Good morning, and welcome to the Standex International’s Q2 2019 Earnings Conference Call. [Operator Instructions] Thank you. I will now turn the call over to Mr. David Calusdian from Sharon Merrill. Please go ahead

Thank you, Stephanie. Please note that the presentation accompanying management’s remarks can be found on Standex’s Investor Relations website, www.standex.com. Please see Standex’s Safe Harbor statement on Slide 2. Matters that Standex management will discuss on today’s conference call include predictions, estimates, expectations and other forward-looking statements. These statements are subject to risks and uncertainties that could cause actual results to differ materially. You should refer to Standex’s recent SEC filings and public announcements for a detailed list of risk factors. In addition, I would like to remind you that today’s discussion will include references to 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 non-GAAP measures, including adjusted net income, adjusted income from operations, adjusted net income from continuing operations, adjusted operating margin and free operating cash flow. These non-GAAP financial measures are intended to serve as a complement to results provided in accordance with accounting principles generally accepted in the United States. Standex believes that such information provides an additional measurement and consistent historical comparison of the Company’s performance. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP measures is available in Standex’s second quarter news release. On the call today is Standex’s Chairman, President and Chief Executive Officer, David Dunbar; and Chief Financial Officer, Tom DeByle. Please turn to Slide three, as I turn the call over to David.

Thank you David. Before turning to our slides let me make a few introductory comments. We’re in the middle innings of a strategic transformation of this company from a broadly diversified portfolio company to a more focused industrial operating company. There are still many moving pieces here at Standex and I want to point out the factors that we look to as indicators of whether we’re making good progress. Our core objective is to evolve the company’s sales to higher growth markets with businesses that deliver higher quality earnings. We accomplished this through portfolio moves and organic initiatives. We acquired Tenibac and Agile over the summer, and announced the divestiture of cooking solutions in October. We continued to drive organic sales growth through our value creation system and new sales from growth laneways grew 42% to $14.5 million in the quarter. The mix towards stronger businesses positions us to better face the headwinds and setbacks in other businesses, and it is reading through in our results this quarter. Despite the headwinds we faced in the quarter, we grew 5.3% and increased our adjusted EBITDA margin by 76 basis points. Now let’s turn to Q2 performance highlights on Slide three. In Q2, overall revenues increased by 0.3% to $195.5 million with organic sales up 1.6% and acquisitions delivering 5.1%. Operating income was up 117 basis points in Q2, and adjusted operating income was up 38 basis points. EPS on both the GAAP and adjusted basis was $0.98 a share as a result of corporate financing decisions, affecting interest and tax. We had a net debt position of $196.5 million at the end of Q2. During the quarter, we opportunistically bought back $17.1 million of stock. In business highlights, we delivered strong organic growth in our Electronics, Engineering Technology, Scientific and Hydraulics…

Thank you David and good morning everyone. Slide five shows our historical trend of adjusted earnings per share and sales on a GAAP basis as well as on an adjusted basis. GAAP earnings per share was $0.98 for Q2 FY 2019 which compares to a loss of $0.34 for the year ago quarter. Our adjusted earnings per share for Q2 FY 2019 was also $0.98 which was flat versus the prior year despite the fact that sales were up 5.3%. As David noted, adjusted EPS was impacted by higher interest expense, a higher tax rate year-over-year. Interest expense was up versus the prior year based upon three key elements. First, borrowing for acquisitions. Second, higher working capital needs and third, stock repurchases during the quarter. We anticipate interest expense to come down in the fourth quarter as we complete the sale of cooking solutions and the repatriation of cash. The tax rate was higher as the planned repatriation of cash is subject to foreign withholding, which is in our blended rate for the quarter. As shown on the bottom of slide -- of the slide our revenue and earnings performance this quarter was consistent with our historical seasonal trends. Please turn to Slide six, which details our revenue changes by segment. Overall, Q2 organic growth was up 1.6% with three of our five businesses Engineering Technologies, Electronics and Hydraulics demonstrating organic growth. Our scientific business included in our food service numbers, had strong organic sales growth of 11.3% however, did not offset the decline in sales from the refrigeration business. Acquisitions of Tenibac in Engraving and Agile and Electronics contributed 5.1% to our Q2 growth, while foreign exchange had an unfavorable 1.4% contribution. Please turn to Slide seven, which summarizes our second quarter results on a GAAP and adjusted basis.…

