IDEX Corporation (NYSE:IEX) Q3 2023 Earnings Call Transcript

IDEX Corporation (NYSE:IEX) Q3 2023 Earnings Call Transcript October 26, 2023

Operator: Greetings, and welcome to IDEX Corporation’s Third Quarter 2023 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Allison Lausas. Thank you. You may begin.

Allison Lausas: Good morning, everyone. This is Allison Lausas, Interim Chief Financial Officer and Chief Accounting Officer for IDEX Corporation. Thank you for joining us for our discussion of the IDEX third quarter 2023 financial highlights. Last night, we issued a press release outlining our company’s financial and operating performance for the 3 months ending September 30, 2023. The press release, along with the presentation slides to be used during today’s webcast, can be accessed on our company website at idexcorp.com. Joining me today is Eric Ashleman, our Chief Executive Officer and President. Today, we will begin with Eric providing an overview of the state of IDEX’s business. I will then discuss IDEX’s third quarter financial results, an update on segment performance in the markets they serve, and our outlook for the fourth quarter and full year 2023.

Following our 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 2 hours after the call concludes, by dialing the toll-free number (877) 660-6853 and entering conference ID 13734464, or simply log on to our company 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 will now turn this call over to our CEO and President, Eric Ashleman.

Eric Ashleman: Thanks, Allison, and good morning, everyone. I have some important news on Slide 5. Before turning to our results and outlook, I’d like to introduce Allison Lausas, who is serving as our interim CFO. Allison has been with us for over 2 years, serving as our Vice President and Chief Accounting Officer. She also leads our Investor Relations and financial planning and analysis functions. During her tenure at IDEX, Allison has done an outstanding job, serving as a strong partner to our former CFO, Bill Grogan, and myself. Thank you, Allison, for all you’re doing in your expanded interim role. And I’d also like to thank Bill for his many years of service at IDEX. Also, as you saw in our release yesterday, we are pleased to announce that Abhi Khandelwal is joining IDEX in November as our next CFO.

Abhi joins us from Multi-Color Corporation, a global packaging services and label solutions provider, where he served as CFO. Prior to that, he served as Senior Vice President and CFO of CIRCOR International. He previously worked at IDEX for over 10 years, serving as my financial partner during most of my term as COO. We’re thrilled to have him back with us, and I consider us very fortunate to have leaders like Abhi and Allison at the top of our finance organization. With that, I’ll turn to our Q3 performance. I’m on Slide 7. IDEX delivered strong results in the third quarter, delivering robust profitability in an environment where volumes are stabilizing at lower levels. We also generated excellent cash flows as we continue to execute on our cost containment and inventory reduction plans.

I’d like to thank our IDEX teams around the globe for their contributions in driving these outstanding results. This was very solid execution in a difficult environment. Recall that we expected our industrial and municipal markets within FMT and FSDP to reach the end of an elongated and moderate destocking cycle within the third quarter. That played out as expected. Our analytical instrumentation, life sciences, pharma and semicon markets within HST largely held at equilibrium in Q3 and bounced along the bottom after an unprecedented rapid destocking cycle in the first half of the year. Taken together, this moves IDEX into a very natural position, where lead times, backlogs and next quarter visibility, all aligned with typical pre-pandemic profiles.

Looking forward, we continue to see divergence between end market prospects. There are discrete attractive opportunities within each of our segments, many of which are tied to transformational catalysts within environmental sustainability or critical infrastructure. Examples include water analytics, space broadband and battery production. These sit within a broader framework of uncertainty driven by macro concerns that include higher interest rates and expanding geopolitical risk. More specifically, demand rebounds for our most pressured HST businesses appear to have moved out a bit into 2024. We continue to believe that organizational agility, speed of decision-making, outstanding business quality and a strong culture serve us well to navigate the twists and turns ahead.

We can both dynamically assign capital and resources to our best near-term opportunities, while we stay focused on our long-term strategy of profitable growth outperformance. In terms of capital deployment, M&A continues to be a top focus. Within our funnel builds, we are aggressively following complementary threads between our most growth advantaged businesses and technologies as we seek to build our breakthrough competitive advantage. We did this recently with our Nexsight acquisition, expanding our reach within water analytics through enhanced hardware and software capabilities. Our Iridian acquisition earlier this year boosted integrated capabilities within thin-film optics. Our inorganic pipeline is robust and of high quality, allowing us to engage in M&A with discipline and strong strategic intent.

And our balance sheet has ample capacity to continue to execute on our best opportunities. Finally, we divested our Micropump business during the quarter and repaid $150 million on our term note facility. As we continue to focus on long-term growth, occasional portfolio realignment will occur. We expect this transfer of ownership will better position Micropump as it joins a collection of like-minded businesses, focused on similar technologies and customers. I would like to express my appreciation for all the Micropump team has done since joining IDEX in 1995. With that, I’ll turn it over to Allison to discuss our financial results.

