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Edited Transcript of AME earnings conference call or presentation 30-Jul-19 12:30pm GMT

Q2 2019 Ametek Inc Earnings Call

BERWYN Aug 1, 2019 (Thomson StreetEvents) -- Edited Transcript of Ametek Inc earnings conference call or presentation Tuesday, July 30, 2019 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* David A. Zapico

AMETEK, Inc. - Chairman & CEO

* Kevin C. Coleman

AMETEK, Inc. - VP of IR

* William Joseph Burke

AMETEK, Inc. - Executive VP & CFO

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Conference Call Participants

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* Allison Ann Marie Poliniak-Cusic

Wells Fargo Securities, LLC, Research Division - Director & Senior Equity Analyst

* Andrew Burris Obin

BofA Merrill Lynch, Research Division - MD

* Brett Logan Linzey

Vertical Research Partners, LLC - VP

* Christopher D. Glynn

Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst

* Deane Michael Dray

RBC Capital Markets, LLC, Research Division - Analyst

* Joseph Craig Giordano

Cowen and Company, LLC, Research Division - MD and Senior Analyst

* Joshua Charles Pokrzywinski

Morgan Stanley, Research Division - Equity Analyst

* Matt J. Summerville

D.A. Davidson & Co., Research Division - MD & Senior Analyst

* Nigel Edward Coe

Wolfe Research, LLC - MD & Senior Research Analyst

* Robert Paul McCarthy

Stephens Inc., Research Division - MD & Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen. Welcome to the Q2 2019 AMETEK, Inc. Earnings Conference Call. (Operator Instructions) As a reminder, today's conference is being recorded.

I would now like to introduce your host for this conference call, Mr. Kevin Coleman, Vice President, Investor Relations. You may begin.

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Kevin C. Coleman, AMETEK, Inc. - VP of IR [2]

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Great. Thank you, Kevin. Good morning, everyone, and thank you for joining us for AMETEK's Second Quarter 2019 Earnings Conference Call. With me today are Dave Zapico, Chairman and Chief Executive Officer; and Bill Burke, Executive Vice President and Chief Financial Officer.

AMETEK's second quarter results were released earlier this morning and are available on market systems and in the Investors section of our website. This call is also being webcasted and can be accessed on our website. The webcast will be archived and made available on our site later today.

During the course of today's call, we will make forward-looking statements, which are subject to change based on various risk factors and uncertainties that may cause actual results to differ significantly from expectations. A detailed discussion of the risks and uncertainties that may affect our future results is contained in AMETEK's filings with the SEC. AMETEK disclaims any intention or obligation to update or revise any forward-looking statements.

Also, any references made on this call to 2018 or 2019 results will be on an adjusted basis, excluding after tax, acquisition-related intangible amortization and excluding the fourth quarter 2018 gain related to the finalization of the impact of the 2017 Tax Cuts and Jobs Act. Reconciliations between GAAP and adjusted measures can be found in our press release and on the Investors section of our website.

We'll begin today with prepared remarks by Dave and Bill and then open it up for the questions. I'll now turn the meeting to Dave.

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David A. Zapico, AMETEK, Inc. - Chairman & CEO [3]

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Thank you, Kevin, and good morning, everyone. AMETEK had an excellent second quarter. We exceeded earnings guidance on solid organic sales growth, contributions from acquisitions and exceptional operating performance. In the process, we delivered a record level of sales, EBITDA, operating income and adjusted diluted earnings per share. We also delivered impressive growth in operating cash flow in the quarter.

Given these strong results on our outlook for the back half of the year, we have again increased our full year earnings guidance range. These results continue to highlight the strength of the AMETEK growth model and our ability to deliver strong and consistent performance for our shareholders.

Now on to the financial highlights for the quarter. Total sales were a record $1.29 billion, up 7% compared to the second quarter of 2018. Organic sales growth was solid at 3%, acquisitions added 5%, and foreign currency was a 1-point headwind. EBITDA in the second quarter was a record $349 million, up 10% over the same period in 2018, and EBITDA margins were excellent at 27%.

Operating income was a record at $295.4 million, a 9% increase over the second quarter of 2018. Reported operating income margins were up 60 basis points to 22.9%, and excluding the dilutive impact of acquisitions, operating margins increased an impressive 110 basis points over the prior year period. This exceptional operating performance reflects the strength of our operational excellence initiatives. Earnings were a record $1.05 per diluted share, up 14% over the prior year, and exceeding our guidance range of $1 to $1.02 per diluted share. Lastly, operating cash flow was superb in the quarter, up 21% to $246 million.

Now on to the individual operating groups. First, the Electronic Instruments Group. EIG's second quarter sales were $820.2 million, up 10% over last year's second quarter. Recent acquisitions contribute 8%, organic sales were up 3% and foreign currency was a 1-point headwind.

