AMETEK, Inc. (AME) Q3 2014 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the AMETEK Third Quarter 2014 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded Tuesday, October 28, 2014. I would now like to turn the conference over to Kevin Coleman, Vice President of Investor Relations. Please go ahead, sir.

Great. Thank you, Suzy. Good morning, everyone. Welcome to AMETEK's Third Quarter Earnings Conference Call. Joining me this morning are: Frank Hermance, Chairman and CEO; and Bob Mandos, Executive Vice President and Chief Financial Officer. AMETEK's third quarter results were released earlier this morning. These results are available electronically on market systems and on our website at the Investors section of ametek.com. A tape of today's call may be accessed until November 11 by calling (800) 633-8284 and entering the confirmation code number 21736047. This conference call is also webcasted. It can be accessed at ametek.com and at streetevents.com. The conference call will be archived on both of these sites. I will remind you that any statements made by AMETEK during the call that are not historical in nature are to be considered forward-looking statements. As such, these statements are subject to change based on various risk factors and uncertainties that may cause actual results to differ significantly from expectations. A detailed discussion of the risks and uncertainties that may affect our future results is contained in AMETEK's filings with the Securities and Exchange Commission. AMETEK disclaims any intention or obligation to update or revise any forward-looking statements. I will also refer you to the Investors section of ametek.com for a reconciliation of any non-GAAP financial measures used during this conference call. We will begin today with prepared remarks, and then we'll open it up for questions. I'll now turn the meeting over to Frank.

