Idex Corporation (IEX) — Q1 2017 Earnings Call Transcript

Great. Thank you, Brenda. Good morning, everyone. This is Mike Yates, Vice President and Chief Accounting Officer for IDEX Corporation. Thank you for joining us for a discussion of the IDEX first quarter financial highlights. Last night, we issued a press release outlining our company’s financial and operating performance for the three-month period ending March 31, 2017. The press release, along with the presentation slides to be used during today’s webcast can be accessed on our company’s website at www.idexcorp.com. Joining me today is Andy Silvernail, our Chairman and CEO; and Bill Grogan, our Chief Financial Officer. The format for our call today is as follows. We will begin with Andy providing an overview of the first quarter financial results and an update on what we have seen in the world. He will then walk you through the operating performance at each of our segments, and finally, we will wrap up with an outlook for the second quarter and full year 2017. Following the prepared remarks, we will open the call for your questions. If you should need to exit the call for any reason, you may access a complete replay beginning approximately two hours after the call concludes by dialing the toll-free number 877-660-6853 and entering conference ID 13652253, or you may simply log on to the company’s home page for the webcast replay. As we begin, a brief reminder. This call may contain certain forward-looking statements that are subject to the Safe Harbor language in today’s press release and in IDEX’s filings with the Securities and Exchange Commission. With that, I’ll turn the call over to our Chairman and CEO, Andy Silvernail.

