Good day and welcome to the AMETEK's Third Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentations, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Kevin Coleman, Vice President of Investor Relations and Treasurer. Please go ahead.

Thank you, Abigail. Good morning and thank you for joining us for AMETEK's third quarter 2023 Earnings Conference Call. With me today are Dave Zapico, Chairman and Chief Executive Officer and Bill Burke, Executive Vice President and Chief Financial Officer. During the course of today's call, we will be making forward-looking statements, which 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 risk and uncertainties that may affect our future results is contained in AMETEK's filings with the SEC. AMETEK disclaims any intention or obligation to update or revise any forward-looking statements. Any references made on this call to 2022 or 2023 results or to 2023 guidance will be on an adjusted basis, excluding after-tax, acquisition-related intangible amortization. Reconciliations between GAAP and adjusted measures can be found in our press release and on the Investors section of our website. We'll begin today's call with prepared remarks by Dave and Bill, and then we'll open it up for questions. I'll now turn the meeting over to Dave.

Thank you, Kevin, and good morning, everyone. AMETEK delivered excellent results in the third quarter, highlighted by outstanding operational execution, superb margin expansion, strong cash flows and earnings ahead of our expectations. In the quarter, we established records for operating income, operating margins, earnings per share, EBITDA and cash flows. Given these strong results and our outlook for the balance of the year, we have again, increased our earnings guidance for the full year. We have also been very active on the acquisition front. During the third quarter, we completed the acquisition of United Electronics Industries and subsequent to the end of the third quarter, we acquired Amplifier Research. Today, we also announced the signing of a definitive purchase agreement to acquire Paragon Medical, a highly attractive acquisition, which broadens our exposure in the Medical Technology space. I will provide more details on these acquisitions shortly. Now let me turn to our third quarter results. Third quarter sales were $1.62 billion, up 5% over the same period in 2022. Organic sales growth was flat. Acquisitions added four points in the quarter and foreign currency added one point. Book-to-bill in the quarter was 0.96. We ended the quarter with a very strong backlog of $3.4 billion, near record levels and down a modest 2% sequentially. Our backlog is up 5% from last year's third quarter and up 23% or $640 million from the end of 2021. AMETEK's operating performance in the third quarter was exceptional. Operating income in the quarter was a record $438 million, a 14% increase over the third quarter of 2022. Operating margins were a record 27% in the quarter, up a sizable 220 basis points from the prior year. EBITDA in the quarter was also a record at $511 million, up 10% over the prior year, with…

Thank you, Dave. As Dave noted, AMETEK delivered outstanding results in the third quarter, with exceptional operating performance, robust margin expansion and strong cash flows. Let me provide some additional financial highlights for the quarter. Third quarter general and administrative expenses were $24.6 million essentially unchanged from the prior year, and as a percentage of sales, were 1.5% versus 1.6% in last year's third quarter. For 2023, general and administrative expenses are expected to be approximately 1.5% of sales, in line with last year's G&A to sales level. Other income and expense was a headwind of $9 million in the quarter, due largely to lower pension income and higher due diligence costs. The effective tax rate in the quarter was 17.7%, down from 19% in the third quarter of 2022, due to improved utilization of tax credits. For 2023, we now anticipate our effective tax rate to be between 18.5% and 19%. And as we stated in the past, actual quarterly tax rates can differ dramatically, either positively or negatively from this full year estimated rate. Capital expenditures in the third quarter were $29 million, and we continue to expect capital expenditures to be approximately $145 million for the full year or about 2% of sales. Depreciation and amortization expense in the quarter was $82 million. For the full year, we expect depreciation and amortization to be approximately $330 million, including after-tax, acquisition-related intangible amortization of approximately $157 million or $0.68 per share. Operating working capital in the third quarter was 19.1% of sales. Cash flow was excellent in the quarter with outstanding growth versus the prior year. Operating cash flow was a record $473 million, up 45% versus the third quarter of 2022, while free cash flow was also a record at $444 million, up 49% over the prior…

Thank you, Bill. Abigail, could we please open the lines for questions?

