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Edited Transcript of IEX earnings conference call or presentation 30-Jan-19 3:30pm GMT

Q4 2018 IDEX Corp Earnings Call

LAKE FOREST Jan 31, 2019 (Thomson StreetEvents) -- Edited Transcript of IDEX Corp earnings conference call or presentation Wednesday, January 30, 2019 at 3:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Andrew K. Silvernail

IDEX Corporation - Chairman, CEO & President

* William K. Grogan

IDEX Corporation - CFO & Senior VP

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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

* Deane Michael Dray

RBC Capital Markets, LLC, Research Division - Analyst

* Joseph Craig Giordano

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

* Matt J. Summerville

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

* Michael Patrick Halloran

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* Nathan Hardie Jones

Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst

* Robert Scott Graham

BMO Capital Markets Equity Research - Analyst

* Walter Scott Liptak

Seaport Global Securities LLC, Research Division - MD & Senior Industrials Analyst

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Presentation

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Operator [1]

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Greetings, and welcome to the IDEX Corporation Fourth Quarter 2018 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Bill Grogan. Thank you. You may begin.

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William K. Grogan, IDEX Corporation - CFO & Senior VP [2]

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Thank you, Matt. Good morning, everyone. This is Bill Grogan, Chief Financial Officer for IDEX Corporation. I'm stepping in for Mike Yates this morning and will cover the introduction. Mike, unfortunately, lost power overnight due to the polar vortex hitting Chicago and is anxiously awaiting power to get restored to his house. We're hoping to get back power soon, Mike.

Okay. Let me start by saying thank you for joining us for discussion of the fourth quarter and full year 2018 financial highlights. Last night, we issued a press release outlining our company's financial and operating performance for the 3 months and year ending December 31, 2018.

The press release, along with the presentation slides to be used during today's webcast, can be accessed on our company's website at idexcorp.com.

Joining me today is Andy Silvernail, our Chairman and CEO. The format for our call today is as follows: we will begin with Andy providing an overview and update on market conditions, geographies and our capital deployment strategies. I will then discuss our fourth quarter and full year 2018 financial results and walk you through the operating performance within each of our segments. And then Andy will wrap up with our outlook for the first quarter and full year 2019. Following our prepared remarks, we'll open the call for questions.

If you should need to exit the call for any reason, you may access the complete replay beginning approximately 2 hours after the call concludes by dialing the toll-free number (877) 660-6853 and entering conference ID 13684161. 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 at IDEX's filings with the Securities and Exchange Commission.

With that, I'll now turn the call over to our Chairman and CEO, Andy Silvernail.

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Andrew K. Silvernail, IDEX Corporation - Chairman, CEO & President [3]

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Thanks, Bill, and good morning, everybody. I appreciate you joining us here to discuss the fourth quarter of last year and also the full year operating results from 2018. I'm going to start with some highlights from 2018 and then move to the outlook for 2019.

2018 was another record year for IDEX. We hit all-time highs of all of our key metrics, and we continue to outperform the market. The overall macroeconomy was strong, and our teams capitalized when we leverage our target organic growth initiatives to deliver results above and beyond the underlying market support.

We continue to invest back in our businesses with record levels of CapEx and engineering investment in 2018. Those investments helped drive our terrific topline performance as well as margin performance. We saw over 100 basis points improvement in op margin in all 3 segments. Our balance sheet is in great position, and we have plenty of capacity to deploy capital across our framework and drive long-term value for shareholders.

Looking ahead to 2019, we're monitoring the geopolitical and global economic environment and its volatility. However, we're confident in our long-term strategic objective to grow faster than the underlying market. We're able to do so as a result of our leading positions and diversified product portfolio, and we look forward to another solid year in 2019.

Now let me take a moment to talk about what we're seeing in the markets that we serve and the regions we do businesses in. In the industrial market, the conditions remain favorable, and we see this in both FMT and in HST. Day rates for our book and ship businesses continue at high levels, project activity is decent and our growth funnel is very solid.

In Scientific Fluidics and Optics, our life science markets continue to expand, we're seeing strong growth across IVD/BIO and DNA sequencing, driven by new product, project traction and share gains.

In energy, we did see some softness in Q4. And with the fluctuation of energy prices, we expect to see that kind of throughout the year. As it firms up now, that could get better as we get into 2019. The teams continue to drive growth through new project activity and over serving our customers.

In ag, the OEMs are holding up, but depressed commodity prices and lower net farm income are concerning. We're watching that closely as we head into 2019.

On the municipal markets, the North American market is stable and expected to modestly expand. Our focus remains on new product development in water and investments in emerging markets within Fire & Rescue.

The semicon market is small for us relative to our portfolio, but it's growing rapidly in the last couple of years. It was a difficult market in Q4, and we see more softness into next year.

Now let me move on to the geographic outlook. Sales across all geographies performed well in the quarter with North America leading the way. We're starting to see lower market support in Europe and in Asia but our targeted growth initiatives have driven positive results across the globe.

Looking ahead, the fundamentals are still decent as evidenced by stable day rates and strong project funnels, but we do have pockets of concern in some markets and general caution with the overall 2019 global economic condition.

Let me switch gears for a second here and talk about what we're seeing with tariffs and inflation.

In the current tariff environment, if we expect that to continue, our best estimate is an incremental $5 million to $7 million of impact in 2019. We'll continue to employ internal countermeasures to offset these additional costs, and we do not see them as significant headwinds for us as we go into this year.

Inflation has slowed down on a material side, but we are experiencing wage inflation. However, we have and will continue to mitigate inflation through productivity and price realization. Again, regardless of the external environment, which we expect to be more challenging and remain volatile in 2019, we're committed to outperform our markets.