Thank you, Tom. Please turn to Slide 14. And I’ll begin our segment overview with the Food Service Equipment Group. In Q2, revenues from continuing operations decreased 6.2% and operating income decreased 13% compared to prior year. Scientific sales were up 11.3% as we benefited from new equipment rollout at major drug retail customers. This was more than offset by the double digit sales decline in refrigeration where we experienced ongoing soft demand from Drug Retail, Dollar Stores and Quick Service Restaurants in line with national industry wide levels. Looking ahead, we remain focused on continuing to grow differentiated products through the promotion and introduction of new offerings in the scientific, merchandising and specialty pump businesses. Including our new innovative scientific Diamond series products shown on the slide. In addition, we will be displaying several new products at NAFEM Show in Florida in February. We also are implementing additional productivity and operational excellence actions to better align the refrigeration business with current market conditions and to better position are well established NorLake and Master Bilt brands to capitalize when the markets recover. Turning to Slide 15. Engraving sales increased 13.6% driven primarily by the addition of the Tenibac-Graphion business that we acquired last summer. Though global sales into auto markets increase organic sales decrease due to headwinds from a decline in Chinese exports due to the impact of tariffs on Chinese toolmakers. Reduction and texturizing sales to consumer products toolmakers and the push out of an Innovent drum order. Engraving operating income decline 5.2% due to three distinct items; outsourcing expenses related to laser capacity, a tariff related program cancellation, and increased investment in Tool Finishing and Nickel Shell growth laneways programs. Looking ahead, we remain focused on completing the Tenibac integration, which is progressing well. In addition, we will…

[Operator Instructions] Your first question comes from Chris Moore with CJS Securities.

Hi, good morning, guys.

Good morning.

Hi, Chris.

Good morning. Maybe we could start with Electronics. Just, could you maybe provide a little bit more detail in terms of the tariff-related demand slowdown in China and maybe your kind of best guess in terms of, kind of the outlook and how that could possibly -- timing in terms of potential resolution things like that.

Yes, many of our Electronics in China are sold to OEMs that then export from China and there -- they may have been impacted by the tariffs. We expect that to continue this quarter. Beyond that, I guess your guess is probably as good as mine. So our -- with some confidence, we see continued softness in Asia in Q3.

Got you. On the Engraving side, any different conversations there in terms of China?

No, not really there is different pockets of toolmakers in China. And then in Southwest China, many of those toolmakers export. They were the ones that were hit. And it actually came as a bit of a surprise to us. We actually had a large job on our floor in our Engraving side in Dongguan and it was canceled as we were starting to do the texturizing and they decide to sources those tools. It was the most amazing thing we’ve ever seen that happened before. So that caught us a bit off guard. That will likely continue also through this quarter, and we’ll see how that the macro level negotiations between China and the U.S. go and tariffs.

Got it. On Refrigeration side, it sounds like you talked about additional productivity operational excellence. So there’s additional restructuring within refrigeration or how should we kind of look at this?

No. I think it’s more a continuous improvement. The shame is, if we look at the internal metrics of our plants, the plants are operating better than they have in prior years. The restructuring we did last year -- we modify the cost structure, but we also put in a lot of process improvements in both the plants and that’s reading through right in the first time measures, quality, productivity, and we continue to roll out those events cell-by-cell through the plant to continue or continue improvements. But -- the comment about continued productivity improvements was in that [Indiscernible] in continuous improvement. We did not expect in a more significant restructuring in that business.

Got you. And, so let me just jump back to Engraving real quick. So you talked about expecting Q3 volumes to be a bit lower, and then Q4 kind of recovering a little bit. What’s the assumption behind the pickup in Q4?

Just that new customer OEM, the OEM new model release schedule supports a pickup in Q4.