Thank you. [Operator Instructions] Our first question comes from Deane Dray with RBC Capital Markets. Your line is open.

Thank you. Good morning everyone.

Good morning, Deane.

Hey, congrats on all the M&A successes here. Maybe we can start with Paragon. It looks right in your wheelhouse, precision medical robotics. If you could provide some color on the company in terms of like what percent are consumables? We're really like seeing all those one use applications. So consumables, comment on margins and growth, if you could, please?

Yes. Sure. I'll give you my view of Paragon. As you stated, the leading provider of highly engineered medical components and instruments. When you look at the key market drivers of this acquisition, you have the aging population, the demographic shifts, you also have procedure innovation, where the minimally invasive procedures are becoming more percentages of surgeries, and they do a great job with that. And also in this market, there's a continuing trend toward outsourcing the OEMs. And they want to -- the OEMs want to accelerate their time to market, and Paragon is really well positioned with significant new product wins in this space. It serves specialty applications. I talked about the orthopedics, minimally invasive surgery, robotic surgery and drug delivery. Orthopedics is the largest, but they're strong positions in each of the applications. Now, the portfolio is one of your questions, consisted of single-use and consumable surgical instruments and implantable components, and about 40% of the business is recurring in nature. So the single-use and consumables surgical instruments are about 40% of the revenue. So we really like that. As a blue-chip customer base, over 600 programs, with diverse sources of revenue, about 85% of the business is on sole-source programs. It's a very, very sticky business. When you combine the regulatory environment with lengthy approval processes and the capabilities of Paragon, there's high switching costs. It's a business that has unique value to its customer base. We did a lot of surveys in the market, and they're the highest quality provider. They have excellent customer service. A differentiator for them is their design and development capability. And I really considered a true partner by their customers. And when I look at this from -- that's about Paragon, when I look at what it does for AMETEK,…

All right. That was a great overview, and you hit all the key questions on the consumables, margins and growth. So it sounds like a great story. And if I could just -- on a follow-up question on EMG. So we're seeing destocking all over the sector in biopharma and med tech. Be interested in hearing from you, besides the destocking, is there any kind of read-through on the end markets in those businesses? Are you seeing any slowing there? And look, no one's getting -- no one has a crystal ball here in terms of how long you think this lasts, but I'd love to hear your expectation on the duration of this inventory normalization. Thanks.

Yes. Sure, Deane, great questions. For the quarter, we grew our top line 5% on a mid-single-digit guide. Our revenue was in line with the guide. The acquisition performed a bit better. And we maintained, as I said, our full year sales guide mid-to-high single-digits and organic growth of mid-single-digits. To maintain that organic guide for the full year, our Aerospace and Defense business is stronger and our automation is weaker. And they're offsetting. That's one of the benefits of the AMETEK portfolio. And specifically in terms of Q3 revenue, we saw faster destocking in our automation businesses than we anticipated. So that's what we saw there. And we expect the destocking to continue through the end of the year. In terms of your question is, is it a, destock or a downturn? It's very difficult dynamic environment right now and lots of uncertainties, with the geopolitical risk, the interest rate increases. They're factoring in, for sure. But from what we see, this is largely an inventory correction. And demand looks constructive, with many new projects in the offing and the projects are not being delayed or canceled. Our Aerospace and Defense looks solid. Our Medical looks solid, significant projects and semiconductor, clean energy, power grid. So we remain positive post-destocking. And we think that destocking will continue through the end of the year. And in terms of 2024, we're going to sit down with our teams and understand what's going on. But in general, we're constructive.

That's all really helpful. Thank you.

Thank you, Deane.

Our next question comes from Matt Summerville with D.A. Davidson. Your line is open.

Thanks. Good morning.

Hi, Matt.

Dave, your EIG margin this quarter really moved into a new ZIP code for AMETEK. I was wondering if you could maybe talk about the key drivers as you just think about the sequential performance, right, Rev flat, profitability up $28 million on the OP line as well as kind of the year-over-year dynamics, so maybe if you can just kind of flesh all of that out, that would be helpful. And then I have a follow-up.

