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Edited Transcript of SXI earnings conference call or presentation 31-Jan-19 3:00pm GMT

Q2 2019 Standex International Corp Earnings Call

SALEM Mar 27, 2020 (Thomson StreetEvents) -- Edited Transcript of Standex International Corp earnings conference call or presentation Thursday, January 31, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* David A. Dunbar

Standex International Corporation - Chairman, President & CEO

* David C. Calusdian

Sharon Merrill Associates, Inc. - President

* Thomas D. DeByle

Standex International Corporation - COO

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Conference Call Participants

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* Christopher Paul McGinnis

Sidoti & Company, LLC - Special Situations Equity Analyst

* Christopher Paul Moore

CJS Securities, Inc. - Senior Research Analyst

* DeForest R. Hinman

Walthausen & Co., LLC - Research Analyst

* George James Godfrey

CL King & Associates, Inc., Research Division - Former Senior VP & Senior Research Analyst

* John R. Cummings

Copeland Capital Management, LLC - Partner & Research Analyst

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Presentation

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Operator [1]

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Good morning, and welcome to the Standex International's Q2 2019 Earnings Conference Call. (Operator Instructions)

I will now like to turn the call over to David Calusdian from Sharon Merrill. Please go ahead.

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David C. Calusdian, Sharon Merrill Associates, Inc. - President [2]

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Thank you, Stephanie. Please note that the presentation accompanying management's remarks can be 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 most recent 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 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 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. 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 3 as I turn the call over to David.

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David A. Dunbar, Standex International Corporation - Chairman, President & CEO [3]

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Thank you, David. Before turning to our slides, let me make a few introductory comments. We are 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. A 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 this 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 3. In Q2, overall revenues increased 5.3% 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 Technologies, scientific and Hydraulics businesses. As I mentioned, sales with new offerings grew 42% to $14.5 million in the quarter principally in Electronics and Engraving.

In Engineering Technologies, after several years of hard work and targeted investments, we're beginning to see profitability improvement as we delivered another sequential quarter of increased margins. This further reaffirms our expectations for the business to deliver strong sales and margin improvement in the second half of our fiscal year as we capitalize on increased demand in the aviation, space, energy and defense markets.

On the portfolio front, I'm pleased to say that the Tenibac and Agile integrations are proceeding well. And the Cooking Solutions group divestiture is also proceeding well and in line with the expectations we communicated previously.

Our Q2 performance was impacted by several headwinds, including the ongoing softness in the North American refrigeration market, that impacted revenue by $5 million and EBIT by $1.7 million. We continue to take actions to better align the Refrigeration business with current market demand so that we can better leverage the benefits of the restructuring actions that were completed last year.

Softness in China is affecting our Electronics and Engraving businesses and material inflation is a headwind for Electronics. In addition, our team remains focused on deploying our operating model, Standex Value Creation System, to continuously improve our organic performance as we also continue to make portfolio moves that further improve the profile of the company.

Please turn to Slide 4. Here is the high-level look at the key signposts in our financial performance. Overall, sales growth of 5.3% was accompanied by an increase in quality of earnings as reflected in increases in gross profit, operating income and a 76 basis point improvement in EBITDA margin. You can also see the significant effect that interest and tax had on net income, resulting in EPS flat to last year. These effects were temporary and masked the underlying performance strength of the company overall.

When I began here 5 years ago, we communicated that we would target an EBITDA margin of 15%. You can see in the upper right graph that in the past 5 years our EBITDA margin has increased from 12.5% to 15.5%. This is a key reference point for us and one we use as we evaluate internal investments and the attractiveness of acquisitions. We have since raised our target to 17% as communicated previously. We are confident that we're taking the necessary actions to drive our transformation forward and look forward to keeping our shareholders updated as we deliver on key milestones and advance on our journey.

With that, I will turn the call to Tom to review our second quarter results. Tom?

