Idex Corporation (IEX) — Q1 2019 Earnings Call Transcript

Thank you, Doug. Good morning everyone. This is Mike Yates. I'm Vice President and Chief Accounting Officer for IDEX Corporation. Let me start by saying 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 months ending March 31, 2019. And later today, we will file our 10-Q. 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 and an update on market conditions, geographies and our capital deployment strategies. Bill will then discuss our first quarter financial results and walk through the operating performance within each of our segments. And finally, Andy will wrap up the call with an outlook for the quarter and the full year 2019. Following these 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 number 13684162 or you may simply log onto our company's homepage for the webcast replay. Before we begin, a brief reminder. This call may contain certain forward-looking statements that are subject to the Safe Harbor language in last night's press release and in IDEX's filings with the Securities and Exchange Commission. With that, I'll now turn our call over to our Chairman and CEO, Andy Silvernail.

Thanks, Mike. Good morning, everybody and thank you for joining us for our first quarter call. I'd like to start with some key themes. Q1 results were strong and somewhat better than our expectations from 90 days ago. Bill will walk you through the details, but overall I'm pleased with our organic growth in both orders and sales, the team's execution was outstanding driving operating margin expansion and cash flow and this helped us deliver another quarterly EPS record driven by both operational outperformance and favorable tax rate. Momentum continued in our industrial, municipal and life science markets both partially offset by softness in ag and semicon as well as some lumpiness in our project-oriented businesses, specifically dispensing and MPT. There were some concerns of slowing global economic – the global economy and those do remain, but we're confident in our ability to grow faster than the underlying markets as a result of our market-leading positions, our ability to capture price, and deliver on our targeted growth initiatives. Putting it all together, we're raising our full year EPS guidance while maintaining our organic revenue growth expectations. Now, I'd like to take a moment and talk about what we're seeing across the markets we serve and the regions we do business in. In the industrial market, the overall conditions remain favorable with continued strength in OEM and our targeted growth initiatives. We are however seeing some day rate volatility in pockets of our business, due to customer caution about the macro outlook. In Scientific Fluidics and Optics, our life science, markets continue to expand. Our IVD/BIO business is leveraging new product launches and platform wins to our growth and the AI market demand remains solid. In Energy, we're seeing some rebound due to the higher oil prices. Mobile truck builder demand is increasing and we're seeing positive signs in the aviation fueling space. In municipal, the North American market continues to modestly expand. Our focus remains on new product development notably a recent launch of new hydraulic tool in our SAM system and Fire & Rescue, as well as continued expansion in emerging markets. In ag, we're expressing some contraction due to macro uncertainty around the soybean tariffs and the OEM slowdowns. We are seeing some growth in Latin America and Europe, but North America is a challenge. In semicon, we continue to see broad-based pressure by lower investments in Asia and the downturn in memory chip demand after substantial growth in 2017 and 2018. In auto, as you all know, there's been a slowdown of global light vehicle sales and that's driven some softness in this market, but as you know that's a relatively small piece for us. Now, let's move on to the geographic outlook. Sales across the majority of geographies performed well in the quarter with North America leading the way. Asia was positive, specifically India and China was primarily driven by our initiatives versus the macro trends. The European economy lost some traction in Q1 and we saw some supply chain disruptions ahead of Brexit. And finally, we are seeing some softness in the German economy. Nevertheless, our targeted growth initiatives and new products continued to drive positive results around the globe. All right. Let me turn now to capital deployment. M&A continues to be a priority for us. With that said, there remains a challenge in the current environment, due to valuation. Our teams have evaluated several deals, but our approach has not changed and we will remain very disciplined with our return framework. We will only close on a deal that fits the IDEX sales competition and delivers long-term value for our shareholders. This remains our number one priority. As I said, our balance sheet is very healthy our gross leverage is 1.3 times and our net leverage is 0.6 times. When the right deal comes along for IDEX, we will capitalize on it. In terms of the other capital deployment, we did repurchase $52 million of stock in the quarter at an average price of about $140 a share. We also returned $33 million to our shareholders via dividends. Let me turn it over to Bill, who is going to go over our financial results and our segment discussion.