Yes. Sure, Matt. I mean if you'll go back and look at my last quarter or two, I told you EIG, was gaining momentum, and the momentum certainly showed up in Q3. We had an excellent operating quarter. I mean EIG margins were up 360 basis points, driven by high contribution leverage on the growth. We really had excellent price cost. We had strongly performing acquisitions and it all came together to put up record margins.

And then, just as a follow-up. With respect to Paragon, I appreciate the stats you shared. Is there any way to kind of parse out what you think year one cash EPS accretion would look like? And then what the expected closure timing might be for that? Thanks.

Great questions, Matt. We think the closure -- it's dependent on regulatory approval, but nothing atypical. But we think -- we'll get the approvals and close sometime in the first quarter. In terms of year one, yes, we'll have a very modest cash EPS accretion. It's going to be impacted by purchase accounting, integration costs, realignment cost to financing costs, we'll pay with this with a mix of cash and debt. And -- but we'll have very strong accretion in year two. And we're excited about getting the business under our wing, improving the business and delivering and we're very excited.

Just real quick, Dave. So you're not planning to non-GAAP those items out, you're just going to run them through the P&L then?

We'll make that decision at the time. Historically, we have not broken them out, but with the amount of acquisition activity that we have. It may make sense to do that. We haven't made a decision yet.

Got it. Thank you guys.

Our next question comes from Allison Poliniak with Wells Fargo. Your line is open.

Hi. Good morning.

Good morning, Allison.

Just want to go back to your comments on automation. If I recall, that's typically a canary in the coal mine. But it seems from your comments what I'm reading through, I just want to clarify that it just seems to be more industry destocking for you in that market? Or was it something that -- I want to make sure I understand.

Yes. We think it's destocking. We think it's destocking. And the destocking last through the year-end. And -- but post destocking, we remain constructive. We are -- that business automation sells to a lot of markets and the health care part of that market is not doing well right now and some of the other exposures, but we think it's clearly destocking.

Got it. And then on growth investments, keeping to the $100 million, how should we be thinking about into 2024? Is it something that you think there could be a raise there? And then just even with Paragon, what that R&D? I think you talked about the design piece of it being very -- a big part of that, how does design in R&D? Is it higher than the typical AMETEK? How should we be thinking about?

I think you should think about Paragon is matching the AMETEK profile.

Got it. And then organic investments as we kind of look to 2024 is...

Yes. I mean we're going to sit down with each of our teams, discuss 2024 over the next six weeks. We're going to review each of the individual businesses. We do deep dives, as you know, into what they are seeing in their niches, their market dynamics, growth opportunities, cost reduction opportunities, and we want to go through that -- these meetings before there's any commentary in 2024. We'll tell you in early February. But -- so in terms of talking about next year, we'll have the typical things like we expect price to offset inflation and CapEx will be about 2% of sales and things like that. But we're going to defer from talking about the overall plan until we get to meet with our teams and understand at a detailed level.

Perfect. Thank you.

Thank you, Allison.

Our next question comes from Jeffrey Sprague with Vertical Research Partners. Your line is open.

Hey. Thank you. Good morning, everyone.

Good morning, Jeff.

Good morning, Dave. Just to come back to Paragon, maybe one more time. Maybe somebody else will come at it again. I just kind of want to understand the -- maybe the profit improvement plan going forward. Because it looks like rough math right, margins, EBITDA margin is 25% or so. You're doing 800 to 1,000 bps better now than that in EIG. When you talk about kind of the aspirations for the business and the cost cutting and other opportunities, is that the sort of Zip code and margin improvement we should be thinking about here? And if so, over kind of how long a period of time?

Yes. That is the Zip code and it's over time. And we're going to build a plan with the management team and show them all the resources that AMETEK has and some of our business processes. But what you're talking about is in the Zip code of what we have planned.

And just to elaborate a little bit more on how this fits. Is there a kind of a commercial or operational synergy with other parts of the business? Or should we just think of this as an interesting, healthy kind of stand-alone business that drops into the portfolio?

We have an existing business in our EMG business. It's about a $200 million business. It's -- or called our engineered medical components. So we're familiar with these segments. There's completely different end markets, but think about that as additive to that existing position, but in a greater scale.

