more modest growth there. But there, we have pretty good visibility. So I think I have covered them all.

[Ademir Sarcevic, executive]

Yes, I think and Electronics support.

[Michael Shlisky, analyst]

I think you did, yes. And in that high-growth environment and especially if you've got some new products rolling out and perhaps some R&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 the small bites of additional margin, excluding your stock cost? Could there be a bit more of expansion in '25 we could be seeing here in '24?

[Ademir Sarcevic, executive]

Yes, Mike, it's Ademir. 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 -- they will be number one. The other thing I'll just mention it, we want to continue to invest in R&D and our commercial sales activity because we believe that's the investment for the future and investment with the new products so we can continue to roll these developments and products over time.

So yes, we expect to 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&D expenses.

[Operator]

[Operator Instructions] And your next question comes from the line of Gary Prestopino of Barrington Research.

[Gary Prestopino, analyst]

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 an Engineering Solutions -- or in Electronics, how much of those are really targeted to what you would call your fast-growth markets?

[David Dunbar, executive]

The new products are being released next year. We have 3 basic categories there are. Reed 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 target fast-growth markets and others just expanded adjacencies to help us fill a broader solution set for current customers. So let's say half of them are fast-growth markets.

[Operator]

And there are no further questions at this time. I would now like to turn the call over to our CEO, David Dunbar, for closing remarks.

[David Dunbar, executive]

Thank you, 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 fourth quarter 2024 call.

[Operator]

And ladies and gentlemen, this concludes today's conference call. Thank you for your participation. And you may now disconnect. Have a good day.