Thanks, Andy. I'll start with our first quarter financial results on slide 4. Q1 orders of $655 million was an all-time record, and was up 4% overall and 6% organically. All three segments were up with FMT leading the way. Q1 revenue was $622 million, up 2% overall and 4% organically. We expanded gross margins by 40 basis points to 45.6%, primarily due to price, production efficiencies, and volume leverage, partially offset by investments in engineering related to new product development. Our Q1 operating margin was 23.8%, up 120 basis points compared with the adjusted prior year period, mainly driven by our gross margin expansion, lower intangible amortization, and lower variable compensation costs. Q1 net income was $110 million resulting in record-high EPS of $1.44, up $0.15 or 12% over prior period — prior year adjusted EPS. Our Q1 effective tax rate was 19.5%, which was lower than the 24% in the prior year period, mainly due to an increase in foreign tax credits, discrete tax expense in the prior year period, and the mix of global pre-tax income. The first quarter ETR of 19.5% was also 300 basis points, lower than our previously guided amount, mainly due to a higher excess tax benefit from greater than expected stock option exercises in the quarter. This lower tax rate accounted for five out of the seven EPS favorability compared to the midpoint of our previous guidance. The remaining $0.02 of EPS favorability was operationally driven. Free cash flow was solid at $76 million, up 12% over the last year, and 69% of net income. This was our highest Q1 free cash flow of all time. In regards to the balance sheet no change here. Gross and net leverage remain very healthy. The combination of our strong balance sheet capacity on our revolver and free cash flow provides us with an ability to deploy $2 billion in the next 12 months for the right opportunities. I'll now turn to the segment discussion. I'm on slide 5, starting with Fluid & Metering. FMT continues to deliver strong numbers, from both an order and revenue perspective. Q1 orders were up 8% overall and 10% organically. Q1 sales were up 4% overall and 6% organically. Operating margin was strong at 29.6%, up 110 basis points over the adjusted prior year quarter, mainly due to price, volume leverage and productivity initiatives. As Andy mentioned earlier, we are seeing some day rate fluctuation in pockets of the business, but overall the fundamental strength within the industrial sector continues to drive solid results. Our Viking and Richter businesses posted record order and sales in Q1 with continued project wins in the processing and chemical markets across the globe. The municipal water business remains steady, and the oil and gas market conditions have improved due to oil price increases and stabilization. The only business in this segment that contracted year-over-year was Banjo. The concerns we highlighted with the ag market in Q4 materialized in Q1, and we continue to be cautious on the balance of the outlook for Banjo. Overall, the targeted growth efforts across our businesses in this segment continue to gain wins and market share. Let's move on to Health & Science turning to slide 6. Q1 orders were flat overall, but up 1% organically. We highlighted on our last call, we expected a tougher comp for HST orders due to an OEM blanket we received early in Q4 of last year. Along with the last time buy we offered customers in Q1 of 2018, as we eliminated the product line as part of the Rochester COE project. Normalizing for the items, orders would have been up 5% organically for the segment. From a sales perspective, Q1 sales were up 2% overall and 3% organically. I'll give you a bit more color on this in a minute. Operating margin increased 10 basis points to 24%. This was primarily due to lower amortization. Core margin performance was negatively impacted by lower project volume in FX and MPT. Overall, HST's performance was primarily driven by continued success in Scientific Fluidics and Optics. Underlying AI and IVD/BIO markets remain positive and we continue to grow through targeted NPD efforts in collaboration with our key customers. Gast saw strong underlying industrial OEM demand and solid execution on our growth initiatives in the food and beverage market. On the negative side, organic growth was impacted by contraction in our sealing business, which was affected by both a downturn in semicon and lower auto sales. Finally, MPT backlog remains strong and has grown sequentially versus last quarter, but timing of project shipments is skewed towards later quarters in the year due to longer lead times. I'm now moving on to our final segment, Diversified. I'm on Slide 7. Q1 orders were up 5% overall and 9% organically. Revenues were down 2% overall, but up 1% organically. Operating margin of 25.8% increased 90 basis points in the quarter. This was mainly attributable to price, productivity initiatives, more than offsetting our volume decreases. FST's performance was driven by our Fire & Rescue business continuing to see growth across most of the product categories and geographies with several project wins resulting from new product launches. Band-IT saw growth in several of its verticals with aerospace leading the way. They also had some nice project wins in cable management. Our dispensing business was down around 15% organically for the quarter as they had a tough comp against some larger projects last year. We expect them to recover some as we progress through the year but will be down overall for the full year based upon timing of customer replenishment cycles. I'll now pass it back to Andy to provide an update on our 2019 guidance.