Allison Lausas: Thanks, Eric. Moving on to our third quarter consolidated financial results on Slide 9. All comparisons are against the third quarter of 2022, unless otherwise stated. Orders of $712 million were down 9% overall and down 11% organically. We experienced an organic decrease within our HST and FMT segment and organic growth in FSD. Sales of $793 million were down 4% overall and down 6% organically. We experienced a 15% organic decrease in HST and a 1% decrease in FMT. FSD revenues grew organically by 3%. Gross margin of 44.1% decreased by 220 basis points compared with last year. Adjusted gross margin decreased 90 basis points, primarily due to lower volume leverage and unfavorable mix, which was partially offset by strong operational productivity and price costs.

Adjusted EBITDA margin was 28.4%, down 30 basis points. I will discuss the drivers of adjusted EBITDA on the next slide. On a GAAP basis, our Q3 effective tax rate of 20.2% was lower than our effective rate in the third quarter of 2022 of 21.8%. The rate was driven down by both the finalization of research expenditure capitalization treatment that served to increase tax benefits on foreign source income and a tax election related to the Muon acquisition that reduced our minimum tax on foreign earnings. These favorable rate items were partly offset by tax recorded on the gain from the Micropump divestiture and are not expected to have a significant impact on our fourth quarter rate. Net income was $209 million, which resulted in GAAP EPS of $2.75.

Adjusted net income was $161 million, with adjusted EPS of $2.12, which is down $0.02 or 1%. The lower tax rate contributed $0.11 of adjusted EPS favorability in the current quarter compared to both the prior year and the midpoint of our third quarter guidance. Finally, cash from operations of $227 million was up 14%, primarily due to lower working capital, driven by inventory reductions. Free cash flow for the quarter was $207 million, up 14% versus last year and achieved a conversion rate of 129% of adjusted net income. We drove over $25 million of inventory out of the business in the third quarter through our targeted reduction efforts, and we saw inventory turns remain consistent with last quarter due to lower sales. Moving on to Slide 10, which details the drivers of our third quarter adjusted EBITDA.

Adjusted EBITDA decreased by $6 million compared to the third quarter 2022. Our 6% organic sales reduction unfavorably impacted adjusted EBITDA by $37 million flowing through at our prior year adjusted gross margin rate. Price cost was accretive to margins, and we drove operational productivity that offset employee-related inflation. Mix was unfavorable by $6 million, mainly centered in HST, due to continued volume declines in our analytical instrumentation, life science and semiconductor components. Resource and discretionary spending was favorable versus last year, as we continue to execute on our cost containment plan given the top line pressure we are experiencing. Reductions in variable compensation expense contributed $8 million of benefit in the quarter.

These results yielded a negative 31% organic flow-through. Overall, our team’s focus on cost containment and resource reallocation has effectively managed our revenue decline, ensuring continuity of our most valuable resources has IDEX well positioned to recover and grow back stronger than before when market dynamics turn favorable. Muon and Iridian acquisitions, net of Knight and Micropump divestitures and FX contributed an additional $9 million of adjusted EBITDA. With that, I’ll provide a deeper look at our segment performance. I’m on Page 11. In our Fluid & Metering technology segment, orders decreased by 5% organically, mainly due to an expected slowdown in our industrial businesses and continued customer destocking in our agriculture business.

Sales decreased by 1% organically, driven by this destocking impact, partly offset by favorable energy, chemical and water performance. We began to see our industrial order day rates decline in the second quarter of this year, and they remain steady at that level throughout the third quarter. Although our customers continue to exercise caution, due to recession concerns and lower energy prices, we see tailwinds tied to domestic infrastructure initiatives and within mining. Within agriculture, we continue to experience the impact of distribution destocking, exacerbated by declining net farm incoming crop prices. Our delivery continues to outperform our competitors, and we are focused on targeted share gain to offset this pressure. Additionally, the acquisition of KZValve and the adoption of its automated actuation technology is delivering strong results.

On the energy side, we continue to execute well, driving down backlogs and lead times. Underlying market demand remains steady, but we expect to see revenue declines versus third quarter as our backlog position normalizes. In the chemical market, we continue to see positive results across the U.S., Europe and Asia, with pharma and battery applications providing opportunities for growth. Our water business continues to exhibit growth. Our opportunity funnels are increasing, and we see no signs of municipal project funding delays as we approach 2024. Adjusted EBITDA margin expanded 50 basis points compared to last year, primarily due to strong price cost and favorable operational productivity more than offsetting lower volume leverage. Moving to the HST segment.

