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Executives

Michael Yates – Vice President and Chief Accounting Officer

Andy Silvernail – Chairman and CEO

Heath Mitts – Vice President and CFO

Analysts

Nathan Jones – Stifel Nicolaus

Joe Radigan – KeyBanc

Mike Halloran – Robert W. Baird

Allison Poliniak – Wells Fargo

Scott Graham – Jefferies

Charlie Brady – BMO Capital Markets

Mike Wherley – Janney Capital Markets

Jim Giannakouros – Oppenheimer

Walt Liptak – Barrington Research

IDEX Corporation (IEX) Q2 2012 Results Earnings Call July 24, 2012 10:30 AM ET

Operator

Good morning. My name is Sarah, and I will be your conference operator today. At this time, I would like to welcome everyone to the IDEX Corporation Q2 2012 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions)

Thank you. Mr. Michael Yates, Vice President and Chief Accounting Officer. You may begin your conference.

Michael Yates

Thank you, Sarah. Good morning, everyone. And thank you for joining us for our discussion of the IDEX second quarter 2012 financial highlights.

Last night, we issued a press release outlining our company’s financial and operating performance for the three and six-month period ended June 30, 2012. The press release, along with the presentation slides to be used during today’s webcast can be accessed on our company’s website at www.idexcorp.com.

Joining me today from IDEX management are Andy Silvernail, our Chairman and CEO; and Heath Mitts, Vice President and Chief Financial Officer.

The format for our call today is as follows, we will begin with our mid-year assessment and our perspective on the business. Next, we will discuss the second quarter 2012 results, followed by a walk-through of our three business segments. Finally, we will wrap-up with an outlook for the reminder of 2012 and following our prepared remarks, we’ll open the call for your questions.

If you should need to exit the call for any reason, you may access a complete replay beginning approximately two hours after the call concludes. By dialing the toll-free number 855-859-2056 and entering the conference ID 40917655 or you may simply log on to our company’s homepage for the webcast replay.

As we begin, a brief reminder. This call may contain certain forward-looking statements that are subject to the Safe Harbor language in today’s press release and in IDEX’s filings with the Securities and Exchange Commission.

With that, I’ll now turn this call over to our Chairman and CEO, Andy Silvernail. Andy?

Andy Silvernail

Thanks Mike. I’m now on slide five everyone. Last night we issued our second quarter results. We outlined Q2 records in orders, sales and cash flow, and we returned $43 million to shareholders in dividends and share repurchases.

However, we missed our earnings expectations and we see the balance of the year as more challenging than we did in Q1. It is our goal to consistently deliver superior earnings and cash flow growth in both good and difficult times.

Our strategy and our operating model are proven, which is reflected in our strong cash flow performance and margin expansion in Q2.

Before we get into the details of the quarter, I’m going to talk big picture, the recent global trends, the successes we’ve had and some of the specific challenges we faced in the first half.

As we exited the first quarter, we saw strength throughout the vast majority of our markets. We had a healthy backlog and solid order rates throughout the portfolio. Within a few weeks of delivering our guidance update in April, we saw certain markets deteriorate.

Order rates softened first in Europe and then in China, which combined to make up about one-third of our sales. Our second quarter guidance did not anticipate the magnitude of the deceleration.

In the quarter, we reduced backlog by $28 million. While we plan to burn down blanket orders and ship large scheduled projects, roughly half is attribute to macroeconomic headwinds.

The good news is that North America and most of the emerging markets remain strong. However, we fully expect this challenge -- the challenging macroeconomic conditions to continue through the remainder of the year, if these external factors that have caused us to take down our full year guidance accordingly.

We’ll face these challenges head-on. Before I turn to the segment detail, I want to highlight what differentiates IDEX in times like these. I want to take a moment to talk about our core strengths that have consistently allowed us to deliver strong earnings and cash flow performance, regardless of the external environment.

It’s our objective to deliver consistent, double-digit annual earnings growth through the cycle with strong cash flow, while returning capital to shareholders in a disciplined manner.

To deliver on our objectives, we rely on three core strengths. First, we have outstanding defensible businesses. Our strategy is to be the leader in an attractive, highly engineered niche markets where we can differentiate.

Within the IDEX, 80% of our businesses have underlying markets to grow well above global GDP. It’s our goal to consistently deliver 5% to 7% annual organic growth through the business cycle. It’s also here that our diversity across markets, products and geographies is a major strength.

We have businesses with over century of history. We thrive because we take care of our customers. We do this through terrific product quality and innovation, applications excellence and best-in-class service. Year in and year out, we’re rewarded with loyalty and [shareholder] gains from customers across our platforms and around the world.

Our second key strength is execution, from product quality and lead-times to margin expansion and outstanding cash conversion. We win for our customers and our shareholders through disciplined tough-minded execution.

Finally, our cash flow dynamics and balance sheet put us in a great position. Over the next three years, we have the ability to put in excess of $1 billion to work. It is our intent to allocate capital to maximize total shareholder return.

Acquisitions have been a key part of our capital strategy and they will remain important. We will be disciplined. Our current M&A funnel is solid. We have a focus on small and medium-size businesses that fit our core strategy and we are well-aligned with the existing platforms.

We’ve built our six-strategic platforms to be prepared to integrate deals and improve returns. Just last Friday, we announced the acquisition of Matcon, which will be part of our Material Process Technology platform.

Matcon provides IDEX with a more expansive part of processing offering, while leveraging our respective channel strengths. We are very pleased to bring this strategically critical company and their tremendous leadership team into IDEX.

