IDEX - Q3 2023

Transcript

Operator (participant)

Greetings, and welcome to IDEX Corporation's Q3 2023 Earnings Conference Call. At this time, all participants are on a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Allison Lausas. Thank you. You may begin.

Allison Lausas (Interim CFO and Chief Accounting Officer)

Good morning, everyone. This is Allison Lausas, Interim Chief Financial Officer and Chief Accounting Officer for IDEX Corporation. Thank you for joining us for our discussion of the IDEX Q3 2023 Financial Highlights. Last night, we issued a press release outlining our company's financial and operating performance for the three months ending September 30th, 2023. The press release, along with the presentation slides to be used during today's webcast, can be accessed on our company website at idexcorp.com. Joining me today is Eric Ashleman, our Chief Executive Officer and President. Today, we will begin with Eric providing an overview of the state of IDEX's business. I will then discuss IDEX Q3 financial results, an 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 two hours after the call concludes by dialing the toll-free number 877-660-6853 and entering conference ID 13734464, or simply log on to our company homepage for the webcast replay. Before we begin, a brief reminder. This call may contain certain forward-looking statements that are subject to the safe harbor language in last night's press release and in IDEX's filings with the Securities and Exchange Commission. With that, I'll now turn this call over to our CEO and President, Eric Ashleman.

Eric Ashleman (CEO and President)

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

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

I'd like to thank our IDEX teams around the globe for their contributions in driving these outstanding results. This was very solid execution in a difficult environment. Recall that we expected our industrial and municipal markets within FMT and FSDP to reach the end of an elongated and moderate destocking cycle within the Q3. That played out as expected. Our analytical instrumentation, life sciences, pharma, and semicon markets within HST largely held at equilibrium in Q3 and bounced along the bottom after an unprecedented rapid destocking cycle in the H1 of the year. Taken together, this moves IDEX into a very natural position where lead times, backlogs, and next quarter visibility all align with typical pre-pandemic profiles. Looking forward, we continue to see divergence between end market prospects.

There are discrete, attractive opportunities within each of our segments, many of which are tied to transformational catalysts within environmental sustainability or critical infrastructure. Examples include water analytics, space broadband, and battery production. These sit within a broader framework of uncertainty driven by macro concerns that include higher interest rates and expanding geopolitical risk. Most specifically, demand rebounds for our most pressured HST businesses appear to have moved out a bit into 2024. We continue to believe that organizational agility, speed of decision-making, outstanding business quality, and a strong culture serve us well to navigate the twists and turns ahead. We can both dynamically assign capital and resources to our best near-term opportunities, while we stay focused on our long-term strategy of profitable growth outperformance. In terms of capital deployment, M&A continues to be a top focus.

Within our funnel builds, we are aggressively following complementary threads between our most growth-advantaged businesses and technologies as we seek to build out breakthrough competitive advantage. We did this recently with our Nexsight acquisition, expanding our reach within water analytics through enhanced hardware and software capabilities. Our Iridian acquisition earlier this year boosted integrative capabilities within thin-film optics. Our inorganic pipeline is robust and of high quality, allowing us to engage in M&A with discipline and strong strategic intent, and our balance sheet has ample capacity to continue to execute on our best opportunities. Finally, we divested our Micropump business during the quarter and repaid $150 million on our term note facility. As we continue to focus on long-term growth, occasional portfolio realignment will occur.

We expect this transfer of ownership will better position Micropump as it joins a collection of like-minded businesses focused on similar technologies and customers. I would like to express my appreciation for all the Micropump team has done since joining IDEX in 1995. With that, I'll turn it over to Allison to discuss our financial results.

Allison Lausas (Interim CFO and Chief Accounting Officer)

Thanks, Eric. Moving on to our Q3 consolidated financial results on slide nine. All comparisons are against the Q3 of 2022, unless otherwise stated. Orders of $712 million were down 9% overall and down 11% organically. We experienced an organic decrease within our HST and FMT segments and organic growth in FSD. Sales of $793 million were down 4% overall and down 6% organically. We experienced a 15% organic decrease in HST and a 1% decrease in FMT. FSD revenues grew organically by 3%. Gross margin of 44.1% decreased by 220 basis points compared with last year. Adjusted gross margin decreased 90 basis points, primarily due to lower volume leverage and unfavorable mix, which was partially offset by strong operational productivity and price cost.

