STANDEX INTERNATIONAL CORP/DE/ - Quarter Report: 2020 September (Form 10-Q)

STANDEX INTERNATIONAL CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all adjustments necessary to present fairly the results of operations for the three months ended September 30, 2020 and 2019, the cash flows for the three months ended  September 30, 2020 and 2019 and the financial position of Standex International Corporation (“Standex”, the “Company”, “we”, “us”, or “our”), at  September 30, 2020. The interim results are not necessarily indicative of results for a full year. The following unaudited condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and note disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to those rules and regulations, although the company believes that the disclosures made are adequate to make the information not misleading. The unaudited condensed consolidated financial statements and notes do not contain information which would substantially duplicate the disclosures contained in the audited annual consolidated financial statements and notes for the year ended  June 30, 2020. The condensed consolidated balance sheet at  June 30, 2020 was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America. The financial statements contained herein should be read in conjunction with the Annual Report on Form 10-K and in particular the audited consolidated financial statements for the year ended  June 30, 2020. Unless otherwise noted, references to years are to the Company’s fiscal years.

Certain prior period amounts have been reclassified to conform to the current period presentation. In pursuing our business strategy, we have divested certain businesses and recorded activities of these businesses as discontinued operations. During the third quarter of 2020, the Company decided to divest its Refrigerated Solutions Group which consists of two operating segments in order to focus its financial assets and managerial resources on its remaining portfolio of businesses. Results of the Refrigerated Solutions Group in prior periods have been classified as discontinued operations in the Condensed Consolidated Financial Statements and excluded from the results of continuing operations. In the fourth quarter of fiscal year 2020, the Company reviewed the quantitative and qualitative characteristics of its remaining businesses and determined that it has seven operating segments that aggregate to five reportable segments.  Please refer to Note 16 Industry Segment Information for further information reportable segments. All periods presented have been revised to reflect the new reportable segments.

The estimates and assumptions used in the preparation of the consolidated financial statements have considered the implications on the Company as a result of the onset of the COVID-19 pandemic and its related economic impacts. As a result of the COVID-19 pandemic,  there is heightened volatility and uncertainty in customer demand and the worldwide economy. However, the magnitude of such impact on the Company’s business and its duration is uncertain. The Company is not aware of any specific event or circumstance that would require an update to its estimates or adjustments to the carrying value of its assets and liabilities as of  September 30, 2020 and the issuance date of this Annual Report on Form 10-K.

The Company considers events or transactions that occur after the balance sheet date but before the financial statements are issued to provide additional evidence relative to certain estimates or to identify matters that require additional disclosure. We evaluated subsequent events through the date and time our unaudited condensed consolidated financial statements were issued.

Recently Issued Accounting Pronouncements

In   March 2020, the FASB issued ASU 2020-04, Facilitation of the Effects of Reference Rate Reform on Financial Reporting. The ASU provides optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedging relationships, subject to meeting certain criteria, that reference LIBOR or another reference rate expected to be discontinued. ASU 2020-04 is effective for all entities as of   March 12, 2020 through   December 31, 2022. The Company adopted ASU 2020-04 in fiscal year 2021.  The adoption did not have a material impact on the consolidated financial statements.

In  June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which modifies the measurement approach for credit losses on financial assets measured on an amortized cost basis from an “incurred loss” method to “an expected loss” method. In   November 2019, the FASB issued ASU 2019-11, Codification Improvements to Topic 326, Financial Instruments – Credit Losses. ASU 2019-11 is an accounting pronouncement that amends ASU 2016-13. This amendment provides clarity and improves the codification to ASU 2016-13. The pronouncements are concurrently effective for fiscal years beginning after   December 15, 2019 and interim periods therein. The Company adopted ASU 2016-13 in fiscal year 2021.  The adoption did not have a material impact on the consolidated financial statements.

As a result of the adoption of ASU 2016-13, the Company has updated its critical accounting policy related to trade account receivables and allowances for credit losses as of September 30, 2020 from what was previously disclosed in our audited financial statements for the year ended June 30, 2020 as follows:

All trade account receivables are reported net of allowances for credit losses. The allowances for credit losses represent management’s best estimate of the credit losses expected from our trade account receivables over the life of the underlying assets. Assets with similar risk characteristics are pooled together for determination of their current expected credit losses. We regularly perform detailed reviews of our pooled assets to evaluate the collectability of receivables based on a combination of past, current, and future financial and qualitative factors that may affect customers’ ability to pay. In circumstances where we are aware of a specific customer’s inability to meet its financial obligations, a specific reserve is recorded against amounts due to reduce the recognized receivable to the amount reasonably expected to be collected.

In  August 2018, the FASB issued ASU No. 2018-14, Compensation - Retirement Benefits - Defined Benefit Plans - General (Subtopic 715-20). The amendments in ASU 2018-14 remove, modify and add various disclosure requirements around the topic in order to clarify and improve the cost-benefit nature of disclosures. This ASU is effective for annual reporting periods, and interim periods with those reporting periods, beginning after  December 15, 2020 with early adoption permitted. The amendments must be applied on a retrospective basis for all periods presented. The company is currently evaluating the impacts the adoption of this ASU will have on its Consolidated Financial Statements.

The Company’s recent acquisitions are strategically significant to the future growth prospects of the Company. At the time of the acquisition and September 30, 2020, the Company evaluated the significance of each acquisition on a standalone basis and in aggregate, considering both qualitative and quantitative factors.