Thank you, Kevin, and good morning, everyone. AMETEK had an excellent third quarter, driven by strong execution of our Four Growth Strategies. We established records for sales, operating income, net income and diluted earnings per share in the quarter. As expected, Zygo integration costs incurred in the quarter were $13.7 million or $0.05 per diluted share. All financial results and commentary on the call today will be on an adjusted basis, excluding these integration costs. Now on to the third quarter results. Sales in the quarter were very strong, up 16% to $1.03 billion. Organic sales increased 3.5%, in line with our expectations, while acquisitions added 12.5% and currency was flat. Operating income for the third quarter was also very strong, up 13% to $231.8 million. Operating income margin in the quarter was 22.5% compared to 23% in the third quarter of 2013. Excluding the dilutive impact on operating margins of recent acquisitions, AMETEK's operating margins in the quarter were 23.4%, up 40 basis points from the prior year. Net income and diluted earnings per share were both up 19% over last year's third quarter to $152.5 million and $0.62, respectively, and diluted earnings per share were above the high end of our guidance range. Orders in the third quarter were $1 billion, up 6% from the prior year with 3% organic growth. Operating cash flow in the third quarter was excellent, up 18% to $197 million. Operating working capital was also very strong at 17.8% of sales, down from last year's third quarter of 18.2%. Turning our attention now to the individual operating groups. The Electronic Instruments Group had a great quarter. Sales were up 26% to $631.6 million on broad-based strength across our Aerospace, Process and Power & Industrial businesses plus the contributions from the recent acquisitions. Organic sales were up 4%, acquisitions added 22% and foreign currency was flat during the quarter. EIG's operating income increased 17% to $162 million, and operating margins were 25.6%. Excluding the dilutive impact on operating margins of recent acquisitions, EIG's operating margins were 28%, up 10 basis points from last year's third quarter. The Electromechanical Group also had a very strong quarter with excellent operating performance. Sales were up 3% to $400.2 million, organic sales were up 2% and foreign currency added 1%. Growth was driven by strength in our Precision Motion Control and Engineered Materials, Interconnects and Packaging businesses. EMG's operating income increased 6% to $82 million, and operating margins were 20.5%, up 60 basis points from last year's third quarter. Now turning to our Four Growth Strategies of Operational Excellence, Global and Market Expansion, New Product Development and Strategic Acquisitions. First, I will touch on New Product Development. We continue to increase our investment in RD&E to ensure our businesses are developing the right products to serve our customers and markets. In 2014, we expect to spend approximately $210 million, a 17% increase over 2013. Our CAMECA business continues to develop highly advanced elemental and isotopic microanalysis instrumentation for the high-end materials analysis markets. In the third quarter, they launched their latest generation in tomographic atom probes, the CAMECA Leap 5000. The Leap 5000 is the only materials analysis technology currently available that offers both 3D characterization and chemical composition analysis at the atomic scale. Improving on previous technology, the Leap 5000 has increased detection efficiency across a number of metals, semiconductors and insulators, delivering improved compositional analysis and detection limits. Our Taylor Hobson business, a leading provider of surface and form metrology instrument utilizing both contact and noncontact solutions, continues to expand our ultraprecision metrology product offering with the introduction of the Talyrond 500H. This new product is a highly advanced metrology instrument used to analyze surface finish, roundness and contour for use in a wide range of high-volume precision manufacturing applications. The Talyrond 500, offering industry-leading speed, accuracy and repeatability, uses rotary, vertical and horizontal measuring axes to duplicate a machine tool's environment and exactly reproduce the workpiece shape, enabling precise control of manufacturing processes. Lastly, AMETEK's Chandler Engineering business, which provides testing instrumentation for the upstream oil and gas market, has launched the Model 3300 In-Line Viscometer. This viscometer is used for real-time on-site viscosity measurements of fracturing fluids, an increasingly important measurement driving improved efficiency in the completion of oil and gas wells. The Model 3300 is ruggedized to withstand harsh field conditions while providing operators with continuous, real-time measurements of the viscosity and temperature of fracturing fluids. We are seeing strong demand for this new viscometer. From an overall perspective, revenue from products introduced over the last 3 years was 23% of sales in the third quarter, up from 21% in last year's third quarter. Now turning to our second strategy of Global and Market Expansion. Global and Market Expansion continues to be important driver for AMETEK's long-term growth as we are increasingly expanding our presence in attractive, higher-growth market segments and geographic regions. In the third quarter of 2014, international sales represented 53% of our total sales. We saw solid growth in the BRIC countries in the third quarter with continued strong growth in China, where organic sales grew mid-teens on a percentage basis. The growth in China was broad based across our businesses and reflects the benefits of our continued focus on expanding our sales, service and distribution capabilities in this region. We will continue to make investments to develop and expand our global sales channels, service capabilities and manufacturing footprint in order to position our businesses to capitalize on the attractive long-term global growth opportunities. Now turning to our third strategy of acquisitions. We continue to see great success with our acquisition strategy. Thus far in 2014, we have completed 5 acquisitions, deploying approximately $570 million -- $575 million in capital and acquiring over $285 million in revenue. Over the last 15 months, we've acquired 8 businesses, deployed approximately $1 billion in capital and acquired approximately $460 million in revenue. Our acquisition pipeline remains strong, and I expect you're going to hear from us hopefully before year end. I will provide some background on our most recent acquisition, AMPTEK, which we completed in the third quarter. AMPTEK is a privately held manufacturer of instrumentation and detectors used to identify composition of materials using x-ray fluorescence. Its products are sold to OEMs that manufacture nondestructive testing devices to measure elemental composition in metal production, pharmaceutical products, electronics and environmental samples. AMPTEK is an excellent strategic acquisition as it provides us with attractive sensor and detector technology as well as strong research and development capabilities, which will help to accelerate future technology developments for our served market. They're headquartered in Bedford, Massachusetts and has annual sales of approximately $30 million. We're quite pleased with the pace of our acquisition activity over the last 15 months. More importantly, we're excited about the quality of the businesses we acquired during that time and the great strategic fit of these businesses within AMETEK. The integration of these recent acquisitions has gone very well. We'll continue to capitalize on our strong core competency of acquiring and integrating high-quality businesses while looking to expand our presence in attractive market segments. Lastly, I will touch on Operational Excellence. We continue to see excellent results from our various Operational Excellence initiatives. Our management teams and employees continue to do a great job driving operational improvements through their businesses by leveraging the numerous Operational Excellence tools we have in place throughout the company. Operational Excellence activities include Lean Manufacturing, Six Sigma in our factory and back-office operations, Design for Six Sigma in our New Product Development efforts, global sourcing and strategic procurement initiatives, movement of production to low-cost locales and value engineering. Through our global sourcing and strategic procurement initiatives, we recognized $19 million in savings in the third quarter and have recognized approximately $53 million in incremental savings thus far in 2014. As a result of the continued strong efforts of our team, we expect approximately $100 million in total cost savings in 2014 through our various Operational Excellence initiatives, including $70 million in savings through our global sourcing and strategic procurement initiatives. This is an increase in total cost savings from our prior estimate of $95 million. Turning now to the outlook for the remainder of 2014. The global growth environment remains sluggish. For all of 2014, we continue to expect revenue to be up low double digits on a percentage basis from 2013, reflecting low- to mid-single-digit organic growth and the contribution from recent acquisitions. Earnings for 2014 are expected to be in the range of $2.40 to $2.42 per diluted share, up 14% to 15% over 2013. We raised the low end of our previous guidance from $2.37 to $2.40 per diluted share. Fourth quarter 2014 sales are expected to be up high single digits on a percentage basis from last year's fourth quarter with organic growth up low to mid-single digits. We estimate our earnings to be approximately $0.60 to $0.62 per diluted share, including the additional interest expense associated with our recent private placement and expected foreign currency headwinds. This guidance represents a 9% to 13% increase over last year's fourth quarter. So in summary, we delivered excellent results in the quarter. Our balance sheet remains strong, and we generate significant cash flow that provides us with plenty of liquidity to operate the business and pursue our acquisition strategy. Our excellent portfolio of businesses and our focus on driving success through our Four Growth Strategies should enable us to continue to deliver strong and consistent earnings growth. Bob Mandos will now cover some of the financial details, and then we'll be happy to answer your questions. Bob?