Thanks Bill. So, let's wrap things up and I'm going to summarize here with some additional details on 2019 for both the second quarter and the full year I'm on the last slide and that's slide 8. In Q2, we're estimating EPS $1.47 to $1.50 with organic revenue growth in the range of 4% to 5% and operating margin about 24%. We're projecting 2% topline headwind from FX based on the March 31st rates which translates to $0.02 headwind in EPS. Q2 effective tax rate is expected to be about 22.5% and corporate cost will be around $20 million. Looking at the full year, we're raising our full year EPS guidance. We now expect earnings to be in the range of $5.70 to $5.85. Full year organic revenue growth remains the same at 4% to 5% with operating margin of about 24%. Topline FX impact will be about 1% based on the March 31 rates. For the full year, we expect our tax rate to be about 22%, CapEx to be about $60 million, and free cash flow in the range of 105% to 110%, and finally corporate cost in the range of $80 million to $82 million. As always our earnings guidance excludes any costs associated with future acquisitions or restructuring. With that, Doug, let me pause here and we're going to turn it over for questions.

Hi guys. Good morning.

Good morning.

Can we go back to commentary around MPT. I want to just make sure I understand that. I think Bill you were saying sales were weak in the quarter but you have a strong backlog so it's really timing of when those projects are getting delivered. Is that correct?

Yes, MPT is going to be down for the first half, but they will back up in the first half and overall positive for the full year.

Yes, we have built a backlog and have a strong position in MPT, but it is related to dispensing. These areas tend to fluctuate the most in our business, and we expect to see that backlog work its way through in the second half.

Got it. And then what are those one-time events that you referred to on the slide? Is that just the order commentary you are talking about?

Correct.

Okay, perfect. And then regarding acquisitions, we notice a lot of instability in the markets. Are you sensing any changes in multiples starting to narrow, given the lengthy process you've faced?

Not really. It's been pretty consistent and I think for us, Allison, it really continues to be working it very hard and being patient and disciplined. Eventually something will break here but the last thing we want to do is do a really expensive deal that doesn't fit our framework. So, we're going to keep our discipline.

Fair enough. And then last corporate expense, it looked that it was adjusted down a little bit. Is that just your cost control or is there something else in there?

No, just a flow through of the favorable variable compensation that we incurred in the first quarter.

Perfect. Thank you.

Thanks Allison.

Good morning gentlemen.

Good morning Mike.

I'm hoping to clarify a couple of things here, Andy. If I recall, you were projecting a low single-digit environment from an end-market perspective, with some quarter-to-quarter fluctuations. Is that still the case, or has there been any change? Additionally, could you connect this with insights from some of your leading indicator companies? I know you didn't mention Warren Rupp, but Gast and BAND-IT both performed very well in the quarter, so I'm hoping you can help me piece this together.

It was actually a mixed quarter. If you look at how things progressed, the first half of the quarter was pretty soft, but we saw a broad uptick in strength in the second half. This was a positive indicator, and the building backlog along with a 6% order rate suggests good momentum as we approach Q2. However, looking at those businesses, the cycles have been quite short, which also presents mixed results. If we exclude very specific successes we've secured, the day rate business showed significant variability, while the industrial side remained relatively strong. Overall, I don’t believe our perspective has changed much from what we discussed three months ago.

Any different on the regional side?

Yes, a little bit. I think Asia is probably a little bit better than we had expected, North America is just about what we had expected, and Europe's a little weaker.

Great. Appreciate it. Thank you.

Thanks Mike.

Thank you. Good morning everyone.

Hey Deane.

Hey, maybe we can start with a review of some of these sector puts and takes that a number of the multi-industries have been commenting on either there were or were not affected. So, let's start with there were some issues about pull-forward of demand out of the first quarter into the fourth quarter. There was a company last night reported at the close, where it ended up being much bigger than they thought. Did you see any of that dynamic? Was that at all related to the softer start of the year for you guys?

Not really. We had that one order in HST that we discussed at the end of the previous quarter, but it's not a significant issue.

And that wasn't tariff related, somebody get ahead of something that was pure timing.

No, no, no. That was purely a matter of timing with the customer. Generally, we are operating on such short cycles that we do not usually engage in the types of games you see out there. Last year, when the tariff issues arose, we experienced some unusual activity between the second and third quarters, but looking back at 2019 and 2018, I don't believe it has a significant impact on us.

Good. And then I didn't hear weather come up at all, but when I hear about ag softness, there was a company Pantera had issues there with weather. Anything on your side?

Yes. The only weather here was my house being shut down by the weather but…

That was last quarter.

You're correct. There were some fluctuations, but they weren't significant. Regarding the agricultural market, it's currently weak, a trend we anticipated late last year. We warned that the surge in activity wouldn't be sustainable, and that prediction has proven accurate. They will need to navigate through their cycle. As for whether they've hit the bottom yet, opinions vary and we're cautious about making that determination at this time. However, agriculture is a key business for us, and we believe we have a solid strategy for the rest of the year.

