Ametek Inc (AME) — Q2 2021 Earnings Call Transcript

Thank you, Michelle. Good morning, and thank you for joining us for AMETEK's second quarter 2021 earnings conference call. With me today are Dave Zapico, Chairman and Chief Executive Officer; and Bill Burke, Executive Vice President and Chief Financial Officer. During the course of today's call, we will make forward-looking statements, which are subject to change based on various risk factors and uncertainties that may cause actual results to differ significantly from expectations. A detailed discussion of the risks and uncertainties that may affect our future results is contained in AMETEK's filings with the SEC. AMETEK disclaims any intention or obligation to update or revise any forward-looking statements. Any references made on this call to 2020 or 2021 results will be on an adjusted basis, excluding after-tax, acquisition-related intangible amortization, and also excluding the gain from the sale of Reading Alloys in the first quarter of 2020, and the realignment charge taken in the first quarter of 2020. Reconciliations between GAAP and adjusted measures can be found in our press release and on the Investors section of our website. We'll begin today's call with prepared remarks by Dave and Bill, and then open it up for questions. I'll now turn the meeting over to Dave.

Thank you, Kevin, and good morning, everyone. AMETEK delivered outstanding results in the second quarter. Strong sales growth and outstanding operating performance led to a high quality of earnings that exceeded our expectations. We established record levels of sales, orders, operating income, and adjusted earnings per share in the quarter. This performance comes as we are still early in our economic recovery and reflects the outstanding efforts of our teams. We also ended the quarter with a record backlog driven by exceptionally strong and broad-based orders growth, providing strong visibility across our mid and long cycle business profile. The five acquisitions we completed earlier this year are integrating nicely and are well-positioned to drive strong growth. Given our second quarter results and outlook for the back half of 2021, we have increased our sales and earnings guidance for the year. Now, let me turn to our second quarter results. Our businesses saw robust broad-based sales growth in the quarter. Overall, sales were a record $1.39 billion, up 37% over the same period in 2020. Organic sales growth was 25%; acquisitions added 10 points to growth, while foreign currency added two points. Overall, orders in the quarter were a record $1.91 billion, a sharp increase of 92% over the prior year, while organic orders were an impressive 44% up in the quarter. We ended the quarter with a record backlog of $2.5 billion, which is up over $700 million from the start of the year. Our businesses also delivered exceptional operating performance in the quarter. While global supply chains remain tight, our businesses are doing a fantastic job managing through these challenges, as is reflected in our results. Second quarter operating income was a record $317 million, a nearly 40% increase over the second quarter of 2020, and operating margins expanded 40 basis points, to 22.8%. Excluding the dilutive impact of acquisitions, core operating margins expanded an exceptional 160 basis points to 24%. EBITDA in the quarter was $387 million, up 34% over the prior year's second quarter, with EBITDA margins of 27.9%. This operating performance led to earnings of $1.15 per diluted share, up 37% over the second quarter of 2020, and above our guidance range of $1.08 to $1.10. Our businesses also generated strong cash flows in the quarter, which position us well to continue investing in our businesses and on strategic acquisitions. In the second quarter, operating cash flow was $287 million, and free cash flow conversion was 114% in income. Let me revise some additional details of the operating group level. Both our Electronic Instruments Group and Electromechanical Group delivered strong organic sales growth with excellent core margin expansion in the quarter. Sales for EIG were a record $934 million, up 44% over last year's second quarter. Organic sales were up 27%, recent acquisitions added 16%, and foreign currency added nearly two points. EIG's second quarter operating income was $227 million, up 42% versus the same quarter last year, and