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Thomas D. DeByle, Standex International Corporation - COO [4]

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Thank you, David, and good morning, everyone. Slide 5 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 '19, which compares to a loss of $0.34 for the year-ago quarter. Our adjusted earnings per share for Q2 FY '19 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 3 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 the slide, our revenue and earnings performance this quarter was consistent with our historical seasonal trends.

Please turn to Slide 6, which details our revenue changes by segment. Overall, Q2 organic growth was up 1.6% with 3 of our 5 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 and Engraving and Agile in Electronics contributed 5.1% to our Q2 growth, while foreign exchange had an unfavorable 1.4% contribution.

Please turn to Slide 7, which summarizes our second quarter results on a GAAP and adjusted basis. Operating margin was up 117 basis points on a GAAP basis and 38 basis points on a non-GAAP basis. Earnings per share in Q2 FY '19 were $0.98 on a GAAP basis and non-GAAP basis. EPS was a loss of $0.34 in the prior year period on a GAAP basis due to the impact of the then recently passed U.S. tax law of $0.98 on a non-GAAP basis last year. As mentioned earlier, business unit performance was up. However, EPS was impacted by the higher interest expense and tax rates in the quarter versus prior year. We anticipate lower interest expense in our fourth quarter fiscal '19.

Please turn to Slide 8, which is a bridge that illustrates the impact of special items on net income from continuing operations for the quarter. The current quarter reflects the benefit of lower restructuring cost offset by higher interest cost and higher tax rate. More specifically, tax-affected special items in Q2 FY '19 include $0.1 million of restructuring charges, $0.6 million of acquisition-related cost offset by $0.8 million of discrete tax items. Q2 2019 GAAP net income was $12.5 million compared to a net loss of $4.3 million for the same quarter last year. Adjusted net income of $12.5 million was flat with the same quarter last year.

Turning to Slide 9. Net working capital at the end of the second quarter of fiscal '19 was $164.9 million compared with $142.5 million in the prior year quarter. Working capital turns decreased to 4.7 from 5.2 in the year-ago period. Two items impacted working capital turns. First, the new accounting standards, ASC 606, for revenue recognition decreased working capital turns by 0.3 turns in the current quarter. This relates to the longer manufacturing processes at our Engineering Technologies segment. Second, in the prior year, we had higher accounts payable related to the cabinet move from our Hudson, Wisconsin to New Albany, Mississippi facility causing a 0.2 improvement to working capital turns in the prior year. If you were to restate both periods, working capital turns would be 5 in both periods. Acquisitions did not have a material impact on working capital turns, however, did increase working capital by $8.1 million versus the prior year.

Slide 10 illustrates our debt management. We closed the quarter with net debt, defined as funded debt less cash, of approximately $196.5 million compared with $190.2 million at the end of the first quarter. Our ratio of net debt to capital was 30.3% at the end of Q2 compared with 29.2% at the end of the first quarter. And EBITDA to funded debt was 2.08x compared to 2.35x at the end of Q1.

During the quarter, we renewed our credit facility, increasing the facility from $400 million to $500 million with favorable terms. We continue to expect to repatriate the $50 million in fiscal '19. At the end of the second quarter, we had repatriated only $5.6 million. The repatriation process in many locations involves approvals from foreign governments, statutory audits and other approvals that lengthen the repatriation cycle. We continue to work through these requirements in multiple jurisdictions in order to achieve our repatriation targets and we expect to be completed early in Q4.

To wrap up where we are on debt. We completed -- we will complete the sale of our Cooking Solutions group and repatriation of foreign cash before our fiscal year end. We will apply the proceeds in line with our capital allocation approach. We will use the new credit facility and lower leverage to strengthen our higher-growth operating businesses through strategic organic growth investments and acquisitions.

Please turn to Slide 11. Overall, capital spending in Q2 came in at $7.6 million. During the quarter, key investments were made to add additional laser and nickel shell capacity in Engraving. In addition, we made productivity and facility investments in our Electronics segment. Looking ahead, we continue to project our capital spending in fiscal 2019 in the range of $35 million to $36 million to support our growth initiatives and operational excellence initiatives. We expect depreciation to be about $23 million and amortization to be about $9 million.

