IDEX Q3 2023 Earnings Call Transcript

Quartr
Provided by Quartr
October 26, 2023

There are 12 speakers on the call.

Operator

Greetings, and welcome to IDEX Corporation's Third Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen only mode. A question and answer session will follow the formal presentation. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Alison Losses.

Operator

Thank you. You may begin.

Speaker 1

Good morning, everyone. This is Alison Lasas, Interim Chief Financial Thank you for joining us for our discussion of the IDEXX Q3 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 Aschleman, our Chief Executive Officer and President.

Speaker 1

Today, we will begin with Eric providing an overview of I will then discuss IDEXX's 3rd quarter financial results and update on segment performance in the markets they serve and our outlook for the Q4 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 137 34464 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 IDEXX's filings with the Securities and Exchange Commission.

Speaker 1

With that, I'll now turn this call over to our CEO and President, Eric Ashelman.

Speaker 2

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 Losses, 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.

Speaker 2

During her tenure at IDEXX, Alison 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 IDEXX. Also, as you saw in our release yesterday, we are pleased to announce that Abhi Kandilwal is joining IDEXX in November as our next CFO. Abid joins us from Multicolor 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.

Speaker 2

He previously worked at IDEXX 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 Alison at the top of our finance organization. With that, I'll turn to our Q3 performance. I'm on Slide 7. IDEXX delivered strong results in the Q3, delivering robust profitability in an environment where volumes are stabilizing at lower levels.

Speaker 2

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 IDEXX 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 3rd quarter. That played out as expected.

Speaker 2

Our analytical instrumentation, life sciences, pharma and semicon markets with an 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 IDEXX into a very natural position where lead times, backlogs and next quarter visibility all align with 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.

Speaker 2

These sit within a broader framework of uncertainty driven by macro 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 and A continues to be a top focus. Within our funnel builds, we are aggressively following complementary threads between our most Growth advantage businesses and technologies as we seek to build out breakthrough competitive advantage.

Speaker 2

We did this recently with our NexSite acquisition, Expanding our reach within water analytics through enhanced hardware and software capabilities, our Iridium acquisition earlier this year boosted integrative capabilities within Thin Film Optics. Our inorganic pipeline is robust and of high quality, allowing us to engage in M and A with 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 $150,000,000 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 collection of like minded businesses focused on similar technologies and customers.

Speaker 2

I would like to express my appreciation for all the MicroPump team has done since Joining IDEXX in 1995. With that, I'll turn it over to Allison to discuss our financial results.

Speaker 1

Thanks, Eric. Moving on to our Q3 consolidated financial results on Slide 9. All comparisons are against Orders of $712,000,000 were down 9% overall and down 11% organically. We experienced an organic decrease within our HST and FMT segments and organic growth in FSD. Sales of $793,000,000 were down 4% overall and down 6% organically.

Speaker 1

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 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 cost. Adjusted EBITDA margin was 28.4%, down 30 basis points. I will discuss the drivers of adjusted EBITDA on the next slide.

Speaker 1

On a GAAP basis, Our Q3 effective tax rate of 20.2 percent was lower than our effective rate in the Q3 2022 of 21.8%. The rate was driven down by both the finalization of research expenditure capitalization treatment that serves to increase tax benefits on foreign source income and a tax election related to the Mulan acquisition that reduced our minimum tax on foreign earnings. These favorable rate items were partly set by tax recorded on the gain from the MicroPump divestiture and are not expected to have a significant impact on our 4th quarter rate. Net income was $209,000,000 which resulted in GAAP EPS of $2.75 Adjusted net income was 161,000,000 with adjusted EPS of $2.12 which is down 0 point 0 $2 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 Q3 guidance.

Speaker 1

Finally, Cash from operations of $227,000,000 was up 14%, primarily due to lower working capital driven by inventory reductions. Free cash flow for the quarter was $207,000,000 up 14% versus last year and achieved a conversion rate of 129 percent of adjusted net income. We drove over $25,000,000 of inventory out of in the Q3 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 3rd quarter adjusted EBITDA. Adjusted EBITDA by $6,000,000 compared to the Q3 2022.

Speaker 1

Our 6% organic sales reduction unfavorably impacted adjusted EBITDA by $37,000,000 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 $6,000,000 mainly centered in HST 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 Reductions in variable compensation expense contributed $8,000,000 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.