operating margins were 24.3%. Excluding acquisitions, EIG's core margins were 26.3%, expanding an impressive 170 basis points over the comparable period. The Electromechanical Group also delivered strong sales growth and outstanding operating performance. EMG's second quarter sales increased 24% versus their prior year, to $452 million. Organic sales growth was 21%, and currency added three points to the quarter. Growth was broad-based across our EMG businesses, with particularly strong growth in our Advanced Motion Solutions business. EMG's operating income in the second quarter was a record $112 million, up 32% compared to the prior-year period, and EMG's operating margins expanded an exceptional 170 basis points to a record 24.9%. Now switching to our acquisition strategy, as we noted during our previous call, we completed the acquisitions of Abaco and NSI-MI at the beginning of the second quarter. These acquisitions, as well as the first quarter acquisitions of Magnetrol, Crank Software, and EGS are performing very well, and the integration work for these businesses is progressing as expected. AMETEK's strong cash flow generation continues to bolster our capacity for capital deployment, including investment in strategic acquisitions. Our M&A teams continue to work diligently through a robust pipeline of attractive acquisition opportunities, and we expect to remain active over the balance of the year. Additionally, we're continuing to make key investments in support of our organic growth initiatives. We remain committed to investing in research, development and engineering of our advanced technology products, and to continue providing our customers with innovative solutions and maintaining our leading positions in niche markets and applications. In the second quarter, we invested $72 million in R&D and for the full year we now expect to invest more than $300 million or approximately 5.5% of sales. For all of 2021, we now expect to invest approximately $100 million in incremental growth investments. In addition to R&D, this total investment includes our finance sales and marketing functions, along with investments to help drive our digital transformation and allow our businesses to accelerate growth. As noted, operating performance in the second quarter was outstanding, with strong core margin expansion, despite having to absorb the return of temporary costs into our cost structure. While we were seeing higher levels of inflation due to the tightness of the global supply chain, we're capturing higher levels of price given our differentiated solutions, allowing us to maintain a healthy price versus inflation spread. Additionally, we continue to see the benefits of our various operational excellence initiatives. For the full year, we now expect approximately $145 million of operational excellence savings. Now, moving to our updated outlook for the remainder of 2021, given our strong performance in the second quarter, along with our order momentum and record backlog, we have again raised our 2021 sales and earnings guidance. For the full year, we now expect overall sales to be up approximately 20% and organic sales up approximately 10% over 2020. Diluted earnings per share for 2021 are now expected to be in the range of $4.62 to $4.68, an increase of 17% to 18% over 2020's comparable basis, and above our prior guide of $4.48 to $4.56 per diluted share. For the third quarter, we anticipate that overall sales will be up in the mid-20% range versus the same period last year. Third quarter earnings per diluted share are now expected to be between $1.16 to $1.18, up 15% to 17% over last year's third quarter. In summary, AMETEK's second quarter results were superb with excellent sales and order growth and high quality earnings growth exceeded expectations. Our strong operating performance in the first half of the year shows the strength and flexibility of the AMETEK growth model. Our differentiated technology solutions and market-leading positions across diverse niche applications have allowed us to navigate through difficult economic cycles and emerge as a stronger company each time. The proven sustainable nature of the AMETEK growth model continues to drive long-term success for all of AMETEK's stakeholders. I'll now turn it over to Bill Burke, who will cover some of the financial details of the quarter and we'll be glad to take your questions, Bill?