Our Materials Analysis business delivered another very solid quarter through high-end analytical instrumentation solutions, including several new product introductions, are helping our customers solve increasingly complex challenges in attractive growth markets.

Our Aerospace businesses also performed nicely as demand remains very solid across the Aerospace & Defense markets. In addition to the strong top line growth, EIG delivered outstanding operating performance in the second quarter. Operating income increased 10% to $212.9 million with reported operating income margins up 26%. Excluding the dilutive impact of acquisitions, EIG's margins expanded 90 basis points over the prior year.

The Electromechanical Group also had a strong quarter with solid organic sales and impressive operating performance. Second quarter sales for EMG were $469.2 million, up 1% over the same period in 2018. EMG's organic sales growth was 3%; and foreign currency, a 2-point headwind. EMG's operating performance was excellent with operating income a record $101.1 million, up 7% over the prior year second quarter. Operating margins for EMG increased sharply to 21.5%, up 120 basis points over the same period last year.

AMETEK's results in the second quarter and through the first half of the year were excellent. We are firmly positioned for another year with strong growth and record results. Our highly differentiated businesses continue to execute the AMETEK growth model, driving long-term sustainable value for our shareholders.

I'd like to highlight some of our businesses' recent accomplishments, and then I'll touch on our updated outlook and guidance for the remainder of the year.

First, I would like to congratulate the team at Creaform for recently winning 2 Red Dot Awards for innovative product design of their HandySCAN BLACK and Go! Scan SPARK metrology products. Launched in April, both new 3D scanners were designed with enhanced features and a sleek new ergonomic design. Now in its third generation, the HandySCAN BLACK has been optimized to meet the designs -- meet the needs of design, manufacturing of metrology professionals looking for the most effective and reliable way to acquire accurate 3D measurements of physical objects. The HandySCAN BLACK provides highly accurate and repeatable results even in difficult environments and with complex surfaces.

The Go! SCAN SPARK offers the fastest and most friendly 3D scanning experience in the market. Designed to scan any object without need for a setup, it offers flawless texture and geometry acquisition as well as impressive details in a rich color palette. The Red Dot Award is a world-renowned competition that is used to identify the most innovative new products across several product categories.

I'd also like to congratulate our Dunkermotoren business for winning the Maschinenmarkt's Best in Industry Award for their BG 95 dPro servo motors solutions. Dunkermotoren is a global leader in advanced motion control solutions serving a broad set of end markets, including medical, laboratory, Factory Automation and motive applications. Their BG 95 dPro sets a standard in integrated servo motors with improved flexibility, functionality, precision and operational reliability.

The Red Dot and Best of Industry Awards and the success of these new products are testaments to the strength of our new product development teams. So congratulations to everyone at Creaform and Dunkermotoren for these outstanding recognitions.

We remain committed to investing in our research and development efforts to provide a leading-edge innovative products and technologies to our customers. In 2019, we expect to spend approximately $260 million on RD&E, up 13% over last year's level. And we are seeing excellent results as our new product Vitality Index was a very strong 25% in the quarter.

Now shifting to operational excellence. Our operational excellence tools are adding significant value for our businesses. We continue to drive efficiency improvements across our operation to enhance our profitability and improve cash flow as was evident in our operating performance during the second quarter. For all of 2019, we now expect approximately $85 million in savings from our operational excellence initiatives with the majority of these savings generated from material sourcing. This is an increase from our previous estimate of $80 million in annual savings.

Finally, we remain very active yet disciplined in our acquisition efforts. Our business development teams continue to manage a strong pipeline of acquisition opportunities. AMETEK remains focused on deploying our strong free cash flow on value-enhancing acquisitions.

I'll now move to the updated earnings guidance for 2019. Given our performance in the second quarter and our near-record backlog, we now expect 2019 earnings per diluted share to be in the range of $4.04 to $4.10, up 10% to 12% over 2018 earnings. This new guidance range has increased from our previous guidance range of $3.98 to $4.08 per diluted share. We continue to expect overall sales for the year to be up high single digits with organic sales up 3% to 5%. Overall sales in the third quarter are expected to be up high single digits. Earnings for the third quarter are anticipated to be in the range of $1 to $1.02 per diluted share, up 10% to 12% over the prior year period.

To summarize, we are pleased with our second quarter results. We remain focused on driving continued growth through the end of the year and well into the future. Our businesses' market-leading differentiated technologies and their execution of the AMETEK growth model are driving strong results for our stakeholders.

I will now turn it over to Bill Burke, who will cover some of the financial details of the quarter, then we'll be glad to take your questions. Bill?

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William Joseph Burke, AMETEK, Inc. - Executive VP & CFO [4]

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Thank you, Dave. As Dave noted, AMETEK had an excellent second quarter, capping off the first half of the year with record results. Let me provide some additional financial highlights for the quarter.

