Idex Corporation (IEX) — Q2 2017 Earnings Call Transcript

Thank you, Doug. Good morning, everyone. This is Mike Yates, Vice President and Chief Accounting Officer for IDEX Corporation. Thank you for joining us for our discussion of the IDEX second quarter financial highlights. Last night, we issued a press release outlining our company's financial and operating performance for the three-month period ending June 30, 2017. Later today, we will file our 10-Q for the same period. The press release and 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 second quarter financial results and an update on our markets and geographies. He'll then walk you through the operating performance of each of our segments. Finally, we will wrap up with an outlook for the third quarter and full-year 2017. Following our prepared remarks, we'll then 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 the conference ID 13652252, or you may simply log on to the company's homepage for the webcast replay. As we begin, a brief reminder. This call may contain certain forward-looking statements that are subject to Safe Harbor language in today's press release and in IDEX's filings with the Securities and Exchange Commission. With that, I'll now turn the call over to our Chairman and CEO, Andy Silvernail.

Thanks, Mike. Good morning, everybody. Thank you for joining us here in our second quarter conference call. Look, the first and second quarters were very positive, and they have produced strong results here in the first half of the year. I'm pleased with the way the team continues to capitalize on the rebounding economy and successfully execute our growth strategy, setting us up for what we think is going to be mid-single-digit organic growth here for all of 2017. In the second quarter, we had pretty broad-based overall performance. There are only a couple of pockets that were soft. But really, as we think about the strength so far in our businesses and the sustained economic outlook, we think the operating results for the balance of the year are going to be very solid. As I mentioned, there are a few pockets of weakness in our portfolio, primarily around Midstream Energy. We've discussed this quite a bit in the last couple of calls where the midstream really lagged the improvement in upstream. We have seen continued improvement in the upstream, but the midstream is still soft. However, I will say that there's some evidence of a bottoming, and we're prepared for the market here to improve in the second half of the year. I'll provide more details as I walk through the markets and the segments. But overall, it was a strong quarter and we're very pleased with the results for the first half. Orders were really strong in all three segments. They were up 11% overall, 9% organically. HST delivered organic order growth of 11%, FMT had organic order growth of 9%, and FSD had organic growth of 7%. So all three segments are really showing nice order progress. We also built $12 million of backlog in the second quarter. For those of you who have known the story for a long time, you'll know that this is not typical for us. Typically, we burn our backlog in the second quarter, so this sets us up well here going into the second half. Organic revenue was up 3%, driven by HST, which was up 6% organically, and FMT, which was up 4% organically. FSD was down 1% organically in terms of sales for the quarter, but that was really entirely due to a project delay in the North American dispensing market. We did see a nice ratable increase in sales and orders throughout the quarter, and it's what we like to see as we moved through the quarter, and we saw that strength from April to May to June. Flow through was 36.8% when we adjusted for the $2.6 million of net charges compared to the prior year. The teams did an excellent job in the second quarter, and we saw that in the results. As I mentioned, organic orders and sales were up 9% and 3%, respectively. Operating margin was 21.8%, which was up 110 basis points. EPS was $1.08, which was up $0.09 or 9% for the quarter, and free cash flow was $78 million. We increased our gross margin by 40 basis points to 44.8%. However, if we back out the $3.6 million of fair value inventory step-up compared to the prior period, it was down about 30 basis points. This was due to some increased investments in engineering that we had in the quarter, primarily around accelerating growth and some pockets of inefficiencies in our supply chain, which I'll discuss in a few moments. We also increased our quarterly dividend by 9% to $0.37 in the second quarter. Let me take a minute here and, as I usually do, talk about what we're seeing