In the first half of the year, we deployed approximately $80 million on M&A. We are in various stages of diligence on a number of deals and we expect to announce additional transactions by year end.

Along with M&A, we will continue to have an attractive dividend payout and we will supplement our capital strategy with more consistent and strategic share repurchases.

In the first half of 2012, we bought back nearly 1 million IDEX shares. We see the buybacks is extremely attractive means to deploy capital at the current levels and we have nearly $90 million left on our current repurchase plan.

Before turning to the segment detail, I want to talk about our Optics and Photonics platform, and more specifically CVI. As we mentioned previously when talking about CVI, the business has exposure to defense, electronics and life science, and each of these have been softer than anticipated.

As a result, we’re behind our initial objectives and we have a lower profit profile at CVI as it exit 2012 than we anticipated. Needless to say, CVI had a dilutive impact on our consolidated financial performance.

Despite the current challenges, we like this space and the profitable growth potential. It is a market with superior long-term growth rates, very good profit and cash flow dynamics, differentiated technology and fragmented landscape. This business has a very good underlying potential for IDEX.

The CVI back on track, we are reducing structural costs through manufacturing footprint and complexity reduction. And we are investing in core product development and core customers. These actions will solidify the foundation for growth and will provide outstanding margin contribution on incremental sales.

We’re working through a tough patch in optics, but we like this business and the broader market segment. And we have excellent leadership in place to execute the strategy and support future growth.

Now, I’ll turn to the quarterly details. We’ll walk through what’s going well and what needs improvement. I’ll lay out our revised guidance that we do every quarter and we’ll open it up for Q&A.

With that, let’s turn to the quarterly results. I’m now on page six everyone. As I mentioned in my opening, we delivered Q2 record for orders, sales and cash flow. Sales were up 9% in total, up 6% organically. All of our segments delivered organic growth. FX was a significant headwind in the quarter, nearly 3%.

Our second quarter adjusted EPS was $0.67, that’s up 8% year-over-year. We incurred approximately $2.6 million of restructuring costs in the quarter as we executed our previously announced actions and prepare for slower growth environment. We fell $0.03 per share in the quarter from foreign currency translation and acquisition-related charges.

As we signaled last quarter, further restructuring actions will take place in 2012. But as always we’ll continue to invest in our global expansion and product development. We’re dealing with the realities of today’s environment, while having an eye on accelerating sustainable organic growth.

Turning to margins in the quarter, adjusted operating margin of 18.5% was up 30 basis points from prior year. Productivity and operating leverage on the organic growth drove the increase. It was partially offset by CVI’s dilutive margin impact. You’ll see as we go through the segment detail, tremendous execution despite the economic uncertainty.

Finally, free cash flow was $71 million, up 54% to the prior year. This is a very good story and I’m proud of the teams focused on cash conversion and working capital management.

It’s a testament to the team’s ability to deliver results. Our people know how to get it done and we will deliver strong earnings and cash flow growth even in a low single-digit global GDP environment.

With that, let’s turn to the segment detail. I’ll begin with a segment walk on Fluid & Metering and I’m on page seven. For the quarter, orders were down 2% organically. The softness is primarily attributed to slowdown in Europe and China infrastructure spending.

Our Ag business is experiencing tremendous demand. The second quarter growth was up mid-teens and the second half will also grow nicely year-over-year. But just remember that this is a pretty seasonal business.

Our Energy outlook remains positive. We see strength in North America, the Middle East, Africa, Asia and Russia, slightly offset by softness in Western Europe.

Our Chemical Industrial businesses are performing well. They are delivering operating profit expansion to productivity and creating differentiation through reduced lead-times. The team has also done an excellent job, identifying emerging market opportunities to offset the declines in Europe and the slowdown in China.

Finally, in our water platform, we’re seeing the news headlines play out. Europe and China are slowing. But I’m cautiously optimistic about the prospects for the U.S. market. We have seen some early signs of improvement. Across the globe, in water, capital expenses are being replaced with operating expenses as mini budgets are tight where project work has been delayed for too long.

Overall, FMT sales increased 3% organically for the quarter. Operating margin of 22.1% was up 220 basis points from prior year. The team’s dedication to OpEx and commercial excellence is paying off. The FMT team did a great job navigating the tough economic uncertainty and delivering outstanding profitability.

I’m on Health & Science on page eight. Orders were up 26% for the quarter, up 7% organically. Sales increased 21%, up 3% on an organic basis.

Shortly after our Q1 earnings call, we completed the acquisition of ERC, a degassing instrumentation manufacturer located in Japan. And I’m pleased to announce the integration of ERC into our scientific fluidic platform and it’s well underway.

The remainder of the scientific fluidic platform has delivered modest growth in line with our expectations. They continue to perform well relative to their respective end markets through share and content gains, as well as geographic expansion.

Our Material Process Technology platform is seeing solid demand for food and pharma processing equipment, particularly in Asia. As I mentioned earlier, we closed on the Matcon acquisition last week.

Precision Polymer Engineering, our high-performance seals and gasket business is performing extremely well, particularly as they penetrate further into oil and gas applications. This will provide a broader segment and geographic reach going forward.

Outside of the selected end market challenges in our Optics and Photonics, the remaining HST businesses are generally in line with our expectations, with the strength in North America offset by a softer Europe.

Operating margin of 16.6% is a 470 basis point decrease compared with the second quarter 2011, which is primarily due to the dilutive impact from acquisitions. As you recall, this is the same magnitude of impact we experienced in Q1. When excluding acquisitions and acquisition-related charges, operating margin would have increased modestly compared to prior year.