Core selling expense in the second quarter was roughly in line with last year's second quarter. Second quarter general and administrative expenses were up slightly over the same period in 2018, and as a percentage of sales were 1.4% versus last year's level of 1.5%.

The effective tax rate in the quarter was 20.4%, down from last year's second quarter tax rate of 21.9%. For 2019, we now expect our effective tax rate to be approximately 21%, and as we've stated in the past, actual quarterly tax rates can differ dramatically, either positively or negatively from this full year estimated rate.

Working capital was 18.3% in the second quarter, essentially unchanged from the first quarter. Capital expenditures were $22 million in the quarter, and for the full year of 2019, we continue to expect capital expenditures to be approximately $100 million or 1.9% of sales.

Depreciation and amortization expense in the quarter was $57 million. For the full year, we continue to expect depreciation and amortization to be approximately $235 million, including acquisition-related intangible amortization of approximately $130 million or $0.43 per diluted share.

Our businesses continue to generate very strong levels of cash flow. Second quarter operating cash flow was $246 million, up 21% over last year's second quarter, and free cash flow was $224 million, up 20% over last year. As a percentage of net income, free cash flow conversion was 104%, and we continue to expect full year free cash flow conversion of approximately 110% of net income. The primary use of our strong free cash flow is to support our acquisition efforts, and as Dave has noted, our pipeline remains healthy and we have significant financial flexibility to continue our acquisition strategy.

Total debt at the end of the second quarter was $2.47 billion, down from $2.63 billion at the end of 2018. Offsetting this debt is cash and cash equivalents of $568 million, resulting in a net debt-to-EBITDA ratio as of June 30 of 1.4x. We remain well positioned to support our growth initiatives with approximately $2 billion of cash and existing credit facilities.

To conclude, our businesses delivered outstanding performance with high-quality results in the second quarter. Our outlook remains positive through the back half of 2019, given our strong balance sheet and excellent cash flows. Kevin?

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Kevin C. Coleman, AMETEK, Inc. - VP of IR [5]

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Great. Thank you, Bill. And Kevin, can we please open the lines for questions?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Matt Summerville with D.A. Davidson.

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Matt J. Summerville, D.A. Davidson & Co., Research Division - MD & Senior Analyst [2]

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A couple of questions. First, can you give us a little color on where incoming order rates organically were for the total company and by business? And also, just given the macro choppiness out there, can you talk about what sort of linearity you saw during the quarter and what you're seeing thus far in your business in July?

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David A. Zapico, AMETEK, Inc. - Chairman & CEO [3]

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Sure, Matt. In terms of orders, Q2 orders were up 4%, and organic orders were flat. They were very slightly positive. In our EIG business, the order rates were in line with the organic sales growth in the quarter, and the EMG orders were down a bit. We had some delays in our Automation & Engineered Solutions businesses. And we ended the quarter with a near-record backlog of $1.7 billion. And in terms of the order patterns and sales patterns during the quarter, they followed a similar trend. We had a -- May was a bit better than April, and June was a bit better than May, which is very typical for our business. But the growth each month, as it stepped up, was more subdued than past quarters. So pretty typical but a little less of a ramp.

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Matt J. Summerville, D.A. Davidson & Co., Research Division - MD & Senior Analyst [4]

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And then as a follow-up, where were you in the quarter on price versus inflation?

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David A. Zapico, AMETEK, Inc. - Chairman & CEO [5]

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Sure, Matt. Sure. Q2 was much like the second half of '18 and the first quarter of '19. We had an excellent quarter. We achieved a 2-point [surprise] across our entire portfolio. Total inflation, the impact of tariffs was a bit less than 1.5%, so we had a positive spread, and we're very pleased with the results. As you know, the results speak to the highly differentiated nature of AMETEK's product portfolio. We have leadership positions in niche markets around the globe, and we really have some focus and determination to make sure we stay in front of a changing global environment. So we're very pleased with the results.

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Operator [6]

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Our next question comes from Nigel Coe with Wolfe Research.

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Nigel Edward Coe, Wolfe Research, LLC - MD & Senior Research Analyst [7]

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I thought it may be a good time to perhaps run through the end markets and the geographies in a bit more detail.

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David A. Zapico, AMETEK, Inc. - Chairman & CEO [8]

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Right. Sure thing, Nigel. Post on our market segment commentary, I'll start with our process businesses. They had another excellent quarter with overall sales up low teens on a percentage basis driven by mid-single-digit organic sales growth and contributions from the acquisitions of Forza, Telular and Spectro Scientific. As I mentioned in the prepared remarks, our Materials Analysis business had a particularly strong organic growth quarter driven by solid new product introductions and solid demand for their high-end instrumentation. And for all of '29 (sic) [2019], we continue to expect process organic sales to be up mid-single digits.