Thank you, Dave. As Dave highlighted, AMETEK delivered outstanding results in the second quarter, with strong sales and orders growth, excellent operating performance, and a high quality of earnings. Let me provide some additional financial highlights for the quarter. Second quarter general and administrative expenses were $22.5 million, up $5.6 million from the prior-year, largely due to higher compensation expense. As a percentage of total sales, G&A was 1.6% for the quarter, versus 1.7% in the same period last year. For 2021, general and administrative expenses are now expected to be approximately $15 million or expected to be up approximately $15 million on higher compensation costs. The effective tax rate in the second quarter was 20.6%, compared to 19.5% in the same quarter last year. The higher rate was driven by the impact of a U.K. range and the associated remeasurement of our deferred tax liabilities. For 2021, we continue to expect our effective tax rate to be between 19% and 20%. And as we've stated in the past, actual quarterly tax rates can differ dramatically, either positively or negatively from this full-year estimated rate. Our businesses continue to manage their working capital exceptionally well. For the quarter, working capital was 13.9% of sales, down an impressive 570 basis points from the 19.6% reported in the second quarter of 2020. Capital expenditures in the second quarter were $23 million, and we continue to expect capital expenditures to be approximately $120 million for the full-year. Depreciation and amortization expense in the second quarter was $75 million. For all of 2021, we continue to expect depreciation and amortization to be approximately $300 million, including after-tax acquisition-related intangible amortization of approximately $141 million or $0.61 per diluted share. As Dave highlighted, our businesses continue to generate strong levels of cash given our asset-light business model and strong working capital management. In the second quarter, operating cash flow was $287 million, and free cash flow was $264 million, with free cash flow conversion in the quarter a very strong 114% of net income. Total debt at quarter end was $2.96 billion, offsetting this debt was cash and cash equivalents of $390 million. As Dave noted, we've been very active on the acquisition front. During the second quarter, we deployed approximately $1.58 billion on the acquisitions of Abaco Systems and NSI-MI. This was in addition to the acquisitions of EGS, Crank Software, and Magnetrol which were completed in the first quarter of the year. Combined, we have deployed approximately $1.85 billion on five strategic acquisitions thus far in 2021. At quarter end, our gross debt to EBITDA ratio and our net debt to EBITDA ratio were 1.9 times and 1.6 times, respectively. We remain well-positioned to deploy additional capital and invest in our acquisition strategy given our strong financial capacity and flexibility. At quarter end, we had approximately $2 billion of cash in existing credit facilities to support our growth initiatives. To summarize, our businesses delivered excellent results in the second quarter that outperformed our expectations. The performance of our businesses through the first half of the year, along with our strong balance sheet, tremendous cash flow generation, and the dedication of our world-class workforce has positioned the company exceptionally well for meaningful growth in 2021 and beyond.

Thank you, Bill. Michelle, we're ready to take questions.

Thanks. A couple of questions, Dave, you mentioned price costs, but could you talk about what sort of spread you actually experienced in Q2? What your realization was in terms of price year-on-year, and whether you're contemplating any incremental pricing actions or surcharges in the back-half?

Great question, Matt. In the second quarter, we were very pleased that our pricing continues to offset inflation. We achieved about 3% of price across our entire portfolio, and total inflation was about two points. So, we had about a 100 basis point positive spread. And we want to stay ahead of it. We want to stay there. And with all the acquisitions that we did and all the costs from those acquisitions, it showed up. We had 170 basis points of core margin expansion. And that pricing really helped us deliver that. So, we're ahead of the game now, we plan on staying there. There is increasing inflation, but with the 3% pricing and the 2% inflation, we were very pleased with our performance during the quarter.

And then just as a follow-up, can you speak to the organic order cadence you experienced over the course of the quarter? And if you can give us a read on maybe what you saw in July? Thank you.

Yes, sure. I mean as we said before, the organic orders were up substantially. During the quarter, they grew every month, with June being the strongest month of the quarter. Sales also grew every month sequentially. And June was also the strongest month of the quarter, and so a very strong trend during the quarter. And then with July, it was a very solid month, and was supportive of our forecast and guide. So, we feel real good about the orders trend in the business.

Great. Thank you, guys.

Hi. Good morning, guys.

Good morning, Josh.

Dave, just on the inflation discussion, I guess the material side is only one piece of it. You have labor, you have logistics costs, there's kind of a cocktail of things in there.

Right.

How should we think of 2Q as being kind of the high watermark of inflation for the year relative to the back-half? Like when does that peak or perhaps get a little easier?