Finally, on Fire & Safety/Diversified, I’m on page nine. The segment continues to perform. Orders were up 3% organically. Sales increased 10%, up 15% organically. This was driven by growth across the entire segment with particular strength in dispensing.

The North America and U.K. fire markets appear to have leveled out and we continue to have success internationally and through product adjacencies in North America. The rescue business remains strong, but we’re keeping an eye on military spend in North America and in China.

Our banding and clamping business expanded, continues to do a very nice job on covering growth opportunities and nearly delivering solid mid single-digit growth by continuing to win in vertical market such as oil and gas, even as they see softness from international markets.

In Dispensing, they had an exceptional quarter and they began shipping their large first quarter replenishment order. These shipments will continue into 2013. Outside of last quarter’s large order, we’re starting to see some encouraging signs for our North American Dispensing market which will be partially offset by a softer Europe.

Operating margin of 23.4% was down 210 basis points from second quarter of last year, but this is attributed to the gain on sale of property recorded in the second quarter of 2011. Excluding this gain, operating margins were up 50 basis points for the segment due to productivity and prior structural actions.

Mix in the quarter, somewhat high, it’s a very good story for HST. All of the individual businesses within the segment delivered margin expansion year-over-year. As we look forward, we expect the margins to continue to expand, particularly when the cost savings related to the fire suppression, footprint consolidation began in 2013.

All right. Turning to page 10. I’ll take a few minutes to bridge our current year 2012 EPS guidance to our previous guidance. Our prior year guidance of $2.80 to $2.85 did not anticipate the rate of deceleration we experienced in Europe and a lesser extent China, as well as softness experienced in our select optics end markets.

As you can see, the significant items impacting our second quarter earnings will continue for the remainder of the year. First is our second quarter mess. The remaining bridging items represent changes to the second half.

Given the geographic order patterns experienced in the second quarter, we anticipate a slower growth in the back half, which will result in approximately mid single-digit organic growth for the entire year.

Next, certain end markets, particularly impacting CVI have slowed. This change in our outlook has a $0.04 EPS impact.

Finally, foreign currency will impact earnings in the second half by $0.03 compared to prior guidance.

As I mentioned before, ERC was acquired in the second quarter. This transaction provides a small benefit in the second half of the year. These changes bridge you from our prior guidance of $2.80 to $2.85 to a revised range of $2.65 to $2.70.

I’m now on slide 11 and this is our detailed guidance page. We expect Q3 EPS to be in the $0.62 to $0.64 range. Q3 organic revenue growth will be approximately 3%. FX will have a negative year-over-year impact on Q3 sales of approximately 3%.

For the full year, we now anticipate organic growth will be in mid-single digits and acquired revenue will add approximately 4% with a negative FX impact of approximately 2%. This will deliver EPS in the range of $2.65 to $2.70.

Adjusted full year operating margin for the company will be approximately 18.5% and we will continue to flow through profit on an organic revenue growth between 30% and 35%.

A few other modeling items. The 2012 tax rate will be about 30%. CapEx about $40 million, and we have consistently demonstrated our ability to convert cash well in excess of net income.

We’ll continue to repurchase shares as part of our capital deployment in line with the second quarter activity. And again, our earnings projections exclude any future restructuring and any future acquisitions and any related charges.

With that, I’d like to open it up to all of your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Nathan Jones with Stifel Nicolaus.

Nathan Jones – Stifel Nicolaus

Good morning, guys.

Andy Silvernail

Good morning.

Nathan Jones – Stifel Nicolaus

Can I just start on the guidance update? It seems fairly heavily skewed towards the fourth quarter rather than third quarter with 10 or 12% sequential growth in earnings from the third quarter to fourth quarter. Can you talk about what gives you confidence that you’re going to see a rebound in the fourth quarter from the third quarter levels?

Heath Mitts

Hey, Nathan. This is Heath. Part of this is just the seasonality. If you look at it on a sequential basis, Q3 is always the lowest quarter during the year and there’s certain businesses that have a natural ramp-up, specifically in our rescue tools and in our Ag business that see a much softer Q3 is ahead of stocking.

Nathan Jones – Stifel Nicolaus

Okay. So then, I guess, just on CVI, can you talk about what actions you’ve taken to right size the cost structure there in front of softer demand? What’s planned, what kind of cost savings you think you can get out of it and those kinds of things?

Andy Silvernail

Yeah. No problem, Nathan. This is Andy. Well, first and foremost, we have reduced the overall headcount in the business by a magnitude of plus 20%. So we’ve been pretty aggressive there. We have a fully consolidated one facility and partially consolidated a couple of other facilities already in the past year.

As we look forward, we have rationalization happening at two major manufacturing facilities as we go forward. And we’re going to continue to invest in product development and around a number of core customers.

So we’ve been pretty aggressive already. The thing to remember here, this is a very high contribution margin business. And so, as you struggle with topline, it’s tough to catch frankly. Let’s be honest about that. But on the upside, it’s a business that drives very, very strong incremental profitability.

Nathan Jones – Stifel Nicolaus

So in terms of the 20% headcount reduction, can you kind of give us an idea of what the change from 2Q to 3Q, specifically would be on the reduced headcount?

Andy Silvernail

On the total numbers? Not specific in there. This is something that’s been ongoing and it’s been part of our execution plan, frankly. We have ramped it up as we saw some slippage in the topline from Q1 to Q2. But it’s -- to get into that level of detail we would probably not be constructive.