Slide 12 details the reconciliation of free operating cash flows, which were $7.7 million for the quarter. As you can see on the graph, our free operating cash flow followed seasonal patterns for the quarter. We expect the free operating cash flow to improve throughout the remainder of the fiscal year and continue to target 100% of net income on average over a 3- to 5-year planning horizon.

With that, I'll turn the call back to David.

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David A. Dunbar, Standex International Corporation - Chairman, President & CEO [5]

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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 rollouts in 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 product shown on the slide. In addition, we will be displaying several new products at the NAFEM show in Florida in February. We're also implementing additional productivity and operational excellence actions to better align the Refrigeration business with current market conditions and to better position our well established Nor-Lake 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 increased, organic sales decreased due to headwinds from a decline in Chinese exports due to the impact of tariffs on Chinese toolmakers, reduction in texturizing sales to consumer products toolmakers and the pushout of an Innovent drum order. Engraving operating income declined 5.2% due to 3 distinct items: outsourcing expenses related to laser capacity; a tariff-related program cancellation; and increased investment in tool finishing and nickel shell growth laneway programs.

Looking ahead, we remain focused on completing the Tenibac integration, which is progressing well. In addition, we will continue to execute on growth laneways, like architecture, nickel shell, laser and performance services that position Standex to capitalize on robust automotive program rollouts and the proliferation of electric vehicles. We anticipate lower volumes in Q3 as tariff-related headwinds are expected to continue. However, we expect volumes to begin to recover as we move into Q4.

Please turn to Slide 16, Engineering Technologies. Sales grew 7.5% year-over-year due to strength in space and energy, which was partially offset by lower aviation component sales. Orders increased in aviation lip-skin components, defense and space markets. For the second quarter in a row, ETG's operating income increased sequentially with operating income margin growing to 8.7%, demonstrating the hard work our team has been putting in is driving improved profitability.

Development work on a key space program lowered overall margins in the quarter. However, once developed and put into production, the program is expected to drive higher margins. Going forward, we are focused on delivering sales and margin improvement in the second half of our fiscal year as we capitalize on increased demand in aviation, space, energy and defense markets. In addition, we're completing the productivity improvements to increase machine uptime and reduce setup times. The benefits of this program are expected to flow through by the end of the fiscal year.

Please turn to Slide 17, Electronics. Electronics sales increased 14.5% year-over-year, with double-digit growth in sensors, switches, relays and planar technologies. This was partially offset by tariff-related demand slowdown in Asia. Adjusted operating income was up 4.1% year-over-year. The Agile acquisition contributed to overall electronic sales growth and was impacted by a slowdown in the semiconductor equipment market. The Switch business also experienced $1.1 million of material inflation.

During the quarter, we opened our first Electronics factory in India to serve as a global source and provide better support to a growing customer base in India. Looking ahead, we are focused on following up on new business leads and accelerating new business opportunities, such as battery management systems in electric vehicles, machine safety and medical sensor programs to counter softer market conditions. In addition, we continue to advance the integration of Agile Magnetics to further enhance our ability to service the high-reliability, mission-critical and custom-designed magnetics market.

Please turn to Slide 18, Hydraulics. Hydraulics sales increased by 13.4% with orders and backlog increasing double digits as well. This was driven by robust market strength in the container handling aftermarket and Refuse markets. Operating income grew 27.2% year-over-year, with operating margin of 15.9%, reflecting the favorable elimination of section 301 tariffs on certain products from our Chinese subsidiary as well as productivity improvements due to CNC machine uptime. We remain optimistic about the Hydraulics segment as we continue to leverage the benefits of these productivity improvements, the strong market environment and the anticipated softening of metal prices in the next few quarters.

Before we go to questions, let me leave you with a few key thoughts shown on Slide 19. First, despite the market headwinds we faced during the quarter, we delivered top line growth of 5.3%, we grew gross profit, operating income and EBITDA margins. And we had very strong performances in Electronics, Engineering Technologies, scientific and Hydraulics.