Yes, the 2% figure I mentioned reflects total inflation in our business, which includes more than just materials. Regarding whether inflation has peaked, it's important to note that while inflation is rising, we are actively managing it. At this point, I wouldn't say it's peaked yet. There are some temporary spikes in costs, but it’s challenging to distinguish those from the underlying inflation trends. The honest answer is that we’re uncertain, but we will continue to manage proactively.

Got it. And then just in terms of the end markets or customer behaviors that are standing out. This recovery seems unusual in a few different ways, but are you guys seeing kind of the classic more CapEx-facing applications or industries bounce back or is it all just sort of in the mix together? Or anything you could sort of comment on that would be helpful.

What we're seeing this quarter is the start of what looks like a classic mid-cycle recovery. Our focus is primarily on mid-cycle and long-cycle businesses, and we're witnessing the initial signs of this recovery. In particular, our automation and engineered solutions sectors have shown strong mid-cycle performance, picking up earlier this year and maintaining that strength. Additionally, our power business experienced significant growth, with an impressive organic growth rate in the mid-30% range. This aligns with our expectations, starting with automation, followed by process and power sectors, and eventually, we anticipate a recovery in the commercial aerospace market in a year or two. While it's challenging to separate the typical cycle from customer behavior reacting to supply chain issues and the COVID rebound, I feel optimistic. The robust underlying demand suggests a lengthy recovery phase as part of a broader cycle, especially since there has been limited investment in the industrial sector over the past five years. We are well-positioned to capitalize on that investment. Beneath the COVID recovery, I see a classic cyclical recovery that aligns with our expectations for our businesses at this stage of the cycle. I hope that clarifies things for you.

Perfect, great color. Thanks, Dave.

Hi, good morning.

Good morning.

I just want to go back to your comment on the incremental investment into the business. Could you give us a little bit more color in terms of where that incremental investment is going, is it specific verticals or is it much more broad spread, just any additional color would be helpful?

Sure. As we said, we're putting about $100 million of incremental investment in our P&L. And that was raised about $5 million from the last quarter, so some new opportunities are coming up. And I'd put it in several areas. I mean we're investing in core product development. That's the future of our business, and we want to stay with the best benefits in our products with our customers. That's happening, that's about probably a third of that $100 million. And then the other two-thirds is in sales and marketing and our digitization effort. So, we're doing a lot of things to improve our customer-facing capability. We're doing a lot of things around digital marketing, our sales force effectiveness. And teams are motivated and is working well, and we've able to do continued investing during the depths of the virus, and we're accelerating now. So, it's $100 million, it's in product development, and it's in sales and marketing, but a lot of it is in the digital space.

Great. Could you provide some insights into the commercial aerospace market? I know there are many concerns regarding the Delta variant. Has this changed your perspective on the recovery of the MRO or the commercial aerospace market overall?

Great question. The commercial aerospace is about 7% of our portfolio now. And we're obviously watching that Delta variant very closely, because we're not sure exactly what's going to happen. We haven't seen a downturn yet from the Delta variant. And our commercial aerospace business had a very good quarter. I mean we were up 25% in commercial aerospace. Our aftermarket business and our business jet market were stronger than our OEM markets. And that business, for the year, we haven't changed our outlook for the year. For our whole aerospace and defense business, we're still staying up low-to-mid single digits, so we're not seeing the same kind of traction in that business right now, partially because the aftermarket is doing better than the OE business. But it's stabilized for sure, it's 7% of our business, and we're watching it closely with the Delta variant. I mean we haven't seen a change yet in passenger model, but that could happen. So, that's the best information I can give you.

Great. Thanks so much.

Thank you.

Thank you. Hi, Dave, Bill, and Kevin.

Good morning, Scott.

Good morning to you. So, I was just wondering, could you kind of quantify what the add-backs of the temporary reduction costs from last year were in the second quarter and maybe a feel for the second-half?