Let's turn now and talk a little bit about M&A. The current valuation environment remains the biggest hurdle for us when it comes to acquisitions. Our team is hard at work with evaluating several deals, but we're going to be disciplined with our return framework and we'll only move forward when our target has great strategic impact and financial impact and it fits our style of competition.

Shareholder returns is our #1 focus, and we'll continue to evaluate yields with our commitment of providing long-term shareholder value. Our balance sheet is in very strong position and when the right deal comes along, we'll capitalize on it. Our gross leverage is 1.3x and our net leverage is only 0.6x.

Consistent with our balanced capital allocation framework, we repurchased $174 million of stock in 2018 with $122 million of that coming in the fourth quarter with opportunistic purchases. We also returned $127 million to shareholders in 2018 via dividends. I'm going to pause now. I'm going to turn it back over to Bill Grogan who's going to talk about financial results and our segment discussion.

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William K. Grogan, IDEX Corporation - CFO & Senior VP [4]

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Thanks, Andy. I'll start with our consolidated financial results. I'm on Slide 4. Order rates slowed down in Q4. We were up 1% overall and 2% organically. However, for the year, orders were up 7% overall and 6% organically. A solid year from an order intake perspective.

For the Q4 slowdown, I'll get into more detail as we go through the segment discussions, but I'd like to say this, our core industrial franchises did extremely well in the quarter. Secondly, we did see some timing-related issues where we had some early receipts in Q3 and some delays out of Q4. And finally, we did see some true softness in a few markets. But we think the quarter is closer to 5% organic growth number if we normalize some of these items, closer to where we think our new run rate will be for 2019.

From a sales perspective, Q4 revenue was up 5% overall and organically as well, while fiscal year revenue is up 9% overall and 8% organically. This was our highest organic sales growth since 2011.

We expanded gross margins by 10 basis points for both Q4 and the year, primarily due to production efficiencies and volume leverage. This was partially offset by investments we made in engineering related to new product development.

Q4 adjusted operating margin was 23.3%, up 120 basis points. And fiscal year adjusted op margin was 23.4%, 150-basis-point increase. The teams did an excellent job of leveraging the great organic performance throughout the year in the bottom line results.

Q4 net income was $98 million resulting in EPS of $1.27. Excluding restructuring expenses, adjusted EPS was $1.31, up $0.19 or 17%. Full year net income was for $411 million with EPS of $5.29. Again, excluding restructuring expenses, adjusted EPS was $5.41, up $1.10, or 26% higher than last year.

Our Q4 effective tax rate was 23.8% resulting in an ETR of 22.4% for the year. Both rates were lower than our previous guidance, resulting in $0.04 of EPS favorability in the quarter. The difference was primarily due to additional interpretations the IRS provided on tax reform, along with the reduction in the statutory rate in the Netherlands.

Free cash flow for Q4 was strong at $137 million, up 14% and 136% of adjusted net income, which resulted in full year free cash flow of $423 million, which was up 9% and 101% of adjusted net income. Free cash flow was only up 9% for the year primarily due to working capital and capital expenditures investments that we made to support our long-term growth.

In regards to the balance sheet, it remains very healthy. Gross debt leverage is 1.3x, while our net debt leverage is at 0.6x. The combination of our strong balance sheet, capacity on the revolver and free cash flow provides us the ability to deploy well over $1.5 billion over the next 12 months.

I'll now turn to our segment discussion. I'm on Slide 5 starting with Fluid & Metering. FMT continues to deliver strong numbers from both an order and a revenue perspective. Q4 orders were flat overall, up 2% organically, while full year orders were up 6% overall and 7% organically. The lower order rate was primarily driven by the timing of pre-season orders for Banjo, where in Q3 orders were up 36% and Q4 orders were down 5% as well as we saw some project pushout in the quarter in the chemical and energy markets.

Q4 sales were up 7% overall and 8% organically, while full year sales were up 8% overall and 9% organically.

Adjusted for restructuring expenses, Q4 op margin is 29.1%, up 70 basis points over the prior year quarter. Full year op margin was 29.2%, up 150 basis points.

FMT's performance was primarily driven by market growth across the industrial and chemicals sectors coupled with continued stability in the muni market. Those served as the core drivers of growth over the year as evidenced by strong global demand in core distribution and project wins across the group. Oil price fluctuations in Q4 did postpone some investments, but we're seeing market conditions improve as we have seen prices increase and stabilize.

Ag orders rates did slow in Q4 primarily due to the timing of the pre-season orders I mentioned earlier, but the fundamental economics in ags do give us some concern heading into 2019.

Project funnels in various end markets remain strong and active, but have been less predictable in timing as we close out the year with the backdrop of caution in the global market. However, overall, the targeted growth efforts across our businesses in this segment continue to gain wins in market share regardless of the slower market support.

Let's move on to Health & Science, turning to Slide 6. We are very pleased with the Health & Science results, both for Q4 as well as the fiscal year. Q4 orders were up 10% overall and 9% organically, while full year orders were up 10% overall and 7% organically.

In the quarter, the 9% organic growth was aided by some timing shifts related to receipts of annual POs by some of our large OEM customers.

Q4 sales were up 8% overall and 7% organically, while fiscal year sales were up 9% and 6% organically. Excluding restructuring expenses, Q4 adjusting -- adjusted op margin was 23.4% and full year adjusted op margin was 23.6%. Both margins up over 110 basis points over the prior year.

HST's performance is primarily driven by continued success of our IVD/BIO and our Life Science Optics businesses where they continue to outpace the market due to targeted NPD efforts in collaboration with key customers. HST industrial remains strong with double-digit growth due to some large wins within our gas business and also continued strength in their day rate distribution business.

Strong execution in MPT drove customer lead times and helped enable growth. We also had some solid project wins in the pharma and food space that drove double-digit orders increases.

Finally, despite the downturn in the semicon market, our Sealing Solutions continue to perform well in oil and gas and the industrial end markets.