We experienced a 24% organic orders decrease and a 15% organic sales decrease, mainly due to pressure across the life sciences, analytical instrumentation and semiconductor markets as well as industrial market performance similar to that within FMT. Adjusted EBITDA margins contracted by 410 basis points, primarily due to lower volume leverage and unfavorable mix, partially offset by strong price cost and favorable operational productivity. Our analytical instrumentation business continues to experience customers destocking, which remains driven by China softness, lower pharma-biopharma spending and overall caution around the global economy. We expect that performance will remain stable at this level in the fourth quarter, with improvement in 2024.

We see a similar trend within our life science business. Semiconductor continues to experience softness with the expectation that the market has reached a bottom in the third quarter. We anticipate a broader market will begin to recover at some point in 2024. We continue to see positive results stemming from our space, broadband laser communication initiatives, which are bolstered by Iridian’s technological capabilities. Our material processing technology business continues to experience softness across pharma markets but are seeing some early signs of improvement within biopharma, food and nutrition as well as tailwinds connected to leveraging our technology and battery production application. Industrial markets and HST slowed in the quarter, in line with FMT’s results.

Finally, turning to our Fire & Safety Diversified Products segment. Organic orders grew by 2% versus third quarter last year and organic sales grew 3%, with strong fire and safety results more than offsetting destocking at BAND-IT. Adjusted EBITDA margins expanded by 150 basis points, primarily due to strong price cost and favorable operational productivity, partially offset by unfavorable mix and lower volume leverage. The paint market remains mixed. The uncertain global macro environment is driving consumer confidence lower, while at the same time, the construction market in North America remains strong. Within our fire business, we do not see any significant changes to North America fire OEM production capacity. We continue to win through value-add integrated systems and technology and standardized offerings that enable higher OEM throughput.

Our Europe and Asia businesses remain steady. Rescue performance remains steady as well, although we are seeing some signs of North American budget delays and inventory reduction due to high borrowing costs. BAND-IT continues to outperform a relatively flat U.S. auto market due to having content on high-priority vehicles. There is some pressure on the energy side, driven by lower oil prices, and we experienced some destocking within aviation. With that, I would like to provide an update on our outlook for the fourth quarter and full year 2023. I’m on Slide 12. In Q4, we are projecting GAAP EPS to range from $1.50 to $1.55 and adjusted EPS to range from $1.74 to $1.79. Organic revenue is expected to decline 8% to 9% and adjusted EBITDA margins are expected to be about 26%.

We expect that our HST revenues will be slightly unfavorable versus our previous guide, offset by FMT volumes landing better than expected. Equally, our strong execution in the third quarter allowed us to work through our backlog faster than expected. This is driving an equal and offsetting $0.05 of impact to third quarter results and fourth quarter expectations. Turning to the full year 2023. We are maintaining our full year organic revenue guidance of down 1% to 2%. At the midpoint, we have raised our EPS guidance by $0.20, with approximately $0.11 driven by lower third quarter effective tax rate and the remainder coming from third quarter operational outperformance, partly offset by $0.05 of revenue timing due to accelerated backlog burn in the third quarter.

In summary, we estimate full year organic revenue contraction of 1% to 2% to yield GAAP EPS of $7.91 to $7.96 and adjusted EPS of $8.13 to $8.18. Adjusted EBITDA margin is expected to be approximately 27.5%. Capital expenditures are anticipated to be about $80 million, and free cash flow is expected to be 100-plus percent of adjusted net income. With that, I’ll turn it over to the operator for your questions.

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Q&A Session

Operator: [Operator Instructions] Our first question comes from Deane Dray with RBC Capital Markets.

Deane Dray: First, start with congratulations on the CFO news. We’ve heard from a couple of former IDEX executives who are seeing obvious praises. So that’s fabulous you got him to rejoin. And then can I add my thanks to Allison for all her help in her role as interim CFO.

Eric Ashleman: Thanks for both comments.

Allison Lausas: Thank you.

Deane Dray: So maybe, Eric, for some big picture questions, macro. You’re great at kind of synthesizing all the different inputs here and having knows that macro is giving us a lot of mixed signals. But maybe just click through like the day rates, that started to slow in the second quarter. What’s your take on that? Lead times and anything from your leading businesses, like BAND-IT and Warren Rupp, that suggests how things are going to play out over the near term?

Eric Ashleman: Yes. Well, I mean, we often refer to those as the kind of canaries in our coal mine. And we discretely track about five of those businesses and keep an eye on weekly order rates and do it at the sort of small order flow day-to-day stuff level. We parse out projects. What we can see in there is, frankly, between the second and the third quarter, they’re almost dead on flat. So the kind of moderate destocking cycle that we predicted at the beginning of the year, I think, largely played out through the first half of the year and frankly, moderated. Even quarter to — month-to-month within the quarter, we didn’t see a lot of changes there. So what that says is kind of our distributors because there’s a lot in that world.