Adjusted EBITDA margin was 28.4%, down 30 basis points. I will discuss the drivers of adjusted EBITDA on the next slide. On a GAAP basis, our Q3 effective tax rate of 20.2% was lower than our effective rate in the Q3 of 2022 of 21.8%. The rate was driven down by both the finalization of research expenditure capitalization treatment that served to increase tax benefits on foreign source income, and a tax selection related to the Milan acquisition that reduced our minimum tax on foreign earnings. These favorable rate items were partly offset by tax recorded on the gain from the Micropump divestiture and are not expected to have a significant impact on our Q4 rate. Net income was $209 million, which resulted in GAAP EPS of $2.75.

Adjusted net income was $161 million, with adjusted EPS of $2.12, which is down $0.02 or 1%. The lower tax rate contributed $0.11 of adjusted EPS favorability in the current quarter compared to both the prior year and the midpoint of our Q3 guidance. Finally, cash from operations of $227 million was up 14%, primarily due to lower working capital, driven by inventory reductions. Free cash flow for the quarter was $207 million, up 14% versus last year, and achieved a conversion rate of 129% of adjusted net income. We drove over $25 million of inventory out of the business in the 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 Q3 adjusted EBITDA. Adjusted EBITDA decreased by $6 million compared to the Q3 of 2022. Our 6% organic sales reduction unfavorably impacted adjusted EBITDA by $37 million, flowing through at our prior year adjusted growth margin rate. Price cost was accretive to margins, and we drove operational productivity that offset employee-related inflation. Mix was unfavorable by $6 million, mainly centered in HST, due to continued volume declines in our analytical instrumentation, life science, and semiconductor components. Resource and discretionary spending was favorable versus last year as we continue to execute on our cost containment plan given the top-line pressure we are experiencing. Reductions in variable compensation expense contributed $8 million of benefit in the quarter. These results yielded a negative 31% organic flow-through.

Overall, our team's focus on cost containment and resource reallocation has effectively managed our revenue decline. Ensuring continuity of our most valuable resources has IDEX well-positioned to recover and grow back stronger than before when market dynamics turn favorable. Muon and Iridian acquisitions, net of Knight and Micropump divestitures and FX, contributed an additional $9 million of Adjusted EBITDA. With that, I'll provide a deeper look at our segment performance. I'm on page 11. In our fluid and metering technology segment, orders decreased by 5% organically, mainly due to an expected slowdown in our industrial businesses and continued customers destocking in our agriculture business. Sales decreased by 1% organically, driven by this destocking impact, partly offset by favorable energy, chemical, and water performance.

We began to see our industrial order day rates decline in the Q2 of this year, and they remained 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. Additionally, the acquisition of KZValve and the adoption of its automated actuation technology is delivering strong results. On the energy side, we continue to execute well, driving down backlogs and lead times. Underlying market demand remains steady, but we expect to see revenue declines versus Q3 as our backlog position normalizes.

In the chemical market, we continue to see positive results across the U.S., Europe, and Asia, with pharma and battery applications providing opportunities for growth. Our water business continues to exhibit growth. Our opportunity funnels are increasing, and we see no signs of municipal project funding delays as we approach 2024. Adjusted EBITDA margin expanded 50 basis points compared to last year, primarily due to strong Price Cost and favorable operational productivity, more than offsetting lower volume leverage. Moving to the HST segment, we experienced a 24% organic orders decrease and a 15% organic sales decrease, mainly due to pressure across the life sciences, analytical instrumentation, and semiconductor markets, as well as industrial market performance similar to that within FMT.

Adjusted EBITDA margins contracted by 410 basis points, primarily due to lower volume leverage and unfavorable mix, partially offset by strong price cost and favorable operational productivity. Our analytical instrumentation business continues to experience customers destocking, which remains driven by China softness, lower pharma/biopharma spending, and overall caution around the global economy. We expect that performance will remain stable at this level in the Q4 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 initiative, which are bolstered by Iridian's technological capabilities.

Our material processing technology business continues to experience softness across pharma markets, but are seeing some early signs of improvement within biopharma, food and nutrition, as well as tailwinds connected to leveraging our technology in battery production applications. 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 BAND-IT. Adjusted EBITDA margins expanded by 150 basis points, primarily due to strong price cost and favorable operational productivity, partially offset by unfavorable mix and lower volume leverage. The paint market remains mixed. The uncertain global macro environment is driving consumer confidence lower, while at the same time, the construction market in North America remains strong.