Renco Electronics

During the first quarter of fiscal year 2021, the Company acquired Renco Electronics, a designer and manufacturer of customized standard magnetics components and products including transformers, inductors, chokes and coils for power and RF applications.  Renco’s end markets and customer base in areas such as consumer and industrial applications are highly complementary to our existing business with the potential to further expand key account relationships and capitalize on cross selling opportunities between the two companies.  Renco operates one manufacturing facility in Florida and is supported by contract manufacturers in Asia.  Renco’s results are reported within our Electronics segment. 

The Company paid $30.4 million in cash for all of the issued and outstanding equity interests of Renco Electronics. The preliminary purchase price was allocated to the net tangible and identifiable intangible assets acquired and liabilities assumed based on a preliminary estimate of their fair values on the closing date. The Company did acquire property, plant and equipment for which an initial estimate of the fair value remains in-process. The Company has commenced a formal valuation of the acquired assets and liabilities and has updated the preliminary intangible assets based on the preliminary valuation results. Goodwill recorded from this transaction is attributable to Renco’s significant engineering and technical expertise in end markets supported by strong engineer-to-engineer relationships. In addition, Renco’s end markets and customer base in areas such as consumer and industrial are highly complementary to the Company’s existing business.

Intangible assets of $10.4 million are preliminarily recorded, consisting primarily of $3.6 million for indefinite lived trademarks, and $6.8 million of customer relationships to be amortized over 12 years. The Company’s assigned fair values are preliminary as of September 30, 2020 until such time as the valuation can be finalized. The goodwill of $14.2 million created by the transaction is deductible for income tax purposes.

The Company signed a new lease agreement with a related party, an entity in which the Renco Electronics President is a shareholder, on July 15, 2020. The lease is for three years and is subject to renewal, at the Company’s option under similar terms and conditions. The Company recorded a fair value adjustment of $0.4 million in connection with this lease, which is included in other acquired assets in the table below.

At the inception of an arrangement, the Company determines whether the arrangement is or contains a lease based on the unique facts and circumstances present in the arrangement. Leases with a term greater than one year are recognized on the balance sheet as right-of-use assets and short-term and long-term lease liabilities, as applicable. As of September 30, 2020, the Company recorded right of use assets of $3.3 million, current lease liabilities of $1.8 million and non-current lease liabilities of $1.5 million, related to two operating leases in connection with the acquisition of Renco. Renco does not have material financing leases.

Please refer to Note 4 Fair Value Measurements for further information about the valuation of the $3.0 million contingent consideration liability.

The components of the fair value of the Renco Electronics acquisition, including the preliminary allocation of the purchase price at September 30, 2020, are as follows (in thousands):

Acquisition-Related Costs

Acquisition-related costs include costs related to acquired businesses and other pending acquisitions. These costs consist of (i) deferred compensation and (ii) acquisition-related professional service fees and expenses, including financial advisory, legal, accounting, and other outside services incurred in connection with acquisition activities, and regulatory matters related to acquired entities. These costs do not include purchase accounting expenses, which we define as acquired backlog and the step-up of inventory to fair value, or the amortization of the acquired intangible assets.

Contingent consideration payable to the Horizon seller is based on continued employment of the seller on the second and third anniversary of the closing date of the acquisition. The Company is contractually obligated to pay contingent consideration payments in connection with the Horizon Scientific acquisition based on the criteria of continued employment of the seller on the second and third anniversary of the closing date of the acquisition. The seller of Horizon remained employed on the second and third anniversaries of the closing date and payments were made to the seller in the second quarters of fiscal year 2019 and 2020. This obligation is considered settled as of  June 30, 2020.

Acquisition-related costs consist of miscellaneous professional service fees and expenses for our recent acquisitions.

The components of acquisition-related costs are as follows (in thousands):

Most of the Company’s contracts have a single performance obligation which represents the product or service being sold to the customer. Some contracts include multiple performance obligations such as a product and the related installation and/or extended warranty. Additionally, most of the Company’s contracts offer assurance type warranties in connection with the sale of a product to customers. Assurance type warranties provide a customer with assurance that the product complies with agreed-upon specifications. Assurance type warranties do not represent a separate performance obligation.

In general, the Company recognizes revenue at the point in time control transfers to its customer based on predetermined shipping terms. Revenue recognized under long-term contracts within the Engineering Technologies and Engraving groups for highly customized customer products that have no alternative use and in which the contract specifies the Company has a right to payment for its costs, plus a reasonable margin are recognized over time. For products manufactured over time, the transfer of control is measured pro rata, based upon current estimates of costs to complete such contracts. Losses on contracts are fully recognized in the period in which the losses become determinable. Revisions in profit estimates are reflected on a cumulative basis in the period in which the basis for such revision becomes known.

Disaggregation of Revenue from Contracts with Customers

The following table presents revenue disaggregated by product line and segment (in thousands):

The following table presents revenue from continuing operations disaggregated by geography based on company’s locations (in thousands):

⁽¹⁾ EMEA consists primarily of Europe, Middle East and S. Africa.

The following table presents revenue from continuing operations disaggregated by timing of recognition (in thousands):

Contract Balances

Contract assets represent sales recognized in excess of billings related to work completed but not yet shipped for which revenue is recognized over time. Contract assets are recorded as prepaid and other current assets. Contract liabilities are customer deposits for which revenue has not been recognized. Current contract liabilities are recorded as accrued expenses.