Thank you, Frank. As Frank noted, we had a great third quarter with strong overall results. I will provide some further details. In the quarter, core growth in selling expenses was in line with core growth in sales. General and administrative expenses were 1.2% of sales versus 1.3% of sales in last year's third quarter. In the quarter, as was contemplated in our guidance, were onetime events benefiting the tax line, which were largely offset by a related negative impact in other expense. For 2014, we expect our tax rate to be approximately 28% as a result of our ongoing international and state tax planning initiatives and the third quarter tax benefit, as just highlighted. As we've said before, actual quarterly tax rates can differ dramatically, be it positively or negatively, from this full year rate. On the balance sheet, working capital, defined as receivables plus inventory plus payables, was 17.8% of sales in the quarter versus 18.2% in last year's third quarter. Strong working capital management will remain a key priority. Capital expenditures were $18 million for the quarter. Full year 2014 capital expenditures are expected to be approximately $70 million. Depreciation and amortization was $37 million for the quarter. 2014 depreciation and amortization is expected to be approximately $142 million. Operating cash flow was $197 million in the third quarter, up 18% over last year's third quarter. The free cash flow was $179 million in the quarter or 126% of net income, up 19% over last year's third quarter. For the full year, we expect free cash flow to be approximately 110% of net income. Total debt was $1.64 billion at September 30, up $222 million from the 2013 year-end, largely the result of the Zygo acquisition. Offsetting this debt is cash and cash equivalents of $370 million, resulting in a net debt-to-capital ratio at September 30 of 26.8%. At September 30, we had approximately $1.2 billion of cash and existing credit facilities to fund our growth initiatives. This amount reflects the private placement agreement we entered into on September 30 to sell $700 million of senior notes. The initial private placement funding of $500 million received on September 30 was used to pay down our revolver balance. The remaining funding of $200 million will be received in 2015 with the proceeds expected to be used to pay down term debt due at that time. The private placement had a weighted average interest rate of 3.88% and was well received by our lenders. It provides AMETEK with a larger financing capacity and increased flexibility to support our growth initiatives. In summary, we had a very strong third quarter. We are well positioned for further growth, both organically and through acquisitions, with a strong balance sheet and cash flows.

Great. Thank you, Bob. Suzy, we're now happy to open it up for questions.

[Operator Instructions] Our first question coming from the line of Allison Poliniak with Wells Fargo.

Frank, just given the changing dynamics in crude prices here, could you maybe walk us through how we should think about your energy-related businesses in this kind of environment?