Yes, the best way I can answer is we talked about, last year; we had about $90 million in temporary costs that we removed from the P&L. Now we're at, fast-forward to the end of Q2, so about a month ago, they came in during the quarter. But by the end of the quarter they were pretty much all backend, except travel expenses. So there was about $10 million or $15 million of travel expenses. They're bleeding in slower than we anticipated earlier in the year, but largely all the expenses, besides travel, are back in the P&L.

So, correct me, if you would, on the math on that. So, we will see some add-backs in the third quarter and fourth quarter, but on a declining basis?

Yes, there will be additional costs because we will experience the full effects of the quarter, and there are also some challenges arising from our compensation system. We set budgets and targets for our compensation, and since we're having a successful year, that presents another challenge. Thus, we can expect some extra costs in the second half of the year that will have an effect.

Got it, thank you. Would you mind giving us, Dave, a sketch of what your research market looks like right now?

Yes, the research market is doing well. It's starting to pick up a bit. But that market is probably more impacted than the classic industrial market, because a lot of the research institutions were slow to start up. There's difficulty getting access to the facilities. So, the market is hanging in there, it's doing well. But it's certainly not inflecting up as much as in the general industrial markets.

Thank you. Lastly, regarding the acquisition pipeline, I understand you mentioned a $2 billion availability. What does that figure indicate about capacity, since you can potentially borrow more? More importantly, how does the quality of the pipeline look at this moment? In your last call, you mentioned the possibility of achieving something similar in the second half as you did in the first half. Could you provide an update on that thought? Thank you.

Yes, our teams are very active now, and we would like to finalize a deal between now and the end of the year, although there's no guarantee. There are many properties available in the market and a lot of activity, but finding the right opportunities that we can acquire and that will become part of the AMETEK portfolio is a different challenge. As we have mentioned before, our acquisition strategy is not limited by capital; instead, it focuses on identifying the right acquisitions. Our teams are performing excellently. Regarding our capacity to complete deals, I will have Bill provide further insights on that.

Yes. Thanks, Dave. Yes, certainly, you made the point, we could go borrow more, and our banks and others tell us they're more than happy to lend to us. That couple of billion dollars would still only give us a mid-twos kind of leverage. So, still you could even say somewhat underleveraged for the company. So, plenty of opportunity and plenty of resources available to us to do even more than the $2 billion, and I think as Dave mentioned, this isn't a capital-constrained strategy, this is finding the right businesses to fit with our portfolio that we think can generate value for our shareholders over the long-term.

Yes. Okay. Thank you, both.

Thank you, Scott.

Hi. Yes, good morning.

Good morning, Andrew.

Just a question, just putting a couple of things together, you've said you are adding to growth investments. And I know what it takes for AMETEK to sort of loosen its purse strings. You did talk about underinvestment among the industrials over the past five years. Looking forward, do you see structurally high need for CapEx over the next couple of years from your customers?

Yes, that could be the case. There may be a situation similar to the industrial recession of 2015-2016. We experienced a few years of solid growth after that, but then came the pandemic. Supply chains are currently under stress, and while companies are addressing immediate challenges, some capacity will likely be added. I believe this could be one of the results of the current economic cycle. We are quite optimistic about the industrial cycle at this moment. As I mentioned earlier, there is a bounce back from COVID, and it's challenging to separate that bounce from long-term growth. However, we are definitely noticing that customers are planning differently than just anticipating a temporary bounce.

Thank you. And then the follow-up question, I mean people ask me about Delta variant impact on aerospace, but I think there are also some headlines in Asia, people trying to figure out if Delta variant is having any impact on rate of growth in Asia, and China specifically. Could you just talk about what it is you're seeing in China, Asia, not only as end market, but also what are you hearing from your supply chain? Is Delta variant sort of something that you're tracking in that region? Thank you.