Switch to Aerospace. Our Aerospace & Defense businesses delivered another excellent quarter with high single-digit organic sales growth. This growth reflects the attractive positions we have across a diverse set of aerospace and defense platforms. Similar to the first quarter, growth in the second quarter was broad-based across our various aerospace markets. We had a notable strength in our commercial OEM and third-party MRO businesses. And given the solid start to the year, we're increasing our expectations for Aerospace and now expect mid- to high single-digit organic sales growth for all of 2019 with balanced growth across each market.

Our Power & Industrial segment in the second quarter, sales were up low single digits driven by the contribution from the recent acquisition of Motec. Organic sales were down slightly in the quarter and in line with our expectations. For all of 2019, we continue to expect low to mid-single-digit organic sales growth, given the strength of our backlog and solid order patterns in these businesses.

And finally, sales of our Automation & Engineered Solutions businesses were up low single digits for the second quarter against a difficult prior year comp. For all of 2019, we now expect low to mid-single-digit organic sales growth for Automation & Engineered Solutions, and we are seeing some order delays in certain businesses. So we lowered that Automation & Engineered Solutions segment from mid- to low to mid. And we increased our Aerospace guide to a bit also.

So just summarize the whole thing. Continue to expect overall full year organic sales growth of 3% to 5%. As I said, we modestly increased growth forecast for Aerospace while modestly decreasing our growth forecast for Automation & Engineered Solutions. And really, no change to process, and in Power & Industrial process performed very well in the quarter, and they look strong.

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Nigel Edward Coe, Wolfe Research, LLC - MD & Senior Research Analyst [9]

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Great. And maybe if you could just touch on what you're seeing in China. Perhaps just address the 3% to 5% organic implies some acceleration in the back half of the year to get to the high end of that range. What gives you confidence that, that can accelerate on top of comps in the back half?

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David A. Zapico, AMETEK, Inc. - Chairman & CEO [10]

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Right. Sure. Right. Yes, we had overall sales ended up within our guidance range, and organic sales ended up within our guidance range. And at the half year, we are at 4%, so right smack dab middle in our guide.

So in terms of geography, we saw some solid growth across Europe and the U.S., and Asia was down mid-single digits. So you really have about 80% of our business up mid-single digits. And Asia, which is about 18% of our business, was down mid-single-digits.

We see in the U.S., where we were up mid-single digits, the strongest growth was at Process and our Aerospace businesses. In Europe, we were up mid-single digits, we had broad-based growth, and Oil & Gas and Aerospace had particularly strong quarters. And Asia was down mid-single digits, and China was down a bit more than mid-single-digits. So we had some down a bit more after 2-plus years of very strong growth. But it's about 7% of our sales, and clearly, they're being impacted by the #1 and #2 economies in the trade war. So we're watching that closely, but given its relative size, it hasn't been too much of a headwind yet.

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Operator [11]

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Our next question comes from Josh Pokrzywinski with Morgan Stanley.

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Joshua Charles Pokrzywinski, Morgan Stanley, Research Division - Equity Analyst [12]

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I guess just to follow up on the last question, thinking about some of the end markets that are doing better or ones that got a little softer. And Dave, I think, is it fair characterization to say some of the longer-cycle stuff, Aerospace, Process, is really what gives you the visibility in the guide and the confidence in the second half and the shorter-cycle end markets and Automation are, I guess, what's holding you back but can also turn quickly? Is that a fair characterization as a starting point?

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David A. Zapico, AMETEK, Inc. - Chairman & CEO [13]

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Yes. I'd say that's a fair characterization. In our Automation businesses, we're dealing with OEM customers, and they delay placing orders in the quarter. They're -- we didn't lose these orders, they're delayed, and they're cautious. But there's a healthy order pipeline. So I would say that's a good characterization with -- we have strength in Aerospace and solid with Process and some weakness in Automation. So that's a good summary.

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Joshua Charles Pokrzywinski, Morgan Stanley, Research Division - Equity Analyst [14]

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So I think in the Automation space, a lot of folks in that orbit have called out auto and electronics as being kind of the 2 biggest headwinds. Is that safe to say it's the same end markets for you guys? Or is there something else that's cropped up within that?

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David A. Zapico, AMETEK, Inc. - Chairman & CEO [15]

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Yes. I would say it's -- we have some motive customers there, and that was weaker. There was also some Factory Automation customers. That was weaker. And to balance that, there was some medical and food industry automation that were okay. So -- but those are OEM customers, and the motive and the -- for Factory Automation were the areas that it was a bit light.

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Joshua Charles Pokrzywinski, Morgan Stanley, Research Division - Equity Analyst [16]

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Got it. And then just one last one for me. Obviously, with the string of acquisitions over the last couple of years, a bit more diversity in the portfolio and some deeper niches, how have those performed? Or have you even noticed the change in the growth rates or performance as some of the macro has gotten a bit choppier?