Got it. All right. Appreciate it. Let me jump back in [Indiscernible]

All right. Thank you, Chris.

Your next question comes from George Godfrey with CLK.

Thank you. Good morning, Dave and Tom.

Good Morning, George.

Hello, George.

I wanted to ask about the inflation class you call out on the Electric -- Electronics segment. Are those cost will you be able to push through to the customers over time?

So that’s kind of an interesting very specific commodity. You know reed switches, we tip our reed switches with rhodium is well known in the industry. Different reed switch manufacturers use different noble elements. We use rhodium on a line of our switches in Japan. And it's rhodium prices that have accelerated quickly this last year. We have been able to pass some of that through to the market. And we’re looking at other ways to mitigate that in the future. But in the – it was a rapid pickup in the quarter and this last quarter was a $1 million. We anticipate being able to mute that in the future with price and also some innovations that the operations believe they can bring to be more efficient with rhodium.

Got it. And then, maybe also call out offset slowness in the semiconductor market in the Electronics segment. And as I look at the year-over-year margin compression it’s about 360 basis points for Electronics. Is there a revenue mix shift combined in that semiconductor products that maybe they’re more profitable than other pieces of that business?

Well, the semiconductor mix shift really was -- effect the Agile acquisition. That's one of the reasons we're attracted to Agile, it was in very good position in semiconductor equipment and soon after we acquired Agile that business begin to soften. So that really isn’t – it hasn’t been in the business long enough that we could call that a mix shift.

Okay. And then last question from me is, you called out China weakness for both Electronics and Engraving. I though I heard you expect some recovery there in Q4. But then later in your commentary I thought you kind of backtracking that. You're guess is as good as mine. So I just wanted to be clear that Engraving you expect to come back in China. In Electronics, no, you do not or you’re uncertain at this time? Or do I pull it at that level?

That’s probably fair. Its probably maybe you worded a little differently. Let's say, Q4 based on the current customer schedules in Engraving we see a comeback in Q4. Based on the visibility we have for the Electronics customers, we don't see that pickup in Q4. But I have to say, our visibility somewhat limited. We’re confident in a softer Q3 for Electronics. And Q4 will depend on some macro effects between U.S. and China negotiations and your market activity in Asia and Europe.

Got it. Thank you very much.

Thank you, George.

Your next question is from Chris McGinnis with Sidoti & Company.

Good morning. Thanks for taking my questions. Can you maybe just on the tariff impact. Can you maybe just give a little bit of color on how much of a percentage those products are that you're serving to China that are being impacted? Is there a large portion of that portfolio? Or is it a small portion? And how much color you can give us?

Let’s take your turn, [Indiscernible] back into that. So it's really these toolmakers in Southwest China that really impacted. So the impact in the quarter in order of magnitude about 1 million and our China business is very profitable too, Chris.

Okay. The small -- larger because of the impact on the margin side?

Yes.

And then, just I guess on the Food Service -- on the Refrigeration, any -- and if you said that I apologize. Just any maybe positive outlook would given. I know you talked about subway and some other bigger customers coming back. Any visibility on that often because that should help benefit over the next year? Or how we’re looking there?

We are still well positioned for that and some other opportunities, if they go ahead. With that and other opportunities there are discussions between the corporate and franchise owners of how much we invest in the individual shops which is delaying those -- delaying those rollouts.

Okay. And then lastly, just talking about space program that weighed on the margin in the quarter, but then you think going forward should be more profitable. Can you just maybe provide a little bit more detail on that? Thanks.

Tom, on our order of magnitude there?

Yes. It’s probably depressed our margin rate, 200 basis points.

All right. And then what happened -- what changes going forward that improves like that…?

As soon they get into production, you know these are development programs that work over 18 months and we’re getting towards the end of it. They’re making good progress.

Great. Okay. Thanks for that. I appreciate. Thanks. Good luck in Q and Q3.

Thank you, Chris.

Your next question comes from DeForest Hinman with Walthausen & Company.

Hi. Thanks for taking my question. Just so I’m kind of beating a dead horse here on the tariffs, but just so I understand, I thought we had kind of a localized Engraving texturization business. We sell product in the market it’s demanded. So how is the business impacted by Chinese or U.S. tariffs on Chinese export?