Now moving on to our final segment, Diversified. I'm on Slide 7. Q4 orders were down 10% overall and 8% organically, primarily due to the lumpiness of our dispensing business coupled with the timing of a large annual blanket order at BAND-IT, while full year orders were up 5% overall and up 4% organically. Q4 sales were down 2% overall and 1% organically, while full year sales were up 9% overall and 7% organically. We'll give more details on that in a moment.

Excluding restructuring expenses, Q4 adjusted op margin of 26.5% was flat with the prior year, while adjusted fiscal year-end operating margin was 26.8%, up 170 basis points from prior year.

FSD sales performance was primarily driven by our Fire business reporting high single-digit growth due to strength across most of their product categories and geographies.

Rescue sales were up due to the strong project volume in emerging markets and several wins in key markets in the U.S.

BAND-IT saw growth across most of its verticals with transportation sales up due to significant volume increases in their airbag applications through new product and new platform wins. They also had some nice project wins in the Middle East.

The sales growth in Fire & Rescue and in BAND-IT was muted by the lumpiness of the dispensing business, which was down 25% for the quarter. But it was up 7% for the year. Dispensing does have market leading market positions across all of their geographies, but it is our most project-oriented business and creates tough comps from time-to-time. The dispensing sales decrease was the primary reason for op margin being down -- or excuse me, being flat for the quarter as well for FSD.

I'll now pass it back to Andy to talk about our expectations for 2019.

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Andrew K. Silvernail, IDEX Corporation - Chairman, CEO & President [5]

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Thanks, Bill. Everybody, I'm on Slide 8. We can work through 2019 guidance. So on an operational basis, we expect full year organic revenue growth to be in the 4% to 5% range, which will provide $0.30 to $0.50 of benefit to EPS. We expect our productivity initiatives to offset inflation and then leverage these actions to drive about $0.03 of benefit over 2018.

As I mentioned earlier, our focus has always been to invest in our best organic opportunities: people, new products as well as applications -- new applications for existing products. We'll continue to make these investments across all 3 segments, and these growth investments will create about $0.05 of pressure in 2019.

Although our 2 acquisitions in 2018, Finger Lakes and Phantom, will provide very modest boost to the top line in 2019, we're not expecting a significant benefit to the bottom line because of deal amortization.

Let's take a quick look at a couple of nonoperational items. First, FX, it will be a headwind in 2019 based on the December 31 rates and provide about $30 million of top line pressure. The bottom line pressure from FX has 2 pieces to it that, together, add up to about $0.15. $0.11 is from FX translation due to the higher rates plus an additional $0.04 on foreign currency transaction gain that we recorded in Q1 of 2018 as we unwound intercompany loans relative the tax reform -- 2017 tax reform that we talked about last year.

Second, share buyback activities that we've mentioned before have taken our share count down and have boost our EPS in 2019 by about $0.06.

So in summary, we're projecting organic revenue growth in the 4% to 5% range and have EPS expectations of $5.60 to $5.80. We're going to wrap things up here. I'll summarize things regarding 2019 -- the fourth quarter and the full year. I'm on our last slide, that's Slide 9.

In Q1, we're estimating EPS of $1.35 to $1.38 with organic revenue growth again in the 4% to 5% range and op margin at about 23%. We're projecting a 1% top line headwind from FX, again based on the December 31 rates, which translates to about $0.02 of EPS.

However, as I mentioned earlier, we're also facing an additional $0.04 of FX headwind from the transactional gain that we incurred in Q1 of 2018. The Q1 effective tax rate is expected to be 22.5% and corporate costs should be about $20 million to $22 million.

If we turn to the full year 2019, again, EPS is expected to be $5.60 to $5.80. Full year organic revenue growth should be in the 4% to 5% range and op margin ought to be about 23.5% to 24%. Top line FX will be impacted by 1%, again based on the December 31 rates.

Full year effective tax rate should be about 22.5%. CapEx is anticipated to be about $60 million, and free cash flow should be about 105% to 110% of net income. And corporate costs are expected to be in the range of about $80 million to $84 million for the year. As always, our earnings and guidance exclude any potential associated costs, future acquisitions or restructuring.

With that, Matt, we're going to pause here, and I'll turn it back over to you for questions from folks on the phone.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question is from Allison Poliniak from Wells Fargo.

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Allison Ann Marie Poliniak-Cusic, Wells Fargo Securities, LLC, Research Division - Director & Senior Equity Analyst [2]

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I want to go back to -- I think I heard it correctly, on the order rates in Q4 trying to normalize some of the puts and takes. Were you saying the order rates was around 5%, organically? Or did I hear that wrong?

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Andrew K. Silvernail, IDEX Corporation - Chairman, CEO & President [3]

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Yes, let's -- we'll talk to it and let me give us a little bit of high level and Bill, if you want to jump in, go ahead. So it was a pretty unusual quarter from an order perspective, Allison. And what I mean by that is we kind of look at our normalized book-and-turn business and our normalized funnel, that was kind of right in that 4% to 5% range, so it was real solid, but we had a bunch of things that moved around. In dispensing, we had some pretty big overall project things that moved around. And actually, in BAND-IT, too. And so in both those places, we had some pretty good sized chunks of things that got pushed over into 2019. And so I can -- I would certainly understand the concern of the headline organic 2%, but I do think that the underlying day rate support is more than that mid-single-digit. Bill, anything you want to add?

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William K. Grogan, IDEX Corporation - CFO & Senior VP [4]

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Yes, totally agree. I mean, as Andy said, a lot of puts and takes. But if you normalize our core -- as we reconcile the business, as we prepare to go into 2019, really comfortable with a close to 5% organic number in Q4, hence, our guide for the balance of '19.