The following table provides information about contract assets and liability balances as of  September 30, 2020 (in thousands):

During the three months ended September 30, 2020, we recognized the following revenue as a result of changes in the contract liability balances (in thousands):

The timing of revenue recognition, invoicing and cash collections results in billed receivables, contract assets and contract liabilities on the consolidated balance sheets. When consideration is received from a customer prior to transferring goods or services to the customer under the terms of a contract, a contract liability is recorded. Contract liabilities are recognized as revenue after control of the goods and services are transferred to the customer and all revenue recognition criteria have been met.

The financial instruments shown below are presented at fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Where available, fair value is based on observable market prices or parameters or derived from such prices or parameters. Where observable prices or inputs are not available, valuation models may be applied.

Assets and liabilities recorded at fair value in the consolidated balance sheet are categorized based upon the level of judgment associated with the inputs used to measure their fair values. Hierarchical levels directly related to the amount of subjectivity associated with the inputs to fair valuation of these assets and liabilities and the methodologies used in valuation are as follows:

Level 1 – Quoted prices (unadjusted) in active markets for identical assets and liabilities. The Company’s deferred compensation plan assets consist of shares in various mutual funds (for the deferred compensation plan, investments are participant-directed) which invest in a broad portfolio of debt and equity securities. These assets are valued based on publicly quoted market prices for the funds’ shares as of the balance sheet dates.

Level 2 – Inputs, other than quoted prices in an active market, that are observable either directly or indirectly through correlation with market data. For foreign exchange forward contracts and interest rate swaps, the Company values the instruments based on the market price of instruments with similar terms, which are based on spot and forward rates as of the balance sheet dates. The Company has considered the creditworthiness of counterparties in valuing all assets and liabilities.

Level 3 – Unobservable inputs based upon the Company’s best estimate of what market participants would use in pricing the asset or liability.

There were no transfers of assets or liabilities between any levels of the fair value measurement hierarchy at September 30, 2020 and June 30, 2020. The Company’s policy is to recognize transfers between levels as of the date they occur.

Cash and cash equivalents, accounts receivable, and accounts payable are carried at cost, which approximates fair value.

Items presented at fair value at  September 30, 2020 and  June 30, 2020 consisted of the following (in thousands):

The financial liabilities based upon Level 3 inputs include contingent consideration arrangements relating to our acquisitions of Renco Electronics, GS Engineering or Piazza Rosa. The Company is contractually obligated to pay contingent consideration payments to the Sellers of these businesses based on the achievement of certain criteria.

Contingent consideration payable to the Piazza Rosa sellers is based on the achievement of certain revenue targets of each of the first three years following the acquisition. Contingent acquisition payments are payable in euros and can be paid through fiscal year 2021. As of September 30, 2020, the Company could be required to pay up to $0.9 million for contingent consideration arrangements if the revenue targets are met.

Contingent consideration payable to the GS Engineering sellers is based on the achievement of certain revenue and gross margin targets of each of the first five years following the acquisition. Contingent acquisition payments are scheduled to be paid in periods through fiscal year 2024. As of September 30, 2020, the Company could be required to pay up to $12.8 million for contingent consideration arrangements if the revenue and gross margin targets are met.

Contingent consideration payable to the Renco Electronics sellers is based on the achievement of certain earnings targets of each of the first three years following the acquisition. Contingent acquisition payments are scheduled to be paid in periods through fiscal year 2024. As of September 30, 2020, the Company could be required to pay up to $3.5 million for contingent consideration arrangements if the earnings targets are met.

We have determined the fair value of the liabilities for the contingent consideration based on a probability-weighted discounted cash flow analysis. This fair value measurement is based on significant inputs not observable in the market and thus represents a Level 3 measurement within the fair value hierarchy. The fair value of the contingent consideration liability associated with future payments was based on several factors, the most significant of which are continued employment of the seller and the risk-adjusted discount rate for the fair value measurement. As of September 30, 2020, the range of outcomes nor the assumptions used to develop the estimates had changed for the Piazza Rosa or GS Engineering arrangements. In connection with the acquisition of Renco Electronics in the first quarter of fiscal year 2021, the Company recorded a $3.0 million contingent consideration in non-current liabilities.

The Company will update its assumptions each reporting period based on new developments and record such amounts at fair value based on the revised assumptions until the consideration is paid.

In pursuing our business strategy, the Company continues to divest certain businesses and record activities of these businesses as discontinued operations.

During the third quarter of fiscal 2020, in order to focus its financial assets and managerial resources on its remaining portfolio of businesses, the Company entered into a definitive agreement to sell the Refrigerated Solutions Group, consisting of the Master-Bilt and NorLake operating segments, to Ten Oaks Group for a cash purchase price of $10.6 million, subject to post-closing adjustments and various transaction fees. The Refrigerated Solutions Group was a part of the Company's Food Service Equipment segment and manufactured refrigerated cabinets and walk-ins for customers food service and retail end markets.

Results of the Refrigerated Solutions Group in current and prior periods have been classified as discontinued operations in the Unaudited Condensed Consolidated Financial Statements and excluded from the results of continuing operations.  Activity related to discontinued operations for the three months ended September 30, 2020 and 2019 is as follows (in thousands):

Net assets (liabilities) were ($0.1) million and $2.3 million as of September 30, 2020 and June 30, 2020, respectively.