Nathan Jones – Stifel Nicolaus

Okay. Is there an opportunity to make the cost structure kind of less fixed and more variable at CVI or is it -- there is something structurally within that business that just requires a high level of fixed cost?

Andy Silvernail

Yeah. There are a handful of actions that you can do in terms of outsourcing of some less value-added product and we’re in the process of doing that. But recognize that a lot of that business is involved in the areas of coding and coders are fixed costs structure and it’s exceptionally inefficient to outsource that in terms of quality and productivity.

And it’s a business that because of that as you see incremental revenue growth, it really is an outstanding profit generator and cash generator, but we’re -- candidly, we’re facing on the downside some of that pain.

Nathan Jones – Stifel Nicolaus

Okay. Thanks. I’ll get back in queue.

Andy Silvernail

Thanks, Nathan.

Operator

Your next question comes from the line of Matt Summerville with KeyBanc.

Joe Radigan – KeyBanc

Hi. Good morning. This is actually Joe Radigan on for Matt.

Andy Silvernail

Hey, Joe.

Joe Radigan – KeyBanc

Hey, Andy. Can you give a little more granularity on the 6% organic growth rate in the quarter? What was the growth rate in the U.S., geographically U.S., Europe, China and the other emerging market?

Andy Silvernail

So the U.S. was very strong, Joe. And across the Board, we -- basically in every business that we have, the U.S. continued to be strong. Certainly, the underlying markets were strong and we had some great success in terms of overall product introductions and taking share.

As you look across the international landscape, it really kind of flipped on its head compared to what’s happened in the last three or four years where in the last three or four year, international growth was above U.S. and now the U.S. growth is considerably above the rest of the international landscape.

Very specifically as you kind of parse that out, what you will see is you’ll see China continues to grow, although we did see a meaningful slowdown and Europe contracted. Europe, I think is a tough story kind of across the spectrum and we expect it to continue that way, and we are operating with that expectation. And while, the second quarter was tough from a China perspective, we expect that to have some rebound as we go forward.

Joe Radigan – KeyBanc

Okay. And then how much of the restructuring in CVI in Europe? Have you run into difficulties there with workers’ councils or other issues that have impeded your progress in getting that or is this -- is it mostly just slower top-line?

Andy Silvernail

We are relatively fortunate based on where things are located in Europe, that we have more flexibility. We don’t have a lot of our cost structure in Europe in the most difficult places to do business. We have them in places that are little bit easier. So we have some flexibility. To the -- so we are able to get after that. At the same time, kind of regardless of where you are in Europe, it is slower than if you are in the U.S.

Joe Radigan – KeyBanc

All right. Okay. And then maybe last question. Book-to-bill in HST has been below one for a while now. Do you think you can get positive organic growth there in the second half?

Andy Silvernail

I think you got to kind of parse it. I’m going to separate CVI for a second, talk about the other pieces. And our expectation is that, we will start to see improving overall book-to-bill across those businesses. From a CVI perspective, we are being cautious. We’re looking at it from the perspective of our -- the need to take down that fixed cost structure and not count on a major rebound.

But minus that piece of the business, I think we’re going to start to see some improving comps going forward. Although, I don’t think it’s going to be dramatic, Joe, don’t get me wrong. I don’t think we see a major rebound in the second half.

Joe Radigan – KeyBanc

Okay. Great. Thanks, Andy. I appreciate it.

Andy Silvernail

Bet you, Joe. Thank you.

Operator

Your next question comes from the line of Mike Halloran with Robert W. Baird.

Mike Halloran – Robert W. Baird

Good morning, guys.

Andy Silvernail

Hey, Mike.

Mike Halloran – Robert W. Baird

So when we look at those HST margins and specifically some of the restructuring activity and things like that you are pushing through here. Feels like guidance is assuming relatively comparable plus or minus HST margins as you move into the third quarter.

But are you guys expecting to get some sort of improvement in that piece, in other words mitigate some of the headwinds as you have on the CVIs as you move to the fourth quarter? And maybe you could talk through what a realistic run rate can look like once you get some of these restructuring things push through at the current volume levels there?

Heath Mitts

Mike. This is Heath. With the restructuring actions that are in play right now and the things that we have ready announced internally and so forth. I’d expect that we would exit the year somewhere in the mid-18s for the segment.

That’s down probably 50 basis points from what I’d have said 90 days ago. And just given some of the topline pressures that we’re not expecting, we’re planning for no major recovery in the market.

So with restructuring actions and I mean quite obviously there were some one-time charges in the Q2 numbers associated with some step-up costs and so forth with the ERC and the PPC acquisitions that go away that I would expect it to be in the mid-18s as we exit the year.

Mike Halloran – Robert W. Baird

That’s very helpful. And then on the United States side, you guys talked about very strong 2Q trends, any signs of slowing anywhere? I know you guys mentioned that the muni side seemed to be picking up a little bit, early signs that it is picking up. Any other areas where you are seeing any sort of different change in the environment? Any sort of inflection point one way or another?

Andy Silvernail

Yeah. The answer to that is no, but I will say we’re -- while we’re happy with the growth that we’re seeing Mike in the U.S., I think we’re all cautious. And I think we should be cautious. We’re looking very, very closely at daily book and turn business. And what will not happen is we will not be caught with our pants down, so to speak, if we see a slowing.

So right now it’s pretty consistent. At the same time, that kind of major catalyst for growth that may come from our government kind of getting out of its own way. We don’t expect to see that. There have been some very, very recent positive signs on the housing front, which would certainly help the number of our businesses. But at the same time, we really feel like we got to control our own destiny here.