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Andrew K. Silvernail, IDEX Corporation - Chairman, CEO & President [5]

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Yes. What I would add to that, too, Allison, that I didn't mention. On a positive side in the fourth quarter, we had a real nice blanket order that happened in HST. And so we will see a hole relative to that, that usually has happened historically in the first quarter and happened in the fourth quarter. So as we -- when we're talking again here in 90 days, you will see some headwind from that on an order rate basis in HST. So just so you understand the puts and takes.

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Allison Ann Marie Poliniak-Cusic, Wells Fargo Securities, LLC, Research Division - Director & Senior Equity Analyst [6]

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Great, that's helpful. And then you talked about project pushouts. I think you mentioned chemicals specifically. Is this just typical project pushouts that happen? Or does it feel like something underlying that's going on there at this point?

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Andrew K. Silvernail, IDEX Corporation - Chairman, CEO & President [7]

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You know that the fourth quarter was a pretty lumpy quarter. I mean, historically, what we'd see is we'd see strength ramp through the quarter. In the fourth quarter, it happened right up until the holidays, that's what kind of things would look like. And what the quarter looked like here was a weaker October. Actually, a really good November and then a weaker December. And what we -- so obviously, we've been talking with our customers to make sure it's not something systemic. And what we just heard time and again is with all the craziness in the world, there was a big pause in December. And so -- and by the way, what we've seen in January supports that. So I walk out of January not feeling really concerned about what we saw in December, and I think it's normalizing now. Bill, anything you want to add?

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William K. Grogan, IDEX Corporation - CFO & Senior VP [8]

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Yes, so that point is the things that we saw pushed December, we realized several of those here in January.

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Andrew K. Silvernail, IDEX Corporation - Chairman, CEO & President [9]

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Yes.

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Operator [10]

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Our next question is from Mike Halloran from Robert W. Baird.

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Michael Patrick Halloran, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [11]

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So just following up on that. When you think about the non-lumpy pieces of the business, so getting rid of dispensing and any of the other project-oriented stuff, how have you seen trends track trying to strip out comparisons? Has it been relatively stable in the context of that? Or is it seeing some of that same December stall and then reaccelerate?

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Andrew K. Silvernail, IDEX Corporation - Chairman, CEO & President [12]

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No, there's been -- well, maybe a little bit of that, but not as much as, I call, the project-related stuff, Mike. And so generally, the day rate businesses, and if you look at -- if you got to think of day rate businesses, it's basically everything except for a couple of things in Life Sciences that happen once or twice a year, dispensing, MPT and then the BAND-IT thing, they've got a couple of large customers that put in -- typically put it in blankets that move around. But that -- it's not really project-related, Mike, it's more just, when does the blanket hit? Everything else in the portfolio, so you're talking 75% of the business, is you're looking at day rate type stuff, maybe 2/3 of the business. And that's really stable, nothing surprising there.

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Michael Patrick Halloran, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [13]

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And you always offer a good, broader perspective. So maybe you can try to balance the what is certainly confident commentary on your side and growth expectations for '19 that are healthy with a lot of the headline news we're seeing and some of the regional risk and geopolitical risk out there and how you're blending that all together?

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Andrew K. Silvernail, IDEX Corporation - Chairman, CEO & President [14]

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Yes. So maybe, Mike, the way to take a step back and think of it is, we believe we'll deliver 200 basis points -- 200 to 300 basis points better than the underlying markets. And as we have triangulated on global industrial production forecast, those look to be in kind of a 2% to 3% range. And that's what kind of gives us confidence around that, that 4% to 5% as we think about this year. That being said, we were very purposeful in our written commentary here or in our prepared remarks about the volatility that we continue to see in the world. I think that the fourth quarter, that variability that you saw, October, November, December, is really -- is a good example of what I think the world is going to look like. We had 8 quarters of sequentially ramping growth rates. And I think we mentioned a quarter or 2 ago, certainly last quarter, that we thought that was going to change, it will become more lumpy, more volatile and that is where we are. And so if we buy into a 2% to 3% industrial production, we will land at that 4% to 5%, we feel very confident. But that underlying volatility is real and it's something we're paying a lot of attention to.

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Michael Patrick Halloran, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [15]

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So just 1 follow-up on that. When you -- because there's volatility month-to-month, quarter-to-quarter here, what are you guys tracking or looking at internally to get a sense for what is just volatility or cause for something more -- cause for more concern?

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Andrew K. Silvernail, IDEX Corporation - Chairman, CEO & President [16]

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Yes. So there are -- honestly, there are kind of 2 or 3 things that really matter, right. So if you think about what accelerates our business or decelerates our business, Mike, right, one is what's happening to day rates. And so -- and the day rates actually matter more to us than anything else because so much of our business is quick turn. And so we're monitoring those. And in those, we've always talked about the BAND-IT core industrial business, the Gast business, the Warren Rupp business. Those are 3 really good beacons. And right now, they'd tell us that things are okay. That's what they'd say. So that day rate piece is something we spend time on. As you look at project, as you know, Mike, we don't typically do big projects. I mean, there's one here, one there that's really meaningful. What matters though is the size of them and what's happening to where they sit in the scheduling. When you start to see projects shrink in size, number one; and number two, they get multiple kicks down the road, that's when you start to worry, right? When you get something pushed from December to January, you kind of get it, especially when it shows up in January. You understand it. And you get the, "January, nope, it's now April. Nope, it's now..." When you start to get that, and things that were $1 million have now gone to $250,000, that's when start to get concerned.

The last thing I'd say is just really close relationships that we have with our OEMs and our value-added distributors, those are conversations that are just happening every day. Now sometimes they don't know their own businesses as well as we do sometimes. And so understanding kind of what's happening to their turnaround. We don't see a lot of things stocked for the most point, but we do have electronic Kanbans at major OEMs. So we monitor those. And we do have a handful of distributors who are a little bit more classic in their inventory setups, and so we watch those, too.