Second, the actions we've taken to transform our portfolio continue to evolve the company to higher-quality mix of businesses. In the past 12 months, we acquired Tenibac and Agile and moved Cooking to discontinued operations. This supported the 76 basis point increase in EBITDA as a percent of sales in the quarter.

Third, as we turned to the second half of 2019, although we expect to face certain headwinds, we are positioned to capitalize on several catalysts. These include expected strong second half performances by scientific, Hydraulics and Engineering Technologies and new business opportunities in all businesses. In addition, as we complete the sale of Cooking and wind down our repatriation program, we expect to improve our leverage ratio versus the prior year and add more dry powder to our balance sheet.

Fourth, we continue to focus our investments on our large funnel of organic initiatives and acquisitions that enhance our high-return platforms, such as Electronics and Engraving. With a strong balance sheet, we are well positioned to invest in the platforms where we see the greatest opportunity to enhance shareholder value. We're confident that we're taking the actions necessary to align the business with market demand, while also positioning Standex to deliver on our long-term financial targets and fulfill our mission to become a best-in-class operating company. We are excited for the opportunities ahead and thank our employees, customers and shareholders for your support. We look forward to keeping you updated.

Now with that, we'll take your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from Chris Moore with CJS Securities.

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Christopher Paul Moore, CJS Securities, Inc. - Senior Research Analyst [2]

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Maybe we could start with Electronics. 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 and things like that?

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David A. Dunbar, Standex International Corporation - Chairman, President & CEO [3]

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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, again, your guess is probably as good as mine. So our -- with some confidence, we see continued softness in Asia in Q3.

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Christopher Paul Moore, CJS Securities, Inc. - Senior Research Analyst [4]

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

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David A. Dunbar, Standex International Corporation - Chairman, President & CEO [5]

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No, not really. There are 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 the Dongguan and it was canceled as we were starting to do the texturizing and they decided to source those tools. It was the most amazing thing, never seen that happen before. So that caught us a bit off guard. That will likely continue also through this quarter, and we will see how the macro level negotiations between China and U.S. go on tariffs.

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Christopher Paul Moore, CJS Securities, Inc. - Senior Research Analyst [6]

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Got it. And on Refrigeration side, it sounds like you talked about additional productivity, operational excellence. So there is additional restructuring within Refrigeration? Or how should we kind of look at that?

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David A. Dunbar, Standex International Corporation - Chairman, President & CEO [7]

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No. I think it's more 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 modified the cost structure, but we also put in a lot of process improvements in both the plants and that's reading through right first-time measures, quality, productivity. And we continue to roll out those events cell-by-cell through the plant to continue improvements. But -- so the comment about continued productivity improvements was in that way, in continuous improvements. We do not expect more significant restructuring in that business.

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Christopher Paul Moore, CJS Securities, Inc. - Senior Research Analyst [8]

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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?

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David A. Dunbar, Standex International Corporation - Chairman, President & CEO [9]

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

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Operator [10]

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Your next question comes from George Godfrey with CLK.

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George James Godfrey, CL King & Associates, Inc., Research Division - Former Senior VP & Senior Research Analyst [11]

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I wanted to ask about the inflation cost that you call out in electric -- Electronics segment. Are those costs that you'll be able to push through to the customers over time?

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David A. Dunbar, Standex International Corporation - Chairman, President & CEO [12]

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So that's kind of an interesting very specific commodity. Reed switches, we tip our reed switches with rhodium, 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 $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 our rhodium.

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George James Godfrey, CL King & Associates, Inc., Research Division - Former Senior VP & Senior Research Analyst [13]

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Got it. And then, maybe you also call out offset slowness in the semiconductor market in the Electronics segment. And if I look at the year-over-year margin compressions about 360 basis points in Electronics, is there a revenue mix shift combined in that semiconductor product that maybe they are more profitable than other pieces of that business?