Inventories are comprised of the following (in thousands):

Distribution costs associated with the sale of inventory, which are recorded as a component of selling, general and administrative expenses in the accompanying Unaudited Condensed Consolidated Statements of Operations, were $2.5 million and $2.5 million for the three months ended September 30, 2020 and 2019, respectively.

Changes to goodwill during the period ended  September 30, 2020 were as follows (in thousands):

The expected cost associated with warranty obligations on our products is recorded as a component of cost of sales when the revenue is recognized. The Company’s estimate of warranty cost is based on contract terms and historical warranty loss experience that is periodically adjusted for recent actual experience. Since warranty estimates are forecasts based on the best available information, claims costs may differ from amounts provided. Adjustments to initial obligations for warranties are made as changes in the obligations become reasonably estimable.

The changes in warranty reserve from continuing operations, which are recorded as a component of accrued liabilities, as of  September 30, 2020 and  June 30, 2020 were as follows (in thousands):

Long-term debt is comprised of the following (in thousands):

Bank Credit Agreements

During the second quarter of fiscal year 2019, the Company entered into a five-year Amended and Restated Credit Agreement (“Credit Facility”, or “facility”). The facility has a borrowing limit of $500 million. The facility can be increased by an amount of up to $250 million, in accordance with specified conditions contained in the agreement. The facility also includes a $10 million sublimit for swing line loans and a $35 million sublimit for letters of credit.

In connection with the acquisition of Renco, the company assumed $0.7 million of debt under the Paycheck Protection Program, within the CARES Act. These borrowings mature in April 2022.

At September 30, 2020, the Company had standby letters of credit outstanding, primarily for insurance purposes, of $6.0 million and had the ability to borrow $206.4 million under the facility. Funds borrowed under the facility  may be used for the repayment of debt, working capital, capital expenditures, acquisitions (so long as certain conditions, including a specified funded debt to EBITDA leverage ratio is maintained), and other general corporate purposes.  The facility contains customary representations, warranties and restrictive covenants, as well as specific financial covenants which the Company was compliant with as of  September 30, 2020.  At September 30, 2020, the carrying value of the current borrowings approximate fair value.

Accrued expenses from continuing operations recorded in our Consolidated Balance Sheets at September 30, 2020 and   June 30, 2020 consist of the following (in thousands):

The Company is exposed to market risks from changes in interest rates, commodity prices and changes in foreign currency rates. We selectively use derivative financial instruments in order to manage these risks. Information about the Company’s derivative financial instruments is as follows:

Interest Rate Swaps

From time to time as dictated by market opportunities, the Company enters into interest rate swap agreements designed to manage exposure to interest rates on the Company’s variable rate indebtedness. The Company recognizes all derivatives on its balance sheet at fair value. The Company has designated its interest rate swap agreements, including those that are forward-dated, as cash flow hedges, and changes in the fair value of the swaps are recognized in other comprehensive income (loss) until the hedged items are recognized in earnings. Hedge ineffectiveness, if any, associated with the swaps will be reported by the Company in interest expense.

The Company’s effective swap agreements convert the base borrowing rate on $200.0 million of debt due under our revolving credit agreement from a variable rate equal to LIBOR to a weighted average fixed rate of 1.27% at September 30, 2020. The fair value of the swaps, recognized in accrued expenses and in other comprehensive income (loss), is as follows (in thousands, except percentages):

The Company reported no losses for the three months ended September 30, 2020 and 2019, as a result of hedge ineffectiveness. Future changes in these swap arrangements, including termination of the agreements, may result in a reclassification of any gain or loss reported in accumulated other comprehensive income (loss) into earnings as an adjustment to interest expense. Accumulated other comprehensive income (loss) related to these instruments is being amortized into interest expense concurrent with the hedged exposure.

Foreign Exchange Contracts

Forward foreign currency exchange contracts are used to limit the impact of currency fluctuations on certain anticipated foreign cash flows, such as collections from customers and loan payments between subsidiaries. The Company enters into such contracts for hedging purposes only. The Company has designated certain of these currency contracts as hedges, and changes in the fair value of these contracts are recognized in other comprehensive income (loss) until the hedged items are recognized in earnings. Hedge ineffectiveness, if any, associated with these contracts will be reported in net income. At September 30, 2020 and June 30, 2020, the Company had outstanding forward contracts related to hedges of intercompany loans with net unrealized losses of $2.4 million and $2.5 million, respectively, which approximate the unrealized gains and losses on the related loans. The contracts have maturity dates ranging from 2021 to 2024, which correspond to the related intercompany loans.

The notional amounts of the Company’s forward contracts, by currency, are as follows:

The table below presents the fair value of derivative financial instruments as well as their classification on the balance sheet (in thousands):

The table below presents the amount of gain (loss) recognized in comprehensive income on our derivative financial instruments (effective portion) designated as hedging instruments and their classification within comprehensive income for the periods ended (in thousands):

The table below presents the amount reclassified from accumulated other comprehensive income (loss) to Net Income for the periods ended (in thousands):

The Company has defined benefit pension plans covering certain current and former employees both inside and outside of the U.S. The Company’s pension plan for U.S. employees is frozen for substantially all participants and has been replaced with a defined contribution benefit plan.