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Operator [17]

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Our next question is from Deane Dray from RBC Capital Markets.

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Deane Michael Dray, RBC Capital Markets, LLC, Research Division - Analyst [18]

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And a special shout out to Mike to get his power back and get back to normal.

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Andrew K. Silvernail, IDEX Corporation - Chairman, CEO & President [19]

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Yes, no kidding. It was 26 below, Deane, when I drove in. That didn't include the wind.

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Deane Michael Dray, RBC Capital Markets, LLC, Research Division - Analyst [20]

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That just gets dangerous, so good luck with all of that. I think you're sending it our way to the East Coast, too. Just let me echo Mike's comments. Just then that how helpful it is that what you were able to parse out your business and the indicators. That's real helpful to us. And just to clarify, I heard Bill chime in at the end on Allison's question about those 2 orders that were pushed, the dispensing and BAND-IT. So are they in that January category? Maybe just provide color on those, just since it's so fresh.

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William K. Grogan, IDEX Corporation - CFO & Senior VP [21]

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So the BAND-IT order, they split their annual PO into 2 6-month POs. So we expect that to get the BAND-IT piece later in the first half. And dispensing, a couple of projects, we have landed and expect to land here within the next couple of weeks.

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Deane Michael Dray, RBC Capital Markets, LLC, Research Division - Analyst [22]

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Good. You said BAND-IT's typically a blanket-type order and so that's not surprising?

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Andrew K. Silvernail, IDEX Corporation - Chairman, CEO & President [23]

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Yes, yes.

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William K. Grogan, IDEX Corporation - CFO & Senior VP [24]

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Deane, that is a very specific large aerospace customer that we have. Most of the balance of their business is in that type. It's isolated really to a single customer and how they are breaking up their orders in 2019 versus what they've done the last 2 years.

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Deane Michael Dray, RBC Capital Markets, LLC, Research Division - Analyst [25]

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And we've seen some softening in the whole dispensing supply chain. Is that also what you're seeing there?

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Andrew K. Silvernail, IDEX Corporation - Chairman, CEO & President [26]

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So the issue you have with dispensing, right, is we monitor market share, Deane, pretty carefully, right, because of our leadership position. And to make sure that we're not losing anything significant. So that's kind of #1. Number two, when you get into some of these larger programs, they hit periodically and it just makes for, frankly, a really difficult comp when you go for -- and you can go for a year or 2 without having that. And so we had some activity in '18 as we closed out -- excuse me, '17, as we closed out '18 we didn't have that. And we'll see what happens here in '19, right. We track every single age of machine and replacement cycle and et cetera, but it's really driven by some of these larger paint retailers and whether they are going to refresh or not. And we just don't know that really until a few months until they're ready to move.

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Deane Michael Dray, RBC Capital Markets, LLC, Research Division - Analyst [27]

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Got it. And then just to swing over on the 2018 free cash flow, came out on the right side of that 100% threshold that everyone watches. And you parsed out the 2 factors, which makes sense: higher working capital and the CapEx. So maybe some color there, how much of the working capital reverses? And then on the CapEx, can you call out any of the projects and what kind of IRRs that you're seeing or that you expect on those investments?

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Andrew K. Silvernail, IDEX Corporation - Chairman, CEO & President [28]

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You want to take that?

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William K. Grogan, IDEX Corporation - CFO & Senior VP [29]

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Yes, yes. Sure. I would say specifically on the CapEx, I think this year, we looked at a bunch of investments relative to new products and getting the capabilities, to enhance our ability to get to market faster. We looked at several businesses that we have that have the opportunity to upgrade equipment to improve productivity and throughput to support the increased growth that we had. But these are 12- to 24-month returns, higher than our overall IDEX return on invested capital numbers. So no-brainer from an investment perspective. And the teams really took a hard look as we've seen CapEx ramp, still significantly below most of our peer groups relative to the capital we need to operate the business in, but high return projects. Relative to the working capital, there's some opportunity here as we level out on the growth side to unwind some things. And you see our guide is higher than the 101% that we saw in 2018.

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

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Great. And just last quick question on Fire & Safety, have the orders started to show up yet in India? I know that's a big growth opportunity for you guys. Where does that stand?

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Andrew K. Silvernail, IDEX Corporation - Chairman, CEO & President [31]

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Yes, I was actually over there between Thanksgiving and Christmas, and we did a specific review on that. And that's actually starting to play out nicely. We're starting to get some of the wins. The spend, as you know, is there's a little bit of a national and then it turns into kind of regional or state, how the funds are distributed. And we are seeing some of that break, and we're seeing some pretty nice growth there.

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Operator [32]

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Our next question is from Nathan Jones from Stifel.

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Nathan Hardie Jones, Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst [33]

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I'm going to go to the margin side of this. The guidance for 2019 has "only" 30 to 40 basis points in margin expansion.

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Andrew K. Silvernail, IDEX Corporation - Chairman, CEO & President [34]

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Thank you, Nathan.

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Nathan Hardie Jones, Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst [35]

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Well, it's significantly less than what have you guys have been doing for the last few years. So I'm wondering if we can talk a little bit about the puts and takes there. I'd imagine that there's probably not that much less in your fixed bucket at the moment that sees margins crop up a bit. Obviously, there's some impact from higher investments here. Probably a little bit lower incremental margins because you've got a little bit lower organic growth. But just if you can work through kind of the puts and takes of that margin increase in 2019.