Our end users, all of us were kind of back to the right inventory position based on our quick replenishment, our fast lead times. And now I think it goes into the question of sort of an uncertain environment, when does it start to flex upward? Those would be the businesses. Of course, we would watch to see early indications of that. So for right now, it’s flattened out. It’s holding. There’s decent activity out there. There’s certainly opportunities here and there, but not signaling any further trouble and waiting to see if it brings forth some more encouraging signs.

Deane Dray: And then the second question is in HST in the Analytical Instruments Life Sciences, and I’ll preface this with — no one has gotten this right so far. Just the — whether it’s the Thermo and Danaher and that whole group, it’s been pretty fluid. And so I wanted to just see your degree of confidence that we’re bottoming here because there’s some suggestion that it’s not just destocking, but there might be some end market demand here in this equipment, the analytical instrument side, some demand falling off. So it seems to have gotten worse in October. So just your degree of confidence, how does this calibrate the first half of ’24 for this business for you?

Eric Ashleman: I want to take a little time here because I think I got to set our context in relation to those comments in the environment you described. First of all, as I said in the prepared remarks, I mean, we’re talking about four buckets of business primarily that kind of fall into this category. Analytical instruments, life science, of course, that’s the larger piece of it. Pharma exposure as well as semicon, that’s about half of HST, and that’s the piece that we’re describing when we walk through this. Then I want to back up and say, if you think about time line, you actually have to go back, we’re almost a year into this, for us. Because of the short clinical nature, we actually saw some of this noise in Q4 of last year.

And as you said, we and others, I think, have to get our heads around the fact that it’s actually been a series of additive components that’s played out here over the course of that year. Initially, thought it was just simply aggressive demand turning to something more moderate. Of course, we felt that in our businesses in Q4. Then, it was a reexamination of inventory positions and just frankly, seeing way too much of it at many points. And of course, that destocking played out. I think here in the second and third quarter, it’s been kind of a second or third inning, if you will, of some concerns about some macro forces, probably the most significant being China’s contribution or lack thereof as we — going forward relative to what it has been in earlier periods.

So there’s kind of three things that played out. What I think that’s done for us is, of course, we felt that pretty aggressively in the earlier piece. So there’s a lot of businesses because of the component nature of the products we make. And here more moderately in the last quarter, and I can see that our backlog position, our visibility within the quarter, our kind of inventory position in factories where we supply, that’s an equilibrium. So I don’t see any more external forces or things that would come in there simply trying to unwind the past. That does mean, frankly, that we’re kind of open to the recovery loop that’s ahead of us and the uncertainty of when it will occur and how it might play out. And again, Deane, I back up a little bit and say, we’re hitting that from four different levels.

So while there could be some things that fall off in other places as people kind of think about demand and where they may go, maybe some of those are in the life science arenas, that we’re going to have some other things that are going to potentially be working against that, that may wash that out in the interim. So equilibrium is a little bit more of a variable term for us. But I think those abnormal shocks to the system that we saw play out over the last year or so. We’re essentially seeing that those are behind us. And now, like everybody else, we can lean forward, go and kind of poke the customer level and take a look at what people are doing in innovation streams and start to plan our course from here.

Operator: Our next question is from Mike Halloran with Robert W. Baird.

Mike Halloran: So I want to follow up to both those questions Deane asked. So just to make sure I’m clear on what you’re saying on the life science analytical instrumentation side. You’re not necessarily saying that you’re expecting the end market to recover from here in some sort of linear fashion or anything like that? You’re just saying sell-in is at the point where it’s matching with sell-out? Or am I misinterpreting that?

Eric Ashleman: No, I think that’s good. You probably summarized it a little better than I did, but I was trying to make sure people can understand that context for us. Again, we’re — what’s really important to recognize here, we’re inside the life science instrument at the component level or inside the lithography instruments. So these are critical items, very fast replenishment. And so yes, I was describing us kind of unwinding a series of unnatural patterns, but we are now in sync. And we’re in sync and essentially open to the same variability that, that end market is at this point.

Mike Halloran: Exactly. And so as you get into next year, that’s where the variability hits, but at least the comps are easy starting from, call it, mid-4Q onward type range?

Eric Ashleman: Well, yes, certainly, as the year progresses, the comps get increasingly easier.

Mike Halloran: Got it. And then you talked about the short cycle side of things. From a destock perspective, that makes a lot of sense. Maybe higher level, how are you thinking about the economically sensitive parts of your business as we head into ’24? The risk profile, as you’re seeing in, doesn’t sound like the day rates are saying that there’s much worsening going on, but maybe some of that’s being clouded by the destock piece. So just some help as we think on a full [indiscernible].