Within our fire business, we do not see any significant changes to North America fire OEM production capacity. We continue to win through value-add integrated systems and technology and standardized offerings that enable higher OEM throughput. Our Europe and Asia businesses remain steady. Rescue performance remains steady as well, although we are seeing some signs of North American budget delays and inventory reductions due to high borrowing costs. BAND-IT continues to outperform a relatively flat U.S. auto market due to having content on high priority vehicles. There is some pressure on the energy side, driven by lower oil prices, and we experienced some destocking within aviation. With that, I would like to provide an update on our outlook for the Q4 and full year 2023. I'm on slide 12.

In Q4, we are projecting GAAP EPS to range from $1.50-$1.55, and adjusted EPS to range from $1.74-$1.79. Organic revenue is expected to decline 8%-9%, and adjusted EBITDA margins are expected to be about 26%. We expect that our HST revenues will be slightly unfavorable versus our previous guide, offset by FMT volumes landing better than expected. Equally, our strong execution in the Q3 allowed us to work through our backlog faster than expected. This is driving an equal and offsetting $0.05 of impact to Q3 results and Q4 expectations. Turning to the full year 2023. We are maintaining our full year organic revenue guidance of down 1%-2%.

At the midpoint, we have raised our EPS guidance by $0.20, with approximately $0.11 driven by lower Q3 effective tax rate and the remainder coming from Q3 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%-2% to yield GAAP EPS of $7.91-$7.96, and adjusted EPS of $8.13-$8.18. Adjusted EBITDA margin is expected to be approximately 27.5%. Capital expenditures are anticipated to be about $80 million, and free cash flow is expected to be 100+% of adjusted net income. With that, I'll turn it over to the operator for your questions.

Operator (participant)

Thank you. At this time, we'll be conducting a question-and-answer session. If you'd like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment please, while we poll for questions. Our first question comes from Deane Dray with RBC Capital Markets. Please proceed with your question.

Deane Dray (Managing Director and Multi-Industry & Electrical Equipment Equity Analyst)

Thank you. Good morning, everyone.

Eric Ashleman (CEO and President)

Hey, Dean.

Deane Dray (Managing Director and Multi-Industry & Electrical Equipment Equity Analyst)

Hey, first, start with congratulations on the CFO news. We've heard from a couple of former IDEX executives who are singing Abhi'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?

Eric Ashleman (CEO and President)

Thanks for both comments.

Allison Lausas (Interim CFO and Chief Accounting Officer)

Thanks, Deane.

Deane Dray (Managing Director and Multi-Industry & Electrical Equipment Equity Analyst)

You're very welcome. So maybe, Eric, for some big picture questions, Micro, you're great at kind of synthesizing all the different inputs here, and heaven knows that Micro is giving us a lot of mixed signals, but maybe just click through, like, the day rates. That started to slow in the Q2. You know, 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?

Eric Ashleman (CEO and President)

Yeah. Well, I mean, we often refer to those as the kind of canaries in our coal mine, and we discreetly track about five of those businesses and keep an eye on weekly order rates and do it at the sort of, you know, small order flow, day-to-day stuff level. We parse out projects. What we can see in there is frankly, between the Q2 and the Q3, they're almost dead on flat. You know, so the kind of moderate destocking cycle that we predicted at the beginning of the year, I think largely played out, you know, 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.

You know, what that says is kind of our distributors, 'cause 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. Now, I think, you know, 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. For right now, it's flattened out. It's holding. There's decent activity out there. There's certainly opportunities here and there, but not signaling any further trouble and waiting to see if it brings forth some more encouraging signs.

Deane Dray (Managing Director and Multi-Industry & Electrical Equipment Equity Analyst)

All right, appreciate all that color. The second question is in HST, in the Analytical Instruments Life Sciences. I'll preface this with, no one has gotten this right so far. Just, you know, whether it's the Thermo and Danaher and that whole group, it's been pretty fluid. I want to just say your degree of confidence that, you know, 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. It seems to have gotten worse in October. Just your degree of confidence, how does this calibrate the H1 of 2024 for this business for you?