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Andrew K. Silvernail, IDEX Corporation - Chairman, CEO & President [36]

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I think -- let me talk about it first and if Bill wants to kick in too, we'll do that. But I think that the increase that we're looking at, to me, is what a normalized expansion should look like based on the kind of growth that we're factoring, right? So that to me feels right. Frankly, in 2018, our margin expansion was a little hot, right? So obviously, we outgrew our expectations and so you just got much stronger incrementals throughout the year. I've said a few times that, look, if you're below 30% incrementals, you're probably investing too much. And if you're above 40% for a long time without kind of structural actions, then you're probably not investing enough. And so this feels about right. And I think we can sustain that at those growth rates. And then if you saw the world get tougher, our job would be to boost that and not lose a lot of ground here, right? And for some reason, we saw some improvement in growth rates, we'd probably invest a little bit more. Probably not as aggressively as we had in the last 2 years, but we'd probably have to invest a little bit more, Nathan, than we have. And part of you -- if you go back to the bridge that you looked at -- Bill, I may get this wrong, so correct me. But I think last year, we laid out $0.16 of incremental investment for the year in our bridge.

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William K. Grogan, IDEX Corporation - CFO & Senior VP [37]

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A little bit less than that but it was double digit, yes.

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Andrew K. Silvernail, IDEX Corporation - Chairman, CEO & President [38]

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Yes, and this year is kind of 5-ish. So you can see we are definitely tailing that back down a little bit based on how quickly the environment is expanding.

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Nathan Hardie Jones, Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst [39]

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Does currency impact the margins at all? Or is this primarily just translation that just affects the actual dollar number but not the margin?

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William K. Grogan, IDEX Corporation - CFO & Senior VP [40]

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Correct.

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Andrew K. Silvernail, IDEX Corporation - Chairman, CEO & President [41]

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Translation, that's right.

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Nathan Hardie Jones, Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst [42]

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Got it. If maybe just -- I mean, I know everybody's fairly concerned about the environment in China. And I think you guys do less than 10% of revenue over there, but you do have a few businesses that participate over there. So just any color you can give on what you're seeing in China at the moment?

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Andrew K. Silvernail, IDEX Corporation - Chairman, CEO & President [43]

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Yes, absolutely. And part of that trip where I was in India, I was in China in that same period, too. So that was a big question we were talking about here just a month ago. Look, it's definitely slowing. There's no doubt about that. There are -- the concern on the ground in China is pretty substantial. The -- when you get -- when you start talking to people who are living it day-to-day, they are concerned about the growth rates. We've had some really strong growth in China in the last year or 2 because of -- we frankly fixed a problem that we've had for a while, and so we've had some good growth, and we expect to see some continued good growth because of that. But I do think, overall, that market support is coming down. Now the key to that, I think, Nathan, is where are you picking, right? So which markets are you picking in? This isn't a ubiquitous statement that everything is slowing, but more things than not are. And so I think we got to be -- you got to be in China for China to sell into the region. You got to be in there for the long term, but I do think, certainly, in 2019, I think it's going to be more challenging.

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Nathan Hardie Jones, Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst [44]

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Just last one on capital allocation. You guys got a bit more aggressive in the fourth quarter on share repo. Is that just a function of the market melted down? And you saw an opportunity to get your stock at a good price and we shouldn't read more than that into it?

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Andrew K. Silvernail, IDEX Corporation - Chairman, CEO & President [45]

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I think that's exactly right. We're following the framework that we've always talked about relative to intrinsic value and being more aggressive when we see disconnects, and we saw a disconnect.

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Operator [46]

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Our next question from Scott Graham from BMO Capital Markets.

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Robert Scott Graham, BMO Capital Markets Equity Research - Analyst [47]

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I was hoping you could tell us what pricing was in the quarter and then what materials inflation was relative to that? I know that's not how you do it. You look for productivity. But I'm just -- for the purposes of the old price cost question, if you could help us out.

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William K. Grogan, IDEX Corporation - CFO & Senior VP [48]

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Yes, price capture is a little bit over a point, and the inflation -- we maintained that 30-point spread that we've been able to do throughout the last 2 years.

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Robert Scott Graham, BMO Capital Markets Equity Research - Analyst [49]

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And that's just materials inflation or was that all inflation?

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William K. Grogan, IDEX Corporation - CFO & Senior VP [50]

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It's material and wage at a gross margin level.

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Andrew K. Silvernail, IDEX Corporation - Chairman, CEO & President [51]

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How about just materials?

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William K. Grogan, IDEX Corporation - CFO & Senior VP [52]

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It's...

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Andrew K. Silvernail, IDEX Corporation - Chairman, CEO & President [53]

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It's slowed a lot. Yes.

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William K. Grogan, IDEX Corporation - CFO & Senior VP [54]

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Yes. Right. So there's -- materials leveled off -- material inflation leveled off in the back half and a little bit of kicker as we saw some of the tariff increases come through in the third and fourth quarter.

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Robert Scott Graham, BMO Capital Markets Equity Research - Analyst [55]

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Got it. Bill, you went through the capital allocation thinking for 2019. You mentioned the billion-dollar number. Forgive me, but I wasn't able to write that fast. So could you kind of say kind of where you guys are at capital allocation heading into the year?

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Andrew K. Silvernail, IDEX Corporation - Chairman, CEO & President [56]

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Yes, Scott, we're at 1.3x gross leverage and 0.6x net. We have -- what we said in our comment too is over $1.5 billion. It's closer to $2 billion that we have availability on at any time here in the next 12 months.

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Robert Scott Graham, BMO Capital Markets Equity Research - Analyst [57]

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So would it suggest that in the absence of M&A that your $0.06 of share reduction benefit for '19 might prove conservative?

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Andrew K. Silvernail, IDEX Corporation - Chairman, CEO & President [58]

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Really depends, right. So we're going to stick with the framework. And as we've said several times, but just to remind folks, our framework, we take a look at and we just did it in the fall with our board. We take a look at what we think the long-term intrinsic value is. So we build in a buffer relative to opportunity costs of capital. And then as we see our stock behave relative to that, we decide how aggressive we're going to get. And we build that framework into a 10b5-1 in closed periods, and we use the same framework in open periods. And so what we try to do, Scott, is really bring discipline to it, so it's not people reacting emotionally to good or bad news.