Yes. Let me rewind the clock a few months. When we talked in prior quarters about tariff impact we knew it was affecting our hydraulic business. We also knew it was affecting our scientific business, but they were in the same budget on the competitors, they were able to pass the cost through. In the quarter DeForest we learned that, as I mentioned in Southwest China, a number of toolmakers primarily serve an export market. So the manufactured tools in China, they send them to our shop for texturizing, the toolmaker takes them back and then exports. And it's that niche of Chinese toolmakers that are been impacted by tariff. And so we didn’t not call that this last – last quarter when we spoke with you, we didn't have visibility to that effect at the time.

Okay. So just kind of the way it moves around versus us directly exporting the product to the U.S.?

Yes. We do not export the product. We provide the services to toolmakers in the regions where we participate. And it was their ability to compete globally with the tariffs that was impacted.

Okay. And then on the Engraving we called out the three items you're calling them discrete. Can we get a dollar number on each of those outsourcing expenses on laser program cancellation? Did we eat that and then the delayed drum?

Yes. On the order of magnitude, the last one -- within the Engraving business, we have this business called -- with the brand name Innovent. That makes drums that go into production lines for diapers and incontinence pads and things. It's about $12 million business year in year out. In the quarter, they had a program that pushed out. It's about $1 million in sales in very high gross margins. So, $1 millions of sales and over 50% gross margins. The -- older the laser outsourcing is $600,000 of cost and that had to do with some lasers that were down and just it took awhile and recalibrated up and running again in that time they were down to satisfy customer demand, we outsource that work to other companies that lasers -- that reduce the margins. And then the third one was the...

It was the cancellation of the program in China. About $800,000 in sales we didn't get it at a high margin.

And you said, it sound like that was on the floor and they canceled it. So we have to eat some…

The toolmaker get, but we didn't have to eat anything. We just -- we didn't collect the sales and the margin that was in our forecast or expectation.

Okay. So this $600,000 of outsource laser costs that -- should we think about that is being onetime in nature?

Yes. Yes.

And then on the Innovent drum, is that still loss or that just push to...?

No, no. We received yet pushed out a quarter.

That's helpful. And then -- we had a lot of commentary changes global with auto production in terms of a shift toward more SUVs from domestic auto manufacturers and then from the global numbers changing in terms of outlook. It sounds like we have a little bit of a drop in the third quarter on Engraving and then, a pickup in the fourth quarter. In the past you talk about visibility in your Engraving business based on platform ramps as like that. Should we still be anticipating a positive organic growth outlook on a next 12 month basis for that business?

Yes. The industry data we key up IHS -- data from IHS. We compare it to input from all of our sites and that data supports growth over the next 12 months. And moving to SUVs was a good move for us. We make -- there is more invested in interior aesthetics in an SUV, they're higher in cars than -- higher in vehicles than other cars. So yes, we stick by that, we just hit. We have good visibility to these OEM schedules. So we can comment on the Q3 softness and have confidence about Q4 pickup.

Then when we think about the margins for this business, I have to do the math more closely, but there's some onetime things in there. This is the lowest margin we've had in the segments – a long time. Then we look back at 2018 and 2017 obviously it was very strong year. Where should we be thinking about where the margins for this business could go and we've made some investments in new technologies and things like that, but should we fundamentally be seeing a improvement in margin going forward based on new technology, new programs and higher revenue outlook on an organic basis?

Yes. We look at the gross margins of the jobs we deliver, both traditional and new technologies continue to support our view that this is a low 20% margin. So if you anchor yourself for 22% EBIT, as we've seen in the past that's in line with our expectations.

Okay. And then, on the rhodium prices going up, are we -- do we have any long term contracts with that or are we buying in the spot market when we are purchasing a product?

It's a mix of product market. It's definitely is the spot market for us.

Okay. And I know we've been working on some stuff either reduce rhodium or switch to alternative metals. I mean, how far along are we potentially achieving. Is this still a ways out or is that more of a near-term opportunity?