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David A. Zapico, AMETEK, Inc. - Chairman & CEO [17]

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Yes. One of the characteristics of the acquisitions we did over the past 2 years were they were largely U.S.-based, and they've held up very well. So the acquisitions are performing extremely well, and they're meeting their acquisition models and it's driving the performance of the company as you can see in the results.

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Operator [18]

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Our next question comes from Andrew Obin with Bank of America.

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Andrew Burris Obin, BofA Merrill Lynch, Research Division - MD [19]

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Just a question. Did I hear correctly that China was down in the quarter? I apologize if I missed it.

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David A. Zapico, AMETEK, Inc. - Chairman & CEO [20]

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Yes. Yes. What we went through the geographies were up in the U.S., mid-single digits; down in Europe, mid-single digits -- excuse me, up in U.S., up in Europe mid-single digits; down in Asia, mid-single digits. And China was down a bit more than Asia.

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Andrew Burris Obin, BofA Merrill Lynch, Research Division - MD [21]

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So the question on China, I'm just wondering, could you just walk us what happened in the quarter in China? Because my sense was that the Chinese business, very niche-y. You have a lot of growth initiatives there. And just trying to get a sense when did it turn in the quarter or if you have this kind of clarity on the call.

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David A. Zapico, AMETEK, Inc. - Chairman & CEO [22]

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Yes. China has been very choppy and inconsistent through the balance of this year. We do have -- we had very difficult comps that we're running into there. So it was mainly in our Automation business where we saw weakness, but it was -- in China, it was more broad-based. A lot of the businesses were down a bit. So as -- again, it was a difficult comp, and I think they're just dealing with the uncertainty and the trade war, and we've been watching it closely. And it's 7% of our business. And fortunately, we have about 80% of our business growing mid-single digits. So it's been inconsistent. That's the best way to describe it, Andrew.

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Andrew Burris Obin, BofA Merrill Lynch, Research Division - MD [23]

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Yes. No. Of course. And then -- and just a broader question, I think others have tried to sort of get to the question. If I look at your peers, most of them actually did cut organic growth outlook. If I look at the historical relationship between your revenue growth and industrial production, your guidance does imply that things are different. You did highlight more North American acquisitions over the past couple of years. But could you also talk about the impact of the growth initiatives? Because I know, Dave, when we meet with AMETEK folks, they're really highlighting how you're pivoting more to growth. Any way you can quantify what the growth initiative's doing to cyclicality or the growth profile of AMETEK? That would be terrific.

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David A. Zapico, AMETEK, Inc. - Chairman & CEO [24]

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Yes. Sure. When I think about our portfolio, we had the U.S.-based acquisitions over the past year, but we also have about 13% of our business now with health care. And our Aerospace business is performing well. So those are all things that are driving us right now.

And when I look at the -- we definitely have improved our organic growth capability. We're making great progress. As you saw when you visited some of our operation, there was -- the teams are excited, and we're seeing positive results. But I don't think that, that's -- it's very difficult to quantify that. And we're using the tools, and the way we've talked about it is through the cycle, we'll get a point better of organic growth. So I'm not sure in the current environment, it's pretty -- you can draw a distinction between what we've done in organic growth and the current results.

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Operator [25]

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Our next question comes from Deane Dray with RBC Capital Markets.

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Deane Michael Dray, RBC Capital Markets, LLC, Research Division - Analyst [26]

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Maybe we can start with price cost in the quarter? How did that play out in expectations for the second half and what role tariffs had?

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David A. Zapico, AMETEK, Inc. - Chairman & CEO [27]

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Great. Yes. I think I'll start with the tariffs. And as you know, we're comprised of niche-differentiated businesses, and we have low CapEx by design. So our model gives us a lot of flexibility in dealing with those situations. And in Q2, the situation played out as we predicted. We had about $0.01 of -- from the direct impact of tariffs, and we offset that completely with price. So -- and we're expecting a similar level of activity in the second half of the year.

And going back to the price question, Q2 '19 was much like the second half of '18 and the first quarter of '19. We had an excellent quarter. We achieved 2% of price across our entire business, that's both in EIG and EMG. Total inflation and the impact of tariffs added together was a bit less than 1.5%. So we had a good contribution to margin from our price, less total inflation and tariffs, and we're very pleased with the results.

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Deane Michael Dray, RBC Capital Markets, LLC, Research Division - Analyst [28]

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That's all great to hear. And then in the verticals and the end markets, did I hear your comment on Oil & Gas? How did that...

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David A. Zapico, AMETEK, Inc. - Chairman & CEO [29]

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No. Yes. We didn't comment. Oil & Gas had a particularly strong quarter in Europe, and we include the Middle East in Europe. And when you look at the whole segment, it was up 10% in Q2. So good, strong organic growth in both our upstream and mid- and downstream businesses. And we are pleased with the performance.