Good. And then just last one from me. Can you comment on price costs in the quarter? And any changes in the outlook for the year?

Yes. We are still seeing pricing above 1%. Inflation has moderated slightly, which provided us with some additional benefits compared to our expectations of 30 to 40 basis points, resulting in a better-than-anticipated outcome. We believe we are well-positioned for the remainder of the year.

Great to hear. Thank you.

Thanks Deane.

Thanks. Two questions. First, in the prepared remarks, you referenced supply chain disruptions you saw in Europe. Can you get into a little bit more granular detail on that? And whether that's still with you here as we're into the second quarter at this point?

Yes. The main issue was specific to the U.K., where we have several businesses, especially in fire and sealing. There was noticeable product hoarding as people prepared for the anticipated Brexit date. Now that that deadline has been pushed back, we will see how things develop. There were certainly changes in the supply chain between the U.K. and the continent. While it may not significantly affect us, it is a concern for those businesses. We will monitor the situation, but I expect that as things progress, we will continue to experience some unusual behaviors.

And then are you seeing any evidence? You mentioned sort of the short-cycle day rate business, but beyond that are you kind of thinking in some of your longer-cycle businesses, are you seeing any evidence that customers are delaying capital decisions awaiting some sort of outcome with all of this trade stuff?

Certainly. I believe that if we reflect on last summer, we can see that people have been more cautious about investing larger amounts of capital while the tariff situation is being resolved, especially with the U.S. government shutdown. These factors have made many hesitant. During my recent trip to China, it became clear that there is a noticeable wait-and-see attitude in Asia as well. Likewise, U.S. businesses heavily involved with China are adopting a similar approach, closely monitoring developments. I think this creates a limitation in the natural balance between supply and demand in the current climate.

Thanks Andy.

Thanks Matt.

Good morning everyone.

Hey, Nathan.

Hi Andy. Question here just on FMT and the impact that Banjo had in the quarter. I mean, you got pretty phenomenal order growth 110 basis points of margin expansion, and I think Banjo is one of the higher-margin businesses in there so it probably was a bit of a drag on margin expansion. Can you maybe talk about what the drive from Banjo was? You're getting pretty close to 30% operating margins now. Can we see that number breach this year?

Yes. It's actually less of an impact than expected. While there is definitely some effect, we believe it's diminishing for various reasons. Most importantly, the margin profile of the rest of FMT has improved relative to Banjo, so the mix impact isn't as significant as anticipated. In the grand scheme, Banjo represents less than 5% of IDEX sales. Even when considering its impact on FMT, it accounts for approximately 12% to 14% of FMT business, which is not negligible, but certainly not as significant as it would have been five years ago.

Okay. You mentioned some areas of weakness in FMT, but haven't specified what they are. Could you provide more details on which businesses or end-markets are experiencing that weakness?

Yes. More generally, the areas of real weakness across the company are in agriculture, semiconductors, and automotive. The positive aspect is that these markets combined account for less than 10% of IDEX's revenue. So while there are some weaknesses, the larger issue I've referenced in my prepared remarks pertains to the volatility of day rates. We've observed this volatility in various periods, particularly going into and coming out of 2015 and 2016, as well as last summer. When considering any kind of inflection, positive or negative, this volatility tends to resurface. This relates back to the earlier question about capital being tied up. When capital is constrained, the book-and-turn business usually experiences more volatility, and project timelines can be delayed. Overall, the good news is that if we see some easing in these conditions, the volatility should diminish, leading to a positive shift.

Okay. So going to 2015, 2016 and coming out of 2015, 2016, that volatility clearly resulted in a big downturn and a big upswing. I guess the volatility last summer didn't really move the needle in a big way one, way or the other.

I would say that we are still in a six-month period. Looking back from the third quarter to the first quarter, it has been six months characterized by both weak months and very strong months. Therefore, I believe we are still in that uncertain phase.

Okay. So you're still in the period of volatile day rates waiting to see whether that's going to sort itself out or jump off a cliff or inflect up, or something like that. Any sense from you of what you think is going to happen around that?

The issue, I think, is this isn't tied to normal economic activities. It's very big macro and political issues and so I don't have any idea.

Fair enough. Fair enough. And I'm glad to stay in market and praise you there. All right. Thanks guys.

Thanks, Nathan.

Thanks, Nathan.

Hey, guys. Good morning.

Hi, Joe.

Some of the higher-profile OEMs and certain HST areas like mass spectrometry and chromatography mentioned a potential buildup in the channel. I'm curious about your observations regarding this. I understand the sales cycle is longer for you in this area. How do you perceive this situation? Does it seem temporary to you?