And then maybe just one last one from me. The med tech world has been a little rocky here the last couple of years, procedures post-COVID everything. You characterized it as a double-digit secular grower. But are they kind of sitting in a little bit of a trough here impacted by those sorts of forces? Or maybe just kind of the...

Not really. They're growing nicely. I mean you have the market growth that they're benefiting from, and they happen to be in the fastest areas. They've deployed their resources well and they're benefiting from the faster fastest growth areas. The -- there's -- they're winning new business on new programs, it's pretty substantial. And we did surveys on these businesses, and this is a really good business in terms of their capability and how they take care of their customers, and they're definitely winning share. So, it's going to be a low double-digit grower for the next few years, and a lot of that's programmed in. Now that's the way we're looking at. There's going to be ups and downs as we go throughout the years, but this is a solid business with really good growth prospects.

Great. Congrats and good luck with it.

Our next question comes from Scott Graham with Seaport Research Partners. Your line is open

Hi, good morning. Thanks for taking minute here. Nice quarter.

Good morning, Scott. Thank you.

You just -- a couple ideas filled what was the working capital percent last year?

Give me one second on that.

Sure. Sure. I'll just -- I'll ask another one.

I got it. It was 18.4.

18.4. Okay. Thanks. And then the $1.5 billion of availability, just maybe walk us through there. That is net of Paragon, I assume? And is that like an assumption at about 2.5 times leverage?

No, that's the amount of cash and availability under our revolver post-Paragon. The leverage post-Paragon would only be about 1.5 times EBITDA at the gross level. So substantial …

Okay.

--financial flexibility as well as we're still well under-levered I would say. And as Dave has talked about, lots of other opportunities available to us as we look to continue the acquisition strategy. So again, it's always finding the right businesses for the AMETEK portfolio. It is not capital constrained.

Right. Right. Yes, that's how you do that as well.

Other way to make that--

I guess--

Other way to make that--

Sure.

Other way to make that, as Bill said, post-Paragon, we have 1.5 leverage, we wanted to take at up to 2.5 leverage, which is we've been there before, and that's not a high number for all. We can spend $2.6 billion on acquisitions, above and beyond Paragon. So we're in the M&A game, and our pipeline looks really good. And we have the balance sheet to be able to execute on it and the capability to integrate these businesses.

Thank you for that. I appreciate it. When you are looking at deals these days in this interest rate environment, you're obviously funding them off of a lot of balance sheet liquidity and admittedly, maybe now higher rates off of the revolver. But are you impute an interest rate that is kind of more market-oriented when you make these decisions?

Yes. Our models use current borrowing rates as part of that decision-making process.

Got it. Thank you. Last question is the typical one, Dave, would you mind kind of maybe unbundling on the four divisions?

Sure, Scott, I'll walk around the business. I'll start with our Process business. And -- overall, sales for Process were up mid-single-digits, at low single-digit organic sales and the contribution from the acquisition of Navitar. And demand across our Process markets remains solid. Our products and technologies are well aligned with important secular growth trends like the energy transition and health care. Growth in the quarter was strongest across these end-markets, while our high-end optics business in Zygo continues to perform very well, with strong demand for our custom optical solutions. And for the full year, we continue to expect mid-single-digit organic sales growth for our Process businesses. Going to Aerospace & Defense Next. Aerospace & Defense continues to perform well. Organic sales were up low-double digits in the quarter. Growth remains strong and broad-based across our A&D sub-segments. Our growth in the quarter was strongest in our defense businesses, while commercial OEM and aftermarket businesses also grew at healthy levels. Given this strong performance, we now expect sales for Aerospace & Defense to increase mid-teens, on a percentage basis for the full year. In Power & Industrial, those businesses delivered solid results in the third quarter, with overall sales up mid-teens. This growth was driven by a low single-digit organic sales growth and the contribution from the acquisition of RTDS technologies. We saw the strongest growth in the quarter across our renewable Energy and Power Simulation businesses, including RTDS. Our Power businesses are well positioned to benefit from long-term investments required to modernize the electric power grid and build-out of the renewable energy infrastructure globally. And for all of 2023, we continue to expect mid-single-digit organic sales growth for our Power business. And finally, our Automation & Engineered Solutions business. Overall sales for AE&S, were down mid-single-digits in the quarter, with contributions from the acquisition of Bison Engineering, being more than offset by a low double-digit decrease in organic sales. As we expected, the impact from normalization of inventory levels, which we talked about earlier, across our OEM customer base, combined with the challenging prior year comparisons, created a short-term headwind for our OEM exposed businesses. We believe underlying demand is solid. As we talked about earlier, and across our diverse Automation & Engineered Solutions markets, we remain constructive. But we do expect, as we said before, the inventory normalization is going to recur throughout the OEM customer base will continue through the end of the year. And now for the full year, we expect organic sales for our Automation & Engineered Solutions businesses to be down mid-single-digits versus the prior year. So that's all for the subsegment commentary here, Scott.