in our markets and in regions around the world. Industrial distribution continues to be steady. We see continuous signs of recovery in all markets around the globe. Energy, as I mentioned, was a mixed bag. Upstream is strong, specifically in our BAND-IT and Sealing businesses. But for FMT, in the midstream applications, it has generally lagged. As I said, I think we're seeing a bottom, and I believe we'll see some improvement here in the second half. Agriculture has been a positive story, with our Banjo business being strong and up double-digits, indicating a significant recovery. Life sciences – Scientific Fluidics and Optics continues to be a market stronghold for us. We've noted many times that there is a healthy product cycle moving through that industry, and we are benefiting from it. Semicon has also been strong, and we're gaining market share there. Municipal end markets in both Water and Fire remain positive. If we turn to the regional look: North America is continuing its recovery, regardless of the political silliness we are currently witnessing in the U.S. We've seen strength in various markets including transportation, semicon, industrial distribution, agriculture, life sciences, and upstream oil and gas. Europe continues to improve, despite some pressures from the strengthening U.S. dollar; core markets are performing well. The same can be said for Asia, where there have been some setbacks in India due to changes in tax laws, but we believe this is a short-term challenge that we will benefit from in the future. A few comments on capital deployment before I move into the operating results and segment discussions: Our strategy remains constant. We prioritize long-term organic growth, disciplined M&A, consistent dividends, and opportunistic share repurchases. On the organic growth side, you're seeing the benefits of those investments. The teams have executed our strategies around targeted growth and new product development very effectively, leading to strong organic growth in orders for the first half of the year, and we expect this to continue into the second half. As for dividends, we increased our dividend by 9% to $0.37 quarterly in April. During share repurchases, we bought back about $2 million of stock in the quarter, involving 24,000 shares. We view share repurchases as a tool for driving long-term shareholder value when the timing is right. As for M&A opportunities, our funnel remains robust, having actually improved a bit in the second quarter. We're actively seeking and executing deals that would enhance long-term shareholder value. Our financial position remains strong. We paid off our U.S. revolver in the second quarter. Our debt-to-cap ratio stands at 28%, while our net leverage is 1.2 times and gross leverage is 1.5 times. This strong balance sheet, combined with robust cash flows, places us in a very favorable position regarding capital deployment. Let's shift gears and discuss the financial results. In Q2, our revenue amounted to $573 million, up 4% overall and 3% organically, driven by HST, which was up 6%, and FMT, up 4%. Orders were $586 million, also reflecting an 11% increase overall and 9% organically. Every segment delivered organic order growth: HST up 11%, FMT up 9%, FSD up 7%. Q2 net income was $84 million or $1.08 per share, up $0.09 or 9% from the previous year. As noted in January, we are committed to making growth investments in new product development and funding our growth initiatives globally. For the first half of the year, our engineering spend—which covers all aspects of engineering including R&D and applications engineering—was up 14% year-over-year. Our operating margin stood at 21.8% for the quarter, up 110 basis points, driven by volume leverage, benefits from our prior restructuring, and a $2.6 million cost from last year that we did not experience this year. Free cash flow totaled $78 million, which is 93% of net income; this was slightly down from Q2 of last year, primarily due to increased tax payments and higher working capital as we experienced growth, although our capital efficiency remains strong. We also had increased CapEx. Remember that on a year-to-date basis, our free cash flow is up 8% year-over-year. Now let's proceed to segment discussions, starting with Fluid & Metering. In Q2, FMT enjoyed a solid quarter, with organic orders and sales up 9% and 4%, respectively. Operating margins improved by 270 basis points due to volume leverage from organic growth, restructuring savings, and lower amortization. The water business remains resilient, showing strength in U.S. municipal markets. Although sales on an apples-to-apples basis improved, reported