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Robert Scott Graham, BMO Capital Markets Equity Research - Analyst [59]

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Got you. Last question. Can you tell us after -- this is actually what is now the first month. You indicated that your sort of run rate, your day rate orders were kind of 5-ish in the fourth quarter? What does the number look like in January?

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Andrew K. Silvernail, IDEX Corporation - Chairman, CEO & President [60]

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It's not much different, right? We're basically kind of on our plan so far for the year, so -- and we feel pretty good about it. I mean, just for the start of the year. I wouldn't get overly excited about it. And it's not bad news, it's basically what we expect.

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Operator [61]

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Our next question is from Matt Summerville from D.A. Davidson.

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Matt J. Summerville, D.A. Davidson & Co., Research Division - MD & Senior Analyst [62]

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Just 2 questions. First, can you give a little bit more geographic granularity around how you performed in North America, Europe, Asia for Q4 around that 5%? And then what the expectation is sort of around the 4% to 5% that you're guiding organically for '19?

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Andrew K. Silvernail, IDEX Corporation - Chairman, CEO & President [63]

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Yes. So North America -- as we said it in comments, North America continues to lead the way and has so for quite some time. And all indicators, Matt, suggest that, that's going to be the case in '19 unless we see a material global softening, right, which -- well, that is the biggest concern that I have. The biggest concern that I have is the volatility that we have, the geopolitical instability that's out there, the length of duration of the expansion overall, not the industrial, but the overall. That's what I think the risk is. But North America has continued to be strong. Asia and Europe both started to soften 2 quarters ago. I think we mentioned that in the last call. And that's continued. Now Asia is -- this kind of depends upon where you are, right? So China has softened. India's still pretty good and other parts of kind of Asia Pac have been okay. Europe, I think the biggest concern in Europe is Germany, right? We've got a pretty good footprint in Germany. We export a lot to other parts in the world from Germany. And the softness that I think everybody experienced was above expectations, right? It was softer than people had thought. And so that's a place that we're keeping a pretty close eye on.

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Matt J. Summerville, D.A. Davidson & Co., Research Division - MD & Senior Analyst [64]

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And then as my follow-up, can you just give a little more detail on what you're seeing in your energy facing businesses and FMT and with respect to BAND-IT? Maybe tying in sort of up-, mid-, downstream commentary there?

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Andrew K. Silvernail, IDEX Corporation - Chairman, CEO & President [65]

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Yes. So as you know, Matt, we got to be somewhat careful in this commentary because we're not the best barometers for what's going on in the energy field, just by the nature of the nicheness where we play, number one. And the fact that most of what we do is kind of midstream, and so I would just caution people that we're not the best barometer. But that being said, when the oil prices, the energy prices kind of tanked there, we did see a slowing. And it was reasonable. I mean, it was a material slowing for that piece of business, which has since, we've seen it pick back up here. Some of what we're experiencing, in terms of positives, we know are driven by our own activity. So we've got some very specific wins and we've got BAND-IT that we can put our finger on, that are kind of nonmarket related. Same thing I'd say over LC and Corken. And so I would say that the general market conditions have been softer with recently a little bit of improvement. But I still think that, that's -- I'm going to put that in the cautionary category. And our job is to keep getting wins and, frankly, keep taking down lead times. One of the things that we have certainly learned around energy is that the folks who are deep in the upstream, the pricing sensitivity is brutal when things go south, and we just don't have that. So that's not a place we want to put big bets into the future. But also lead times really matter, right? So your speed of service and quality of service is a major advantage in those markets. And so we're spending more time there trying to build that advantage.

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Operator [66]

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Our next question is from Joe Giordano from Cowen and Company.

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

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So Andy, I've got to say you sound more optimistic than I expected on this quarter.

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Andrew K. Silvernail, IDEX Corporation - Chairman, CEO & President [68]

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Well, I think, Joe, it's -- I obviously -- everyone gets a little bit of a reputation. I think my optimism is more on our ability to execute than it is on the markets, to be clear, right? I just -- we've built some really excellent capability around executing. And look, we're calling -- we're kind of living with what the global "experts" are saying around global industrial production, and that's a really good starting point for us. But where I feel good is our ability to consistently outperform. And so a lot of this depends upon what your view is, right, of the markets. And at this stage, we're not bucking the trend. We do tend to be earlier cycle. And so I will tell you, there are parts of the fourth quarter I got a little nervous during the fourth quarter because of the clunkiness that we were seeing. And that coming back has given me a better feeling about certainly earlier in the year.

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

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So you're talking about the 200 bps that you expect to do over market. And I think you've proven the ability that, that's a reasonable expectation, but when you think about that market component, that other 200 -- we have a couple of auto guys that we've talked to, and it's a different market clearly, but they're guiding, like, way underneath what current third-party estimates are for growth. So do you feel like you're gaming the market at all? Or are you just like this is a number, it will probably go down, but we're using what they say for now, like, does that makes sense?

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Andrew K. Silvernail, IDEX Corporation - Chairman, CEO & President [70]

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It's hard to tell, right? So our -- my point of view of this is we kind of start with what do we think the world -- what does the world think is going to happen? What are the experts saying is going to happen? And we tend to be a little bit more bearish on that, right. So if the world is saying 2% to 3%, we'll tend to go more towards 2% than we will towards 3%, right. And then from there, it's really starting to dissect where we have exposure and where we don't, right? And the nice part of our portfolio is we have really brought exposure. And so there isn't a lot on the margin that happens relative to our exposure versus global exposure except maybe in a quarter, right? A quarter or a half year. And then it's fully driven by our ability to get some things done. And so as I sit here, my confidence level on our ability to execute is high. My confidence level on the responsibility and the capability of the folks who are in the geopolitical discussion is exceptionally low. I have no confidence that they're going to get it right. And so my concern then, right, is an event that gets driven by the intersection of the aging cycle and the irresponsibility of global leaders.