Thanks, Mike. Good morning, everybody. I appreciate you joining us here for our first quarter conference call. Obviously, I am pleased with the results here for the quarter. It’s the first time in literally two years that we have had this kind of strong organic revenue growth, and we did see improvement overall throughout our businesses and the team is executing extremely well. As you know, we have been talking here for some time about the difficult market conditions, specifically in our industrial and energy markets. I have been very pleased with how our teams have tackled this over the last couple of years in this industrial recession. They have faced these pressures, delivered good results in the face of the challenges, and we are starting to see some recovery. In the first quarter, we saw evidence of this, really starting in the third quarter of last year, we started to see a little bit of rebound in the late part of the third quarter, particularly in the North American industrial markets. The improvements that we saw in the first quarter were broad-based across most of our markets. This, on the industrial side, has been coupled with the continued strength in our life sciences and scientific businesses, and with all this coming together, we have a more favorable outlook for the balance of the year. I am going to talk in depth here in a few minutes about what we are seeing inside our businesses, but before that, I thought I would take a look at what's going on in the markets and the regions. For the first quarter, we had a really clear view of what we can deliver when you combine our ability to execute with some improved market conditions. We had organic revenue growth that was up 5%, driven by outstanding execution in FMT, which was up 6% organically and HST, which was up 5%, and both of these delivered robust order growth as well. We had 5% organic order growth at FMT and 8% organic order growth at HST. FSD presented a somewhat different picture. We had 1% organic revenue growth. We had orders down 11% on an organic basis, but sifting through this, it's really due to some tough comparisons and the movement of some things late in the first quarter into the second quarter. Overall, with FSD, we have no real concerns regarding the underlying order pattern. So, obviously, we are optimistic. We do remain a little bit cautious, and I'm going to talk about that in a second. Some of the things that I think are out there that we just need to be mindful of. But our teams did a great job in the quarter. Overall, organic order growth was up 2%, and organic revenue growth was up 5%, as I mentioned. Operating margin was at 21.8%, which was up 120 basis points. Adjusted EPS was $1.03 which was up $0.14 or 16%. Cash flow was up 21% to $75 million, and importantly, we did build $15 million of backlog in the quarter. Also in the quarter, we incurred about $5 million in restructuring costs, mainly around site consolidation, and this is all in support of the strategies that we have outlined about building scale in our businesses and driving long-term competitive advantage. Our balance sheet is in great shape. We ended the quarter at about 1.7 times gross leverage and have very strong free cash flow. Taking a look at what's going on in the market and regions around the world, first on the industrial side. The industrial markets have improved across our regions. Importantly, in North American industrial distribution, we had strength in the fourth quarter that has continued throughout the first quarter, marking the first sustained rebound that we have seen in some time. Energy remains somewhat mixed. Upstream has been good, and we see that in our Band-It sealing business, but that’s a pretty small part of our overall business. The midstream has remained pretty muted. We see strength in aviation and our mobile business, but overall, as you look at truck builds, those are down due to a very warm winter, which has impacted the market. Agriculture began to show signs of recovery at the end of last year, and while that recovery will be slow, the signs are positive. In scientific fluidics and life sciences generally, we experienced continued strength in IVD, bioanalytical instrumentation, and optics. Finally, in municipal markets, trends have remained relatively steady. Regarding regions, North America led the recovery with strength across most businesses and markets. Conditions in Europe have also improved significantly, particularly in the auto and housing sectors, and we haven't seen any negative impacts from Brexit. In Asia, the good story we've had in India has continued, and we saw some positive turns in China. This all adds up to some good news and a more positive outlook certainly than we have had in some time. However, I want to share a word of caution. While we are happy with the broad-based improvements in the markets and our team's execution, I am cautious about the overall outlook. My personal view is that financial and M&A markets have priced in a lot of good news. Confidence levels have risen, driven by low interest rates, and particularly so up until the last week or so, with respect to the policy improvements in the U.S. concerning tax reforms or infrastructure spending. I don’t think many of the risks have been fully accounted for regarding potential issues that could impact demand. It’s important to acknowledge the political conflict, policy gridlock in the U.S., or the unpredictability surrounding U.S. domestic and foreign policy. I mention this not because we have control over these factors, as we are certainly not experts, but it introduces volatility. As we look toward the back half of the year, it’s challenging to grasp major impacts that could arise. While I am pleased with the start of 2017, I believe we have to be mindful about getting ahead of ourselves, and our focus remains on controlling what we can. In terms of capital deployment, it’s a crucial part of our overall strategy, focusing on long-term organic growth investments, disciplined M&A, consistent dividends, and opportunistic share repurchases. We believe that we have significantly outperformed our markets during this quarter and throughout the industrial recession by committing to investing for long-term organic growth. That commitment will not change. We believe superior organic growth is the key value driver for our company, and we will continue to invest in strategic projects and personnel. The investment series we discussed in detail during our last call has begun, and we are committed to ensuring we are making those investments moving forward. Let me turn to the first quarter results. Revenue in the quarter was $544 million, which was up 10% in total and up 5% organically. As I mentioned, it was driven by 6% and 5% organic growth in FMT and HST, respectively. It's worth mentioning that this is the first time we have seen organic revenue growth since the end of 2014, which I am very pleased about. Orders were up 8% at $569 million, 2% organically. FMT was up 5%, while HST was up 8%. The underlying businesses maintained strong order rates as we moved into the second quarter. Furthermore, we built $15 million of backlog in the quarter. The team did an excellent job of executing, and March was particularly strong for us. You have seen the flow-through to the bottom line reflecting those efforts. When adjusting for $5 million in restructuring costs, the operating margin was at 21.8%, up 120 basis points. Cash flow was a great story, up 21% to $75 million. Net income was also strong, reflecting $75 million or $0.99 on a GAAP basis, and $1.03 on an adjusted basis. Now let’s look at the different segments. Starting with fluid metering, FMT had an excellent quarter with sales and orders up 5% and 6%, respectively. When adjusted for $1.6 million in restructuring, the operating margin was up 300 basis points in the quarter. Water continues to be a strong story, with solid municipal and industrial market trends. We are seeing seasonal factors pointing toward a strong second quarter. The development of new products has been among the best in the company. For industrial fluids, all trends I discussed previously have positively impacted this business, especially the increases in North American distribution and an uptick in upstream oil and gas, albeit a smaller contribution. Overall, our energy sector has seen improvements in aviation projects and solid mobile markets, particularly around LPG, though we expect that market to remain soft for now. Agriculture has begun to show decent improvement, which we interpret as a positive sign moving forward. Regarding health and science, similar strength was observed in this sector with organic orders up 8% and revenue up 5%. The margin increase is primarily reflected in a strong performance from life sciences and optics segments, which continue to solidify our offerings in analytical instrumentation and bio IVD markets. In summary, I am pleased with our progress, though awareness of current market volatility remains vital as we move through this year. Looking ahead, for the second quarter, we estimate EPS in the range of $1.04 to $1.06, with revenue up 2% to 3% year-over-year and operating margins around 21.5%. Our full-year guidance reflects increases in our growth rate expectations to 3% to 4% and operating margins of about 21.5%. Based on our performance thus far, we believe there will be a slight impact from foreign exchange rates this year. Corporate costs are anticipated to be around $66 million, and we maintain a robust outlook for free cash flow conversion around 120%. As always, our guidance excludes any impacts from potential acquisitions or restructuring activities as we move throughout the remainder of the year.