And we’ve got to work within what we think is going to be a more muted environment and make sure we can deliver very strong earnings and very strong cash flow regardless of that.

Mike Halloran – Robert W. Baird

And then last one from me. When you think about the commentary from some of your larger life sciences oriented customer base, what kind of things are they saying from an environment standpoint, from an outlook standpoint? And have they grown any more positive or any more negative in the most recent quarter here?

Andy Silvernail

As always we won’t talk about any specifics. We never do that with any specific customer. But what I would say is that what we saw in the outlook that we had 90 days ago is pretty consistent. You see bits and pieces that are getting better but also realize that you’re coming off of some weaker comps here in the back half of last year.

I really do believe that we’re going to have to get into the end of this year, first of next year with some of the -- frankly the political decisions and the political pressures specifically the fiscal cliff to get some resolution and to get comfort in larger swaths of that market.

Mike Halloran – Robert W. Baird

Good stuff. Thanks for the time guys.

Andy Silvernail

Thank you very much, Mike.

Operator

Your next question comes from the line of Allison Poliniak with Wells Fargo.

Allison Poliniak – Wells Fargo

Guys, good morning.

Andy Silvernail

Hi, Allison.

Allison Poliniak – Wells Fargo

On the FMT side, could you remind us again what percent of revenue in that segment is Europe and China focused?

Andy Silvernail

Yeah. It’s about a third for FMT and about a third across the business. It is pretty consistent plus or minus a few points, Allison.

Allison Poliniak – Wells Fargo

Okay. And then FMT, can you discuss the order of trends in the quarter? Were they pretty stable? I mean, did we notice any, I guess, big deceleration as we move through the quarter? Can you just talk about that a little bit?

Andy Silvernail

No. It was pretty -- what I will say is, it was pretty level after -- it was a few weeks into the quarter that kind of across the board we saw some of the softness. Obviously, we had our earnings release I think in the second or third week and we saw it pretty soon thereafter.

And that was pretty consistent with really Europe being the big culprit and China decelerating. And then if we look across the businesses, as we mentioned, most of the businesses are still holding up pretty well, especially with U.S. exposure. Water, globally is struggling I think more than expected. And the U.S. has a few little signs that are encouraging, although I wouldn’t blow that out of proportion.

Allison Poliniak – Wells Fargo

Okay. Great. And then just last question, your focus on the acquisition environments in really small-to-medium business. Can you take about the environment in terms of how some of these smaller medium-sized businesses become, I guess, more favorable, wanting to come to the table? Any thoughts there?

Andy Silvernail

Yeah. I really do think it’s a bifurcated market right now and we’ve seen it for quite some time. And what I mean by that is the small-to-medium size stuff that is I will call it that really fits, really closely to the existing platforms, almost tuck-in type acquisitions. Those things are more prominent I think in the marketplace generally. But also, you know, recognize that most of the stuff that we’re talking about, we have been cultivating for a very, very long time and they had to live through a couple of pretty tough cycles going back to kind of ‘07.

So that is more favorable. The larger deal size, I still think it is less favorable, basically because of pricing. And there just aren’t a lot of things out there that are kind of core to us that are big that I think are going to have any kind of a favorable pricing.

Allison Poliniak – Wells Fargo

Okay. Great. Thank you.

Andy Silvernail

You bet. Thanks Alison, take care.

Operator

So our next question comes from the line of Scott Graham with Jefferies.

Scott Graham – Jefferies

Hi. Good morning, almost afternoon, I guess.

Andy Silvernail

Hey, Scott.

Scott Graham – Jefferies

So on the cost cutting, really two questions, the first one being the cost cutting. You have heard me ask this question a couple of times now Andy with the company a little bit bigger. Are we moving into a period where it’s appropriate to look at cost cutting maybe with -- at a little higher level? Forever, it’s been 20 million to 25 million. You seem to be much more aggressive on the cost side than your predecessor. And I’m just wondering if that’s a number that we could maybe think about as a new target, maybe in the $30 million range or whatever number it is that you are thinking of, if it’s higher?

Andy Silvernail

Yeah. I think, Scott, 20 million to 25 million is a pretty good number. And the reason I say that, Scott, is that a lot of the benefits, I’ll call them the easy benefits, right. When we were a little bit smaller, we plucked a lot of that low hanging fruit so to speak. So, I think that 20 million to 25 million is still a pretty good number from that perspective.

I will say however, that overall, driving net productivity, right. And I mean productivity more than just manufacturing. So productivity throughout the entire value stream, as you look at fixed costs including SG&A, as you look at fixed costs in, kind of, non-direct labor, non-material, we can take a sharper eye to that. And that’s been a big piece of our focus here in the last year is recognizing that although we’re a very profitable company and we have great defensibility in our businesses, we need to be very tough-minded about overall execution and our ability to drive net productivity year-over-year.

Heath Mitts

Scott, this is Heath. Just to clarify, when we’ve talked about the 20 million to 25 million in the past which is a number that still resonates, that excludes a lot of the major restructuring programs that we’re talking about in conjunction with the CVI integration, in conjunction with some of the things we’re doing in the fire suppression front, in terms of collapsing a couple of facilities into one and some selective pieces otherwise.

That 20 million to 25 million really represents the sourcing savings and then what we term internally the OpEx savings side of things. So, I don’t want to -- if you added up the restructuring piece with what I would call kind of the ongoing sourcing in OpEx savings, it would be a larger number.