Net Periodic Benefit Cost for the Company’s U.S. and Foreign pension benefit plans for the three months ended September 30, 2020 and 2019 consisted of the following components (in thousands):

The contributions made to defined benefit plans for the three months ended September 30, 2020 and 2019 are presented below along with remaining contributions to be made for fiscal year 2021 (in thousands):

The Company's effective tax rate from continuing operations for the first quarter of the fiscal year ending June 30, 2021 was 20.7% compared with 27.8% for the prior year quarter.  The tax rate was impacted in current period by the following items: (i) minimization of global intangible low-taxed income and enhancement of the deduction for foreign derived intangible income, (ii) foreign tax credit optimization strategies, (iii) a benefit  due to the carryback of losses generated in the fiscal year ending June 30, 2019 and (iv) the jurisdictional mix of earnings.

The following table sets forth a reconciliation of the number of shares (in thousands) used in the computation of basic and diluted earnings per share:

Earnings available to common stockholders are the same for computing both basic and diluted earnings per share. There were 11,352 outstanding instruments that had an anti-dilutive effect at September 30, 2020. There were no outstanding instruments that had an anti-dilutive effect at September 30, 2019.   

Performance stock units of 130,461 and 86,806 for the three months ended September 30, 2020 and 2019, respectively, are excluded from the diluted earnings per share calculation as the performance criteria have not been met.

The components of the Company’s accumulated other comprehensive income (loss) are as follows (in thousands):

From time to time, the Company is subject to various claims and legal proceedings, including claims related to environmental remediation, either asserted or unasserted, that arise in the ordinary course of business. While the outcome of these proceedings and claims cannot be predicted with certainty, the Company’s management does not believe that the outcome of any of the currently existing legal matters will have a material impact on the Company’s consolidated financial position, results of operations or cash flow. The Company accrues for losses related to a claim or litigation when the Company’s management considers a potential loss probable and can reasonably estimate such potential loss.

In the fourth quarter of fiscal year 2020, the Company reviewed the quantitative and qualitative characteristics of its remaining businesses and determined that it has seven operating segments that aggregate to five reportable segments.  The reportable segments are organized around the types of products sold:

All periods presented have been revised accordingly to reflect the new reportable segments.

Net sales and income (loss) from continuing operations by segment for the three months ended September 30, 2020 and 2019 were as follows (in thousands):

Net sales include only transactions with unaffiliated customers and include no intersegment sales. Income (loss) from operations by segment excludes interest expense and other non-operating income (expense).

The Company has undertaken a number of initiatives that have resulted in severance, restructuring, and related charges.

2021 Restructuring Initiatives

The Company continues to focus its efforts to reduce cost and improve productivity across its businesses, particularly through headcount reductions, facility closures, and consolidations. Restructuring expenses primarily related to headcount reductions and other cost saving initiatives. The Company expects the 2021 restructuring activities to be completed by 2022. 

Prior Year Restructuring Initiatives 

Restructuring expenses primarily related to headcount reductions and facility rationalization within our Specialty Solutions segment. The Company also incurred restructuring expenses related to third party assistance with analysis and implementation of these activities. The Company expects the prior year restructuring activities to be completed by 2021.

A summary of charges by initiative is as follows (in thousands):

Activity in the reserve related to the initiatives is as follows (in thousands):

The Company’s total restructuring expenses by segment are as follows (in thousands):

Restructuring expense is expected to be approximately $1.7 million for the remainder of fiscal year 2021.

 Statements contained in this Quarterly Report that are not based on historical facts are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements may be identified by the use of forward-looking terminology such as “should,” “could,” “may,” “will,” “expect,” “believe,” “estimate,” “anticipate,” “intend,” “continue,” or similar terms or variations of those terms or the negative of those terms. There are many factors that affect the Company’s business and the results of its operations and that may cause the actual results of operations in future periods to differ materially from those currently expected or anticipated. These factors include, but are not limited to: the impact of pandemics such as the current coronavirus on employees, our supply chain, and the demand for our products and services around the world; materially adverse or unanticipated legal judgments, fines, penalties or settlements; conditions in the financial and banking markets, including fluctuations in exchange rates and the inability to repatriate foreign cash; domestic and international economic conditions, including the impact, length and degree of economic downturns on the customers and markets we serve and more specifically conditions in the automotive, construction, aerospace, transportation, food service equipment, consumer appliance, energy, oil and gas and general industrial markets; lower-cost competition; the relative mix of products which impact margins and operating efficiencies in certain of our businesses; the impact of higher raw material and component costs, particularly steel, certain materials used in electronics parts, petroleum based products, and refrigeration components; an inability to realize the expected cost savings from restructuring activities including effective completion of plant consolidations, cost reduction efforts including procurement savings and productivity enhancements, capital management improvements, strategic capital expenditures, and the implementation of lean enterprise manufacturing techniques; the potential for losses associated with the exit from or divestiture of businesses that are no longer strategic or no longer meet our growth and return expectations; the inability to achieve the savings expected from global sourcing of raw materials and diversification efforts in emerging markets; the impact on cost structure and on economic conditions as a result of actual and threatened increases in trade tariffs; the inability to attain expected benefits from acquisitions and the inability to effectively consummate and integrate such acquisitions and achieve synergies envisioned by the Company; market acceptance of our products; our ability to design, introduce and sell new products and related product components; the ability to redesign certain of our products to continue meeting evolving regulatory requirements; the impact of delays initiated by our customers; and our ability to increase manufacturing production to meet demand; and potential changes to future pension funding requirements. To read more about these risk factors, please see the “Risk Factors” section of our most recent annual report on Form 10-K. In addition, any forward-looking statements represent management's estimates only as of the day made and should not be relied upon as representing management's estimates as of any subsequent date. While the Company may elect to update forward-looking statements at some point in the future, the Company and management specifically disclaim any obligation to do so, even if management's estimates change.