Eric Ashleman (CEO and President)

So I want to take a little time here because I, I think I got to set our context in relation to, to those comments and the environment you described. You know, first of all, as I said in the prepared remarks, I mean, we're, we're talking about four buckets of business primarily, that kind of fall into this category. Analytical instruments, life science, of course, that's, that's the larger piece of it. But, you know, pharma exposure as well as semicon, that's about half of HST, and, you know, that's the piece that we're, you know, we're describing when we walk through this. Then I want to back up and say, you know, if you think about timeline, you actually have to go back. We're almost a year into this, for us.

Because of the short cycle nature, we actually saw some of this noise in Q4 of last year. As you said, we and others, you know, I, I think, had to get our heads around the fact that it's actually been a series of additive components, you know, that's played out here over the course of that year. Initially, thought it was just, you know, simply aggressive demand turning to something more moderate. Of course, we felt that in, 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 Q2 and Q3, it's been, you know, kind of a second or third inning, if you will, of, you know, some concerns about some macro forces, probably the most significant being China's contribution or lack thereof, you know, as we going forward, relative to what it has been in earlier periods. So 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, 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, you know, that we're kind of open to the recovery loop, that, that's ahead of us and the uncertainty of when it will occur and how it might play out. And again, Deane, I back up a little bit and say we're hitting that from four different levels. So while, you know, 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, you know, that we're gonna have some other things that are gonna potentially be working against that, that may wash that out in the interim.

So equilibrium's 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, you know, go and kind of poke at the customer level and take a look at what people are doing in innovation streams and, you know, start to plan our course from here.

Deane Dray (Managing Director and Multi-Industry & Electrical Equipment Equity Analyst)

It's all very helpful context, Eric. Thank you.

Eric Ashleman (CEO and President)

Thanks, Deane.

Operator (participant)

Our next question is from Mike Halloran with Robert W. Baird. Please proceed with your question.

Mike Halloran (Senior Research Analyst and Associate Director of Research)

Hey, good morning, everyone.

Eric Ashleman (CEO and President)

Hi, Mike.

Mike Halloran (Senior Research Analyst and Associate Director of Research)

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

Eric Ashleman (CEO and President)

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

Mike Halloran (Senior Research Analyst and Associate Director of Research)

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

Eric Ashleman (CEO and President)

Well, yeah, certainly as the year progresses, the comps get increasingly easier.

Mike Halloran (Senior Research Analyst and Associate Director of Research)

Yeah. Got it. And then, and then you, you talked about the short cycle side of things. From a destock perspective, that makes a lot of sense. Maybe higher level, how are you thinking about the economically sensitive parts of your business as we head into 2024? You know, the risk profile as you're seeing it. Doesn't sound like the day rates are saying that there's, there's much worsening going on, but maybe some of that's being clouded by the destock piece. So just some help as we, we think on a forward basis.

Eric Ashleman (CEO and President)

Yeah. I mean, it's interesting. I think, you know, 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, you know, producing things and putting it to work. Certainly around it, though, you know, discussions around longer-term commitments or things that are gonna 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 pour gas on the, you know, on the things that are happening day to day, but kind of backing up with a wait and see approach, at a higher level just because of uncertainties for anything that's sort of past the horizon.

Mike Halloran (Senior Research Analyst and Associate Director of Research)

Yeah, makes sense. One quick follow-up, clarification for Allison. Did you say that $0.05 shifted from 4Q into 3Q? I just wanna clarify what that statement was, Allison.

Allison Lausas (Interim CFO and Chief Accounting Officer)

That's correct, Mike.

Mike Halloran (Senior Research Analyst and Associate Director of Research)

Okay, great.

Allison Lausas (Interim CFO and Chief Accounting Officer)

So we saw a more aggressive backlog pull down in Q3, so it's just a shift of timing within the back half of the year.

Mike Halloran (Senior Research Analyst and Associate Director of Research)

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

Allison Lausas (Interim CFO and Chief Accounting Officer)

Yep.

Eric Ashleman (CEO and President)

Thanks, Mike.

Operator (participant)

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

Nathan Jones (Managing Director)

Good morning, everyone.

Eric Ashleman (CEO and President)

Hey, Nathan.

Nathan Jones (Managing Director)

I guess I'll ask a question about the order rates here. The order rates in FMT, the actual dollars of order 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?