Speaker 1

Ensuring continuity of our most valuable resources has IDEX well positioned to recover and grow back stronger than before when market dynamics turn favorable. Luan and Iridium acquisitions, net of Knight and Micropump divestitures and FX, Contributed an additional $9,000,000 of adjusted EBITDA. With that, I'll provide a deeper look at our segment performance. I'm on Page 11. In our Fluid and Metering Technologies segment, orders decreased by 5 percent organically, mainly due to an expected slowdown in our industrial businesses and continued customers destocking in our agriculture business.

Speaker 1

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 Q2 of this year, and they remain steady at that level throughout the Q3. 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 income and crop prices. Our delivery continues to outperform our competitors, and we are focused on targeted share gain to offset this pressure.

Speaker 1

Additionally, the acquisition of KZ Valve 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 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.

Speaker 1

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 4 10 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 pharmabiopharma spending and overall caution around the global economy.

Speaker 1

We expect that performance will remain stable at this level in the 4th 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 bottom in the Q3. 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 Iridium's technological capabilities.

Speaker 1

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 in HST slowed in the quarter, in line with FMT's results. Finally, Turning to our Fire and Safety Diversified Products segment. Organic orders grew by 2% versus Q3 last year And organic sales grew 3% with strong fire and safety results more than offsetting destocking at Bandit. 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.

Speaker 1

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.

Speaker 1

Rescue performance remains steady as well. Although we are seeing some signs of North American budget delays and inventory reductions due to high borrowing costs. Sandvik continues to outperform a relatively flat U. S. Auto market due to having content on high priority vehicles.

Speaker 1

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 Q4 and full year 2023. I'm on Slide 12. In Q4, we are projecting GAAP EPS to range from $1.50 to 1 0.55 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 Equally, our strong execution in the 3rd quarter allowed us to work through our backlog faster than expected.

Speaker 1

This is driving an equal and offsetting $0.05 of impact to 3rd quarter results and 4th 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 Great and the remainder coming from 3rd quarter operational outperformance, partly offset by $0.05 of revenue timing due to accelerated backlog burn in the Q3. 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 percent.

Speaker 1

Capital expenditures are anticipated to be about $80,000,000 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.

Operator

Thank you. At this time, we'll be conducting a question and answer session. Our first question comes from Deane Dray with RBC Capital Markets. Please proceed with your question.

Speaker 3

Thank you. Good morning, everyone.

Speaker 2

Hey, Dean.

Speaker 3

First, start with congratulations on the CFO news. We've heard from a couple of former IDEXX executives who are singing Avi's Praises, so that's fabulous you got him to rejoin. And then can I add my thanks to Allison for all her help and her role as Interim CFO?

Speaker 2

Thanks for both comments.

Speaker 4

Thank you.

Speaker 3

You're very welcome. So maybe Eric for some big picture Questions, macro, you're great at kind of synthesizing all the different inputs here And heaven 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 Q2. What's your take on that, on lead times and anything from Your leading businesses like BAND IT and Warren Rupp that suggest how things are going to play out over the near term?

Speaker 2

Yes. Well, I mean, we often refer to those as the kind of canaries in our coal mine. And we discreetly track About 5 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.

Speaker 2

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, we're 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 In 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.

Speaker 2

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.

Speaker 3

All right. Appreciate all that color. And then the second question is in HST and the analytical instruments life sciences. And I'll preface this with No one has gotten this right so far. Whether it's the Thermo And Danaher and that whole group, it's been pretty fluid.

Speaker 3

And so I wanted to 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 And it seems to have gotten worse in October. So just your degree of confidence, how does this calibrate, the first half of twenty twenty four for this business for you.

Speaker 2

So I want to take a little time here because I think I got to Set our context in relation to those comments and the environment you described. First of all, as we said in the prepared remarks, We're talking about 4 buckets of business primarily that kind of fall into this category. Analytical instruments, life science, of course, that's the larger piece of it. But 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 timeline, you actually have to go back, we're almost a year into this for us.

Speaker 2

Because of the short cycle nature, we actually saw some of this noise in Q4 of last year. And as you said, we and others, I think I 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, we 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.

Speaker 2

So it's kind of three things have played out. What I think that's done for us is, of course, we felt that pretty aggressively in the earlier piece, service sooner than 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 in 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, Dean, I'd back up a little bit and say we're hitting that from 4 different levels.