figures demonstrated a slight decline due to previous divestitures. The team has excelled in new product development, bolstering organic growth success. In industrial fluids, our pump businesses, notably Viking and Warren Rupp, recorded strong double-digit year-over-year increases. Our targeted growth initiatives around LACT skids in upstream oil and gas continue to perform exceptionally well, and the industrial markets are generally stable. The Valves business is improving. Energy, as previously mentioned, has been mixed. While we observe some weakness in the LPG mobile market, we believe we are approaching a bottom and expect improvement in the second half. Our aviation project funnel is strong, positioning us well as we approach the back half of 2017. The agricultural landscape looks promising, with strong global demand projected to continue leading to double-digit orders and sales growth. Now let’s talk about Health & Science. Similar to FMT, HST achieved two robust quarters of organic order growth, which was up 11% in the quarter, while sales rose 6% over the previous year. Operating margins increased by 60 basis points, primarily due to restructuring activities and higher volume. Our Life Science and Optics businesses—Fluids and Optics—are flourishing across major markets such as AI, Bio IVD, and DNA sequencing. The healthy product pipeline expected to come into the market suggests that our share gains will continue across most platforms, which is promising. In our Sealing business, we are experiencing record production levels at our Blackburn facility in England, with organic orders and revenues both up double digits. The SFC acquisition is exceeding our plans and is ahead of our original projections. The semicon market remains strong, as does our investment in the new facility in Texas. The heavy-equipment market is also showing improvement. HST industrial overall has been stable, with strength noted in pharma and nutrition within Material Process technology. Although we encountered some operational inefficiencies due to our site consolidation this quarter, we anticipate rectifying that through the third quarter and positioning ourselves for growth. Regarding the Diversified segment, organic orders rose 7% in the quarter. However, organic sales dipped 1% due to a project delay in dispensing. Operating margins increased by 80 basis points, driven by the inventory step-up for Akron Brass, partly offset by margin dilution from prior year acquisitions. Concerning the dispensing section, we had a significant order from the previous quarter that was delayed, so we did not recognize that in Q2. Additionally, we noted that the X-SMART product has started to plateau after being extremely successful. We are confident that the upcoming new product initiatives in the second half of the year will help us accelerate growth within this platform. The Asian and European dispensing markets are also performing better than anticipated, though we do see some foreign exchange impacts. In Fire & Safety, we achieved excellent results in rescue tools and fire pumps, enjoying another strong quarter. The OEM and municipal markets were solid, and we are gaining market share. Furthermore, the European market is showing signs of recovery. In terms of Akron Brass and AWG, we successfully continue to work towards our goal of delivering a 500 basis point margin improvement. Lastly, for BAND-IT, we had a great quarter. We witnessed recovery in energy and have continued to gain market share. Now, I’ll provide an update for Q3 and full-year guidance. For Q3, we think EPS will be between $1.04 and $1.06. We expect organic revenue growth to be around 6% with operating margins of approximately 21.8%. The Q3 tax rate is expected to be about 26.5%. For foreign exchange, we anticipate a flat impact for the quarter, while corporate costs should be around $17 million. Looking at the full year, based on the first half performance, strength of our Q2 order intake and a solid overall rebound in the markets, we're adjusting our full-year guidance. Previously at $4 to $4.10, we are now raising it to $4.18 to $4.23. We are also increasing our full-year organic revenue expectations to 5%, with the operational margins reaching about 21.8%. We expect FX to present less than a 1% headwind for the year, with corporate costs estimating around $68 million and projecting free cash flow at about 120% of net income. Lastly, I want to clarify that we have yet to include the effects of any future acquisitions or potential restructuring costs that may arise. With that, let me pause, Doug, operator, and turn it back over to you to open the floor for questions.