Eric Ashleman (CEO and President)

Yeah, but, well, 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 from Mike. I mean, I think you're seeing people moving to shorter increments of order patterns. They know now companies like, I mean, certainly IDEX, we can deliver with fast replenishment. Our customer satisfaction metrics are really good. So 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 to, you know, two 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, you know, 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. 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.

Nathan Jones (Managing Director)

I guess my follow-up question, I know you guys don't do a lot of large projects, but you have stuff that goes into larger projects. I think investors are being concerned that rising interest rates, persistent inflation, are changing the dynamics, changing the, the ROI for customers on those investments. Can you talk about what you're seeing on, on customers' willingness to, you know, to let out these larger capital projects? I know historically you've seen, you know, people hesitate in, in these kinds of environments. Just any color you can give us on what you're seeing there.

Eric Ashleman (CEO and President)

Yeah. Well, and that's, that's probably a piece of the, the answer to your last question as well. I mean, the, you know, the, the, the certainty around projects like that is not very good. And you've got some people that are, you know, 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, and a point, on the calendar where people are pointing to where things might come to fruition in that, in that, side of it. Again, contextually for us, that's not all of our businesses, but we'll see it as part of a plan expansion commitment or something like that, you know, 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, you know, kind of running the current system faster and, you know, a little bit, a little bit longer, before you rebuild it due to that same level of uncertainty.

Nathan Jones (Managing Director)

Great. Thanks for taking my questions.

Eric Ashleman (CEO and President)

Thanks, Nathan.

Operator (participant)

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

Allison Poliniak (Director and Senior Analyst)

Hi, good morning.

Eric Ashleman (CEO and President)

Hi.

Allison Poliniak (Director and Senior Analyst)

So, Eric, I just want to go back to HST. One of the things IDEX has been known for is investing through the cycle. 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? You know, has it slowed at all? Should we expect maybe a slower organic coming out of this? Just any thoughts there.

Eric Ashleman (CEO and President)

Well, it's actually, I'm glad you mentioned that, because in many ways, when at ground level in those businesses, you kind of see two realities sitting side by side, and they're actually quite different. One is the near-term reactive reality of, you know, what's happened over here in the last year, and where order levels are and what daily requirements are, lots of cost containment and being super crisp around 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 coming here.

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. I was talking to Tara Tereso, who runs our businesses there, and she's describing some of the projects that we're working on in conjunction with, you know, 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 gonna go.

As it comes out, you know, 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 to those best opportunities and frankly, overfeed them in times like this. So that. You've actually called it exactly how we see it at ground level.

Allison Poliniak (Director and Senior Analyst)

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

Eric Ashleman (CEO and President)

Well, I think, I mean, it's, you know, 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, you know, from time to time. But I wouldn't view it just as this one as a massive transformational shift in portfolio for IDEX. But as we increasingly think about, you know, look, what we're trying to do here is drive growth outperformance, a little tighter integrative ability between the pieces of IDEX. I referenced that in the opening comments.

Things that kind of stand alone, that don't have that ability to scale, we're gonna take a look at, assess that carefully, and then if it feels like the right decision is a potential different owner, then we'll continue to make those choices. But I wouldn't sum it up to something more aggressive than that.

Allison Poliniak (Director and Senior Analyst)

Great. Thank you.

Eric Ashleman (CEO and President)

Thanks, Allison.

Operator (participant)

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

Vlad Bystricky (VP and Equity Research Analyst)

Good morning. Thanks for taking my call. So maybe just one more on HST. I know you, you previously talked about an expectation 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, and your views on the likely trajectory of semicon-related demand going forward.

Eric Ashleman (CEO and President)

Yeah. Again, it's an important but a small part of IDEX, less than 10%. I think that one is pushed further into 2024. I mean, it's stable here, and we're certainly—we hit it from a variety of levels. We're in fabs, we're in metrology instruments, we're in memory, we're in sophisticated sides of it, and, you know, so we see it from a whole bunch of different spots. 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. You know, they can't do much without our parts and components.

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

Vlad Bystricky (VP and Equity Research Analyst)

Okay, that's helpful. And then maybe just shifting to FSDP. Again, on the orders that FSDP took a step down sequentially. So I guess just any color on, is there something seasonal there or you know, just how you're thinking about FSDP orders, you know, evolving into 4Q and going forward?