Thanks very much.

Thank you, Scott.

Our next question comes from Nigel Coe with Wolfe Research. Your line is open.

Thanks. Good morning and congrats on the deal, deals even. Okay. So good morning. Can you hear me?

Yes. We can hear you Nigel.

Okay. Good. I couldn't hear you. Okay. So maybe you could do the same process geographically, talk about what you're seeing by geography. I'd be curious about Europe and China. And also, you gave some perspective on business performance. Maybe you could talk about -- maybe just for a final point on 4Q, maybe talk about core growth and acquisition and contribution for 4Q?

Okay. Q4 and geography. Okay. I'll go across the geographies. We had continued solid growth in the US, with the international slowing a bit. So I'll unpack that a bit. The US was up mid-single-digits, with notable strength in our process business. Europe was down low single-digits, notable strength in process and our aerospace business, but weakness in automation. You mentioned China. Our China exposure was down 3%. Strong growth in process weakness in automation. And overall, Asia was down about 10%. So China did better than overall Asia, kind of about 9% of sales. So again, up in the US, slowing in international markets. And the second question you asked was on Q4 and the guide for Q4. And our sales will be up mid-single-digits. We'll grow in revenue. There are two factors impacting the earnings in Q4. One of them is a higher tax rate. And the second one is there's some acquisition, integration costs and they're related to the deals we completed. But we're very confident in our guide for Q4.

I'm sorry, David, what is the core growth for 4Q?

Core growth for Q4 was low to mid-single-digits.

Okay. So that's obviously acceleration from 3Q. What's driving that acceleration?

I think we're seeing some good demand on the EIG side from the typical year-end selling -- year-end sales that we typically get of capital spending, plus the EIG business is performing well. So our aerospace and our process businesses are performing well, and that's what driving the organic sales in Q4 to be higher than the organic sales in Q3.

Got it. That's helpful. Maybe just one more for me. So obviously, Paragon, big deal. You've posed another smaller deal. You sound really bullish on the outlook as well. So it seems like the cut line is still pretty fertile. I mean are we seeing here a change in behavior from sellers that we see more willing sellers? Are we seeing any change in sort of multiples here? Any color on the market would be helpful.

Yes, I think it's a little choppy in the market and people are reevaluating. And the interest rates are higher. So financing that debt on a continuing organization may be a challenge. And as I said, in the beginning of the year, our pipeline is strong. I would categorize our pipeline right now is very strong. We have a lot of attractive candidates we're looking at. And I'm just bullish on being able to differentiate AMETEK's performance over the next 12 to 24 months with our OpEx and our M&A.

Great. Thank you.

Our next question comes from Christopher Glynn with Oppenheimer. Your line is open

Thank you. Good morning.

Good morning, Chris.

I want to keep it going on Paragon a little bit. I think you listed as -- for medical components and instruments. I'm wondering if it is the OEM and some of the instrument spaces? And also a little bit on ownership history and the deal process competitiveness and such.