Hi, guys. Good morning.

Hey, Allison.

Andy, I want to talk—you mentioned quite a bit of market share gains driving some of the order acceleration across segments, and you guys have done a lot of investing over the years to get to this point. Is there any way to help us understand—in terms of market share gains—are they at 1% or 2% above market? Any generalization or color that you can provide?

Yeah. We actually did some deeper analysis than we have in the past in preparation for this call, anticipating that this would be a topic of interest. From an order perspective, we've broken it down along our major businesses. What we estimate is that about half of what we're seeing in order growth is coming from the market, and about half is attributable to discrete wins that we can clearly identify. There are some significant wins around Life Sciences in Scientific Fluidics & Optics and others related to Viking and our LACT skids investment, as well as our Water businesses. So while there are noticeable big wins, much of it is smaller wins combined that accumulate to considerable numbers. So currently, we perceive that roughly half of our 9% organic order growth stems from market improvement, with the other half derived from specific initiatives.

That's great. As I look at the segment margins relative to your overall corporate margin targets for the outlook, are there any mix issues—outside of volume—that we should be concerned about as we conduct our modeling?

I don't think so, Allison. The overall mix equation appears to be stable. While HST demonstrated strong growth in Life Sciences and Sealing, which inherently have higher margins, there were also some inefficiencies in our supply chain. To clarify, the $3 million of inefficiencies specifically emerged from HST as a result of the acceleration in growth, necessitating some catch-up action in our supply chain. That said, we expect to resolve these issues through the remainder of the year.

Great, thanks. That's helpful.

You're welcome.

Good morning, everyone.

Hi, Nathan.

I'm following up on Allison's questions regarding growth investments. Over the past couple of years, you’ve devoted substantial resources toward growth initiatives. Is there more that you can pursue currently? Are you constrained by manpower or manufacturing capabilities? With higher growth expectations generating more cash, are you planning to increase investments to enhance these growth rates?

You know, Nathan, you may have seen that the engineering expenses for the year surpassed our expectation as we performed better than initially anticipated. We have made an additional investment in engineering to support our initiatives. I don't perceive significant constraints in the medium term, but in the short term, there may be constraints concerning engineering manpower, which we are actively addressing. We are committed to fully funding our initiatives and are not scaling back our plans.

And Nathan, this is Bill. Just to add, we want to dive deeply into a limited number of initiatives. Our success is a result of focusing on a small number of critical projects rather than spreading ourselves thin across too many areas.

Historically, Andy, you've mentioned it is easier to scale up your business rather than down. Given the current environment, where growth is increasing, how do you anticipate managing potential costs to avoid diminishing returns?

While there may be slight increases in costs, I expect we will maintain our target increments above 35%. We must consider that if we limit spending during an upswing and fail to meet growth demands, it can significantly impact revenue. However, our visibility is solid, and we target areas that should yield healthy increments above that 35% mark. Nevertheless, we will prioritize long-term growth over short-term metrics.

Thank you, very helpful.

You bet, Nathan.

Good morning, everyone.

Good morning, Mike.

In recent quarters, your outlook has become increasingly positive, though your commentary has typically maintained a cautious tone. This quarter seems different. Could you provide some insights into your improved outlook for sustainability?

If you recall from last quarter, I was cautious for two key reasons: geopolitical risks and the lack of sustained investment in significant projects. I assess the geopolitical risks remain unchanged. However, I’ve observed increased structural investment without direct government influence, which has bolstered my confidence. We're also seeing sectors that struggled beginning to stabilize, like midstream energy, giving us hope for improvements through the second half of the year and into early 2018.

What was the order cadence through the quarter? Did you see any atypical trends?

The order consistency throughout the quarter was typical. For example, in April, we recorded orders of $183 million, increasing to $196 million in May, and reaching $207 million in June. Sales mirrored this pattern with $174 million in April, $189 million in May, and $210 million in June. This uniform ramp indicates strong engagement.

Appreciate the insight. How does your acquisition pipeline appear?

The acquisition pipeline looks promising. We have more opportunities in the pipeline than we've had in a while, although completion can be challenging due to fluctuating pricing dynamics. Nonetheless, we have more discussions than we did three months ago, indicating strong market interest.

Thanks for your insights.

You bet, Mike. Thank you.

Hi, good morning. This is Jeff standing in for Deane.

Good morning.

Could you discuss the dispensing order that was delayed? What was its size, and will it come in the third or fourth quarter?

The delayed dispensing order, which we discussed previously, is approximately in the $5 million range—meaningful for the dispensing business and specifically for the FSD segment. While we anticipate the order will materialize, we must align our timelines with customer requirements. As it stands, we are about 90 days behind schedule, though we feel optimistic that it will convert into sales.