This is Katya for Scott Graham. Could you discuss a little bit about what pricing for the company in the first quarter was?

You know, we were very consistent, Katya, with what we have seen here in the past, which is about a point. So not a big deviation from what we have seen, and so it’s pretty consistent with prior trends.

And what about the inflation offset?

Actually, we haven't seen a lot of inflation yet. I will note that obviously around some of the commodities have started to inch up. We do expect that inflation will become a larger issue as we progress through the year. Our planning has accounted for this and we are mindful of the potential increases in commodity prices with the optimistic outlook. Bill, anything you would add on that?

As we continue to monitor inflation, we look for opportunities to pass on the cost.

Yes, this is very high on our list, Katya, making sure we don’t get behind the inflation curve if that starts to pick up. Our expectation is it will, right, so this is very much a priority for us.

One more question, sorry about that. Can you discuss why corporate expenses look lower for the rest of the year?

No, it's pretty consistent. It is not meaningfully different from what we have talked about in the past. It's around $16 million to $16.5 million in the quarter, plus or minus.

This is Adam Farley on for Nathan. First question is on North American industrial. You called out in the press release that there was some improvement in larger capital projects. What markets are driving this improvement specifically related to those larger capital projects?

It's actually pretty broad-based. Energy is a place that we have seen more of it, specifically upstream energy. We haven't started seeing it in the midstream yet, so to speak. You’re starting to see it. To be clear, it's not huge capital investment; it’s larger projects beginning to move through the pipeline.

Turning to gross margins. What are the sources of gross margin improvement? Is it COGS reduction, value pricing, maybe new product releases, or all of the above?

It's actually all of the above. Pricing is about what we expected it to be, plus or minus. I mentioned when Katya asked, it's a point. The math is actually a little bit less than a point in the first quarter, but that’s about what we expected. You’re getting some of the volume leverage in our business, specifically FMT; you get a lot of volume leverage. These are very high contribution margin businesses, so you’re seeing improvements there. The work we've done around segmenting our portfolio and specifically our fixed businesses is yielding more overall leverage than we have had in the past.

First on sustainability here. The confidence levels seem much higher, Andy, based on what you have seen over the last couple of quarters, three quarters in a row of positive organic orders. Can you discuss how much you think is inventory replenishment, and how much is going directly to end market demand? The broad-based project activity seems favorable for sustainability, but anything underneath there?

This is a strong question. March was really good. January started well too, though February was muted. My cautionary tone in earlier prepared comments comes from seeing spottiness in our order book. So, I'm mindful of that. March was strong in terms of orders and our ability to execute. The improvements we saw were broad-based; it's not a singular market, and our life sciences businesses have performed well. Overall, I think it’s more market demand-driven rather than inventory-related.

On the margin side, historically we have always talked about organic revenue acceleration correlating with that drop-through for you guys. You put in a nice drop in the quarter. Moving forward, how are you expecting the margins? Was there something in the first quarter besides mix that might not be repeatable?

We're only about 30 bps off from what we discussed for the year. It's not a big number. We experienced favorable mix in FMT this quarter, which seems to have positively impacted margins. We do think we’ve made a step toward more sustainable margins, but we had favorable mix in FMT this quarter. Overall, I would expect operating margins around 21.5%; I am comfortable with that.

This is actually Patrick standing in for Charles. I wanted to touch on growth investments. I think last quarter you mentioned top-line investments at around 11%, which was a headwind on the bottom line. How much of that has been realized in the first quarter, and how should we think about its progression from management's viewpoint?

We are right on track. The planned spending for the first quarter has occurred as expected. I don’t foresee any surprises there. A favorable environment can prompt additional investments, so if these performance levels sustain, I expect some further investments, though not large ones.

Can you discuss some of the new product rollouts you guys have done or will be doing following the first quarter?

Yes. It's pretty broad-based. In our new product offerings, we have launched significant innovations in conjunction with our customers in scientific fluidics. These efforts took years to develop, so we are poised for returns in '17. We've got new products in our water business and upcoming releases in dispensing with the next-generation X-Smart, which is set to move into more competitive market segments.