Yes. When you think about Paragon, they're largely selling to an OEM customer base, but they do sell some of their surgical instruments directly to the end customer, but it's largely an OEM customer base. We purchased the business from American Securities. And from our view, they did an excellent job running the business and got a fantastic management team in place, a good growth strategy. And they're -- what they did is really position kind of a pure med tech play, by positioning this with some other parts of their portfolio. So we're pretty excited about what we're buying.

Thanks for the added color.

Yes. Thank you, Chris.

Our next question comes from Peter Costa with Mizuho. Your line is open

Good morning, everyone. This is Peter as on for Brett Linzey. So just coming back to orders. Could you provide some context during the monthly order cadence through the quarter and then moving into October? Have you been seeing anything concerning or anything tracking better than your internal expectations? Thank you.

No, I think the quarterly evolution of orders is about what we see. We mentioned our book-to-bill and things like that. And we started out in Q4 in line with what we need to deliver those results. So we had talked -- in our last few earnings calls, we highlighted a couple of dynamics that would impact orders. And our orders have been very strong for an extended period of time. In fact, we averaged 18% organic growth in 2021 and 2022. And we had 12 consecutive quarters up to this quarter with positive book-to-bill. So as a result, we have a near record backlog. As we said, these dynamics are playing out as we anticipated.

Perfect. Thank you.

Yes.

Our next question comes from Andrew Obin with Bank of America. Your line is open.

Hi. This is David Ridley-Lane on for Andrew Obin. Wondering, if you've seen …

Good morning, David.

Good morning. Wondering, if you've seen any impact from the higher interest rates on end market demand? And in particular, some of the other publicly traded test and measurement companies have mentioned project delays, particularly in China, have you seen anything along those lines?

Yes. As I mentioned, we were down about 3% organically in China, so there was some delays, but it wasn't substantial. In terms of increasing interest rates, that's one of the uncertainties that we're clearly looking at. And it's a very dynamic environment right now. And there are factors for sure, but we're not seeing an impact on projects, proceeding or anything like that from the interest rates at this point.

Got it. And are you supply chain constrained at this point in your Aerospace and Defense businesses? Is that a sort of a limiter on growth accelerating and even greater overtime?

We are not supply chain limited in Aerospace at this time. Now the industry is dealing with some supply chain difficulties, but we're not limited.

All right. Thank you very much.

Next?

One moment for our next question. Our next question comes from Michael Anastasiou with TD Cowen. Your line is open.

Thank you. Good morning everyone.

Good morning, Michael.

Good morning, Michael.

Back to Paragon, currently, medical-related revenues are about, give or take, 10% of sales. And after this acquisition, it takes you to about 20%. So was just expecting -- just curious if you're expecting to make like a deeper push into medical moving forward? And then what is sort of like the best way to think about balancing M&A dollars for these different end markets as well? Any color would be helpful.

Yes. There's a balance in AMETEK's end markets. And we really like that balance. That's why we're able to navigate some of the challenges that we're going through right now. So it's -- we plan on keeping that balance. But if there are other attractive areas in the medical space, we'll certainly look at them. But it's -- we like the balance in the portfolio. And what was your other question, Michael? M&A dollars. I mean we have a distributed operating model. In all of our businesses, we have management teams there that are doing strategy work around their businesses and trying to make their businesses better, and they're bringing forward acquisition candidates. So we don't have a predefined number of -- predefined amount of capital that we're going to apply to certain markets. We're going to be looking for the deal, the deal quality, the quality of the businesses and if we have the management teams to integrate them. So we have a different viewpoint. We don't look at it from the top down in terms of dollars allocated per market.

Got you. That's helpful. And just kind of diving back into it. So potentially, depending on availability of assets and not such, do you expect total revenues to the medical end market increasing over time? And how do you expect that?

Yes. It's 20% now. It could go 25%, 30%. That wouldn't bother us, but we plan on having a diversified revenue base.

Great. Thank you.

Thank you.

Thank you. That concludes the question-and-answer session. At this time, I would like to turn it back to Kevin Coleman for closing remarks.

Thank you, Abigail, and thanks, everyone, for joining us for our conference call. As a reminder, a replay of today's webcast can be accessed in the Investors section of ametek.com. Have a great day.

Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.