Overview

We are a diversified industrial manufacturer with leading positions in a variety of products and services that are used in diverse commercial and industrial markets. We have seven operating segments aggregated into five reportable segments: Electronics, Engraving, Scientific, Engineering Technologies, and Specialty Solutions. Our segments differentiate themselves by collaborating with our customers in order to develop and deliver custom solutions or engineered components that solve problems for our customers or otherwise meet their needs (a business model we refer to as “Customer Intimacy”). Overall management, strategic development and financial control are led by the executive staff at our corporate headquarters located in Salem, New Hampshire. 

Our long-term strategy is to enhance shareholder value by building larger, more profitable “Customer Intimacy” focused industrial platforms through a value creation system that assists management in meeting specific corporate and business unit financial and strategic performance goals in order to create, improve, and enhance shareholder value. In so doing, we expect to focus our financial assets and managerial resources on our higher growth and operating margin businesses while considering divestiture of those businesses that we feel are not strategic or do not meet our growth and return expectations. 

The Standex Value Creation System is a methodology which provides standard work and consistent tools used throughout the company in order to achieve our organization’s goals. The Standex Value Creation System employs four components: Balanced Performance Plan, Growth Disciplines, Operational Excellence, and Talent Management. The Balanced Performance Plan process aligns annual goals throughout the company and provides a standard reporting, management and review process.  It is focused on setting, tracking and reviewing annual and quarterly targets that support our short and long-term goals.  The Growth Disciplines use a standard work playbook of tools and processes including market maps, market tests and growth laneways to identify, explore and execute on opportunities that expand the business organically and through acquisitions.  Operational Excellence also employs a standard work playbook of tools and processes, based on LEAN, to improve operating execution (effectiveness), eliminate waste (efficiency) and thereby improve profitability, cash flow and customer satisfaction.  Finally, Talent Management is an organizational development process that provides training, development, and succession planning for employees throughout our worldwide organization.  The Standex Value Creation System ties all disciplines together under a common umbrella by providing a standard playbook of tools and processes to deliver our business objectives. Through the use of our Standex Value Creation System, we have developed a balanced approach to value creation.  While we intend to continue investing acquisition capital in high margin and growth segments such as Electronics, Engraving, and Scientific, we will continue to support all of our businesses as they enhance value through deployment of our GDP+ and OpEx playbooks. 

It is our objective to grow larger and more profitable business units through both organic initiatives and acquisitions.  We seek to identify and implement organic growth initiatives such as new product development, geographic expansion, and the introduction of products and technologies into new markets, key accounts and strategic sales channel partners.  Also, we have a long-term objective to create sizable business platforms by adding strategically aligned or “bolt on” acquisitions to strengthen the individual businesses, create both sales and cost synergies with our core business platforms, and accelerate their growth and margin improvement.  We look to create both sales and cost synergies within our core business platforms, accelerate growth and improve margins.  We have a particular focus on identifying and investing in opportunities that complement our products and will increase the global presence and capabilities of our businesses.  From time to time, we have divested, and likely will continue to divest, businesses that we feel are not strategic or do not meet our growth and return expectations.

As part of our ongoing strategy:

As a result of our portfolio moves over the last several years, we have transformed Standex to a company with end market exposure that is no longer dependent on sales of standard products to the food service industry and into a more focused group of businesses selling customized solutions to high value end markets via a compelling customer value proposition.  The narrowing of the portfolio allows for greater management focus on driving operational disciplines and positions us well to withstand the COVID-19 crisis and invest selectively in our ongoing pipeline of organic and inorganic opportunities.

We develop “Customer Intimacy” by utilizing the Standex Growth Disciplines to partner with our customers in order to develop and deliver custom solutions or engineered components.  By partnering with our customers during long-term product development cycles, we become an extension of their development teams.  Through this Partner, Solve, Deliver® approach, we are able to secure our position as a preferred long-term solution provider for our products and components.  This strategy results in increased sales and operating margins that enhance shareholder returns. 

Standex Operational Excellence drives continuous improvement in the efficiency of our businesses, both on the shop floor and in the office environment.  We recognize that our businesses are competing in a global economy that requires us to improve our competitive position.  We have deployed a number of management competencies to drive improvements in the cost structure of our business units including operational excellence through lean enterprise, the use of low cost manufacturing facilities, the consolidation of manufacturing facilities to achieve economies of scale and leveraging of fixed infrastructure costs, alternate sourcing to achieve procurement cost reductions, and capital improvements to increase productivity.

The Company’s strong historical cash flow has been a cornerstone for funding our capital allocation strategy.  We use cash flow generated from operations to fund the strategic growth programs described above, including acquisitions and investments for organic growth, investments in capital assets to upgrade our facilities, improve productivity and lower costs, and to return cash to our shareholders through payment of dividends and stock buybacks. 