Yes, sure, Allison. Obviously, the price of crude has come down. Yesterday, it dipped for a while even below $80 a barrel but did end up above $80 a barrel. If there's going to be any impact, and I must say we have not seen any as of yet, do we -- I have talked to all of our energy-related businesses, and they have not seen anything yet in terms of any impact. I think one way to look at the possible impact is to look at our upstream business. Our upstream business is about $125 million of sales. So if less oil wells are going to be drilled, we could see some impact on that segment. But I think the very encouraging thing here, and you've heard me talk to this over the last several quarters, is that there has been a rebalance in terms of our Process businesses in general, where, as a result of recent acquisitions as well as just the fact that the Oil & Gas business is a small part of the Process businesses, our unrelated Oil & Gas businesses have been doing extremely well this year. And if we go back to like last year, our Oil & Gas businesses were sort of a driver for the Process growth. And as we enter this year, that was no longer true, actually, even before this drop in oil prices. And there's been a sort of a rebalance, and we're getting extremely good growth out of our Ultra Precision Technologies business, our Materials Analysis business and our Measurement & Calibration Technologies business, which has rebalanced the Process area so that our growth remained good in the third quarter. It was up organically mid-single digits. And also, with the acquisitions we've done, it was up actually 25% in the quarter. So there could be some impact, but we don't believe it's going to be significant in terms of AMETEK's overall performance.

That's great. And then just turning to the vitality index that you talked about with New Products. It's certainly been ticking up, which one would expect with your RD&E expense. But is there any way, I don't even know, to look at it, sort of acquisitions, what you've done recently? Is that causing that number to tick up maybe a little bit more than we would have expected on an organic basis?

Yes, I think that's a good analysis, Allison. There's no question that the acquisitions that we have done over the last couple of years are much more technology focused, and they are basically winning in the market based on technology. And their investment levels are a bit higher than what AMETEK has historically been, which is really inherent in our strategy to keep moving the level of differentiation of our businesses at sort of up that differentiation curve. And as a result, this vitality index continues to creep up. And 23% is a pretty high number for any sort of industrial -- multi-industry company. It's obviously low with respect to full technology companies like sort of on the West Coast. But in terms of our type of company, it's a very, very good number. We're going to continue to invest. We think it's the key reason why our profit margins are where they are.

Our next question coming from the line of Mark Douglass with Longbow Research.

Bob, housekeeping on payables.

Yes,$382 million.

$382 million. Okay. And Frank, you said orders were up 3% organically?

That's correct.

Okay. What was your backlog?

Backlog was $1.22 billion, and that was up about $75 million from the beginning of the year.

Okay. Can you go through your walk on the different businesses in the quarter and what you're expecting in 2014?

Sure. Sure, I'd be glad to, Mark. So let's start with EIG, and I'll start with EIG Aerospace. They had another really good quarter. Sales were up mid-single digits on a percentage basis, and that was driven by continued strength in both commercial aerospace and our business -- and regional jet business. The business and regional jet business benefited significantly from excellent growth in the mid- and high-end business jet as well as the commercial helicopter markets. We have helicopter sales in that business and regional jet sort of segmentation. We expect continued strong performance in EIG Aerospace in the fourth quarter. And for all of 2014, Aerospace in EIG should be up mid-single digits. Moving to Process, our Process businesses had an excellent quarter. As I mentioned in response to Allison's question, overall sales were up about 25%. Organic sales were up mid-single digits on a percentage basis, driven by strong performance in Ultra Precision Technologies, Measurement & Calibration Technologies and our Materials Analysis businesses. The overall growth benefited from the 6 recent acquisitions in this business, which are AMPTEK, Zygo, Luphos, VTI Instruments, Creaform and Controls Southeast. And for the full year, we expect our Process businesses to grow mid-teens overall with organic growth up low to mid-single digits. And the last part of EIG, our Power & Industrial businesses, had really a great quarter. Overall sales were up 40% as a result of mid-single-digit organic growth and the contributions from the acquisitions of Powervar and Teseq. Organic growth was strong of both -- across both the Power and the Industrial businesses. We're expecting overall sales for Power & Industrial to be up about 30% in 2014 with organic growth up low to mid-single digits. So if you take those 3 sub-segments in EIG, for all of EIG we expect overall 2014 sales to be up high teens on a percentage basis with organic growth up low to mid-single digits. Moving to the other part of the company. In EMG, our differentiated EMG businesses had a very good quarter, sales up mid-single digits on a percentage basis. We saw strong growth in our Precision Motion Control and Engineered Materials, Interconnects and Packaging businesses. And for all of 2014, we expect our differentiated EMG businesses to be up low to mid-single digits. And the last part of our company, which is Floorcare & Specialty Motors, sales in our Floorcare & Specialty Motors businesses were down mid-single digits in the quarter against a pretty difficult comparison from the prior year. And for all of 2014, we expect sales for this business to be roughly flat. And if you saw in those 2 parts of EMG, for all of EMG we're expecting overall growth to be low to mid-single digits in 2014. And thus, if you take EIG and EMG, as I mentioned in my opening remarks, for AMETEK as a whole in 2014, we're expecting this low double-digit sales growth with organic growth up low to mid-single digits. And that walks you through, Mark.