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Deane Michael Dray, RBC Capital Markets, LLC, Research Division - Analyst [30]

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Good. And then on the opening question, I might have -- with Matt, I might have missed the answer he asked about how July had looked.

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David A. Zapico, AMETEK, Inc. - Chairman & CEO [31]

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Right. Yes, I don't think -- yes, we covered the quarter. We talked about the quarter being an increase each month, but it was more subdued for us. And in July, we're right on our plan. So July isn't over, but we're on target. So July feels pretty good.

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Operator [32]

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Our next question comes from Robert McCarthy with Stephens.

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Robert Paul McCarthy, Stephens Inc., Research Division - MD & Analyst [33]

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Can you hear me?

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David A. Zapico, AMETEK, Inc. - Chairman & CEO [34]

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Yes.

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Robert Paul McCarthy, Stephens Inc., Research Division - MD & Analyst [35]

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Congratulations on a good quarter. I guess the first question I would have is around your incremental margins on a core basis. Could you talk through that, just excluding acquisition and some of the distortions we might see there?

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David A. Zapico, AMETEK, Inc. - Chairman & CEO [36]

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Right. We're very pleased with our margin performance in the quarter. Our core margins were excellent. The EIG, if you take out the acquisitions, it was up 90 basis points. And EMG, where there was an acquisition, was up 120 basis points. So just outstanding margins, outstanding operating performance, and it showed up in the incrementals also. We had core incrementals of about 60%. EIG was about 50%, and EMG was about 70%. So excellent operating performance around the horn.

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Robert Paul McCarthy, Stephens Inc., Research Division - MD & Analyst [37]

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Now definitely, could you speak -- just stepping back on the performance on the cash cycle and cash generation and more of your Aerospace, and while you probably have very little, explicit Defense exposure. But your Aerospace and longer-cycle businesses in terms of how you do there, in terms of free cash flow to net income conversion or operating cash flow typically. Is that below or above the company average?

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David A. Zapico, AMETEK, Inc. - Chairman & CEO [38]

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Yes. The Aerospace business is a great cash generator for us. So I would say it, in terms of the various components of working capital, Aerospace ends up being a little higher as a percentage of sales because they're dealing with the aftermarket, and -- but they're higher-margin businesses. So yes, the higher working capital but higher margins. And that's characteristic of the Aerospace business, and it's been that way for a long time.

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Robert Paul McCarthy, Stephens Inc., Research Division - MD & Analyst [39]

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Yes, it's nice to have good cash generation there. The final question is, just looking at the environment you're seeing right now, obviously, went through kind of a rocky road in kind of the '14 to '16 time frame with deflation, Oil & Gas kind of contraction, and it led to some challenging organic growth and also some restructuring, right? Do you think we're anticipating, what we're seeing right now over the next 12 to 18 months, incremental restructuring from you guys?

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David A. Zapico, AMETEK, Inc. - Chairman & CEO [40]

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AMETEK, we're on our various businesses. We're always doing some level of restructuring, and those were reported in the operating results.

In terms of a big restructuring, our realignment activity, the effect of the entire company, right now, we're not seeing that. We're pretty confident around the second half of the year. But if things change, we're good at doing it, and we have plenty of opportunities to drive cost reduction. So as I sit here with a solid proof of businesses, generating cash flow, margin expansion with a robust backlog of deals, with a strong balance sheet, I feel very optimistic about AMETEK's performance and being able to outperform the current environment.

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Operator [41]

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Our next question comes from Brett Linzey with Vertical Research.

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Brett Logan Linzey, Vertical Research Partners, LLC - VP [42]

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Just a question pertaining to some of the recent portfolio moves if -- and in recent, I mean you had 2017, 2018 acquisitions. If we're to drill down and look at the recurring element or the aftermarket element as a percent of sales of those businesses, how does that mix look of those acquired assets versus the legacy portfolio? You're actually mixing up with a stickier revenue base…

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David A. Zapico, AMETEK, Inc. - Chairman & CEO [43]

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Yes, we are mixing often. And when we announce those deals, we address the recurring revenue. Telular stands out. It was -- it's about 2/3 of the business that's recurring. But many of the businesses like the Spectro Scientific was 30%, 40%. And so we're mixing up, and the recurring baseline of AMETEK, it was about 20%, but the recent acquisitions have been a bit more than that.

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Brett Logan Linzey, Vertical Research Partners, LLC - VP [44]

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Okay. Great. And then if we continue to see this industrial slowdown historically, you've talked about incrementals on the way up of 30% to 35%. If we flip that script and think about potential downside, what type of decremental preservation do you see if we get into an environment where sales are declining modestly? And then I guess, a follow-on there, are there any countermeasure of plans in place that can help you get at cost relatively quickly if things do turn a little bit south there?