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

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I think that's definitely fair. Last thing for me, so you guys spent a lot of growth investments this year. You're calling out another $0.05 next year. So obviously, less of an incremental but still a big number off a big year like in gross dollar terms. So are you -- do you feel like you're keying up more and more things to start restructuring and taper down? Like, maybe not executing on them yet, that things have gone -- day rates still look good, but are you, like, keying up more of this stuff now than you were, like, maybe a year ago?

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Andrew K. Silvernail, IDEX Corporation - Chairman, CEO & President [72]

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I think -- this -- if I actually take a look at cap spending, let's go back 2 or 3 years, right. That's when it started to pick up little bit. We went from kind of 1.6%, 1.7%. We're now at 2.1%, 2.2%. So that, call it, 4/10 to 5/10 of a point of increase in cap spending, what that's been associated with is really is the function of all of the segmentation work we've been doing for a half a decade and getting better and better at picking the organic growth opportunities and the productivity projects that have much bigger bang for the buck. And so what was -- so I go back to my comments just a few moments ago. My confidence level about our ability to execute over and above whatever the market does is really based on that. And so that investment is mirroring that condition. And so I think where we are is -- I feel pretty comfortable that we're in a range that we're likely to be for a while.

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Operator [73]

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Our next question is from Walter Liptak from Seaport Global.

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Walter Scott Liptak, Seaport Global Securities LLC, Research Division - MD & Senior Industrials Analyst [74]

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I think I've got one question left for you, whichever line. I want to go back to the margin questions. And you're netting inflation with productivity. So I wonder if we could just drill down into that productivity part of it. How do you feel about productivity in 2019? And how much more is there to go on bringing up margins, 2019, 2020? Is there still a lot of work to do?

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William K. Grogan, IDEX Corporation - CFO & Senior VP [75]

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Walt, it's Bill. I would say a couple of things. First, I'd refer to Andy's earlier comment on margin expansion, in that 30 to 50 basis points relative to the 4% to 5% growth that we've seen. Relative to our ability to drive incremental productivity, there's still stuff out there. I mean, the teams have a rolling 12-month funnel that we leverage, actively looking at ways to improve material costs through alternate sourcing, reengineering parts to take cost out, labor efficiencies, overhead streamlining through -- we did a site consolidation this year, and other capital investment to improve our overall throughput with enhanced technologies. So as we look at the funnel, our projects that we've signed up for this year from our internal plans is on par with what we delivered in 2018.

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Walter Scott Liptak, Seaport Global Securities LLC, Research Division - MD & Senior Industrials Analyst [76]

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And just thinking about that longer term, you guys have done a great job with productivity over the last few years. Are we -- are margins sort of peaking out here? Or is this the kind of a process where you can keep on going for a number of years and continue to get that 30 to 50 basis points margin improvement?

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Andrew K. Silvernail, IDEX Corporation - Chairman, CEO & President [77]

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Walt, I think we can still go get more. And kind of 2 pieces of thinking around that. The first one is we spend a lot of time looking at the difference between our contribution margin and our op margin. And when you do that walk right, you've got about a 40-point walk that we call conversion cost. And so you can still reinvest aggressively back into the business and still very, very actively improve conversion cost to get the kind of lift that we're talking about without starving the business. So that's kind of the first -- just, I think, structurally, one of the things that I think makes IDEX different and a far more, on average, more attractive financial engine, for lack of a better term, is that reality, right? And so if you assume you're going to get positive growth in the business, once you get kind of past 2% -- at about 2%, you're paying the bills, right? You're covering your normal inflation. And once you get past that, you have the ability to get some level of expansion. And if you're on the mid-single digits, you're going to get that 30 to 50 basis points, chances are. And I think that, that reality of the IDEX economic engine, I think is really, really important. And so we just spend a ton of time -- when we say productivity, right, we're not trying to grind out kind of marginal productivity. We go in to every cycle -- when I say cycle, Bill said we got a 12-month rolling funnel. Every time we have a business review, we're looking a year forward. And we have a base expectation that people are going to cover or do better than inflation. And when you partner that with a business to get positive -- that gets positive price, there's really no reason why you can't continue to see margin expansion, certainly as you move from what we're calling now 23% to 24% into the mid- to high-20s.

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Operator [78]

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This concludes the question-and-answer session. I'd like to turn the floor back to management for any closing comments.

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Andrew K. Silvernail, IDEX Corporation - Chairman, CEO & President [79]

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So first of all, let me just say thank you for everybody for your time and your effort that you put into following IDEX. We appreciate the analyst community, and we appreciate our investment community.

I think it's important to note, we're very cautious about the underlying environment, right, that's out there in terms of where we are in the cycle in terms of the likelihood of a recession. We very much believe that somewhere in the next 24 to 36 months, there's going to be a recession and we believe that to be true. At the same time, we think that the long term relative to the industrial cycle, we actually think is really attractive. And so we want to put ourselves in a position to really win over the long-term. And I like what we're doing in terms of focused investment, putting our money on our highest priorities, continuing to segment our business, building our team. And the team's done a great job. I want to congratulate them. They've really been outstanding. And so I want to thank everybody there.

And then just as a final word before we go, being a Maine native from New England, I've got to say, go Pats. So with that, we'll cover things. We'll finish up the day. I want to thank you, Matt, and thank you everybody again. Take care.

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Operator [80]

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Great. Thank you. This does conclude today's teleconference. You may disconnect your lines at this time. Thank you again for your participation.