Restructuring expenses reflect costs associated with the Company’s efforts of continuously improving operational efficiency and expanding globally in order to remain competitive in our end-user markets.  We incur costs for actions to size our businesses to a level appropriate for current economic conditions, improve our cost structure, enhance our competitive position and increase operating margins.  Such expenses include costs for moving facilities to locations that allow for lower fixed and variable costs, external consultants who provide additional expertise starting up plants after relocation, downsizing operations because of changing economic conditions, and other costs resulting from asset redeployment decisions.  Shutdown costs include severance, benefits, stay bonuses, lease and contract terminations, asset write-downs, costs of moving fixed assets, and moving and relocation costs. Vacant facility costs include maintenance, utilities, property taxes and other costs.

We monitor a number of key performance indicators (“KPIs”) including net sales, income from operations, backlog, effective income tax rate, gross profit margin, and operating cash flow.  A discussion of these KPIs is included below.  We may also supplement the discussion of these KPIs by identifying the impact of foreign exchange rates, acquisitions, and other significant items when they have a material impact on a specific KPI. 

We believe the discussion of these items provides enhanced information to investors by disclosing their impact on the overall trend which provides a clearer comparative view of the KPI, as applicable.  For discussion of the impact of foreign exchange rates on KPIs, the Company calculates the impact as the difference between the current period KPI calculated at the current period exchange rate as compared to the KPI calculated at the historical exchange rate for the prior period.  For discussion of the impact of acquisitions, we isolate the effect on the KPI amount that would have existed regardless of our acquisition.  Sales resulting from synergies between the acquisition and existing operations of the Company are considered organic growth for the purposes of our discussion.

Unless otherwise noted, references to years are to fiscal years.

Impact of COVID-19 Pandemic on the Company

Given the global nature of our business and the number of our facilities in China, we were impacted by COVID-19 related issues beginning in February of our third quarter of fiscal year 2020.  We took immediate, and effective action to protect our health and safety, continue to serve our customers, support our communities and manage our cash flows.  Our priority was and remains the health and safety of all of our employees.  Each of our facilities is following safe practices as defined in their local jurisdictions as well as sharing experiences and innovative ways of overcoming challenges brought on by the crisis during updates with global site leaders.  We are rigorously following health protocols in our plants, including changing work cell configurations and revising shift schedules when appropriate, in order to do our best to maintain operations.  We have experienced revenue losses in many of our businesses due to the impact that the pandemic has had on our customers.

Given the impact that the pandemic created on our backlog and incoming order rate, we took actions to identify and implement cost savings and restructuring actions with each of our operating units as well as our corporate headquarters.  Actions identified include reducing outside discretionary spend, the natural elimination of travel and trade show expenses that were a result of COVID-19 related curtailments, implementation of rolling furloughs in several businesses where appropriate, and the elimination of certain salaried and hourly positions. The costs, including restructuring charges, for many of these items occurred in our fourth quarter of fiscal year 2020. 

We exited the first quarter of fiscal year 2021 with $93.7 million in cash and $200.0 million of borrowings under our revolving credit facility.  Our leverage ratio covenant, as defined in our revolving credit agreement, was 1.45 to 1 and allowed us the capacity to borrow an additional $206.4 million at September 30, 2020.

Finally, we are reviewing our ability to participate in any governmental assistance programs available to us in each of our global locations, and we will participate in these programs as available and appropriate.  For instance, we have elected to take advantage of provisions in the United States Coronavirus Aid, Relief, and Economic Security (“CARES”) Act, which allows for deferral until December 31, 2020 of defined benefit pension plan contributions due during calendar year 2020. Prior to passage of the CARES Act, we were required to make payments of $1.5 million in the fourth quarter of fiscal year 2020 and an additional $3.3 million in the first two quarters of fiscal year 2021, which we will now defer until December of fiscal year 2021. We believe that the we have sufficient liquidity around the world and access to financing to execute on our short and long-term strategic plans. 

Net sales decreased in the first quarter of fiscal year 2021 by $4.7 million or 3.0% when compared to the prior year quarter. The acquisition of Renco contributed $5.9 million or 3.8% to overall sales growth. Organic sales declined $12.8 million or 8.2%, primarily as a result of impacts due to the COVID pandemic while foreign currency had a $2.2 million or 1.4% positive impact on sales.  We discuss our results and outlook for each segment below.

Gross Profit Margin

Our gross margin for the first quarter of fiscal year 2021 was 36.2% which declined from the prior year quarter’s gross margin of 37.3% primarily a result of the impact of $0.6 million related to the amortization of purchase accounting expenses associated with the Renco acquisition in addition to increased material costs in Electronics.

Selling, General, and Administrative Expenses

Selling, General, and Administrative Expenses (“SG&A”) for the first quarter of fiscal year 2021 were $38.9 million, or 25.7% of sales, compared to $40.1 million, or 25.7% of sales, during the prior year quarter.  SG&A expenses during the quarter were impacted by on-going SG&A expenses related to our recent acquisitions of $0.9 million offset by a reduction in incentive compensation and management transition costs compared to the prior year quarter.

Restructuring Charges

We incurred restructuring expenses of $1.5 million during the first quarter of fiscal year 2021 and fiscal year 2020.  Restructuring expenses during the quarter primarily related to the announced closure of a Specialty Solutions pump rotor production facility in Ireland.  We expect to incur restructuring costs of approximately $1.7 million throughout the remainder of fiscal year 2021 as we continue to focus our efforts to reduce cost and improve productivity across its businesses, particularly through headcount reductions, facility closures, and consolidations.