Scott Graham – Jefferies

Okay. The second question relates to the acquisitions that -- there was a comment, I think you made, Andy about -- your focus is on the small and mid-sized acquisitions. And then I think shortly after that you talked about how company is ready to deploy in $1 billion over the next three years. Can you kind of maybe connect those dots for me because small to midsized is not going to get us to $1 billion?

Andy Silvernail

Sure. That’s a fair statement. I think the first thing, Scott, is that statement was directed at -- we are going to be balanced in our overall capital deployment. Right? We’re going to deploy capital to drive total shareholder return. Acquisitions are clearly the first thing that comes into that strategy and are going to be very important. I think you are right, we are not going to deploy $1 billion in $20 million acquisition, that’s absolutely not going to happen. But as you think about what I consider small to midsize, I am calling $20 million to $100 million, maybe $125 million plus or minus, that’s what I would include in that basket.

And so, I think what’s very important here is that we have a great balance sheet. We have plenty of available capital. We have terrific cash flow. We are -- the platform strategy and organization that we put in place, allows us to do more acquisitions with less risk, because we’re able to be balanced across the platform. You saw that with the ERC going into scientific fluidics and then Matcon going into Material Process Technology.

So I do think we increase our overall financial capacity. We increase our organizational capacity. And we’re going to deploy capital to drive overall shareholder returns.

Scott Graham – Jefferies

Okay. Thanks that’s all I had.

Andy Silvernail

Thanks Scott.

Operator

Your next question comes from the line of Charlie Brady with BMO Capital Markets.

Charlie Brady – BMO Capital Markets

Hey. Good morning guys.

Andy Silvernail

Hi, Charlie.

Charlie Brady – BMO Capital Markets

Just on the commentary about the water market, water -- wastewater market. I guess, my perception had been from you guys that international had actually being doing particularly out of the U.K. being doing a lot better than North America. It seems like that’s obviously slipped right now.

But I guess, what’s -- can you give a little more granularity on really where you are seeing or what gives you optimism that the U.S. market is actually doing a little bit better than maybe you thought it was three, six month ago?

Andy Silvernail

A couple of things, the coat activity has picked up meaningfully. I was actually just doing operating reviews last week with a number of our water businesses around the country and we’re seeing the coat activity improve. I am not going to say that the order activity is substantially improving, but with the coat activity is improving.

And if you look at our water service business ADS, a couple of interesting trends there. Number one, that the coat activity has meaningfully improved. Their order book has gotten better, especially when you’re looking at things with long-term point of view.

Meaning, what you are seeing happening as you are seeing what was historically capital projects turning into operating expenses, which means that I think what we’re seeing here is municipality still don’t have the big money to go out and raise a lot of cash through muni bonds, but at the same time they have to implement some of the structural changes to their systems. And so they are re-diverting some cash from capital to operating. So they get those things done.

So we’re seeing that a meaningful change in the timeframe of some of these projects. But some of the coats that are coming through and some of the dollars that are being quoted are -- they are definitely different than we saw three, six, nine months ago.

So, but I’m being very cautious. I -- we’ve said this before and I will say it again. This is driven by tax receipts. And so there are some pieces of news that we’re seeing about improvements around housing front which really drives the tax received at the community level. But let’s just say I’m cautiously optimistic. I don’t want to get too far upfront on this.

Charlie Brady – BMO Capital Markets

Okay. Thanks. And just on the European market, particularly with Germany which is your largest, I guess…

Andy Silvernail

Yeah.

Charlie Brady – BMO Capital Markets

….International market there a lot of that gets re-exported out of Germany. Can you just speak to kind of that market specifically? Has Germany -- is Germany kind of still holding up because historically, its kind of holding up may be a little bit better than rest of Europe, but is that still the case or is that kind of turn down relative to what was 90 days ago?

Andy Silvernail

So, just to put in perspective Europe as a total, so how we’re ringing the cash registered in Europe is to about 26% of our overall business. A lot of that ends up in non-European markets. So, it’s not all directly in Europe. About 10 points is Germany with the same characteristics that I just mentioned, probably more so from an export basis.

I was over in Europe just a month or so ago for the [ACME] show, which kind of -- is our biggest show on the FMT side and actually HST to some degree also in Europe. And you continue to see real dichotomy, right. The folks who are European, excuse me, the folks who are German and so predominately in German are exporting outside of Continental Europe are still pretty happy and the folks who are anything but that are struggling. And that’s the way characterize it. That being said, Germany is slower than we saw in the first quarter and we expect that to be the case as we look forward.

Charlie Brady – BMO Capital Markets

Okay. Thank you.

Andy Silvernail

You bet Charley. Take care.

Operator

Your next question comes from the line of Mike Wherley with Janney Capital Markets.

Mike Wherley – Janney Capital Markets

Good morning, guys.

Andy Silvernail

Hey, Mike.

Mike Wherley – Janney Capital Markets

I was just wondering on the chemical business, I want to dig in a little bit to that strength that you’re seeing. Is there any of that from increasing investment do you think, because of the price of natural gas is where it is or is it all just other benefits?

Andy Silvernail

Not yet, Mike. We’ve gotten that question a lot. The infrastructure spending around the price of natural gas and I think the major U.S. infrastructure build out and then eventually I think the global build out. Because remember, what’s been found in the U.S. from a shale perspective, there are equal or much larger repositories other places of the world.

So the phenomenon that we have started to see in the U.S. is going to scale very aggressively internationally around that. So that being said, the infrastructure will build out around that, its very, very long cycle. It takes a long time. It’s very political. You’ve seen just with the Keystone pipeline and that’s a lay up and it taking I don’t know how many years. So we haven’t seen that yet, Mike. But we expect to see that over time.