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David A. Zapico, AMETEK, Inc. - Chairman & CEO [45]

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Right. Yes, as you know, we have high contribution margins in our business, very profitable businesses. But we also have excellent operating capability, and we have seasoned general managers that know how to operate both in up cycles and down cycles. And clearly, going into a down cycle, we have plenty of opportunities and plenty of projects, and we have the ability to pull those forward. And we're also very good at managing our working capital and generate a lot of cash. So if we get into that environment, it's an environment where we're experienced, and we'll perform well on a relative basis. But right at this point, we're not seeing that.

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Brett Logan Linzey, Vertical Research Partners, LLC - VP [46]

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But based on some of those actions and what's been in motion, I mean, do you think you can preserve a decremental margin much less than 30%?

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David A. Zapico, AMETEK, Inc. - Chairman & CEO [47]

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Yes. I think it's definitely, but again, when something like that happens, and it depends where it comes from. And...

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William Joseph Burke, AMETEK, Inc. - Executive VP & CFO [48]

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And the depth of it.

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David A. Zapico, AMETEK, Inc. - Chairman & CEO [49]

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And the depth of how deep is a good comment, Bill. So we have to look at it if that happens when it comes. And I'm sure there'll be another recession, and I'm sure we'll manage our way through it very well.

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Operator [50]

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Our next question comes from Allison Poliniak with Wells Fargo.

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Allison Ann Marie Poliniak-Cusic, Wells Fargo Securities, LLC, Research Division - Director & Senior Equity Analyst [51]

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Just want to follow along on that operational excellence kind of theme. You did increase your operational excellence savings for 2019. Can you talk -- was it just sort of a natural callout of where some of these programs ended or ending? Or is it some acceleration in certain areas?

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David A. Zapico, AMETEK, Inc. - Chairman & CEO [52]

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We're seeing acceleration. I mean at the beginning of the year, we had about $80 million of operational excellence savings, and $60 million of it was from sourcing and $20 million of it was from other projects that we had. And what we're really seeing is an acceleration on the sourcing side. So our sourcing teams are doing an outstanding job, absolutely outstanding job of dealing with the mitigation of tariffs and moving us to different regions of the world and delivering incremental savings. So really, the incremental savings from sourcing was increased from $60 million to $65 million, and that drove the operational excellence savings increase from $80 million to $85 million. And that savings that are in the P&L for 2019, and we saw that's a ratable kind of thing. And we saw it ramp-up from Q1 to Q2. So we're very confident in the second half of that.

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Allison Ann Marie Poliniak-Cusic, Wells Fargo Securities, LLC, Research Division - Director & Senior Equity Analyst [53]

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Great. And then I may have missed it, the Aerospace, the increase in growth for that sector. Was there a specific subsegment there or region that's driving that increased growth relative to your expectations?

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David A. Zapico, AMETEK, Inc. - Chairman & CEO [54]

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Yes. We had a -- if you look at the business jet market, the business jet market was up low double digits and coming off of pretty easy comp, but it's continuing to perform. So the military market, the third-party MRO had a fantastic quarter in the second quarter. The commercial business continues strong. So it was really the entire market that did well. But if you look into the details, the business jet market ticked up, and we improved the guidance for that for the year. But the higher -- the entire Aerospace business, we increased to mid- to high single digits.

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Operator [55]

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Our next question comes from Christopher Glynn with Oppenheimer.

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Christopher D. Glynn, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [56]

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Dave, so I think you mentioned $2 billion cash and available credit. I think it's the first quarter in a little while. You didn't talk about a couple of new bolt-ons, I know. I know they don't come every quarter. But just update us, the pipeline still very vibrant?

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David A. Zapico, AMETEK, Inc. - Chairman & CEO [57]

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It is. It is. Chris, we had a record Q4 '18 where we closed 3 deals and spent about $750 million. And our pipeline is very good. And we're evaluating a number of opportunities, and as you know, it's difficult to predict when they're going to happen in the short term. But I feel very confident in the long term in our capability in this area and our strong balance sheet. So we're very optimistic that we're going to be able to deploy our free cash flow on acquisitions in the long term. Right now, we're being disciplined. I mean we're looking at a lot of properties, and when we do a deal, we're going to get your return on capital.

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Christopher D. Glynn, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [58]

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And on the outlook, generally calling for continuity versus the macros clearly weakening, I understand you don't have much distribution, you're much more direct. So that's clearly an advantage you have in the current environment. But are we moving into a phase where backlog conversion picks up to kind of preserve that organic continuity? Just want a little more kind of complexion around that.

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David A. Zapico, AMETEK, Inc. - Chairman & CEO [59]

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Yes. We have a near-record backlog of $1.7 billion, which gives us some confidence in the second half. And if you look into that backlog, there's some opportunities to convert some of it. So that's one of the reasons that we're confident in the guidance in the second half. We're performing well. We got our Aerospace growth. Our process business is going well. The U.S. market is doing extremely well. And we got a solid backlog and it provides conversion opportunities. So that's the way we're looking at it, and we feel good about it.