What indicators do you consider most favorable heading into the second half and 2018?

Three key aspects: first, the broad-based nature of growth across our diversified portfolio signals an improving economy. Second, we can clearly identify the sources of incremental revenue growth resulting from planned initiatives. Finally, our business segmentation enables us to effectively target high-quality revenue, yielding high returns and margins. Overall, these factors paint a positive picture for IDEX within this improving environment.

Thank you.

Thank you.

Hey, good morning, all.

Good morning, Scott.

First question on pricing. Can you provide any details on how that is trending across different businesses?

Certainly, Scott. The trend remains consistent, with price increases ranging between 0.5 to 1 percentage point across our sectors. Even so, our FMT businesses generally secure more price traction, while HST experiences limited price flexibility due to higher customer concentration, primarily through multiyear contracts. Price increases in FSD tend to fall between those two extremes, but nothing material has shifted.

Thanks, and regarding the fixed businesses, I've seen that approximately 25% of sales figure. What’s the margin profile of those businesses, and do you foresee opportunities to fund them better as the year unfolds?

We are making considerable progress; we review this on a monthly basis concerning profitability improvement. We've successfully moved several businesses out of the 'fixed bucket' to the 'growth' categories. I expect to continue this trend, and currently, we are ahead of margin improvement goals in those segments.

I would also like to remind you that roughly one-third of that fixed bucket comprises our new acquisitions. We are on course and have successfully implemented a plan to deliver 500 basis points of margin improvement in those businesses.

Yes, absolutely.

By next year's first quarter, what do you estimate that fixed percentage will be?

We will need to examine that closely. However, if we neutralize for no additional acquisitions, it's likely to fall within the 15% to 20% range, demonstrating our progress in transitioning those businesses.

Thank you.

Thank you.

Hi. Good morning, everyone.

Good morning.

Just wanted to follow up about Akron Brass and AWG. It sounds like you're realizing good margin progression in those businesses. If you isolate those two, how has their organic growth profile performed in the first half of the year?

It has been strong, exceeding our expectations. Discretely picking out their organic growth has become more difficult because we're amalgamating the sales channels. By the end of this year, it’s likely we won't distinguish between Fire and the legacy businesses because they will be fully integrated. But overall, they are meeting or surpassing our goals.

Understood. Shifting to M&A, how do your various strategic pillars—meaning private equity sites versus carve-outs—compare in terms of the acquisition pipeline, and where do you see the most potential?

The private equity market remains steady. We've seen a noticeable uptick in private equity availability for acquisition opportunities, alongside an increase in corporate divestitures. These changes are generally influenced by market conditions and the improved performance of sellers.

Thanks for the clarification. One last question regarding contingent consideration: what was the size of that, and where is it recorded?

It was $1 million.

Thank you.

Thank you.

Thanks. I have a couple of questions. First, regarding FMT: considering the absolute revenue levels in Q2 this year versus last year are quite similar, what is driving the step function improvement in operating profit, given that margins have also seen substantial growth?

Yes, I think 27% is a good baseline for future operating margins. This improvement is driven by several factors, including the divestiture of lower-margin businesses. The rebound in our stronger businesses, such as Warren Rupp, Viking, and Banjo, which collectively exhibit superior profit contributions, accounts for a significant portion of this enhancement. So when you consider these elements together, that's the resultant difference.

Regarding HST, you mentioned a new product cycle. How significant is this for IDEX going forward? Over what time frame do you envision this ramping up?

This new product cycle concerns about 15% of our total business. We predict robust performance through 2017, 2018, and even into 2019, assuming commercial success. While we don’t anticipate growth rates as high as what we’re witnessing now, we do expect mid-single-digit organic growth in this segment for the foreseeable future. Key drivers include disruptions in mass spectrometry, increased testing demands in IVD and Bio, and a favorable outlook in DNA sequencing, in contrast to the softness over the past few years.