We have some switches that use other like resonium. Those are growing. Some applications are -- the specific switch with rhodium is approved. So that will be -- it can be a longer process to change that. The longer-term solution for rhodium is process efficiency, efficiency which we're looking at which -- if things go well sometime in the next few quarters and we hope to introduce some efficiency measures that would reduce our rhodium usage.

And is it still targeted at -- low 20% operating margin in that business?

Yes.

And we've spoken about previously.

Yes.

And then on the engineered business, we'll talk about a bright spot, axing out that space cost that you just talked about. It looks like that business is moving toward that double digit operating profit margin level which would be a big change versus where that segments been previously. Should we be anticipating double digit sales growth, double digit operating margins in the second half of this year?

Yes. Yes.

Okay.

Yes, very strong backlog. And this is a business that has great visibility out several quarters to their volume. I mentioned in the text that they've been investing efforts in setup time improvements change over time reduction. They need that to expand the capacity for the backlog they have coming at them.

Okay. And then strong back to Electronics, I forgot to ask this. Where is the backlog number in that business right now?

[Indiscernible].

Okay. And then while you getting that. Can you just give us an update in terms of where we are with Cooking Solutions that transaction? Anything you can tell us in terms of the interest. Number of people we're talking to, NDAs, and we did disclose that one small transaction. Should we read into that the transaction happened sooner rather than later, given our June 2019 target of selling that business?

Yes. I would just say this that when we first announced this in October and then in subsequent communications at the Baird conference, we communicated that there is a lot of interest in the business, but we're pleased with the interest both from strategics and NPEs. We communicated. We anticipated a closed during this current quarter, and we're still -- we're still on track to meet those expectations.

Okay. And then on the share repurchase...?

Then the backlokg -- DeForest, the backlogs were up -- backlogs for under a year were up $8 million year-over-year, but of course, some of that is Agile. And you'll see it in the queue later today or tomorrow.

Okay. Sure. Can you just give us update on capital deployment priorities? I see the repurchase activity in the second quarter, it's looking at trailing metrics, it's the biggest repurchase we've done in over a decade...

In a long, long time. Yes.

So should we -- well, first can you give us an update on how you're allocating capital allocation priorities?

Yes. Our capital allocation model hasn't changed. We look at -- we keep the lights on, and then we prioritize strategic investments for growth with our organic businesses with a floor. We look at cash on cash returns 15% IRR. We have a good -- a good list of investment opportunities in our growing businesses we intend to fund. We then look at acquisitions with attractive returns I tell you, we have a good funnel. We have some very attractive acquisitions out there that would reinforce our growth businesses. And then we get into evaluation of a serious buyback. And in this last quarter, as we looked at, and we just compared if we take $10 million and put it into a capital investment one of our businesses, let’s say, return to 15% IRR knowing the EBITDA the business generates. And what we believe the business is worth what creates more value for the shareholders buyback or CAPEX. And there was a period in this last quarter after our last earnings release that math was favorable to doing a buyback. So we'll continue to take an opportunistic view of our buyback. We have $100 million authorization from the board we announced a few years ago. So we've used just about $2 million to $20 million in total. So I'd say there's nothing has changed in our priority or the approach to capital allocation. We have this authorization and are able to execute it when need it.

$33 million used.

Okay. We used $33 million of the 100. Okay.

And could you repeat that certainly, could you repeat that $33 million has been used of the $100 million authorization?

Yes. We also use that to overcome dilution from executive comp. So we've used $33 million of the $100 million authorization.

Okay. And it looks like your share price is down and it's below the level. I think that you disclosed you were buying. So that's math. I guess once again its favorable terms as -- whether or not we should be buying stock. Is that a true statement?

We have to run the analysis, but directionally – that makes sense.

Your next question comes from John Cumming with Copeland Capital.

Hi, guys. Thanks for taking the question. Just one question on Agile. Was that business actually down year-over-year in sales? And I'm just trying to understand more about the exposure there to the semiconductor industry?

I believe so. I believe they are down year-on-year.