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David A. Dunbar, Standex International Corporation - Chairman, President & CEO [14]

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Well, the semiconductor mix shift really -- is like 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 began to soften. So it -- that really isn't -- it hasn't been in the business long enough that we could call out a mix shift.

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George James Godfrey, CL King & Associates, Inc., Research Division - Former Senior VP & Senior Research Analyst [15]

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Okay. And then last question for me is, you called out China weakness for both Electronics and Engraving. I thought I heard you expect some recovery there in Q4, but then later in your commentary, I thought you're 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 and Electronics, no, you do not or you're uncertain at this time? Or do I pull it at that level?

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David A. Dunbar, Standex International Corporation - Chairman, President & CEO [16]

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That's probably fair, it doesn't -- 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 with our Electronics customers, we don't see that pickup in Q4. But I have to say, our visibility is 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 market activity in Asia and Europe.

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Operator [17]

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

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Christopher Paul McGinnis, Sidoti & Company, LLC - Special Situations Equity Analyst [18]

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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?

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David A. Dunbar, Standex International Corporation - Chairman, President & CEO [19]

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Let's think here. Tom, [I go] back into this. So it's really these toolmakers in Southwest China that really got impacted. So the impact in the quarter in order of magnitude about $1 million. And our China business is very profitable too, Chris. So...

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Christopher Paul McGinnis, Sidoti & Company, LLC - Special Situations Equity Analyst [20]

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

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David A. Dunbar, Standex International Corporation - Chairman, President & CEO [21]

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Yes, right.

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Christopher Paul Moore, CJS Securities, Inc. - Senior Research Analyst [22]

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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 given -- I know you've talked about the Subway and some other bigger customers coming back. Any visibility on that offer that should help benefit over the next year? Or how we look in there?

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David A. Dunbar, Standex International Corporation - Chairman, President & CEO [23]

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

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Christopher Paul McGinnis, Sidoti & Company, LLC - Special Situations Equity Analyst [24]

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Okay. And then lastly, you just talked about a 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?

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David A. Dunbar, Standex International Corporation - Chairman, President & CEO [25]

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Tom, on our magnitude there?

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Thomas D. DeByle, Standex International Corporation - COO [26]

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Yes, it probably depressed our margin rate 200 basis points.

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Christopher Paul McGinnis, Sidoti & Company, LLC - Special Situations Equity Analyst [27]

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All right. And then what changes going forward that, that improves? Like...

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David A. Dunbar, Standex International Corporation - Chairman, President & CEO [28]

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As soon as 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 are making good progress.

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Operator [29]

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

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DeForest R. Hinman, Walthausen & Co., LLC - Research Analyst [30]

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Just so I'm kind of beating a dead horse here on the tariffs, but just so we understand. I thought we had kind of a localized Engraving texturization business, we sell the product in the market it's demanded. So how is the business impacted by Chinese -- or U.S. tariffs on Chinese exports?

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David A. Dunbar, Standex International Corporation - Chairman, President & CEO [31]

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Yes. Let me rewind the clock a few knots. When we talked in prior quarters about tariff impact, we knew it was affecting our Hydraulics business. We also knew it was affecting our scientific business, but they were in the same budget as 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 our toolmakers primarily serve in export markets. So they manufacture the tools in China, they send them to our shop for texturizing, the toolmaker takes it back and then exports. And it's that niche of Chinese toolmakers that have been impacted by tariff. And so we did not call that out this last quarter when we spoke with you because we didn't have visibility to that effect at the time.

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DeForest R. Hinman, Walthausen & Co., LLC - Research Analyst [32]

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Okay, so it's just kind of the way it moves around versus us directly exporting the product to the U.S.?

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David A. Dunbar, Standex International Corporation - Chairman, President & CEO [33]

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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.

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DeForest R. Hinman, Walthausen & Co., LLC - Research Analyst [34]

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Okay. And then on Engraving, we called out the 3 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?