During the second quarter, we experienced a strong performance in Asia, with growth of about 30%. This growth was broad-based, with significant contributions from our automation and process instruments businesses. Specifically in China, we saw a growth rate of 27%, indicating that our process instrumentation businesses continue to perform well there. We're aware of the recent press reports regarding the situation in the region and are still operating all our plants. While we are facing some COVID-related challenges, they are similar to what we've been experiencing over the past few months, although there is potentially more spread occurring in China at the moment. We are monitoring the situation closely, but the growth in China remains robust, with a 27% increase in the quarter.

Really appreciate the answers. Great quarter, thanks a lot.

Thank you, Andrew.

Hi, thanks. Good morning, everyone.

Good morning, Jeff.

Just coming around to the deals and actually what you've done year-to-date, I think you were previously thinking about $0.18 or so accretion this year and a carryover benefit of $0.35 to $0.38 and into next year. Just wondering now that these assets are actually fully in-house and you're betting them down, does that outlook change much and does anything in particular stand out?

No, I think the same outlook. It's we haven't changed it at all. And we said, we get about $0.18 of benefit in 2021, and it's looking like that's going to be a good number for us.

Great. And then just coming back to kind of supply chains that, I'm sorry, I was on the call a few minutes late, but was there any place in the portfolio where you were unable to kind of meet demand or there was issues up and down the supply chain somewhere else where perhaps even you could deliver, but the customer didn't necessarily want it because of their own issues with deliverability and availability?

Yes. There were issues like that going on all over Jeff, but I'd say that in general, in the second quarter, our teams did an excellent job and we had the material and we had the labor and we had the execution to get out what we needed to. There are certainly challenges in that broader materials and logistics right now, our guidance reflects the known risks. These issues are going to be with us for some period of time. And we're managing the issue with dedicated business unit personnel. So, each business unit has a team on their supply chain, but we also have an overlay over company-wide resources or global sourcing team and they're doing an effective job right now. The big area of focus for us right now is on semiconductor chip availability. And we're looking at that very closely trying to do secure our supply chains. And you can end up with a situation where you think you have a firm delivery and the day comes from the delivery and it's not there. I think everybody in the industrial world is delivering with that right now. And it causes with me a game of Whac-A-Mole where you're scrambling to get your output out but our people did a good job in the second quarter. And there is an element of prudent judgment in our second-half guide. But our guidance reflects all of our known risks.

Great. I appreciate the perspective. Thanks a lot.

Thank you, Jeff.

Thanks. Good morning, Dave, Bill, and Kevin. So I just wanted to clarify Dave, I think you said June had the highest rate of year-over-year orders and sales organic growth. I would've thought the comps got steeper from April through June. So one just wanted to clarify and two what's implied there if you're accelerating on steeper comps.

Yes. I may have said the wrong thing if I said acceleration of the orders, both orders and sales grew sequentially every month, but June being the strongest month of the quarter. So, that doesn't mean that they're ready to change; accelerated, that means that June was higher than May, May was higher than April, for both orders, and we had a very strong trend in July also.

Okay. Thanks. I might've heard you right. And then just wanting to go into your advanced motion controls, motion solutions, you talked about front end investment there. I'm curious what you're seeing in terms of the types of automation architectures. There are changes going there. Is that coming your way in particular, had increasing front end competitiveness, just curious kind of panoramic of that automation space?

Yes. A lot of what we're doing is discrete automation and we've also done some factory automation and we've invested heavily over the past few years. So position our product portfolio and our capability at the top of the market, and we're benefiting from it now because as customers ramp up, our automation technology is helping them better serve their customer bases and the demand has been strong for many quarters. And we don't expect that to change.

Okay. Thank you.

Welcome.

Thanks. Good morning, everybody.

Good morning, Rob.

So I actually also had a question just on the comments on industrial investment in CapEx, etcetera. I'm a little bit curious if you flush it out. Are you hearing the desire to spend coming back from your customers? There may be some technology changes that are encouraging automation, localization and so forth. And I'm just curious if that's kind of where you think things will go based on what you're hearing. And then just maybe a comment on breadth of industry, I don't know if that's focused a little bit more on pharma and medical or wide across the businesses, do you have an insight into. Thank you. Bye.