Mike Wherley – Janney Capital Markets

So, where is the real strength coming from mechanical side of it right now?

Andy Silvernail

The U.S. piece has stayed strong. Although, China is weaker. The rest of the emerging markets is very, very good. The Middle East is very good. So that’s where we are kind of seeing it. So the weakness in Western Europe and the slowdown in China, the rest of the world is pretty solid.

Mike Wherley – Janney Capital Markets

Okay. And then I was wondering on the CVI, is it possible to give us a pro forma sales decline that the company had in the quarter?

Andy Silvernail

We don’t actually break out that level of detail…

Mike Wherley – Janney Capital Markets

Okay.

Andy Silvernail

In there, we just -- that’s not something we’ve historically done and that said that would be a bad precedent to set. At the same time, we did see slowdown from Q1 to Q2. It wasn’t massive, but it was a slowdown. And we’re kind of expecting similar type of performance as we look at Q3 with some modest seasonal improvement as we look at Q4.

Mike Wherley – Janney Capital Markets

Okay. And then the last question I have was just on the M&A pipeline. Is it still skewed more towards HST then after these three deals this year or might there be a shift towards FMT?

Andy Silvernail

There is actually more in the FMT pipeline right now. Not meaningfully, but there is more and there is more further down that FMT pipeline right now. But over time, I’ve said this before and we will really keep position unless something strategically really changes. We like the balance. We like the balance an awful lot. And as we work the pipeline and cultivate it, we’re going to try to keep the balance.

Mike Wherley – Janney Capital Markets

Okay. Thanks a lot guys.

Andy Silvernail

Thanks, Mike.

Operator

Your next question comes from the line of Jim Giannakouros with Oppenheimer.

Jim Giannakouros – Oppenheimer

Good morning, guys.

Andy Silvernail

Hey, Jim.

Jim Giannakouros – Oppenheimer

Tacking onto that last question, as far as your acquisition pipeline, is there geographic concentration worth noting?

Andy Silvernail

Not really. I would say if there’s anything to really note is just kind of frankly funny to see the private equity stuff that is coming out really aggressively, at least, in the last couple of months, which you always got to be a little bit cautious about that. Things with more European content, I think some people try to rush out the door, those things don’t happen short cycles.

So we’re seeing -- we’re still seeing some pretty good overall balance. Obviously, anything with a lot of European content we’re looking at really critically, right just because what is going on in the world right now.

At the same time, I think it’s important to say, Jim, that if you went back and you looked at ‘07, ‘08, ‘09, there are number of European properties, they got transacted on very attractive properties, that some people shied away from, and right now have turned into huge winners. So, we got to be critical about it, but at the same time, we shouldn’t walk away just because something has European content.

Jim Giannakouros – Oppenheimer

Got it. And are you seeing material cost benefiting your gross margins? How should we be thinking about gross margin trend in the second half? Is that a point of support to your EPS expectations for the year?

Andy Silvernail

Minimally. Heath.

Heath Mitts

It’s a little bit of help where we have the surcharges that are index based. But you got to remember right, those good calculated periodically, generally, quarterly or so. And they have to roll through inventory in terms of before you see in the P&L.

So, I think to the extent the trend continues. We’ll see more meaningful in terms of our EPS and so forth in 2013 than we probably see in the back half of the year. But it’s certainly trending in our favor, which we like. But I wouldn’t want to call it out as a major tailwind.

Jim Giannakouros – Oppenheimer

Got it. And just to go back to HST margins down 470 bps. Can you get a little more granular as far as breaking down the moving parts there? How much was attributable to the CVI amortization or incremental cost relative to ERC and Precision Photonics mix issues. And I guess the partially offsetting benefits from the belt-tightening…

Andy Silvernail

I am going to hold, Jim, I’m going to hold to -- obviously, we have the data but just as a precedent. I’m going to hold to what we put into the earnings release, which is if you exclude the impact of margins operating -- I’m sorry, if you exclude the impact of acquisitions, the operating margins would have been up about 40 basis points versus down 470.

I would tell you that the lion share of that is the optics piece of things, the CVI piece. And within that obviously, a chunk of that is driven by intangible amortization within that piece. But then you also have some step-up costs and other things related to ERC that were included in there. So, these are normal course of business, we didn’t adjust for the numbers in that so.

Jim Giannakouros – Oppenheimer

Okay. Thanks. And last question, the organic sales growth in FSD, 15%. Can you -- I guess, get a little granular there as to how much was driven by the dispensing order and how much by shrink in rescue tools or other measurable drivers there?

Andy Silvernail

I would say, obviously, dispensing had a piece of it, because it was coming off of a difficult comp period from the prior year. Rescue tools also performed well. But even within that fire suppression, the fire piece was mid-single digit growth and Band-It did well. So it wasn’t all one piece of it.

Heath Mitts

And the teams across that segment, they delivered organic growth, organic order improvement and expansion of margins at every single business, right. They mix those that was off of a little bit but the team there, we’re very, very proud of the work that they’ve done. They took a lot of tough medicine last year. If you recall back this time last year, we were talking about some of that medicine and it’s paid off.

Jim Giannakouros – Oppenheimer

Got it. Thank you.

Operator

Your next question comes from the line of Nathan Jones with Stifel Nicolaus.

Nathan Jones – Stifel Nicolaus

Good morning again, guys. Just following on to Mike’s question on the CVI, it sounded to me like you said CVI was down in the second quarter but should be flat in the third quarter and up in the fourth quarter. With the other businesses still doing better than CVI, is it fair to assume that you are looking for sequential revenue growth in HST from 2Q to 3Q and then again in 4Q?