Speaker 2

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, we're going to have some other things that are going We're 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 at 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. Please proceed with your question.

Speaker 5

Hey, good morning everyone.

Speaker 2

Hi, Mike. So I

Speaker 5

want to follow-up to both those questions Dean 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 at matching with sell out or am I misinterpreting that?

Speaker 2

No, I think that's a good you probably summarized it a little better than I did, but I was trying to make sure people could understand that context for us. Again, What's really important to recognize here, we're inside the life science instrument at a component level or inside the lithography instrument. 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.

Speaker 5

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 Site range?

Speaker 2

Well, yes, certainly as the year progresses, the comps get

Speaker 5

increasingly easier. 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 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 So just some help as we think in a full

Speaker 2

context. Yes. I mean, it is interesting. I think the industrial System is still performing at a pretty high level. I mean, the day rates that we're talking about here, that flatness that I described in those canary levels, that's Pretty healthy business that suggests people are working, factories are producing things and putting it to work.

Speaker 2

Certainly around it though, discussions around longer term commitments or things that are going to happen in the spring of next year, I mean, they're just they're harder conversations to have Because of all the uncertainty that people are feeling, pick anything from the higher interest rate position or the increasing geopolitical risk that's out there, Consequences of a major election in the U. S. Next year. So I can see a lot of people on the one side continuing to kind of forecast on the things that are happening day to day, but kind of backing up with a wait and see approach at a higher level Because of uncertainties for anything that's sort of past the horizon.

Speaker 5

Yes, it makes sense. One quick follow-up, clarification for Allison. Did you

Speaker 6

say that

Speaker 5

$0.05 shifted from 4Q into 3Q? I just want to clarify what that statement was, Allison.

Speaker 1

That's correct, Mike. So we find more aggressive backlog pull down in Q3. So it's just a Shift of timing within the back half of the year.

Speaker 2

Great. I was

Speaker 5

just making sure I had the direction correct. Appreciate it. Thanks, everyone.

Speaker 2

Yes. Thanks, Bonnie.

Operator

Our next question comes from Nathan Jones with Stifel. Please proceed with your question.

Speaker 2

Good morning, everyone. Hey, Nathan.

Speaker 6

I guess I'll ask a question about the order rates here. The order rates in FMT, the actual dollars of orders is a bit lower in 3Q than in 2Q and orders in HST In 3Q, a bit lower than 2Q. Is it possible for you to kind of separate out what you think is Decline in customer backlogs versus what actual declined in end market demand. And I guess what I'm trying to get at here is, if you're talking about inventory correction having happened and we move to sell ins more towards sell through. Wouldn't that imply then that you should see sequential improvement in the actual dollars of orders In both of those businesses as we move into the Q4?

Speaker 2

Yes. But look, again, I put a lot of weight on the predictive abilities of those, early indicator businesses that we have to talk a lot about sort of day to day, How the system is operating, so I think that again, that stability means a lot. In this environment, order patterns do change a little bit. Remember, The earlier comment I had there for Mike, I mean, I think you're seeing people moving to shorter increments of order patterns. They know now companies like, Certainly IDEXX, we can deliver with faster replenishment.

Speaker 2

Our customer satisfaction metrics are really good. If you feel any uncertainty, you don't have to give us nearly the same kind of visibility in your order requirements that you had 2 quarters ago or a year ago. So I think you do see a piece of that, that changes in the order profiling more of a order it as you go. And so and again, we ate into some pretty aggressive backlog along the way. And anytime lead times keep coming down, I mean, that does tend to influence order patterns for folks on the other side.

Speaker 2

So I think it's things like that playing out By and large around a pretty stable base, especially on the industrial side, that to me says, I think this is a stable environment, but one that's looking for The next catalyst.

Speaker 6

And I guess my follow-up question, I know you guys don't do a lot of large projects, but you have are changing the dynamics, changing the ROI for customers on those investments. Can you talk about what you're seeing

Speaker 2

on customers' willingness to let

Speaker 6

out these larger capital willingness to let out these larger capital projects. I know historically you've seen people hesitate In these kinds of environments, so just any color you can give us on what you're saying there?