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Operator [60]

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Our next question comes from Joe Giordano with Cowen.

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Joseph Craig Giordano, Cowen and Company, LLC, Research Division - MD and Senior Analyst [61]

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Bill, just one quick clarification. The tax rate was a little light in the quarter. Anything specific going on there? And I know you gave the full year, but I missed it. What's your view for that?

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William Joseph Burke, AMETEK, Inc. - Executive VP & CFO [62]

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Full year is now 21%. What we saw in the quarter was about 150 basis points down year-over-year. Benefits from excess tax benefits from stock compensation and as well there were some changes in some state tax laws that helped us drive that rate down to 20.4% in the second quarter.

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Joseph Craig Giordano, Cowen and Company, LLC, Research Division - MD and Senior Analyst [63]

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And 21% good forward number to use like out into the model, too?

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William Joseph Burke, AMETEK, Inc. - Executive VP & CFO [64]

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We're looking at a number that's probably, to get to the average of 21% for the year, it's more 22% in the back half of the year.

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Joseph Craig Giordano, Cowen and Company, LLC, Research Division - MD and Senior Analyst [65]

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No, I mean more full like a full year going forward like into 2020. Is like a 21% a fair number to use?

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William Joseph Burke, AMETEK, Inc. - Executive VP & CFO [66]

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That's -- we'll be working to get to that level next year.

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Joseph Craig Giordano, Cowen and Company, LLC, Research Division - MD and Senior Analyst [67]

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Okay. So we've kind of got to this a couple of times asked different ways. As top line starts to slow, and then maybe we're still in the same organic range, but maybe we're talking more midpoint or lower. And earlier in the year, maybe we're talking midpoint or higher. Particularly in markets like maybe heavy truck where there's some obvious declines probably coming up, are you like teeing up anything here are to take some actions? And along the same lines, your cost-out this year, really strong. Sourcing, accelerating. What's the opportunity set look like into next year for cost-out broadly?

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David A. Zapico, AMETEK, Inc. - Chairman & CEO [68]

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Right. Well, the opportunity set is very good to -- at all times. As part of our strategic planning process we go through with all of our businesses, they have a 3-year plan for cost reductions that involve sourcing, some plant consolidations and everything. We have a viable set of projects to pull from. So we really have some opportunities to do that and -- but when you mentioned the trucking marker, that business is now less than 2% of sales, and the mix...

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Joseph Craig Giordano, Cowen and Company, LLC, Research Division - MD and Senior Analyst [69]

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Definitely. Yes.

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David A. Zapico, AMETEK, Inc. - Chairman & CEO [70]

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Yes. We bought Motec earlier in the year, and they're in the -- really good business. And that business is actually growing. So it mutes any decline that we have in the other part of the business. So we have a situation where we've been modifying our portfolio over time. And there we have a good growth in the camera and the algorithms, the software of the vehicles. And we're really -- it's changed the outlook for that part of the business. So you have a little bit of a portfolio work that's going on, and we still feel good for the second half. I mean your point is valid. Maybe we're more toward the midpoint or the low end than the high end, but we're 4% through the half year right in the middle of our guide, and we feel confident for the second half of the year.

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Joseph Craig Giordano, Cowen and Company, LLC, Research Division - MD and Senior Analyst [71]

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So I guess what I'm getting at, I know that you're not -- I know that you're looking forward and you're not sitting on your hands as things start to weaken from a macros perspective. Early in the year, orders growing 12% organically. Or like last year, orders going 12% organically in the first quarter and now we're at flat. So how are you just -- I'm guessing like the decisions are somewhat different now. So how are you acting differently than maybe you were a year ago or something like that?

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David A. Zapico, AMETEK, Inc. - Chairman & CEO [72]

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Yes. I'd just point you to margins. And we really have some seasoned operators in our businesses, and they have -- they're reacting to their plans. So when their business has softened, they're adjusting their cost structures. And with our -- you saw excellent core incrementals in the quarter, you saw excellent operating income on a reported basis. We were up 60 basis points after we did a bunch of dilutive deals, and without the acquisitions, we were at 110 basis points. So I think the AMETEK operational excellence is really working for you, and there's plenty of room to go and a long runway to that.

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Operator [73]

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And I'm not showing any further questions at this time. I'd like to turn the call back over to our host.

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Kevin C. Coleman, AMETEK, Inc. - VP of IR [74]

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Great. Thank you, Kevin, for all your help, and thank you, everyone, for joining our call today. And as a reminder, a replay of today's webcast will be available on our website shortly. Thank you.

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Operator [75]

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Ladies and gentlemen, this does conclude today's presentation. You may now disconnect, and have a wonderful day.