Heath Mitts

Well, I think, Andy’s, comments were related to sequential not so much year-over-year.

Andy Silvernail

Right. Right.

Nathan Jones – Stifel Nicolaus

I am looking at sequential. I am looking at sequential. So, going from 170.6, 3Q should be higher than that and 4Q should be higher than 3Q.

Heath Mitts

Yeah.

Andy Silvernail

Go ahead.

Heath Mitts

No. I am sorry. It’s essentially kind of flat Q2, 3Q. There is -- you’ve got a couple of pieces there right, got the CVI piece which is kind of plus or minus 2Q, 3Q and then some balance across the overall business in terms of mix and seasonality. So -- but generally, you are looking at essentially flat revenue Q2, 3Q.

Nathan Jones – Stifel Nicolaus

Okay. I don’t know whether you’re going to want to answer this. But I’m just trying to kind of think about the impact on margins from step up charges related to acquisitions. Is it impossible to quantify that, that goes away in 3Q?

Heath Mitts

Within the segments about $1 million.

Nathan Jones – Stifel Nicolaus

Okay.

Heath Mitts

I mean, there are always moving parts.

Andy Silvernail

But you’ve also got Matcon coming in.

Heath Mitts

And you got Matcon coming in. They will have a little bit of step-up related to Matcon in the third quarter. And we had some inventory charges in the segment in the quarter as well. So there are always moving parts in any given quarter. But there is enough that we have some confidence in our improving margin condition there regardless of any topline support.

Nathan Jones – Stifel Nicolaus

Okay. That’s helpful. Thanks. And thanks very much.

Andy Silvernail

Thank you.

Operator

Your next question comes from the line of Walt Liptak with Barrington Research.

Andy Silvernail

Hey, Walt.

Walt Liptak – Barrington Research

Hi, thanks. Good morning, guys. I wanted to ask about the organic growth assumption and better than the guidance, especially for the FMT business. You have 3% organic growth in the quarter. What are you looking for in the second half?

Andy Silvernail

I think the second half it looks a lot like the second quarter for that segment.

Walt Liptak – Barrington Research

Okay. And what about Europe? I don’t know. I got on the call late. Could you break out what organic was like in Europe?

Heath Mitts

No. What we said was that U.S. piece grew very nicely and the international piece was much slower. It was not negative growth international but it was much, much slower.

Andy Silvernail

And Europe on the tail end of that.

Walt Liptak – Barrington Research

Okay.

Andy Silvernail

And that’s more a companywide comment, Walt, but that would apply for FMT specifically as well.

Walt Liptak – Barrington Research

Okay. And in the second half, what are you thinking about for Europe, specifically FMT?

Andy Silvernail

Well, very similar. We’re not expecting any recovery out of Europe in our guidance.

Walt Liptak – Barrington Research

Okay. Is it -- okay I’ll leave it at that? And let me take a chance and ask this one. Recently done number of acquisitions that get rolled into HST division, I understand that the mix is in the pipeline is shifting a little bit. But how would you characterize, I guess, the timing of the deals and I guess your appetite for more of these Health & Science acquisitions, given the way the organic revenue growth has been trending?

Andy Silvernail

Yeah. I think you’ve got to, kind of, split that in that as you look at optics in Photonics. We’re not going to put more work on that team until we’re comfortable that we’re where we want to be on CVI. And so from that perspective, we have throttled that back and will throttle that back. The only way we would do want is if something that is very strategically important to us. We’re there and we would probably set that to the side for a short period of time.

On the other side of it, Walt, as you look at the pipeline, there is a good pipeline within the other parts of the platform. If I look at ceiling, as I look at Material Process Technology and to some degree scientific fluidics, that I think are attractive and we will continue to work. And I don’t think we should shy away from those.

Walt Liptak – Barrington Research

Okay. And the organic growth? I think you referred to a comment saying that government spending needs to come back or you were referring to something. I wanted to get a…

Andy Silvernail

Yeah.

Walt Liptak – Barrington Research

… better -- more clarity on what you think needs to happen for the organic growth to turn a little bit more positive?

Andy Silvernail

Well, if we really had a slower organic growth environment here now for about a year. When I look at very specifically, the analytical instruments in the life science market, that is not the case as you look at about 50% of the rest of that portfolio. That still has very good growth potential.

And frankly, when you think of this from a strategic perspective, those markets -- we believe very strongly, those markets are going to outperform global GDP. And so, while we may not buying -- may not making acquisitions because it is going to have 10% organic growth next year, we certainly will continue to do acquisitions in HST because we believe the segment that we play in -- we believe strongly that the segments that we play in have superior growth capabilities.

Walt Liptak – Barrington Research

Okay. Great. Thanks for the clarity.

Andy Silvernail

Thanks Walt.

Operator

(Operator Instructions) At this time, there are no further questions.

Andy Silvernail

All right. Well, thank you all very much for joining us today. We appreciate the interest that you have in the business, the ongoing interest you have in the business. We fully understand the challenges that are in the marketplace today. At the same time, we have got a set of very, very strong businesses that are executing and have the ability to drive very consistent high performance.

And we’re very focused on execution. So we’re going to work with the realities of the environment in front of us. And our job is to really drive superior returns. So again, thank you for your time and we appreciate it and we’ll talk to you guys very soon. Take care.

Operator

This concludes today’s conference call. You may now disconnect.

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