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David A. Dunbar, Standex International Corporation - Chairman, President & CEO [35]

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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 a $12 million business year in, year out. In the quarter, they have about -- they had a program that pushed out, it's about $1 million in sales and very high gross margins. So $1 million of sales and over 50% gross margins. The laser outsourcing is $600,000 of cost and that had to do with some lasers that were down and just took a while to recalibrated up and running and they're up and running again. In that time they were down, to satisfy customer demand, we outsourced that work to other companies that had lasers and that reduced the margins. And then the third one was the...

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Thomas D. DeByle, Standex International Corporation - COO [36]

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

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DeForest R. Hinman, Walthausen & Co., LLC - Research Analyst [37]

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And you said, it sounded like that was on the floor and they canceled it. So did we have to eat some cost?

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David A. Dunbar, Standex International Corporation - Chairman, President & CEO [38]

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We didn't -- the toolmaker did, but we didn't have to eat anything. We just...

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Thomas D. DeByle, Standex International Corporation - COO [39]

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We just counted on that.

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David A. Dunbar, Standex International Corporation - Chairman, President & CEO [40]

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Yes. We didn't collect the sales on the margin that was in our forecast or expectation.

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DeForest R. Hinman, Walthausen & Co., LLC - Research Analyst [41]

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Okay. So the $600,000 of outsourced laser cost, should we think about that as being one-time in nature?

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David A. Dunbar, Standex International Corporation - Chairman, President & CEO [42]

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Yes.

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DeForest R. Hinman, Walthausen & Co., LLC - Research Analyst [43]

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And then on the drum, is that still a loss or that's just push through?

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David A. Dunbar, Standex International Corporation - Chairman, President & CEO [44]

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No. We received it, yes, pushed out a quarter.

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DeForest R. Hinman, Walthausen & Co., LLC - Research Analyst [45]

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Okay. That's helpful. And then, is -- we've had a lot of commentary and changes globally with auto production in terms of shift towards more SUVs, some domestic auto manufacturers and then some of 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 talked about visibility in your Engraving business based on platform ramps and things like that. Should we still be anticipating a positive organic growth outlook on a next 12-month basis for that business?

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David A. Dunbar, Standex International Corporation - Chairman, President & CEO [46]

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Yes. The industry data -- we key up IHS -- data from IHS. We compare it to input from our -- 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 -- higher in vehicles than other cars. So we think 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.

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DeForest R. Hinman, Walthausen & Co., LLC - Research Analyst [47]

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Then when we think about the margins for this business, I have to do the math more closely, but there's some one-time things there just with the lowest margins we've had in this segment in a long time. Then we look back at 2018 and 2017 obviously was very strong year. Where should we be thinking about where the margins for this business could go? I know you've made some investments in some of the 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?

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David A. Dunbar, Standex International Corporation - Chairman, President & CEO [48]

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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 a -- that's in line with our expectations.

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DeForest R. Hinman, Walthausen & Co., LLC - Research Analyst [49]

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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 were purchasing that product?

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Thomas D. DeByle, Standex International Corporation - COO [50]

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

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DeForest R. Hinman, Walthausen & Co., LLC - Research Analyst [51]

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And I know we've been working on some stuff to either reduce rhodium or switch to alternative metals. How far along are we in potentially achieving that? Is this 4-ways out? Or is that more of a near-term opportunity?

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David A. Dunbar, Standex International Corporation - Chairman, President & CEO [52]

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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, which we're looking at, which -- if things go well sometime in the next few quarters, we hope to introduce some efficiency measures that would reduce our rhodium usage.

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DeForest R. Hinman, Walthausen & Co., LLC - Research Analyst [53]

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

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Thomas D. DeByle, Standex International Corporation - COO [54]

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Yes.

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DeForest R. Hinman, Walthausen & Co., LLC - Research Analyst [55]

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As we spoke about previously?

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Thomas D. DeByle, Standex International Corporation - COO [56]

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Yes.

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DeForest R. Hinman, Walthausen & Co., LLC - Research Analyst [57]

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

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Thomas D. DeByle, Standex International Corporation - COO [58]

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Yes.