Yes, the first point is I think localization of manufacturing and people developing more durable supply chains is definitely one of the drivers of the demand we're seeing. What was your second question Rob? It was the.

Well, so whether technology changes are also doing it and then breadth of portfolio.

Breadth of portfolio, so again, the first part of the question, we're definitely seeing localization drive demand. Those people look for more durable, more local supply chains. What we're really seeing it, if you go through our portfolio, look let's start with our process businesses with our largest business. It grew mid-20s organic during the quarter. Really strong levels demand essentially all MRs, leading to really robust sales and orders. Our growth was particularly strong in one of our instrumentation businesses called our ultra-precision technology business that had a great quarter and they're benefiting from a metrology measurement technology related to automation. And you think about the power and industrial business, that business was up 30% organic in the quarter. The businesses that did well there, both segments power and industrial and particularly strong growth in our Brookfield business and our business. Again, that was broad-based. And the power and industrial business was kind of one of the laggers on orders to pick up. And we were really pleased to see that. And then we talked about our automation and engineer solutions business. They were up low-20s organic and that's been strong for a period of time with a robust and strong demand continuing. So, all of those are strong. Our aerospace and defense business had a really good quarter. The sales were up high teens on a percentage basis versus the prior year. So this is about 19% of our portfolio. Organic sales were up high teens on a percentage basis, a solid growth across all segments. As I mentioned as an answer to Allison's question earlier, our commercial business was up 25% and our defense business was up about 10%. And for all the 21 that business, we're still not changing. We're continuing to expect low-to-mid single digit organic growth. So if I pulled the aerospace and defense business outside of the portfolio, I'd say that's the one that's, it's bottomed and it's doing well. But we're still looking at that commercial OEM business and watching it bottom, but everything else besides that is showing an uptrend.

Great, thank you.

Thank you, Rob.

Hey, guys, good morning.

Good morning, Joe.

Yes. I was interested in the growth investments, the $100 million and you talked about like, two thirds of it going towards like the sales and marketing and digital aspects of your business. Are you seeing kind of coming out of COVID just given like the kind of bespoke nature of your products and like specialized nature of your products? Is there like a fundamental change in how you sell these? Like, is it going to be, you finding it easier to do it digitally and less like in-person and it just kind of like see change in how you do business going forward?

I think there is a change Joe, and I think that digital transformation is impacting all elements of our business, and we have these different niche of businesses, but some of the technology and the sales and marketing functions applies to all of them. So from digital marketing to e-commerce to augmented reality use to a demo and service our products to the efficiency we're getting out of automating routine clerical tasks and remote process improvement. There's a lot of things going into the digital plans that we have, the digital transformation. So we have and they do impact all of our businesses. And it's kind of a theme across all of our independent niches. So we're focused a lot on improving the business in that area. And we did learn a lot during the pandemic downturn and or taking what we learned and we're making it better and we're institutionalizing some of our best practices.

And then, just a follow-up, in your Asia businesses, at least on the margins more recently, have you seen anything that kind of reflects the macro data, at least in China getting a little weaker here? Are you seeing anything like on the margins that that kind of mirror that, are you kind of changing the way you're operating there a little bit to kind of get ahead of that?

Yes, we're not changing anything yet. And we're not seeing a downturn. But China has been very strong, they were one of the first economies out of the pandemic. So we're looking at it closely. And as I mentioned, our growth was up about 27%. It remains strong, and we have strong quotation activity. I've seen all the reports about the Chinese economy slowing down, and there's probably some of that going on. But in our particular niches where we're playing, we have notable strength.

Thanks guys.

Okay, thank you.

Thank you. Good morning, everyone.

Good morning, Deane.