Our next question coming from the line of Scott Graham with Jefferies.

So I was wondering what the fourth quarter impact of the private placement interest was versus what you kind of had in your guidance before. That would be helpful.

Yes, there's 2 things that were -- affected our estimates in the fourth quarter. One was the private placement, and that was about a $0.01. And the other was foreign exchange because as you know, the foreign exchange rates have moved quite considerably. And using the September 30 rates on foreign exchange, we basically have another $0.01 of hurt in the quarter. So if you take those $0.02, which we -- really, we're not counting on having those issues, but we were able to overcome them with both -- some sales performance improvements as well as improvements on the Operational Excellence side. If you'll notice, we raised our guidance in terms of the amount of cost savings we're putting through the P&L from that $95 million up to the $100 million level. If it weren't for those 2 items, we would have been able to increase our guidance.

Yes, got it. My follow-up question is you're kind of signaling that you're close to the alter on something again potentially for the fourth quarter. I was just wondering, Frank, if there's any possibility of getting a little bit more color on that, like which division you're looking at to add to. And if at all possible, is this sort of AMPTEK size? Is it Zygo size? Is it something in between?

Well, we're looking actually at a couple of different possibilities right now. And we are in active conversations and I think within the next day, we'll be in active due diligence on another -- of business. I'm hesitant to give too much color on it, but I can tell you that both of these businesses do happen to be on the EIG side of the business. And they're both really, really good businesses, and -- but I'm -- I just don't want to give any more color on these because obviously, we're under confidentiality agreements in terms of these 2 deals. I think that really, the key message here also is that acquisitions are really a process at AMETEK and that we are just continually doing this. And where other companies have been having difficulties over the course of the last probably 2 years, I think you'll notice or Ken noticed that we have been able to do a large number of deals and buy them at reasonable multiples even though we all know the pricing of deals has gone up. And I think it really reflects the fact that we have a very, very solid process that we're continually looking at deals, continually filtering deals. And whether we close a deal in the fourth quarter, we may or we may not if something doesn't go as we expect. But the point is if we don't, we'll close something else in the first quarter. So it's just a continual effort, and we're just going to keep doing this. We think it's the best way to deploy capital and get a return on that capital. That will continue to push our stock price in a positive direction.

[Operator Instructions] Our next question coming from the line of Richard Eastman with Robert W. Baird. Richard C. Eastman - Robert W. Baird & Co. Incorporated, Research Division: And could you just talk through a minute or 2 about geographic growth? I mean, you really flagged some impressive growth out of China. How did the other regions look on a core basis, U.S., Europe, against that 3.5% core growth rate?

Sure, Richard. If you look around the world, the U.S. was up about 5%, Europe was up about 1% and Asia was up about 5%. If you look outside of China -- china was actually up 17% organically. And if you look outside of China in both Korea and Japan, we had some very difficult comparisons to last quarter. So that's why that Asia growth is maybe a little bit lower than what you would expect given our China performance. The U.S. continues to get a bit better, and -- which is good. I believe that's the highest organic growth we've had in the U.S. in a while. And Europe is a little bit weaker, and I think it generally reflects the economic situation that is going on in Europe. Richard C. Eastman - Robert W. Baird & Co. Incorporated, Research Division: And does the Asian business in general and China in particular, does AMETEK lead there with their EIG business?