Acquisition Related Expenses

We incurred acquisition-related expenses of less than $0.1 million during the first quarter of fiscal year 2021. Acquisition-related expenses typically consist of due diligence, integration, and valuation expenses incurred in connection with recent acquisitions.

Income from Operations

Income from operations for the first quarter of fiscal year 2021 was $14.4 million, compared to $15.9 million during the prior year quarter.  The decline of $1.5 million, or 9.4% is primarily due to the impact of volume related losses triggered by the COVID-19 pandemic along with material inflation, partially offset by cost reduction activities and productivity improvement initiatives implemented in all of our businesses.  

Interest Expense

Interest expense for the first quarter of fiscal year 2021 was $1.5 million, a 30.0% decline from interest expense of $2.1 million during the prior year quarter.  The decreased interest expense is due to a lower effective interest rate of 2.57% as of September 30, 2020, as compared to 3.41% as of September 30, 2019 offset by an increase in borrowings outstanding during the quarter. 

Income Taxes

The Company's effective tax rate from continuing operations for the first quarter of the fiscal year ending June 30, 2021 was 20.7% compared with 27.8% for the prior year quarter.  The tax rate was impacted in current period by the following items: (i) minimization of global intangible low-taxed income and enhancement of the deduction for foreign derived intangible income, (ii) foreign tax credit optimization strategies, (iii) a benefit  due to the carryback of losses generated in the fiscal year ending June 30, 2019 and (iv) the jurisdictional mix of earnings. 

Backlog

Backlog includes all active or open orders for goods and services.  Backlog also includes any future deliveries based on executed customer contracts, so long as such deliveries are based on agreed upon delivery schedules.  With the exception of our Engineering Technologies group, backlog has limited value as an indicator for the Company’s businesses because of our relatively short delivery periods and rapid inventory turnover.  Due to the nature of long-term agreements in the Engineering Technologies group, the timing of orders and delivery dates can vary considerably resulting in significant backlog changes from one period to another.  Backlog orders are not necessarily an indicator of future sales levels because of variations in lead times and customer production demand pull systems. Customers may delay delivery of products or cancel orders prior to shipment, subject to possible cancellation penalties.  In general, the majority of net realizable backlog beyond one year comes from the Engineering Technologies group. 

Total backlog realizable under one year decreased $21.2 million, or 12.3%, to $151.9 million at September 30, 2020 from $173.1 million at September 30, 2019. We experienced an increase in backlog at Scientific due to increased demand by retail pharmacy customers while the acquisition of Renco increased Electronics backlog by $7.1 million.  Backlog declines in the Engineering Technologies segment are primarily due to weakening demand in the aviation sector due to COVID pandemic related slowdowns in that industry.

Electronics

Net sales in the first quarter of fiscal year 2021 increased by $8.7 million, or 18.6%, when compared to the prior year quarter. Organic sales increased $1.8 million, or 3.9% mostly due to strength in Asia partially offset by weakness within the European market. The acquisition of Renco contributed sales of $5.9 million or 12.6%. Additionally, foreign exchange rates favorably affected sales by $1.0 million or 2.1 %. Income from operations in the first quarter of fiscal year 2021 increased by $0.4 million, or 5.4%, when compared to the prior year quarter. The operating income increase was the result of organic sales growth, various cost saving initiatives and the impact of the Renco Electronics acquisition, offset by inflationary material cost increases and $0.6 million of purchase accounting expenses. 

In the second quarter, we expect revenue to be slightly higher sequentially and improve in the second half of the fiscal year as demand accelerates in the European markets. 

Engraving

Net sales in the first quarter of fiscal year 2021 decreased by $2.0 million, or 5.3%, when compared to the prior year. Organic sales declined by $3.1 million, or 7.9%, as a result of the timing of automotive projects.  Organic declines were partially offset by foreign exchange impacts of $1.0 million, or 2.6%, for the quarter.  Income from operations for the first quarter of fiscal year 2021 decreased by $0.7 million, or 10.2%, when compared to the prior year. The decrease was primarily a result of organic sales declines for the year, partially offset by favorable foreign exchange impacts.

Looking forward, we expect sales volume and income from operations to improve due to our expectations regarding new automotive launches along with the continued introduction of our soft skin and tool finishing offerings throughout our global sales network. Additionally, we expect to see sequential operating income improvement as we continue to realize benefits of cost and productivity actions.

Scientific

Net sales in the first quarter of fiscal year 2021 increased by $1.9 million, or 13.0%, compared to the prior year.  Net sales increase reflects overall growth in end markets including retail pharmaceutical chains, clinical laboratories, and academic institutions.  Income from operations in the first quarter of fiscal year 2021 increased $0.4 million, or 10.0%, when compared to the prior year quarter reflecting revenue growth partially offset with re-investments in the business for future growth opportunities. 

In fiscal second quarter 2021, the Company expects to see a sequential revenue increase driven primarily by continued positive trends in retail pharmaceutical chains and clinical end markets.  Operating margin is expected to slightly improve reflecting volume increase balanced with reinvestment in the business for R&D and future growth opportunities. We continue to enact measures to prepare for anticipated increases in demand for medication and COVID-19 vaccine storage in the coming quarters.