Allison Lausas (Interim CFO and Chief Accounting Officer)

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

Vlad Bystricky (VP and Equity Research Analyst)

Okay, that's helpful. Thanks, Allison.

Allison Lausas (Interim CFO and Chief Accounting Officer)

Yep.

Vlad Bystricky (VP and Equity Research Analyst)

Thank you.

Operator (participant)

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

Rob Wertheimer (Founding Partner and Director of Research)

Thank you. I'm enjoying the conversation and the education on life sciences and HST. It's obviously been a bit more volatile than many, many expected. I wonder if you could do almost like a one-on-one on what normalization looks like. A simpler question is, what drives customer purchasing? Is it your customer's customer's volumes? Is it innovation cycles? Is it CapEx cycles and competence cycles?

Eric Ashleman (CEO and President)

Yeah.

Rob Wertheimer (Founding Partner and Director of Research)

Just how your products flow through that life cycle.

Eric Ashleman (CEO and President)

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, you know, of leading OEMs. So it's quite different from many other parts of IDEX in that respect. You know, it up until the pandemic and some of the forces that have, that we've seen here in the last three or four years, it's not typically been a very cyclical kind of industry. 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 know, you can think of this as these are, these are platform centric businesses.

So an innovation stream comes in, somebody's 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, and you're concurrently always working on different iterations of things in either early gestation or late. So it's very, very classically aligned that way. So you do have good visibility into, you know, 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.

Rob Wertheimer (Founding Partner and Director of Research)

Perfect. Thank you. And if I know there was a lot on that topic, but I appreciate it. And then if I can just go a little bit further afield, 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, you know, any general characterization of that market, and I'll stop there.

Eric Ashleman (CEO and President)

Yeah, well, I mean, certainly, and for—I mean, we've tried here for the last two or three 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 playing in components and nichey 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. That's not always possible to the extent it isn't. I would agree that, you know, you've seen something quite different here with higher interest rates.

There's obviously some levels that, you know, 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. You know, so you could view that as quite positive. 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, you know, 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 it much more discreetly, a bit more in the weeds, and ideally in a proprietary way.

Rob Wertheimer (Founding Partner and Director of Research)

Great. Thank you.

Eric Ashleman (CEO and President)

You bet.

Operator (participant)

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

Andrew Buscaglia (Senior Analyst of US Industrial Technology)

Hey, guys. You know, looking into your FMT segment, you know, your margins were so strong, you know, really on declining organic sales. I'm wondering, you know, kind of tied to the question asked on HST is, you know, how do you invest from here with, you know, your, your orders are, you know, moderating or declining into year-end. You know, how do you, how do you tie that to your margins in, in the context of protecting them? Or, you know, if your outlook sounds like everything's as expected, so do you continue to invest here? Yeah, just kind of seeing where your head's at with, you know, with where that market's going and, and what it means for margins.

Eric Ashleman (CEO and President)

Yes. Well, a couple of things here. First, I'm glad you noticed. I mean, the FMT segment in particular has fantastic performance. Over the last couple of quarters, Q3 was really good. What you're seeing there is, look, reasonable cost containment. We run them, we run 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 IDEX side and really drive an outstanding performance. I would say from an investment profile, I mean, these, you know, these are businesses, some of which are 80, 90, 100 years old. They're really, really well positioned.

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

But the base of the business, you know, it's just the kind of core of the franchise; 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.

Andrew Buscaglia (Senior Analyst of US Industrial Technology)

So that mid, kind of mid-30s, you know, EBITDA margins and, you know, well into the low 30s operating margins is really sustainable in your view, you know, even if those order trends continue to go negative and organic sales just weakens into 2024?

Eric Ashleman (CEO and President)

I mean, there's a couple things to keep in mind there. These, you know, at any point, and we've seen it a 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, you know, 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. We, you know, 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 price, pricing. So there's a little bit of a piece on here I'd be careful of, is assuming it's perpetual state. It's, it's the good part of this part of the cycle.

Andrew Buscaglia (Senior Analyst of US Industrial Technology)

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

Eric Ashleman (CEO and President)

Yep.

Operator (participant)

Our next question comes from Brett Linzey with Mizuho. Please proceed with your question.