Great, thank you.

You're welcome.

Hi, guys. This is actually Patrick Wu standing in for Charley. Thanks for taking my question.

Hi, Patrick.

I wanted to touch upon the margin profiles across your segments. Given the improvement in organic growth relative to your prior forecasts, do you feel it's appropriate to revisit your margin targets, or do you anticipate exiting the year at the high end of your previous range?

I don't believe we need to make drastic adjustments. We've consistently targeted FMT margins at around 27%, for HST around 23%, and about 25% for FSD. Our established expectations factor in a solid margin expansion while still accommodating necessary investments. Therefore, I don’t foresee significant upward adjustments at this stage.

Understood. Regarding your new products developed over the past 12 to 18 months, what percentage of your sales derive from these? Additionally, what do you foresee for that figure in 2018?

We tend not to focus too heavily on that specific metric. I've been advocating to de-emphasize vitality indices. Our business model relies on long product life cycles, which ensures resilience. Rather than fixate on arbitrary growth figures, we prioritize performing above the market by 200 basis points annually. Consistent adherence to this strategy culminates in remarkable long-term benefits.

Thank you for that clarity. One final housekeeping detail: was the deferred dispensing order factored into this quarter's order growth figures?

No, it was not included.

Thanks again.

Hey, guys. Good morning.

Hey, Joe.

I wanted to discuss China briefly. There are headlines regarding housing sector constraints and regulatory measures aimed at restraining pricing and investment. What is your perception of activity there, and how sustainable do you believe it is? How are you positioning yourself in anticipation of these potential government regulations?

China overall has improved for us recently. Although we faced a couple of tough years, the business environment is getting better. We don’t foresee any major regulations that might considerably impact our situation. Still, our exposure in China is relatively minor, comprising about 5% to 6% of our sales.

Is there any specific insight into the municipal side of the Fire businesses in China?

Yes, we have indeed seen considerable improvement in our Rescue business in China after a couple of sluggish years. We plan to roll out a series of new products from our Dinglee facility and believe they will be very effective in capturing market interest.

Thank you.

You bet. Thank you.

Hi, guys. Good morning.

Good morning.

Can you share your views on capital allocation priorities in the current market, considering your robust acquisition pipeline against the backdrop of new product opportunities?

I am fortunate that we are not restrictively capital constrained for growth investments. We are committed to fully funding our organic growth investments due to strong free cash flow, making it our primary focus. Our secondary priority is delivering steady dividends at 30% to 35% of net income. Following this, we will then assess M&A opportunities or share buybacks when it makes strategic sense. It's paramount for us to be patient during times of elevated valuations, building cash to leverage advantageous opportunities as they arise.

Thank you.

You're welcome.

Hey, good morning, guys.

Good morning.

I have a question about HST: approximately 30% to 40% of the business is industrial-focused. Can you share insights regarding the order performance there, especially in segments like MPT and sealing?

If we assess the order landscape in HST for the second quarter, both Sealing and Life Sciences showcased robust double-digit growth. In contrast, as we mentioned earlier, MPT presents us with some challenges due to previous consolidation that impacted business volume. Nevertheless, the industrial segment remains steady and is tracking at or slightly above expectations.

What was the cadence of those orders? Any notable trends in July?

The order cadence has remained consistent without any significant deviations, and July is progressing in alignment with our expectations. Bill, any thoughts on this?

No, I don’t think there are any surprises.

Alright, thank you.

Thank you.

Thank you all very much. As we close this call, I want to acknowledge the strong results and the ongoing engagement within our order book. I have great appreciation for the team here at IDEX. Our over 7,000 associates have put tremendous efforts into implementing a differentiated approach to conducting our business. They focused on deep segmentation, making targeted investment in growth, and maintaining diligent capital allocations. I am proud of how we've executed with our operating model, and I am optimistic about the long-term success positioning we've achieved. Thank you to the analysts and investors for your support and attention to our company. We look forward to reconnecting in 90 days. Take care.