Speaker 2

Yes. Well, that's probably a piece of the answer to your last question as well. I mean, The certainty around projects like that is not very good. And you've got some people that are they're still talking about them, but they start to move that Time horizon, we're getting closer to 2024 like a magnet. And so it becomes a reference point and a point in the calendar where people Pointing to where things might come to fruition in that side of it.

Speaker 2

Again, contextually for us, that's not all of our businesses, We'll see it as part of a plan expansion commitment or something like that for food or something related to infrastructure. So those kind of discrete things that require a lot of capital would come together, a lot of planning. I think there is a lot more uncertainty around them. And it's Instead, it's kind of running the current system faster and a little bit longer before you rebuild it due to that same level of uncertainty.

Speaker 6

Great. Thanks for taking my questions.

Speaker 2

Thanks, Dave.

Operator

Our next question comes from Allison Poliniak with Wells Fargo. Please proceed with your question.

Speaker 7

Hi, good morning. So Eric, I just want to go back to HST. One of the things IDEXX has been known for is investing through the cycle. Could Could you maybe talk to the new product development cycle in analytical instrumentation life sciences? Or maybe even how you're thinking about that Investment, has it slowed at all?

Speaker 7

Should we expect maybe a slower organic coming out of this? Just any thoughts there.

Speaker 2

Well, Actually, I'm glad you mentioned that because in many ways, at ground level in those businesses, you kind of see 2 realities sitting side by side and they're actually quite different. One is the near term reactive reality of what's happened over here in the last Where order levels are, what daily requirements are, lots of cost containment and being super crisp about their own productivity and just getting the product out. But even at the customer level, I mean, I think you see that entire world is spending a lot of time thinking through, okay, What do we need to do to innovate to get ahead of the game in the next cycle? Because I can't find anybody that doesn't see that there's going to be something more positive The same megatrends that have been driving that sector forever are not very far out ahead of us and will occur again. But when they do, we're seeing at the customer level and within our business is a real step up in terms of innovative steps to get after it.

Speaker 2

I Talking to Tara Tureza, who runs our businesses there and she's describing some of the projects that we're working on in conjunction with really significant customers. And It's some of the highest degrees of innovation jumps that I've frankly seen in the last few years. So I think there's actually a very purposeful collaborative arrangement here to talk about where this industry is going to go. And as it comes out, this is one of the reasons I think we try to stay as fast and nimble as we can, so we can put capital and resources Those best opportunities and frankly overfeed them in times like this. So you've actually called it exactly how we see it at ground level.

Speaker 7

That's great color. Thank you. And then a small divestiture, as you think of the portfolio today, obviously, a very unusual cycle here. Was this sort of just a one off or is this something that you think we might see more of as we go forward here? Just any thoughts?

Speaker 2

Well, I think, I mean, It's a nice little business. I think as we looked at it, we just don't have a lot of technology that's similar. We didn't see necessarily an ability to scale it. And larger scale versions of it tend to be in markets that are not as attractive for us. So I do think that level of thinking is something that we do Constantly, and you could see it play out that way from time to time, but I wouldn't view it just as this one isn't as a massive transformational shift in portfolio for IDEXX.

Speaker 2

But as we increasingly think about, look, what we're trying to do here is drive growth outperformance, Little tighter integrative ability between the pieces of IDEXX, I referenced that in the opening comments. Things that kind of stand alone That don't have that ability to scale, we're going to take a look at assess that carefully. And then if it feels like the right decision is Thanks, Alex.

Operator

Our next question comes from Vlad Baiserbi with Citigroup. Please proceed with your question.

Speaker 4

Good morning. Thanks for taking my call. So maybe just one more on HST. I know you previously talked about for semicon markets to stabilize during 3Q with recovery, I think beginning in 4Q. I don't know if I missed it, but maybe you can give us more color on how semicon markets specifically are trending versus Your prior expectations and your views on the likely trajectory of, semicon related demand going forward?

Speaker 2

Yes. Again, it's an important but a small part of IDEXX at less than 10%. But I think that one is pushed further into 2024. I mean, it's stable here. We're certainly and we hit it from a variety of levels.

Speaker 2

We're in fabs, we're in metrology instruments, we're in memory, we're in sophisticated sides of it. And so we see it from a whole bunch of different spots, But I think all of it suggests the recovery of that sector is a little bit further out into 2024. We're certainly close to those customers. We're critical. They can't do much without our parts and components.