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David A. Dunbar, Standex International Corporation - Chairman, President & CEO [59]

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

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DeForest R. Hinman, Walthausen & Co., LLC - Research Analyst [60]

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

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David A. Dunbar, Standex International Corporation - Chairman, President & CEO [61]

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We'll have to pull that out.

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DeForest R. Hinman, Walthausen & Co., LLC - Research Analyst [62]

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Okay. And while you're 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 interest, the number of people who you are talking to, NDAs, and we did disclose that 1 small transaction, should be read into that with the transaction happens sooner rather than later, given our June 2019 target of selling that business?

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David A. Dunbar, Standex International Corporation - Chairman, President & CEO [63]

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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's a lot of interest in the business, we're pleased with the interest both from strategics and NPEs. We communicated we anticipated a close during this current quarter, and we're still on track to meet those expectations.

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DeForest R. Hinman, Walthausen & Co., LLC - Research Analyst [64]

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Okay, and then on the ...

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Thomas D. DeByle, Standex International Corporation - COO [65]

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Then the backlog -- 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.

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DeForest R. Hinman, Walthausen & Co., LLC - Research Analyst [66]

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Okay. Sure. And 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.

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David A. Dunbar, Standex International Corporation - Chairman, President & CEO [67]

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In a long time, yes.

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DeForest R. Hinman, Walthausen & Co., LLC - Research Analyst [68]

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

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David A. Dunbar, Standex International Corporation - Chairman, President & CEO [69]

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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 organic businesses with the floor of -- when we look at cash-on-cash returns, 15% IRR, we have 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 buyback. And in this last quarter, as we look at, and we just compared if we're to take $10 million and put it into a capital investment in 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 -- $20 million total.

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Thomas D. DeByle, Standex International Corporation - COO [70]

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$20 million.

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David A. Dunbar, Standex International Corporation - Chairman, President & CEO [71]

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So I'd say this, nothing has changed in our priority or the approach to capital allocation. We have this authorization and are able to execute it when needed.

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Thomas D. DeByle, Standex International Corporation - COO [72]

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$33 million used.

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David A. Dunbar, Standex International Corporation - Chairman, President & CEO [73]

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Okay. We've used $33 million of the $100 million, okay. I'm sorry.

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DeForest R. Hinman, Walthausen & Co., LLC - Research Analyst [74]

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Could you repeat that? $33 million has been used of the $100 million authorization?

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David A. Dunbar, Standex International Corporation - Chairman, President & CEO [75]

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Yes, because we also used that to overcome dilution from executive comps. So we've used $33 million of the $100 million authorization.

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DeForest R. Hinman, Walthausen & Co., LLC - Research Analyst [76]

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

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David A. Dunbar, Standex International Corporation - Chairman, President & CEO [77]

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Correct. We have to run the analysis, but directionally, yes, it makes sense.

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Operator [78]

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Your next question comes from John Cummings with Copeland Capital.

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John R. Cummings, Copeland Capital Management, LLC - Partner & Research Analyst [79]

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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?

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David A. Dunbar, Standex International Corporation - Chairman, President & CEO [80]

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Oh gosh, I believe so. I believe they are down year-on-year.

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John R. Cummings, Copeland Capital Management, LLC - Partner & Research Analyst [81]

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

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David A. Dunbar, Standex International Corporation - Chairman, President & CEO [82]

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

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John R. Cummings, Copeland Capital Management, LLC - Partner & Research Analyst [83]

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

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David A. Dunbar, Standex International Corporation - Chairman, President & CEO [84]

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From EBITDA standpoint, if you look at our Electronics business, we got our switches and sensors, which is our highest-margin segment, our higher-reliability magnetics is something below that EBIT -- EBITDAs.

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Thomas D. DeByle, Standex International Corporation - COO [85]

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In the 20s.

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David A. Dunbar, Standex International Corporation - Chairman, President & CEO [86]

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In the low 20s.

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Thomas D. DeByle, Standex International Corporation - COO [87]

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Yes.