Brett Linzey (Senior US Industrials Equity Research Analyst)

Hey, good morning. Yeah, thanks for taking the questions. 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 as 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?

Allison Lausas (Interim CFO and Chief Accounting Officer)

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

Brett Linzey (Senior US Industrials Equity Research Analyst)

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

Eric Ashleman (CEO and President)

Yeah, 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 in major cities, certainly here in the U.S. I think those two things together, you know, are putting in. I've always thought of it as a warm blanket, multi-year blanket. You know, it's just, it takes a long time to spend money in that sector. It's just these projects are just. They take a long time to engineer, roll out, and go out there.

And so no matter how discrete the kind of pop on funding might be, it's, it's always gonna have a little bit of an elongated run out. So we sort of view that as a, as a comfortable blanket for businesses like ours and others that are in this sector. We've seen that. It's held up, held up again in this quarter as well. I mean, to, to dimensionalize it, you know, you can look at the, the size of Water and IDEX, and, you know, it's, it's, again, it's a, it's a nice piece of the, the portfolio, and we would see that it would stay at the upper end of the growth profile.

Brett Linzey (Senior US Industrials Equity Research Analyst)

All right. Appreciate it. Great quarter.

Eric Ashleman (CEO and President)

Thank you.

Operator (participant)

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

Joe Giordano (Managing Director)

Hey, guys. Good morning.

Eric Ashleman (CEO and President)

Hi, Joe.

Joe Giordano (Managing Director)

I just want to clarify, like you say, a lot of the, you know, 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 does your actual orders kind of look like in October relative to the rest of the quarter? Like, do you think HST orders, should we be thinking up in dollars versus the Q3 in the Q4? Does that make sense?

Eric Ashleman (CEO and President)

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

Allison Lausas (Interim CFO and Chief Accounting Officer)

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.

Joe Giordano (Managing Director)

Okay, so that may be not necessarily a sign that things are improving, it's just kind of a seasonal order uptick?

Allison Lausas (Interim CFO and Chief Accounting Officer)

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

Joe Giordano (Managing Director)

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 does, like, a organic decline in HST kind of be, like, baked in for 2024? Like, when do orders need to start to improve for that to be a positive number, theoretically?

Eric Ashleman (CEO and President)

Well, look, I think we'd have to monitor this pretty—we obviously will through the balance of the Q4. As always, everybody kind of does the same planning cycles at the same time, so, you know, that's the best opportunity for us, for us to get in front of customers, talk about programs, things that they're launching, their confidence in them. You know, I think we want to watch it quarter by quarter and stay super close to it. These are the most dynamic markets that we have in the whole place. I just, you know, 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.

You know, we're, 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, you know, the industry heads in different directions here, we are in sync with it. We're a, you know, we're a critical component supplier to folks that are making very sophisticated instruments and things for a variety of different markets and geographies. And, you know, we are somewhat dependent on their success. We are completely dependent on their success, their call, the way that they're seeing that those, those markets are going to traverse. You know, 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, and 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. Again, it's four buckets of business for us, occasionally move at slightly different rates, and we can move resources around. But we'll see how it plays out as we go through 2024.

Joe Giordano (Managing Director)

That's fair. And just last, 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?

Eric Ashleman (CEO and President)

We still have a couple of businesses that have longer backlogs. I mean, they're still working through generally 'cause lingering issues in supply chains and elsewhere. We spoke of one in energy, but we talked about, you know, 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 other pockets in here that we're trying to get back down to kind of all IDEX level.

Joe Giordano (Managing Director)

Thanks, guys.

Operator (participant)

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

Eric Ashleman (CEO and President)

Okay. Well, thanks for everybody for joining our call, and I always do, I want to thank the members of the IDEX team that are on for really, really strong execution and performance in the quarter. A few comments here. I think there's certainly. Look, there's a lot of uncertainty out there, you know, in the environment. I think it's going to require a certain amount of patience. You know, but as I think about IDEX 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&A. It's well-positioned, certainly to support long-term growth outperformance. I really think our flat and 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. Our teams and leaders are outstanding, and frankly, they're going to be outstanding plus one, as Abhi joins us here in November. So with that, you know, when things break, we'll be all set up here, I think, to really support a nice extended run for IDEX, as the world starts to dial in and responds to, frankly, the trends that we know are all coming. So with that, thanks for your support, and have a great day.

Operator (participant)

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