Yes, we observed that the life sciences segment is performing quite well. However, we haven't seen that translate with our major customers. We have established electronic Kanbans with them, providing us with decent visibility. However, our insight into how this affects their supply chain and their customers is more limited. Nonetheless, I don't anticipate this will become a significant issue.

Right. FSD, I mean, the sudden increase in orders is likely surprising for many people. How sustainable do you think that is? Is that a segment that might see a natural decline this year? How do you view that situation now?

No., I think, overall, it's going to be up for the year. I think, there will be, again, quarter-to-quarter volatility for dispensing, right. Sales were down 15%, but orders were up 10%. We called on the fourth quarter we had something to push in the first quarter. We landed that order, but Fire & Rescue, really strong mid-single digit and just got the same expectations for BAND-IT.

Yes.

And then just one more question from me. We've discussed day rate volatility quite a bit here. Andy, I know this is something that really captures your attention. What actions do you take when you're uncertain about which direction it will go? Do you prepare for one outcome or take measures to be ready if it swings one way or another? I know you dislike being unprepared for that, but how do you manage it?

We are as, I've said many, many times in the past we react much better to the upside than we do to the downside. And so, we can move pretty quickly as demand inflects upwards. And I'm happy to have to chase that a little bit. That's all right with me. The contribution margins are going to be high and you're really chasing it with supply chain and labor. And so, I can deal with that. Getting way out in front and having the markets turned over on you is very painful, right? Because now you're firing people and you've got a really difficult contribution margin on the backside where the decrementals become painful. So I'd rather be conservative going into that, I have to chase the upside a little than I would getting out in front and having to dramatically react to the downside.

That’s fair. Thanks.

Thank you.

Hi. Good morning, guys.

Hi, Bryan.

Nice start to the year.

Thank you.

I was hoping you could offer a little color on the SAM launch in Fire & Safety. I know, you literally just introduced to the market, but it seems like that's going to be a game-changing technology. Curious about initial reception? And whether it's already contributing to FSD order rate?

I appreciate the question, Bryan. We had the North American fire show in Indianapolis a few weeks ago where we introduced both the SAM system and the new eDRAULIC tool. The reaction to the SAM system has been incredible, with a great number of attendees at our booth and positive feedback from customers. We've already secured our first major customer, but I can't disclose who they are just yet. This acquisition was significant; it was focused on enhancing the user interface and integrating all our components into a single system, which puts us at the forefront of IoT and digital technology. Over the years, we expect to greatly improve productivity and safety in fire trucks, which is very important. However, this process will take time due to two main reasons. Firstly, there is currently a backlog of orders with fire truck OEMs, so changes must be made to existing orders for innovation to take effect. Secondly, there is an existing large installed base that will require conversion. I believe that over the next three to five years, we will make substantial gains in market share thanks to our strong intellectual property, which I see as a game changer for us. Considering the next decade, our position in the fire market regarding this capability is significant.

That's extremely helpful color. Thank you. And if we could follow-up a little on M&A. Obviously you have a lot of dry powder right now and good scale and diversification across platforms. With the resources you have in place is larger scale or more transformational M&A prospective going forward?

You know Bryan, we're pretty cautious about that. If you look at the universe of businesses that would be transformational. So let's say, our size to have our size, right. If you look at businesses of that scope and scale there are very few that fit naturally with IDEX. There are a handful and those are the things that we keep up on and we work on all the time. And there are a few that we could do that would be wonderful combinations with IDEX, but it's not very many. It has to be at the right price and you've got you be able to drive real synergies. That being said, as you look from say that size down to $300 million, $500 million or so call it $300 million to $1 billion in revenue, there's quite a bit of stuff out there. And it's really a matter of timing and being able to do a deal at the right kind of economics that fits our style of competition. And if that happens, we will move really quickly. We looked at a bunch year, we put a ton of effort into them and we just need to keep to our style of competition and the discipline around our return frameworks and not get seduced into doing mid single-digit ROIC deals that are "accretive" but are really disastrous to the capital structure and the return structure of the business over the long term. And we're just not going to do that.

Makes perfect sense. Thank you again.

Thanks, Bryan.

Thanks very much, and thank you everyone for joining us here on the first quarter call. More than anything else, I want to thank the teams here at IDEX who do just a tremendous job being laser-sharp focused on our customers, understanding that in a market like this we really do need to execute and execute well and they've done that. And then, discipline around how we spend this free cash flow. And so the teams, I'm very proud of the teams that we have and the culture that we've built. And I look forward to catching up with everybody in the next 90 days. Take care.