Speaker 2

So we'll get that intelligence, but I suspect the order ramp will start somewhere out into 2024.

Speaker 4

Okay. That's helpful. Then maybe just shifting to FSDP. Again, on the orders at SACP took a step down sequentially. So I guess Any color on is there something seasonal there or just how you're thinking about FSPP orders evolving into 4Q and going forward?

Speaker 1

Sure, Vlad. No, I can take that. That's really the step down, due to dispensing as cycle did come to an end there. So you see that pull down in Q3. You'll see it also A bit into 4th, but also in Q4, we've got a bit of seasonality in Fire and Rescue, Fewer production days.

Speaker 4

Okay, that's helpful. Thanks, Allison. Yes. Thank you.

Operator

Our next question is from Rob Wertheimer with Melius Research. Please proceed with your question.

Speaker 8

Thank you. I'm showing the conversation and the education on life sciences and HST. It's obviously been A bit more volatile than many expected. And I wonder if you could do almost like a 101 on what normalization looks like With a simple question is what drives customer purchasing? Is it your customers' customers' volumes?

Speaker 8

Is it innovation cycles? Is CapEx cycles and confidence cycles, just how your products flow through that lifecycle?

Speaker 2

No, I appreciate it, Rob. So Look, this is a first of all, it's a super direct business. So we're talking with a relatively concentrated customer set of leading OEMs. So it's quite different from many other parts of IDEXX in that respect. Up until the pandemic and some of that we've seen here in the last 3 or 4 years, it's not typically been a very cyclical kind of industry.

Speaker 2

It's generally stayed at the kind of mid to high single digits depending on where we sort of jump in, with the exception of the semi portion, of course. In all cases, You can think of this as these are platform centric businesses. So an innovation stream comes in, somebody is Looking to move to the next level and it's either their instrument or their lithography machine or their device, is moving up Well ahead of that, our engineers are in there on the design cycle, and working on the spec points and you secure the spec. So Essentially, it's pretty classic platform business. Once you're in on a platform, you run the duration of it.

Speaker 2

And you're concurrently always working on different iterations of things in either So it's very, very classically aligned that way. So you do have good visibility into Plans for programs, plans for program launches, the variable that you run into, of course, is the adoption, the run out of those devices, the Take up the inventory positions on them, all the things that we've talked about as we've kind of gone through the last year here.

Speaker 8

Perfect. Thank you. And if I and I know there's a lot on that topic, but I appreciate it. And then if I can just go a little bit further field, just in the general Acquisition market, you've seen cost of capital rising for private equity perhaps faster than when you guys have pretty good cash flow. Are getting easier to win or any general characterization of that market?

Speaker 8

And I'll stop there.

Speaker 2

Yes. Well, I mean, certainly and for I mean, we've tried here for the last 2 or 3 years to be very, very focused on Frankly, cultivating proprietary transactions, we're taking advantage a little bit of the environment where we're comfortable. We're planning components in niche environments. We often see things and interact with people that maybe are not as well known in the outside world. So we depend on multi year relationships and conversations to try to get ourselves to a position where frankly there aren't a lot of competitors in line as we're looking at an asset.

Speaker 2

That's not always possible to the extent it isn't. I would agree that, you've seen something quite different here with higher interest rates. There's obviously some levels that people that need a lot of debt financing can only get to and can't pass. That will allow a property to Probably stay out and play longer with strategics like us and others that might be taking a look at it. So you could view that as quite positive.

Speaker 2

I would say on the other side though too because of that environment, maybe here more recently, you see some others that are a little bit more reluctant to transact in that way because They want to wait for a recovery loop or better demand curves that would support higher valuations on terminal values. So I think it's probably a little bit of wash on that side, but in many ways, we've always considered this better for us if we're working at Much more discreetly, a bit more in the weeds and ideally in a proprietary way.

Speaker 8

Great. Thank

Speaker 2

you. You bet.

Operator

Our next question comes from Andrew Buscala with BNP. Please proceed with your question.

Speaker 9

Hey, guys. Looking into your FMT segment, Your margins were so strong, really on declining organic sales. I'm wondering kind of tied to a question asked on HSD is, how do you invest from here with your orders Are moderating or declining into year end. How do you tie that to your margins in the context of protecting them or your outlook? Sounds like everything is as expected.