What is the order rate for the early days of April compared to March?

Orders have been in line with our expectations in April. March was stronger than we had anticipated, but February was softer, so there remains volatility in our order patterns, though the tone is more positive.

Regarding orders in FST, were any large projects pushed into Q2?

Yes, some have been pushed based on customer readiness. It's not a concern; it's typical timing. The ongoing nature is manageable.

Could you return to the margin question? You mentioned a favorable mix in FMT for Q1. How should we consider that moving forward as well as the specific verticals that drove that mix?

I don’t know that it will maintain that level for the year. Some of it relates to expectations. Agriculture was stronger than anticipated, which was favorable. We have various brands with higher contribution margins. The balance of the year will depend on maintaining strategic mix.

You mentioned your concerns about sustainability in recovery. Are there any specific markets you're particularly worried about?

I wouldn't pinpoint any specific market right now. However, I view industry trends as still being in the early stages of recovery. We are literally six months out of a challenging industrial recession, and while the tone is better, I approach business with prudence given the persistent volatility. Regarding FMT and water, you highlighted new products and strong order growth. Is there a way to separate our performance by new products versus market growth? I believe so. If we target approximately 3% to 4% growth this year and add 1% to 2% for our new products, I think that's reasonable to anticipate, assuming market performance stays steady.

Starting with HST, could you provide additional context around order growth? What drove the inflection to the 8% increase? Was it due to sealing, life sciences, or MPT?

The industrial side had decent performance. Most strength came from sealing, followed by scientific fluidics and optics. Sealing was the strongest grower in the quarter, which affected mix negatively.

Could we discuss the advancements driving the strong performance in fluidics and optics in 2017 and 2018?

The main storyline is our capacity to deliver an improved fluidic system to various customers, specifically in IVD and bioanalytical instrumentation. We're expanding our market share driven by high-quality performance, integrating optics and fluidics, which was a primary goal of our merger years ago.

Was a large MPT order from Q4 shipped in the first quarter? How much of the growth can be attributed to that?

Most of that order will ship in the second quarter.

Can you elaborate on what you are seeing in the fire business, specifically comparing suppression versus safety, and provide some geographic insight? I know certain regions were more challenged before.

The Akron integration has gone well, surpassing expectations with considerable improvements on several fronts, such as product and channel structure. Our thesis emphasized integrating high-value components into fire trucks, and electronics are increasingly significant. The Chinese business has improved as tenders held off have been released, and we have won several tenders against competition.

Regarding FMT, you noted a margin improvement. Is that adjustment due to significant volume? What would be an appropriate band for margins on that business moving forward?

Yes, I would suggest maintaining margins around the 26% to 27% range for FMT, which seems to be the consistent level under normal circumstances.

Returning to the 2017 guide, you have raised the organic growth forecast while maintaining margin estimates. Is it surprising not to see better leverage there? Where are the volume-based incrementals projected for 2017?

It's difficult to specifically separate the new investments from what we expect in terms of leverage. Generally, we observe that the flows we've anticipated align well with what we’ve expected over time.

Regarding energy commentary, can you describe order flow entering April?

You have to break that down a little; upstream has been strong across various segments, but midstream remains muted as we anticipate softer performance in the LPG market.

Looking ahead, will the recent lumpiness be evident in both orders and sales moving forward?

Exactly. You will see order lumpiness hitting us while in sales, we will see gaps into the second quarter, shaping expectations accordingly.

Could you clarify the margin improvements in FMT specifically? How is product activity benefiting margins overall?

The modalities are blended; approximately two-thirds of the 300 bps improvement stems from top-line volume leverage and mix, one-third resulting from productivity factors. Margins remain susceptible to price and mix variations as products differ.

As we approach the latter part of 2017, can you discuss anticipated performance across your operating segments?

The most significant question is how the North American industrial markets perform; they are the primary areas for growth and have shown favorable trends. We expect continued strong performance, but it remains crucial to stay aware of potential volatility as we approach year-end.

Thank you all for joining us for our first quarter conference call. I am very proud of how our teams have executed despite headwinds for the past couple of years. We see improvement in the outlook, evidenced by our revised guidance, yet it is prudent not to get overconfident. Our commitment lies in delivering for shareholders while managing carefully for potential volatility. Thank you for your continued support, and we look forward to speaking with you again in 90 days. Take care.