And then their exposure in semis, I'm just trying to understand exactly, is it all exposed to semiconductor market and in which areas?

No, no. We have a good military aerospace component to have semis. That was 30% of their business in semi and then the other industrial applications.

Okay. And what about the margins of that business versus I guess the overall Electronics. How does they compare?

From an EBITDA standpoint, if you look at our Electronics business we've got our switches and sensors which is our highest margin segment or high reliability magnetics is something below that EBITDA in the low 20s. So probably a couple of 100 basis points lower than the sensor business but in line with the overall.

Okay. And then I guess -- I think when you announced that acquisition, you said, they did about 17 million in sales, I guess in their fiscal year. What's your expectation for I guess this next upcoming year? Is that business even with what's happened? I mean, is that business going to grow or anything could be more flattish or down, is it down significantly, I'm just trying to get some sense of the number there?

Yes. We are four months into it. First few weeks expected to be down some 5% to 10% maybe on the year with that semiconductor push out. There's also some repair business for the navy that there was a slug last year. The next round of that business has been scheduled, but it will be in our next fiscal year, so, first year probably down 5% to 10%. And then we see it picking back up.

Okay. Thanks. And then just one question on Refrigeration. I’ll say continued weakness there. Is there any reason you can get to this on a bigger picture reason why that whole industry is seeing such a decline this year?

Well, I would -- I did wake up this morning to realize when it's 22 below zero in most of the country, nobody wants to buy Refrigeration, but if you look long-term -- if you look long-term, it is a business that has had an increasing number of low cost imports affecting a growing piece of the business. So there's been more price competition. We also showed a company a year or two ago we showed how the channels have evolved in the marketplace to much more business is flowing through buying groups and dealers which is the lower margin channel and also kind of just intermediates manufacturers which we showed there is a couple of years ago, we showed that that effect a little was about a 400 basis point impact on our margin from 2013 to 2017, I think with the two numbers. The final thing is the walk in part of the business is really tied to North American construction. Once you put a walk it becomes basically an integral part of the building. And unless you do a significant remodel or store expansions you're not going to see much of a pickup in the market.

Okay. Thanks for the color. And then just one more follow up on Engraving you mentioned in the Chinese toolmakers being impacted. I’m just trying to understand where the end customer I guess ends up going for that product. I guess assuming they don't buy it from the Chinese toolmaker and I'm guessing you guys are global and so I'm just wondering why I guess you're not getting it from and why you didn't benefit?

Yes. You're exactly right. Our understanding is just this one program was canceled, I think it was canceled. That is not going to be done. And Tom was out there, so he may know more about it.

It was a large U.S. OEM. And they canceled the program for the car. I mean a lot of the cars, so that the vans are getting cancelled and being replaced by SUV's and pickup trucks. So they try to just scrap that tooling.

But you're right, John, in that, we do anticipate that for the programs that continue if we lose the order in China we'll pick it up somewhere else in the world maybe a quarter here or there.

Maybe cancel that whole program.

In this case it was just outright.

Right.

Okay. All right. Thanks.

[Operator Instructions]. Our next question is a follow up from George Godfrey with CLK.

Thank you. Just two questions, Tom. What are you using for the tax rate going forward in Q3 and Q4?

29%.

29%. And then you have really a target dollar amount for gross that at the end of the year?

No. We don't. No. I mean, we want to stay between now 1.5 times and 3 times leverage that we say is our capital allocation.

Got it. All right. Thank you very much.

Thank you. There are no further questions. I will now turn it back to management for any closing remarks.

I want to thank everybody for your participation. The good questions as you follow the business. There are a lot of moving pieces in Standex, and we don't -- we're not moving in a straight line, but I think we shared with you how we're thinking about how to allocate our cash regenerate our capital to continually move the business to higher quality earnings. If you look above the line or even EBITDA came in kind of about where we wanted them to the interest and the tax. In George's last question, interest and tax had a big effect on EPS and I think Tom did a nice job explaining that. So we look forward to go on a way running the business for another three months coming back and reporting to you next quarter. Thank you.

Thank you. That does conclude today's conference call. You may now disconnect.