Speaker 9

So do you continue to invest here? Just kind of seeing where your head's at with where that market is going and what it means for margin?

Speaker 2

Yes. Well, a couple of things here. Well, first, I'm glad you noticed. I mean, the FMT segment in particular, I mean, has fantastic performance. Over the last couple of quarters, Q3 was really good.

Speaker 2

What you're seeing there is, look, reasonable cost containment, we run them we're in those businesses pretty lean anyways. It's much easier to run them at a steady state than kind of the last few years have been. So that brings out our best. And frankly, our teams have recognized, they're doing their part from an IDEXX side and really driving outstanding performance. I would say from an investment profile, I mean, these are businesses, some of which are 80, 90, 100 years old.

Speaker 2

They are really, really well positioned. They do very well in almost all versions of economic realities are out there. So making sure that they stay innovative, well positioned with the right channel partners out in the right places, That's something we're always thoughtful of. We typically the investments when we talk about growth investments, they're generally people based And there are often discrete additive things that we'll do to go at certain things like battery production to support a mobility e mobility economy or something like that. So we'll augment and make those investments or not depending on We view kind of the state of the outside world, but the base of the business, they just kind of core the franchise.

Speaker 2

We are really, really careful of that to make sure that that domain expertise that supports all that positioning and differentiation and incredible margins is sound for any reality.

Speaker 9

And so that mid kind of mid-30s EBITDA margins and well into the low-30s Operating margins is really sustainable in your view even if those order trends continue to go negative and organic sales just, yes, Weekends into 2024?

Speaker 2

I mean, there's a couple of things to keep in mind there. These at any point and we've seen it Couple of times over the last few years, if that business gets kind of close to flat or negative, the deleveraging side of things is really tough because of the strong contribution margins and our commitment to kind of maintain the core. So depending where things go, we always have to be aware of that. We are also at Probably the best point of the price cost cycle, here now. That's as the spread that we're at Today is probably not going to continue out into the future.

Speaker 2

We've always been a company that gets price. Of course, it's been more aggressive here lately with inflation. We're now at a point where those prices are sticky. There's some moderation on the inputs. This is the best part of the cycle and this is the best part of the company that gets that pricing.

Speaker 2

So there's a little bit of a piece on here, I'd be careful of assuming its perpetual state, it's the good part of this part of the cycle.

Speaker 9

Okay. All right. Makes sense. Thanks, Eric.

Speaker 6

Yes.

Operator

Our next question comes from Brett Linzey with Mizuho.

Speaker 10

Just one more on HST. So encouraging to see the stabilization and certainly the recovery path is going to take some time to play out and figure out. But Just in terms of the profit recovery on the other side, should we think of the business is yielding a stronger than average incremental margin as they do or when they do recover? Or do you need some cost to come back? Any way to dimension that?

Speaker 1

As we recover, they'll lever nicely. And so, a longer term expectation for the HST set of businesses is more in the EBITDA margins of 29% plus.

Speaker 10

Okay, great. Thanks. And then just shifting over to the comments you made on water, Sounds like the opportunity funnel is increasing. You might be able to size that and is it related to some of the fiscal stimulus or other Independent factors driving that strength.

Speaker 2

Yes. Well, I mean, the water side of things has been steady throughout. I would say it's indirectly related, of course, to a lot of the focused efforts to invest in our infrastructure. Frankly, the state of our infrastructure has now gotten to the point where it's impossible to look away from as well. We've seen that on a major scale and major cities certainly here in the U.

Speaker 2

S. I I think those two things together are putting in I've always thought of it as a warm blanket, multiyear blanket. It's just it takes a long time to Spend money in that sector. These projects are just they take a long time to engineer rollout and go out there. And so no matter how discrete the kind of pop Funding might be, it's always going to have a little bit of an elongated run out.

Speaker 2

So we sort of view that as a comfortable blanket for businesses like ours and others that are in this sector. We've seen that. It's held up again in this quarter as well. I mean to dimensionalize it, you can look at the size of water in IDEXX And it's again, it's a nice piece of the portfolio and we would see that it would stay at the upper end of the growth profile.

Speaker 10

All right. Appreciate it. Great quarter.

Speaker 2

Thank you.

Operator

Our next question comes Joe Giordano with TD Cowen. Please proceed with your question.