Hey, just in terms of some of the second-half dynamics, on some of the temporary costs coming back in, as well as higher incentive compensation, what does that do for expectations on incrementals?

Yes, I believe the core incrementals for the year are 35%. However, in the second half, we will see some costs return to the P&L, which may slightly decrease margins. This is accounted for in our guidance. Additionally, the acquisitions are margin dilutive and we are experiencing a resurgence of temporary costs in our cost structure. We are also being cautious in our guidance regarding supply chain dynamics. As you may recall, Deane, we faced a challenging comparison in Q4, where our EBITDA margins exceeded 30%. Therefore, we expect some margin dilution in the second half as we work through the one-time costs associated with the acquisitions. The temporary costs we mentioned will be returning, but all of this is reflected in our guidance.

That's very helpful. And Dave, I think the key question that everyone would love to hear your comments on the supply chain challenges and you said, you expected to last for some period of time, just from what you're seeing today, across your businesses, how do you think this plays out, is this a multiple quarter, is it carry in to 2022, you're handling it well on price costs. But just your expectation here, how long these conditions last?

That's a great question, Deane, I think the semiconductor element of it can last longer, so that can go out to two, three, four quarters as capacity gets put in place. Not specific to semiconductor, but to broader supply chain challenges. Yes, I can see those moderating in a couple of quarters. But semiconductor could last a little bit longer.

And are you carrying any more buffer inventory in your businesses just to kind of protect yourself from the surprises about, you expected the delivery, and it's not there. But is that and are we seeing that in the working capital?

Yes, the working capital was down about more than 500 basis points, but actually embedded in that was about $50 million more in inventory. So, we've allowed the operating teams guide and secure the parts that they need, and we're certainly not scrimping in that area. But at the same time, it's tough. They get the parts that you need. So we're managing it closely and as I said, we have a good team, both within our local business units combined with our corporate oversight, we're getting good results. But that is a big challenge for us right now.

That's all good to hear. Thank you.

Thank you.

Hey, good morning, guys. It's Ken Newman on for Steve.

Hey, Ken good to hear you.

Thanks. I just wanted to touch back on the semiconductor market comments you just made. Can you just remind us how big that market is for you today? And I'm curious if you just talk to the outlook for the sub sector in terms of capital investments from your customers?

I'll do that, Ken. But I want to be clear, what I was talking about was the semiconductor chips that are supplied to AMETEK, when I was talking about the supply chain tightness, but the semiconductor market is an important market for AMETEK. So we do participate in it from the viewpoint of sales and it's about 6% of our business. So, little under $300 million and we're seeing some solid growth there because we participate both in the research market and the ramp in chip production and application areas we're seeing particular strength would be the EUV optics market, the semiconductor research market, our businesses named CAMECA and ZYGO are doing quite well there and we expect our semiconductor sales to be up in the mid-teen 20% level this year.

Understood. And then, just touching back on the incremental R&D investments for new product development for the year, can you give us some color on where your Vitality Index has trended through the quarter? And I'm just curious if you have any thoughts on how are you seeing that, how you see that the Vitality Index change as these new investments start to monetize?

Yes, our Vitality Index in the quarter was a little better than 23%. So it was a good number. And we have to get our system put in place with some of these acquisitions that we've done. So there's the tracking systems that we put in place aren't in all the acquisitions yet. So we can't look at those businesses the same way we look at our current businesses, but in general, we have a strong vitality, we have a number in the low 20s, we're happy. And we think there's good opportunities for our businesses, and we're funding them and it's a big area for us is important for us as they get our product development teams, working together, introducing new products, because that's fundamental for both the AMETEK pricing story to be able to stay in front of inflation and also growing organic growth in the niche markets that we're leaders in. So it's really important to us.

Thanks for the color.

Thank you, Ken.

Thank you, Michelle. Thank you everyone for joining our call today. Have a wonderful day.