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David A. Dunbar, Standex International Corporation - Chairman, President & CEO [88]

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So probably a couple of hundred basis points lower than sensor business, but in line with the overall.

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John R. Cummings, Copeland Capital Management, LLC - Partner & Research Analyst [89]

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Okay. And then I guess your -- when you announced the acquisition, you said, they did about $17 million in sales, I guess, in their fiscal year. So 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 if you think it would be more flattish or down? Is it down significantly? I'm just trying to get some sense of the number there?

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David A. Dunbar, Standex International Corporation - Chairman, President & CEO [90]

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Yes. We are four months into it. So first, we expect it to be down some 5% to 10%, maybe on the year with that semiconductor pushout. There's also some repair business for the Navy that 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, you're probably down 5% to 10% and then we see it picking back up.

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John R. Cummings, Copeland Capital Management, LLC - Partner & Research Analyst [91]

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Okay. And then just one question on Refrigeration. Obviously, a continued weakness there. Is there any reason you can give us on a bigger picture or a reason why that whole industry is seeing such a decline this year?

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David A. Dunbar, Standex International Corporation - Chairman, President & CEO [92]

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Well, I would -- I did wake up this morning and realized it was 22 below 0 in most of the country, nobody wants to buy refrigeration. But 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 on, a couple -- a year or 2 ago, we showed how the channels have evolved in the marketplace to much more businesses flowing through buying groups and dealers, which is the lower margin channel and also kind of just intermediate manufacturers. We showed -- actually a couple of years ago, we showed that, that effect alone was about a 400 basis point impact on our margin from 2013 to 2017, I think were the 2 numbers. The final thing is the walk-in part of the business is really tied to North American construction. Once you put a walk-in, it becomes basically an integral part of the building and unless you do significant remodel or store expansions, you're not going to see much of a pickup in walk-ins.

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John R. Cummings, Copeland Capital Management, LLC - Partner & Research Analyst [93]

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Okay. And then just one more follow-up on Engraving. You mentioned the Chinese toolmakers being impacted, I'm just trying to understand where the end customer, I guess, ends up going to that product? I guess, it seems they don't buy it from the Chinese toolmaker. You guys are global and so I'm just trying to understand why, I guess, who they're getting it from and why you didn't benefit?

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David A. Dunbar, Standex International Corporation - Chairman, President & CEO [94]

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

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Thomas D. DeByle, Standex International Corporation - COO [95]

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It was a large U.S. OEM, and they canceled the program for the car. I mean, a lot of the cars, the vans are getting canceled and being replaced by SUVs and pickup trucks. So they probably just grabbed that tooling.

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David A. Dunbar, Standex International Corporation - Chairman, President & CEO [96]

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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 may be a quarter here or there.

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Thomas D. DeByle, Standex International Corporation - COO [97]

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We're not going to cancel that whole program.

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David A. Dunbar, Standex International Corporation - Chairman, President & CEO [98]

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In this case, it was just outright canceled.

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Operator [99]

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(Operator Instructions) Your next question is a follow-up from George Godfrey with CLK.

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George James Godfrey, CL King & Associates, Inc., Research Division - Former Senior VP & Senior Research Analyst [100]

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

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Thomas D. DeByle, Standex International Corporation - COO [101]

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29%.

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George James Godfrey, CL King & Associates, Inc., Research Division - Former Senior VP & Senior Research Analyst [102]

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

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Thomas D. DeByle, Standex International Corporation - COO [103]

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No, we don't. No. I mean, we want to stay between that 1.5 and 3x leverage that we say as our capital allocation.

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Operator [104]

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

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David A. Dunbar, Standex International Corporation - Chairman, President & CEO [105]

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All right. I want to thank everybody for your participation. The good questions for those of you who 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 -- the cash we generate and our capital to continually moving the business to higher-quality earnings. If you look at above the line or even EBITDA came in, kind of, about where we wanted them to, the interest and the tax, 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 3 months, coming back and reporting to you next quarter. Thank you.

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Operator [106]

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