Speaker 11

Hey guys, good morning.

Speaker 2

Hi, Joe.

Speaker 11

I just want to clarify, like I said, a lot of your customers and stuff in HST and the areas of weakness now have been kind of talking about October got worse. So I know that you were very clear that like the inventory situations and destocks have normalized, but what is your actual orders kind of look like in October relative to the rest of the Do you think HSE orders, should we be thinking up in dollars versus the Q3 and the Q4? Does that make sense?

Speaker 2

Well, look, I'll let go ahead, Allison.

Speaker 1

Sure. No, I think on a pure dollars basis, We should expect to see some higher orders in the Q4, but there is some blanket activity also that happens as we wrap the year.

Speaker 11

Okay. So that maybe not necessarily a sign that things are improving, it's just kind of a seasonal order uptick?

Speaker 1

That's right. We'll need to be we'll need to keep close watch.

Speaker 11

At what point, just extension of that, Just given like the nature of that business and the fact that you're running kind of book to bill sub-one there still, like at what point Can you just like an organic decline in HSC kind of be like baked in for 2024? Like when do orders need to start to improve for that to See a positive number theoretically.

Speaker 2

Okay. I think we'd have to monitor this We obviously will through the balance of the Q4. As always, everybody kind of does the same planning cycles at the same time. That's the best opportunity for us to get in front of customers, talk about programs, things that they're launching, their confidence in them. I think we want to watch it quarter by quarter and stay super close to it.

Speaker 2

These are the most dynamic markets that we have in the whole place. I just I come back to kind of the comments I made. I think when Mike asked the question, he did such a good job summarizing it in the beginning. We're basically saying that we've taken all of the inventory related noise out of this and that's essentially the echo of the past. I will say to the extent the industry heads in different directions here, we are in sync with it.

Speaker 2

We're a critical component supplier, The folks that are making very sophisticated instruments and things for a variety of different markets and geographies. And we are somewhat dependent on we are Completely dependent on their success, their call, the way that they're seeing that those markets are going to traverse. What we can do from our side is Provide, I think a timely and relevant diagnostic mainly because of the fact we're so short cycle We're going to feel and see those inflections sooner than almost anybody. And so with that in mind, we need to stay close to them. We'll understand all of those things.

Speaker 2

Again, it's 4 buckets of business for us, occasionally moves at slightly different rates and we can move resources around. And we'll see how it plays out as we go through 'twenty four.

Speaker 11

That's fair. And just lastly, with the accelerated kind of backlog burn that you had this quarter, are there targeted opportunities to do that again in the Q4 in parts of your business?

Speaker 2

We still have a couple of businesses that have longer backlogs. I mean, they're still working through generally because lingering issues in supply chains and elsewhere. We spoke of 1 in energy, but we talked about it's pretty strong in the Q3. A lot of that was us getting some more of that backlog out related to some consolidation stuff that we've done about a year ago. It's not many of them, but we do have a couple of other pockets in here that we're trying to get back down to kind of all idex level.

Speaker 11

Thanks, guys.

Operator

We have reached the end of the question and answer session. I'd now like to turn the call back over to Eric Ashelman for closing comments.

Speaker 2

Okay. Well, thanks for everybody for joining our call. And I always do, I want to thank the members of the IDEXX Team that are on, for some really, really strong execution and performance in the quarter. I just a few comments here. I think there's certainly a lot of uncertainty out there in the environment.

Speaker 2

I think it's going to require a certain amount of patience. But as I think about IDEXX and the things that we can control, here's what I know. I know our portfolio is in great shape. It's growing through M and A. It's well positioned.

Speaker 2

Certainly, this will support long term growth outperformance. I really think our flattened decentralized structure keeps us agile and nimble. We can move things around and resource things probably faster than anybody, and we do that each and every day. And our teams and leaders are outstanding, and frankly, they're going to be outstanding plus 1, as Abhi joins us here in November. So with that, when things break, we'll be all set up here, I think, to really support a nice extended run for IDEXX as the world starts to dial in and responds to frankly the trends that we know are all coming.

Speaker 2

So with that, thanks for your support and have a great day.

Operator

This concludes today's conference. You may disconnect your lines at this time and we thank you for your participation.

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Earnings Conference Call
IDEX Q3 2023
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