Yes, I would say the EIG businesses are definitely the leader. We have done a tremendous amount, and the team has really done some good work in continuing to expand our distribution channels there for the EIG businesses. But I must say that our EMG businesses are also starting to penetrate quite significantly. Obviously, our Floorcare business has been there for a long time, and we are manufacturing products there for the Floorcare business. But also, our Engineered Materials, Interconnects and Packaging businesses has a plant in Malaysia, and they are starting to have really good penetration in Asia. And also, our Precision Motion Control business, both through the acquisition of Dunker in Germany, which have substantial sales in Europe, as well as our original PMC business, which was predominantly U.S.-based, has expanded quite well. So I think your comment is right that the leadership and the penetration came and is coming from EIG, but EMG is also starting to realize really good opportunities there. And as we look across the regions, even though there's been a lot in the press about slowing organic growth in Asia, those numbers are still a lot higher than anyplace else in the world. And therefore, we're going to continue to invest and continue to get our fair share of the business there. Richard C. Eastman - Robert W. Baird & Co. Incorporated, Research Division: Okay. And then just as a follow-up, Frank, when you look at the business today, and obviously kind of the intermediate-term kind of business environment is just very hazy. I mean, we've got this oil and gas noise out there. I noticed your EMIP business has perked up, which might be more of a later-cycle business. But how do you just get your arms around business conditions globally here? I mean, do you feel we're kind of in this mid-cycle malaise a little bit? Or how do you -- are any of your businesses kind of picking up?

Yes, it's a great question, Richard. And I think the best way to characterize it is if I look at the total global environment right now, I wouldn't use the word hazy because I think when we went back in time, some of the downturns were what I would call hazy. Here, I think we know what is occurring. We know the U.S. is getting better. We know there's substantial opportunities in the Far East, which we're capitalizing on. We know Europe is a bit weaker. So we're just going to capitalize on what we see in terms of that market and where -- markets -- and where we're investing. So we're going to put more investment in the Far East, we're going to put more investment in the U.S. and we're not going to put quite as much in Europe. And yes, your question regarding specific businesses, we have just tremendous balance in our businesses. And I think it's one of the advantages that AMETEK has had for many, many years in that we're not really tied to any one segment significantly. And therefore, when oil and gas starts to shake a little bit, yes, that could have maybe a bit of a negative impact. But heck, Aerospace is doing just great. When you've got this huge backlog at Boeing and Airbus, 8-year backlogs, we're doing tremendously well in the business in regional jet sector, and that sector really hasn't even come back from a market viewpoint. So that's one that we are starting to see accelerated growth and have actually seen accelerated growth through our New Product Development activities. And we expect the market is going to start to turn up, and you're feeling some of that now. Some of the reports in this quarter from some of the business jet manufacturers are starting to see some -- production go up. And it's not going to be at the levels, say, of 2007 in the near term, but the growth rates are really good. So that's the part of our business that I feel very, very good about. And yes, to your point, Engineered Materials, Interconnects and Packaging business is definitely in a rebound mode. Our Precision Motion Control business is doing extremely well and they're growing at a nice clip. So I'm not sitting here in what I call a hazy environment. I wish the growth worldwide was about 4 or 5 points higher, but you sort of deal with it and it also plays to our strength on the Operational Excellence side. When you don't have the 7% and 8% and 9% organic growth, you've got to get the earnings through Operational Excellence. And we're pretty good at that and we're just going to continue to make continued improvements in terms of the efficiency of the business. Richard C. Eastman - Robert W. Baird & Co. Incorporated, Research Division: Okay. And the environment seems to be strong enough here. Are you still generating kind of the 1.5 points to 2 points of price underneath?

Yes. Yes. Richard C. Eastman - Robert W. Baird & Co. Incorporated, Research Division: Okay, so that's still there as well.

Thank you. Mr. Coleman, there are no further questions at this time. I will now turn the call back to you. Please continue with your presentation or closing remarks.

Great. Thank you, Suzy. And thank you, everyone, for joining our call today. As a reminder, a replay of the call may be accessed at ametek.com and at streetevents.com. And as always, if there's any questions, I am available at (610) 889-5247. Thanks again.